CVS Health Corp (CVS) 2005 Q4 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 fourth quarter 2005 earnings conference call. [OPERATOR INSTRUCTIONS] Thank you.

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

Sir, please go ahead.

Okay, thank you, operator.

And good morning, everyone.

And I want to thank you for joining us for Caremark's fourth quarter 2005 earnings call.

With me today are Howard McClure, Chief Operating Officer and Pete Clemens, our Chief Financial Officer, and I would like to introduce Craig Hartman, who has recently joined us as Vice President of Investor Relations.

Today on the call, we will briefly highlight the accomplishments and the financial performance of the fourth quarter and of the year.

Also going to touch on our outlook for 2006.

Pete will then cover the financial results in more detail, and finally, as always, we will take your questions.

During this conference call, we anticipate making projections and forward-looking statements including earnings per share projections, revenue and growth forecasts, the anticipated impact of Medicare Part D, and other assumptions about our future financial performance, including the substance related to our 2006 guidance.

Current and prospective investors are cautioned that any such forward-looking statements are not guarantees of future performance, involve risks and uncertainties, that actual results may differ materially due to various factors.

For example, adverse developments with respect to the company's operating plan, objectives, competitive developments, the success of the Medicare Part D implementation, the timing and launch of new branded engineered pharmaceuticals, and regulatory and legal matters, government investigations, and governmental action regarding pricing and reimbursements.

Additional factors that could affect our business can be found in our forms 10-K, 10-Q and other SEC filings.

This conference call includes certain non-GAAP financial measures.

A complete reconciliation to the most directly comparable GAAP measures can be found in the tables attached to the earnings press release.

You can access the press release on the live webcast and a replay of this conference call from the Investor Relations section of Caremark Rx .com until March 1, 2006.

I'm pleased that Caremark has once again delivered record earnings in the fourth quarter and for the full year of 2005, and am particularly proud of the employees who have worked so hard to deliver these results over the past year.

This morning, we have reported very strong financial results for the past year, and after excluding one-time favorable debts this quarter, Q4 adjusted diluted earnings per share drew 22%, $0.55 per share, in line with our guidance and equal to First Call consensus.

For the year, adjusted diluted earnings per share were $1.97, up 41% from pro forma of 2004.

Again, very strong results for the year.

Revenues grew 4% in the fourth quarter, and 8% for the full year.

As in previous quarters, our top line result was driven by strong growth in mail and specialty revenues, offset by declining retail revenues, as we've lost some retail awarded [inaudible] accounts in the last couple of years.

Those we have talked to you about on previous calls.

Pete will give you the details, but the highlights include PBM mail service revenue growth of 27% for the quarter and 29% for the year.

And specialty mail revenue growth of 30% in Q4, and 40% for the entire year.

Remember, higher generic dispensing rates in 2005 slowed our top line growth, and if GDR was the same in 2005 and 2004, revenue growth would have been nearly 9% in Q4, or 13% for the full year.

Obviously as we look forward, we got to keep that this in mind, that because of the impact of generics particularly, what we will see over the next couple of years, that this will be a dampening effect on revenue growth.

EBITDA grew 15% during the fourth quarter to $445 million.

For the full year, EBITDA was up 30% to more than $1.6 billion.

EBITDA per adjusted script increased again to $2.86 in the fourth quarter.

This compares to EBITDA per adjusted script of $2.18 in Q4 of 2004, or a 31% growth over last year.

Growth in EBITDA per script driven by growth in specialty, mail order, and generic utilization, as well as operating efficiency improvements.

These solid EBITDA numbers clearly indicate that the business continues to generate strong operating cash flow, and we intend to put that cash to good use.

We've been actually buying back shares under our increased share repurchase authorization, because we do believe that our stock price is attractive at this time.

We are also considering other strategic uses of cash to maximize shareholder value, including acquisitions, and the potential payment of dividends.

Turning to 2006, we are looking forward to delivering on an aggressive set of goals for this year.

Medicare Part D is an important new growth opportunity, and we intend to capitalize on it as we fulfill an important role of providing access to medicines to eligible participants who previously could not afford them or did not have access to them.

As you know, there are a number of branded medications that will face generic launches in 2006 and 2007.

We continue to enhance our current programs while developing new innovative programs designed to encourage the use of generics in order to help our clients maximize their health care investments.

Another priority. as it has been in the past, is to continue our mail and specialty business increasing value to both our customers, as well as to you, the shareholders.

As you see, we have tightened our guidance range for the year from where we were last quarter.

We have taken a conservative view in our opinion of the Medicare Part D program at this time, because of startup issues that we have seen from CMS over the last few weeks particularly as it relates to eligibility.

Once we have clarity on some of these issues, we will re-evaluate guidance for the year.

All together, we expect once again to deliver strong results in 2006, much like we've done in 2005.

At the current time, we expect to grow 2006 earnings by 18% to 21% in the range of $2.33 to $2.38 per share.

Now, this guidance range does not include stock option expense of approximately $50 million to $55 million that we will recognize under FAS 123-R.

When we report quarterly earnings in 2006, stock option expense will be included, so our 2006 guidance range, including option expense, is $2.25 to $2.30.

And keep in mind that the previous range that we had given you last quarter of $2.30 to $2.38 excluded stock option expense as well.

So the $2.33 to $2.38 is comparable to those numbers that we have given you in the past.

At this time, we will turn it over to Pete who will review the financial performance in more detail, and then we will come back and take your questions.

Pete?

Thanks, Mac, and good morning, everyone.

I will go through the GAAP performance for the fourth quarter and full year 2005, as well as our performance on a pro forma basis for the full year of 2005, assuming advanced PCS was included for all 12 months of 2004.

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

As a result, Caremark's GAAP performance for 2005 included the operation of AdvancePCS.

However, for 2004, the AdvancePCS results are included in Caremark's results only during the period beginning on March 24, 2004, through the end of 2004.

First, our GAAP results.

You will note that we had a couple of favorable one-time items during the fourth quarter, which resulted in earnings per share of $0.64.

This figure includes integration and other related expenses of $2 million, a nonoperating gain of $26 million, resulting from the sale of a residual interest in a previously divested subsidiary, related to discontinued operations, and a favorable adjustment to the tax provision during the quarter.

The tax adjustment related to the conclusion of an IRS audit of another former discontinued operation subsidiary that was also divested several years ago.

As you will notice in the press release tables, excluding the gain on the sale of the investment, and using a 39% effective tax rate, our earnings per share would have been $0.55, equal to our previous guidance.

Revenues were $8.4 billion for the quarter, an increase of 4.4% over the same period in the prior year.

As Mac indicated, higher generic dispensing rates dampened revenue growth by 4.3 percentage points during the quarter.

In other words, revenue growth would have been 8.7% if the generic dispensing rates had remained constant with the fourth quarter of 2004.

The rising trend in generic dispensing rates continues to generate savings for our customers and participants, as well as results in increased profitability for the company.

For the quarter, Caremark's mail prescriptions processed were 15 million, an increase of 20% over the fourth quarter of 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 totaled 111 million, a decrease of approximately 21% from the fourth quarter of 2004.

As we have discussed, this decrease wast anticipated due to the termination of certain clients that were retail-oriented in 2005.

Humana was the most recent large health plan which left Caremark in October of 2005, as was discussed on our last earnings conference call.

Mail penetration rate was 28.5% in the fourth quarter of 2005, compared to 20.8% in the same period of 2004.

The company's mail generic dispensing rate for the quarter was 40.6%, compared to 39.3% last year, while the retail generic dispensing rate was 54.4%, compared to 50.4% in the comparable quarter of 2004.

During the fourth quarter, of 2005, Caremark's gross profit margin was 6.8%, up from 6.4% in the same period of 2004.

As you know, the increase in the gross margin continues to be driven by the strong growth in mail revenues, including specialty, and higher generic dispensing rates experienced throughout 2005.

EBITDA for the fourth quarter, excluding integration and other related expenses and the nonoperating gain I already mentioned, was $445 million, an increase of 15% over the fourth quarter of last year.

EBITDA per adjusted script was $2.86, for the quarter, compared to $2.18 the same period last year, representing an increase of 31%.

Again, the growth in profitability per claim was primarily the result of the increase in mail penetration and generic dispensing rates.

For the full year 2005, Caremark reported diluted earnings per share of $2.05, which includes integration and other related expenses of $11 million, the nonoperating gain, and the favorable tax treatment in the fourth quarter already mentioned.

Excluding these items, and using a 39.5% effective tax rate, earnings per share were $1.97, also equal to our previously discussed guidance for the year.

Revenues were $33 billion for 2005, an increase of approximately $7 billion over the same period in the prior year.

EBITDA for the year was $1.6 billion, compared to $1.2 billion in 2004.

Now, I will turn to the pro forma comparisons for 2005, assuming that the AdvancePCS operations were included in the full year of 2004.

For 2005, revenues increased approximately 8.5%, from pro forma 2004.

Increases in our generic dispensing rates during 2005 dampened revenue growth by approximately 4.9 percentage points.

Said another way, revenue growth would have been 13.4% for the year, if the generic dispensing rates had remained constant with 2004.

For the year, mail prescriptions grew by 24%, to 58.3 million, while retail claims decreased by 12% to 478 million for the year.

EBITDA for 2005, excluding integration and other related expenses and the nonoperating gain already mentioned, increased by 30% over 2004 on a pro forma basis.

EBITDA per adjusted claim in 2005 was $2.50, an increase of 36% over pro forma 2004.

Diluted earnings per share excluding integration and other related expenses, the nonoperating gain, and the favorable tax adjustment during the fourth quarter, was $1.97, an increase of 41% compared to pro forma diluted earnings of $1.40 in 2004.

Caremark's balance sheet continues to get stronger.

At December 31, 2005, cash and short-term investments were almost $2 billion, and total debt outstanding was $450 million.

As you know, Caremark's $450 million of senior notes mature in the fourth quarter of this year.

As a result, the portion of those notes that cannot be funded by our existing line of credit availability, are classified as current liabilities on the balance sheet.

At this point, it is still our intent to refinance the notes upon maturity.

Cash flow from operations during the fourth quarter was a strong $509 million, compared to $487 million in the fourth quarter of last year.

For 2005, Caremark cash flow from operations was $1.3 billion, compared to $1.6 billion in 2004.

Capital expenditures totaled $41 million for the quarter, and $138 million for the year.

During the fourth quarter, we also repurchased 1.8 million shares of our common stock for approximately $90 million.

Thus far, during 2006, we have purchased an additional 4.7 million shares, spending approximately $236 million.

In total, we now have used $1.22 billion to buy 34 million shares of stock in the open market, leaving $528 million remaining on our $1.75 billion repurchase authorization.

Now I will discuss our current outlook.

We continue to be optimistic about our opportunities for this year.

As we have mentioned in the past, 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 begin the year.

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

As noted in our press release, we have tightened our 2006 guidance range that we outlined back in November.

We now believe that Caremark will earn between $2.33 and $2.38 in 2006, before the impact of expensing stock options under FAS 123-R.

Including the impact of expensing stock options we believe Caremark will earn between $2.25 and $2.30.

We expect revenue growth for the year to be between 5% and 10%, compared to 2005.

Since the company will expense stock options in the future, and report quarterly earnings and including stock option expense, we ask that you include stock option expense when generating your estimates for consistency.

This 2006 guidance is based on a number of assumptions, including the following items.

Stock option expense is expected to total $50 million to $55 million in 2006.

As you know, this figure is an estimate that can change based on the actual number of shares granted during 2006, the timing of the grants, the stock price at the time of the grant, interest rates, as well as other factors.

Depreciation expense is expected to be $105 million to $110 million.

Amortization expense related to certain identifiable intangible assets is estimated to be approximately $44 million.

Net interest income for 2006 is expected to be $45 million to $50 million.

This figure obviously is dependent on interest rates during the year, as well as the amount of cash that we have invested, which can vary based on share repurchase activity and other cash uses.

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

In terms of share count, we expect weighted average shares outstanding, assuming full dilution, of 453 to 455 million.

It these numbers take into account share repurchase activity to date, and will vary based on the market value of the stock and option activity.

We expect capital expenditures for 2006 to total approximately $150 million, but could be higher or lower depending on timing of certain projects.

From a cash flow standpoint, I would like to remind that you that we expect our cash taxes to be more closely aligned with our effective book tax rate in 2006 than in prior years.

In modeling cash flow on a quarterly basis, our cash tax payments will be heaviest during the second quarter.

This is a significant change for the company now that we have utilized our federal net operating loss carry-forward.

That said, we expect cash flow from operations, even after this change, to remain very strong and should be more than a billion dollars again this year.

As we have announced in our press release today, we expect first quarter 2006 diluted earnings per share including $10 million to $12 million of stock option expense under FAS 123-R to be $0.49 to $0.50.

As you see in the press release, before considering stock option expense, we believe our earnings per share for the first quarter will be $0.50 to $0.51.

As we mentioned on our last earnings conference call, earnings per share in the first quarter is historically lower than the fourth quarter of the prior year, due to a number of factors.

This year will be no different, as you can see from our guidance levels.

Thanks a lot.

And I will now turn it back over to Mac.

Okay and thank you, Pete.

And before we take questions, let me just be sure and clarify one thing.

Early on, when Pete was talking about the income tax rates, and $0.55 a share, I just want to be sure this clarifies it is a 39.5% tax rate to get to that number.

But we have had a good year.

We've had a good quarter.

Time now to turn to the future and what we continue to do for the rest of this year and the years to come.

So we will be glad to take your questions, and, operator, you can go ahead and put us into the queue.

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

Please go ahead with your question.

Great.

Thanks very much.

And good morning, everyone.

Was just wondering if perhaps you could talk, Mac, a little bit about the fact that CMS just recently named you as one of the finalists under the Caps program, just wondering what your thoughts are on oncology is this a potential future acquisition opportunity, or are you talking about just the existing drugs that you currently distribute around helping those with oncology needs, and then secondly, was wondering if you could perhaps talk about what your clients are doing as far as formulary changes now that we're into 2006 with a large statin losing patent protection, and what some of the manufacturers are doing from a rebate perspective?

Sure, I will let Howard talk to you about the Caps program, and we'll come up and pick up the rest of them.

Lisa, we are looking at the Caps program but, as you know, the oncology market is one that has its share of reimbursement challenges.

We think from a standpoint of our customers, we can help them better and looking at ways to help them manage their costs, in the oncology marketplace.

We will look at the Caps component as an opportunity, but at this point, it is more of a distribution or wholesale model than it is really a delivery to participants.

So would you view -- I mean Howard, I was just surprised to see you named as one of the finalists under the Caps program, so is this an area you're looking to build out in the future?

Yeah, it will be, Lisa.

Okay.

And then Mac, if you had any comments around the statin class and what you're seeing from both manufacturers on the rebate side, as well as what customers are doing.

As far as the plan design this year, I think we've seen a lot of changes at this point.

Keep in mind this is a mid-year launch, and most customers' plans go into effect January 1, so it really will become a 1/1/07 issue as we go forward.

As we have, particularly within the statin class, and as that begins to come home, our focus is on overall low [inaudible] costs for the participants and for the health plan or for the company that is providing the benefit.

So the way that we manage this overall thing, we will take into account when the generic comes to marketplace, after generic Zocor's introduced, we'll re-evaluate our PDL.

It's always first driven by the clinical component and make a determination of what is in the best interest of the client and the patient.

You know, we have to keep in mind that Lipitor is a good drug.

A lot of doctors like to use it.

So we expect that it will continue to be a drug that is prescribed, so you have to balance all those between what you can take to generic, when you can take it, versus the clinical expectations of the physician and the patient, and the clinical, not just expectations, but the clinical results that come out of it.

So our P & T committee will make the first determination about what our PDL will be, and then from that standpoint forward we will go forward as to how we contract for these.

As far as other manufacturers, I don't think we've seen a whole lot going on at this point in time, other than -- different than what we've seen in the past.

As again, we typically contract on the long term for a lot of that, but clearly, starting in the latter half of this year and going into '07, there will be a lot of different contract strategies that go into place to take into account all these generics.

Is it a proper assumption then that Pfizer hasn't changed their rebating relationships with the PBMs with the anticipation of Zocor losing the patent protection? .

I think there's some concern that they would have changed their rebating practices at the first of January, 2006.

Well, I mean I can't speak to other PBM's because I don't know what their contracts are.

I know that we've got a contract that is still in existence and runs forward.

So we've not seen any changes to our contract that we have.

Great.

Thank you very much.

The next question is from David MacDonald with SunTrust.

Please go ahead with your question.

Good morning, guys.

Hey, Mac, just wanted to follow up on the Lipitor point.

Can you give some sense in terms of what type of stickiness you're seeing in the market?

I mean, I know some folks have talked about moving share away from Lipitor, but with the popularity of that drug, a little of color there.

And secondly I was wondering if you could give us some sense about Part D, if some of those issues started to settle down and preliminarily what you're hearing from your customers and then I've just got one more follow up.

Okay.

I don't think that we've seen any great movement from Lipitor in the marketplace, what we would see in the marketplace, I don't think we've seen that at this point.

And again, keep in mind that there will be a lot of things that go into that factor, or other factors as you go through this, whether it is first the clinical quality of the product, and the drug, and what patients are working on today.

And if they'v got a drug that's doing a good job for them, you just don't all of a sudden make a change and go somewhere else with it.

So, you know, time will tell on that.

And you got to get the generic out first.

And then just Part D, Mac?

Part D is primarily the issues that we've seen and been dealing with eligibility and everybody knowing, I think, exactly how many individuals they have assigned to them, and people that have signed up, and CMS is working hard on it, but it's not cleared up yet, and I think this is just being very candid and very honest, this is going to take a little while for them to work through.

So until they get that worked through, and we know exactly how many participants we've ended up, with we have taken a very conservative view of that.

And then Mac, I guess final question, when you think about cash deployment, potential acquisitions, can you give us some sense in terms of, in an ideal world, what type of capital structure would you like to be carrying?

As a multiple of EBITDA, how many times on the debt side, is two to three times where you kind of would like to have the company if you were to fine a property that made sense?

Well, I mean, you know, rather than trying to get the exact ranges, that is going to be driven by the strategic nature of the property that we find, and if we do.

I don't want to overlever the company.

I'm not going to do that.

You all know my view on debt.

And I get criticized for it.

But at the same time, until you run a company that can't afford to pay its bills because it's got too much debt, then you probably won't appreciate probably where I come from, and not that we're ever going to get in that position, because we're doing extraordinarily well.

But I guess the bottom line is we will leverage up the balance sheet to do an acquisition, sure, but it's got to be the right strategic acquisition, but I'm not going to overload the balance sheet.

Thank you.

Your next question is from Tom Gallucci with Merrill Lynch.

Please go ahead with your question.

Thanks.

Good morning.

Just a couple of quick follow-ups here to some comments that have already been made.

On the balance sheet issue, Mac, you mentioned the possibility of dividend at some point, or at least considering it.

What are the key issues surrounding the payment of a dividend at some point that you would think about?

Well, I think the key issues, Tom, are enhancing returns to the shareholders.

Would we perhaps drive or gain a broader shareholder representation in some people that do look for dividends, and the stocks as they do, given the quality of this company's balance sheet, and the quality of our cash flow, and the extent of our cash flow, a dividend wouldn't hurt the company.

And wouldn't keep us from doing another strategic [inaudible].

We would look at it as the shareholder's money, and we enhance shareholder value by paying a dividend.

Is there a time line or a milestone that we should be thinking about for any pertinent decisions here?

I think we will make some decisions pretty quickly on this.

Okay.

And then Pete, to one of your points, about the net operating loss carry-forward and the impact on cash flow, just to make sure we're looking at apples-to-apples, can you remind us what maybe the benefit was in the fourth quarter of '04, to cash flow, so we can kind of look at that quarterly operating cash flow year-over-year, and what was the benefit in '05 as we look to comparing to '06?

If you look at the cash flow statement, Tom, you'll see the '05 benefit of about $390 million.

Deferred tax asset has come down.

We utilize substantially all of that asset prior to the fourth quarter.

Now, in the fourth quarter, we didn't have significant tax payments, because they're based on the estimates for the first three quarters.

You will start to see that in the first quarter of this year.

You probably ought to call --

We can talk about th at offline if you want.

Sure.

That's helpful.

The payments will make a difference.

That's helpful.

And then just the last thing, Mac, you kind of mentioned being conservative on the Medicare front.

Is that more from a revenue perspective, as you mentioned, you didn't really -- you don't even have your hands necessarily around how many lives you have, or have we also seen increased costs there that are hard to predict as well?

I don't think we've seen really increased costs that are so hard to predict, as much as we've seen hard to understand exactly who is enrolled and who's not enrolled, and then, we are incurring costs that we think we'll be reimbursed for, but until I get a check, then I'm not going to count on it.

For people that we don't know whether they're enrolled or not, we think they are, CMS thinks they're not, yet they keep telling us to provide prescriptions for these people, and don't disenroll them just because they don't think they're enrolled with us.

So -- but you could have some of that the other way, where we've got some other plans that CMS thinks they're enrolled with us, and the plan thinks they're enrolled with them so they're providing scripts, and so we're going to have a big reconciliation that goes on between plans, I think, as this goes through.

But this is clearly been an issue that we have all had to -- the whole industry, I think, is having to work through, and that will just be one of those things.

But we've said okay, until all this settles down, we're going to be conservative about how to look at this program.

But I don't think we are seeing any utilization trends that are any different than what we had anticipated when we went into the program.

It is just a matter of who is eligible, who is not eligible, and where do the numbers finally settle down, and what your actual enrollment that have you here.

Great, that's helpful, thanks a lot.

The next question is from Larry Marsh with Lehman Brothers.

Please go ahead with your question.

Yes, thanks.

Good morning.

First, I guess, Peter, clarification around top line guidance.

In November, you talked about '06 top line being up 8% to 10%.

Now you're saying 5% to 10%.

Obviously not impacting your profit assumptions.

Is that driven by a greater-than-expected impact on generics or a stronger Q4?

Or is it something else as we look at it?

Larry, no, it is really generated by just another look at the numbers for the year.

We did have one, I think, well-publicized loss in well care, which impacts for the back half of the year.

But it is just looking at all our assumptions all over again, and given your range that we think is reasonable.

And keep in mind that we said we were still in a bunch of process when we did the last time.

And part of this, when you look at the Medicare peaks too.

How many enrollee does you actually have, so we had to widen that range a little bit to know where we are.

And one more thing to add on all of this, Larry is, again, on the generic side, I mean I'm not sure revenues are what the company ought to -- the investors really ought to focus on today because the generic wave that is coming is going to impact revenues but it's good for us and it's good for our clients, so look at the scripts and the cash flows of the company, and don't get too hung up on revenues given that.

Good point.

And I'm sorry, when you said well care are you talking about Well Choice or --

Well Mark, I'm sorry.

Oh, I'm sorry.

Okay.

Thank you.

Part D costs, Mac, I just want to make sure I understand what you're communicating, let's see, before you had said that you thought Part D would be somewhat additive to '06, and you didn't break it out any more specifically, than that, and today you're communicating, you know, good reason to be conservative.

Are you still suggesting that you think it could be slightly accretive to '06, and that once you get more clarity, you will revisit those estimates?

Or are you trying to be more conservative than what you communicated with Q3?

Well, I don't think I'm -- I guess what I'm saying is that I think that this can be a good program for us, assuming that enrollment comes in where we hope it will come in.

And if it settles down in an area that could be positive to us, then yes, there is a possibility that in our guidance we need to revisit it and see where the numbers actually will be, but at this point in time, given we looked at the $2.38, is the same that we gave you last quarter, we increased the bottom end some, then I'd say that we really have pretty much stayed where we have been on the Medicare side of trying to look at things from a conservative standpoint.

But, you know, hopefully there is some upside there, but we just don't know yet.

Okay.

And then finally, I know Mac, at your analyst day, you talked about why it was difficult to predict exactly what sort of pricing you may anticipate on generics given things like citizens petition, form 4 filings, is that still the case as you look at in the back half of '06 or do you feel like you have any more clarity as to how the supplier situation could shake out on some of these big products?

We think we've got more clarity, as we've gone and done more contracting since then.

But keep in mind, you still have those uncertainties that I laid out, just that you just talked about that will always be there, in the generic marketplace.

And we go on a drug-by-drug basis when we make and build our budgets, and what we think the pricing will come in at.

So we're very diligent about how we do it.

But just always a lot of moving parts to it, but we have obviously since the last investor call, done more on the generic side from a contracting standpoint to know where we think we will be.

Is it fair to say you still feel encouraged about your ability to use your scale to your advantage in the second half in '07?

Yes.

Okay.

Thanks.

Second half of '06 and '07, is that what you said?

Yes.

Yes, when you said second half of '07, okay, but second half of '06 and '07, yes.

Okay.

Very good.

Thank you.

Thank you.

Your next question is from Glen Santangelo of Credit Suisse.

Please go ahead with your question.

Yeah, hey, Mac and Peter, I just had one more question on this revenue growth.

I don't want to fixate on it, Pete, but it kind of seems like did you a little over 4% in the quarter and then you're guiding at 5% to 10% for next year.

Within that 4%, we include the federal employees contract, and then we have greater contribution from generics this year.

What kind of accelerates that top line growth?

Is that kind of say anything about expected market share shifts or new business wins?

And then as sort of a related question, we continue to see pretty sizable increases in your revenue, for not only your mail order claim, but also in the retail claims, which I kind of find surprising, so if you can can kind of comment on the trends on a revenue per claim basis as well, that would be helpful.

Glen, this is Howard.

I'll take a shot at some of that.

One of the things that is driving revenue growth is some of the things that drove revenue growth last year and that is specialty product lines.

We're seeing some good product availability there.

We've got our eyes on some very good targets in that marketplace.

And as we continue to bring through clients that have major medical spend in, and increase our specialties, we see that as an opportunity, and that is certainly helping the growth rates there.

Medicare, will drive some revenue growth, as we have our Silver Script product or our dual eligible product, we'll drive some revenue growth as well.

That gets tampered down by the increasing generics.

So it's really just kind of a mix of things back and forth.

But some of the opportunities that will drive growth in the revenue line.

Glen, one more thing, too.

Don't forget this is an annual guidance number, okay?

So you're going to see fluctuations within quarters that could result from somebody left us last year in April for example.

We will have them in Q1 but we -- we won't have in Q1 this year and we did have in Q1 last year, so there's things from that standpoint that affect our growth rate, too.

Any -- any sizable starts this year that maybe the market isn't focused on?

No, we pretty much know where everything is so far.

I think this year is pretty much over with.

Okay.

Thanks.

Your next question is from Michael Baker with Raymond James.

Please go ahead with your question.

Yes, Mac, I was wondering if you could give us an early read on employers' plans with respect to their retirees for '07 and then I just have one follow-up.

Yes, we've not seen the employers -- we only had, I think, a very small number of employees -- or employers for this past year that decided to drop retiree coverage and only two I think that actually did it on PDP.

For '07 just now beginning the discussion process, we have heard some employers say we're not going to have enough information until '08 to make a decision.

What we're going to do, because of the -- they got to see what is going to happen in '07.

We got other employers that are looking at whether or not they are going to keep retiree coverage, so it is just now starting up, I think the discussion process.

I will point out that with our PDP offering that we had and the programs that we have in Medicare that we think we are well positioned, that when those employers do decide or if they do decide to drop coverage, that we've got a product to bring in to those employees.

And we feel very strongly and we didn't really talk about it a whole lot, but when we decided to go with the national PDP, that this was one of the reasons that we did it, and we are going to have some employers that decide to drop coverage, everybody is.

And if you don't have an offering for them, then they're going on to some other marketplace, so one of our jobs this year is those that do decide that they'll drop retiree coverage, or if they want to look at a different option as to how to deal with it.

We've got an option that we've put in place that can give them a very attractive place to go.

And then in terms of those that decided to drop for this year, did you find yourselves in a marketing advantage position to work with HR on a smooth transition there, and if you can give us just a general sense of how much were you able to retain in those cases.

I did.

Howard, I don't know if you know a percentage.

In both cases, we worked as either a [wrap] PDP or working with them, and I think we retained an excess of 90%, Mac, on both those -- on both those accounts.

Thank you.

Your next question is from Ricky Goldwasser with UBS.

Please go ahead with your question.

Good morning.

I have some follow-up questions.

Following up on Larry's question on Part D, I just want to clarify, when you looked at your budget and revisited your assumption, did you lower your estimated Part D, which was then offset by other things that look better now, potentially greater benefit of the interest income line, and better branded inflation in the quarter?

You cut out on part of that, Ricky, I'm sorry, so I missed the front part.

What was the first part of the question?

The first part was really kind of on your guidance and your revised guidance.

Just wanted to clarify whether your new kind of assumptions reflect lower benefit on Part D in an effort to be more conservative than were offset by potentially better interest income, better branded inflation, or other things that you are seeing now that looked better than they did in the third quarter.

No, I think when we gave you the guidance in the third quarter, our assumptions from that point in time would probably have been a little more conservative in that regard, but if you look at the top number, it is still the same top number.

So I think don't think anything has changed a lot in the third quarter, and we're just not ready at this point to stand up and say this is exactly where Medicare Part D is going to shake out for us this year until we have better eligibility numbers, so I think you need to look and say the numbers are roughly the same as where they are at the same time, -- as I said, once we find out exactly where it is shaking out and where it is, then we will look at revising that guidance.

Okay.

And then on the generic side, again you kind of put a disclosure today saying that obviously timing of generic introductions and number of players will have an impact on your numbers.

Are those based on your guidance, guidance seems to be kind of equally distributed throughout the year with no substantial update in the second half of the year, so again, there, should we assume that you are trying to be more conservative there?

And then also in your assumptions, are you assuming any therapeutic substitution, I guess that's a follow-up on kind of the Lipitor questions that you have been getting, or are you just kind of in your numbers factoring in conversion from the branded product going offpatent to its generic form?

We've not given quarterly guidance other than just for next quarter, so I don't know how you're drawing conclusions about where it's spread throughout the year.

So as it always does, we ramp up from the first quarter to the fourth quarter, for a number of reasons including how we recognize rebates and other things, and this year, keeping in mind that you will see generic start launching mid-year.

So that will have an impact in the latter part of the year, but also keep in mind, as I said earlier, that people do not change plan designs in the middle of the year.

So your generic impact will obviously be muted somewhat, I think, until have you a full year and the ability to have a full year's plan design that deals with it.

So all that is -- goes into the factor of what we do.

I really don't know what we assume versus just the substitution or therapeutic requests of [inaudible] assumed any from that standpoint.

But I don't know.

I don't get down to that level of detail.

Okay.

And then lastly, on your mail generic dispensing rate.

Sequentially I think they were up about 80 basis points, -- was better than your retail generics dispensing rate.

I think it was probably the best sequential improvement over the last four quarters.

Is this more a reflection of product mix shift. or is it a client mix shift?

We've had a success particularly in our health plan business of increasing generic penetration rates than we have in the past, so I think that is probably one of the biggest movers that we've had there.

A bit of a shift in the mix of business probably has driven the other part of it.

Thank you.

The next question is from Bob Willoughby with Banc of America Securities.

Please go ahead with your question.

Mac, or Pete, did you break out what Medicare spending was in the fourth quarter?

And could you r possibly speak to your expectation for the first quarter?

We spent about $12 million in total for the quarter.

That includes $8 million in capital.

So about $4 million in expense.

Okay.

And the first quarter, any idea?

No, I mean the first quarter is a different ball game.

We're looking at a program now, so we will spend some capital dollars this year, probably not quite as much as what we spent last year.

Yes, I mean to try to compare those two numbers is meaningless because we now have a call center that is fully open and operational and several hundred people in, it those kinds of things, so this is really in an operational mode today, and those things people do some other things, so it really wouldn't be comparable to try to look at it that way.

Great.

Thank you.

Your next question is from Christopher McFadden with Goldman Sachs.

Please go ahead with your question.

Thank you.

Good morning.

Mac, you talked about some of the planning and other uncertainties or estimation challenges associated with the Part D program in terms of enrollees, qualifying enrollees.

Are you doing anything different or distinct in terms of accounting for some of those variations as you are thinking about ramping this plan up?

And if so, where might we see those expressed on the balance sheet or elsewhere in your financial results?

And then secondly, you have obviously talked here about the strong capital position of the company and the ability to think about acquisitions, at a high level without obviously talking about individual targets or companies, at a high level, could you frame out where some of the areas that you think would be complimentary for Caremark that you might think about investigating potential strategic additions or other types of partnerships?

Thank you.

Chris, could you amplify a little bit on the first part?

I'm not sure exactly your question.

Earlier in the call, you were making a point, for example, that individual patients maybe think they're enrolled in one of your plans and you may not have it captured quite that way, or vice versa, and that CMS obviously has a strong incentive for the stability of the overall plan to make sure that patients are served.

And/or there might be other sort of unique characteristics of managing a noncommercial plan.

And I'm just wondering are there special or unique accounting treatments, or estimates you're making to help take some of those scenarios into account?

Well, I mean obviously, do you have the -- where FASB comes out and talks about how you account for a plan like this, and the revenue and expense recognition and how the reserves dip, so we're following all of those rules and guidelines to make sure that it gets accounted for that way.

You know, beyond that, it is just keeping track of what you've paid that may end up going somewhere else, and we've been told there will be a plan reconciliation and everything trued up.

So if anything at all happens, you might have a very small amount in the balance sheet as it relates to receivables from someone else, or payables to someone else that we accounted for

So to be clear, you do have some reserves or reserving activity that are put aside to help take -- account for certain patient or circumstances for which the exact paper trail is not yet fully played out?

Yeah, but it is not a material amount.

Keep that in mind that this is early in the program and the biggest issue is -- I mean I just want a stable eligibility number and a stable group so I know who I was dealing with -- who I was supposed to be dealing with, and CMS is working hard to try to get those issues to where they should be.

Do have you a high level estimate in patients as opposed to dollars of how many -- what percentage of your total enrolled Part D or dual eligibles would now fit into a category for which there is some refinement or some work that needs to be done to kind of fully kind of complete their application?

It is a moving target every week.

So it is not a majority of it.

It is the biggest [inaudible] but it's -- it's not going to be a vast majority of our enrollees or anything like that.

But it is a number that continues to move around.

And I think maybe give you a number, it changes every time I get a tape from them.

So it would only be as good as the last tape I got.

Could be in the range of 25% of those patients?

Oh, no, no, no.

It is about not about 25%.

And on those priorities related to areas to expand the business?

From an acquisition standpoint, and again, try not to give away anything strategic, I've talked before that there are a lot of areas in which are akin to what we do in a lot of ways, and a lot of the patients that we take care of today that utilize a variety of medical supplies that we don't supply, so anything to the full -- that we're very actively looking along those lines.

We're looking at over-the-counter-type products.

We're looking at continuing to expand the -- the on-site pharmacies that we currently have to date.

And in select large clients.

So I guess it would be safe to say, when I looked at expansion opportunities, it's not buying another PBM but it's adding more products and services to the portfolio.

Do you think that the skill set that Caremark has would fit well into an inpatient setting?

That's very different than we are.

Just like somebody asked about institutional pharmacy, and I don't see a lot of opportunity there.

Inpatient setting is probably not something that is at the top of our screen right now.

Very good.

Thank you.

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

Please go ahead with your question.

Mac, on the last conference call, you gave a number of 200 million encompassing both the '05 losses with the '06 wins and losses of about 200 million.

Can you just update us on that number in terms of where you are right now?

Given I think the activity which, again, as Pete said, was publicized probably pretty flat right now, Pete?

Is that right.

That's flat to down a little bit.

Probably on a year-over-year basis.

Yes.

One reason we took the number down to 5% to 10%.

Okay.

And then Pete, you are telling us not to focus on the revenue growth numbers.

Can you give us some sense on the claim side in terms of where the growth is going to be?

I assume you're going to grow on the mail side, but it looks like retail is going to be down for the year.

Am I looking at that right?

Retail, you got to remember, if you are looking at the base business, yes, retail will be down for the year because of the losses that we've already experienced that, will continue and lap into 2006.

You got to remember, though, the Medicare Part D program is going to be a -- the vast majority of it will be a retail program.

So, you know, depending on the ramp-up of that, we will see how that goes.

There's two factors really to look at, and so the results of that we will see.

Can you give us in the quarter excluding the losses you saw where the mail -- I mean where the retail component was?

We've never gotten to specific claim numbers and we won't start doing that now.

Okay.

All right.

Thanks, appreciate it.

Your next question is from Kent Dolliver with SG Cowen and Company.

Please go ahead with your question, sir.

Hi, thanks.

Notwithstanding some of the issues you have with CMS right now with your PDP, some of the anecdotes, some of the enrollment numbers coming out of the health plans, including at least one of your clients, it looked pretty good.

How is the health plan support part of Part D working out so far?

Has that been a cleaner handoff for you?

Yes, I think it has gone well from an operational perspective.

Probably one of our larger clients this week, and they're very complimentary about the way the transition went, and particularly about the way our service levels are handling.

But I think, every plan has the same issues that we have over eligibility, and so I mean it is just nothing that you need to -- the Caremark or the PBM's, it's pretty much universal, but just from the health plan standpoint, we said we are going to support our customers, I think we've done a good job with that.

Okay.

That's good.

Second question is could you give a little further detail with regard to the performance of specialty this quarter?

From what standpoint?

I'm not sure if you gave a specialty specific revenue growth number, but --

Yes, 30% growth.

Okay.

Pretty much with where it's been for the last three or four quarters, right?

A little bit higher, I think for the year, it ended up being almost 40% but I think the 30% has to do with comparisons with the fourth quarter and the percentages, we're not in that network anymore, when that typically would kick in.

That's great.

Thank you.

Your next question is from Matt Perry with Wachovia.

Please go ahead with your question.

Hi, guys.

Just a couple of financial statement type of questions.

You reported again a small integration expense in the quarter.

And given the -- if it was related to AdvancePCS, given that deal was closed quite some time ago, do you expect to report anything similar in '06?

No, we don't.

We don't, John.

We're -- those items really are related to the AdvancePCS operations still in 2006.

Severance, relocation, things like that.

But we do not intend to report any more.

It is an immaterial number at this point.

Okay.

And if I think about the synergies you've been able to generate on the cost side from AdvancePCS, are you at a kind of run rate level now, or are there still, levers to pull to increase those synergies?

No, I think we're pretty much at a run rate.

And then just lastly, on the FAS 123 expense, would that show up mostly in SG&A?

Yes.

Mostly in SG&A.

Wherever the bodies are, but that would be mostly what would show up.

And just a much --

It could be a small piece in cost of service.

Okay.

Great.

All right.

Thanks very much.

Your next question is from John Kreger with William Blair.

Please go ahead with your question.

Thanks.

Hi.

A question about claims growth in the fourth quarter.

Can you give us a sense about how long you had the Humana contract before it rolled off?

I think we had it until October 12.

Is that what you mean?

Yes, it is.

Okay.

And then I know you don't like to talk about claims growth prospectively, but can you give us a sense as you lapped the federal mail employee mail contract, is it safe to assume that that added about 10 percentage points to your growth rate in the fourth quarter for mail claims?

We have regularly said that that is about a 10 million annualized script contract on the mail side.

So whatever that is.

Okay.

And then one last question, not sure if you've had enough experience yet with Part D, but are you getting a sense about how the utilization is trending as people enroll?

Are there -- excuse me -- are the utilization stats going up at all?

Well, there is a population that is an elderly population, so as they compare to what we expected and as we compare it to similar type populations that we've managed in the employer book of business, I think it is fairly consistent.

Consistent with your expectations?

Right.

Great.

Thanks.

Thank you.

At this time, there are no further questions.

I would like to turn the conference back over to Mr. Crawford for any closing remarks.

Okay.

Thank you everyone, for dialing in.

As usual, we will be here, and do not hesitate to call if you have any questions.

Thank you.

Thank you for participating in today's conference.

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