CVS Caremark's (CVS) CEO Larry Merlo on Q2 2014 Results - Earnings Call Transcript

Aug. 5.14 | About: CVS Health (CVS)

Start Time: 08:30

End Time: 09:48

CVS Caremark Corporation (NYSE:CVS)

Q2 2014 Earnings Conference Call

August 05, 2014, 08:30 AM ET

Executives

Larry J. Merlo - President and CEO

David M. Denton - EVP and CFO

Jonathan C. Roberts - President, PBM

Helena B. Foulkes - President, Retail Business

Nancy R. Christal - SVP, IR

Analysts

John Heinbockel - Guggenheim Securities

Robert Jones - Goldman Sachs

Meredith Adler - Barclays Capital

Eric Percher - Barclays Capital

Ricky Goldwasser - Morgan Stanley

Scott Mushkin - Wolfe Research

Lisa Gill - JPMorgan

David Larsen - Leerink Partners

George Hill - Deutsche Bank

Ross Muken - ISI Group

Steven Valiquette - UBS

Peter Costa - Wells Fargo Securities

Robert Willoughby - Bank of America Merrill Lynch

Charles Rhyee - Cowen and Company

Mark Wiltamuth - Jefferies

Frank Morgan - RBC Capital Markets

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Q2 2014 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, Tuesday, August 5, 2014.

I would now like to turn the conference over to Nancy Christal, Senior Vice President, Investor Relations. Please go ahead, ma’am.

Nancy R. Christal

Thank you. Good morning, everyone, and thanks for joining us. I’m here this morning with Larry Merlo, President and CEO, who will provide a business update; and Dave Denton, Executive Vice President and CFO, who will review our second quarter results as well as guidance for the third quarter and year.

Jon Roberts, President of PBM; and Helena Foulkes, President of the Retail Business, 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 no more than one question with a quick follow-up, so we can provide more callers with the chance to ask their question.

Now I have one key date to announce this morning. We plan to host our annual Analyst Day on the morning of Tuesday, December 16 in New York City. At that time, you’ll have the opportunity to hear from several members of our senior management team who will provide 2015 guidance as well as a comprehensive update on our growth strategy. We plan to send invitations with more specific details via email sometime in August, so please save the date. Again, that’s Tuesday, December 16. If you don’t receive an invitation and would like to attend, please contact me at your earliest convenience.

Please note that just before this call, we posted a slide presentation on our website that summarizes the information you will hear today as well as some additional facts and figures regarding our operating performance and guidance. Additionally, our quarterly report on Form 10-Q will be filed by the close of business today and it will be available on our website at that time.

During today’s presentation, we will make forward-looking statements within the meaning of the federal securities laws. By their nature, all forward-looking statements involve risks and uncertainties. Actual results may differ materially from those contemplated by the forward-looking statements for a number of reasons as described in our SEC filings including the Risk Factors section and cautionary statement disclosures in those filings.

During this call, we’ll also use some non-GAAP financial measures when talking about our company’s performance including free cash flow and adjusted EPS. In accordance with SEC regulations, you can find the definitions of these non-GAAP items as well as reconciliations to comparable GAAP measures on the Investor Relations portion of our website.

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

Now, let me turn this over to Larry Merlo.

Larry J. Merlo

Thanks, Nancy. Good morning, everyone, and thanks for joining us to hear more about the strong results we posted for the second quarter. I’m pleased to say that we met or exceeded our expectations on every key major performance. Our adjusted earnings per share increased 16.5% to $1.13 per share. That’s $0.02 above the high end of our guidance range.

Both the PMB and Retail segments exceeded our revenue expectations and delivered strong gross margins. And as a result, operating profit in the Retail business grew 6.5% and profit in the PBM grew 30% exceeding our expectations. Additionally, we generated nearly 400 million of free cash keeping us on track to achieve our full year free cash flow goal.

Now given our strong performance year-to-date, we are raising and narrowing our adjusted earnings per share guidance for the year to a range of $4.43 to $4.51 and that’s up from our previous range of $4.36 to $4.50, and Dave will provide the details behind our financial results and guidance during his review. But before I move on, I do want to say that I’m extremely proud of the work our colleagues are doing to drive continued strong results across the enterprise.

So let me turn to a brief business update and I’ll start by level-setting how we see the current state of health reform. I think as everybody knows, there are reported to be about 8 million individuals who have enrolled in the public exchanges and we saw the biggest increase occur toward the end of open enrollment. The mix of individuals who were newly insured as opposed to those who previously had coverage, it still remains unclear with various sources quoting anywhere from a low of 27% of individuals newly insured up to a high of 85% with multiple data points suggesting it might be somewhere in between.

With regard to Medicaid, available data indicates that 6.7 million individuals have gained coverage, which is up from 3 million at the time of our last earnings call. Now while the net number of newly insured remains somewhat of a mystery, we can be confident that several million Americans have gained coverage in recent months and this should provide a positive secular trend in pharmacy volume growth for the next several years. Our experience to-date with respect for the combined impact of both public exchanges and the expansion of Medicaid is consistent overall with our expectations and is expected to yield a modest benefit in '14.

We continue to expand our focus on building strategic enterprise relationships with health plans whether or not we’re the PBM. We support more than 25 commercial health plans, co-ops and Medicaid managed care organizations across 26 states as their PBM and we expect this number to grow. We have also implemented preferred pharmacy networks or Maintenance Choice in more than 20 states, and as we emphasized at our December Analyst Day we are well positioned across the enterprise to partner with health plans in a variety of ways and we’re actively helping them advance their strategies in their respective markets while growing our enterprise share.

Now let me update you on our 10-year agreement with Cardinal Health that’s built upon our combined sourcing expertise. As you’re aware, last month we completed the formation of Red Oak Sourcing, the largest generic sourcing entity here in the U.S. and located in Foxborough, Massachusetts. And at that time, the employees and functional responsibilities were transitioned from CVS Caremark and Cardinal to Red Oak Sourcing.

As we worked together to get the venture up and running, we further refined certain aspects of our agreement and the structure of the final agreement is slightly different than what we’ve talked about previously, so Dave will walk through how the venture works during his financial review highlighting the three ways in which the venture is expected to deliver value. So we remain excited about Red Oak and we look forward to its future contributions.

Moving to our PBM business, I’ll start with an update on the 2015 selling season. And as we noted on our last call, the marketplace has been active. Pricing remains competitive, yet rationale and I’m pleased to report that to-date we have been very successful in this selling season. Gross wins for '15 currently stand at 5.4 billion and span across all client segments while net new business stands at 2.6 billion, and this net new number includes business lost through acquisition, which makes up more than 60% of the lost business. These net new business numbers do not account for any impact from our individual Med-D prescription drug plan, which I’ll touch on a little later.

As for renewals, we’ve completed nearly 70% of the 26 billion in business up for renewal with the retention rate of nearly 97%. And I think our selling season success reflects our track record of generating savings for our clients through our unique suite of capabilities, top of mind for clients this selling season is achieving better control of their specialty spend. Among our clients, specialty represents about 22.5% of total drug spend under the pharmacy benefit and projections have this continuing to grow at a mid-teens rate.

Now all specialty spend including that paid under the medical benefit will likely to grow to as much as 50% of total drug spend by 2018. So I think you can see it’s critical that we bring meaningful solutions to the challenges. Our specialty business remains strong in the second quarter as revenues were up about 53% year-over-year. In addition to benefits from new business and the addition of Coram, another driver of specialty revenue growth was Sovaldi, the new hep C drug.

There are estimated to be roughly 3 million people in the U.S. requiring treatment and as everyone knows, the potential costs of treatment is very high. As you might imagine, the growing costs in this category are of significant concern to our clients and we have a number of programs in place to ensure appropriate utilization and cost management. And as competing products become available late this year and next, we will look for opportunities to introduce formulary management to further drive down costs.

At CVS Caremark, we continued to differentiate our specialty offerings in the marketplace with a goal of providing a high level of clinical support to patients, while managing trend for our clients and driving continued share gains. As an example, our Specialty Connect offering has been rolled out. It has been well received by both clients and patients and you’ll recall that Specialty Connect integrates our mail and retail capabilities providing choice and convenience for patients while preserving the central clinical expertise that leads to better health outcomes. No other PBM can offer this today.

As of late July, more than 60,000 specialty patients have been transitioned to this specialty service model, which again offers enhanced clinical and benefit support. The program is generating high satisfaction scores with patients, it resonates with clients as a differentiated approach to simplifying the specialty process for members and physicians appreciate the ease of use in getting patients started on therapy.

Our medical pharmacy management program also continues to enjoy strong interest and uptake in the marketplace with several new implementations underway and our site of care offering through our Coram infusion business enables us to provide patients more convenient, low cost alternatives to hospital infusions whether at the physician’s office, a retail infusion site or even the patient’s home.

The Coram organization has been fully integrated into the specialty group and our new capabilities have been a topic of discussion in the current selling season for specialty business on a carve-in or standalone basis. So we remain optimistic that we can continue to gain specialty pharmacy share, as we work to develop innovative offerings that capitalize on our unique ability to optimize cost, quality and access.

Another important way that we manage trend for clients is through our highly proactive approach to formulary management, which is you’ll recall we introduced to the marketplace back in 2011 for the 2012 planned year. Since then we have updated our formulary on an annual basis with a mission of being able to manage trend for our clients while providing comprehensive, cost effective and clinically appropriate options for their plan members.

Now building on our formulary success of the last three years, we recently notified our clients that we will be removing 22 products in addition to select diabetes test strips for the 2015 formulary. And from 2012 through 2015, our rigorous approach to formulary management is expected to result in total savings to our clients of more than $3.5 billion.

Before turning to Retail, let me touch briefly on our Med-D PDP SilverScript. As expected, we currently have approximately 3 million lives in our individual PDP. And for the first half of 2014, our normal monthly attrition has been only partially offset by choosers and auto-assignees. And as we came out of sanction earlier this year, we began to enroll choosers in February and received dual auto assignees in May.

Additionally, as the dual demonstration projects continue to progress in certain states, we do expect to see some transition of dual eligible lives through the second half of this year. And while we may recapture some of these lives through our health planned partners, it is likely we will lose a modest number of lives as a result. So we expect to end the year with about 2.9 million lives in our individual PDP and we continue to see significant opportunity to grow the individual PDP business over the long term.

As a matter of fact, last Thursday, we received the preliminary benchmark results from CMS for 2015 and I’m pleased to report that SilverScript was below the benchmark and therefore qualified in 32 of the 34 regions. The only regions we didn’t qualify were Alaska and Nevada, consistent with prior years. So the strong benchmark results should enable us to retain the vast majority of the auto-assignees we currently serve, so we’re very pleased with the outcome.

Moving on to the Retail business, following the effects of the difficult weather and flu season that we experienced in Q1, total same-store sales reaccelerated sequentially in Q2 increasing 3.3%. Pharmacy same-store sales increased 5% versus the year ago and were negatively impacted by about 160 basis points due to recent generic introductions. Pharmacy comps were also negatively impacted by approximately 130 basis points due to the transfer of specialty scripts from our Retail segment to our PBM segment as a result of the new Specialty Connect offering and Dave will talk more about that later. Pharmacy script comps increased 3.9% on a 30-day equivalent basis and we continued to gain pharmacy share.

I want to touch on a topic that has received a lot of attention lately based on some competitor commentary, that being generic inflation and pharmacy reimbursement pressures. You’ll recall that when we gave our 2014 guidance last December, we told you that we expected continued pressure on pharmacy reimbursement, and the market is generally consistent with what we anticipated.

As to generic inflation, while the cost of goods inflation does exist on some generic items, it is not material in the context of our overall purchasing volume and again was generally within our expectations. On balance, the deflationary nature of the generic pharmaceutical market remains intact and overall, our pharmacy margins increased this quarter for multiple reasons were in line with our expectations, and again Dave will talk more about this in the financial review.

As for the front store business, comps decreased 0.4%. Our front store comps were positively impacted by approximately 80 basis points from the shift of the Easter holiday. And as plan for exiting the tobacco category this fall, we have begun to see a sales impact. Our front store comps would have been approximately 110 basis points higher if you exclude tobacco in the estimated associated basket sales.

Now adjusting for this tobacco impact and the Easter shift, front store comps were roughly flat in the quarter, sequentially improving from Q1. Front store traffic declined, as customers continued to aggregate their trips and at the same time, our average basket size continued to increase reflecting the strength of our loyalty program and the personalization it enables us to offer. And consistent with our prior statements, we are making responsible investments in profitable promotions and remain committed to not chasing empty sales.

Driving higher margin store brand sales continues to be another area of focus. We saw notable growth in share gains and store brands this quarter with store brands as a percent of front store sales increasing about 80 basis points to 18%. And we see significant opportunities to continue to expand our share of strong brand products by building on our core equities and health and beauty while also seeking opportunistic growth in other areas.

Additionally, in order to drive better results, we continued to explore innovative personalization strategies through insights from ExtraCare. As an example, during the second quarter, we expanded our send to card digital coupon option for all ExtraCare personalized offers that were historically only available either at the ExtraCare coupon center or on the bottom of a customer’s register receipt. Adoption has been very strong with over half of our registered users already trying this new feature and we also continue to turbocharge our personalized email promotions with our active email subscriber list growing 21% versus the same quarter last year.

Turning to our retail drugstore program, we opened 34 new stores, relocated eight and closed four, resulting in 30 net new stores in the quarter and we’re on track to achieve square footage growth of 2% to 3% for the year. In the quarter, we recently announced that we have a definitive agreement to purchase Navarro Discount Pharmacy. Navarro is the largest Hispanic-owned drug store chain in the U.S. with 33 retail drugstore locations in the Miami-Dade county area in addition to Navarro Health Services, a specialty pharmacy serving patients with complex or chronic diseases.

We expect to maintain the current product mix and we’ll learn from our Navarro colleagues about Hispanic marketing and merchandizing, and we expect these lessons to be transferable to certain other CVS markets. The Navarro brand is one of the most recognizable in the Hispanic marketplace. We plan to retain it. If you recall, we adopted a similar strategy in maintaining the Longs Drugs name for our acquired locations in Hawaii. That has been successful. And we expect to complete the Navarro transaction later this year.

Let me touch briefly on MinuteClinic, which continues on its healthy growth trajectory. In the second quarter, revenues increased 24% versus a year ago. We opened 32 net new clinics in the quarter bringing our total to 60 year-to-date and keeping us on track to open at least 150 new clinics this year. We currently operate 860 clinics in 28 states plus the District of Columbia and in recent news, a new partnership with USA Football named MinuteClinic, their official retail medical clinic and sports physical provider and we will offer a special discount for sports physicals to more than 1 million young athletes and their coaches.

CVS Caremark and MinuteClinic also added four new health system alliances during the quarter and another four in July bringing our total number of affiliations with major U.S. health systems to 40.

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

David M. Denton

Thank you, Larry, and good morning, everyone. As I typically do, I’ll begin this morning by highlighting how our disciplined approach to capital allocations continues to enhance shareholder value. I’ll follow that discussion with a detailed review of our strong second quarter followed by an update on our guidance. So let’s begin.

During the second quarter, we continued our long track record of paying quarterly dividends to our shareholders with payments totaling $322 million. With a strong earnings outlook for the remainder of this year, we expect our dividend payout ratio to surpass 25% at some point during 2014. We’re making continued good progress towards achieving our 35% payout target by 2018.

Additionally, we repurchased 16 million shares for approximately $1.2 billion at an average price of $74.91 per share. Year-to-date, we repurchased more than 27 million shares or $2 billion and we still expect to complete at least $4 billion of share repurchases with the full year of 2014. So between dividends and share repurchases, we’ve returned more than $1.5 billion to our shareholders in the second quarter alone and have returned more than $2.6 billion during the first half of this year. Our goal has been to return more than $5 billion in 2014 and we remain on track to meet that goal.

As Larry said, we generated nearly $400 million of free cash in the second quarter bringing our total for the first six months of the year to approximately $2.2 billion. The key driver continues to be our healthy growth in earnings coupled with improvements in our working capital performance fueled mainly by the PBM’s growth. All-in, we continue to expect to generate free cash between $5.5 billion and $5.8 billion in 2014.

Turning to the income statement. Adjusted earnings per share from continuing operations came in at $1.13 per share, up 16.5% versus LY and $0.02 above the high end of our guidance range. The strong performance reflects solid growth across all of our operating segments.

The retail segment produced results at the high-end of our expectations while the enterprise’s outperformance was driven primarily by better-than-expected results from the PBM. GAAP diluted EPS was $1.06 per share, and now let me quickly walk you through our results.

On a consolidated basis, revenues in the second quarter increased 10.7% or approximately $3.4 billion to $34.6 billion. PBM net revenues increased 16.2% or approximately $3 billion to $21.8 billion. The strong performance was driven by net new business, specialty pharmacy growth, drug inflation and product mix.

Offsetting this to some degree were lower mail choice claims reflecting the decline in traditional mail order volumes and an increase in generic dispensing. The PBM’s generic dispensing rate increased approximately 180 basis points versus the same quarter of LY to 82%.

Now revenues in the retail business increased 4.5% in the quarter or approximately $730 million to $16.9 billion. Sales in the retail segment were better-than-expected driven primarily by branded drug inflation as well as volumes. Retail GDR increased by approximately 160 basis points versus the second quarter of '13 to 84%.

Let me point out that with the second quarter results, we have begun to experience the type of shift between segments that are highlighted at past Analyst Days. As you know, our focus isn’t limited to just one channel, mail or retail, as it is for many of our competitors. Our channel and business segment agnostic offerings will enhance the performance of the enterprise and sometimes at the expense of one individual segment.

For that reason, recall that we have been suggesting that you focus on the growth of the enterprise rather than the individual segments to best gauge our success. And with the implementation of Specialty Connect this past quarter, we essentially transferred revenues out of the retail pharmacy segment and into the PBM segment as the PBM took over the dispensing of nearly all specialty prescriptions filled by CVS Caremark.

As anticipated, the transition had a larger impact on sales dollars than scripts given the high cost of specialty drugs. The impact on sales dollars in the second quarter was approximately $145 million and this impact will grow larger as we ramp up in the third and fourth quarters. Obviously, this shift dampened year-over-year top line growth at retail while enhancing revenue growth in the PBM. And as Larry said, it had an approximately 130 basis point negative impact on retail pharmacy comps but it had an insignificant impact on retail script volume.

Now turning to gross margin. The consolidated company posted an 18.3% margin in the quarter, a decline of approximately 40 basis points compared to Q2 of '13. This margin decline was the result of a mix shift as the lower margin PBM segment grew faster than the retail segment. Both operating segments saw their margins improve. Additionally, margins benefitted from the finalization of California’s Medicaid reimbursement rates, which I referenced on our last earnings call. This finalization benefitted retail gross margin by $53 million in the quarter and PBM gross margin by $16 million. This impact was consistent with the guidance we provided earlier this year.

Within the PBM segment, gross margins increased approximately 35 basis points versus the same quarter of LY to 5.5% while gross profit dollars increased approximately 24% year-over-year. The increase year-over-year was primarily driven by growth in our specialty business, favorable purchasing economics and the increase in GDR. We continue to see these positive margin drivers partially offset by typical client price compression.

Now gross margin in the retail segment was 31.4%, up 40 basis points over LY. Gross profit dollars increased 5.9% year-over-year. Pharmacy margins improved in the quarter as we benefitted from the increase in GDR and the finalization of the reduction in California’s Medicaid reimbursement rates that I noted earlier. Our pharmacy margins notably improved even without the impact of this rate finalization.

At the same time, we saw front store margins decline as anticipated in the quarter, driven mainly by the markdown of some tobacco products as well as the unexpected bankruptcy of one of our vendors. Total operating expenses as a percent of revenues improved by approximately 50 basis points from Q2 of '13 to 11.9% while total SG&A dollars grew by 6.4%.

The PBM segment’s expenses grew by 10% and its SG&A rate was 1.5%, an improvement of approximately 10 basis points versus LY. In the retail segment, SG&A as a percent of sales declined approximately 20 basis points to 21.3% while expenses grew by 5.6%. This reflects the deleveraging effect of generics as well as the impact of Specialty Connect as the retail segment transitions sales to the PBM segment without a corresponding expense reduction.

Within the corporate segment, expenses were up $29 million to $205 million. This increase is primarily related to benefit costs as well as strategic initiatives. Now adding it all up, operating margin for the total enterprise improved approximately five basis points to 6.4%. Operating margin in the PBM improved approximately 45 basis points to 4%. Now operating margin at retail improved about 20 basis points to 10.1%.

For the quarter, PBM operating profit was strong growing 30.1%, which is higher than expected. Retail operating profit increased a very healthy 6.5% at the high end of our expectations. Now going below the line on the consolidated income statement, net interest expense in the quarter increased approximately $32 million from last year to $158 million. The debt we issued in the fourth quarter of LY was the primary driver of this increase. Our weighted average share count was 1.17 billion shares and finally our effective tax rate was 39.2%.

Now let me update you on our guidance. As always, I’ll focus on the highlights. You can find the additional details of our guidance in the slide presentation that we posted on our website earlier this morning. As we stated in the press release, we are both raising and narrowing our full year 2014 EPS ranges given our strong results to-date. We currently expect to deliver adjusted earnings per share in 2014 in the range of $4.43 to $4.51 reflecting strong year-over-year growth of 11.75% to 14% and that’s excluding the gain of approximately $0.04 associated with the legal settlement in the third quarter of '13.

GAAP diluted EPS from continuing operations is expected to be in the range of $4.16 to $4.24. While we beat the high end of our guidance in the second quarter by $0.02, we increased the top of the range for the year by $0.01. This delta reflects a few moving pieces among them the minor shift in timing associated with the fixed payment we will receive from Cardinal as well as a slightly higher tax rate.

As Larry said, the structure of the final agreement is a bit different from what we have previously described. So let me explain how the venture works. There are three ways in which the arrangement can provide value to us. First, as we previously stated, we will receive a fixed quarterly payment from Cardinal that recognizes the greater relative purchasing volume that CVS Caremark has today.

Under the final agreement, we will receive 39 quarterly payments of $25.6 million beginning in the fourth quarter of this year rather than 40 quarterly payments of 25 million, which would have begun in the third quarter of this year. There is no change in the overall value of fixed payments. It’s simply a timing shift that more accurately reflects the operational ramp up associated with this venture.

Second, there is a new component to our arrangement providing the potential for additional predetermined quarterly payments from Cardinal to CVS Caremark beginning in the third quarter of 2015. These payments will only occur to the extent that certain milestones are achieved. And finally, as we have explained previously, we believe there will be incremental value to our current generic procurement created through the combination of our purchasing volumes.

So while the fixed payments will now begin a quarter later than originally planned, the overall value of the fixed payments remains the same and the potential for incremental value resulting from the venture remains high. So we continue to be excited about this venture and we look forward to its future contributions.

With that, turning back to 2014 full year guidance, we now expect consolidated net revenue growth to be in the range of 8% to 9% raising the midpoint by approximately 260 basis points over our prior guidance. We’ve increased our top line outlook in the PBM and now expect revenue growth of 13.75% to 14.75%, approximately 5 percentage points higher than our prior guidance. This revised guidance reflects our expectations for better-than-expected growth within specialty pharmacy, fueled by a combination of both inflation and new product mix.

Additionally, taken into account our performance in the second quarter, we are narrowing the top line outlook at retail, raising the bottom and the range and we now expect growth of 1.25% to 2%. And consistent with that outlook, we are also revising our guidance for total same-store sales and now expect growth between 0.25% and 1%. Keep in mind that these anticipated revenue growth rates reflect our expectations around the impact from our decision to exit the tobacco category.

Larry mentioned the impact to Q2 comps as we approach our target date to be out of the category in the fall, we expect the impact to grow. For the full year of 2014, the impact will be as high as 400 basis points from front store comps. And given what we’ve seen to-date, we expect front store comps could be negatively impacted by 400 to 500 basis points in Q3 and roughly double that in Q4. So when you lay out your models, please keep this in mind.

Guidance for operating profit growth in our segments has also been revised. We are narrowing retail operating profit by 25 basis points on both ends. We now expect retail operating profit to increase 7.25% to 8.5% year-over-year. And in the PBM, given the outperformance in Q2 and increased confidence in the back half of the year, we now expect operating profit to increase 12.5% to 14.5%.

As for our tax rate this year, we now expect it to be approximately 39.4% with the narrowing and raising of our EPS guidance range, operating cash flow guidance also changes. We now expect between 7.2 billion and 7.5 billion of operating cash flow, an increase of $200 million. And as I said before, our free cash flow guidance for the year remains in the range of $5.5 billion to $5.8 billion as we expect capital expenditures to be slightly higher than we originally planned.

Now in the third quarter, we expect adjusted earnings per share to be in the range of $1.11 to $1.14 per share, reflecting growth of 5.25% to 8.25% versus Q3 of '13, again after removing the gain associated with the legal settlement from last year’s results. GAAP diluted EPS from continuing operations is expected to be in the range of $1.04 to $1.07 in the third quarter.

Within the retail segment, we expect revenues to grow $0.25 to 1.75% versus the third quarter of last year. Adjusted script comps are expected to increase in the range of 3.75% to 4.75% while we expect total same-store sales in the range of down 1% to up 0.5%. As I noted before, if sales of tobacco and the associated baskets are excluded, our expectations for front store comps in the quarter would be 400 to 500 basis points higher.

In the PBM, we expect revenue growth of 14.25% and 15.25% driven by continued strong growth in specialty mix and inflation. We expect retail operating profit growth of 7% to 9% in the third quarter. We expect PBM operating profit growth of 1.5% to 4.5% in the third quarter.

So in closing, this was a great quarter with strong financial results across the board. And as a result, we both raised and narrowed our guidance for the full year and we continued to expect strong free cash flow and to deploy it in a way that maximizes value to our shareholders.

With that, let me turn it back over to Larry.

Larry J. Merlo

Okay. Thanks, Dave. I couldn’t be happier with the work of our colleagues, they work that they’re doing to provide good service to our clients and help people on their path to better health while delivering strong results for our shareholders. I think as we’ve talked this morning and in prior meetings, our unmatched enterprise assets are enabling us to provide innovative integrated solutions in breakthrough products and as the healthcare environment evolves, we are uniquely positioned to address the quality, affordability and accessibility challenges in the healthcare system today. So we’re highly focused on the unique opportunities we see for growth and we’ll continue to take an active and growing role in shaping the future of healthcare.

So with that, let’s go ahead and open it up for your questions. Operator?

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). Our first question comes from the line of John Heinbockel with Guggenheim. Please go ahead.

John Heinbockel - Guggenheim Securities

Hi, Larry. So a strategic question. When you think about Specialty Connect, how is that starting to impact your dialogue with potential customers? And with that in mind, how do you think that will impact your ability to reduce drug spend, and does it become a game-changer in terms of market share on the PBM side with new accounts?

Larry J. Merlo

Good morning, John. I’ll start and then I think Jon will probably jump in as well. And I think that we really have a surround sound specialty program, okay. I mean we highlighted Specialty Connect this morning and I think that’s one important component, but I think our ability to not just manage the specialty drug but manage the specialty patient I think is what is the real differentiator in the marketplace. And I’ll let Jon pick up from there and talk about the various ways we’re doing that.

Jonathan C. Roberts

Yes, so John as I talk to clients about Specialty Connect, what they really like is opening up the access because specialty has historically been a mail order only access for their members with some retail outlets but not really that accessible. And as clients become more focused on it, they’re really excited about this capability and they think of it like Maintenance Choice that as you know has been very successful in the marketplace. And one of our customers is also a physician, so as we talk to physicians they like the fact that we’re opening up convenience for their patients. And specialty today has its business with our PBM clients but there’s also a big open market in Medicare and fee-for-service Medicaid that again physicians have the ability to influence where those members go. So we expect to grow within our PBM base through clients selecting us because of these integrated capabilities but we also believe we’re going to get a disproportionate amount of referrals from physicians as well.

John Heinbockel - Guggenheim Securities

Okay. How much of an issue is compliance in that business and therefore is that a significant opportunity on the broader cost side?

Jonathan C. Roberts

As you look at it adherence – when you say compliance, I’m thinking adherence to the medication.

John Heinbockel - Guggenheim Securities

Yes.

Jonathan C. Roberts

Historically, retail has performed very much under what traditional specialty pharmacies have been able to perform at. And with Specialty Connect we have achieved the same levels of adherence with our Specialty Connect patients that we have with our specialty pharmacies because we’re able to connect all the clinical capabilities and back-ins of specialty. I know that is a concern that pharma had when we talked to them, but we’ve showed them results and have actually demonstrated an even higher level of adherence because now patients can select which channel they go to. So, we think we’ve solved that and that’s a real benefit.

John Heinbockel - Guggenheim Securities

Okay, thank you.

Larry J. Merlo

Thanks, John.

Operator

Our next question comes from the line of Robert Jones with Goldman Sachs. Please go ahead.

Robert Jones - Goldman Sachs

Thanks for the questions. Larry, I want to go back to your comments on prescription utilization. You touched on a little bit of what you were seeing from ACA and Medicaid expansion. As I look at the script growth in the quarter 3.9% exceeding the guidance, it looks like the guide for the next quarter is 3.75% to 4.75%, so a little bit of acceleration. Could you maybe just parse out a little bit what you’re seeing from ACA but also from the broader market utilization?

Larry J. Merlo

Bob, I think the broader market I think we’re seeing utilization pretty flat I think from the exchanges I think as had previously talked, I think we’re seeing more of a benefit coming out of the Medicaid expansion. I think there’s still some uncertainty as we mentioned in our prepared remarks in terms of when you look at the exchange population, just how many of those are incremental to health insurance coverage. So I think we’ve talked about the fact that we see '14 as a transition year. As we mentioned earlier, we do believe there is a modest benefit more of it coming from Medicaid in '14 but I think that we certainly see this ramping up as we move into '15 and beyond.

Robert Jones - Goldman Sachs

That’s helpful. And then I guess just a quick follow up on the formulary changes you commented on I think at the Analyst Day. You mentioned that in 2014 you’d save clients about $1 billion. I believe the update today was from 2012 to 2015 it’s 3.5. I guess just maybe if you could isolate the most recent changes and what kind of savings those would generate? And then I guess more broadly and more importantly, how successful have you been in shifting clients to these more restrictive formularies?

Larry J. Merlo

Bob, I mean we’re not going to provide any more granular information in terms of – to the first part of the your question. I think in terms of the second part, we have been able to manage transition across members as well as physicians in a very seamless fashion, recognize that. The formulary changes that we’re talking about affect a very small percent of our member base. And that has allowed us to do a lot of, I’ll call it seamless transition in terms of making it a nonevent for the patient as well as the physician.

Jonathan C. Roberts

This is Jon. The only thing that I would add is that we expect pharmacy trend, year-over-year growth to the pharmacy spend to grow due to continued AWP inflation, increase in utilization that we just spoke about and the growth in specialty sourcing and clients very open and much more receptive than they had been historically about narrowing formularies. We’re about to about 95 exclusions now. I’ll tell you as we’re making these decisions and these decisions are made through a clinical filter that’s reviewed by our P&T Committee, we are still generating tremendous value for our clients each year and we think there continues to be opportunity particularly in specialty.

Robert Jones - Goldman Sachs

Great. Thanks for the comment.

Operator

Our next question comes from the line of Meredith Adler with Barclays. Please go ahead.

Meredith Adler - Barclays Capital

Good morning. I have one question about the frontend and then Eric Percher will have a question. I know you’ve talked about the weakness in traffic in the frontend as a function of people consolidating trips. I was just wondering if you could talk – and of course your own initiatives, but if you could talk a little bit about what you think is going on both with the consumer, are they in fact pulling back and whether you’ve seen any changes in the competitive environment; anybody responding to weak traffic?

Larry J. Merlo

Meredith, I don’t think we’re seeing any changes in the consumer. I think that the consumer continues to be a cautious purchaser of products. At the same time, I don’t think we’ve seen a change in the competitive environment. We still see an awful lot of promotion across competitors. And we mentioned earlier, we’re continuing to be very disciplined about and quite frankly find that sweet spot. Oftentimes we talk about the art and science in terms of investment spending to drive traffic but to be able to do that in such a way that we’re driving profitable sales.

Helena B. Foulkes

I would just jump in and agree with that, Meredith. I think it’s fairly consistent with what we’ve been talking about in the last couple of calls. Consumers are still be a cautious. Where we really – our focus is health, beauty and personal care and we continue to be encouraged by our performance in those categories. Clearly, our decision on tobacco drove changes as you look at our share in the general mechanize business, but overall I would say competitors continue to be promoting more than they were last year and more than we are, so we’re watching that carefully. We’re really trying to make smart choices so that at the end of the day we’re driving profitable growth.

Meredith Adler - Barclays Capital

Great. And Eric, you have a question right.

Eric Percher - Barclays Capital

Yes, quickly on Specialty Connect, are most of the lives that are moving over from the pharmacy to PBM open market today, is that primarily who served at the pharmacy? And then the lives that we see in Specialty Connect beyond the movement over, have you begun to see traction in expanding the program or is that over the next several months?

Jonathan C. Roberts

Hi, Eric. So the mix of customers that are moving over is a combination of open and lives that we have. And as we think about growing Specialty Connect, it’s going to be by driving a higher share of open lives which we’ll do through working with physicians and through new client wins as new clients decide to move to us because of all of our integrated capabilities, Specialty Connect which is one of those.

Larry J. Merlo

Eric, the other thing that I think you’ll find interesting, Jon touched on or maybe an analogy of Specialty Connect to Maintenance Choice and what we have seen out of the gate is about 50% of the customers choose to pick up the specialty script at retail which ironically is very consistent with what we saw from Maintenance Choice when we first highlighted the program a few years back.

Eric Percher - Barclays Capital

That is interesting. Thank you.

Larry J. Merlo

Thank you.

Operator

Our next question comes from the line of Ricky Goldwasser with Morgan Stanley. Please go ahead.

Ricky Goldwasser - Morgan Stanley

Hi. Good morning. Can you give us some additional color on the growth at 90-day at retail? And where do you think we are in kind of again that market shift?

Larry J. Merlo

Ricky, we have continued to see accelerated growth at 90 days scripts. I would say it’s growing much faster than the 30-day bucket, if you will. Today it represents about – I think it’s 29% of our retail prescription pie, if you will.

Ricky Goldwasser - Morgan Stanley

Okay. And when we think about the opportunity as the opportunity for that is kind of like 50% to 60% of scripts you’re presenting kind of like the maintenance script. Is that how we should be thinking about it?

Larry J. Merlo

Yes, I mean I think you have it right in terms of how you’re thinking about the maintenance bucket of scripts versus the acute side and yes, I think it’s reasonable to expect it to continue its growth trajectory as we’ve seen the last couple of years.

Ricky Goldwasser - Morgan Stanley

Okay. And then the one follow up on generic inflation. Obviously you’ve done a very good job in mitigating the impact. Can you share with us your expectations for generic inflation for the remainder of the year and any thoughts if this is kind of like sustainable trend that will continue just kind of like longer term?

David M. Denton

Hi, Ricky. This is Dave. We don’t really provide a forecast for generic inflation. I’ll just make on comment just from the nature of the generic marketplace and we’re encouraged obviously with the joint venture that we’ve created with Cardinal but also encouraged that we believe strongly that the generic marketplace is long term a deflationary market and we believe that we’re well positioned to work hard in that marketplace to lower our cost and also lower the cost for our clients and the patients that we serve.

Ricky Goldwasser - Morgan Stanley

Okay. Thank you.

Larry J. Merlo

Thanks, Ricky.

Operator

Our next question comes from the line of Scott Mushkin with Wolfe Research. Please go ahead.

Scott Mushkin - Wolfe Research

Hi, guys. Thanks for taking my questions. So first, wanted some clarity on the PBM operating growth in the third quarter, just remind us what – it’s quite a bit less than we saw in the second quarter, so I was hoping to just get reminded on why we get some deceleration there?

David M. Denton

Hi, Scott, this is Dave. If you recall back to kind of even to Analyst Day, we fully expected that Q3 was going to be our softest quarter from a growth perspective. So this is very much in line with that expectation. Clearly, the cadence to profitability is tied to really two events is the time to break open generics and when they overlapped LY. And secondly the timing of profitability as we cycle through Medicare Part D. So both of those events are impacting Q3 and consistent as we thought they would impact Q3.

Scott Mushkin - Wolfe Research

That’s perfect. And then my second question really goes to I guess thinking about the asset and the asset turns as we move into the future, not next year but as we move out. It seems like CVS Caremark is uniquely positioned to kind of improve their asset turns with the clinics, with Specialty Connect. Can you guys take us out into the future? What will a store, if you really want to call it a store, three to five years look like as we move out? You guys have any thoughts around that. I know it’s kind of a high in the sky question, but I was wondering if you had some thoughts there?

Larry J. Merlo

Scott, I think I’ll start and others may jump in here. But I think you hypothesis is correct. It’s going to evolve from what exist today and we’ve talked a lot about the fixed asset base within the store and the fact that that next prescription has a disproportionate flow through to the bottom line, okay. At the same time, we do see opportunities to extend the pharmacy experience into the front store and I think that Helena has begun some work, some exciting work in terms of the opportunities that that creates. So we’re certainly not in a position where we’ve cracked the code on that or we’re ready to talk to about it other than the fact that I do think that you will see something different in the future from what you see today.

David M. Denton

Scott, this is Dave. I think the most, at least mid-term opportunity we have to improve asset turns, if you will, first is – one’s kind of the just the growth of the service model to the degree that we grow services in our outlets. We do that without deploying a bunch of capital from an asset perspective. And then secondly, as we talked about many times is we do have opportunities from an inventory perspective and making sure that we maximize I’d say the supply chain across all of our channels will be important to us over the long term.

Scott Mushkin - Wolfe Research

All right, guys. Thanks very much for taking my questions.

Larry J. Merlo

Thanks, Scott.

David M. Denton

Thanks, Scott.

Operator

Our next question comes from the line of Lisa Gill. Please go ahead.

Lisa Gill - JPMorgan

Great. Thank you. Jon, I was wondering if I could just maybe start with some questions around the selling season, 5.4 billion of gross new wins. Can you just talk about what people are buying this year? Are you seeing Maintenance Choice, specialty? Is there anywhere that you can give us some metrics around who those new clients are and what programs they bought for 2015?

Jonathan C. Roberts

Well, Lisa, we’re obviously very happy with this year’s selling season and when you look at the mix of clients, I think it’s very balanced with employer’s health plans and government business. And I can’t really point to really any one program that has moved up in their priority other than specialty, but we now continue to expand our integrated offerings and many of which are unique, such as Maintenance Choice and Specialty Connect, Pharmacy Advisor and MinuteClinic and all those combined resonate. And then when we talk about our ability to be able to touch members and influence their behavior and impact outcomes that results in lower prices to the client, that continues to resonate. And I think – I’ve probably seen a little more interest in specialty which has become the top priority in the marketplace and I believe our assets are unmatched. We talked about Specialty Connect earlier, but we also have Accordant, which is a rare disease management company that we link to our specialty offering and that treats not just rare specialty disease state, but it treats the comorbidities. And most of these patients have other diseases that they’re dealing with. We’ve talked in the past about NovoLogix have to spend in the medical benefit not really being managed. We have that capability. Home infusion people are very interested in as well, moving people out of expensive hospital settings into their homes or infusion clinics.

Lisa Gill - JPMorgan

I guess really what I’m trying to get at is more on the upside, Jon, as we think about 2015 and things that they’ve signed up for, how does it impact profitability of those clients? So do the majority sign up for your specialty programs? Did you see people that were electing to do Maintenance Choice, I’m trying to get some more of the finance side of it?

Jonathan C. Roberts

I would say it’s pretty consistent with what we’ve seen in prior years. With health plans probably don’t take as many of our programs as employers do. W are seeing more uptake in our formulary strategy than we’ve seen in the past. Maintenance Choice 2.0 we’re beginning to see uptake in the health plans that historically haven’t really emphasized a mail benefit. But I think I would think about it, Lisa, as consistently what we’ve historically say.

Lisa Gill - JPMorgan

Okay, great. Thank you.

Larry J. Merlo

Thanks, Lisa.

Operator

Our next question comes from the line of David Larsen with Leerink Partners. Please go ahead.

David Larsen - Leerink Partners

Hi. Can you please talk about the joint venture with Cardinal? And I guess there is some new aspects to it, like just on a very high level, what’s sort of the nature of those incremental milestones might be? And I’m assuming that if those milestones are met, it would mean more earnings for all parties involved. Thanks.

Larry J. Merlo

David, good morning. I guess I’ll just start by saying that when we formalized the JV agreement, we had established some guiding principles that spoke to the goals of the entity to reduce cost for our clients, our customers while making the supply chain more efficient and to create win-win opportunities such that there’s equity and fairness in the value that gets created. So obviously over the past six months, we’ve had a lot more time to dig into the data. And it simply made sense to modify the agreement with those guiding principles that I outlined in mind. We’re not going to provide any granularity around some of those milestones but I think we have had a terrific relationship with Cardinal for many years. I think that that’s what led to the JV being created and I couldn’t be more pleased with how the teams from CVS Caremark and Cardinal have come together in the spirit of how do we improve efficiency and drive down costs. And I think we’re off to a terrific start.

David Larsen - Leerink Partners

Great. Thanks a lot.

Larry J. Merlo

Thank you.

Operator

Our next question comes from the line of George Hill with Deutsche Bank. Please go ahead.

George Hill - Deutsche Bank

Good morning, Larry and Dave, and thanks for his my question. I just wanted to quick check, I heard one point that you brought up. Did you say you expected long-term generic drugs to be inflationary or deflationary? Part of that broke up on my end.

Larry J. Merlo

I’m sorry, very much deflationary, George.

George Hill - Deutsche Bank

Okay. And then maybe delving into the prepared comments a bit more. It sounds like you're seeing inflation in the small book of the business and then deflation, significant deflation in the rest of the book. And I would ask are you seeing that deflation in acquisition costs? And is that deflation finding its way all the way to kind of the list price or the AWP price from your perspective?

David M. Denton

George, this is Dave, maybe I’ll start. Clearly, what we’re signed up to do is our purpose in life is to work to reduce cost for the clients that we serve and the members that we serve that either use this via mail order or use this in our retail outlets or use this in various and sundry other matters. And so when we look at generic inflation, our focus is to control that and to push down those cost to goods sold at this point in time.

Larry J. Merlo

George, I think as Dave pointed out, overall we see a deflationary nature in the generic environment and we’re really not going to comment on specific products or AWPs.

George Hill - Deutsche Bank

Okay, all right. Then maybe just a quick tack on. From what we hear you guys have been active in significant selling success tacking MinuteClinic onto health plans with the zero co-pay option this selling season. I guess can you talk about expected growth in MinuteClinic as we look out to ‘15?

Larry J. Merlo

I think as we pointed out this morning, we continue to see significant growth. Some of that is organic in terms of the ongoing growth of the existing clinics and some of that is being driving by our expansion. We said earlier we’ll open up on 150 clinics this year. I think it certainly is a discussion in the selling season. I think that kind of the ticket to the game metrics are being right on price and service, but we’ve got a lot of other elements with which we can offer clients the MinuteClinic option being one and one that it’s getting a lot of attention.

George Hill - Deutsche Bank

All right, I appreciate the color. Thank you.

Larry J. Merlo

Thanks.

Operator

Our next question comes from the line of Ross Muken with ISI Group. Please go ahead.

Ross Muken - ISI Group

Good morning, guys, and congrats. If we look at sort of the pacing of wins in the selling season, one of your competitors was sort of suggesting that as it sort of tailed off and then as we look into the out-year, the sort of momentum of their peers inclusive of you was sort of waning. If we looked at like your hit rate – your win rate over the course of the selling season, was it fairly consistent? Did you feel like you gained momentum as you put up some of these big wins? It seems like more recently we've seen a number of public names of size. I'm just trying to get a sense for kind of tone and how you feel like the business had momentum through the most recent RPs you been in?

Jonathan C. Roberts

Ross, so I would say we’re continuing to win in the marketplace. I think this year has been particularly good and I think it has a lot to do with everything I was talking about to Lisa with our integrated assets, our ability to deliver cost has a lot to do with what we do with generics and our formulary strategy and the fact that we focus on service to both our clients and their members. So, they like our story and we’re very happy with the wins that we’ve had this year.

Ross Muken - ISI Group

And maybe Dave, M&A activity has kind of picked up. You guys have obviously been quite selective and strategic the last few years. As you look at sort of the environment, both in assets here and maybe also abroad, how would you kind of characterize the pipeline and your sort of intent to maybe deploy a little bit more of the balance sheet? Obviously, you've done a great job on returning free cash but you've also been historically pretty prudent on the tuck-in side.

David M. Denton

Yes, Ross, obviously M&A has been part of our DNA for a long time in our company. We’ve been very clear that as we think about capital deployment, one area to deploy capital is in kind of investing backward in organically in our business and we will continue to do that. I would say that at the same time, we’re going to be to your point very disciplined in how we approach the market. If you look at our asset base today, we don’t have any glaring gaps or holes in capabilities at this point in time. But as we said, to a degree that we can bolt-on assets that make sense that we have line of sight to both synergies and returns, we’ll do that. And I think that the market is still active in that perspective.

Ross Muken - ISI Group

Great. And congrats again guys.

Larry J. Merlo

Thanks, Ross.

Operator

Our next question comes from the line of Steven Valiquette with UBS. Please go ahead.

Steven Valiquette - UBS

Thanks. Good morning. So just one other quick one on the PBM selling season success that you've had, I'm just curious with it now 70% complete, can you draw any sort of conclusion that the decision to stop the retail tobacco sales may have helped you win some PBM business? I'm curious whether this has come up frequently in RFPs and investment (indiscernible) and has anybody cited that they chose you specifically because of that decision, just curious on that? Thanks.

Larry J. Merlo

Steve, I think it’s hard to point any one win and attribute to the tobacco decision. I can tell you that it’s had a lot of discussion with our clients. Obviously recognizing our clients and the fact that they’re working hard to get their members or their employees to stop smoking, they have applauded our decision. Listen, I think it’s one of those intangibles that again back to my earlier point about you got to be right on the basics and then once you’re right on the basics there, I think we have a lot of intangibles that collectively I think become something very meaningful in the client’s eyes.

Steven Valiquette - UBS

Okay. Just one other quick one on the formulary restrictions; pretty topical this week, but it seems a couple years ago this caused a little bit of negative PR for CVS back in 2011, 2012. But now it seems like these changes are helping you or at least the negativity seems almost nonexistent now. So I guess I'm just curious, any thoughts or color you may have on why the psychology may have changed a little bit among your customers on the better receptivity to formulary changes now, let's say, versus a few years ago?

Larry J. Merlo

Steve, it’s a great question. I think if we rewind three of four years, I think what we learned with that decision was the strategy was right. And I remember talking – as we talked to clients back in late 2011 or early '12, the issue that they had that created the negatively was from an execution largely the timing of the communication, that’s where we were out of sync. We weren’t lined up with their benefit cycle. So I think once we made that course correction, which was an easy one to fix, I think that all the noise subsided.

Steven Valiquette - UBS

Okay, that's great. Thanks.

Larry J. Merlo

Thank you.

Operator

Thank you. Our next question comes from the line of Peter Costa with Wells Fargo. Please go ahead.

Peter Costa - Wells Fargo Securities

Hi. Thanks, guys. Appreciate all the discussion about 2015. But moving back to the tobacco decision, is your view that it's still going to be about 2 billion in annualized sales that would be impacted by that decision or has that number changed given the fact you talked about sort of a double the 400 to 500 basis point impact on same-store for the fourth quarter?

Helena B. Foulkes

Yes, we’re still tracking very much towards that $2 billion. The results we’re seeing are in line with what we expected and we said early on it would have a $0.06 to $0.09 impact this year and we’re tracking towards that.

Peter Costa - Wells Fargo Securities

And in terms of the impact on the same-store in the fourth quarter? That seems like that would be a bigger number.

David M. Denton

If you just look at what we communicated, we said that in the third quarter that the exit of the tobacco category would be somewhere between 400 and 500 basis points to front store comp impact, negatively impact. And that rate would essentially double as we cycle into Q4. And so that’s essentially how you should think about modeling the progression of that.

Larry J. Merlo

And keep in mind that the $2 billion reflected tobacco sales, companion items within that basket and that is a full year revenue number.

Peter Costa - Wells Fargo Securities

Okay. Thank you.

Larry J. Merlo

Thank you.

Operator

Thank you. Our next question comes from the line of Robert Willoughby with Bank of America Merrill Lynch. Please go ahead.

Robert Willoughby - Bank of America Merrill Lynch

Just one left. Do you have any guess or forecast in terms of what your share of the Caremark accounts could be by year end?

Larry J. Merlo

You mean dispensing share within CVS pharmacy?

Robert Willoughby - Bank of America Merrill Lynch

Yes, CVS market share with Caremark plans. It was at 31% at the end of last year. Where does that trend to?

Larry J. Merlo

Yes, we don’t forecast that and disclose that.

Robert Willoughby - Bank of America Merrill Lynch

Would it be something you’d give us at the end of the year at the Investor Day?

Larry J. Merlo

Typically it’s something that we discuss at Investor Day, yes.

Robert Willoughby - Bank of America Merrill Lynch

Thank you.

Larry J. Merlo

Thanks, Bob.

Operator

Thank you. Our next question comes from the line of Charles Rhyee with Cowen and Company. Please go ahead.

Charles Rhyee - Cowen and Company

Yes. Thanks for taking the question. Actually, I have another question on the exclusion lists. It seems like this time around from what I've read is you've kind of adopted more of also using prior authorization versus outright exclusion. Just curious on how you kind of make that decision? And then secondly, how do you manage for drugs that you exclude where companies – where the manufacturers then try to work around that? How do you communicate with your clients and how do you stop to make sure that your plans don't really – that you don't end up actually paying for that or your employers?

Jonathan C. Roberts

Yes. So, Charles, as far as manufacturers working around it, I think that’s the beauty of the exclusion program. They used to try to work around our formulary tiering through co-pay coupons. So once the drug is excluded, the member will have to pay 100% so it would be hard for a manufacturer to work around that. Our strategy around excluding has really not changed. We’ve always had prior authorizations. We do have the ability if a physician feels like a particular drug has a medical necessity that they have the ability to get to that drug, but it’s a very, very small percent of patients that have physicians that want to get them on a particular drug. So it’s really a safety outlook for them.

Charles Rhyee - Cowen and Company

Great. And then just a follow up just on that in general. It seems like this is an area that not only yourself but some of your competitors are starting to really adopt more aggressively. Do you see that this is the next big tool for you to use and to really help manage costs down? So how do you see these lists expanding over time? Is this a big opportunity for you?

Jonathan C. Roberts

Well, we have the template exclusion that we’ve been talking about but we also have more aggressive formularies that clients can opt into. So the next step up excludes 170 drugs and then there’s another step that excludes 300 drugs which essentially is all generics. So we do see as we move into the out years, we’re going to be moving towards some of the more restrictive formularies that we think clients are going to be very interested in. So there’s a lot more work and a lot more runway here.

Charles Rhyee - Cowen and Company

Great. Thank you.

Larry J. Merlo

Okay. We’ll take two more questions please.

Operator

Our next question comes from the line of Mark Wiltamuth with Jefferies. Please go ahead.

Mark Wiltamuth - Jefferies

Hi. Could you give us what the specialty growth was organically excluding acquisitions?

Larry J. Merlo

I don’t think we have that, Mark. We can…

David M. Denton

Hi, Mark. This is Dave. I don’t know that we really had any significant acquisitions in that number. Most of that is of [Coram] (ph).

Mark Wiltamuth - Jefferies

But Coram is in there, right?

David M. Denton

Other than that.

Mark Wiltamuth - Jefferies

Okay.

David M. Denton

I don’t know that off the top of my head. The growth rate is still organically significant.

Mark Wiltamuth - Jefferies

Okay. And then maybe just give us on the generics a little timing on how you look at the break open market for generics here in the next 12 months or so? Maybe by quarter, where you think we’ll get some better opportunities on generic margins?

David M. Denton

Yes. This is Dave, maybe I’ll touch that. I just want to say that the generic launch and break open schedules, if you kind of watch the market, those launch dates continue to evolve a bit. Some move out, some move in even since what we talked about at Analyst Day. And if you look at it, many of the '14 launches have been in flux. As we look into '15 I think some of the break open generics will look a little bit lower than we originally planned when we look back at Analyst Day in December of last year. But I would say it’s still very fluid at this point in time. We’ll continue to kind of assess the situation and give you updates as it becomes pertinent.

Mark Wiltamuth - Jefferies

And second half of '14 versus the first half of '14, better or worse for generics?

David M. Denton

You got to think about how we cycle to LY, so if you look at the cycle of our back half for this year to back half of last year is a little worse.

Mark Wiltamuth - Jefferies

Okay. Thank you very much.

Larry J. Merlo

Okay. Last question.

Operator

Our final question comes from the line of Frank Morgan with RBC Capital Markets. Please go ahead.

Frank Morgan - RBC Capital Markets

Good morning. I was hoping to get a little bit more color on the PDP (indiscernible) for the balance of the year, is there any chance that there might be conservatism in the assumptions about the auto-assignees or the choosers you're taking? And basically give us a longer term view how you see next year playing out as well? Thanks.

David M. Denton

Hi, Frank. This is Dave, maybe I’ll start here. I think if you look just from a PDP perspective the number of lives, the real I guess opportunity to gain lives is early in the year. So I think if you look to the balance of the year, I don’t think there’s a material change or opportunity that presents itself in the marketplace. As we cycle into '15, I think we’re encouraged by what we heard from a benchmark perspective. I think that although that’s what we’ve heard, we don’t really know what the opportunities are at this point in time. I think we have a very attractive product as we cycle into '15, but as far as the auto-assignees we’ll need to understand more fully how the market will evolve and we won’t know that for several more months yet.

Frank Morgan - RBC Capital Markets

Thank you.

Larry J. Merlo

Okay. And just limping back on Mark’s question on specialty, in our remarks we said specialty growth was 53%. If you back Coram out of that number, the growth was around 40%, so just bringing closure to that.

So with that, let me thank everyone. I know this was a bit of a long call, but a lot of information and thanks for your continued interest in CVS Caremark.

Operator

Ladies and gentlemen, this does conclude the conference for today. We thank you for your participation and ask that you please disconnect your lines.

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