Medco Health Solutions (MHS) reported EPS of $1.08, ($1.14 excluding $43.6 million expenses associated with the pending Express Scripts merger) during the fourth quarter of fiscal 2011, up 22.7% year over year. After adjusting for amortization of intangible assets and merger-related expenses, the company’s adjusted EPS stood at $1.25, beating the Zacks Consensus Estimate of $1.17 and 26.3% higher than the year-ago level.
Increased sales combined with 8.3% reduction in number of share outstanding contributed to the bottom-line improvement during the quarter.
Additionally, the introduction of generic Lipitor contributed 3 cents to the fourth quarter EPS. For the full year, adjusted EPS came in at $4.17, surpassing the Zacks Consensus Estimate of $4.10 and was up 17.5% year over year. EPS for the full year was also ahead of management’s guided range of $4.08-$4.12.
Medco reported an increase of 12.2% in revenues on a year-over-year basis to $18.6 billion, surpassing the Zacks Consensus Estimate of $17.4 billion. Revenues stood at $70.1 billion for the full year, up 6.2% year over year and beat the Zacks Consensus Estimate of $68.5 billion. The increase in revenue was primarily driven by contributions from significant client wins coupled with higher prices charged for branded drugs, partially offset by higher volumes of lower-priced generic drugs.
During the quarter, Medco witnessed a robust 18.3% year-over-year upside in service revenue based on the sales from United BioSource (UBC) and growth in its client service offerings. Revenues from Medco’s specialty pharmacy segment, Accredo Health Group, surged 28.3% to $3.8 billion primarily due to higher prescription volumes, rise in manufacturer brand pricing, further utilization of specialty products and the impact of recently introduced drugs. Product categories, which witnessed stupendous revenue growth, were multiple sclerosis, rheumatoid arthritis, oncology and hepatitis.
During the reported quarter, the generic dispensing rate increased 2.5 percentage points to 74.7% from the year-ago level. Both mail-order and retail generic dispensing rates increased 3.2 percentage points to 66.1% and 2.4 percentage points to 76.2%, respectively. The year-over-year growth in the overall generic dispensing rate enhanced the incremental savings of the company’s clients and members to approximately $900 million.
In the reported quarter, net product revenues of $18.6 billion included $11.3 billion in retail products while the rest came from mail order products. Both retail and mail-order products spiked 9.8% and 15.6% year over year, respectively.
Total adjusted prescription volume increased 7.7% to $263.1 million from the year-ago period, reflecting an extra week of volume in fourth quarter 2011 with mail-order volume increasing 9.0% to 30.4 million. Branded mail order prescription volume dipped 1.0% year over year to 10.3 million, while generic mail-order prescription volume increased 14.9% to 20.1 million. Retail prescription volumes also rose 7.0% to 172.7 million.
Medco’s gross margin during the quarter contracted 10 basis points (bps) year over year to 6.7%.Selling, general and administrative (SG&A) expenses increased 2.5% year over year to $439.4 million (excluding the pending merger-related expenses).
Medco exited fiscal 2011 with $229.1 million in cash and cash equivalents; down from $853.4 million at the end of fiscal 2010. Cash flows from operations were $1,282.4 million in 2011 compared with $2,344.7 million in 2010. For fiscal 2011, the company repurchased 29.3 million shares for $1.78 billion. However, the company has suspended share repurchases due to the pending merger with Express Scripts (ESRX).
Outlook
With 2012 generic wave commenced on November 30, Medco expects to continue as a strong contributor in 2012.
Recommendation
We are looking forward to the closure of the proposed merger between Express Script and Medco, scheduled for the first half of 2012. Although both the companies believe this merger would expand the service offering and reduce costs, others contend the union would have an anti-competitive impact, hurting consumer sentiment and possibly leading to higher prices and inferior service. Recently, US Federal Trade Commission (FTC) issued a ‘second request’ to both Medco and Express Scripts seeking additional information pertaining to the pending deal, also supported by the American Antitrust Institute (AAI). However, on February 10, both the companies declared that they have fulfilled the requirements with regards to the second request.
Medco has been witnessing severe challenges over the past few quarters as it lost several contracts, mostly to CVS Caremark (CVS). Owing to this, the proposed merger with Express Scripts can prove to be a lifeline for Medco. Although Medco is confident about the deal, the company will suffer a major blow if the situation turns around.
Currently, we are Neutral on Medco and Express Scripts, which correspond to the Zacks #3 Rank (short-term Hold rating).
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