Medco third quarter net revenue increases 10.3% to $16.3 billion

Nov 2 2010

Third-Quarter 2010 Highlights:

• GAAP diluted earnings per share (EPS) increased 23.2 percent to a record $0.85 from $0.69 in third-quarter 2009
• Diluted EPS, excluding amortization of intangible assets from the 2003 spin-off, increased 21.3 percent to a record $0.91 from $0.75 in third-quarter 2009
• Total net revenues increased 10.3 percent to $16.3 billion
• Specialty pharmacy revenues increased 19.9 percent to a record $2.9 billion
• Record gross margin of $1.12 billion representing a gross margin percentage of 6.9 percent
• Record EBITDA of $771 million and record EBITDA per adjusted prescription of $3.28
• Mail-order prescriptions increased 7.1 percent to 27.3 million, with generic volumes increasing 15.5 percent to a record of 17.1 million
• Generic dispensing rate increased 3.9 percentage points to a record 71.6 percent

Raises and Narrows 2010 EPS Guidance Range:

• Raises and narrows full-year 2010 GAAP diluted EPS range to $3.14 to $3.16, representing 20 to 21 percent growth over 2009. The previous guidance range was $3.10 to $3.15 per share.
• Raises and narrows full-year 2010 diluted EPS range, excluding amortization of intangible assets from the 2003 spin-off, to $3.38 to $3.40, representing 19 to 20 percent growth over 2009. The previous guidance range was $3.34 to $3.39 per share.

2011 Guidance and Change to Non-GAAP Measure:

• Full-year 2011 GAAP diluted EPS is expected to be in the range of $3.53 to $3.66, representing growth of 12 to 17 percent over the raised and narrowed 2010 guidance.
• For reference, though this non-GAAP EPS measure will not be used in 2011, diluted EPS excluding intangible amortization from the 2003 spin-off is expected to increase to a range of $3.80 to $3.93, representing growth of 12 to 16 percent over the raised and narrowed 2010 guidance (please see Table 9).
• The non-GAAP diluted EPS measure will be changed commencing in 2011 to exclude all intangible amortization, compared to our previous practice of only excluding intangible amortization from the 2003 spin-off. Full-year 2011 diluted EPS, excluding all intangible amortization, is expected to be in the range of $3.99 to $4.12, representing growth of 12 to 17 percent over the 2010 full-year equivalent of $3.53 to $3.55 (please see Table 9).
• The new non-GAAP EPS measure will be easier to understand and will be consistent with what is reported by other companies in our industry.

Medco Health Solutions, Inc. (NYSE: MHS) today reported record third-quarter 2010 GAAP diluted EPS of $0.85, up 23.2 percent compared to $0.69 for the third quarter of 2009. Adjusting for the amortization of intangible assets that existed when Medco became a publicly traded company in 2003, third-quarter 2010 diluted earnings per share increased 21.3 percent to a record $0.91, from $0.75 in the third quarter of 2009.

Medco raised and narrowed its 2010 EPS guidance range, and now expects GAAP diluted EPS growth of 20 to 21 percent over 2009 and, excluding amortization of intangible assets from the 2003 spin-off, diluted EPS growth of 19 to 20 percent.

Medco provided guidance for full-year 2011 GAAP diluted EPS growth of 12 to 17 percent, and diluted EPS growth excluding all intangible amortization (a new measure) of 12 to 17 percent.

“Our record third-quarter performance, the raised and narrowed 2010 EPS guidance, and solid 2011 EPS guidance all point to the continued strength of our business, especially when considering that the incremental EPS contribution from new generic introductions in 2011 is the lightest we will see in this decade through 2020. Looking forward, we expect that 2012 will reflect a very significant contribution from new generic introductions – in fact the highest of this decade and the highest in our history,” said Medco Chairman and Chief Executive Officer David B. Snow Jr.

“Medco’s sales and client retention results remain strong. We are retaining more than 99 percent of our business both in 2010 and 2011. We are winning and retaining clients at profitable levels and our annualized new-named and net-new sales for 2010 are each exceeding $5 billion. For 2011, our annualized new-named sales increased to $1.7 billion from the previously reported $1 billion, and net-new sales for 2011 are now $1.4 billion,” Snow said.

“Our acquisition of United BioSource was completed on September 16, and we are once again extending the Medco capabilities to drive service-oriented value in the areas of drug safety and economic evaluation. This acquisition adds a powerful asset to Medco’s portfolio, and gives us the ability to take what we call ‘Smarter Medicine’ to an entirely new level for the benefit of patients with chronic and complex disease, our clients, and our shareholders,” Snow added.  

Third-Quarter Financial and Operational Results

Medco reported net revenues of $16.3 billion in third-quarter 2010, representing a 10.3 percent increase over third-quarter 2009 -- primarily as a result of contributions from significant new client wins and higher prices charged by brand-name pharmaceutical manufacturers, partially offset by higher volumes of lower-priced generic drugs. Medco’s generic dispensing rate increased 3.9 percentage points from third-quarter 2009 to a record 71.6 percent. The mail-order generic dispensing rate increased 4.7 percentage points to a record 62.8 percent and the retail generic dispensing rate increased 3.7 percentage points to a record 73.1 percent. Higher volumes of lower-priced generic drugs reduced net revenues for third-quarter 2010 by a record amount of approximately $1.04 billion, delivering significant savings to clients and members.  

Total prescription volume, adjusting for the difference in days supply between mail-order and retail, was 235.2 million, a 6.8 percent increase over the third quarter of 2009. Mail-order prescription volume was 27.3 million, a 7.1 percent increase from third-quarter 2009. Importantly, while brand-name mail-order prescription volumes decreased 4.7 percent to 10.2 million prescriptions in the third quarter of 2010, mail-order generic prescription volumes increased 15.5 percent to a record 17.1 million.

Significant new business wins also drove higher retail volumes, reaching 154.0 million prescriptions, a 6.7 percent increase over third-quarter 2009. The adjusted mail-order penetration rate was consistent at 34.5 percent for the third quarters of both 2010 and 2009.

Total gross margin for third-quarter 2010 was a record $1.12 billion, representing a 7.6 percent increase over third-quarter 2009. The total gross margin percentage decreased slightly to 6.9 percent from 7.0 percent in the third quarter of 2009, and was 40 basis points higher than the 6.5 percent reported for second-quarter 2010.  

Total selling, general and administrative expenses of $395 million increased 7.0 percent, or $26.0 million, from third-quarter 2009, and include approximately $9 million in nonrecurring expenses associated with the closing of the United BioSource acquisition.    

Earnings Before Interest Income/Expense, Taxes, Depreciation and Amortization (EBITDA) for the quarter reached a record $771.0 million, an increase of 7.2 percent, or $51.7 million, over the same period last year. EBITDA per adjusted prescription for third-quarter 2010 reached a record $3.28, representing a slight increase over the previous record of $3.27 in the third quarter of 2009 (please see Table 6). On a sequential basis, third-quarter 2010 EBITDA per adjusted prescription increased 7.2 percent from $3.06 in second-quarter 2010.

Total interest and other (income) expense, net, of $40.8 million in third-quarter 2010 reflects a slight increase of $0.9 million compared to the same period in 2009, attributable to higher debt levels from the $1.0 billion senior notes issuance which closed on September 10 and was associated with the acquisition of United BioSource.

Income before the provision for income taxes for the third quarter reached a record of $612.5 million, and increased 10.8 percent compared to $552.7 million in the third quarter of 2009.

The third-quarter 2010 effective tax rate of 39.3 percent was consistent with third-quarter 2009.

Net income increased 10.7 percent over the same quarter last year to a record $371.5 million.

Medco’s year-to-date cash flows from operations of $1.37 billion decreased by $1.18 billion compared to 2009 mainly as a result of significant inventory reductions and strong retail claim volume growth in 2009. The company expects cash flow from operations of approximately $2.4 billion for full-year 2010. The company closed third-quarter 2010 with nearly $900 million of cash on its balance sheet.

Richard J. Rubino, chief financial officer stated, “In addition to strong third quarter year-over-year results, we also demonstrated strong fundamental EPS and profitability growth on a sequential quarterly basis.”

“Our performance this quarter exceeded the guidance we provided on our second-quarter earnings call regarding sequential growth in key financial metrics. Compared to the second-quarter of 2010, the third quarter reflects a 40 basis point improvement in gross margin percentage, a 7.2 percent increase in EBITDA per adjusted prescription, and 10.4 percent growth in GAAP diluted EPS. Our balance sheet remains healthy and we will continue to allocate our capital in ways that drive even further shareholder value in the future,” concluded Rubino.  

Specialty Pharmacy Group

Revenues for Accredo Health Group grew 19.9 percent to a record $2.9 billion in the third quarter of 2010, reflecting significant new client wins and growth across the specialty business.

Accredo’s gross margin percentage decreased to 6.8 percent in the third quarter of 2010 compared to 7.4 percent for the same period in 2009, primarily resulting from product, channel and new-client mix.  Operating income grew 19.8 percent to a record $111.7 million from $93.2 million in the third quarter of 2009, driven primarily by the revenue growth.  

Share Repurchase Programs

During the third quarter of 2010, Medco repurchased a total of 17.1 million shares at a total cost of $903.5 million and an average per-share cost of $52.81. Through the end of the third quarter, year-to-date 2010 share repurchases totaled 54.2 million shares at a total cost of $3.161 billion and an average per-share cost of $58.37. On an inception-to-date basis, since share repurchases commenced in 2005, Medco repurchased a total of 240.4 million shares at a total cost of $10.1 billion and an average per-share cost of $42.01.

There have been no repurchases in the fourth-quarter 2010 to date. Medco has approximately $1.4 billion remaining of the $3.0 billion authorization that was approved in May 2010.

Raises and Narrows 2010 Guidance Range

Medco raised and narrowed the full-year 2010 GAAP diluted EPS range to $3.14 to $3.16, representing growth of 20 to 21 percent over 2009. The previous GAAP diluted EPS guidance range was $3.10 to $3.15. Medco raised and narrowed the full-year 2010 diluted EPS range, excluding the amortization of intangible assets from the 2003 spin-off, to $3.38 to $3.40, representing growth of 19 to 20 percent over 2009. The previous diluted EPS guidance range was $3.34 to $3.39.

Provides 2011 Guidance and Revises Non-GAAP EPS Measure

Medco provided full-year 2011 GAAP diluted EPS guidance of $3.53 to $3.66, representing growth of 12 to 17 percent over the raised and narrowed 2010 guidance.

While this measure will not be used in 2011, diluted EPS excluding intangible amortization from the 2003 spin-off is guided to increase to a range of $3.80 to $3.93, representing growth of 12 to 16 percent over the raised and narrowed 2010 guidance.

The non-GAAP diluted EPS measure will be changed commencing in 2011 to exclude all intangible amortization, resulting in diluted EPS excluding all intangible amortization in the guidance range of $3.99 to $4.12, representing growth of 12 to 17 percent over the 2010 full-year equivalent of $3.53 to $3.55 (please see Table 9).

This measure is being changed in 2011 to exclude all intangible amortization expense in order to make it easier for readers of the financial statements to reconcile to GAAP EPS and to enhance comparability in non-GAAP reporting with our industry peers.  

Use of Non-GAAP Measures

Medco calculates and uses EBITDA and EBITDA per adjusted prescription as indicators of its ability to generate cash from its reported operating results.  These measurements are used in concert with net income and cash flows from operations, which measure actual cash generated in the period.  In addition, Medco believes that EBITDA and EBITDA per adjusted prescription are supplemental measurement tools used by analysts and investors to help evaluate overall operating performance and the ability to incur and service debt and make capital expenditures.  EBITDA does not represent funds available for Medco’s discretionary use and is not intended to represent or to be used as a substitute for net income or cash flows from operations data, as measured under U.S. Generally Accepted Accounting Principles (GAAP).  The items excluded from EBITDA, but included in the calculation of reported net income, are significant components of the consolidated statements of income and must be considered in performing a comprehensive assessment of overall financial performance.  EBITDA, and the associated year-to-year trends, should not be considered in isolation.  Medco’s calculation of EBITDA may not be consistent with calculations of EBITDA used by other companies.

EBITDA per adjusted prescription is calculated by dividing EBITDA by the adjusted prescription volume for the period.  This measure is used as an indicator of EBITDA performance on a per-unit basis, providing insight into the cash-generating ability of each prescription.  EBITDA, and as a result, EBITDA per adjusted prescription, are affected by the changes in prescription volumes between retail and mail order, the relative representation of brand-name, generic and specialty pharmacy drugs, as well as the level of efficiency in the business.  Adjusted prescription volume equals substantially all mail-order prescriptions multiplied by three, plus retail prescriptions.  These mail-order prescriptions are multiplied by three to adjust for the fact that they include approximately three times the amount of product days supplied compared with retail prescriptions.

Medco has historically used diluted earnings per share excluding intangible asset amortization expense from when Medco became a publicly-traded company in 2003 as a supplemental measure of operating performance.  The excluded amortization is associated with intangible assets that had been previously pushed down to the consolidated balance sheets of Medco. This measure is being changed in 2011 to exclude all intangible amortization expense to make it easier for readers of the financial statements to reconcile to GAAP EPS and to enhance comparability in non-GAAP reporting with our industry peers.