CVS Health Corp (CVS) 2012 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by.

Welcome to the CVS Caremark fourth-quarter earnings call.

During the presentation all participants will be in a listen-only mode.

Afterwards, we will conduct a question-and-answer session.

(Operator Instructions)

As a reminder, this conference is being recorded Wednesday, February 6, 2013.

I would now like to turn the conference over to Nancy Christal, Senior Vice President Investor Relations.

Please go ahead, ma'am.

Thanks, Susie.

Good morning, everyone, and thanks for joining us today.

I'm here with Larry Merlo, President and CEO, who will provide a business update.

And Dave Denton, Executive Vice President and CFO, who will review our financials.

Jon Roberts, President of Caremark, and Mark Cosby, President of CVS/Pharmacy are also with us today, and will participate in the question-and-answer session following our prepared remarks.

During the Q&A, please limit yourself to one or two questions so we can provide more analysts and investors a chance to ask their questions.

Please note that we posted a slide presentation on our website this morning.

And it summarizes the information on this call, as well as key facts and figures around our operating performance and guidance.

So I recommend that you take a look at that.

Additionally, note that we plan to file our annual report on Form 10-K later this month.

And it will be available through our website at that time.

During this call we'll discuss some non-GAAP financial measures in talking about our Company's performance, namely free cash flow, EBITDA and adjusted EPS.

In accordance with SEC regulations, you can find the definitions of the non-GAAP items I mentioned, as well as a reconciliation to comparable GAAP measures on the Investor Relations portion of our website.

And, as always, today's call is being simulcast on our website and it will be archived there following the call for one year.

Now before we begin, our attorneys have asked me to read the Safe Harbor statement.

During this presentation, we'll make certain forward-looking statements that are subject to risks and uncertainties that could cause actual results to differ materially.

Accordingly, for these forward-looking statements, we claim the protection of the Safe Harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995.

We strongly recommend that you become familiar with the specific risks and uncertainties that are described in the risk factors section of our most recently filed annual report on Form 10-K.

And that you review the section entitled Cautionary Statements Concerning Forward-Looking Statements in our most recently filed quarterly report on Form 10-Q.

And now I'll turn this over to Larry Merlo.

Thanks, Nancy.

Good morning, everyone, and thanks for joining us today.

Obviously, we're very pleased with the strong results we posted in the fourth quarter and full-year 2012, with solid performance across the enterprise.

If you exclude the one-time cost of $0.17 per share related to the early extinguishment of debt, adjusted earnings per share from continuing operations for the fourth quarter and full year were $1.14 and $3.43, respectively.

Demonstrating very healthy underlying growth of 28% for the quarter, 23% for the year.

You'll recall that in December we retired some long-term debt, replacing it with debt at lower interest rates.

And that refinancing, and the associated one-time cost, was not included in our guidance.

So our fourth-quarter results reflect strong performances at the high end of our expectations in both the retail and PBM segments.

In addition, below-the-line benefits from a lower effective tax rate and fewer shares than expected drove the outperformance.

With the quarter exceeding the high end of our guidance by $0.03 per share.

We also generated $1.1 billion in free cash flow in the quarter, bringing the 2012 total to $5.2 billion, which also exceeded our goal for the year.

Now, in addition to posting better-than-expected 2012 results, this morning we're raising our guidance for 2013, taking into account the anticipated accretion from the debt refinancing.

We now expect to achieve adjusted earnings per share for '13 in the range of $3.86 to $4.

And that's up $0.02 from our previous range of $3.84 to $3.98.

And Dave will provide the details of our guidance during his financial review.

So with that, let me provide a brief business update.

And I'll start with our PBM.

Since our analyst day in mid December, there has been no material change in the 2013 selling season.

And with nearly 85% of our client renewals completed to date, our retention rate stands at 96%.

On analyst day, we reported net new business wins for '13 of about $400 million.

And while we have had some additional wins since analyst day, we expect the impact of the recent CMS sanction -- which I'll speak about shortly -- to basically offset those recent wins.

So, again, our net new business for ' 13 stands at about $400 million.

Now, it's obviously very early in the 2014 selling season but efforts are well underway.

And our differentiated offerings continue to gain attention in the marketplace.

Client interest in our unique Maintenance Choice offerings continues to be robust.

And we now have about 15.8 million lives covered by more than 1,100 plans that have implemented or committed to implement our Maintenance Choice offerings.

And that number is up from 14.5 million lives at our last update.

And looking forward we see the potential to increase the number of lives to an even higher level.

We are enrolling new lives into both of our Maintenance Choice offerings, with some clients opting for the 1.0 offering, and others opting for the new 2.0 design.

Most of the lives our coming from plans that previously had voluntary mail plan design, so these clients can now begin to experience the cost savings Maintenance Choice offers.

Pharmacy Advisor, our flagship clinical offering, has also made strong advances.

Five new disease states have been successfully implemented as of January 1, including asthma, COPD, depression, osteoporosis and breast cancer.

And as we said on analyst day, we expect to have about 900 clients with about 16 million members enrolled in all or some of our available programs.

And we have seen a very positive response from clients to the newly expanded offerings.

We also began offering Pharmacy Advisor to our Medicare clients on January 1. And we're excited about future opportunities to support these clients, as they strive to improve their star ratings.

And I think these are two great examples of how we're capitalizing on our integrated assets.

And these programs are helping to lower healthcare costs, while improving the health of those we serve.

Now, let me talk more about the recent CMS sanction on our Medicare Part D prescription drug plan.

The sanction means that we cannot enroll new individual SilverScript members, or market our SilverScript plan to potential individual members until the sanction is lifted.

However, current SilverScript members are not affected by this action, including our EGWPs, along with the new individual members that enrolled at the beginning of this plan year.

Our clients' EGWP plans and their members are also not affected by the sanction.

This sanction relates only to our SilverScript plan, and does not affect Medicare Part D plans offered by our health plan clients.

Now, that said, let me acknowledge my disappointment in these circumstances.

Our goal is to execute flawlessly across the organization every day.

And in consolidating the Medicare Part D enrollment systems for SilverScript, we did not deliver on that goal.

So we are working to resolve these issues as expeditiously as possible.

The sanctions should be lifted when CMS is satisfied that the issues are fixed and not likely to recur.

Let me assure you that we are highly focused on working with CMS to bring these issues to resolution as soon as possible.

So with that, I'll turn to three important PBM growth drivers.

The fast-growing specialty pharmacy business, our streamlining initiative, and the Aetna relationship.

Now, the specialty pharmacy business continued on pace, with revenues increasing more than 31% versus the same quarter last year.

And this specialty growth was driven by new PBM clients, new product launches, along with drug price inflation.

And given that specialty costs are growing rapidly, our clients are looking for help to better manage this trend.

And our specialty guideline management program continues to garner a great deal of interest, with some significant new clients adopting the program late last year.

We're also seeing a lot of interest in our specialty medical benefit management program, especially among our health plan customers.

And we have multiple pilots underway.

And we expect to close and implement several other customers during the 2013 year.

So, specialty pharmacy will continue to be a key area of focus for us going forward.

As for the streamlining initiative, we are on track with our efforts to reorganize PBM operations to improve productivity, rationalize capacity, and consolidate our adjudication platforms to one destination platform with enhanced capabilities.

We now have about two-thirds of our business on the destination platform.

And we expect to increase that to 85% by the end of this year.

As for the other transformation activities, we anticipate being more than 95% complete by the end of April.

So, we're on track to deliver significant cost savings from the streamlining efforts.

And we expect to hit the full run rate of annual savings -- that being $225 million to $275 million -- beginning in '14.

And then as for the Aetna relationship, the client systems conversion continues to proceed successfully.

We have further migrations scheduled throughout this year.

And once a client's migration is complete, we can then begin to offer our differentiated products and services.

We have had a successful selling season, as Aetna has added more than 1 million pharmacy lives to their book.

And we have seen interest within the Aetna client base to implement Maintenance Choice and Pharmacy Advisor.

And we believe this has further enhanced Aetna's competitive position in the marketplace.

So we're very optimistic as to what lies ahead as we continue to work with the Aetna team to drive cost savings for their clients.

So with that, let me turn to our retail business.

We had a very strong quarter with same-store sales increasing 4%.

Pharmacy comps also increased 4% in the quarter, with front store comps increasing 3.9%.

New generics had a negative impact of about 1,100 basis points on pharmacy comps.

And you may recall that's up from about 900 basis points in the third quarter.

Script comps increased 11% on a 30-day supply basis.

And 9% when counting 90-day supplies as one script.

We had a slight benefit in the quarter from flu-related scripts and flu shots increasing during December.

In addition, our retention of scripts gained during the Walgreens Express impasse was also a factor.

As expected, we retained at least 60% of the scripts gained during the impasse.

And we estimate the impact added about 340 basis points to our script comp, equating to about 5.5 million to 6 million scripts.

And we remain confident that we will continue to retain at least 60% of the scripts in 2013.

Now, as for the front store business, both customer traffic and the average front store ticket increased notably in the quarter.

I'm sure you're not surprised to hear that we saw particular strengths in cough and cold, allergy and flu-related sales.

Private-label sales represented 18.1% of front store sales in the quarter.

That's up about 20 basis points year-over-year.

And we also continued to see solid sales and share growth in the beauty category, driven by skin care and cosmetics.

In addition, we estimate that the Walgreens Express impasse positively impacted our front-store comp by about 150 basis points in the quarter.

And as for the Christmas season, seasonal sales came in close to but just below our expectations.

When you look at market share, the latest data shows that CVS has gained front-store share versus a year ago.

Our share growth in the drug channel was 226 basis points.

And against multi-outlet competitors, 17 basis points.

Now, let me touch on our ExtraCare program because it continues to be a key differentiator for us, with the scale of our program increasing dramatically in 2012 even with competitive activity in the loyalty space.

Now, both front store and pharmacy transactions with the ExtraCare card increased.

We issued more personalized offers.

And we saw 19% growth in the number of offers redeemed, with many now coming from the ExtraCare coupon centers.

In addition, increased engagement of our ExtraCare members is driving meaningful results.

As an example, we have doubled our e-mail program to more than 15 million active participants.

They have received over 60 million personalized e-mail offers.

That's up 69% versus the prior year.

Beauty Club participation grew by 21% to 11 million customers, affording targeted promotion and profitable sales growth.

And just last week we launched an enhanced ExtraCare program for pharmacy and health rewards.

Now, this is an opt-in program.

And individual enrollment versus household participation allows for more personalized communication.

We can offer members a wider range of rewards for healthy behaviors that can result in improved adherence.

So this program will be a great tool for driving prescription adherence, script consolidation, and customer retention.

And while ExtraCare has been in the marketplace for 15 years, I think these are examples of how we're not sitting still.

These enhanced programs are geared to our higher-value customers.

And it enables us to focus and tailor our rewards, along with enhancing the productivity of our investments.

With that, let me turn to our real estate program.

We opened 45 new or relocated stores.

We closed two, resulting in 35 net new stores in the quarter.

And for the year, we opened 150 new or relocated stores, closed 19.

Resulting in 131 net new stores with 2.1% retail square footage growth.

Now, before turning to MinuteClinic, I want to touch on a recent transaction.

Late last week we closed on the acquisition of Drogaria Onofre, a privately-held retail drugstore chain in Sao Paulo, Brazil, with 44 stores.

This transaction is not financially material to our Company.

However, it is our first foray into the international drugstore space and we wanted to provide a little color this morning.

As you know, we have been exploring opportunities for possible international expansion.

And we've said many times that our approach would be measured, and that we would exercise financial discipline.

And we believe this acquisition is a great example of that strategy in action.

Onofre has a strong reputation in the marketplace.

They do a great job in tailoring their stores to market to different customer segments.

And we view Brazil as an attractive market, given that healthcare and pharmacy are expected to grow double digits for the next decade.

And while chains are prevalent, it is still a highly fragmented market.

So we see nice opportunities to grow the business over time.

And as we've said, we will continue to take a measured approach to our international growth plan.

So with that, let me turn to MinuteClinic, which recorded very strong revenue growth in the quarter.

On a comparable basis, sales were up more than 38%, versus the same quarter last year.

And as we headed into January with the strong flu season, our patient visits at MinuteClinic reached unprecedented daily levels.

In addition to treating acute [visit] patients in the quarter, we continued to work on wellness programs, along with programs aimed at treating chronic conditions.

For example, we've developed a provider education program with the American Heart Association to support our hypertension evaluation visits.

And we're also piloting enhanced smoking cessation and weight management programs.

And the strong growth we've experienced in MinuteClinic's non-acute services is helping us to reduce the seasonality of the business.

We opened 31 net new clinics in the quarter.

And we ended 2012 with 640 clinics in 25 states in the District of Columbia.

And as Andy Sussman noted on analyst day, we're ramping up our expansion plans.

And we expect to open another 150 clinics this year, ending '13 with just under 800 clinics.

MinuteClinic is also expanding its affiliations with many of the nation's leading health systems.

And it's also increasing its collaboration with our PBM clients.

And through all of these efforts, we will help to transform the delivery of primary care in the US, as our healthcare system continues to evolve.

So with that, let me turn it over to Dave for the financial review.

Good morning.

Thank you, Larry.

Today I'll provide a detailed review of our fourth-quarter 2012 results, and review our 2013 guidance.

But let me begin with a wrap-up of last year's capital allocation program, and how we've been using our strong free cash flow to return value to our shareholders.

In the fourth quarter, we finalized the accelerated share repurchase program that we began in September.

And we also repurchased approximately 7.1 million shares for approximately $329 million in the open market.

So, for all of 2012, we repurchased approximately 95 million shares for $4.3 billion, averaging $45.58 per share.

Additionally, we paid approximately $202 million in dividends in the fourth quarter alone, bringing our total for the year to $829 million.

We finished the year with a payout ratio of 21.3%.

And our strong earnings outlook this year, combined with a 38% increase in the dividend we announced at our analyst day, puts us on track to achieve our targeted payout ratio of 25% by the end of 2013, two years ahead of our schedule.

So, between dividends and share repurchases, we've returned more than $5.1 billion to our shareholders just in 2012.

And our expectation is that, between dividends and share repurchases, we will return approximately $5 billion again to our shareholders in 2013.

We generated $5.2 billion of free cash in '12 and $1.1 billion in the fourth quarter alone.

Up $419 million from the same period of LY.

This was driven by our earnings outperformance, as well as improved receivables and payables management, and the timing of certain payments.

Regarding the balance sheet, over the course of 2012 we continued to make great strides in improving our cash cycle, especially within the retail segment.

Inventory days within retail improved by more than 3.5 days in 2012.

And we reduced our retail cash cycle by more than five days throughout the year.

The retail team was able to reduce inventories by approximately $450 million through process improvements.

And while just short of our $500 million goal, we remain committed to further inventory reductions as we move forward.

In the fourth quarter, gross capital expenditures of $716 million were offset by $102 million of sale leaseback activity.

For the year, our net capital expenditures were $1.5 billion, which included $2 billion of gross CapEx, offset by $529 million in sale leaseback proceeds.

As for the income statement, adjusted earnings per share from continuing operations came in at $1.14 per share, approximately $0.03 above the high end of our guidance after you adjust for the impact of the debt refinancing.

GAAP diluted EPS was $0.90 per share.

And, as Larry said, the EPS beat was driven primarily by better than expected below-the-line performance.

But both the PBM and retail segments performed at or above the high end of expectations, as well.

So let me quickly walk down the P&L statement.

On a consolidated basis, revenues in the fourth quarter increased 10.9% to $31.4 billion.

Within the segments, net revenues increased 17.4% in the PBM to $18.6 billion.

The significant number of new client starts in 2012 drove substantial growth over last year.

While Medicare Part D was also a key growth driver.

Acquisitions, such as Universal American and Health Net, as well as organic member growth, are responsible for the volume increases in Medicare Part D. And we continue to see some drug price inflation, particularly in our specialty business, which helped to grow revenues over last year.

These positive revenue drivers were partially offset by the growth in the PBM's generic dispensing rate, which increased 500 basis points versus the same quarter of LY to 80%.

In our retail business, revenues increased 5.1% in the quarter to $16.3 billion, driven primarily by strong same-store sales growth.

Turning to gross margin, we reported 20.1% for the consolidated Company in the quarter, an increase of approximately 45 basis points compared to Q4 of '11.

Within the PBM segment, gross margin increased by 75 basis points versus Q4 of '11 to 7.2%, while gross profit dollars increased 16% year-over-year.

The increase year-over-year was primarily driven by the big increase in GDR, higher volumes, and better acquisition cost economics.

These positive margin drivers were partially offset by client price compression.

Gross margin in the retail segment was 31.3%, up 155 basis points over last year.

This improvement was again driven primarily by the 400 basis point increase in retail GDR to 79.9%.

Additionally, we saw our private-label sales as a percent of front store volume increase by 20 basis points to 18.1%.

Total operating expenses as a percent of revenues were essentially flat to Q4 of '11 at 12.7%.

The PBM segment's SG&A rate improved approximately 25 basis points to 1.6%.

This was primarily driven by strong revenue growth, as well as improvements derived from the streamlining effort.

In the retail segment, SG&A as a percent of sales increased by approximately 125 basis points to 21.6%, while expenses grew by 11.6%.

As expected, this was mainly due to the deleveraging effect of the growth in generics, as well as the fact we were comparing against disproportionately lower spending in Q4 of last year.

Within the corporate segment, expenses were up approximately $30 million to $182 million.

And given all that, operating margin for the total enterprise improved 40 basis points to 7.3%.

Operating margin in the PBM improved approximately 100 basis points to 5.6%.

While operating margin at retail improved by about 35 basis points to 9.7%.

For the quarter we beat our growth estimates for operating profit in both the retail and PBM segments.

Retail operating profit increased a solid 8.9%, exceeding expectations by approximately 90 basis points.

PBM operating profit grew a very healthy 42.9%, some 185 basis points above our guidance range.

Both segments benefited from the positive impact of generics and the increase in GDRs.

Additionally, the PBM also benefited from the increasing profitability, as we moved through the year in the Medicare Part D business.

As well as the increasing benefits derived from the streamlining effort.

Now, going below the line of the consolidated income statement, net interest expense in the quarter increased approximately $12 million from last year to $159.

Additionally, our effective tax rate was 37.1%, lower than expected related to a nonrecurring item.

Our weighted average share count was 1.25 billion shares, approximately 12 million shares lower than anticipated, due to our opportunistic repurchase of additional shares in the open market once the ASR completed.

The tax rate and share count explained the overwhelming majority of our EPS beat.

This, of course, excludes the impact from the debt refinancing.

We booked a one-time loss on the early extinguishment of debt of $348 million, or approximately $0.17 per share.

This action provides an ongoing benefit in terms of lower interest expense going forward.

Now let me update you on our guidance.

Which remains essentially unchanged from analyst day, except for the anticipated $0.02 per share full-year benefit from lower interest expense.

Again, resulting from the debt refinancing.

And you can find the details of our guidance in the slide presentation we posted on our website.

But I'll focus on just a few highlights here.

We currently expect to deliver adjusted EPS in 2013 in the range of $3.80 to $4 per share, reflecting very healthy year-over-year growth of 12.25% to 16.5%, after removing the impact in 2012 related to the early extinguishment of debt.

GAAP diluted EPS from continuing operations is expected to be in the range of $3.61 to $3.75 per share.

We continue to expect consolidated net revenue growth of 0.75% to 2%.

This guidance reflects solid underlying growth across the enterprise.

And it's important to keep in mind the comparison we have to the substantial share gains from the Walgreens Express Scripts impasse last year.

As well as the impact from the continued strong growth of generic utilization.

As you know, increased generic utilization has a negative impact on revenues but a positive impact on profitability.

Also keep in mind that our estimate includes one less day in '13 versus 2012 for leap year.

Guidance for operating profit growth in our retail and PBM segments remain unchanged.

We still expect retail operating profit to increase 5% to 6.75% year-over-year.

And PBM operating profit to increase 10% to 14%.

We anticipate a significant benefit from the debt refinancing.

And are now expecting net interest expense for the year of between $475 million and $485 million, a reduction of approximately $45 million from our prior guidance.

The first-quarter guidance remains unchanged.

We expect adjusted EPS to be in the range of $0.77 to $0.80 per share, reflecting growth of 18% to 23% versus the same period of LY.

GAAP diluted EPS from continuing operations is expected to be in the range of $0.71 to $0.74 per share in the first quarter.

Within the retail segment, we continue to expect revenues to decline 1% to 2.5% year-over-year, driven by the strong growth of generic utilization.

However, given the strong flu season we saw in January, we are trending closer to the higher end of our guidance rather than the lower end.

Operating profit in the retail segment still is expected to grow 9.5% to 11.5% during the first quarter.

While operating profit in the PBM segment is still expected to grow 24% to 31%.

Additionally, our free cash flow guidance for the year remains in the range of $4.8 billion to $5.1 billion.

And I'm very pleased with our significant cash flow generation capabilities.

Which should continue to play an important role in driving shareholder value, now and well into the future.

And with that, I'll turn it back over to Larry.

Okay.

Thanks, Dave.

As I said, we're very pleased with our solid enterprise-wide results, along with our outlook for the future.

And I think as we've communicated in past meetings, CVS Caremark's purpose is to help people on their path to better health.

It's a very strong motivator across our organization.

And with the healthcare environment changing rapidly, we think that presents many opportunities for our Company.

Our distinctive model and the strategic growth framework that we laid out on analyst day should enable us to address the changing needs of our customers, clients, health plans and providers.

While capitalizing on our unique assets to enhance shareholder value.

So, in short, we'll continue to develop innovative solutions that strengthen our healthcare offering.

And we'll continue to align our business initiatives with our purpose, along with the needs of our growing customer groups.

And we think that will be our formula for long-term success.

So with that, we would be happy to take your questions.

(Operator Instructions)

Dane Leone, Macquarie.

Congrats on a great quarter.

When we think about the coming year, I know it's early to really start thinking about the 2014 PBM selling season, I'm just curious with where you've gotten into the PBM streamlining initiative, along with the additional conversions to the destination platform.

Fundamentally, how do you compare going into this year and the capacity for the organization to take on new business versus where you were last year heading into April?

Dane, I'll start, and John can jump in here.

We see no barriers and no limitations around that.

Keep in mind that I had mentioned that about two-thirds of our business is already on the destination platform.

And any new business automatically goes on to that platform.

So there's no conversion activity associated with that.

And this is Jon.

The other thing I would add is we have a separate team that is working on the conversion process.

Totally separate than the teams that implement new business.

And we've implemented $24 billion of net new business over the last three years.

So we think we're very well-positioned to continue to add new business and growth as we move forward.

Great.

And then, one additional question on the SilverScript resolution with CMS.

Could you add any additional color on specific steps that need to be taken or specific timeline when that could be resolved?

As Larry talked about, we had to consolidate our enrollment systems from two acquisitions, which was Universal American PDP, Health Net and SilverScript on the one system.

Which, unfortunately, led to issues with SilverScript's enrollment in claims processing in the January time frame, and an unanticipated increase in call volumes.

So this sanction is focused on SilverScript's enrollment process.

Our remediation plan was submitted to CMS on January 23.

And work is underway to implement the appropriate corrective action.

We have successfully operated these enrollment systems since the inception of Medicare Part D, and continue to expect do so now that the system consolidation is complete.

And we're very focused on working with CMS to correct the issues, and to have the sanction lifted as soon as possible.

And we are confident in our ability to address these issues quickly.

Great.

Thank you very much.

Robert Willoughby, Bank of America.

Any change in philosophy on retail store openings in the US.

What are your targets there?

And just comment briefly what, if any, synergies you expect to derive from Brazil from a cost standpoint.

Rob, your first question in terms of our retail growth strategy, we have no change in our strategy there.

We've talked the last several years about 2% to 3% square footage growth, and our pipeline falls within those boundaries.

And we continue to see opportunities for retail growth here in the US.

As far as synergies go, it will be very minimal.

As I mentioned in my remarks, this transaction is not financially material.

We're talking about 44 stores.

And I think it will be a great learning opportunity for the organization.

Next question?

Stephen Valiquette, UBS.

You mentioned that you obviously retained at least 50% of the Rx from Walgreens in the fourth quarter.

Obviously that's the guidance for 2013, as well.

So, whatever the actual rate is, I think you mentioned previously that you expected it to stay about the same in early 13 as it was exiting '12.

And that the rollover of the calendar year wouldn't really change anything or trigger anything to change the run rate.

So I'm just curious now, without giving any specific numbers, is that indeed the case now that you have probably some read on January?

Thanks.

Yes, Steve.

I think as we've talked about this over the last several months, we had talked about the fact that we didn't see this as being a 12- to 18-month event.

That we believed that we would reach a steady-state run rate.

Towards the end of the year, I think we had acknowledged it could trickle into the first quarter of this year.

And, quite frankly, our retention is actually performing as we had outlined.

So we don't see any change to the comments that we made in the past.

Okay.

That's helpful.

Thanks.

Eric Bosshard, Cleveland Research.

On the retail side of the business, the SG&A growth increased or accelerated a bit in 4Q versus the prior couple quarters.

I'm interested if you can give a little bit of color on that.

And then strategically what you're doing with the drugstore with the retail business to sustain good performance and to further improve market share in '13, if you're doing anything from a marketing or from a merchandising or promotional perspective.

Eric, this is Dave.

Maybe I'll address the SG&A question and then I'll flip it to Larry or Mark on the broader question on retail.

Really, the growth in SG&A in retail for Q4 was driven by our comparisons in Q4 of LY.

So if you look at Q4 of '11, the growth in SG&A was very modest.

We're bumping up against some tough comparisons.

We knew that was going to be the case as we cycled into Q4 of '12.

And so it performed as we expected, so nothing really new there.

And with that, maybe I'll turn it to Mark to talk a bit about the retail business.

The biggest headline that we talked about at the analyst day was around personalization.

And that was really the headline for the quarter.

And it's really the headline as we go into '13.

So our whole goal is to move away from the mass approach and to customize our approach to each individual customer.

We're doing that through how we are clustering our stores.

Which means personalizing the assortment within each store.

That was played out through our urban initiative over the last couple years.

We have a number of initiatives coming up into 2013 to take that to a new level, which we talked about a little bit at the analyst day.

The other big play coming out of personalization is obviously through our ExtraCare program.

As Larry outlined in his comments, that has been a strength for us for many years, 15 years.

And we have a very engaged customer set, as evidenced by the 68% of our transactions and 85% of our sales going through the program.

We ramped that up in a big way in t he fourth quarter, and we're taking that into 2013.

Larry threw out a couple of numbers earlier.

I think they're indicative of that improved engagement.

First, the fact that we increased the number of offers redeemed by 19% over the course of the quarter.

That also was driven by a big increase in the number of offers that came through from our e-mail program.

We more than doubled that program to 15 million.

And increased the number of offers that went through our e-mail program by 69% to over 600 million offers.

We also had some advancements on the Beauty Club front, which rolled out a year ago.

That dramatically improved with some new features that we rolled out.

We increased that by 21% to 11 million.

And, as Larry mentioned in his comments, significant amount of work going through our differentiated ExtraCare center where we are able to deliver customized personalized messages to our customers.

And that will play out as we go into '13 with an initiative that we call Conversion, which allows our customers to shop broadly across the store.

Just most recently, you've probably read a little bit, we just introduced this Pharmacy and Healthy Rewards program, which we've had in place.

Just a little back -- we've had a reward in place for our pharmacy customers for the last several years, as part of our ExtraCare program, where we had $1 for every two prescriptions.

But this most recent program is really different in the fact that it customizes the message to individuals as opposed to households.

We came up with this program over a year ago.

It was tested in five markets and just launched this past week.

The big difference, as I mentioned, it's tied to individuals, not to households.

We can then trigger the messages directly to customers, and customize the message as such.

We have also slightly modified the program.

10 prescriptions equals five ExtraBucks.

And we have many different ways for our customers to earn those ExtraBucks just beyond rewards themselves.

So big advantage from our customers is more value communicated directly to them.

We also believe it will help their adherence.

It's also a great way for us to communicate and retain our most important pharmacy heavy user customers.

So ExtraCare, to answer your question, would be personalization through our conversion programs, through our clustering programs, as well as through our taking ExtraCare to a new level.

Great.

And then if I could just follow-up.

The retail comp in 4Q was quite solid.

What you've talked about for '13 would be a moderation from that.

Can you just square those two facts?

Keep in mind, as you cycle into '13, we've got a couple things happening.

First and foremost you have continued generic GDR expansion, number one.

And, number two is you are comping against some share gains, some high share gains, as we move into 2013 versus what we gained in 2012.

And then, finally, you have one less day in '13 than you have in '12 due to leap year.

Okay.

Thank you.

Matthew Fassler, Goldman Sachs.

Two quick ones.

First of all, just following up on the changes to ExtraCare, as related to the inclusion, or the change in inclusion of prescriptions.

Can you talk about what the breakeven is, or some sense thereof, for the share gains you need to generate?

Because presumably some of the ExtraCare Bucks that are going to be rewarded are for customers you are already doing business with.

So what kind of share gain would you expect to need to generate for this to start to deliver the financial outcome you're looking for?

Matt, I think if you go back to some of the comments that I had made in my prepared remarks, and combine that with what Mark just talked about, through this effort of personalization, we're able to get more granular in terms of where do we make the investments on a customer by customer basis?

Quite frankly, the breakeven point is very low.

You could think of it as reallocating the investment to where it's going to matter the most.

So it makes the investment very productive from a profitability point of view.

Got it.

That's very helpful.

And then, secondly, a modeling question.

As we think about the impact of inter-segment elimination's on EBIT, that was a number that increased quite sharply over the course of 2012.

How should we think about -- you gave us pretty firm guidance on the revenue impact for 2013.

How should we think directionally about the impact on operating income for 2013?

Good question.

Clearly, the inter-Company eliminations will be driven by the successful Maintenance Choice program.

So the more adoption of that program drives additional eliminations for the Company.

Secondly is, the growth in the elimination is also driven strongly by the generic penetration in 2012.

As you know, Lipitor is a very large maintenance drug.

And that drug was used extensively within the mail-order centers.

So therefore it's a drug that's used heavily within the Maintenance Choice product.

And so that disproportionately drove the eliminations in '12.

I would not expect to see the same type of growth as you cycle into '13.

But I think if you take what we said from a guidance perspective and walk your way back, you can come up with an estimate of what that inter-Company segment elimination might be.

Fair enough.

But you would expect EBIT -- because this EBIT impact more than doubled, the revenue half was 19%.

You'd expect those two numbers to be closer in sync directionally.

And, of course, we'll go back and do the math as pure guidance.

That's right.

Thank you so much.

Greg Hessler, Bank of America Merrill Lynch.

As I look at the balance leverage at year-end, was just below 2.5 times.

Which is below your 2.7 times target.

And then based on 2013 guidance, this number should continue to come down next year, as well.

So my question is, has anything changed from a financial policy or capital allocation standpoint?

No.

It has not.

I think we've been very clear from a capital allocation standpoint of how we're going to use our free cash flow.

One, to drive value for our shareholders in really three ways.

One, investing in our business with the appropriate return on invested capital targets and hurdles.

Two, increasing our dividends.

And, three, doing share repurchases that are value enhancing.

And we've said we're going to do that within the context of maintaining an adjusted debt to EBITDA capital structure of 2.7 times.

And while that's our target, we know at times we fluctuate higher or lower to that.

But we'll stay within that range.

And it would be our expectation that we would continue to focus to have our balance sheet and our capital structure within those tolerance levels as we go forward.

Okay.

And then just in terms of the rating, are you guys still committed to the high BBB credit rating, as well, in conjunction with those goals?

Very much so.

We think it's important for us to maintain our high BBB rating.

Both as we think about financing the Company long-term, but also from a short-term basis.

We access the commercial paper market typically on a daily basis.

And that's a very efficient means for us to finance the Company's working capital.

And I think having a BBB rating is important for that.

And also as we think about sale leaseback activities, I think BBB is also important for that function, as well.

So we are very much committed to that, and certainly is our target.

Okay.

Thank you.

I'll pass it on.

Lisa Gill, JPMorgan.

Larry, I know you said it's early to talk about the 2014 selling season.

But can either you or Jon maybe just, one, size what you have up for renewal?

And, two, maybe just characterize the 2014 selling season.

Would you call it a normal selling season?

And the discussions that you're having, obviously reform is coming in 2014, we have exchanges coming in 2014.

What are your current clients thinking around both reform and exchanges, as we start to think about 2014?

Maybe I'll start and then ask Jon to jump in here.

As it relates to the '14 selling season, the amount of business that we have up for renewal is similar to prior years.

We've got about $11 billion to $12 billion up for renewal.

And as we've all acknowledged, it is early.

I'll let Jon touch on what his sense of the market is and what he's hearing from clients around the exchanges, and how they're thinking about their employee base.

Yes.

Lisa, when I -- and I have to separate my response in two segments -- when I talk to employers and how they're thinking about the exchanges, I think most of them are on a wait and see attitude, particularly the large employers which we deal with.

So I think they're going to wait and see how these public exchanges shake out.

The private exchanges are seeing some activity, primarily in the retiree space.

When we talk to our health plan clients, they're obviously gearing up to participate in the exchanges.

So they are interested in our assistance around formulary.

They like our CVS retail stores and the ability to market their brand to consumers.

And then all of our differentiated offerings that we have -- Maintenance Choice, Pharmacy Advisory, the ability to do preferred or even restricted networks.

So a lot more discussion around health plans as they gear up to compete in this space.

And that's where you're going to see most of the growth is with the health plans.

Do you think competitively, Jon, does that help you to win health plan business?

And do you see any large piece of the health plan business that up for renewal for others in 2014 that you say this is something I'm going to target because we think we have something differentiated that we can go to them as they are building out their exchanges?

We're seeing a lot of interest from health plans where we're the PBM.

And we're also seeing interest from health plans where we're not the PBM because of all of our assets.

A little early to talk about what we're seeing from specific health plans coming into the marketplace and looking for bids.

There may be some activity where health plans have a particular PBM but may be looking for different partners as they evolve their exchange strategy.

So you could see some activity there.

And then I just had an accounting question, Dave.

If I look at the potential impact for Medicare MLR regulation to the PDP in 2014, how will that impact your PDP business?

Lisa, that's a great question.

Quite frankly, it's probably a little early to be able to answer that.

Some of the regulations aren't quite solid yet.

I would say that at the end of the day we'll watch it closely and we'll update as we see that regulation evolve at this point.

Okay.

Great.

Thank you.

John Ransom, Raymond James.

Hi -- a couple.

Dave, as you think about your 2013 PBM margin comparisons to 2012, what's the impact on, say, the ramp of the Aetna contract versus, say, the streamlining efforts?

And how should we think about that?

That's a tough question.

I think, in general, we know that both from an Aetna perspective and from a streamlining perspective we're very focused on enhancing our performance in both those areas as we think over time.

Certainly from a streamlining effort we continue to make nice progress on improving the SG&A structure of the organization.

And aligning from a service perspective the metrics in the organization to deliver day in and day out on the service commitments that we have.

Also, from an Aetna perspective, Aetna, as it cycles into '13, they are a net share gainer in adding additional lives, which will drive additional economics for us.

So at the end of the day, as they are successful in the marketplace working with us, that is really the opportunity that we have to broaden our partnership and drive value for them and for us and for the customers that they serve.

Maybe another way of asking about it, I remember you provided some initial accretion targets when you signed that big contract.

Are those still in the ballpark?

Are they better?

Are they worse?

Those are stale.

We said quite some time ago that those were stale, and that there was a lot of moving parts back then.

So those are not good numbers at this point.

We are very focused and very pleased with our relationship with Aetna and how it's progressing, but you can't look at that.

I didn't think so.

And then the other question, just looking at your front end on the retail side, pretty big delta between your large public customers.

What's the impact, do you think, of getting 24 million scripts from ESI?

Do you think there's been some bleed over from those customers?

And will some of that wane this year?

Or do you think it's disconnected from that?

John, we acknowledged that earlier that in the fourth quarter we believe it positively impacted the front-end comps by about 150 basis points.

And that was consistent with what we had seen in prior quarters, as well.

Okay.

Thank you.

John Heinbockel, Guggenheim.

A couple things on Maintenance Choice.

Of the 15.8 million lives, how does that break down between 1.0 and 2.0?

I know Two is new, so is Two less than 10% of that?

John, we're not going to break that out going forward.

We'll continue to report on how we continue to grow the Maintenance Choice population.

But we're not going to delineate between 1.0 and 2.0.

Do you think 2.0, at least near term, does that generate the bulk of the growth in Maintenance Choice, or no?

John, I think as we had outlined, I think at the analyst meeting a year ago, we saw 2.0 as being a key factor in our ability at the time to triple the number of lives that would be appropriate for a Maintenance Choice type program.

And I think over the past year we have seen our lives grow by about 5 million from '11 to '12.

And now we're sitting here saying that we still believe we can double the number of lives that we have.

And it's going to be a combination of the various designs that we have out there.

And if somebody signs up for 2.0, how quickly do you think they migrate to 1.0?

They don't have to wait for the next contract?

They can migrate to 1.0 really at any time.

And we've seen some of that activity.

And we think that, as people get experience with Maintenance Choice 2.0, they actually have an opportunity to deliver, or to generate, more savings by moving up to 1.0, as they move more of their maintenance volume into the Maintenance Choice channel.

So, we think 2.0 is a good entree point for where we are.

Particularly with health plans where we've had pretty low penetration of Maintenance Choice.

They traditionally have liked open access.

We think this really will play well with the health plans.

All right.

And then, lastly, Jon, given that there are now very distinct models out there on the PBM side, and two of your bigger competitors are still involved in integrations, are you more optimistic about '14 selling season than you might have been a year ago?

Or no, that's reading too much into it?

Listen, we're focused on, obviously, ensuring when we're going to the marketplace, we're talking about our differentiated offerings.

We think they are resonating in the market.

You look at our success over the last three years, $24 billion in net new business.

But it still remains a very competitive market.

And we're seeing pricing continues to be very competitive.

No real change over the last few years, but still rational.

So we'll see how it goes.

All right.

Thanks.

Edward Kelly, Credit Suisse.

Good morning, nice quarter.

Larry, I just wanted to confirm one thing, and then ask you my real question.

On the Express Script's loss of customers, has the pace of the customer loss diminished over the last couple of months, or has it been steady?

I'm just trying to clarify something you mentioned earlier.

I think, as I had acknowledged earlier, the migration that we have seen has been pretty much in line with what we've expected.

And you see more attrition in markets where we don't have the concentration of stores.

Which we were talking about that six months ago, that that would likely be the case when an agreement was reached.

So we're seeing those dynamics.

And as I mentioned, it's pretty much on target with how we've thought about it and modeled it.

Okay.

And then my question for you is really related to Brazil.

I know it's small and I certainly appreciate the measured approach to international.

But it's a big opportunity.

So, can you walk us through why you chose this country over others for your first initiative overseas?

How is this market different than the US?

And if you're successful here, how do you grow?

Is this an organic opportunity?

Is it further M&A?

Ed, as I had acknowledged earlier, it's a maturing marketplace.

It's expected to have continued strong growth for the foreseeable future.

As people move up the economic ladder, they're spending more on healthcare as well as education.

And with increased access to healthcare and pharmacy, both are expected to grow over the next several years.

I think one of the other keys for us is the market is receptive to chain pharmacy.

Chains are pretty prevalent in the Brazil market.

But at the same time it's still fragmented.

I think the largest player has about a 9% share.

So we see the opportunity for growth.

And Onofre has an organic growth plan that we will certainly be looking to execute on.

And there may be other opportunities acquisition-wise as we move down the road.

Thank you.

Ross Muken, ISI Group.

As you look at where you've been with Walgreens retention over the last two months or so, as you look at the places where you've done better versus worse, is it geographically dispersed?

Is there a percentage where if someone signs up for an Extra card they're much more likely to stay in the store?

I'm just trying to get a sense for where you feel like you've outperformed, and areas where you've ceded maybe more share.

And what the key drivers of that have been.

Ross, I'm probably a little redundant now with these comments.

But I think you hit on some of the key points.

That, as we talked about a year ago, the acquisition strategy was developed with a retention component.

So we work very hard to get those maintenance users enrolled in ExtraCare.

And I think if you reflect on some of Mark's comments earlier, the ability to communicate with them in a very personalized way is a key element around retention.

And then, as I just mentioned a minute ago, we certainly recognize the convenience and locale, also becomes part of that retention strategy.

So I don't know that there's anything out of the ordinary that I could add to your question.

And maybe just quickly a modeling question on the pharma services business.

As you look at the first-quarter guidance, it implies a bit more deflation versus the rest of the year.

What's driving the step-up of where, given the script guidance, of where we're going from a more significant decline to an increase by the end of the year?

Is there a portion of the year where you're assuming, given mix, something is changing from deflation to inflation?

I'm just trying to get a little bit of clarity.

You're cycling through the first couple of months, the introduction of a large generics -- of large generics in last year, primarily Lipitor.

So that's what's driving that inflation/deflation cadence, if you will.

Ross, keep in mind that, to Dave's point on Lipitor, we cycle that in June 1. So first almost two quarters.

Okay.

Great.

Thanks, guys.

Meredith Adler, Barclays Capital.

Congratulations, guys.

Nice quarter.

I want to go back to just questions about Maintenance Choice 2.0.

It's probably very early but I'm just wondering what kind of feedback -- because this is something really unique for these patients -- is there any feedback coming so far about how they are responding to it?

Or is it really just too early?

Meredith, Maintenance Choice from a member perspective, Maintenance Choice 2.0, will perform the same way as our original Maintenance Choice product, Maintenance Choice 1.0.

So the member has a choice to either go to CVS retail or to go to mail to get a reduced co-pay.

They get a 90-day maintenance script.

The client gets mail pricing.

And so we see about 50% of the members like to go to CVS retail for their Maintenance Choice prescriptions, and the other 50% like to go to mail.

And if you look at the penetration for these voluntary mail customers that move into Maintenance Choice, we see it's on average around 15%.

And so, as we get this new benefit, we think that that penetration will grow beyond 15%.

So that will generate more savings for the client and offer a benefit to the members at no charge.

Actually a savings to the client.

The other thing we're working on is continuing to improve the member experience with 2.0.

So the move between mail and CVS retail can be more seamless.

It's more of a binary choice now.

We can see people go to either retail or mail and stay.

And we're going to evolve our ability to allow them to move much more seamlessly.

People are moving around the country much more now than they used to.

So very positive response.

Members love it.

And clients love it.

And it's a win-win-win-win for everybody.

Great.

And then I have a question about specialty.

Obviously specialty costs are just going up and up and up.

And I think there has been more effort by health plans and payers generally to push more costs onto patients.

What are you hearing from your customers about that?

And do you think that will have any kind of impact on the growth of specialty?

If you look at specialty trend, both on the pharmacy side and the medical side, it's growing at 20%.

If you look at the pipeline, it's dominated by specialty.

And if you look at 8 of the top 10 drugs by 2016, it's going to be specialty.

So, as we move out of this big generic wave, which has delivered tremendous savings, and you combine that with a specialty trend in the double digits that I described, specialty is becoming the highest priority for our patients.

PBMs have traditionally managed specialty on the pharmacy side.

We've expanded our capabilities to manage it on the medical side where really 50% of the specialty spend is.

And we're really going to focus on really three areas to manage costs for the members.

Utilization, unit cost, and drug mix.

So, our clients want us to manage trend.

They want appropriate utilization.

But I think you're going to continue to see significant growth in specialty as we move forward.

And we're expanding the piece of the pie that we are managing for our clients as we move into managing the medical side.

Meredith, we talked a little bit about some of the initiatives that we have underway there, and some of them are in pilot, as we speak.

I think that we're all very excited about the ability for these pilot programs to bring some meaningful solutions to what clients are worried about.

And we'll certainly talk about that as we move forward throughout the year.

Super.

Thank you very much.

Tom Gallucci, Lazard Capital.

My first one is, a lot of attention lately on the PDP area within Medicare drug benefit, and some of the plans that have preferred retail design.

I know you're in some of those, I guess mostly yourself and Aetna, your plan and Aetna's.

And some of the others are in more of the plans out there.

Can you talk about your thoughts around preferred retail networks, both within Medicare and within the private sector, and some of your strategies there, over and above Maintenance Choice obviously?

Tom, I think it's probably important just to level set a little bit in terms of, start with the difference between preferred and narrow/restricted networks.

And I think, as everybody knows, in a narrow restricted network, there are pharmacies that are excluded.

In the preferred network, all pharmacies can participate.

But he customer is incentivized to use one pharmacy over another in the form of a reduced co-pay.

And then when you start peeling back the onion, all preferred networks are not equal from a co-pay differential.

If you look in the Med D space, they could vary anywhere from $1 to $10.

And within the Med D population, there are no restricted networks, there are only preferred networks.

So, as you mentioned, there are plans where we're identified as a preferred pharmacy.

And then there are plans where we're not.

It's clear that there's going to be some movement between pharmacies.

I think it's pretty early to measure the specific impact but we're not seeing anything at this point that we didn't expect to see.

And I think from a retail point of view, we are well-positioned to be a participant more often than not.

And we'll go from there.

Okay.

The other question I had, I think is a minor one, but news today, as the Postal Service sounds like it's finally going to stop delivering on Saturdays.

Can you just talk about any impact, or how you think about that from a mail-order standpoint?

Tom, I saw that, as well.

We see a small percentage of our mailings delivered on Saturday.

So, obviously, for those deliveries, they're not going to happen, and they're going to be pushed to Monday.

I will say that anything that does require Saturday delivery for a member, we have other ways of making that delivery happen.

We do that today and will continue to do that.

So, net-net I think it's a small impact overall.

Maybe an extra day for members.

But generally mail members aren't waiting for the last day to get their mail prescriptions.

And I think the cost impact is negligible.

Thank you.

Ricky Goldwasser, Morgan Stanley.

I had a follow-up on the specialty question.

I know you mentioned that you are moving into managing the medical side.

Can you share with us what's driving this?

Is it your clients that are asking you to expand what you're doing with them?

Or is it coming from the health plan that are reaching out to you and asking for your help, given your expertise?

Yes, Ricky, this is Jon.

We're actually hearing from both health plans and employer clients.

What they see is that, particularly on the medical side, the specialty spend just isn't being managed.

And so there's an opportunity to leverage our capabilities to help manage what I talked about earlier, which is utilization, unit cost and drug mix.

So significant interest and we're moving rapidly to expand and help our clients in these areas.

Okay.

And then one additional question.

Your distribution contract is up for renewal this year.

Any thoughts on when you expect to make a decision on that?

Ricky, as we've mentioned in the past, as a matter of policy we won't comment on individual contracts.

And I think it's widely known we have relationships with both Cardinal and McKesson.

And I'll just say that both of those organizations do a terrific job in servicing the CVS Caremark business.

Okay.

Thanks.

Deborah Weinswig, Citigroup.

Thanks for a great quarter.

I'll make sure to make this a good question.

You talked a lot today about ExtraCare and a lot of the work you've done on the card.

Can you review for us your capital allocation priorities coming off of such a strong quarter?

And how should we think about your investments in tech, whether in retail or the PBM side, especially in light of the increased focus on personalization?

Deb, this is Dave.

From a capital allocation perspective, I can assure you that we have adequate capital to invest in the digital and ExtraCare space, as needed, to drive value for our Company and for our shareholders.

And we've laid out, I think, a fairly clear road map over the next several years on how we're going to enhance all the components associated with those products and services, and the ways in which we engage members and customers more fully.

And we will continue to push in this area.

I think it's an area that we see opportunities over time to drive a lot of value.

And, Deb, I'd just add that that technology road map is very much aligned to the strategic growth framework that we laid out on analyst day in terms of the support that those initiatives would require.

Great.

And then, how are you capitalizing on the customers who came in to visit MinuteClinic, and also the, I think you said an unprecedented number of daily levels of flu shots that were administered, in terms of new patients?

And how might you get them to be more regular customers?

I think, Deb, it is consistent with things that we've talked about in the past.

I don't know if we've looked at this lately, but we knew that a large percent of MinuteClinic patient visits had not had a prescription filled at a CVS.

Now, that could be based on need or demand.

But certainly there is nothing more convenient than being seen by a nurse practitioner and then getting the script filled while you're there.

And then we have the opportunities to engage that patient at the point of care in terms of getting them enrolled in the programs.

And I think our refill teams do a pretty good job in terms of identifying those new patients and letting them know the advantages that CVS has to offer.

Great.

Thanks so much and best of luck.

Listen, everyone, thanks for your time this morning.

And thanks for your continued interest in our Company.

Ladies and gentlemen, that does conclude the conference call for today.

We thank you for your participation and ask that you please disconnect your lines.

Have a great day.