CVS Health Corp (CVS) 2004 Q3 法說會逐字稿

Good morning.

My name is Matthew.

I will be your conference facilitator.

At this time, I would like to welcome everyone to the Caremark Rx third quarter 2004 earnings conference call.

All lines have been placed on mute to prevent any background noise.

After the speakers' remarks, there will be a question and answer period.

If you would like to ask a question during this time, simply press star, then the number 1 on your telephone keypad.

If you would like to withdraw your question, press star, then the number 2.

Thank you.

I would now like to turn the call over to Mr. Mac Crawford, Chairman, President, Chief Executive Officer.

Mr. Crawford, you may begin your conference.

Okay.

Thank you.

I also thank everyone for dialing in this morning for the third quarter earnings call.

I'm going to go ahead and do the forward-looking statement first.

And then we'll get into the call itself.

This conference call contains statements that constitute forward-looking statements within the meaning of the Securities act of 1933 and the Securities Exchange Act of 1934 as amended by the Private Securities Litigation Reform Act of 1995.

Forward-looking statements discussed on this conference call include the intent, belief or current expectations of the Company and members of it senior management team with respect to the anticipated growth prospects for the Company's business, including revenue growth and earnings per share projections and the anticipated amount and timing of synergies and accretion from the advanced PCS transaction.

And the amount of certain expenses to be incurred in connection with the transaction.

As well as the assumptions upon which statements are based.

Prospective investors are cautioned that any such forward-looking statements are not guarantees of future performance, involve risks and uncertainties and that actual results may differ materially from those contemplated by such forward-looking statements.

Important factors currently known to management that could cause actual results to differ materially from those contemplated by the forward-looking statements on this conference call include, but are not limited to; adverse developments with respect to the Company's operating plan and objectives, as well as adverse developments in the healthcare, pharmaceutical industry generally.

Additional factors that could cause actual results to differ materially from those contemplated on this conference call can be found in the Company's annual report on form 10-K for the year ended December 31, 2003, the Company's quarterly reports on form 10-Q for the quarters ended March 31, 2004 and June 30, 2004, and the Company's other periodic filings from time to time with the SEC.

This conference conference call will include certain non-GAAP financial measures as defined under SEC rules.

As required, by SEC rules, we have provided in the footnotes to the press release issued today a reconciliation of those measures to the most directly comparable GAAP measures.

Well again, thank you for calling in and good morning.

And before we get into the earnings discussions, I really want to acknowledge the Caremark employees that have contributed to these results.

We're 7 months into the transaction in which we acquired AdvancePCS and these employees have really done a great job.

I really want the investors to understand that, you know, we got real people here that deliver these services to the customers each and every day.

That are responsible for the results that we achieve both from a customer service, clinical standpoint as well as from a financial perspective.

Also, please recognize that we had 2 PBM pharmacy shutdowns at different times during the quarter because of hurricanes.

We also had several specialty pharmacies and a call center that were shut down because of hurricanes.

Yet we still delivered the service to the participants by having people chip in, work overtime, get the job done, to make sure we continued to deliver these services as well as meet these numbers that you see here today.

Joining me today are Howard McLure, Chief Financial Officer and Pete Clemens, the Treasurer.

I'll give you some highlights and Howard will give you some details on the numbers.

As you saw from the release for the quarter ended September 20, we earned 38 cents a share excluding integration and other related costs, which is 3 cents above consensus estimates on revenues of $7.458 billion.

If you compare these earnings to the same quarter of 2003 presented on a proforma basis, this represents a 41% increase in earnings per share.

EBITDA for the quarter was 335 million, which represents a 32% increase over the 2003 proforma EBITDA of $255 million.

On a GAAP basis, the increase in EBITDA in 2004 compared to 2003 is $185 million, or 123%.

EBITDA margins for the quarter were 4.5% compared to 2003 proforma EBITDA margins of 3.8%, again, a good increase.

This increase can be attributed to higher mail penetration rates, increased generic dispensing rates at both mail and retail and leveraging the expenses and the costs of service areas and in SG&A.

We also continued to see very good growth in our specialty business.

During the quarter on a proforma basis, mail pharmacy revenues increased 23%.

Mail scripts increased 12%.

This growth is being driven by growth in PBM mail operations and as mentioned above, by strong growth in our specialty operations.

Our specialty results continue to validate our belief that a comprehensive offering will be a winner in the marketplace.

And we're certainly seeing the growth taking place in the specialty business as a result of what we have put together here and had together over the years.

Turning to the balance sheet in short term investments at September 30, they total $962 million.

Which means that we had cash in excess of our debt of $363 million.

Keep in mind that during the quarter we also repurchased $304 million of our stock, representing 10.4 million shares, which equates to an average purchase price of $29.23 per share.

Since September 30, we have acquired an additional 4.6 million shares for an aggregate consideration of $134 million.

To date in total under the plan we've acquired 17.9 million shares of a total cost of approximately $500 million, or $27.93 per share.

Which is under the $750 million stock repurchase plan approved by our Board.

Cash flows from continuing operations for the quarter totaled $414 million.

Again, another very solid performance.

As we've indicated on previous calls, I will now give you an update on the net new business for 2005.

Given that the transaction closed in March, which was in the midst of the selling season and we really had a busy year.

The primary focus has been on retention of the accounts that we wanted to retain and implementation of the significant wins, including FEP, Independence Blue Cross, Texas Teachers and the City of Chicago.

I'm happy to say we've had another successful year from the business standpoint, particularly considering all that was going on in integrating these 2 companies.

At the time our net new business stands for 2005 at approximately $1.2 billion.

It's important to note that our new business contains a significant amount of mail and specialty revenue.

Which tends to be our higher margin business for this Company, as you know.

Also, we always reported these numbers in accordance with how we report revenue, the only way that you can gauge impact in our reported revenues.

If we report this number in the future, this is how we'll continue to report our net new business.

Based on our 2005 budget, we have given guidance for 2005.

This is the first guidance that we have given for 2005.

And we currently expect earnings per share to be in the range of 1.88 to 1.92.

The integration of the companies continues to move along well.

We're achieving the synergies in the areas that we expected to achieve them.

And we're pleased at where we stand today.

We had a good quarter.

Results came in well.

Howard's going to give you more detail on it.

Then we'll come back and take questions.

Howard.

Thank you, Mac.

And good morning everyone.

As we have in the past 2 quarters of 2004 I will go through our GAAP performance for the third quarter.

As well as our performance on a proforma basis assuming AdvancePCS was included in our year over year results.

Finally I will provide detail around our guidance that Mac summarized and we included in our press release this morning.

As you know, Caremark closed the acquisition of AdvancePCS on March 24, 2004.

As a result, Caremark's GAAP results include the AdvancePCS operations for the full third quarter in 2004 but not in 2003.

In the third quarter of 2004 Caremark reported diluted earnings per share of 37 cents, which includes integration and other related expenses of approximately 5.8 million, or 3.5 million after tax.

Excluding the integration and other related expenses, Caremark's earnings per share in the third quarter were 38 cents, or 3 cents above first call consensus estimates.

These estimates also do not include the integration and other related expenses.

This represents a 31% increase in diluted earnings per share from the third quarter of 2003.

Earnings per share for the 9 months ended September 30, 2004 were 97 cents.

Excluding the integration and other related expenses, earnings per share were $1 for the first 7 months, an increase of 27% over last year.

Revenues were 7.5 billion for the third quarter and 17.8 billion for the first 9 months, an increase of approximately 5 billion and 11 billion over the same periods in the prior year.

EBITDA excluding integration and other related expenses in the third quarter was 335 million, up 185 million and for the 9 months was 791 million, an increase of 379 million over the prior year.

On a proforma basis, assuming the AdvancePCS acquisition was included in the third quarter of 2003, as it is in the third quarter of 2004, mail prescriptions were 11.8 million for the quarter compared to proforma mail prescriptions for the third quarter 2003 of 10.5 million, an increase of 12%.

Our mail penetration rate was 21% in the third quarter, reflecting the blended mail penetration rate of legacy Caremark of approximately 46%, the mail penetration rate of the legacy AdvancePCS is approximately 12% compared to a proforma 2003 mail penetration rate of 19%.

Retail claims were 132.6 million for the quarter compared to proforma retail clients of 129.7 million, a 2% increase.

As we indicated last quarter, retail claims (revenue) was negatively impacted by AdvancePCS clients who announced their termination prior to the close of the transaction.

Retail clients for legacy Caremark customers grew by 7%.

In the third quarter of 2004, net revenues increased 8% from proforma third quarter 2003.

Caremark's success in driving generics increased generic dispensing rates of mail and retail.

Which due to the lower prices of generics reduced our total revenue growth by approximately 4%.

As most of you know, generics reduce top line revenues but generate higher gross profit.

Our mail generic dispensing rate for Q3 '04 was 38.4%, compared to 35.3% for the proforma Q3 '03.

Our generic retail generic dispensing rate for Q3 '04 was 49.4% compared to 46.4% proforma Q3 '03.

EBITDA excluding integration and other related expenses was strong during the quarter, growing 32% over the proforma third quarter 2003.

EBITDA per claim in the third quarter of 2004 was $2, an increase of 27% over proforma EBITDA per claim for the third quarter of 2003.

Diluted earnings per share excluding integration and other related costs, of 38 cents for the third quarter of 2004, increased 41% compared to proforma diluted earnings per share of 27 cents for the third quarter of 2003.

On on proforma basis, assuming AdvancePCS was included in the entire first 9 months of both 2004 and 2003, net revenues were 22.4 billion, an increase of 8% year over year.

Higher generic dispensing rate had the effect of reducing the revenue growth rate, excluding this impact, growth rate would have been approximately 11% in the first 9 months of 2004.

On a proforma basis, EBITDA for the first 9 months of 2004 excluding integration and other related expenses, was $870 million, an increase of 24% over the first 9 months of 2003.

Proforma EBITDA for claims for the first nine months of 2004 was $1.72, an increase of 20% over proforma 2003 EBITDA per claim.

Proforma diluted earnings per share excluding integration and other related expense in the first 9 months of 2004 were 95 cents, an increase of 30% over the first 9 months of 2003.

Caremark's balance sheet was very strong at the end of the third quarter of 2004.

And we continue to manage our working capital effectively.

Caremark's cash and short term investments were $962 million, total debt outstanding was approximately $600 million.

Debt includes our previously outstanding Caremark 450 million Senior Secured Notes through 2006, and a $148 million term loan.

Cash flow from operations during the third quarter was $414 million, up $249 million over the same quarter last year.

Cash flow from operations in the first 9 months of 2004 was $1.1 billion, an increase of $684 million from the same period 2003.

Capital expenditures totaled $24 million for the third quarter and 55 million for the first 9 months of 2004.

As we announced on July 20, the Board of Directors increased our share repurchase program to a total of $750 million.

Under this program, which began in 2002, we purchased 2.9 million shares prior to the start of the third quarter of 2004.

During the quarter we purchased 10.4 million shares, making the total shares purchased 13.3 million shares as of September 30, 2004.

Share purchase activity had a positive impact on third quarter diluted earnings per share of approximately 0.5 penny.

On September 30, we purchased an additional 4.6 million shares, bringing the total shares repurchased from the beginning of the program in 2002 until today of 17.9 million shares.

As for Caremark's outlook, we announced in our press release today an increase in our fourth quarter 2004 earnings per share guidance, excluding integration and other related expenses, to a range of 43 cents to 44 cents from previous guidance, 41 cents to 42 cents.

With our 9 months results, this increases our guidance for full year 2004 earnings per share, excluding integration and other related expenses in the range of $1.43 to $1.44.

This guidance is based on the detailed guidance assumptions we provided when we announced our first quarter 2004 results.

Which I will update for the remaining fourth quarter.

As we indicated in our press release this morning, we expect net revenues to total 7.8 to 8 billion in the fourth quarter of 2004.

We are still on track to achieve the expected synergies associated with the AdvancePCS acquisition in 2004.

Stock option expense is expected to total approximately $5 million in the fourth quarter of 2004.

Amortization expense related to certain identifiable intangible assets is estimated to be approximately $12 million.

While depreciation expense is expected to total approximately 25 to 26 million in the fourth quarter of 2004.

Net interest expense for Q4 is expected to be in the range of 7 million to 7.5 million.

The Company's effective accounting tax rate is expected to remain at 39.8% for Q4.

However, cash taxes will not increase until the net operating loss carry forwards are fully utilized.

We expect that the net operating loss carry forward's will be fully utilized in the second half of 2005.

The implementation process for the FEP contract continues to proceed on schedule.

Our 2004 guidance includes incremental expenses associated with the implementation of this account.

We still expect the incremental costs of the implementation to negatively impact earnings by approximately 1 to 1.5 cents per share for the fourth quarter.

Let me also remind you that our earnings guidance for the remainder of 2004 does not include integration and other costs associated with the acquisition of AdvancePCS.

GAAP requires that any cost associated with the integration and rationalization of legacy Caremark operations to be expensed deferred while any costs associated with legacy AdvancePCS operations will be capitalized.

On the cash flow front, we expect capital expenditures for the fourth quarter to total approximately $35 to $40 million.

Earnings in 2005, we will continue to benefit from the synergies that we will achieve from the Advance acquisition.

Based on the results of our initial planning process, we have provided our 2005 EPS guidance, excluding integration and other expenses, $1.88 to $1.92 per share.

This represents a growth rate on a GAAP basis excluding integration expenses of 30% and 33% in earnings per share over our 2004 guidance.

We expect that our revenue growth on a GAAP basis after taking into account our net new business wins, estimated increases in generic dispensing rates, net inflation factors, at approximately 30%.

Additionally we expect stock option expense will be approximately $14 million.

Contributing any amounts that might be recorded if and when the FASB finalizes its exposure draft on accounting for stock options.

We expect depreciation expense of approximately $105 million.

Amortization expense of approximately $47 million, net interest expense in the range of $17 to $20 million.

As with our guidance in 2004, this guidance does not include any integration and other related expense that GAAP requires us to expense.

Finally, this guidance is based on an outstanding share count of 460 million shares, which takes into account our share repurchase program to date.

Thanks and now I will turn it back over to Mac.

Okay.

Thank you, Howard.

We had some interference we heard on our side.

Hopefully it didn't keep any of you from hearing anything.

Operator, at this time, let's go ahead and turn it open to questions.

Certainly. (OPERATOR INSTRUCTIONS) Our first question comes from Lisa Gill with J.P. Morgan.

Great.

Good morning, everyone.

I was wondering if you could just talk a little bit about your specialty pharmacy business.

Mac, you talked about it having a good impact as far as business that was signed in 2005.

Can you talk about any of the reimbursement changes as it pertains to your specialty business and how that will impact 2005 guidance?

And then more importantly, if you can - - perhaps even just give us more color as to how well it grew in the quarter?

You did say that it impacted the mail side.

And then just secondly, if you can give us any update on where you stand on the legal investigations, especially Florida, if there is anything new that you can tell us?

Thanks.

Okay.

As far as the specialty business revenue from the top line grew in excess of 35% for the quarter, so it had a very strong quarter out of there.

As far as the reimbursement piece of it, you know, obviously we've said before the changes in hemophilia and the MediCal reimbursement's actually a positive to us.

Because of the way that we had felt that they should be billing that in the past.

And we were I think conservative in how we had done it.

From the standpoint of the Medicare hemophilia reimbursement rates, understand that, you know, you have the acquisition costs and you have the 6 plus percentage and then you had the 6% I guess is was what they had proposed to cover services in that regard.

That got increased I think, to a level of 14 cents, if I'm not mistaken to do that.

As a result it, will have some negative impact that has been factored into our numbers.

And I think that negative impact, if my recollection is right is probably $7 million or so in total next year.

Because our business is just not that substantial in the Medicare world.

Other reimbursement impacts that people have talked about and I won't go through each product, but have a very minimal impact on us, and particularly the size of us and where we are.

Everything that we know has been factored into the guidance we've given you for next year.

And again that, business continues to perform well.

And we are seeing the cross selling opportunities take place coming out of there.

Mac, just before you get to the legal, would you expect to see continued growth rates above 30%, especially pharmacy, going into '05?

Well, the bigger you get, the harder it is to grow at that kind of rate.

So, and I don't even recall what we had baked into the numbers for next year.

But we have seen it grow well, obviously part of the synergies that will come out of the Advance transaction.

Over time.

It won't all be achieved next year.

It will come from growth in that business.

We've never given a separate growth rate on that and I really don't even recall where it sits right now within our budget for next year.

But we did have a very strong quarter.

We've had consistent over 30% in that business this year.

And I don't recall next year, Lisa, exactly what it is.

Some of it will depend upon new product losses obviously and when they come out.

Great and then just one more question as it relates to that.

When you sign contracts for next year, can you just give us an idea of how much, how much business you sign related to specialty?

I mean was it the majority of business had some specialty component?

Or is this a pull-through that will come in in the second or third year of the contract?

Well, every contract that we have typically has the biotech or specialty pricing in it.

But the pull-through normally comes through in the second and third year of the contract.

Okay.

Great and then just if you can give us any update on the legal side.

Legal side, we continue - - we've got the CID's from the State Attorneys General.

We continue to work with them to furnish the information.

Again, it's simply request for information at this point in time.

Nothing new to report on any other situations from that standpoint other than the process just continues.

Great.

Thank you very much.

Your next question comes from Tom Gallucci with Merrill Lynch.

Good morning.

Thank you.

First I was just curious.

Could you give us a little more color on kind of new wins and losses?

Obviously I think we're fairly familiar with some of the major wins.

Can you talk about on the, on overall?

You mentioned there was a lot of mail in there, FEP must boost that up, maybe excess FEP.

Can you talk about the relative mail penetration?

And maybe also the relative amount of specialty business that's in there today versus what you think, you know, the opportunity is to pull through over time?

And what kind of customer types they are and where it's coming from?

Okay.

That's a long list if I forget something, let me know.

You know, from the standpoint of, on a net basis of the 1.2 billion, it's probably about $1.6 billion on a net positive basis of mail.

And about 400 million on a net negative basis of retail.

So as you see, the mix there is very favorable from our standpoint.

In that mail component also includes specialty.

And we normally don't break out the components of those 2 because it's somewhat hard to do from time to time.

But we do have some fairly good sized specialty business that we signed going into next year.

I mean obviously not near the size and sale of an FEP kind of thing.

The mix of it, you know, is a mixture of obviously a big FEP win, health plan business, other state business, corporate business, where it came from.

Some of it came from new carveouts.

Some of it came from our competitors.

Some of it came from smaller PBMs.

And then if I could just ask Howard one follow-up.

I did have some interference.

What was the mail and retail revenue growth in the quarter?

The script growth rates?

The revenues.

Revenue on the mail side was 23% and 2% on mail - - I mean on retail.

I'm sorry.

Okay.

Thank you.

Your next question comes from Robert Willoughby with Banc of American Securities.

Thank you.

Just, Mac, if you look at the generic industry, they have been decimated here on pricing over the - - I guess this quarter.

Can you characterize your margin here, how much of that might have been driven by improvements in the generic pricing relative to your expectations?

No, I don't have that.

I don't know.

I've not looked at that to tell you the truth.

Any commentary in terms - -

I'm sure we got some pickup from it, no doubt.

We continue to do well in the generic side, but I'm not looking - - I've not looked at the volume variance versus the price variance on that side.

Okay.

Thank you.

Your next question comes from Glenn Garmont with First Albany Capital.

Thanks.

Good morning.

As you look out to your new business wins for 2005, is anybody doing anything sort of new or unique on the benefit design front?

And also you talked about it a little bit at your investor day a couple of weeks ago.

With the more toward - - or at least there's a lot of discussion around the issue of transparency.

Has that changed the way you find yourselves bidding on new business?

Thanks.

As far as dealing with the transparency issue, you know, I don't think that - - well, let me back up.

If you really get down to the bottom line, what the customer's are wanting to know, or at least our customers are: Are you working in our best interest on our behalf?

And so clearly there has been a lot more discussion about it.

We've got several different models that we use to bid on.

I'm not going to discuss those because those are competitive in nature and how we do our business.

But I, you know, I think that we have expanded the number of models that we're using.

We've balanced some things that people I think like a lot.

And I think that was attributable to some of the new business that we won this year.

And what was the first part of your question Glenn?

The first part of the question just dealt with, you know, if as you look at the new contract wins, the new business '05, is anybody - - aside from obviously the, you know, the accelerating mail adoption, is anybody doing anything sort of new or interesting on the benefit design front?

No, I think the benefit - - you know, you've got obviously the same trends we've seen in the past, more three-tier, more pushoff to the co-insurance kind of model.

But I think that's, you know, pretty much the same trends that we've seen in that regard.

All right.

Thanks Mac.

Okay.

Your next question comes from Lawrence Marsh with Lehman Brothers.

Yeah, Mac, just are you this morning - - I mean your interest expense for the next year is down a lot from this year.

Which obviously is a testament to continued very strong cash flow.

Are you giving any sort of range of what you hope to generate in cash flow for next year and any expectations of CapEx at this point?

No, we've not given that out at this point, Larry.

We'll give you more color on that as we finish our budget process.

Larry, if you look at where we are this quarter, we're at about 7.3 million or so in net interest expense.

Right.

That gives you an idea.

Cash balances are significantly higher than they have been, when we started the year out.

Right.

Obviously you're assuming a decent amount.

I guess, then Howard, on those points, there is just several minor balance sheet adjustments this quarter versus last on the intangibles, goodwill.

Is that just an judgment on Advanced, or what is that?

Yes, it's basically finalization of the appraisal of the, you know, customer intangibles.

Which the appraisal came in lower than our original estimate.

So it simply moved from other intangibles to goodwill basically.

Okay.

It's really just getting the appraisals in and just adjusting to the actual appraisals versus estimates.

I got it.

And then so I guess, Howard, in your comments, you said 1 to 1.5 cents of expense for FEP.

I know you've said what, 2 cents for third and fourth quarter, so it's about a 0.5 cent to 1 penny for this quarter, is that right?

Yes.

Somewhere in that range.

Roughly, okay.

And then I guess finally, I know we had talked about this last quarter.

But do you have any range of what your legal expenses might be running on an apples to apples basis, year over year at least?

Any sort of growth in legal expenses given the regulatory legal environment, you know, that you're facing?

And is some of that included in - - are you able to capitalize any of those as part of AdvancePCS?

No, no.

We're expensing the legal costs.

And I don't have it at the tip of my fingers.

They are up, no doubt, because of a lot of stuff going on.

But I mean as an example, we are now defending the stuff that Advance was involved in, but we're not capitalizing that.

Right.

It's just - - you know, we recognize it as it's incurred.

Is it fair to say those expense, in your budget for next year, do you expect those costs to go up versus this year, same, or down?

I'm not even looked at that detailed line, Larry.

Okay.

So I don't know off the top of my head.

Okay.

Very good.

Thanks.

Your next question comes from Christopher McFadden with Goldman Sachs.

Thank you.

Good morning. 2 questions.

You talked about some impact and some facility closures associated with hurricanes, that sort of thing.

Any direct expenses that were incurred in the quarter that would have been connected to that?

And then building on that point, you know, as you've now several months into the AdvancePCS integration.

Could you talk in a more granular sense about any updated views on facility network integration?

Perhaps in the past you've talked about where you thought there might be some tangible IT integration opportunities.

Or other kind of drill down on operationally how that process is developing.

Thank you.

Yes.

As it relates to the, the facilities that we had to shut down, those were over a short-term basis.

And I really highlighted that, just to highlight the great job that our people did to move scripts around to make sure that things happened.

You know, I've not even tried to identify what the costs associated with it was.

We just let it hit the quarter and it went on.

But I don't think that is a material amount because we kept it fairly from a minimal standpoint.

Our people did a great job of measuring where we were from that standpoint.

As far as where we - - from a granularity standpoint on kind of synergies and what we've achieved and where we are and operationally: as we've said, we didn't expect any major facility closures.

That's based upon our volumes and where we are.

I don't expect that we will see any.

The - - we continue to work on integrating, for example, in the IT area and in our mail service area to get on one platform within all of the mail service pharmacies.

And by the end of next year, we should be at that point.

We continue to try to rationalize and make sure that we're moving over time.

And again, as I had said before, 4 or 5 or 6 year project to get to one single adjudication engine at some point in time.

But it's, you know, just a matter - - we did this transaction not based upon having significant amounts of layoffs or significant amounts of changes.

We've rationalized parts of the business.

We've combined sales forces.

We had a lot of those detail, nitty-gritty things that you have to do.

You see an improvement in SG&A this quarter.

Some of that relates to headcount.

A lot of it relates to not needing but one senior executive team, not needing but one D&O policy.

A lot of those things that we've said will come through, have come through.

The good news is that we have been meeting and achieving where we thought we would be as we've moved through.

And I'm pleased with what our people are doing and where we stand with it.

Great.

Thank you.

Your next question comes from Kemp Dolliver with SG Cowen and Company.

Thanks, and good morning.

This has been an unusual year for new business because there has been such, you know, visible movement of larger contracts.

And my question is on the 1.2 billion, I assume that reflects contracts such as IBC that started in the middle of this year.

Such that in terms of say the last few months, probably the net change in business overall has been about a wash?

Okay.

I didn't understand your question.

Sorry.

Well, the - - you know this, year we knew a year in advance that, for instance, Healthcare Service Corp. was going to go away.

You know, we knew back in the spring that you had FEP mail coming on.

And then there were some significant contracts like IBC that started mid year that contribute significantly to '05 revenue.

So really my question is once you take those known contracts net amount, I mean how did you do, you know, how much did anything, everything else contribute in that new business?

For next year?

Yes.

Well, anything for next year, like IBC, would be based on, you know, whatever the impact is, so some of that was in this year.

I don't know.

Do you know?

No, I think there - - what you're asking is what's the impact of contracts that were signed.

You know, you also have an impact of contracts that were terminated mid year, so it all kind of washes.

Yes.

That probably washes all out with each other.

What we've given you here is the revenue impact on 2005, the 1.2 billion.

Okay.

That's great.

And also, other than FEP, are there any other significant clients that will push mail penetration up next year, in a push to mandatory mail?

FEP will be the single biggest one.

But I mean you've always got programs in place to try to continue to grow.

As a matter of fact I think just the Advance program that we have as far as trying to increase mail penetration rates there, I think that was almost 900,000 scripts in the quarter that converted from retail to mail.

Just, you know, on existing client base.

So, you know, you've got different accounts that will account for different movements.

You also will be driven by what goes on with new accounts coming on and what they do over time.

That's great.

One last question, has there been any consideration by FEP of going to a more aggressive mail program, given that they now will have one vendor serving the contract?

Not that I know of.

All right.

Thanks a lot.

Your next question comes from Steve Halper with Thomas Weisel Partners.

My question has been answered.

Thanks.

Thanks, Steve.

Your next question comes from Andy Speller with AG Edwards.

That's Andy Speller.

I knew who it was.

Normally they don't butcher that as bad.

My question has to do with synergy number.

Can you give us any incremental figure that in your '05 guidance?

No.

I mean that's - - we're still comfortable with the numbers that we've given out in the past.

So the number you've given out for this year, you're going hit that target and you're not going really give us any future guidance until you kind of reach your capture rate?

Not until get a little further the road.

Okay, and then just more of a numbers question here.

You were cutting out, Howard, when you gave the revenue growth for the '05 guidance.

Can you repeat that for me.

Yes.

Revenue growth would be approximately 30% over the GAAP basis revenues that we are seeing today.

Over '04.

Yes, for '05. 30% in '05 over '04 number.

Okay.

And then in the interest expense line, how much interest income are you recognizing on a quarterly basis given your growing cash balances?

Let's see, interest income - -

Might have to call us back.

Call Pete back.

He'll give it to you.

Okay.

Thanks.

Appreciate it.

Let me just respond on that last, that revenue growth.

Clear on what you heard what Howard said and that is that's 30% over the GAAP basis.

So, you know, if anybody needs some help on that, give Howard a call.

Your next question comes from Kevin Berg with Credit Suisse First Boston.

Yes, how about the competition from some of the managed care companies.

We hear about them trying to keep more business in house and competing against you for other business.

Have you seen them in your finalists presentations any more so than have you in the past?

Are you talking about the Aetnas of the world and the Wellpoints?

Yes.

No.

And in terms of mail, Mac, also, mandatory mail, are you guys, are you seeing more of that?

From a pure mandatory mail, probably not.

From people, you know, putting in incentives for people to go to mail and refill restrictions.

Or from the standpoint of copay changes, yes I think you have seen some acceleration in that.

But just not pure mandatory, no.

There's more like the [Calpers] type of plan that was announced publicly that type of preferred mail?

Yes.

Thank you very much.

Your next question comes from [Lin Yus] with [Stock Dock] Partners.

Yes.

Good morning. 2 questions.

I was wondering if you could look out 3 or 4 years and tell us what you think the percent of your book of business will be from mail at that point in time versus today?

And then secondly with the expectation of the Medicaid drug benefit kicking in in '06, how you see that impacting your business both from an overall incremental customer base as well as possibly from the greater use of mail as well?

Thank you.

Well, 3 to 4 years from now, I think mail will be a bigger percentage.

That's about as much as I know 3 or 4 years out from the standpoint.

That's depending upon an awful lot of things.

Medicare, the - - you know, several impacts will come out of the Medicare growth benefit.

Obviously given our book of business today, we serve a lot of health plans.

To the extent that they participate in the Medicare program to the extent that they are offering an integrated package, then we will be supporting those customers and working with them.

So I would expect given the concentration that some of the clients that we have in certain marketplaces that if they participate, then we're going to see an increased population base that we're serving with them, with this customer base.

And given the age of the customer base, given just the characteristics of Medicare, given the fact that they are on maintenance medications.

And that should logically lead to the fact that they will be utilizing more mail order services than a typical health plan kind of population.

On the corporate side, you know, we've got a lot of corporate clients that are trying to figure out what do they do.

Do they take the subsidy, how does it work?

We're helping them do a lot of analyses.

I will say anecdotally that from what we're seeing so far, it appears that the corporate customers are leaning to taking the subsidy and continuing their insurance programs that they have had in place.

You will have some that will decide that they will give their retirees incentives to move into a Medicare population.

So, you know, we will see a lot of different things happen.

But until we see the regulations, we don't know exactly, and we see where the risk quarters end up.

Where we will be in that equation from a standalone PDP, is something that we're still evaluating.

Still working on and waiting to see over the next couple of months where that settles out.

Operator, next question?

Your next question comes from Ryan Stewart with Piper Jaffray.

Good morning.

Thanks.

Quick question, you know, Mac it's a small part of your business.

But I was wondering if you could report on how Accord is relative to further integration with the overall business?

As well as any comments you could make relative to the CCIP bidding process.

As far as how Accord is doing, we're taking and we're integrating these specialty operations.

I think that's a valuable asset.

I think they are doing well and doing fine.

And I think that's one of the strengths that we now bring to the table when we get into the, the business of bidding on accounts and particularly with dealing with the specialty side of the house.

When you take all the services and the platform that we have, we think we've got the most robust platform that we've got.

As far as the, the bidding process, the - - I'll let Howard talk about that.

We bid on 2 regions and we're still - - that process still just moving along.

Okay.

Great, and then just one - - if you could share any thoughts, again, sort of from a macro perspective on the potential, to you know, establish more of a local presence to further bolster the specialty pharmacy opportunity?

You know, some local specialty pharmacies to handle some of the compounding that's going to be acquired out of a lot of the drugs that are coming out of the pipeline.

Any thoughts relative to that?

Well, we have local presences now with something over 20 pharmacies spread across the country that do a variety of services.

And so you do have a local delivery side for that business today.

Where it goes in the future and how exactly it goes on the specialty side, specialty being delivered at retail, I think is still an opportunity for this industry in the business that we're in.

And that continues to be a focus of ours because we think we do a better job of it.

We can do a better job of servicing the customer.

We'll continuing focusing on migrating that business out of the retail network into our specialty pharmacies.

Okay.

Do you see an opportunity down at the, you know, down at the very local level with, you know, the compounding actually administering of some of these biologics, or is that business for someone else?

Well, that might be a business down the road.

It's not one that's hit the top of our radar screen.

And it's something that we're focused on that we need to be out doing tomorrow.

Okay.

Thanks so much.

Your next question comes from Michael Maguire with Leerink Swann.

Thanks.

Couple of quick follow-ups.

As it relates to terminated contracts, would it be fair to characterize those, the vast majority coming from legacy AdvancePCS' book of business?

That's correct.

Okay.

On the specialty number, is that a proforma number that you gave us year over year?

Yes.

It is proforma.

And so given that seemingly substantially higher than the market, is there any particular competitive groups that you feel you're taking share from?

And any trends to potentially pull out of that?

It's continued penetration of managed care clients, particularly Advance was just the beginning to penetrate that business.

That was one of the things we saw as attractive to this transaction with our capacity, the greater number of products that we had and the complementary market share.

So that's all part of it.

As well as there were some products that advance was dispensing that we're able to bring into our existing customer base.

I think most of that growth is coming from our existing customer base.

Great.

Thank you.

And just one last follow-up.

On the revenue growth number for '05, is there a contract accounting change we should be thinking of, or is there a proforma number perhaps you could give us?

Well, that was based off of the roughly 25 to 26 billion revenue estimate that we've got out there, so that's the basis for the 30% growth rate from the 25 to 26 billion.

Okay.

Thank you.

Your next question comes from Michael Baker with Raymond James.

Yes, first follow-up on the Medicare discussion.

More specifically, are you seeing in the administration some willingness to bend on the risk corridors, either narrow them to make them more attractive from your perspective?

Those are the indications that we're getting.

Okay.

And then I had another follow-up.

And that is you're beginning to see corporations which provide retiree benefits disclosing whether or not they plan to take the subsidy.

Within your book, are you seeing any trend along those lines?

Several of our customers have been among those that have disclosed changes to their retiree expense - - reductions of expenses.

As Mac said earlier, a lot of our customers, we think a lot of them will take the subsidy route.

Yes.

I think the trend that we're seeing right now now is more leaning towards the subsidy route.

Isn't it, Howard?

Yes.

Thank you very much our next question comes from Matt Perry with Wachovia Securities.

Hi.

Just of quick follow-ups.

On the Medicare drug card, could you comment on the enrollment in that program?

And if it accelerated at all in the third quarter?

And secondly, I think last quarter's conference call you said potential new sales pipeline stood at about 4 billion.

Just comments on maybe how much of that business you might have signed up between that call and this call.

And, you know, whether or not you're still competing for a significant portion of '05 business.

There is a good bit of '05 business that we are still competing on that are mid year kind of starts.

Still getting RFP's in from that standpoint.

And still got a robust pipeline in that regard.

I don't have a number off the top of my head to - - giving the 1.2 billion to break it down if quarters.

I just don't have it sitting here.

I think the pipeline still sitting is around $3 billion or thereabouts that we see in front of us that are still '05 starts out there.

And I'm sorry.

I've - -

Medicare drug card, it's been basically flat and you know, this is not something we pay a lot of attention to.

No, it's such a small part of the business.

Most of it - - and you know, the enrollment we continue to get, a lot of it comes through the health plans that we're servicing.

So we got over 20 of those that we're taking care of.

And would it be safe to assume that drugs spend for that program is pretty insignificant?

Yes.

Okay.

Thank you.

Your next question comes from Rashid Sinoan, GIB.

Yes, hi.

Just wonder if you can comment on your capital structure and your debt leverage?

Where you stand at the moment and where you would like to be in the short-term, please?

Well, you know, did the debt that we have right now is obviously about $600 million. 450 of that being Senior Notes that are not repayable until, not called on until '06.

And the balance of it being a term loan.

So I mean we're not levered at all.

As far as in the short-term, you know, I see it staying at about the current levels that they are sitting at today.

Okay.

Thank you.

Your next question comes from Skip Kline with GOS.

Yes.

What are you guys doing in terms of tax planning to make sure we don't pay any cash taxes for a decade?

Well, if you got some great ideas on how to do that because I don't have any ideas how to do that?

Because I don't know how to do that unless we go buy a Company that has a huge NOL that we can utilize, which is hard to do.

We're going to exhaust the NOL as we said at mid '05.

And so we're going start paying taxes at some point here in the next 12 to 18 months.

Okay.

So that we should dial into the cash flow for sure?

Sure.

Thanks a lot.

At this time there, are no further questions.

Gentlemen, do you have any closing remarks?

Yes.

Let me just close it real quick, operator.

Thank you, everyone, for dialing in.

We did have a good quarter.

As we told you, we gave you the guidance that we said we would give.

We're around if you have any questions, clarifications, give us a call.

And we appreciate the attendance.

Thank you very much.

Ladies and gentlemen, that concludes the Caremark RX third quarter 2004 earnings conference call.

We do thank you for your participation.

You may now disconnect.