Medco Health Solutions, Inc. Q2 2008 Earnings Call Transcript

Jul.24.08 | About: Medco Health (MHS)

Medco Health Solutions, Inc. (NYSE:MHS)

Q2 2008 Earnings Call

July 24, 2008 8:30 am ET

Executives

Valerie Haertel – Vice President of Investor Relations

David B. Snow Jr. - Chairman of the Board, Chief Executive Officer

Richard J. Rubino - Chief Financial Officer, Senior Vice President – Finance

Kenneth O. Klepper - President, Chief Operating Officer

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

Tom Moriarty - General Counsel, Secretary and Senior Vice President Pharmaceutical Contracting

Analysts

Larry Marsh – Lehman Brothers

Charles Boorady - Citigroup

Ross Muken – Georgia Bank

Charles Rhyee - of Oppenheimer & Co

Lisa Gill - J.P. Morgan

Glen Santangelo - Credit Suisse

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

Brandon Henry – UBS

Aaron Gordon - Banc of America Securities

Operator

Welcome to the Medco Health Solutions second quarter 2008 earnings conference call. (Operator Instructions) I would now like to turn the call over to Valerie Haertel, Vice President of Investor Relations.

Valerie Haertel

In addition to the more detailed tables we added to our earnings release starting last quarter, we have now introduced a slide presentation on our web site that you can use to follow along with the commentary. It is intended to ensure this forum is as efficient and helpful as possible.

With me today are Chairman and Chief Executive Officer Dave Snow and Chief Financial Officer Rich Rubino, also joining us for our question and answer session are President and Chief Operating Officer Kenny Klepper, President and Chief Executive Officer of Accredo Health Group, Tim Wentworth and our General Council, Secretary and Senior Vice President Pharmaceutical Contracting Tom Moriarty.

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

Forward-looking statements made on this call should be evaluated together with the risks and uncertainties that affect our business, particularly those disclosed in our SEC filings. Copies of Medco’s filings are available from the SEC, the Medco website or from the Medco Investor Relations department. The copyrights for the contents of this discussion and the written materials used on this earnings call are owned by Medco Health Solutions Inc. 2008.

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

David Snow

The strong second quarter earnings we announced today further demonstrate the power of our business model and Medco’s ability to implement and execute. I thank all Medco employees for their unyielding dedication to our clients and their commitment to make Medco a world-class organization.

Today I will briefly review our quarterly results, our 2009 sales performance, and our progress on key strategic initiatives. I will then ask Rich to elaborate on our financials for both the quarter and full year. He will review, in detail, our guidance for 2008 which we have raised and narrowed. Finally we will open the call for your questions. You will notice that we have streamlined our remarks to allow more time for your questions. Your feedback in this regard is always appreciated.

In many respects, the second quarter numbers speak for themselves. We experienced strong growth from the top line to the bottom line across the business and our fundamentals remain very strong. Net revenues for the quarter rose to nearly $12.8 billion, an increase of 15.6%. Net income increased over 22% to $262.7 million.

GAAP diluted earnings per share increased 30.2% to a record $0.51 per share compared to $0.38 in the second quarter of 2007. Excluding the amortization of intangible assets from the 2003 spin off, second quarter 2008 diluted earnings per share increased 30.2% to $0.56 per share from $0.43 per share in the second quarter of 2007.

EBITDA per adjusted script reached a record $3.05 up 19.6% from $2.55 in the second quarter of 2007 and up 3% sequentially from the first quarter of 2008.

Turning to our strategic growth drivers, I will begin a discussion of generics. This quarter we achieved a record high overall generic dispensing rate of 63.7% up 4.8 percentage points from second quarter 2007, delivering $710 million in incremental generic savings to our clients and members. While generics and mail are certainly a meaningful component of our profitability and a new generic pipeline through 2015 will continue to be a strong contributor to our growth, I am particularly pleased with the significant contributions other key drivers in our business are making to our bottom line.

Specifically, turning to mail order, our volume of 26.3 million prescriptions increased 11.9% from second quarter 2007. This reflects solid mail performance, especially when factoring in the previously announced loss of certain Ohio retirement system accounts effective April 1 of this year. Interestingly, in addition to cost, convenience, and clinical superiority, a relatively new drive to the mail channel is the high price of gas. We suspect that this new driver to the mail channel will continue for quite some time.

Our mail order penetration rate on an adjusted prescription basis reached 39.7%, a two percentage point increase over second quarter 2007 as we continue to measurably benefit from our very successful 2008 sales year.

Specialty pharmacy delivered records yet again, largely resulting from new business growth and a favorable product mix. For the second quarter Accredo Health Groups net revenues increased 32.6% to nearly $2 billion. Accredo also generated an 8% gross margin and delivered operating income growth of 24.6% to a record $67.8 million, which translates to $0.08 in earnings per share this quarter or over 15% of our total earnings per share.

Our Accredo acquisition in 2005 was an excellent strategic decision providing an essential part of the continuum of therapy that is so critical to serving patients with complex diseases. Medco’s book of business continues to fuel Accredo’s growth both from new Medco wins and from existing Medco clients preferring Accredo exclusively. An increasing number of clients are also adding medical carve out programs for specialty drugs driving their savings and our growth while improving patient care.

Accredo’s unique care model, which now includes the infusion capabilities from our recent CCF acquisition, delivers a meaningful value proposition to our clients driving this very strong volume growth. Additionally our oncology franchise is showing strong growth in both the oral and self-injectable therapies and represents an area of growing opportunity for us with its strong pipeline of biologics combined with a high degree of client interest and savings.

Turning to new business, our annualized 2008 new name sales to date grew to $6.5 billion, a substantial increase over the $5.1 billion we reported previously, reflecting even further success in our 2008 sales year, with a significant mid-year 2008 win. To date net new sales for 2008 grew to $5.2 billion from the $4.6 billion previously reported. This includes the portion of new name sales recognition in fiscal 2008, organic growth, and erosion from existing accounts, including the effects of employer lay-offs, and finally client losses.

We have completed over 97% of our 2008 scheduled renewals. Our 2008 client retention rate remains at a strong 98% and continues to represent the highest retention rate reported in the industry.

Turning to the 2009 selling season, we are very pleased to report a significant number of new named wins totaling $4.6 billion in annualized 2009 sales to date, including the recently announced win of Coventry Health Cares Medicare business.

All of our sales wins continue to be priced within the fundamental pricing guidelines we have always used. The Coventry win represents about $2 billion in annual net drug spend and 1 million members and includes mail, retail, and specialty pharmacy services. On a net new sales basis we currently stand at $2.9 billion for 2009. This includes all known 2009 client losses including GE and Bell South, calendarization growth and erosion. We are obviously delighted with our sales performance so early in the 2009 selling season. These 2009 new named and net new numbers do not reflect the value of additional claims processing business we have won for which we do not recognize drug spend revenue, but non the less translates to bottom line momentum. Our 2009 renewals to date exceed $11 billion and our scheduled renewals are already over 70% complete. Our 2009 retention rate currently stands at over 97%.

We are pleased to report that we are finalizing a renewal with Blue Cross Blue Shield of Michigan and a new five-year agreement which will significantly expand our relationship to include other segments of their business. This is important to know in light of General Motors recent announcement to discontinue traditional non-union salaried retiree health benefits effective January 1, 2009. Blue Cross Blue Shield of Michigan has the premier health care brand in the state and with the autos. We fully expect the majority of GM’s in state retirees will migrate to Blue Cross Blue Shield of Michigan’s Medicare Advantage and Medicare Supplemental programs for which Medco manages key components of the pharmacy benefit including managing the mail service program. Last year Ford implemented a similar policy for their non-union retirees and a Medco Blue Cross Blue Shield of Michigan partnership retained more than 80% of their in state retirees.

With continued strength in net new business wins and renewals, we have clearly demonstrated the compelling value proposition created by uniting our superior service model with our advanced clinical platform. Our clinical focus on the %0% of members with chronic and complex disease who account for 96% of all pharmacy spending makes sense. The benefits from this comprehensive approach to advance pharmacy are intuitive to our clients and to prospects as evidenced by our wins and retention. It is becoming increasingly clear that beyond managing the costs of drug therapy, our advanced clinical model will help reduce total health care costs associated with chronic and complex disease.

The early results from our therapeutic resource center strategy are very promising. We have recently hired a leading number of clinical authorities at the chronic disease level to drive clear and measurable results in each disease oriented therapeutic resource center.

o lead the clinical development of our TRCs we have hired Peter Juhn MD, MPH as the president of our therapeutic resource centers. Peter joined Medco in April bringing a wealth of clinical expertise, business experience, and professional vision to deliver on the potential of our specialized pharmacy model. Peter most recently served as Vice President for Evidence and Regulatory Policy at Johnson and Johnson. Prior to that role Peter directed the disease management programs for both WellPoint and Kaiser Permanente.

Our efforts in the field of personalized medicine, our pharmacogenomics, are progressing at an acclerated pace. We recently added a seasoned executive from the FDA Felix Freuh to direct our personalized medicine research and development. Felix was a principle in the FDA’s office of clinical pharmacology as their associate director of genomics. In his role he was responsible for the review of genetic and genomic data submitted to the center of drug evaluation and research and initiated and managed new policy developments in the area of pharmacogenomics for the FDA.

Along with our chief medical officer Dr. Robert Epstein, Felix has initiated two dozen new studies extending beyond Medco’s current pilots focused on Coumadin and tamoxifen. You will learn more about these initiatives at our November analyst day. We expect to begin publishing our pharmacogenomics findings in peer reviewed medical journals later this year with the pace accelerating in 2009 and beyond. Our studies are selectively concentrated on the area’s of opportunity that drive the largest positive clinical and financial outcomes for the customers we serve Client interest in our pilot pharmacogenomics programs continues to be strong and in fact over subscribe.

On the political just last week legislation was enacted by congress that addressed two important issues related to Medco. First was a decision regarding the pilot competitive bidding program in 10 metropolitan service areas for the Medicare Part B durable medical equipment diabetes supply program; the second related to e-prescribing. Both of these represent positive developments for Medco.

With respect to diabetic supplies we are encouraged that congress has clearly recognized the flaws in the competitive bidding procurement process, not only with diabetes supplies but in other supply categories. Rather than a 43% reimbursement cut in the ten pilot areas congress instituted a 9.5% cut nationwide effective January 1, 2009. Medco will be reimbursed at the current full fee schedule rate through December 1, 2008 and we expect to mitigate any financial impact from the initial cuts effective in January 2009 through the combined scale of the PolyMedica and Medco assets.

The 9.5% national reduction in reimbursements for 2009 is intended to offset the savings the government had expected from the now suspended Phase I competitive bidding program.

The suspension, for a period lasting 18 to 24 months, will provide Medco ample time to work with CMS and the federal government to improve the diabetes supply procurement process so that it can be enhanced and possibly re-bid.

Medco was built on a platform that thrives in the competitive bidding environment: all of our wins each year and our strong retention rates are achieved in a competitive bidding environment. As long as the bid process is structured in a straightforward manner and conducted on a level playing field we are confident in a positive outcome for Medco, the federal government and very importantly diabetes patients.

We continue to be very pleased with our PolyMedica asset which is performing in line with our expectations and is being fully integrated into our diabetes resource center as part of our comprehensive therapeutic resource center service platform.

The second important component of the legislation relates to e-prescribing. For the first time the largest barrier to physician adoption has been removed. We believe that the incentives and mandates promulgated by congress will encourage physicians to adopt e-prescribing across the entire patient population. History has shown that once adoption takes place from Medicare for reasons of efficiency the medical community quickly changes practice universally for all payer types. For example back in the 1970s when hospitals were instructed by Medicare to build the government electronically the hospital industries complete transition from a paper billing process to an electronic process occurred almost immediately.

The e-prescribing benefits to Medco include real time therapy management, improved generic utilization, optimized channel selection and formulary compliance. Additionally we achieved significant administrative cost savings. E-prescribing will reduce the need for follow up calls to doctors to clarify prescription orders, provide real time alerts for drug–to-drug interactions and help ensure the most cost effective therapy is being dispensed and delivery method is considered in accordance with our clients and members plan design and desires.

We estimate that for every new script received Medco’s cost savings will be nearly $2.00 per new prescription in administrative costs alone. Note that this metric is just for new scripts, which accounts for well over a third of our mail volume and does not include renewals or resales. We will provide additional insight into the benefits of e-prescribing and the expected speed of adoption at our November analyst day.

Today we have delivered another strong quarter in what we are confident will be another strong year. Additionally we reported tremendous success thus far in the 2009 selling season. We are continuing to enhance our core capabilities by expanding our pharmacy services to include the new science of pharmacogenomics as part of our broader specialized practice delivered through Medco therapeutic resource centers. Additionally, as we announced last quarter, our capabilities have expanded beyond the boarders of the United States. We are extending our expertise over seas to deliver a value that is optimized for European market needs similar to the proven value we provide domestically. This expansion provides Medco with a larger footprint for successful long-term growth.

This quarter raised the level and narrowed the range of our full year 2008 guidance as a result of our strong second quarter performance and confidence in the remainder of the year. We are projecting growth in the range of 29% to 31% in GAAP diluted earnings per share with guidance at $2.10 to $2.13 up from the previous range of $2.07 to $2.11.

Excluding the amortization of intangibles from the spin off diluted earnings per share is expected in the range of $2.30 to $2.33 up from the previous range of $2.27 to $2.31 representing a growth rate of 26% to 28% over 2007.

Now I’ll turn the call over to our CFO Rich Rubino, who will review in detail our second quarter 2008 financial performance and our full year 2008 guidance.

Richard Rubino

Medco reported net revenues of nearly $12.8 billion a 15.6% increase. The product net revenues of the total was $12.6 billion representing 15.5 % growth attributable to new business volumes and inflation on brand name drugs. The mail component of the product net revenues totaled over $5.4 billion a 26.5% increase. The retail component of product net revenues was $7.2 billion, an 8.4% increase.

Our mail order prescription volume for the quarter reached 26.3 million, up 2.8 million or 11.9%. As we expected the 26.3 million prescriptions reflects a slight decline sequentially from the 26.6 million in the first quarter of 2008 due to the termination of certain Ohio accounts at the end of the first quarter.

The second quarter 2008 mail order prescription volumes did not include diabetic supplies, primarily filled through PolyMedica, nor do they include volume for over the counter products dispensed in our mail order facilities. Combined volumes for these items totaled approximately 1.5 million units in second quarter 2008 up from the 1.2 million we reported for the first quarter of 2008 with a sequential growth reflecting additional OTC volume from Europa Apotheek Venlo. Retail volume of 119.6 million prescriptions increased 3.2% reflecting new client wins. Total prescriptions adjusted for the difference in days supply between retail and mail was 198.1 million. Our adjusted mail order penetration rate reached 39.7%, up two full percentage points.

Our generic dispensing rates of retail and mail continue to accelerate. Our overall generic dispensing rate increased 4.8 percentage points to a record 63.7%; our retail generic dispensing rate also increased by 4.8 percentage points to 65.6%. Generic dispensing rates at mail, which have a significant impact on our overall profitability, rose 5 percentage points to 54.9%.

Last quarter we mentioned that we had a short-term supply of generic Protonix that was dispensed during the last two months of the first quarter. We had a full supply for the second quarter and expect to have a continued supply of generic supply of Protonix for the remainder of 2008.

Our gross rebates earned in second quarter 2008 reached a record $1 billion, 62 million, an increase of 15.7%. This growth reflects new business wins and increased levels of formulary compliance bolstered by our higher mail penetration and the success of our clinical programs.

Our rebate retention rate was 18.7% second quarter 2008, up 3.1 percentage points from the 15.6% in second quarter 2007. Retention for this quarter is down slightly from the 20% in the first quarter and we expect retention rates for the full year to be fairly consistent with the second quarter.

Moving onto the service category, service revenues of $167.5 million for the quarter grew 22%. Service revenues include client and other service revenues of $118.4 million and manufacturer’s service revenues of $49.1 million. This growth was driven by higher revenues from our clinical programs and nurse services, increased revenues from our clients who use our Medicare Part D offerings and increased administrative fees from higher prescription volume.

Our product margin increased 90 basis points to 6.4% for second quarter 2008 reflecting higher mail volumes and penetration and higher generic dispensing rates. Our overall service margin for second quarter 2008 of 71.9% was slightly ahead of the first quarter 2008 service margin of 70.6%.

Summarizing total gross margin, our overall gross margin for second quarter 2008 increased 90 basis points to 7.3%.

Turning to the specialty pharmacy segment, Accredo Health Group net revenues increased 32.6% to a record of nearly $2 billion and operating income increased 24.6% to a record $67.8 million reflecting strong new business volume

After absorbing new business start-up costs in the last two quarters Accredo Health Groups gross margin increased to 8% from 7.7% in the first quarter and remained consistent with the second quarter of 2007.

Company wide SG&A expenses for the second quarter of 2008 increased 34.5% or $94.4 million to $368.4 million. Over $61 million of the $94.4 million in growth is attributable to the acquisitions of PolyMedica and critical care systems in the fourth quarter of 2007 and majority owned Europa Apotheek Venlo in the first quarter of 2008 with the remainder reflecting employee related expenses from new client wins, execution of our clinical strategies and litigation reserves as part of the normal course of business.

Our second quarter EBITDA increased 27.3% to $604.1 million. We achieved a record EBITDA for adjusted prescription of $3.05 for the quarter, compared to $2.55 in the second quarter of 2007 and $2.96 for the first quarter of 2008, substantially reflecting the improvements in gross margin dynamics previously addressed.

Our intangible amortization expense for second quarter 2008 was $70.6 million compared to $54.6 million for second quarter 2007. The growth of $16 million results from the additions of PolyMedica at $13.6 million, CCS at $1.6 million and Europa Apotheek Venlo at $800,000.00.

Net interest and other expense of $57.5 million increased substantially from $21.9 million in second quarter 2007 and rose 5.9% from the $54.3 million we reported for the first quarter of 2008. This quarter reflects the first full quarter of interest expense from our March bond issuance to fund our recent acquisitions.

The effective tax rate for the second quarter 2008 was 39.9% compared to 39.3% in second quarter 2007.

Net income for second quarter 2008 of $262.7 million was up 22.2% from second quarter 2007.

Moving on to share repurchases, Medco repurchased $12.4 million shares during the second quarter of 2008 at a cost of $562.4 million representing an average share price of $45.22. Year-to-date through the end of the second quarter our share repurchases totaled 33.5 million shares at a cost of approximately $1.6 billion. As of yesterday, July 23, our year-to-date share repurchases totaled 34.9 million shares at an average share price of $46.64, leaving approximately $350 million under the current $5.5 billion authorization.

Our weighted average fully diluted share count for second quarter 2008 of 517.6 million shares reflects a decrease of 46.6 million shares compared to a split adjusted 564.2 million for second quarter 2007. This reflects share repurchases made throughout the period, partially offset by employee stock options.

We ended the second quarter of 2008 with 505.7 million basic shares outstanding, plus a diluted equivalent of approximately 10 million additional shares, bringing the total fully diluted share count to approximately 515.7 million on June 28, 2008. This fully diluted share count is the second quarter ending point and therefore becomes the entry point for the third quarter of 2008.

Turning to the balance sheet, we closed this quarter with $372 million of cash on our balance sheet, compared to $984 million at the end of the second quarter of 2007. Correspondingly, our cash flow from operations for year-to-date 2008 was $200 million, compared to $677 million for year-to-date 2007. The cash flow decreases reflect higher receivables and inventory driven by overall business growth and timing.

Our capital expenditures for June 2008 year-to-date increased $28 million over June 2007 year-do-date to $88 million. The increase reflects investments in our new automated pharmacy in Indiana and included capital associated with PolyMedica, CCS, and Europa Apotheek Venlo.

Our debt of $4.7 billion at the end of the second quarter compares to $2.1 billion at the end of second quarter 2007 reflecting a March 2008 bond offering and additional debt we incurred in the second half of 2007.

Turning to guidance, you will recall that we raised our 2008 guidance on our year end call by 5% and I am very pleased to report that we are further raising our guidance and narrowing the range for 2008 GAAP dilute EPS to $2.10 to $2.13 from the range of $2.07 to $2.11 provided on the year end call representing growth of 29% to 31% over 2007. Excluding the amortization of intangibles in the 2003 spin off, we are raising and narrowing our EPS guidance to $2.30 to $2.33 from $2.27 to $2.31 representing growth of 26% to 28% over 2007.

We continue to expect mail order prescription volumes of 105 million prescriptions.

Regarding our 2008 renew renewals. We realized 70% of the new pricing in the first quarter and 10% in the second quarter. Looking ahead, 15% is expected in the third quarter and the remaining 5% in the fourth quarter. While we did see better than expected efficiencies in our operating groups in the second quarter of 2008, we will incur start-up costs and expenses in the fourth quarter of 2008 as we prepare for the very significant level of 2009 wins that Dave already mentioned.

We are narrowing the range of the Accredo incremental contribution to our earnings $0.04 to $0.05 from the previous range of $0.03 to $0.05. Accredo revenues are now expected to exceed $7.5 billion.

SG&A expenses are now projected at $1 billion, $319 million for the full year, an increase over the high end of our previous range of $1billion $370. This increase primarily reflects expenses associated with our significant new business wins, including bonus wins from our overall strong company performance.

Our net interest expense is now expected to be at the high end of the range we previously provided of $220 to $230 million. Our debt balance at the end of the second quarter is $4.7 billion and we expect to deleverage by the end of the year to levels closer to our balance at the end of the first quarter.

Our effective tax rate is currently expected to be 38.5% for the full year. On our last call we pointed to a range of 38.5% to 39.0%. The actual effective tax rate in the first half of 2008 was 39.8%. Our effective tax rate will be lower in the third quarter than we experienced in the first and second quarters and also lower than what we expect in the fourth quarter. We estimate that the third quarter effective tax rate will approximate 34% due to statute of limitations releases associated with state taxes. These scheduled releases were addressed in our year end 10-K and were included in our original guidance.

Our intangible amortization expense projection remains at $280 million. Our average share count for 2008 is now estimated at 523 million, compared to the $525 million previously provided. This assumes completion this year of the approximately $350 million remaining under our $5.5 billion share repurchase authorization.

Our capital expenditures are still projected at $285 million which includes our new automated dispensing pharmacy in Indiana. The pharmacy is still on track to be operational in mid-2009.

The components of the net increase of $0.02 per share to the high end of our guidance are as follows: an additional $0.04 per share contribution from generics reflecting an expected full year supply of generic Protonix; an additional penny per share from strong Accredo performance, with another penny per share of benefit from the lower weighted average diluted share count. These are partially offset by SG&A expenses which are expected to be $0.02 per share higher interest expense and fourth quarter start-up expenses that combined will cost an additional $0.02 per share.

There are a few points to keep in mind as you model 2008 relative to the third quarter. We expect the continuation of our strong second quarter core business performance. There are no new significant generic introductions expected that will impact our quarter-over-quarter profitability. Directionally the significantly lower third quarter tax rate is expected to result in the third quarter being the strongest EPS quarter of 2008. I would like to note that our second quarter 10-Q will be filed shortly and there will be no special or 1x financial items there in that were not disclosed on this call.

In summary, we are very pleased with our second quarter performance and are confident in our prospects for 2008 and beyond. Looking forward, we plan on providing our 2009 guidance on our third quarter call.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Larry Marsh – Lehman Brothers.

Larry Marsh – Lehman Brothers

My question is on the new names and that new business, Dave a good numbers you are presenting to us. I just wanted to confirm you have taken up the net new, I guess, up $600 million for ’08 from April and you called that a large account win. Is there one in particular we need to be aware of or is that a combination of things?

David Snow

There is more than one, but we’re not really giving you information about whom at this time.

Larry Marsh – Lehman Brothers

Okay and then along with that you’re presenting preliminary information for ’09. I sort of go back and reflect on your initial view of ’08, obviously you’ve exceeded that pretty handily. It seems like the new names is about $2.5 billion more than what you originally suggested back in July of last year. When we think about that for ’09 was there something unusual about ’08 that should keep us from thinking that you’re being again conservative for ’09? And, just remind us where all this new business is coming from.

David Snow

Really all of our business groups are doing extremely well. Our health plan group is having particular strength for the 2009 selling season. I would tell you that the success in our net new sales is always dependent on who is out to bid and the numbers that are out to bid changes in any given year. In fact, there were some people who came out to bid in 2009 that were not on our radar when we first talked about it, so we were very pleasantly surprised. I would also add that the value proposition we’re creating through the initiatives, we’ve talked about many times clinically, as well as our increasingly small service model are driving additional wins.

I think that we’re giving you our best information about 2009 and the 2009 selling season, but again, there are still other opportunities out in 2009, we’re simply telling you where we are to date. It does not mean the 2009 selling season is over.

Larry Marsh – Lehman Brothers

I am assuming Blue Cross of Michigan, I had it down as an end of ’08 renewal, so I wouldn’t assume that that would be priced anything unusual, but obviously that’s part of ’09.

The second, I guess, broad question, is around pricing on the generic book. I know that you and others are out marketing the zero co-pay as kind of an introductory opportunity. How do you think of that as a pricing strategy? Is it really just a way to combat the $4.00 generics retail or is it a completely different mind set?

David Snow

Actually, we’re not marketing a zero co-pay program, so I’m not sure where you got that one. I’m not familiar with any program that’s Medco sponsored in that regard; it might be somebody else, it’s not us.

Larry Marsh – Lehman Brothers

I would be happy to send you what I have. Then finally on the comment on the consolidation of the supplier market and in generics. How do you think of that and is that an opportunity for you over the next couple of years?

David Snow

Yes. I am going to let Tom Moriarty, who really runs that space for us, answer that question.

Tom Moriarty

Our view on the consolidation at this point is favorable to us in our view, mainly because we have a multi-pronged strategy in terms of sourcing and procurement as well as how we approach that with our clients, so we think that these trends continue to be favorable.

Operator

Your next question comes from Charles Boorady with Citigroup.

Charles Boorady - Citigroup

Could you summarize what Medco does or can do to facilitate the e-prescribing today in terms of any technologies you might offer or incentives you offer physicians and whether you plan to promote this idea in any way to physicians by say sending people into physicians offices to offer training or other ways to get the physicians to actually adopt e-prescribing.

David Snow

Yes, there are a couple of things I’d start by saying that RxHub is crucial to the e-prescribing initiative and as you know Medco along with other PBMs have invested in RxHub to be the switch that gets the e-prescriptions to the right PBM. The recent announcement of the combination of SureScripts and RxHub just furthers the legitimacy of this RxHub SureScripts combination as being the switch that drives e-prescribing. RxHub SureScripts has vendor relationships with the majority of major devices out there that provide the e-prescribing service.

Internally to Medco we actually focus on our high prescribing doctors and we have a field force that encourages e-prescribing. We’ve used that model very successfully in our pilot initiatives like the SamA [ph] initiative in Michigan where we dramatically improved e-prescribing rates, but I can tell you that with this federal government sponsorship we are going to see a significant increase in the speed of which we drive adoption of e-prescribing both because of the financial penalties and the ultimate mandates in 2011.

In health care it has always been my experience, when the federal government makes a move like the one they just made doctors, or hospitals, or providers in general, when they change the way they do business they do it for everybody simply because it’s inefficient to do it for just one payer. Medicare is such big volume in a doctor’s office that doctors will move quickly with these mandates and with it will come e-prescribing for all the private payers as well. I think that is a major catalyst.

We have not yet figured out how to estimate between now and 2011 the rate of adoption, but we’re hoping we can give you some better clarity and estimates by analyst day in November.

Charles Boorady - Citigroup

Is there any way to quantify for us what you have invested in your therapeutic resource centers, what they have returned to and how you plan to measure the financial success of that initiative going forward? Specifically, there were a couple of major wins that you had of large health plans that were seriously considering moving the PBM business in-house an stayed with you; I’m wondering how the therapeutic resource centers played into that. On the one hand are they going to embrace it, will they be a customer of the TRC as a way to manage their medical expense or do they actually view that as a strategic threat to their own internal managed care capabilities?

David Snow

There are lots of pieces to your question. I will try to answer two of them and I’ll ask Rich to answer the question on the investment piece.

Health plans are really interested in what we’re doing with TRCs and also pharmacogenomics simply because the things we do in the TRC are designed to better medical loss ratio and if you look at what’s going on in the health plan sector right now, they have issues around medical loss ratio and cutting what you pay to doctors and hospitals is pretty much a strategy that’s run its course in that world and they’re looking for a better strategy and the best strategy that you can go after right now is one that really looks at the patient end-to-end in chronic disease and make a fundamental improvement in clinical outcomes which drives financial outcomes.

Medco’s model, which is therapy management, not disease management, is perfect because drugs for chronic and complex disease are the first line of defense and because of our male model the pharmacists are in the care loop, so they’re trusted advisors and able to influence and engage members in a meaningful way to change their behavior. We’re hoping, we’re pretty confident we’re going to have some data for you in that regard at our November analyst day meeting so you will better understand the power of this model.

Health plans like this we’re getting a lot of uptake. We have built our technologies in the therapeutic resource center in a way that we can integrate with our health plan customers so that when we do therapy management and find a disease management opportunity we can seamlessly integrate the call, the data and everything else with the nurses and case managers in the health plan environment. We are doing this with Healthways and our joint venture today. That same architected technology will work for any of our health plan customers and there has been strong interest. I won’t name the health plans today that are actually using this technology, but we have some that have already adopted and we have others where we’re building it as we speak, so it’s been very positive.

One last piece of your question that I’ll answer before giving it to Rich, and that is how we measure the return. There are multiple returns here, so I’d start by saying I count the TRC and its clinical model as a major driver in our retention rate as well as our new name sales levels. I mean that’s first and foremost, because we are truly getting at the heart of a major problem for the clients we serve and this is a brandable difference that only Medco can do right now, so that’s where I start measuring it. Longer term as we show through this protocol driven, gap in care focus model that we’re building, we’re going to be able to show that the mail channel is a better clinical setting and we will see continued growth of mail scripts within our current book of customers, never mind the new customers we win. We’re seeing evidence of that today, but we’ll see more evidence of that as we roll the data out starting in 2009.

Multiple ways to pay back and the cost of operating under this new model is no different than our past model. We have made some investments in technology and training to get the TRCs up and running and Rich I don’t know if you have any numbers to speak of there.

Richard Rubino

The numbers are really not that significant to today’s point. We took our existing scale and we reconfigured it into specialized TRCs, which is why it’s such a difficult business model to replicate elsewhere in the market place. We had the pharmacist, we had the facilities, and what we’ve done is converted that into specialized pharmacists that are focuses on specific disease states. The investments, to Dave’s point, have been focused on driving technology to the desktop of the pharmacists as well as the ongoing training to ensure that our pharmacists and technicians are deeply trained in their specific areas off specialization.

David Snow

So the big danger in all of this is that we over simplify what our operations and technology teams have done to make this innovation possible, so Kenny, I’ll let you get the last word in. Is there anything else of specific note we should mention relative to that question?

Kenneth Klepper

No I guess the only thing I would add is that we really have the advantage here of building on top of prior years investments with the things that Medco had done actually so many years ago with the front end and the back end which really facilitated this without a lot of capital. It was a lot of operational work that we’ve done, but it has not been capital intensive.

Operator

Your next question comes from Ross Muken with Georgia Bank.

Ross Muken – Georgia Bank

The new business wins are pretty astounding, the numbers are, I think, over a lot of the historical levels we have seen. You have seen in the last year or so a real sort of bifurcation of some of the major business balls in the PBM space, can you make commentary on pricing which has been a concern for people and that’s been, amongst some, the belief of where these deals have been one. This is clearly not the case with EBITDA prescript being strong.

As you sort of rank the most important things to the customers that you’ve won in terms of whether it’s service, the TRCs, the PGX stuff or etc… how would you put in rank order, maybe the top three, what’s really been sort of most important to the client that’s been the big driving force behind this momentum?

David Snow

I think my answer to your question is going to be similar to previous quarters when the same question has been asked, but I’m going to answer it a little differently than I have in the past. If you look at the criteria today that prospects are using when they determine who to select as their PBM, I would say on average 50% of the waiting for the total request for proposal is price. I would say that another 20% is service innovation and the remaining 30% is brandable differences that drive additional value to the client.

When you think about what we’ve done and what we’re doing price per unit is important and that’s usually what’s contemplated in an RFP when you talk about price. But the other dimension of cost that you cannot quantify in a price proposal in an RFP is utilization. Utilization of the drug benefit and equally if not actually important is utilization of the total health care benefit and that value prop is a little more subjective today because the data isn’t there to support it from a consultants point of view when they’re scoring a bid, but I can guarantee you that data is being developed and it will become very powerful, relative to the decision making process in the future when clients are looking at how they evaluate their PBMs.

What we’re building today is the brandable difference we’ve created is people are making decisions on theory there because it’s intuitively powerful. In the not too distant future I see a time where they’re going to actually be able to score that utilization part of this equation for total health care costs which just continues to accelerate the value prop we’ve created.

I think that from a health plan perspective there is one more thing that’s been very important and that has been the strong service we’ve been able to provide our Medicare focused clients on the health plan side as well as on the employer side. We have a very good track record of compliance with the federal government with CMS; a very good track record relative to audits; a good track record relative to reporting on behalf of our clients and that good track record and Medicare specifically, which is a very complicated program, has won us a lot of new business as well. That’s a new factor this year.

Ross Muken – Georgia Bank

EBITDA per script is a metric we all look at pretty closely. You edged above $3.00 here in the quarter. Where can that metric go and what of the dynamic factor is involved there in terms of what’s going to make it be able to sustain this level or should we sort of see it come back down and then gradually re-approach $3.00 again?

Kenneth Klepper

Well for this year we expect the full year EBITDA per adjusted script to average out to higher than the number we saw of $3.05 for the second quarter, so we expect continued growth in the EBITDA per adjusted script trends. We’ll talk about 2009 in our third quarter call, but the drivers are what you would expect; the mail generics and of course the very, very strong Accredo performance that we have experienced and that we expect to continue.

Ross Muken – Georgia Bank

But is there a number that we should think of now because it used to be $3.00 that we would think of years ago as being sort of the limiting returns. Is there a new number out there, is it $4.00, $5.00, $2.50, what is sort of the gaiting point of where we should think that this could potentially get to or is that something for a later discussion?

David Snow

I don’t ever want to put a ceiling on our potential because we’re doing so many things to drive additional value that could actually influence EBITDA per script that I would never put a cap on what we can do. So the more short term granular thing to think about is the mix of business that we bring into our portfolio because as you know, day one a heavy retail account brings down EBITDA per script if it’s big enough on our base, but then obviously we are very good at moving to the mail channel once they come on board and it improves over time, so you’re going to see some up and down fluctuation tied to business mix, but it has nothing to do with capping out on potential.

Ross Muken – Georgia Bank

Any update on the international efforts that you’ve been working on? I know you’ve done some acquisitions in the German market. Any sort of additional thoughts on what we’re likely to see next there in terms of that expansion?

David Snow

No, but I’ll give you two comments. One is that Rich and I recently did a European road show and as part of that we actually spent some time with our new acquisition over in Venlo, Netherlands serving Germany. We also visited some of the retail stores they have a venture with and we left more enthusiastic about the potential in that market than we were when we first talked about it and we were pretty enthusiastic when we first talked about it.

I am very encouraged that Europe generally is at a tipping point relative to their need for managed care interventions and technology to support what they’re doing. It really does remind me of what the United States looked like 20 years ago in terms of PBM markets, so we really like the timing for our entrance into the European market.

I will also tell you that right now we are planning for our investor day in November to have Michael Kohler, the CEO of EAV to come and speak to our analysts and investors at that meeting so you can hear first hand what he sees in the European market and he deals with it every day, so stay tuned for that November meeting.

Operator

Your next question comes from Charles Rhyee with of Oppenheimer & Co.

Charles Rhyee - of Oppenheimer & Co

Rich you talked about SG&A expenses about $1.39 billion. Does that include the depreciation embedded in cost of SG&A?

Richard Rubino

Yes the SG&A as we presented it in our income statement so there is a depreciation component there.

Charles Rhyee - of Oppenheimer & Co

Okay then you talked about the third quarter EPS, given that the lower tax rate being your highest EPS quarter directionally. If we were to back out the tax portion itself, can you give us a sense on would it be sort of equivalent to where we were this current quarter or would that also be maybe a little bit down? How should we think about it x the tax part?

Richard Rubino

If you go from where we are year-to-date to where we expect to be on a full year basis, you’re going to see the fundamental core performance improving steadily, seeing the trends that you’re seeing this quarter. When you do the math on the 34% expected tax rate we expect in the third quarter, that will render the third quarter about a nickel higher, so that yields $0.05 per share just to help you with the math.

Operator

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

Lisa Gill - J.P. Morgan

David, when we think about the new relationship with Blue Cross Blue Shield, this five year relationship and we think about these GM members hopefully migrating over and you being able to still service them, can you just talk a little bit about the profitability for Medco when they’re in your own book of business as a retiree versus you serving them through a Blue Cross Blue Shield plan?

Secondly clearly your mail scripts were very strong in the quarter, coming in better than our expectations. Can you try to maybe reconcile your thoughts around what’s happening with IMS?

Then thirdly as it pertains to the scripts, what are we seeing on the retail side, did we miss something that there was a contract shift of are you seeing that people aren’t picking up their prescriptions on the retail side?

David Snow

I will answer the movement of the GM folks and then I’ll ask Rich to talk. We have done some homework on the IMS situation and I’ll ask Rich to share that with you.

Relative to GM and that movement it’s really not about whether it’s a health plan or it’s direct, the way to think about this is it’s like a renewal. It’s like when you renew a four-year contract, you’re going to reset your pricing, you’re going to reset your base; so when they move over, because it’s a brand new contract with Michigan you’re going to see the same phenomenon in pricing as you would on a client renewal and we’ve talked a lot about that in the past, so you know how it goes down in that first year to about half of what it was and then it grows from there.

Richard Rubino

The IMS data has had some issues over the last several quarters. As you may know Express Scripts data is no longer recorded to IMS. In addition we have seen that there has been inconsistent reporting as the clients have been handed off from one PBM to another. I really would recommend that you just focus on our trends and you really need to dig deeply into the IMS trends and look at other sources as well to get a true sense of what the dynamics are.

What I did in the first quarter, being badgered by the IMS questions is I looked at Medco’s mail scripts along with the mail scripts of our publicly reported competitors and you really don’t get to the trends that IMS was reporting, so I would start there.

With regard to the retail script trend, there is always seasonality of course in retail scripts. When you look at the first quarter, second quarter of 2007 our retail scripts declined about 3%. When you look at the first quarter, second quarter of 2008, we declined about 6%. When you adjust for the fact that we had a high cough and cold flu season in the first quarter of this year as well as some accounts that transitioned, such as the RS accounts, the Ohio accounts, that decline really gets down to more the 4% to 4.5% range, so looking at a 3% decline last year versus 4% to 4.5% this year, I don’t know that that is statistically important.

Lisa Gill - J.P. Morgan

So you’re not seeing any real utilization changes in your book of business today given the current economic conditions?

Kenneth Klepper

No, of course we kept our mail guidance where it was, so we remained strong.

David Snow

There are two things to think about and there are early signs of this. One is that when the consumer is squeezed in the pocket book they are more open to looking at generic alternatives to the brand name drugs because of the savings to their pocket. We are seeing some of that.

The second thing to think about and I mentioned it, and in fact Amazon just mentioned it in their call as well, that with the higher gas prices, people are recognizing that in fact they can save on gas by having things delivered to their home, so they don’t have to go out and burn gas. I don’t think that dynamic is going to change, I do think that that’s a sustainable reason for people to reconsider their shopping habits generally.

Those are both positive consequences of the recession. Of course the negative consequence is the lay offs, especially if those people remain unemployed. I think that’s bad for the US generally, to the extent it’s declines of ours and it affects us.

Lisa Gill - J.P. Morgan

Have you seen much of that at this point?

David Snow

We have seen some. If you’d just look at the numbers we gave you for ’08, you know we gave you some strong growth on the top line versus last time on the new name sales line, but then if you look at the net new line, you don’t get the full impact on net new because of erosion, where calculate in what’s going on relative to lay-offs and everyone’s widely reading about that and it does affect any of the health plans as well as PBMs when clients are turning people over to the unemployed world.

Lisa Gill - J.P. Morgan

Where is the opportunity still in specialty? What percentage of your PBM book today is using the services of Accredo and how much opportunity does there still lie, especially within the PBM books?

David Snow

Tim is here so I’ll let him answer in a granular way. Generally speaking Tim continues to pick up more of our business, but we keep adding more business. The good news is that most of our big wins now are including specialty. So now what’s going on is that we’re actually going beyond the core specialty benefit to the medical side which is a huge opportunity.

Timothy Wentworth

In terms of, I know we showed last analyst day specifically the percentage of book that was penetrated in total spend, as we saw it in gettable spend. We probably still are only at 70% of the total opportunity in the existing book; all of the new clients that come in move through the same programs that our existing clients have moved through. We have over 50 million lives now that are eligible for Accredo, that in other words were in network and increasing numbers of those where we are either preferred or exclusive and double-digit clients moving, as Dave said, onto the medical side.

So I would look at the Medco book as a good solid, 1/3 to 1.2 of my future growth, but that means we’ve got a lot of other things that are also cooking and that’s certainly how it’s played out this quarter and for the first half.

Lisa Gill - J.P. Morgan

When you think about your existing book of business on Accredo, are you seeing anybody migrate out of your book of business so that, for example, they are migrating onto a managed care platform or onto one of the other PBMs?

Timothy Wentworth

No, much of Medco has been a net winter against the other players. We’ve also been a huge net winner, that’s why you heard Rich take our top line guidance up for the year and we are really confident that that’s going to continue. We have seen no erosion. There are some of our health plan clients who are taking certain therapies and managing themselves. We see some loss, but those are not, frankly, the high value therapies where we bring the most point of difference, so we have not seen that in any way really to speak of.

Operator

Your next question comes from Glen Santangelo with Credit Suisse.

Glen Santangelo - Credit Suisse

Dave you gave a lot of detail around the 2009 net new business wins. Did you have any sense for how much you have to renew in 2009 of your existing book that may be up for renewal?

David Snow

We indicated that we were 70% completed on the renewal side at this point in time.

Glen Santangelo - Credit Suisse

My follow up question is on General Motors. They are obviously a unique situation given everything going on in the marketplace and obviously they made the decision they did with their benefits. Are you seeing that type of decision anywhere else in your customer base or do you think this is truly a run off situation?

David Snow

Not really. I think everybody has been reading about what has been going on with the autos. Relative to the bulk of our client base they are in a fairly unique situation and there for they are solving their problems relatively uniquely. The good news is with the Ford experience last year; we have a pretty good line of sight into what’s likely to happen so this is very manageable from our point of view. We don’t see a lot of other customers talking about this sort of thing. The GM decision has been on our radar ever since Ford made its decision.

Glen Santangelo - Credit Suisse

Okay so I shouldn’t think about it as a trend then.

David Snow

Not yet. I would not call this data point a trend. I would say it is maybe an auto trend but I wouldn’t say it’s a trend beyond that.

Operator

Your next question comes from John Kreger of William Blair & Company, L.L.C.

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

You talked about the longer-term opportunity in e-prescribing. Can you give us a sense about how long it will take to integrate RxHub and SureScripts?

David Snow

I don’t know. John Driscoll is our lead on that particular relationship and he is not in the room, but I’m guessing it won’t more than a year. At the risk of oversimplifying, it isn’t that challenging. I’m led to understand it’s going to be a relatively easy integration.

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

If you look across you existing book on a per person basis, what’s the underlying script growth that you’re seeing if any versus historical trends?

Richard Rubino

Organic script growth has been in the low single-digits for the past several quarters including last year.

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

And that’s fairly stable at this point?

Richard Rubino

It’s fairly stable at this point.

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

If you look about the bids and the wins that you’ve had in recent months, can you talk about the up tick you’re seeing from some of your new services like the diabetic supply offerings through PolyMedica and are you seeing any growing interest in restricted pharmacy network?

David Snow

The last few years we have seen a growing interest to restrict network to drive better value, so I wouldn’t call that new now, but that willingness or interest continues for certain types of accounts. Relative to the PolyMedica up take, we have just finished integrating PolyMedica with our therapeutic resource center for diabetes and now we have packaged that offering on a go forward basis and it is in the sales cycle. Some of our new business wins are looking at that specific diabetics TRC offering as an end-to-end opportunity where they might drive at the diseased level, the use of our new clinical approach. It is being received well, but it has only recently been packaged and integrated with the therapeutic resource center, so the sales cycle is going to be similar to the sales cycle for our general business which is somewhere around a year before we really can start measuring the up take.

Operator

Your next question comes from Ricky Goldwasser with UBS.

Brandon Henry – UBS

This is actually Brandon Henry in for Ricky. What was the benefit from Protonix in Q2 and is this already included in current guidance?

Then my other question is was the supply of Protonix from Teva or from Sun?

Richard Rubino

We don’t talk about who is supplying us with product, of course, but let me give you some statistics. The impact of new generics this year, we had previously reported was $0.12, now that is $0.16okay, so that was the + $0.04 generic contribution I pointed to earlier. Of that, total year benefit of $0.16, over 70% of it is fosamax and Protonix. You might recall back on our analyst day on a post split basis we gave a range of $0.08 to $0.10 if Protonix were to go generic and be available full year as a generic and it was also a smaller effects were apportioned.

What we’re saying is essentially about $0.03 to $0.04 on a full year basis from the Protonix which is consistent with the split-adjusted guidance we gave on analyst day.

Operator

Your last question comes from Aaron Gordon from Banc of America Securities.

Aaron Gordon - Banc of America Securities

Is the higher SG&A that we have seen related to the acquisitions, is this going to be the new reality or how do we see opportunities to lower administration costs?

David Snow

We believe now that we have these new assets on board there is opportunity to readjust and realign around SG&A and we’re very focused on that and we hope that it is not the current steady state.

Richard Rubino

We will give you more insight when we have our third quarter call and we point to 2009.

Valerie Haertel

At this point we need to end our call. I know we have a few callers in the queue and we apologize we couldn’t get to all of you, but please feel free to give me a call in Investor Relations, I’m happy to help and we appreciate your time today and look forward to speaking with you.

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