CVS Health Corp (CVS) 2005 Q3 法說會逐字稿

Good morning.

My name is Thea and I will be the conference operator today.

At this time I would like to welcome everyone to the Caremark Rx third quarter 2005 earning 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 session. [OPERATOR INSTRUCTIONS].

Thank you.

I will now turn the conference over to Mr. Mark Crawford, Chairman, President and CEO.

This is Mac Crawford, not Mark.

Good morning everyone.

Thank you for calling in.

Before we get started let me read the forward looking statement.

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 contained in 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 2005 and 2006 earnings per share projections, 2005, 2006 revenue growth and the anticipated impact in 2006 of the Company's Medicare Part D programs 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 not contemplated by the forward looking statements in 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 or pharmaceutical industry generally.

Additional factors that could cause actual results to differ materially from those contemplated in this conference call can be found on the Company's annual report on form 10-K for year ended December 31, 2004 and the Company's other periodic filings from time to time with the SEC This conference call includes certain nonGAAP financial measures as defined under SEC rules.

As required by SEC rules, we are providing in the footnotes to the tables attached to the press release a reconciliation of those measures to the most directly comparable GAAP measures.

Good morning again and as you know we are now three-fourths of the way through 2005 and also have a full 18 months past the closing of the transaction that put the two Companies together.

The results have been very good and I'm particularly proud of the hard work that all our employees put into generate the results that you are seeing today.

As we will discuss we've had another quarter of strong operating performance and after we get through discussing it we will be happy to take questions from you.

This morning we reported diluted earnings per share of $0.51 for the third quarter, which is equal to the guidance that we gave last quarter and the first call consensus estimates.

Revenues for the quarter were 8.1 billion, an increase of 8% over third quarter 2004.

We saw strong growth in our mail service revenues and scripts as mail pharmacy revenues increased 33% and mail claims increased 23%.

Our mail penetration rate continues to rise as it was 27% in the third quarter.

Also included in our mail numbers are our specialty operations, and revenues in our specialty business grew approximately 44% during the third quarter as compared to the same period in 2004, continuing the healthy growth that we have seen this year.

Retail revenues in scripts declined as compared to the same period in 2004.

Please remember that we have previously stated that we expected the decline in the retail portion of our business as we lost some accounts that were primarily retail in nature.

Also increased generic utilization impacted revenue growth.

If generic utilization were the same in 2005 that it was in 2004, then revenue growth would have been 13% as compared to the 8% that we reported.

Speaking of generics, generic dispensing rates continue to increase with mail GDR.s at 39.8% and retail GDR.s at 53.7% for the quarter.

EBITDA excluding interest and related expenses for the quarter was $420.5 million, an increase of 25% over the third quarter of 2004.

Operating cash flows remain strong and our balance sheet continues to strengthen.

Please notice that EBITDA per adjusted claim for the quarter was $2.64, a 32% increase over 2004.

For the 9 months EBITDA per adjusted claim was $2.39, compared to $2.03 last year, an 18% increase.

Steve will give you much more detail on the results for the quarter.

Let me turn now to the balance of the year and 2006.

We expect earnings per share for the fourth quarter, excluding integration and related expenses to be $0.55 per share, which will make earning for the year $1.97 per share.

This is the high-end of the range that we gave you last quarter.

For 2006 we've given you a range of $2.30 to $2.38 per share.

This is based upon where we are currently in our budgeting process, current expectations regarding generic launchings for 2006 and the current expectations and uncertainty around the Medicare drug benefit.

This number excludes the impact of expensing stock options under FASB 123 R.

While we are not giving quarterly guidance please keep in mind that we typically see a sequential decline between the fourth quarter and first quarter of the next year.

We saw the same thing happen this year.

We will again see that next year, and because of the way the Medicare drug benefit ramps up, the decline may be a bit steeper than in prior years.

Also impacting that is the way the generic launchings come in in the latter half of next year.

As you see the balance sheet continues to be strong.

We continue to repurchase shares under our stock buy back plan which now has over $300 million left and I would expect that it would not be unreasonable for the board of directors to increase this plan.

We have an active acquisition pipeline and, of course, we continue to elevate the ability and possibility of paying a dividend.

Bottom line is 34% growth in earnings per share, a very strong quarter.

We hit the numbers that we told you three months ago that we were going to hit.

We've given you an exact number of where we expect to be at the end of the year and those are the numbers that we believe we will get to.

Our people have done a great job.

The integration has gone well.

The sales season has been busy and we are very pleased with where we stand at this point in the year.

Now I will turn it over to Pete and he will go through more detail for you and we will come back and take Q&A.

Thanks, Mac, and good morning everybody.

I will go through our GAAP performance for the third quarter and first 9 months of 2005 as well as our performance on our pro forma basis for the first 9 months of 2005.

Assuming Advance PCS was included for all the 9 months of 2004.

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

As a result Caremark's GAAP results for the first 9 months of 2005 include the operations of Advance PCS.

However, the first 9 months of 2004 only include the Advance PCS operations from March 24 through September 30, 2004.

First our GAAP results.

In the third quarter of 2005 Caremark reported diluted earnings per share of $0.51, which includes integration and other related expenses of $1.7 million, or $1 million after taxes.

Excluding integration and other related expenses, earnings per share for the second quarter were also $0.51, equal to our previous guidance as well as consensus first call estimates.

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

This represents diluted earnings per share growth over the comparable period of last year of 38%.

Revenues were $8.1 billion for the quarter; an increase of approximately 8% over the same period in the prior year.

Our generic dispensing rates dampen revenue growth by roughly 5 percentage points during the quarter.

In other words, revenue growth would have been over 13% if the generic dispensing rates had remained constant with the third quarter of 2004.

Our growing generic dispensing rates continues to generate savings for clients.

For the quarter Caremark's mail prescriptions processed were 14.6 million, an increase of 23% over third quarter 2004.

The increase in mail claims is primarily the result of the addition of the Federal Employee Health Benefit Plan mail business, which began in January.

Retail claims processed total 116 million, a decrease of approximately 12% from the third quarter of 2004.

As Mack mentioned, this decrease was anticipated due to do termination of certain clients that were retail oriented in 2005.

Caremark's mail penetration rate was 27% in the third quarter of 2005 compared to 21% in the same period of 2004.

The Company's mail generic dispensing rate for the quarter was 39.8% compared to 38.4% last year, while the retail generic dispensing rate was 53.7% compared to 49.2% in the comparable quarter of 2004.

During the third quarter of 2005 Caremark's gross profit grew by 19% to $539 million.

Additionally Caremark's gross margin was 6.7% compared to 6.1% in the same period of 2004.

The increase in gross margin can be primarily attributed to the strong growth in mail revenues and higher generic dispensing rates experienced during the period.

EBITDA for the quarter excluding integration and other related expenses was $420 million, an increase of 25% over the third quarter of last year.

EBITDA per adjusted script was $2.64 for the quarter compared to $2.00 even in the same period last year, representing an increase of 32%.

For the first 9 months of 2005 Caremark reported diluted earnings per share of $1.41 which includes integration and other related expenses of $8.8 million or $5.3 million after taxes.

Excluding integration and other related expenses, earnings per share for the first 9 months of 2005 were $1.42.

This represents earnings per share growth over the comparable period of last year of 42%.

Revenues were $24.6 billion for the first 9 months of 2005.

An increase of approximately $6.8 billion over the same period in the prior year.

EBITDA for the 9 months, excluding integration and other related expenses, was $1billion 183 million, an increase of $392 million over the first 9 months of 2004.

Now I will turn to the pro forma comparisons for the 9 months ended September 30, 2005, assuming that Advance PCS operations were included in the full first first 9 months of 2004.

For the 9 months ended September 30, 2005, revenues increased approximately 10% from the comparable period in 2004.

Mail prescriptions grew by 25% to 43.3 million, while retail claims decreased by 9% to 366.7 million for the period.

EBITDA for the first 9 months of 2005, excluding integration and other related expenses, increased by 36% over the same period of 2004 on a pro forma basis.

EBITDA per adjusted claim in the first 9 months of 2005 was $2.39, an increase of 39% over pro forma first 9 months of 2004.

Diluted earnings per share, excluding integration and other related expenses, of $1.42 the first 9 months of 2005 increased by 49% compared to the pro forma diluted earnings per share of $0.95 in the same period of 2004.

Turning to the balance sheet, our September 30, 2005 cash and short term investments were $1.5 billion in total debt outstanding remain $450 million.

Cash flow from operations during the third quarter was $226 million compared to $414 million in the third quarter of last year.

The cash flow in the third quarter of 2005 was lower than the prior year, primarily due to the $137.5 million payment that was made in September related to the settlement between Advance PCS and the U.S. government.

Additionally, during the first 9 months of the year the Company generated sufficient taxable income to fully utilize its Federal Income Tax net operating loss carry forward.

As you know the NOL has been a large source of cash for the Company during the past several years.

As a result the Company's cash taxes paid are anticipated to increase, but shouldn't be significant until the first quarter of 2006.

For the first 9 months ended September 30, 2005, Caremark's cash flow from operations was just under $800 million compared to 1.1 billion in the same period of last year.

Capital expenditures totaled $41 million for the quarter and $97 million year to date.

During the quarter we also repurchased 2.3 million shares of our common stock for approximately $98 million.

Since the end of the second quarter we have purchased an additional 830,000 shares, spending approximately $40 million.

In total we have now used $937 million to buy 28 million shares of stock in the open market, leaving $313 million remaining under our $1.25 billion repurchase authorization.

Now I will discuss our current outlook.

As noted in our press release we have raised our 2005 guidance to the top end of the range that be outlined back in August.

We believe Caremark will earn $1.97 per share for 2005.

Our previous guidance for 2005 was $1.95 to $1.97 per share.

We continue -- we expect revenue growth for the year to be approximately 27% when compared to 2004 GAAP based revenue.

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

Stock option expenses is expected to total $11 million in 2005.

Amortization expense related to certain identifiable intangible assets is estimated to be approximately $47 million and depreciation expense is expected to total approximately $101 million in 2005.

Net interest expense for 2005 is expected to be approximately break even.

The Company's guidance is based on effective accounting tax rate of 39.5%.

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

As you are aware GAAP requires that costs associated with the integration and rationalization of Legacy Caremark operation be expensed, while certain costs associated with Legacy Advance PCS operations are to be capitalized.

White while the vast majority of these items have already been expensed, we continue to expect certain additional items to be recorded in the last quarter of the year.

In terms of the share count, we expect weighted average shares outstanding assuming full dilution of approximately 455 million shares in the fourth quarter and roughly 456 million shares for the year of 2005.

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

We expect capital expenditures for 2005 to total approximately $150 million, but could be higher or lower depending on the timing of certain projects.

As we announced in our press release today, we expect fourth quarter 2005 diluted earnings per share, excluding integration and other related expenses, to be $0.55.

Turning to our initial guidance for 2006, we are excited about our opportunities for the year.

The large pipeline of expected generic drug launches, as well as the potential of the Medicare Part D program have us well positioned as we wrap up 2005.

Keep in mind that each of these items should have a bigger impact to our numbers in the latter part of the year.

For 2006 we believe that diluted earnings per share will be in the range of $2.30 to $2.38 based on a 39.5% effective tax rate and using a share count of approximately 460 million.

This guidance excludes the impact of expensing stock options, which is a requirement under FASB 123 R beginning in January of next year.

Stock option expense for the year is anticipated to be approximately $50 to $55 million on a pretax basis, or approximately $0.07 to $0.08 per share for 2006.

This is an estimate and will vary based on changes in certain variables including the actual number of shares granted next year, the stock price at the time of the grants, interest rates as well as other factors.

Revenues for 2006 are currently anticipated to grow 8% to 10% over 2005 levels.

Keep in mind we are continuing to evaluate the revenue accounting on certain contracts with Medicare Advantage plans so this figure could certainly change.

In addition, the timing of generic launchings will have an influence on this figure in 2006.

I would like to remind you that in the first quarter of 2005 we experienced lower earning than we experienced in the fourth quarter of 2004 due to a number of factors that tend to occur each year including higher expenses from new client adds.

We would expect to experience this again in the first quarter of 2006.

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

Okay.

Thank you, Pete.

And I also have Howard McLure with me and all of us will participate to the extent necessary in the Q&A.

Again, had a good quarter, and I will now, operator, turn it over for questions.

[OPERATOR INSTRUCTIONS] Your first question is from Lisa Gill with J.P. Morgan.

Great.

Thanks very much.

Mac, I was wondering if you could talk at all about the selling season for 2006?

You commented on the fact that it was good, but if you could put a number around that, and then also talk about what's still left out there.

And then secondly, as we think to 2006 maybe you can talk about the formulary changes as it pertains to some of the generics that are coming on later in the year?

And then just lastly, if, Pete, you could maybe walk us through your expectations on this guidance.

On the low end of the guidance are you expecting that we don't see any generics, or perhaps just walk us through a little bit more detail as far as getting from the low end to the higher end of your range in the guidance?

Okay.

As far as the selling season, let me give that to you in several different pieces so that you understand.

Total sales this year of new business were approximately $2.2 billion.

So we had a good year, some of the more notable ones being HCA, Shell Oil, JP Morgan, State of New York.

We also had losses that we talked about, which, as we've said, have been primarily retail in nature.

In fact about 80% of the scripts that we lost through terminated accounts were retail.

Those would include State of Illinois, State of North Carolina and then coming next year as you know CalPERS.

The revenue impact for starts in 2006 versus terminations in 2006, I'm giving you this number because if people are trying to take, say the fourth quarter or third quarter or whatever and annualize the revenues where we are there, I am giving you this number because you would not have some 2005 terminations that are already in our run rate that could get double counted, it would be about $700 million of impact revenue for 2006.

If you take everything that terminated in 2005 and then used the full year of 2006 and the impact that it had in 2006, that would bring a net number down to about $200 million but that would have to be based off of not an annualized number.

So I am trying to give it to you in pieces so people can use it how they want to do it from a modeling standpoint.

Mac, just so I understand, so that 700 million though is the net new business wins for 2006, if we take into account the timing aspect of when other things are rolling off, is that the correct way to look at it?

If you would take the accounts that terminate in 2006 and the accounts that we won in 2006, so if you are going to say you took a fourth quarter revenue number for Caremark that you got 2005 terminations that are already out of that run rate, so I give you that number so if people want to use that as the current run rate that we've got that's the right way to look at it.

Okay.

Now you asked a multipart question.

I did.

Part of it was generics, part of it was guidance, what was the --?

My next part of the question was just to try to understand better what people are doing for their formulary in 2006 and what kind of changes you are seeing with the generics, for example, around Zocor coming into the picture.

ANd then I was just hoping that Pete could maybe just walk us through how you get from the lower end to upper end of your guidance.

As far as the generics, our part of the formulary, I don't think we see people making a lot of changes in their formulary.

Our formularies and where we are today anticipate the generics as they will come along and our contracts anticipate that as well, so I don't think we see any major change from that standpoint.

As far as the lower end and the upper ends of the guidance it's the amount of Medicare lives that come on, it's the timing of generics and when they come.

I'm not going to try to give you a walk through on a dollar basis between the two.

We are still in the middle of our budget process, but this is the range at which we're putting out today.

Great.

Thanks very much.

Your next question is from David MacDonald with SunTrust.

Good morning guys.

A couple of things, Mac, first I was wondering if you could talk a little bit about Vitalink.

You made that investment, early reads, what you are seeing there?

And also can you give us some sense in terms of your employer book of business, is there any overlap in terms of outsource business down there that is within your existing book where you could pick up some lives, an just a little color there, and then I have one or two follow-ups.

he Vitalink acquisition is really the first move outside of the U.S. at least since I've been at the Company.

This is a small PBM that -- started by couple of guys that actually went to school in the States, one is from France, the other is from Columbia.

A couple of things that were attractive about it from our standpoint, one, it is one of the major areas that U.S. multinational companies are currently in, as well as some -- companies that we've been in discussion with are planning to put a significant number of lives there over the next 5 years.

So when we look at Brazil we look at it as an attractive place from the standpoint of employer population moving to some of these, in fact a lot of them are not even current clients of ours that we think opportunities will exist for.

Let me clarify something I said, Vitalink acquisition, it really was an investment, we didn't acquire the whole company, we made a minority investment in it.

So, yes, we think there's an opportunity there.

We've -- are going to work with these people to see if we can't help them grow their business and clearly we've seen some interest in people talking to us as a result of making this transaction.

And, Mac, just one other quick comment on the specialty business, I mean you guys continue to kill it there, can you talk a little bit about any disease states that really jump out .

And on a go forward basis, is longer term term more of a 20 percentage type growth rate more reasonable?

Well, as you get larger and larger its -- although we are $3 billion or so in that business the way that we count it, it's just really mail service delivery, sure, it gets harder to grow at those rates but we've had a good year this year.

Howard, I don't know if you want to speak to any of the disease states that particularly are doing well.

Well, we've had pretty good success in MS and RA and Hep C. Looking into the future, there are some products out there for Huntington's Disease, [indiscernible] some new products out there, some new RA products out there, starting to see a little bit of [indiscernible] growth hormone coming out somewhat of a less expensive product.

So we are very encouraged by what we see in the pipeline.

We've also got we think some contracting opportunities that are in front of us that will continue to grow that business.

Okay.

Thanks very much, guys.

Your next question is from Tom Gallucci with Merrill Lynch.

Good morning.

Thanks for the color so far.

Just a couple of quick questions.

First, wonder if you can give a little bit more color on the mail generic dispensing rate.

I guess they are still up nicely year over year, but maybe plateauing a little bit sequentially versus where we've been.

Is that just a function of what have new generics and timing over there and brands going off patent, or is there also some mix issue given some of the contract turnover that you talked about, Mac?

Howard, you may want to talk about the mix issue.

In some cases some of the cost of loss like most of the State of Illinois, the penetration rate was increasing although it probably wasn't in local business.

As we bring on new business it usually comes in with a lower mail penetration rate, so what we are seeing a little bit is business rolling off with a little higher penetration rates and new stuff comming on lower mail penetration rates.

And then we work through increasing those mail penetration rates as we move through the life of the contract.

This is a major focus of the Company though, given opportunities that we have in front of us and we are doing some pilot projects with some customers using the clinical pharmacists that we have to see if we can't increase the penetration rates on the existing books of business.

So given the opportunities next year that will continue to be a very major focus of the Company.

Great.

And then just the other question is about cash.

Obviously a growing high class problem for you guys is more and more cash on the books.

You've done pretty well, it looks like, on average prices of buying your stock.

You mention an active pipeline.

You mention possibility of considering dividends or increasing the share repurchase program.

I guess can you give us a little bit more color on the level of activity of the pipeline maybe now versus a year ago?

You've obviously got Advance behind you -- well behind you at this point.

What types of triggers do you think about when you think about dividends?

Well, I mean was that two separate questions, talk about the pipeline and talk about dividends?

Or were those related?

I think it's all related just relative to thinking about what you can do with this cash that you are building on the balance sheet.

Well, as far as the pipeline it is much more active than it was a year ago.

As you know we brought in Bill Spalding, who was a guy that we worked with a great deal in the outside legal world who does M&A transactions and he is staffing up his area so we've got much, much more in the pipeline and much, much more activity than we had a year ago or even 6 months ago.

So that's a fairly active way.

As far as what we look at, you obviously look at the balance between what we think the acquisitions that we may have in front of us and what form of currency that we will use versus our cash generating capacity that we have.

And whether it is a share buy back or whether it is a dividend, both being transactions related to the capital of the Company, there are a lot of different factors that go into that, anywhere from on the dividend side, the shareholder base and that you've got, there are expectations that you've got, as well as paying cash to the shareholders and giving it back.

So were very mindful of all of those thing and we're constantly looking at it.

Thanks, Mac.

Your next question is from Larry Marsh with Lehman Brothers.

Yes, good morning, Mac, Howard and Pete.

Just want to clarify, I think last quarter you talked about GAAP revenue guidance growth of 28 to 30 and now you are saying 27%.

Maybe just a reconciliation, what's the difference, and how much of that is just the elimination of certain intercompany revenues that you are talking about in the quarter, Pete?

Yeah, I mean the biggest piece of this was a when we forecasted the Humana claims coming out, we actually miscalculated the impact of that on an average per script -- average selling price per script basis.

So it really isn't a real impact in terms of what we anticipate revenues to be and certainly that will calculation didn't have anything to do with earnings.

It was really an average selling price per script calculation versus total scripts.

We had the Humana kind of moved around a little bit in terms of when it came out, but it ended upcoming out in October.

Right, because it was first disclosed back before you released second quarter so that is not a new thing for you guys.

No, it was just the calculation of the impact on the average selling price per script, which affects, obviously, your revenue calculation.

And then just the slight adjustment in reported revenues with intercompany transactions, what is that?

That's right, it's an elimination that was done in the first two quarters that should have been done but it also did not have an impact on the earnings.

It was an immaterial amount.

Just to follow up, you are saying 8% to 10% next year.

How do we put that in context?

I know -- are you assuming more top line, I don't say dilution from generics, obviously it helps your margins, and I know would you comment about what kind of script growth expectations you might expect for '06?

We are not ready to give out that detailed information yet, Larry, obviously we do have the dilution that should be greater next year that we have seen this year as a result of what's going on with the generic world and as that comes in.

So as we get further through the budget process then we will get more defined as far as script counts and those kind of things, but it'sa multitude of different factors with generics obviously being the big one.

Okay.

And just to clarify, you are saying that Medicare Part D could be additive to next year, but you are not breaking out your auto enrolling expectations or how additive it could be.

Is that right?

We are not breaking that out but we do have it in our numbers.

Okay.

Very good.

Thanks.

Thanks who your next question is from Ricky Goldwasser with UBS.

Yes, good morning.

Mac, before you mentioned that 80% of scripts lost are retail in nature.

Can you tell us what percent -- what's the mail profile of the new business gained that you are seeing in '06?

Let me see if we can get that real quick.

Given the fact that you've got some large corporate accounts and it's going to be much more from the standpoint of mail than what this was.

Ricky, this is Pete.

If you look at the retail business brought on -- retail business lost, it's -- let me make sure I'm looking at the right column here, it's about -- okay, business coming on, it looks like it's -- mail coming on is -- can you go on to your next question, Ricky, and let me look at the schedule for a minute and make sure I got it right.

Well, the next question is really kind of derived from that because based on that I was thinking about what the expectations for mail script growth next year?

Because I think that if you take out the FET contract the normalized mail growth assuming all else is equal was about 4.6% to 5%, so I am trying to understand whether we should look into next year if the mail script growth is higher than that number or lower?

I recollect without the State of New York, it would be about 26% mail.

Okay, without the State of New York it would be about 26% mail, with the State of New York the new business will be about 19% mail.

If you take out the impact of FET and the terminations that we've had our mail growth this year, this quarter was around 7% mail scripts.

And you expect to see similar growth rates into next year?

Again, I'm not giving guidance to that detailed a level for next year, but what we expect is factored in.

Now as far as the State of New York it looks like the 19% mail is lower than the overall business and the other business gained.

But what's the trend that you're seeing there?

Are there plans in place to increase that?

And what was the profile of that contract over the last year, where do you expect it to go next year?

Howard do you want to deal with that?

Yes, Ricky, that plan has had a 90 day at retail component to it and we expect them to continue that and we will, that tends to reduce mail penetration, but we will look in ways to increase the mail penetration in the account because we believe a lot better clinical components to participants and actually a better [indiscernible] profile for the clients.

Keep in mind that we just won this account toward the end of September, so we are just in the midst of implementation and understanding all the pieces of it.

Okay.

But just to make sure that I heard right, so the 90 day retail is now going to be discontinued --

No, no, it's still there.

It's still in place.

Thank you.

Your next question is from Charles [Reid] with Credit Suisse Frist Boston.

Thanks, guys.

I know you said you are still in the budgeting process, but as we think about your assumptions that's imbedded in your 2006 guidance as it pertains to generics, can you talk about -- do you factor it in a blanket assumption maybe on 6 month exclusivities, or do you really look at it on a product by product basis when you are in your budgeting process.

We look at it on a product by product basis.

Some we have assumed and some we haven't where we don't think there will be.

Actually just a quick follow up here, in your press release you talked about estimated stock option expense of about $0.07 to $0.08 in 2006.

Does that include the Advance PCS stock options that you've been expensing so far?

Yes, it does.

That number though falls off in 2006 for that particular line item but it also includes an anticipated grant for next year, which could be different, but it includes a grant of about the same level which we did in the prior year.

So it is an estimate but that includes a future grant.

Yes, got everything there that we know about.

Just to clarify, I think you said your '06 guidance is based on a 460 million share count.

Did I hear that correctly?

That's right.

So does that anticipate what the options you expect coming into the money versus -- or is it really the fact that you haven't imbedded any type of share repurchase at this point.

Yes, you just make an assumption based on a number of factors including stock option -- or the price of the stock including stock options that may come in there.

Obviously that will vary.

We have not put a stock buy back in there.

Yeah, that's right, that includes stock buybacks.

Okay.

Great.

Thank a lot, guys.

Your next question is from Christopher McFadden with Goldman Sachs.

Thank you and good morning.

Mac, you talked a little bit about your enhanced strategic planning team.

Does the acquisition of another large PBM make sense for you in terms of the scale of your business, in terms of the competitive landscape you see out there, and in light of what's the evaluation framework for most of the PBMs in the marketplace today?

I think you hit the key, and that is at what value are you doing the transaction.

And I think it depends upon how you define large.

There are a number of fairly significant, although they may not necessarily fit in the landscape of quote large from a revenue standpoint, players out there that may make sense to us that either bring a different line of business or do something a little unique from what we do.

So from that standpoint certainly they stay on our radar screen and they may be strategic, so we have got some of those that we are looking at.

But clearly evaluation place a big role in making that determination.

Very good.

Thank you.

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

Hi.

Are you able to break out for us how much money you've spent getting ready to administer Part D?

I think we gave an estimate last quarter.

We said 20 million over the back half of the year with 7 million of that being expense.

I think that number is still pretty accurate.

And those, you expect more spending in the fourth quarter relative to the third quarter?

Yes, most of that expense the 7 million will be in the fourth quarter, that's right.

Great.

Thanks.

Your next question is from David Veal with Morgan Stanley.

Good morning and thanks.

Correct me if I'm wrong, but it seems as though most of the large new business wins that you talked about are coming from other large players in the business and it's probably fair to say that the same is true for them.

I wonder if you could speak to the point of whether there's been a material change in the last 3 years as to where the business is coming from, is the carve out trend over?

And is that even a relevant question any more given the rise of the captive PBMs at Etna and Well Point and so on?

You know, I don't think we've seen a dramatic change over the last 3 years between the sources of business than where we see today.

Howard, I don't see a big difference, do you?

No.

Is it fair to say the competitive environment is no worse than it was three years ago, or are you seeing -- my concern is that it feels like the managed care PBMs are gaining some traction in the marketplace.

Is that a trend that you are seeing?

Not in our book of business.

They are clearly out being aggressive and want to be in the marketplace.

I think the competitive landscape is -- it probably is a pretty competitive year this year.

But I don't think it's necessarily driven by the captive PBMs.

Okay.

Great.

Thank you.

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

Only one question.

Just inventories did spike sequentially.

Anything we can really point to?

Mail order was up somewhat, but the inventory seemed to move up a little bit more dramatically.

Nothing significant there, just timing of receipts and payments and they are down significantly since year end, and up a little bit sequentially.

There is really nothing there.

That's it.

Thank you.

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

Thanks.

Just want to follow up there on David's question with regard to who is driving the competitive environment out there if it's not the captive PBMs, who exactly can you point to there?

I'm not going to name names.

You all can figure that out.

It's one of the other big two then, I guess?

Yes, I would say that's exactly right.

So we are not, you are not really seeing any of those alternate smaller PBMs gaining traction in the employer marketplace with that new business model transparency type stuff?

The only significant wins that I'm aware of that came through them are primarily in the state business.

Right.

Okay.

That's what I'm aware of as well.

Right.

And then, Pete, if I could just get a same store retail claims number in the quarter, given the account rationalization and some account losses?

Yes, if you took out all of the wins and losses, I think the claims number would be up about 2%.

That would be a similar number you might expect in the fourth quarter?

There's no big change sequentially going from the third to the fourth quarter in terms of the core business?

We've got Humana rolling off that was supposed to have left and didn't actually do it until October.

That's a big number of claims.

A big number of claim but not of earnings.

Right.

So that's really the only one then?

There's other that is have already rolled off that you will see -- year over year you will see the impact.

Year over year but on a quarter to quarter basis.

Humana is the only one just in the way the're --.

Yeah, I think so.

Okay.

Guys, thank a lot.

Thank you.

Your next question is from Kemp Dolliver with S.G.

Cowen Company.

Good morning.

A couple of questions on the specialty business.

One, could you talk about the revised program out of Medicare and the potential for that over time?

Well, as you know the government had that program out and they pulled it back.

The latest, Kemp, I'm not aware of them having brought it back up, that had a lot of issues about how oncology products are delivered in the marketplace, the primary delivery mechanism -- out of about a $13 billion marketplace place, I believe about 11 billion of it is delivered in physicians offices.

How do those physicians get compensated for doing that is real important there, and I think you can look out at the companies that have done oncology wholesale and you find very thin margins there.

And I think there has got to be some, there will have to be some changes in the way oncologist are compensated, they will have to get their compensation by the services they provide as opposed to the some of the products they do, I think, before that gets real traction.

I really think you've got to see a -- there would have to be a basic change in where the drugs are delivered and reimbursed before you are going to see that program get a lot of traction.

That's great.

Second question, somewhat related, is as you look at Part D and your specialty business, what kind of opportunity do you see for penetrating that market given the formularies that are now in place?

On the specialty side?

Yes.

Specialty marketplace, you know, we are the only person right now providing prescriptions on the Medicare Part D through the demonstration products on specialty.

We've seen some good solid growth in that this year.

We hope, having built the client relationships, we will be able to retain a good bit of that.

We also see some opportunity there as you look at the auto enrollees, those populations do tends to be users of specialty products somewhat higher than in the general population.

But we hope to be able to capture a good portion of that.

We also will participate in a number of networks from our PBM class as well as other people in the Part D networks.

The demonstration project in Medicare Part D has been good for us.

That's super.

Just last question, again this is on Part D, but with so many of the unknowns now known, what are the things you're discussing with the clients right now in terms of how this is going to impact you in '06?

Well, as far as '06 we are pretty far down the road of implementing versus discussing at this point.

I mean it depends upon the client.

Obviously if it is a corporate client then it's -- most all of those people, as I think everyone is aware, are taken a subsidy this year so it's really how you help to administer their program and everything from eligibility to co-pays to the troup, everything that you have got to deal with with the population.

On the health plan side then, obviously it's a lot different in that we are helping them in their program that they are putting together to go out and administer and sell and market these plans.

So, and in our own program will be particularly on the deal eligible for the auto enroll.

We qualified in 27 of the 34 regions, and so from that standpoint we are ramping up to manage our own book of business there.

So a lot of activity going on.

That's great.

Thank you.

Your next question is from Matt Perry with Wachovia Securities.

A couple questions.

First a clarifying question.

The figures you talked about for 2006 new business wins, 2.2 billion in new sales, does that include or exclude incremental Part D revenue?

That excludes Part D.

And then on the second question if you can maybe speak, at least qualitatively, on your success over the last several quarters in penetrating the Legacy Advanced PCS book with your specialty distribution business, and how you've been able to, or to what level you've been able to increase mail penetration in those accounts as well?

Well as far as the penetration of specialty business that continues to move along.

We've seen some good success in that.

We plan to have some additional penetration next year targeting individual customers.

And looking at them for an ability to help them in this area that costs a good bit of money.

Looking at the mail penetration rates, we are making some progress there.

It is again, as we talked about last year, some of it is benefit plan design specific, that helps drive a good bit of mail penetration.

We are still counseling people and being able to consult people on benefit plan designs and look for ways to help drive that mail penetration.

So it's an area we are still looking at, it's an area we are still making progress in, and we have some additional progress to make.

On the specialty side could you comment on roughly what percent of Advance PCS clients you've penetrated relative to the Legacy Caremark clients.

You know, Matt, I don't think we even track that.

We really have tried to put the Companies together and quit focusing on -- particularly -- and the specialty's probably come together as quick as any piece of it, and just focus on selling it.

I really don't even track that.

Okay.

Thanks.

Your next question is from Michael Maguire with Susquehanna.

Thanks.

Just a couple of quick follow-ups.

I know transparency isn't really winning deals out there, is it having any collateral pricing pressure or pricing impact in the employer group market?

I think we've seen price compression this year.

Is it, would you characterize it as significantly different than in last year or two in that segment?

It's stepped up a little bit I would say.

And then in the press release, Mac, you mentioned some additional opportunities as part of the Part D roll out specifically within the employer group segment.

Could you just characterize what that means and whether or not that could be a potential material contributor to the numbers next year?

Well, we are not talking about the numbers as far as exactly how Medicare Part D works, but we think that it's going to be a good program for us.

Okay.

Could you just provide a little bit of color as to exactly how you are providing these services to the employer group clients and whether or not there is any risk to you losing some of those lives as part of the roll out next year?

You've always got -- Go ahead Howard.

We know a very small number of [indiscernible] are not going to provide retiree benefits, we've factored that into our guidance.

But the main way we are providing services to our customers is by assisting them with a subsidy payments, as well as for those who didn't want to provide some benefits, we will be able to bring those, we believe, into our PDP arrangement and provide benefits to them there.

And I think also the fact that we've qualified as one of the 10 national PDPs, and we don't see it as much in '06 as far as people not providing benefits, there's some.

But in '07 and going forward then having the licenses that we've got and the position that we will be in and we think it gives us an opportunity to offer the employer an option that they can give to their employees to go if they do decide to not provide the coverage.

Great.

Thanks for the commentary.

Sure.

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

Thanks.

Good morning.

I apologize if you gave this to us earlier but, Pete, can you help us with your investment income assumption that you've got imbedded in the Company's '06 outlook?

I mean, sure, the interest -- we've haven't given that kind of detailed guidance for '06,

It basically includes the cash that we think we are going to get in the rate.

We haven't broken that out.

Alright, okay.

Thanks.

Your next question is from [Harland Sunderling] with Columbia Management.

Good morning, gentlemen.

Thank you.

Can you speak to your calculation of returns on the ongoing share repurchase?

That is what are you expecting from that share repurchase financially, and is there a point at which the repurchase becomes uneconomical for you, please?

Well, sure, there's a point at which it becomes uneconomical.

Obviously.

I am not going to say what that is and what our calculations are from that standpoint because we try to be opportunistic when we by stock in the marketplace.

But, yes, no doubt it would reach a point that it would become uneconomical or at least other alternatives would be more attractive.

Thank you.

Your next question is from Brian Hennessey with Partner Re

Hi, guys, I just have a question on the capital structure.

You guys have just one noncallable $450 million note left on the balance sheet that's due next October.

Just want to know, A, if you guys plan to relever after that?

B, what you might be targeting in terms of is it shorter duration, longer?

And C, do you guys have a target capital structure?

I would expect that we will have debt on the balance sheet past the maturity of this note and from a capital structure standpoint I think that it makes sense.

So it's clearly something that we are in the process of addressing and figuring out right now.

Thank you.

There are no further questions at this time.

Would you like to have any closing remarks, Mr. Crawford?

No, let me just thank everyone for dialing in.

We will be here all day.

If you have further questions give us a call and we will try to deal with it.

Thank you.

Thank you for participating in today's Caremark Rx third quarter 2005 earnings release.

You may now disconnect.