CVS Health Corp (CVS) 2005 Q1 法說會逐字稿

Good morning my name is Annette and I will be your conference facilitator.

At this time I would like to welcome everyone to the Caremark Rx first quarter 2005 earnings release 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. [OPERATOR INSTRUCTIONS].

Thank you.

I would now like to turn the conference over to Mac Crawford, Chairman, President, and CEO.

Please go ahead, sir.

Okay.

Thank you, Annette.

And good morning, everyone.

And thank you for dialing in.

Before we get started let me go ahead and read the forward-looking statements.

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 its senior management team with respect to the anticipated growth prospects for the Company's business, including revenue growth and earnings per share projections, as well as the assumptions upon which such 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 the respect to the Company's operating plan and objectives, as well as adverse developments in the healthcare or 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, 2004, and the Company's other periodic filings from time to time with the SEC.

This conference call includes 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 those most directly comparable to GAAP measures.

Well, again, good morning.

Thank you for dialing in.

Joining me today are Howard McLure and Pete Clemens.

I will go through a brief discussion, Howard will give you more details, then we'll take questions.

Today we reported earnings of $0.43 per share for the first quarter of 2005, which is in-line with the upper end of the most recent guidance that we had given and is in-line with the First Call estimates.

These earnings represent a 34% increase over the same period in 2004 on a GAAP basis and a 59% increase on a pro forma basis.

Revenues increased $5.4 billion on a GAAP basis and 10% on a pro forma basis to 8.4 billion.

We saw a very strong quarter in mail service much of which is related to the new book of business which started January 1, 2005.

And which was very heavily mail oriented.

In fact, on a pro forma basis, mail pharmacy revenues increased 34% for the quarter.

Retail revenues increased 1% during the quarter and retail claims decreased 5% on a pro forma basis, which I'll talk more about in a second.

Obviously, we're very pleased with the increase in the mail service revenues as this represents a more profitable part of our business.

Also included in the mail numbers are especially mail revenues and scripts which saw its strong growth continue in 2004 and if you'll recall that growth in 2004 was in excess of 30%.

We received some questions this morning before the call regarding gross margins.

Let me point out a few things to you.

First, this has been a historical trend for the Company.

The first quarter has always been lower than the preceding fourth quarter.

There are reasons for this.

First, we have typically brought on large new books of business and this year was no exception where we incurred additional cost in bringing these large books of business on.

Two, we do not know how other people record rebates, but we record them as earned.

This is something we've talked about before.

And as if the contracts with manufacturers ended today that is what we would collect.

Therefore, we do not make estimates for the full year and record them evenly.

This means that our ingredient costs will be higher earlier in the year than they will be later in the year as we achieve higher levels of savings and discounts.

And we, frankly, believe this is a conservative and proper way to record these discounts and that is -- this is what we would get if the contract ended today and this is exactly where we've earned to.

So we're not trying to estimate and look forward and guess what we may do later in the year.

Second, only business we typically find that formulary compliance is not as high in the accounts that we bring over from competitors as they are in the accounts that we manage.

The large account that we brought over this year was formerly with a competitor that had a much higher percentage of one manufacturer's products on their formularies than we have from that manufacturer.

Therefore, it will take some time to get formulary compliance with our formularies at the levels that we expect to see which impacts our cost.

We know this, we budget for it.

Finally, we specifically stated last quarter that sequentially earnings per share for this quarter would be less than the fourth quarter.

Again, with historical trends.

Given all the information that we gave you in the last earnings release, you should have expected that gross margins would be what gross margins are today.

As a matter of fact, for the gross margins that we're showing is exactly what we had budgeted for the year from our internal budget standpoint.

I hope this clears up any questions that you've got.

This is the way that it's typically been, but we did receive questions before the call started.

We wanted to clear that up so you understood.

The other thing I would tell you to look at, gross margins are actually up on a quarter-to-quarter comparison.

I think from about 5% to 5.8%.

So trends still look good.

It is what is consistent with our book of business.

It is the way it's been done.

It is consistent with the guidance that we gave you last quarter.

Let me spend a couple of minutes talking about retail revenues and scripts.

The decline in retail scripts is primarily attributable to two Legacy advance accounts.

The first is HCSC which Blue Cross/Blue Shield of Illinois in Texas, and the other is Great West.

Both of these accounts were primarily retail in their nature and their terminations were disclosed in 2004.

Also expect the retail claims to continue to decline over the remainder of the year as one large health plan that we only do claims processing for will terminate.

We were not making any money on this account when you consider the data processing costs that we were incurring to service it.

Also the State of North Carolina which was almost all retail [is] left, and we'll see some mid-year turns, including the State of Illinois which has already been publicized which will have a negative impact on retail claims volumes in particular.

Again, all of this has been taken into account in the guidance that we've given you today.

Talk a little bit about cost.

You saw good leverage in SG&A expense during the quarter.

This is an ongoing trend for us as SG&A actually decreased in absolute dollars from the same quarter of 2004.

Here you see the impact of the synergies on that line in the income statement as a result of us implementing the programs that we put in place from the acquisition of AdvancePCS.

SG&A was $117.3 million for the quarter in the March 31, 2004, and 110.7 for the current quarter.

I will also point out that cost of revenues increased at a slower rate than did our revenues themselves.

All this resulted in EBITDA of $368 million for the quarter representing a 45% increase over the first quarter of 2005 pro forma EBITDA.

Again, a very strong performance.

EBITDA for adjusted claim was $2.13, a 44% increase over pro forma numbers for 2004.

The balance sheet remains strong.

We've paid down debt and repurchased shares under the Share Repurchase Program.

The only debt we now have outstanding are the 7 3/8% bonds which are noncallable and mature in October in 2006.

Moving to Medicare, as I stated before we are not going to compete with our customers in this book of business.

We are supporting both our health plans and corporate customers as they evaluate and plan what they're going to do.

We're building the infrastructure that we need to build to support all the alternatives that are available to our customers and to us.

At this time we have customers who are going to be PDP's that we will work with, including those that are planning for the deal eligibles as part of their base business.

It's too early to quantify the amount of new business that we will see from this program or exactly when we will see it.

However, it is clear that we will work with a number of our customers who plan to be actively involved in the Medicare program.

To the extent that we decide to become an open PDP there's a June deadline for submitting bids.

We're still working on this from a financial and actuarial standpoint.

The bottom line in Medicare is that we expect to be a significant participant in this program.

Regarding the 2006 sales season we're early into the season, but we're seeing a number of opportunities.

We will update you later in the year as the sales cycle matures.

The integration of AdvancePCS has gone well and we've achieved the synergies that we indicated that we would achieve in 2004.

We remain comfortable with the total synergies of $250 million.

Looking at the remainder of the year, we have previously given you a range of $1.88 to $1.92 for earnings per share for 2005.

We have now raised that guidance to a range of $1.92 to $1.94 per share for 2005.

Another good, solid, busy quarter implemented a very large book of business while still hitting the earnings levels that we said we would achieve.

You saw the increases in EBITDA.

You saw the increases in earnings on a percentage basis.

You saw the increases in EBITDA per script.

The earnings were good.

The balance sheet continues to be strong.

At this time Howard will give you more detail and as I said we'll come back and take questions.

Howard?

Thank you, Mac.

And good morning, everyone.

I will go through our GAAP performance for the first quarter, as well as our performance on a pro forma basis, assuming AdvancePCS was included for all of the first quarter in 2004.

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

As a result Caremark's GAAP results included the AdvancePCS operations for the full first quarter in 2005, but only from March 24th through March 31st in the first quarter of 2004.

In the first quarter of 2005, Caremark reported diluted earnings per share of $0.43 which includes integration and other related expenses of $1.2 million or 0.7 million after taxes.

Excluding integration and other related expenses, earnings per share for the first quarter were $0.43 in-line with First Call consensus estimates.

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

This represents diluted earnings per share growth over the comparable [prior] period of last year of 34% for the quarter.

Revenues were 8.4 billion for the quarter, an increase of approximately 5.4 billion over the same period in the prior year.

EBITDA for the quarter, excluding integration and other related expenses was $368 million, an increase of $194 million over the first quarter of 2004.

On a pro forma basis assuming the AdvancePCS acquisition was included for the entire first quarter of 2004 as it was in 2005, mail claims were 14.3 million, an increase of 26%.

Our mail penetration rate was 24% in the quarter compared to a pro forma 2004 mail penetration rate of 20%.

Retail claims were 130.3 million for the first quarter of 2005 compared to pro forma retail claims of 137.7 million in the first quarter of 2004, a decrease of 5%.

Retail claims for Legacy Caremark customers grew by 6%.

Net revenues in the quarter increased 10% from pro forma first quarter 2004.

Caremark's success in driving generics increased our generic dispensing rates at mail and retail, which due to the lower price of the generics reduced our total revenue growth by approximately 4.6% for the quarter.

Generics reduced topline revenues but generated savings for clients and higher gross profits for us.

Our mail generic dispensing rate for Q1 '05 was 39.5% compared to 36.8% for pro forma Q1 '04.

Our retail generic dispensing rate for Q1 '05 was 52% compared to 41.8% -- excuse me, 48.1% for pro forma Q1 '04.

On a pro forma basis EBITDA, excluding integration and other related expenses grew 45% over pro forma first quarter 2004.

EBITDA per claim in the first quarter of 2005 was $2.13, an increase of 44% over pro forma first quarter 2004.

Diluted earnings per share, excluding integration and other related expenses of $0.43 for the first quarter of 2005 increased 59% compared to pro forma diluted earnings per share of $0.27 in the first quarter of 2004.

Turning to the balance sheet, our March 31, 2005 cash and short-term investments were $1.3 billion and total debt outstanding was approximately $452 million.

During the first quarter we repaid the term loan that was outstanding at December 31, 2004 in the amount of $147 million.

On April 1st we called the remaining 1.7 million in old advanced notes, but at the current time our total debt outstanding consists of Caremark's $450 million Senior Secured Notes due in October 2006.

Cash flow from operations in the first quarter was 267 million, up $64 million over the same quarter last year.

Capital expenditures totaled $27 million for the quarter.

During the quarter we purchased 2.1 million shares of our common stock for a total expenditure of approximately $80 million.

These share repurchases had the effect of increasing EPS less than 0.25 of $0.01 in the first quarter of 2005.

Since the end of the first quarter we have purchased approximately -- an additional 2.2 million shares for a total of approximately $84 million.

As noted in our Press Release we have increased our diluted earnings per share guidance for 2005 to the range of $1.92 to $1.94.

We expect our 2005 revenue will grow in the range of 25% to 28% over 2004 GAAP-based revenue.

Guidance is based on a number of assumptions including the following items.

Stock option expense is expected to total $13 million in 2005.

Since we last provided guidance the SEC has delayed the implementation date for FAS 123R to January 1, 2006, and July 1, 2005.

We will continue to expense those options that relate to the Advance acquisition in 2005.

The FAS 123R would have resulted in approximately $6 million in additional stock option expenses in the second half of 2005, which we included in our previous guidance.

Amortization expense related to certain identifiable and tangible assets is estimated to be approximately $47 million and appreciation expense is expected to total approximately $105 million in 2005.

Net interest expense for 2005 is expected to be in the range of 3 million to $7 million.

Company's effective accounting tax rate is expected to remain at 39.5%.

We continue to expect that the federal net operating loss carry-forwards will be substantially utilized in the second half of 2005.

Our 2005 earnings guidance does not include integration and other related expenses associated with the acquisition of AdvancePCS.

The upper requires the cost associated with the integration and rationalization, certain Legacy Caremark operations be expensed while certain costs associated with the Legacy AdvancePCS operations are able to be capitalized.

While we incurred most of the expense associated with the integration of AdvancePCS during 2004, we continue to expect certain additional expenses to be reported in 2005.

In terms of share count, we currently expect that weighted average shares outstanding assuming full dilution will be approximately 459 million shares in Q2 and should be 460 million shares for the year 2005.

These numbers take into account only share repurchase activity to date and will vary based on the market value of the stock and future option activity.

As you will recall, in our previous guidance we had estimated shares outstanding to be approximately 464 million shares for 2005.

We expect capital expenditures for 2005 to total approximately 135 million to 150 million.

From a cash flow perspective we estimate that two items that we discussed at year end will continue to impact 2005 cash flows from operations.

First the Company will fully utilize a net operating loss carry-forward for tax purposes in the second half of 2005 and we will begin paying taxes at a higher rate.

Second, we have collected a significant amount of manufacturer accounts receivable for Legacy AdvancePCS relating to the time period [proxy] acquisition in 2004.

A good amount of our clients for their share of these rebate collections during the first quarter of 2005, we will still have payments due to customers that will fall into the second quarter of 2005.

However, we do expect that our cash flow for the full year 2005 will be comparable to 2004 after adjusting for the increased tax payments and the reduction in claims payable for terminating clients we discussed at year an end.

As we announced in our Press Release today we expect second quarter 2005 diluted earnings per share, excluding integration and other related expenses to be in the range of $0.45 to $0.46.

Thanks, and now I'll turn it back over to Mac.

Okay.

Thank you, Howard.

And I know we gave you a lot of information there, so we'll be glad to come back and circle up and answer any questions that you have about it.

At this time, Operator, let's go ahead and take questions.

[OPERATOR INSTRUCTIONS].

Your first question will come from Eric Veiel with Wachovia.

Good morning, guys.

A couple of quick questions here.

First, Mac, if you could just help us think about the contracts that you're going to be losing at the end of the year, the health plan contract and, in particular, the data processing cost that you referenced there how you guys go about recouping those, is that something that's a variable cost in your cost structure?

Yes.

And as it relates to this account it was variable costs in the cost structure, so those costs will go away.

Okay.

Great.

So we shouldn't expect an impact from a net earnings basis, but just an EBITDA per script improvement in a lower retail count basically?

That's correct.

And this was a client that, again, we were just doing claims processing for, they were doing all of their own manufacturer contracting, everything else.

We weren't making any money on it and so you're exactly right.

We will see a reduction in claims volume, but we will see no impact to the bottom line, and because of the claim account reductions and it should be an increase in our EBITDA per script.

Great.

And then second question relates more towards the Medicare side.

Does the guidance contemplate any spending related to direct consumer advertising or any build-out there and might that change as you sort of weigh the options over the course of the year?

We don't expect to do any significant direct consumer advertising.

As I said again, most of our business we expect will come through the health plans that we do business with today.

You know, there could be some minimal amount as we get towards the end of the year, but I think in reality given the way that this program will ramp-up in transition, any of that that we may do, and that's assuming that we do, do any would not have a significant impact on this year and more likely come in next year.

Great.

Thanks very much.

Your next question is from Lisa Gill with JPMorgan.

Thanks very much.

Mac, thanks for the additional detail on the gross profits.

Could you just talk a little bit about your expectations around compliance for the -- compliance of the formulary as we get throughout the year.

So should we see a sequential improvement in gross profit as these numbers are now shifted over to your formulary?

And then secondly, can you talk a little bit about specialty pharmacy and talk about where you see the growth, what the drivers of the growth are, and then more importantly, where are you on a percentage of penetration basis with your existing clients?

What's the future opportunity?

Sure.

As far as compliance of the formulary, yes, I mean, that is typically what happens within our book of business is that we see formulary compliance go up the longer that we have the account.

So our anticipation is that that will continue to happen and take place over the rest of the year.

On the Specialty Pharmacy business, we have continued to see good growth in the MS sector and we've seen it in PAH.

We've seen it pretty much across the book of business with the exception of those accounts that we've always said or those areas, such as hemophilia, growth hormone that are fairly static and stay pretty much where they are and don't have a lot of organic growth to them.

But we've seen the growth take place pretty much across the book of business.

What was the other part of the --?

What's your opportunity, how penetrated are you today with your existing accounts for specialty?

I'd have to look that number up.

I don't have it off the top of our head.

But there's still a lot of opportunities, and that's why you're seeing some of this growth that you're seeing.

And that resets -- as an example, we're seeing good growth in the FEP book of business on specialty.

And so we've just barely started penetrating that but we've got a lot of room there.

So is it safe to assume that all new business that you win these days also includes Specialty Pharmacy?

Well, it has been for some time that we had specialty pricing in almost all of the new business that we won.

Specialty was something that, as you recall would be normally a second and third year kind of sell into the account.

And the FEP book of business, it started first year and that was the way that contract works.

So that has been good for us.

Let me also mention that in the Medicare program in the demonstration project, we are I think the only specialty provider of size and scale doing that demonstration project.

We are seeing good growth coming out of that opportunity also.

So when people talk about what are doing in Medicare a lot of times people forget about the specialty side and that we were the one chosen to be the player in the demonstration project.

So we've seen growth coming through that also.

Can you talk about how big that demonstration project is, Mac?

Well, it's -- had been estimated by some people to be as large as 500 million.

We've discounted and cut those numbers back because that was a government estimate and didn't feel like it was what it should be.

Yes, I think currently we're running probably around $100 million in that program today and that is on a fairly quick ramp-up and it's coming through the mail side.

Great.

Thanks for the details.

Your next question will be come from Christopher McFadden with Goldman, Sachs.

Good morning, Mac.

Good morning, everyone.

Taking into account, obviously, some new contract win jets and pretty significant SG&A leverage, certainly on dollar terms on a quarter-over-quarter basis.

Can you talk about, you know, some of the dynamics that helped contribute to that and I guess how are you feeling about cost savings and synergy realization relative to the AdvancePCS relationship, particularly in the context of some of the IT infrastructures that two organizations have brought to the table?

Thanks.

All the sidings in this have not come out of the IT side of the house.

That is where we continue to make the investments and we had already said that that's part of our core operations that we didn't expect to see synergies come out of.

The synergies have really come out of other areas on the SG&A side.

We were able to rationalize from the sales forces to accounting to all the other areas administrative areas that we do business in, and you're seeing it come through these numbers the opportunity of having a much bigger book of revenue and book of business, and that you just don't take one plus one and it becomes two.

Hopefully it's one plus one becomes 1.5 when you put companies together.

And we did a lot of planning on this synergy front, and that's where the success has come from as we've done this.

Your next question will come from Tom Gallucci with Merrill Lynch.

Good morning.

Thanks.

Just a follow-up and one other question a follow-up on the health plan, claims processing business, can you give us an approximate size or script count so we can kind of have that accurately project as we look forward?

Until the -- unless the client approved us to give that out, I don't think that would be appropriate for us to do that because we typically don't talk about individual client information like that, particularly one that has decided that they'll go somewhere else, so.

Okay.

On the --?

We'll try to figure out some way to get you all some guidance on that without giving out confidential information.

Okay.

Thanks.

And on the specialty landscape, just kind of as a follow-up to Lisa, what do you see in terms of the competitive environment, obviously the underlying growth in that business is pretty strong and there's some penetration left in your existing business, but your peers are obviously pushing harder there, so can you talk to the competitive landscape and maybe relative pricing?

Oh, it's competitive just like our PBM book of business is competitive.

We do continue to see strong growth in that area.

The Medicare project obviously you would not expect to be at the same kind of margin levels that your other book of business is.

So yes, we see a competitive marketplace there, but, you know, I've learned in this business that's the environment you're going to be in so you've got to keep your cost down and you've got to grow your volume.

And then in terms of the pipeline, obviously the selling season, it's pretty early there.

You usually say about a third of your business comes up for renewal each year based on an average three-year contract.

Is it a disproportionate amount up for renewal as we look into '06, given kind of the combining of the two companies or is it a pretty average year?

No, I think it's a fairly average year.

We're still sorting through some of the Legacy Advance accounts.

But no, I think other than that, it's a pretty average year.

Okay.

Thank you.

Your next question is from Steven Halper with Thomas Weisel Partners.

Hi.

Are you incurring any incremental cost to prepare for part D as your customers prepare for part D?

Well, sure.

Can you quantify that?

I mean we don't -- that's a cost of doing business.

That's like doing anything else that we do and I think you start quantify whether it's for this book of business or that book of business and we don't even try to break that out to do it.

We manage our departments and our cost and that is just part of our cost of doing business.

But, yes, we are incurring additional costs.

Great.

Thanks.

Your next question is from Ricky Goldwasser from UBS.

Yes, good morning.

Good morning.

On a sequential basis it looks like your retail generic utilization rate was up about 200 basis points, but if you look at the mail segment which is more profitable was up only about 20 basis points sequentially.

Can you talk a little bit about this trend?

Does this reflect in FEP contract and, if so, is it something that you expect to change further in the year, or is this just the structure of the account?

No, I think the major impact does come out of that FEP contract and, yes, we expect over time that those numbers will change and will improve.

So as far as how we kind of look at that and kind of in our models, we shouldn't expect some uptick in generic utilization rate both on a sequential basis not only on year-over-year?

Well, the numbers that we have given you take into account what we think will happen across everything in the book of business.

And that is one of the components of it.

The -- so the numbers we have in it have that in there, but we'll see some improvement this year.

Okay.

Thank you.

Your next question is from Kemp Dolliver with SG Cowen & Company.

Thanks and good morning.

The first question is, based on what your clients have decided so far, Mac, are you pretty well -- going to be pretty well represented in most of the regions or do you still have some gaps you're trying to fill?

Just by our book of business, Kemp, we're going to be pretty well represented not in every region, obviously, because you've got some that are not in there, but most of them we are represented in.

Those that we are not represented in are obviously those that we're evaluating to say, do we want to be in that region as a PDP ourselves.

Okay.

Thanks.

And there was I guess a change in the goodwill assigned to the Advance transaction.

Could someone just talk about the major components of that change because there was some reference to I think legal expenses in particular?

Well, it had to do a lot of different things from, we referenced the legal in there, but it also had to do with some reconciliations of intercompany accounts.

All this was balance sheet entries that had to be taken care of.

It dealt with some receivables that were on the books that had to be dealt with differently.

So all of it was balance sheet-related and all the entries were to the balance sheet.

That's great.

Thank you.

Your next question is from Andy Speller with A.G. Edwards.

Hi, guys.

I have got a couple questions.

First of all, Howard on the cash flow assumption for the year, if on a reported basis you'll be down from where you were in '04; is that correct?

That's correct.

Okay.

And then on a go-forward basis with regard to the retail volume in terms of timing of business coming out, can you give us just some help with regard to modeling on a go-forward basis sequentially for the next three quarters?

That retail stuff I would have seen that effect in Q1.

Okay, so there's not going to be all that much impact on a go-forward basis from other clients coming out?

Talking about on a script basis?

Yes.

Yes, scripts will come down.

Now, one of the unknowns is this health plan that we talked about whether it goes off at the first or the fourth quarter or stays throughout, we don't know.

It's a little uncertain on that one so that one's a little bit hard to estimate for you.

The other I guess, and we will see some dip down in the July quarter as we have -- well, we'll see some this quarter because the State of Illinois went off -- or State of North Carolina, we'll see July 1, State of Illinois.

So both of those we will see some dips in.

I do not, Andy, at the tip of my fingers have those retail counts on those --.

Okay.

I'll follow-up later, but that's helpful.

That's how I thought it hit.

Yes, the North Carolina's the first of this or the first or the second quarter and Illinois would be the first or the third quarter.

Okay.

And then lastly in terms of the 250 million synergy count, how much additional do we have to get to that number?

Not much.

I mean, you're not at that run rate right now, right?

We're getting close.

Okay.

Thank you.

Your next question is from Larry Marsh with Lehman Brothers.

Just a follow-up with Kemp's question on the increase in goodwill.

Are you breaking out how much of the increase would be associated with legal matters, Mac?

No.

Okay.

Second, I guess second question just on elaboration, you're basically communicating that the sequential reduction in gross profit per adjusted script, EBITDA per adjusted script is more to do with how you accrue rebates, obviously you're not going to book them until you earn them, as well as the impact of FEP even though it's a mail contract; is that right?

Yes, I mean that's just typically the way that our, -- if you go back to the previous years and from the guidance we gave you, that's just the way it has worked in the past is that we have a -- if you look on a quarter-to-quarter comparison on say '05 to '04, '04 to '03, you will show good growth in our EBITDA margin, but as far as compared to the fourth quarter, it will be down.

The biggest impact of that is how we record rebates.

The other impact though this year was also just the fact that you had a very, very large account being FEP come on board that had different compliance with the formulary kind of rates than we see in our other book of business.

The biggest piece of it though is still going to be just from how we record rebates and that's just traditionally the way it's been.

As the year goes on, we hit the tiers and we earn greater amounts and our gross profit changes.

So that's still the biggest piece of it.

Right.

And historically you've seen some uptick in those metrics as you go every quarter throughout the year?

Sure.

Is there any reason to think that would be different this year?

No.

Okay.

Two other things, just confirm.

So I guess, the 75 million retail impact is mostly first quarter which is what Howard talked about at the end of the fourth quarter.

So we should not see that replicated into Q2?

The cash flow impact you're speaking of there, Larry?

Yes.

Yes, that's correct.

Okay.

And then third, let's see, part D, I know you -- you don't want to break out any incremental costs associated with the investment for '06.

Mac, I know you've talked about in the past trying to temper people's expectations of what it would look like.

Would you still I guess characterize '06 as being a transition year and that really '07 would be the full ramp year or is there anything in your expectations that has evolved here in the last month or so?

Well, I still think '06 just from the program as a whole is going to be a transition year.

We do have some health plan clients that want us to work with them that I think are going to be fairly aggressive in going after some of this business.

And that has probably solidified or is in the process of solidifying itself more than it has been just as we're seeing more going on with the program which is the same thing that we said before.

As we get more guidance, and we learn more we'll know what to do and our health plan clients are in the same position.

So we've got some I think that will go after it fairly aggressively next year.

I still think that the barriers that the program faces is -- are still the same.

One, the seniors resistance to change and their understanding of this program.

The amount of promotion that the Federal Government does to get the program off and running.

And the still uncertainty about exactly when people are going to get approved, when open enrollments is really going to start, and when you can really expect to see the people coming in.

Outside of the eligibles, which January 1 will get assigned, but we have some clients that are very interested in this dual eligible population that we will benefit from as they come into the book of business that we're serving.

So, I think we're getting more clarity to it.

As I said, we expect to be a significant participate.

It's still I think would not be appropriate on my part to try to jump out and say this is the revenue that I expected to get out of it or these are the number of lives that I expect to get out of it and this is when it expects to come because I think anyone that says that they know exactly when that's going to be is just making a guess.

So we try not to guess.

We try to give you numbers that we feel good about and then where we are.

But I also think that people that view us us from the standpoint of this is how we do our business, and we're conservative about what we do, and what we say.

Anybody that takes that as saying, well, that means you're way behind in what's going on in this program, I think might be making a mistake in making that assumption.

Got it.

Right.

And then finally I know you had said -- you pointed out that '05 on generics is not as big a year as '04 but '06 obviously, much bigger.

You've mentioned 460 basis points of topline impact this quarter.

I that -- do you anticipate that being fairly consistent throughout this year with generics?

Yes, I would expect that.

Maybe pick up some next year with better opportunities?

No, you're actually going to see that number next year if the drugs go generic that we hope will go generic will have a bigger impact on obviously our revenue.

That will decrease our revenue, which is good news.

Right.

So you'd see that in the higher gross margins or higher gross profit per adjusted script?

You could, yes.

Good.

Okay.

All right very good.

Thanks Mac.

Your next question is from David MacDonald with SunTrust Robinson Humphrey.

Yes, good morning, guys.

Two questions.

Hey, Mac, you talked a little bit about you guys having a normal book of business out for bid this year.

I was wondering if you could give us a little more detail on the pipeline in terms of size of opportunity, if it's weighted towards a certain type of account, managed care, large group employer, et cetera?

And then I just had one follow-up?

Depends on who you talk to as to what you get as a size of opportunity.

I've seen some numbers out recently that are a little bit larger than we think they are.

But it's in excess of $5 billion, 5 to $7 billion is what we view the size of the pipeline currently.

But that changes every day as we continue to get RFPs in from different people.

I think that it is a lot of some fairly large managed care accounts that are out there today.

You've got probably, oh, 30% of it being employer government business. 60 or 70 being managed care opportunities is the way we view it today.

Okay.

And Mac, one other thing.

Can you quantify to some degree, obviously before you guys had the FEP mail there was not a lot of incentive historically to look at the retail book and maybe move some retail folks who I could have been better mail customers towards mail.

Can you give us some sense in terms of what percentage or anything anecdotal in terms of the retail book of business and how much of that you think could move to mail now that you have both pieces?

On the FEP side?

Yes.

We are sizing that still, but it is a very large mail account already from the penetration levels that were there.

So it's a little bit early in our analysis of the account to say exactly what might could.

Okay.

Thank you.

Your next question is from Michael Baker with Raymond James.

Yes, I was wondering if you could give us a sense of whether or not any of your contracts include 90 day retail option and, if so, if you've seen any impact to mail volumes?

And then I just have another question after that.

Mark, some of our health plan accounts that have had that provision in it -- I guess some of these Legacy Advance accounts that we've picked up have been in there historically.

I don't think that we have seen any erosion of our mail service as a result of that.

Okay.

And then my other question has to do with the selling season, and as that develops, are you seeing any new contract methodologies introduced either by yourself or your competitors?

We're trying some different things and doing some different things this year.

I'm not going to speak to what they are because it's competitive in nature, and we're early in the season but, yes, we're going to do some different things this year.

If you can't talk specifically can you talk generally, for instance, is it on the rebate side, the retail spread side or the admin fee?

I'm just going to do some things differently, again, it's very competitive from our standpoint, and we'd rather it stay that way.

Thank you.

Your next question is from Michael Maguire with Susquehanna.

Thanks.

Just a quick follow-up on the pipeline question, Mac, could you just give us some sense as to perhaps how much of that is competitive in nature versus organic or carve-out opportunity?

Mike, I don't know that I've got how much of that is coming out of the carve-out and how much of it is from other competitors that we have.

If it's typical with the past years, it will be primarily on a competitive basis, but there'll be some new carve-outs.

As we go on to some other questions, I'll see if I can find that quickly and come back to you and give it to you.

Okay.

Thanks.

And Howard, real quick.

I apologize.

Just wanted to get the detail on the stock option expense.

You mentioned the prior guidance included that potential impact.

And can I assume that you removed it with the new guidance number with regards to FAS 123?

That's right.

The prior guidance was 19 million.

The current guidance is 13 million.

Okay.

Thank you.

Thank you.

Your next question is from Robert Willoughby with Banc of America Securities.

I apologize if you've answered this one, Mac, but just based on the substantial plan sponsor interest to date in the Medicare program and some new entrants in the business, as well as maybe some of the prospects for some of the captive PBMs improving.

Do you see the opportunity for additional consolidation among at least the three-leading independent PBMs at this point?

Well, I don't have any idea about that.

That's probably -- it deals with antitrust and a lot of other issues that I don't have the answer to.

And I assume you're talking about the three of us consolidating or us consolidating other people?

Either/or but it would seem to me based on more competitors out there with Rite Aid getting into the business, some of the captive HMO PBMs doing a bit better.

As the FTC, have they changed any view of the competitiveness of the business?

I haven't asked them, so I don't know.

Thank you.

Your question is from Justin Boisseau with Gates Capital Management.

Hi.

I was wanting to ask a question about cash taxes.

Once you all use up the NOL the second half of this year, what would you expect your cash tax provision to be on a go-forward basis?

Estimated cash tax payments or -- there's no --?

Are you talking about differences, timing differences and the permanent differences in what we're booking on the income statement?

Yes, I presume that the tax rate, the tax provision will be similar in '06 to what it is in '05, but once the NOL is used up you'll probably plan a much higher cash tax each year.

And I was wondering what you estimated that to be as a percent of your tax provision?

It's probably roughly the same -- well, let's see.

It will be GAAP today -- I'm trying to understand the GAAP today.

If you took a look at the cash tax disclosures that were in there today where we talk about taxes and looked at that in relation to the NOL utilization and get an idea of what that percentage looks like.

It's probably from a timing difference standpoint there aren't significant timing differences in the business.

So it's probably 2 or 300 basis points less than the rate.

Okay.

Thanks.

Yes, I mean, it's not going to be a great deal of difference.

At this time there are no further questions.

Are there any closing remarks, gentlemen?

Thank you everyone again for calling in.

We had a good quarter.

You've seen that we're going to have a good year.

The numbers are strong.

The balance sheet is in extraordinary shape.

And if you have any questions, give us a call.

Thank you very much.

Thank you.

This does conclude today's Caremark Rx first quarter 2005 earnings release conference call.

You may now disconnect.