MedcoHealth Solutions' CEO Discusses Q2 2011 Results - Earnings Call Transcript

| About: Medco Health (MHS)

MedcoHealth Solutions (NYSE:MHS)

Q2 2011 Earnings Call

July 21, 2011 8:30 am ET

Executives

David Myers - Vice President of Investor Relations

Jeffrey Hall - Chief Financial Officer and Executive Vice President

George Paz - Chairman, Chief Executive Officer and President

David Snow - Chairman and Chief Executive Officer

Analysts

Lisa Gill - JP Morgan Chase & Co

Ricky Goldwasser - Morgan Stanley

Ross Muken - Deutsche Bank AG

Steven Valiquette - UBS Investment Bank

Thomas Gallucci - Lazard Capital Markets LLC

Lawrence Marsh - Barclays Capital

Robert Willoughby

B. Kemp Dolliver - Avondale Partners, LLC

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

Operator

Welcome to Express Scripts and Medco Health Solutions Definitive Merger Agreement Conference Call and Webcast. Today's call is being recorded and will be available for replay beginning 11:30 a.m. Eastern time. The conference call replay can be accessed by dialing (855) 859-2056 or (404) 537-3406 and entering access code 84888352. [Operator Instructions] It is now my pleasure to turn the floor over to Mr. David Myers, Express Scripts Vice President of Investor Relations for opening remarks. Sir, you may begin.

David Myers

Thank you, and welcome everyone to our conference call to discuss this morning's announcement of the proposed merger of Express Scripts and Medco. With me today are George Paz, Chairman and CEO; and Jeff Hall, CFO from ExpressScripts. Joining us is Dave Snow, Chairman and CEO of Medco.

Before we begin, I need to read the following Safe Harbor statement.

Slide statements are comments made on this conference call may be forward-looking statements and may include, but are not necessarily limited to, financial projections or other statements of the company's plans, objectives, expectations or intentions. These matters involve certain risks and uncertainties. The company's actual results may differ significantly from those projected or suggested in any forward-looking statement due to a variety of factors which are discussed in detail in the company's filings with the Securities and Exchange Commission. In addition, you should refer to the various informational legends included at the end of this presentation for additional information regarding the matters discussed.

Now I'm going to turn the call over to George, who will discuss this morning's announcement.

George Paz

Thank you, David. Before I get started, let me take a minute to welcome Dave Snow to St. Louis. I've a lot of respect for what David and his team have accomplished over the years. They have strong fundamentals and proven people with strengths that are complementary to ours. We look forward to this combination which will accelerate our efforts to lower healthcare costs while improving health outcomes.

David Snow

Thanks, George. We're also excited because our 2 organizations in our own ways represent 2 great success stories in American business. We have each been successful in creating shareholder value because we are both passionate about driving value to our customers through service, innovation and the focus on cost and quality. Organizations have a shared desire to improve the way healthcare is delivered in this country, and I believe this creates a strong foundation for a successful future.

George Paz

Thank you, Dave. Since our inception 25 years ago, we've had an unwavering focus on making the user prescription drugs safe and more affordable. Over the years, we identified and tackled inefficiencies in the healthcare and succeeded through innovation, execution and a commitment to our business model of alignment. This unique foundation of alignment has enabled us to grow, become stronger and enhance our ability to provide dynamic services designed to drive out ways that improve health outcomes.

We have never been better positioned to take advantage of the long-term growth opportunities inherent in the PBMs with marketplace. Our behavior-centric approach continues to gain traction in the marketplace and we lead our sector in earnings growth and return on invested capital.

We have complemented our strong organic growth over the years through successful strategic mergers and acquisitions, which create opportunities to our new business segments, offer new services and increase the scope of our business. We have always been opportunistic in looking for ways to enhance value, and today's announcement of our combination with Medco is a perfect example.

This is a transaction the nation needs now. Massive changes around the horizon for our industry, including healthcare reform and the upcoming wave of brand-name drugs losing patent protection. Meanwhile, healthcare costs continue to rise. In this environment, we have to be nimble and we have to be smart enough to influence events and forward thinking enough to interpret events before they occur. Combined, we can build on our legacy of advancing healthcare, do innovation and an unwavering commitment to our clients.

Both Express Scripts and Medco have different strengths in clinical, specialty pharmacy services, research, the behavioral sciences, pharmacy technology and overall patient care. The combination of these complementary strengths will accelerate our clinical offerings, which will reduce costs and improve health outcomes. Our breadth of services across traditional PBM management, specialty management and Medicare Part D will be unparalleled in history. The combined company will also be well-positioned to help clients and members navigate the landscape in the wake of healthcare reform.

At this point, I'll invite Dave to talk about the transaction from Medco's perspective.

David Snow

Thanks, George. Since we took Medco public in 2003, we doubled the size of our business and delivered average annual earnings per share growth of 22%. We've done that by driving clinical innovation focused on addressing the 50% of patients with chronic and complex disease, who account for 96% of all drug spending and more than 75% of healthcare costs.

We launched Therapeutic Resource Centers, built a world-class Accredo Specialty Pharmacy business, generated breakthrough science in research in the area of personalized medicine, and created a Medicare business that receives CMS' first and only national 5-star rating. We are a trailblazer in pharmacogenomics and have extended our footprint internationally. Clinical excellence in service innovations were the catalyst for our growth, and over the last 8 years, we've quintupled our market cap.

With that history, why this combination? Over the past year, we at Medco have been very, very focused on the changing healthcare environment in this country, which is demanding better, faster and less expensive capabilities for all who participate in the healthcare system. This strategic combination delivers on these important value propositions to the benefit of our clients, patients and shareholders. We look forward to working with you, George and the Express Scripts team, in completing this merger.

George Paz

Thank you, Dave. Our successful track record of strategic combinations is based in a philosophy of taking a best-in-class of both organizations and combining them for the benefit of our clients, patients and stockholders. We will unite the expertise of 2 complementary PBMs to make the delivery of prescription drugs safer and less expensive for millions of Americans. By boning the combined clinical skills with the behavioral sciences, we'll be able to accelerate efforts from our greater efficiencies in the healthcare system and better protect American families from the rising costs of prescription medications.

Our shared vision is to increase therapy adherence, lower costs and drive to better health outcomes. This combination will truly build on our legacy of innovation, alignment with our clients and patients, and our commitment to making drugs safer, more affordable. And because we are aligned, as we deliver increased value to our clients and patients, our shareholder performance improves. This transaction continues our commitment to strong growth, both organically and through strategic combinations. The merger with Medco will provide the opportunity to accelerate our ability to achieve cost savings for our patients and clients while improving health outcomes.

One of the keys to our history of building shareholder value has come through successful strategic mergers and acquisitions. Our focus of the years on execution and innovation has enabled us to successfully integrate these businesses, and we use the same discipline in approaching this transaction.

At this point, I will ask Jeff to discuss the financial aspects of this transaction.

Jeffrey Hall

Thank you, George. Let me start off by saying that we have observed Medco over the years and have worked closely with them on this transaction. It's clear they share our passion for driving out ways in healthcare and providing world-class patient care. This merger is consistent with our philosophy on capital deployment. First, to fund internal investments, and second, to look for strategic mergers and acquisitions.

We have funded our internal needs, and so I'm pleased to take you through some of the details of our combination, which is expected to generate strong returns on the capital invested. The name of the combined companies will be Express Scripts Holding, Inc. It will be headquartered in St. Louis, Missouri. George Paz will be the Chairman and CEO, and the board will consist of Express Scripts existing board, plus 2 members from Medco's board.

We will exchange $28.80 in cash and 0.81 shares of Express Scripts stock for each share of Medco stock. This results in a purchase price of approximately $29 billion or $71.36 per share, which represents a 28% premium over yesterday's closing price. We have committed financing in place for the cash component and anticipate raising permanent capital in the form of bank debt and bonds. We are committed to maintaining our investment grade rating and we have structured this transaction to do so. At the close of this transaction, Express Scripts shareholders will own approximately 59% of the combined company, and Medco shareholders will own about 41%. We expect the transaction to close in the first half of 2012, subject to regulatory approval.

The merger is expected to be slightly accretive in the first full year after closing, and moderately accreting -- accretive after the integration is completed. Based on our due diligence today, we have identified $1 billion of synergy. In addition, we expect to deliver more than $4 billion of annual cash from operations once fully integrated.

For modeling purposes, we have excluded the UnitedHealthcare contract beyond the end of 2012. We have a strong track record of the completing acquisitions, integrating them seamlessly and meeting or exceeding our synergy expectations.

In addition to this track record, we have also demonstrated our ability to reduce leverage rapidly, and our expectations for this transaction are no different. At the time of closing, we expect to be at the debt level of 2.9x EBITDA. We expect to return back to our targeted range of 1 to 2x with an 18 months of closing.

And now I'll turn the call back to George for some final remarks.

George Paz

Thank you, Jeff. We are excited about this outstanding opportunity. This is the seventh major transaction we have made since I joined the company in 1998, and the third one that is doubling the size of our company. We believe that this transaction is pro-competition, will reduce healthcare costs and very much in the public interest.

Everyone agrees that our country needs to get a handle on and control its healthcare costs, and our priority on behalf of our clients and patients is to help drive the way set of the healthcare industry. Reducing costs and improving health outcomes is our primary goal. This goal is reflected on our business model of aligning our interests to those of our clients and our patients. That is, we make money when they save money. This transaction allows us to accelerate cost savings and improve health outcomes. Given the level of competition at the PBM business, the sophistication of our customers and their desire to keep their healthcare costs down and the real benefits arising out of this very exciting transaction, we believe we will work our way successfully through the regulatory approval process. Being disciplined on our approach to acquisition is a key to our success. Our industry-leading ROIC is proof of our ability to acquire and integrate major acquisition. The combination with Medco is a continuum of our disciplined approach.

Our roadmap to completion involves completing all required SEC filings, holding special meetings for both sets of stockholders and working through the regulatory approval process. We believe this transaction can be completed in the first half of 2012. I want to again, share my enthusiasm for this transaction, which validates our differentiated business model and provides a platform of continued strong growth in the future.

At this point, we would be happy to answer any questions. Operator?

Question-and-Answer Session

Operator

[Operator Instructions] Our first question is coming from Robert Willoughby of Bank of America Merrill Lynch.

Robert Willoughby

One long question for you. The synergy number of $1 billion seems low relative to what Express generated on the WellPoint deal. Can you give us anything anecdotally what that $1 billion is comprised of? And secondarily, George, Medco's in a number of businesses that you have had less interest in, in the past, whether it's a Medicare, PDP or infusion therapy or the international arena. Any preliminary views on your plans for some of those relationships?

George Paz

Well, Robert, I think we've always been very open and always tried to be innovative. I look forward to spending the next couple of months or the next 6 months or so or more with David and understanding the opportunities that exist in Europe. And his vision on the different businesses they've entered into over the years. I think what I would tell you at this stage is, we're very early on and we will complete a thorough analysis and determine what's in the best interest of our shareholders and figure out how to enhance value across all lines of our business. From a synergy perspective, I'll let Jeff talk to that. But again, we're very preliminary in this process and we look forward to getting more details as the merger evolves.

Jeffrey Hall

Yes, Bob, so, what we said this morning is based on the due diligence we've identified $1 billion of synergy. But I'd caveat that by saying the deal is, at the end of the day, not about cutting costs, it's about putting 2 great companies together to accelerate cost reductions for our clients and their members in healthcare, while improving the healthcare outcomes for everybody. So that's really the primary focus here. And we're excited about the combined capabilities of the 2 companies to execute on exactly that.

George Paz

And just to pile on real quick, Bob, as you know our business follow an alignment, as we take down those costs for our patients and our clients, we create value for our shareholders. So we believe there's tremendous opportunity here as evidenced in $1 billion.

Operator

The next question comes from Larry Marsh of Barclays Capital.

Lawrence Marsh - Barclays Capital

Several things. One, just George and Dave, could you elaborate a little bit how long you guys have been in any sort of conversation without any confidentiality issues? And then I guess also, as you think about -- I agree, I think the $1 billion synergies seems modest, but I guess a bigger picture view is, when I think about with Medicare, with United, I guess, you're pulling that out of your numbers. But when they mentioned to you that they were terminating their service agreement, did they confirm that they're bringing that in-house or have they not suggested this? And I guess along with that, if they are bringing it in this house, would that be an important argument that you make to the FTC to show valid and strong competition in the marketplace?

George Paz

I'll let Dave speak to the United situation. Do you want to?

David Snow

Yes, sure. Let me take that first. So as you might imagine, the conversations with Express Scripts and the conversations with our client, United, we're on independent, completely independent tracks and came to their own independent conclusion. So the announcement relative to United is tied to last week's conversations with them directly, and our decision that, in fact, what was left on the table was did not meet the needs of our shareholders. So that was an independent decision that we arrived at and that was very recent. And here, it is announced when our decision is made.

Lawrence Marsh - Barclays Capital

I see. But you don't know what they're going to be doing with that business?

David Snow

Well, I mean Larry, what I would say is there is plenty of paper trail that's public that indicates what the alternative is they've been thinking about. So without putting words in Steve Hemsley's mouth, I have to assume that he will go with that other alternative that he's publicly talked about so often, which is take it in-house.

Lawrence Marsh - Barclays Capital

Very good. And then just the timing of the talks and discussion?

George Paz

Dave and I have been friends for a lot of years. We sit on our trade association board together and we've had numerous opportunities to talk in the past. The beauty of our 2 companies is we share a common passion for taking costs out of the system and improving health outcomes, optimally go out at a slightly different or quite a bit differently, but at the end of the day, by combining those 2 differences, we create a tremendous synergistic opportunity to take even more cost out, create better value for our patients and clients, and drive better outcomes. So we're very excited about this.

Lawrence Marsh - Barclays Capital

Right, that's very good. And again I guess, George, just finally, when you mentioned your argument to the FTC, is being able to drive cost down and share those to your customers, that seems to be the important message here today. What would you respond to any pushback around concentration of mail script volume?

George Paz

Well, mails -- I don't want to deliberate the FTC issues. We're obviously going to work very closely. If you take a step back and say what does America need today more than anything else, we -- healthcare costs that are under control and driving quality. You ought to hear David speak from a public podium about quality and how important it is and how important it is to take costs out of the system. Again, we share that common goal. The FTC is part of the administration, which is part of government, which is also is very focused on healthcare costs. We're going to work very hard to show the government the value that this brings to patients and members as we drive those costs out of the system. And we wouldn't be doing this if we didn't think we didn't have a very good chance of getting this through. It's a lot of work and we don't need a lot of work to do nothing. So we're excited about it moving forward.

Operator

Next question comes from Lisa Gill of JPMorgan.

Lisa Gill - JP Morgan Chase & Co

And George, I'll be honest, I mean, I was thinking an acquisition maybe in 2014, so obviously, I think all of us were a little surprised today. Just a few questions I guess around the selling season. Can we maybe just talk about, if the 2012 selling season wrapped up, number one? And number two, if someone has is in the decision-making process of, "I've awarded the business to either Medco or Express," does this open it up for them to come back and perhaps change their decision based on this combined entity? So that would be my first question. And then secondly, is there hope to wrap this up before we get into the 2013 selling season?

George Paz

Well, the answer to the last question first is yes. As far as the selling season is concerned -- I prefer to wait till the third quarter. There's still an awful lot of decisions that are out there. We're in the middle of renewing clients and selling business. And obviously, our companies will remain standalone and compete vigorously in the marketplace until this transaction closes. And I prefer just to hold off on that selling season. As far as clients -- our clients have always asked for more. And the question is, is the more value we can deliver or cost contractions they need? And hopefully, we can deliver more value and that satisfies their needs.

Lisa Gill - JP Morgan Chase & Co

And then, just lastly, George. Obviously, there's a very public dispute between yourself and Walgreens around this. Do you believe that this potential combination brings them back to the table? I mean, this is an awful lot of business for them should the transaction go through.

George Paz

Well, I did call Greg this morning, gave him a heads-up as to what was going on. I think CEOs do that with each other once it became public, of course. And just let him know that this was coming down. And Greg and I talked and it's I'm hopeful that we will come to a conclusion on this. We'll have to look to see how that plays out.

Operator

The next question comes from Ross Muken of Deutsche Bank.

Ross Muken - Deutsche Bank AG

So obviously, this changes the theoretically assuming successful or hopeful close, and this changes the competitive landscape in the context of the positioning of the other entities that now exist post the sort of United business going in house. How do you view, on a pro forma basis, kind of the strategic positioning of the pro forma asset that you've created with the unique capabilities of each of the 2 businesses as it sort of has to compete in this change, but still highly competitive landscape of players that look a bit dissimilar to yourself?

George Paz

To be quite frankly, this is a great world. There's many, many players out there that offer different approach to solve healthcare costs that are increasing. One of the problems I've had over the years is David, my pitch and David's pitch were pretty similar. We both went after the same thing. We both thought that pharmacogenomics and personalized medicine and attacking member decision-making were the right answers. We were fairly close. Obviously, he's one of my competitors. Likes to use the retail drugstore chain as an avenue, another one of my competitors. So quite a few of my competitors are in-house. PBMs for managed care companies, so there's all types, there's tons of competition out there. And the beauty of the world today is, we're fairly unique in our offering. But that gives the chooser of our services many, many different options on how to choose which PBM and which process to go with, that are trying to get to lower their costs. So I think we are very well defined in the industry.

David Snow

And Ross, let me add something. It's Dave. I think if you think about this strategically at 30,000 feet and I'm talking broader than PBM, I'm talking the healthcare system, I believe you are going to see all sorts of combinations across the spectrum of healthcare as everyone realigned to the new imperatives related to healthcare reform and the demands the government is making relative to lowering costs of the healthcare system. And I think this combination puts us squarely on the side of a solution to what the government is hopefully going to be pushing for over the next decade. So I think you'll be surprised that the other healthcare combinations that are encouraged by the incentives in healthcare reform, and this is just an alignment that makes enormous sense as you look to the future.

Ross Muken - Deutsche Bank AG

Great. And maybe just one quick follow-up. In terms of the synergies related to the transaction, how should we think about sort of the pacing assuming that mid-year or first half 2011 close, in terms of what synergies that were named were sort of easier to capture and some flow through kind of in the only part of the transaction? And which would kind of take a slightly longer piece of time?

George Paz

As we said earlier, we expect the deal to close in the first half of 2012 and we're sitting here in the second half of 2011. What I would prefer to do is defer your question until we get closer to the closing and see where we are at. And obviously, on that time, we will build out the guidance and the model for you.

Operator

The next question comes from Steven Valiquette of UBS.

Steven Valiquette - UBS Investment Bank

Just trying to get a little more color on the process with the FTC. Just kind of thinking ahead and being the borderline case. What are the scenarios? Do they come down to potentially giving up a certain percent of customers? Is it just sort of a yes or no with the existing books of business? How does that sort of play out the way you think about the FTC?

George Paz

Well, first of all, I don't share your opinion about a borderline case. I think everything Dave just talked about in healthcare is being delivered in this model of this merger. And I believe it's what America needs, it's what the patients need, it's what the clients need, and our job is to just to provide the information and help the FTC work through this process. And we feel -- as I said earlier, we wouldn't do this if we didn't think we couldn't get it done.

Steven Valiquette - UBS Investment Bank

Okay. So the way it stands right now, you're not too worried from FTC point of view that's what it boils down to?

George Paz

Yes, that's correct.

Operator

The next question comes from John Kreger of William Blair.

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

Just a follow-up question on the synergies and where you think they might come from. George, from your perspective, is there still room as you're going to gain a lot more scale with this deal? Do you still see room to drive additional purchasing opportunities in the channel? And if so, where do you think the biggest opportunities still are?

George Paz

If I take the total cost of goods sold, SG&A and DPC we're talking about $100 billion of spend. I feel very comfortable there's a lot of opportunities to take costs out of the equation.

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

Have you gotten far enough to know what you're going to do on the systems side or the facility side?

George Paz

No, we haven't. We just announced today, John. Without obviously coming. We've got to go through that process. Medco, we compete with them everyday. They've got incredible people, incredible systems and incredible approaches. I'm a little biased, but I think I've got pretty good ones, too. And now the question is, how do I put them both together and get the best of the best? And I'm confident. And if you look back at DPS, we kept their systems. If you look at Value Rx, they brought us the unique capabilities in mail order. As I go down this list, everyone of our acquisitions have been strategic. This one is incredibly strategic to us and they will bring us incredible tools and incredible people. And we are just so excited to be uniting these 2 entities together to pick up that excess cost.

Operator

The next question comes from Ricky Goldwasser of Morgan Stanley.

Ricky Goldwasser - Morgan Stanley

Just a follow-up on the synergies. Does the $1 billion in synergies that you identified from back early on assumes consolidating their relationship with your respective distributors?

George Paz

Again, I'm not going to get into where everything situated now. We're way too early on. We got a lot of work to do. We feel very comfortable with the numbers we have presented, and I'm just going to leave it at that.

Ricky Goldwasser - Morgan Stanley

Okay. and then just in terms of market share of the combined entity, it's kind of like 30% are we in the ballpark once we factor in kind of like take out United out of kind of Medco equation? Is 30% market share a reasonable number to think about it?

George Paz

What's the purpose of your question? I'm trying to?

Ricky Goldwasser - Morgan Stanley

In terms of kind of like your market share in terms of scripts that the combined companies would cover?

George Paz

There's a lot whole lot of things going on right now, Ricky. We're in the middle of selling season. There's a lot of pieces. Why don't we give you that color as we build towards completion of the merger.

Operator

The next question comes from Kemp Dolliver of Avondale Partners.

B. Kemp Dolliver - Avondale Partners, LLC

I'm trying, as a customer, I'm trying to determine -- is the cost savings story here is pretty straightforward as it's been with other deals. But beyond that, given, George, you talked about very similar philosophies, but yes -- but yet, there are things that you all have both companies have done that have been very different in approach and I think at the -- essentially when the rubber meets the road, have had different -- come across differently to the member. So can you talk just a little bit about what the combined entity is going to do, 1 or 2 things that you wouldn't have done, George, on your own?

George Paz

Well, yes, that's actually pretty easy. David's built one tremendously good model of a disease-centric focused TRCs. And what he's been able to accomplish to that focus and improving people's health outcomes is quite incredible. And we went in different paths. We went around with the consumer side. And if I cannot take that disease-centric focus and couple it with understanding that behavioral aspects of the human being and put those 2 together, I think we've got a powerhouse for keeping people adherent, for tracking their needs, delivering incredible value for that patient. At the end of the day, when we deliver value to each and every one of our patients, that rolls up to an incredible savings for our clients, which is what it's all about.

Operator

Our next question comes from Tom Gallucci of Lazard Capital Markets.

Thomas Gallucci - Lazard Capital Markets LLC

George, you mentioned the long history there of Express in doing consolidation, having doubled the company 3x in the last 12 or 13 years. Just as you head into the a deal like this, can you maybe highlight for us some of the things in terms of integration that you think is similar to the types of things you've done in the past, and maybe how this deal or Medco maybe a little bit different?

George Paz

Yes, we're going to cancel everyone's vacation to start with. So we know, they're going over the summer now, everybody's got a challenge. I think this one actually is big, it's complex, but Dave and his team have done an incredible job of keeping on 1 platform and keeping it disciplined. And we look at some of our deals, especially if you go back to the Value Rx deal, I think we bought a company that was 9 standalone entities, running 11 platforms, and many of them, they didn't have great processes and that was a challenge, to say the least. And we've learned a lot as we've rolled those together. So there's always similarities, there's always differences. At the end of the day, the only thing that matters is patient satisfaction and client savings. And we'll make every move and every step with those 2 goals in mind. And we are confident we'll be able to deliver a combined company in a reasonable short order.

Well, thank you, everyone, for joining us. David, any last remarks?

David Snow

No. Thanks for joining us everybody, and stay tuned because I believe this is going to be very exciting.

George Paz

I thank you all for questions, comments, and we look forward to talking to you again in the near future. Thank you.

Operator

Thank you. This concludes today's teleconference. Please disconnect your lines at this time and have a wonderful day.

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