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CVS Caremark (NYSE:CVS)

Q4 2010 Earnings Call

February 03, 2011 8:30 am ET

Executives

David Denton - Chief Financial Officer and Executive Vice President

Nancy Christal - Senior Vice President of Investor Relations

Per Lofberg - Executive Vice President and President of Caremark Pharmacy Services

Larry Merlo - President, Chief Operating Officer, Director and President of CVS Pharmacy - Retail

Thomas Ryan - Chairman and Chief Executive Officer

Analysts

Edward Kelly - Crédit Suisse AG

John Heinbockel - Guggenheim Securities, LLC

Meredith Adler - Barclays Capital

Lisa Gill - JP Morgan Chase & Co

John Ransom - Raymond James & Associates

Scott Mushkin - Jefferies & Company, Inc.

Lawrence Marsh - Barclays Capital

Kemp Dolliver - Avondale Partners, LLC

Mark Wiltamuth - Morgan Stanley

Steven Halper - Stifel, Nicolaus & Co., Inc.

Thomas Gallucci - Lazard Capital Markets LLC

Michael Palahicky

Matthew Fassler - Goldman Sachs Group Inc.

Ann Hynes - Caris & Company

Neil Currie - UBS Investment Bank

Eric Bosshard - Cleveland Research

Operator

Good morning. My name is Regina, and I will be your conference operator today. At this time, I would like to welcome everyone to the CVS Caremark Fourth Quarter 2010 Earnings Conference Call. [Operator Instructions] I would now like to turn the call over to Ms. Nancy Christal, Senior Vice President of Investor Relations. Ms. Christal, you may begin your conference.

Nancy Christal

Thank you, Regina. Good morning, everyone, and thanks for joining us today. I'm here with our senior management team, Tom Ryan, Chairman and CEO of CVS Caremark, will provide some brief opening remarks about his transition to retirement; Larry Merlo, President and COO, who will take the reins as CEO in March, will talk about his priorities to drive growth going forward. He'll also provide an overview of our 2011 guidance and an update on the business. Dave Denton, Executive Vice President and CFO, will provide a financial review for the quarter and some details around our initial guidance for the year. Per Lofberg, President of our PBM business, is also with us today, and will participate in the question-and-answer session that follows our prepared remarks. We have a lot to cover this morning, and we posted slides on our website that summarize the information on this call. I hope you find that helpful.

During the question-and-answer session, please limit your questions to one to two including follow-ups, so we can provide more analysts and investors a chance to ask their questions. This morning, 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 the reconciliations of comparable GAAP measures on the Investor Relations portion of our website. As always, today's call is being simulcast on our IR website. It will also be archived there following the call to make it easy for all investors to access it.

Please note that we expect to file our Form 10-K by February 22, and it will be available through our website at that time. Now before we continue, 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 Tom Ryan.

Thomas Ryan

Thanks, Nancy, and good morning, everyone. Let me touch briefly on the leadership transition that Nancy mentioned before we get into our results and the outlook. As you know, at our annual stockholders meeting last May, we announced a succession plan, under which I would transition to retirement by this year's annual meeting, and Larry Merlo would assume the role of CEO.

Last May, I set up the office of the chairman, so I could work closely with Larry and Per Lofberg, President of our PBM business, throughout the transition. That transition has gone extremely well, and it's time for me to pass the reins to Larry. As you know, we recently announced that Larry will become CEO effective March 1, and I will be non-executive Chairman until our annual meeting this May. At that time, I will retire from the board, and the board intends to appoint David Dorman, a member of our board since 2006, as non-executive Chairman of the Board.

Well, many of you know Larry, but for those of you who don't, he is a seasoned executive with more than 30 years of industry experience. He has delivered outstanding results in every position he has held, and he is the ideal executive to lead our company forward. I am confident in our management team, the assets we have in place, the future of CVS Caremark. Following more than three decades with our company, I can retire with great confidence in the future, and know that we are extremely well-positioned to play an important role in the evolving U.S. health care market, and to generate strong growth and returns to our shareholders.

Now let me turn it over to Larry, who will review the 2010 results, the 2011 guidance and some of his plans, and he will also coordinate the Q&A session at the end. Larry?

Larry Merlo

Well, thanks, Tom, and good morning, everyone. As Tom said, we have worked together for the past 20 years. And I just want to take a minute to thank Tom for his leadership and vision, along with his mentoring and support throughout the years. We certainly have the right assets in place to continue to be a very successful company for years to come, and that is a real credit to Tom's vision of the future of pharmacy healthcare. Throughout his tenure, Tom has built a culture that is focused on innovation, customer service and flawless execution, and I certainly look forward to building upon his legacy.

Now, as part of my transition to the CEO role, I recently appointed our two highest-ranking retail executives to lead the CVS Pharmacy business on an interim basis. Mike Bloom, our Executive V.P. of Merchandising and Supply Chain; and Scott Baker, our EVP of Internal Operations and Real Estate, have taken over the leadership of our Retail business, pending the completion of our search for a new Retail President. These individuals, along with their talented colleagues, have helped make CVS pharmacy number one in our sector, and have consistently demonstrated the highest levels of creativity, leadership and teamwork. And I'm confident this success will continue under Mike and Scott's leadership.

While I'm certainly excited to lead CVS Caremark into the future, I am certainly committed to and confident about our future success. And to be clear, as CEO, one of my top priorities will be to ensure that the CVS Caremark merger is financially successful for our shareholders.

In the past few years, we have accomplished an awful lot. We've set up an infrastructure that will enable the company to be very productive over time. We have the right people in place leading the PBM. We've developed and introduced unique new products and services that have been widely adopted. We completed the rollout of the Consumer Engagement Engine, which is a critical component of our integrated offerings now and into the future. And we saw renewed momentum in our selling season. But quite frankly, some of those things have just taken longer than expected, which has affected both the PBM's performance and the valuation of our company. I am confident that we have the right plan along with the right people, processes, technology and, quite frankly, urgency to deliver on the full potential of this business over the long term. And I'll talk more about how we'll accomplish that throughout my remarks this morning.

But to me, our future success will be defined by three things. First, the flawless execution of our strategy, that being to lower healthcare costs while improving the health of those we serve, leveraging the many benefits of our integrated Pharmacy Services model. And we'll talk more about how we're accelerating the PBM transformation. Second is to stress more cross-functional thinking and action across the company, producing even higher levels of customer service. And three, enhancing value for all of our shareholders in a number of ways, including improvements in dividend payouts and share repurchases.

Now turning to this morning's news, I'm pleased with our fourth quarter and full year results, which were in line with our expectations. We reported adjusted earnings per share from continuing operations of $0.80 for the fourth quarter, $2.69 for the year. We generated $1.5 billion in free cash in the quarter, $3.3 billion for the full year, ahead of our $2.5 billion target, and Dave will review more of the details in his financial review. I'll just say that the cash generation capabilities of our company, both in the short and long term, are quite substantial.

Now before providing the quarterly business update, I want to provide highlights of our initial guidance for 2011. As we stated in our earnings release, we expect to generate between $4 billion and $4.2 billion of free cash flow in '11, up from the $3.3 billion we generated in 2010. We expect adjusted EPS from continuing operations to be in the range of $2.72 to $2.82, reflecting an increase of 1% to 5% from the $2.69 we earned in '10.

In the Retail business, we expect revenue growth of 4% to 6%, operating profit growth of 6% to 8%, with same store sales growth of 2.5% to 4.5%. And with our strong leadership team and the initiatives we have in place, I'm very confident that we'll continue to deliver strong retail growth.

In the PBM, we expect revenue to grow 23% to 26%, and operating profit to decline 5% to 9%. Now this guidance assumes approximately $0.08 of accretion from the acquisition of Universal American's Part D business, assuming a late second quarter close. And as you know, the closing of that transaction's subject to completion of regulatory review, along with approval by the Universal American shareholders. Our guidance also includes approximately $115 million to $130 million, or about $0.05 to $0.06 per share of expenses related to the PBM streamlining initiative. So the PBM will have very strong revenue growth in '11 versus the decline we saw in '10 . So we're extremely pleased with our top line growth, which certainly bodes well for the future. And I think Per has done a great job both stabilizing, as well as growing our client base following the contract losses of a year ago.

But let me take a minute to explain the profit erosion we're seeing in '11 versus '10. The full year wrap effect of the FEP contract extension, which took effect in September of last year, as well as the margin compression from some other renewals are the biggest factors negatively impacting Caremark's profitability in '11. Furthermore, the trough in new generics, along with the PBM streamlining initiative are also affecting our profit outlook for this year. And while Caremark has always enjoyed an industry-leading rate of profitability as evidenced by our industry-leading EBITDA per claim, the combination of these factors will cause our profit level to converge toward industry levels. We are very focused on strategies to offset these margin pressures and drive our bottom line, and I'll touch upon this topic throughout the call.

So as a result, the PBM profit outlook for '11 is a bit below the expectations we had at our Analyst Day. Now since that time, our estimates of the impact of renewal pricing became more clearly quantified, and have resulted in more margin compression than we expected. Looking forward, as we outlined at Analyst Day, we are targeting 9% to 11% compound annual growth in the PBM's operating profit over the next five years. The five-year growth targets we laid out on Analyst Day are not affected by our 2011 guidance. While operating profit is expected to continue to contract this year, we believe we are taking the necessary steps to achieve long-term financial success in the PBM. So 2011 is the year we break trends on top line growth in the PBM, and we expect 2012 to be the year that we break trends on profit growth.

And there are many reasons for optimism about our PBM's long-term prospects, starting with its performance in 2012, and let me give you a few of the reasons why. First and foremost, 2012 is expected to be the strongest year in generic launch history. In fact, the amount of branded drugs expected to come off patent in '12 is more than double that of the past five years, further enhanced by the 2012 wrap effect of Lipitor, assuming a November '11 launch.

Second, the streamlining benefits will begin to outweigh our investment costs. Third, we'll see a ramp in accretion from the Aetna contract. Fourth, we anticipate continued growth in both specialty and the Medicare Part D businesses. And fifth, our focus on client service and satisfaction, along with our innovative products and services, will provide continued momentum in renewal and new sales success. So as I said, I'm focused on ensuring that the PBM will break the recent trend and achieve operating profit growth in '12. It's obviously way too early to get specifics, but we are well-positioned to turn the corner.

Now I've attended several investor conferences over the past few months, and many people have asked why our targets for 2010 through 2015 suggest that PBM margins are expected to decline. So let me tell you why we believe that to be the case and how we plan to drive future growth in the PBM. First, the addition of the very large Aetna contract will obviously have a significant impact on our margins, and Dave will talk a little more about this in his remarks. Second, the retail network currently makes up a substantial portion of our business, and Caremark has always done a great job managing our retail network, and this has been an important driver of cost savings for clients while contributing to our profitability. We are now seeing a growing preference amongst certain clients, especially in the government sector, for pass-through pricing. Third, we have been making investments in lower margin, but high return businesses, like Medicare Part D. And furthermore, is no smaller point, the Caremark has had the highest EBITDA per claim in the industry, and we see that converging toward the industry levels.

Over the past several months, I have worked closely with Per to understand the challenges and opportunities of our PBM business, and I have certainly gained a lot of perspective. So today, I'd like to lay out what I see is our key priorities to achieve our targeted levels of future growth. And first, let me just state for the record that you can be sure that we'll keep our eye on the ball in our industry-leading retail business. We'll continue to innovate to maintain our edge, while driving profitable sales growth. Second, we're focused on driving top line growth in the PBM through continued market share gains and strong client retention, a keen focus on those high-growth sectors, specialty and Med D businesses, as well as identifying additional opportunities for high return bolt-on acquisitions.

Third, we're focused on shifting our mix to higher-margin areas in the PBM. For example, we'll continue to drive our 90-day Mail Choice business, which is comprised of both traditional mail order as well as Maintenance Choice. We'll also continue to drive best-in-class generic dispensing rates, which will be helped by both the upcoming generic wave, as well as our unique plant design, aligning both member and plant incentives. Fourth, we'll execute successfully on the PBM streamlining initiative to improve our overall operations and align our cost structure more closely with peers. We expect to generate more than $1 billion in savings through 2015. This initiative is broad reaching, very important to the PBM's future profitability, and there are many similarities here to what we have accomplished, integrating and consolidating the retail acquisitions we've done. And we're applying many of those same processes to this streamlining effort. Fifth, we'll continue to develop and upsell unique offerings that are unique in the marketplace. And finally, we'll generate substantial and accelerating levels of free cash flow and improve our return on invested capital. So I'm confident that we have a solid plan in place to achieve our long-term earnings growth targets. Additionally, we're generating very significant free cash flow that is expected to accelerate over time. And we're employing disciplined capital allocation practices to drive shareholder value.

So with that, let me turn to the fourth quarter business update. And I'll start with the retail business, which once again delivered industry-leading same store sales and achieved an all-time record 9.2% operating margin. Our same store sales increased 1.7% in the quarter, with pharmacy comps up 2%, and front store comps up 1%. As you know, we were up against the difficult comparison with last year's H1N1 outbreak. And to put that into perspective, on a two-year stack basis, our total comps increased 6.6%, with pharmacy comps up 9.3% and front store comps up 1.3%. We continued to gain share, with our market share up over 20 basis points nationally versus the same quarter a year ago.

Our pharmacy comps were negatively impacted by approximately 250 basis points from new generics in Q4. Pharmacy comps were positively impacted by approximately 300 basis points on a gross basis or 220 basis points on a net basis due to the continued growth of Maintenance Choice. And you'll recall that the net basis takes into account the cannibalization of existing 30-day CVS scripts, converting to 90-day scripts under Maintenance Choice, and is really a better measure of the overall impact.

During 2010, our retail adherence program, which we refer to as our Patient Care Initiative, touched over 30 million unique patients through a variety of interactions designed to help them remain on their medication therapy. And with the completion of the rollout of the consumer engagement engine to our stores in November, we are now able to integrate our Patient Care Initiative into our pharmacy system. This now allows interventions to be seamlessly sent to our entire fleet of stores electronically. And this connectivity enables our pharmacists to more effectively and efficiently conduct these patient interventions, which is a true differentiator for us.

Turning to the front store, consumers remained value conscious, and sentiment remains overall conservative. And given the tough comparison referenced earlier, we saw sales of cold remedies down in October and November, but increasing in December. We had a good Christmas season, with sales up more than 5% over last year, with comparable sell-throughs. And while traffic has been somewhat flat throughout the year, the average ticket continues to increase, which is really a testament to our highly successful and growing ExtraCare loyalty program. We now have more than 67 million active ExtraCare cardholders, and about 70% of our transactions are done using the card. We've taken the ExtraCare program to a new level with the recent launch of the ExtraCare Beauty Club. This program provides those ExtraCare customers who walked in with additional benefits and rewards on beauty purchases.

Throughout 2010, we introduced about 1,100 new private label items to better serve our value conscious customers, and we continue to see healthy growth in private label sales. In the fourth quarter, private label as a percent of front store sales across the chain, increased 50 basis points to 17.8%, for the year, increased 120 basis points to 17%. Now we've also made significant progress on the front store initiatives we talked about on Analyst Day. Over 200 urban remodels were completed this past year, and we are seeing double-digit growth in trips and a 7% to 9% growth rate in both sales and margin. Almost 4,000 of our stores, chain wide, received the expanded consumables planograms, the key goal being to generate trips to drive front store tales, not just consumables sales. And I'm pleased to report that we're seeing growth not only in consumables, but also in the health and beauty segments in these stores. So we're driving incremental trips, improving sales and margin, and enhancing inventory productivity as planned.

As for our real estate program, we opened 39 new or relocated stores, and closed two others in the quarter, resulting in 30 net new stores. For the year, we opened 285 stores and closed 27, resulting in 152 net new stores and retail square footage growth of 2.9%, right in line with our plan. In addition, we completed close to 200 file buys in '10, and expect to do a similar number in 2011. Now this year, we expect to open or relocate approximately 225 to 250 new stores, close 15 others, resulting in approximately 150 net new stores and retail square footage growth of 2% to 3%.

Now let me touch on MinuteClinic. Since its inception, MinuteClinic nurse practitioners have provided care to more than 8.7 million patients, and we continue to see healthy growth in the business. Non-flu vaccination business were up 13% in Q4, 22% for the year, and the lower growth rate in the quarter reflects the significantly lower levels of illness this year versus last year's H1N1 outbreak. As we said on Analyst Day, this year, we intend to start adding about 100 clinics annually. And while we're considering two to three new markets for MinuteClinic, we expect about 75% of the new clinics this year to open in existing markets. MinuteClinic is still in investment mode today, but we expect it to be breakeven on an all-in basis by the end of this year and remain at a breakeven level in 2012 despite the addition of the new clinics. So we remain excited about MinuteClinic's future, as we think it will play an important role in providing care to the 32 million newly insured beginning in 2014 and beyond, especially in light of the shortage of primary care physicians.

Now let me turn to the PBM. We've added a bit more business in the 2011 selling season since our last update. We have won $10.9 billion of gross new business, $9.4 billion on a net basis. And we've completed about 85% of our renewals for 2011 to date, up from 70% at our last update, and our retention rate remains at 97%. And I expect this momentum to continue into the future, as we continue to quantitatively demonstrate to both current and prospective clients our ability to lower their healthcare costs and improve outcomes for their members.

As you know, in late December, we announced that we had entered into a definitive agreement to acquire Universal American's Medicare Part D business upon closing that transaction with more than double our number of covered lives in one of the fastest-growing segments in the PBM space. And based on the latest data from CMS, which will be updated again this month, we would expect to have more than 3.4 million Part D lives post closing, making us a strong number two player in the space. Over time, we expect a growing proportion of population to receive their prescription drug coverage under Medicare Plan, driven both by the graying of baby boomers, as well as the anticipated shift of retirees from employer-based coverage to Medicare. Now given the timing of the expected close, we have included the insurance business in our guidance for the second half of this year. In January of '12, we expect to begin servicing the PBM contracts for both the PDP and Universal American's MAPD business, which currently has about 130,000 lives.

We give you an update on the Aetna implementation, which is off to a terrific start. We've assumed responsibility for mail dispensing, call center and retail network management, and we've successfully transitioned approximately 660 employees from Aetna to CVS Caremark. We expect to begin dispensing specialty prescriptions from CVS Caremark pharmacies in late May, to transition Med D customer service in July, and to implement mail service migration to begin dispensing mail prescriptions from CVS Caremark pharmacies by the end of year. So far, the transition has been very smooth, and we expect that to continue going forward.

Now broadly in the PBM business, we are keenly focused on clinical programs that will promote compliance and lower overall healthcare costs through improved disease management. And it's fair to say that virtually all of our programs deliver superior results once integrated with the consumer engagement engine. Now let me give you an example. The presentation of ready-fill enrollment opportunities for mail scripts at our customer care centers actually saw an eightfold improvement, with the integration with the engagement engine. The CEE now provides all of the capabilities required to fully support our new Pharmacy Advisor program, which is designed to improve adherence and close gaps in care. Pharmacy Advisor program for diabetes launched this past month in January, and our pilot results demonstrated that members improved the number of day supply medication on hand by 16. Members also demonstrated significantly lower drop-off rates, following the first fill of the new medication versus the control group. Interest in the program is growing. Over 10 million lives adopted Pharmacy Advisor at the initial launch, and we now have another 1.3 million lives committed to date. We expect to expand Pharmacy Advisor to other conditions, starting with high-risk members with cardiovascular conditions, beginning in 2012.

Now we've also signed up additional clients for Maintenance Choice, now totaling about 600 clients and representing 7.4 million lives. And we continue to see a shift towards more new clients, as well as more former voluntary mail programs adopting the Maintenance Choice benefit. As an example, 25% of the lives adopting Maintenance Choice for 2011 were new clients compared to only 14% in 2009. And 61% of the lives adopting Maintenance Choice this year came from voluntary mail programs compared to only 16% in 2009.

Now also, recognizing the upcoming generic wave, we continue to encourage the adoption of planned designs to improve our generic dispensing rates. About 170 clients, representing 5.5 million lives, have adopted generic Step Therapy plans. And finally, with our streamlining initiative, we're refining operations, rationalizing capacity and enhancing technology to productively grow our PBM in the coming years. Progress to date includes the closure of four specialty sites, the closure of our Birmingham mail service facility, and the completion of our process to simplify our PBM management structure. These changes will enable a leaner and more nimble organization, and we'll update you further on our progress over time. Now I'll turn it over to Dave Denton for the financial review.

David Denton

Thank you, Larry, and good morning, everyone. Today, I'll provide a detailed review of our fourth quarter financial results. I'll also provide our initial 2011 guidance for both the full year and the first quarter.

Now let me first begin by talking briefly about our capital allocation. Back in October at our Analyst Day, I laid out the significant cash generation capabilities of the company over the next five years, and the discipline we will utilize when deploying the substantial cash we generate to achieve the highest possible return for our shareholders. Based on achieving our five-year growth targets, there could be approximately $30 billion available to enhance shareholder returns over that timeframe.

Now recall that at that time, we set a targeted dividend payout ratio of approximately 25% to 30% by 2015 versus our then current level of 13%. A few weeks ago, we took the first step towards this goal by raising our quarterly dividend by 43%, making this the eighth consecutive year with an increase. Based on our expectations this year, this implies a payout ratio for 2011 of between 19% and 20%. So we've taken a big first step, but obviously, there's plenty of room to continue to grow the dividend over time. We'll continue to use the additional cash to invest in high ROIC efforts and apps in internal projects perhaps $3 billion to $4 billion, on average, of annual value-enhancing share repurchases, could be executed under normal conditions. Of course, the amount of free cash we will generate annually is expected to accelerate with our earnings in 2012 and beyond.

Now being mindful of our balance sheet and focusing on maintaining the high triple-B credit rating, we did not repurchase any shares this quarter. This year, again, we are targeting adjusted debt-to-EBITDA ratio of approximately 2.7x, but we expect to be able to complete, at a minimum, the $2 billion buyback current authorization in place. The guidance we are providing today takes this into account. As you know, enhancing shareholder returns remains a high priority for us. During 2010, we returned more than $1.9 billion to our shareholders through a combination of share repurchases and dividends, and we were able to do this given the $3.3 billion in free cash flow we generated throughout the year.

This far exceeded our guidance of $2.5 billion, which can be attributed to many of our working capital efforts beginning to take hold, along with end-of-year favorable timing. Both DPO and DSO were each approximately one day better than end-of-year 2009 levels.

During the fourth quarter, we produced approximately $1.5 billion in free cash compared to approximately $1.8 billion in last year's fourth quarter. Excluding proceeds from sale leaseback transactions, which contracted by about $430 million, underlying free cash flow increased by approximately $140 million versus last year's fourth quarter. Keep in mind that the proceeds from sale leaseback transactions declined in 2010, as we returned to a more normal pre-acquisition level of sale leasebacks. Gross capital spending during the quarter was approximately $625 million, down from $795 million last year, mostly due to the absence of capital associated with the Longs integration. Given sale leaseback activity of approximately $385 million in the fourth quarter, our net capital net spending was about $245 million.

Turning to the income statement. Adjusted earnings per share was $0.80 for the quarter, an increase of 1% and at the top of our guidance range. We recognized $0.03 in previously unrecognized tax benefits in the quarter, the majority of which was anticipated in our guidance. GAAP diluted EPS came in at $0.75 per share. On a consolidated basis, revenues in the fourth quarter declined by 4% to $24.8 billion.

Drilling down by segment. Net revenues dropped 10% in the PBM to $12.2 billion. The decrease from last year was, of course, driven by the impact of previously announced client terminations, as well as the decrease in Medicare Part D lives, resulting from the 2010 bidding process. PBM pharmacy network revenues in the quarter decreased 15% from 2009 levels to $7.8 billion, while pharmacy network claims declined 13%. Total mail choice revenues increased by about 0.5% to $4.3 billion, while mail choice claims declined by 1%. In addition to client terminations and utilization trends that were a bit softer than expected, the decline in network claims also reflects the growth in mail choice penetration, as claims continue to move from network to mail choice. Our mail choice penetration rate increased 250 basis points to 26.1% versus last year. This is driven by the success of our Maintenance Choice program, which gives our clients the ability to drive their savings provided by 90-day prescriptions without denying their members the choice of access to retail.

In our retail business, we saw revenues increased by 3% to $14.9 billion in the quarter within our guidance. This increase was primarily driven by our same store sales increase of 1.7%, as well as net revenues from new stores and relocations, which accounted for approximately 150 basis points of the increase. Pharmacy revenues continue to benefit from incremental prescription volume associated with our Maintenance Choice product. As Larry explained, Maintenance Choice had a positive impact of 220 basis points on our pharmacy comps this quarter. In addition to the soft prescription trend industry-wide, the tough comparison to the H1N1 frenzy during last year's fourth quarter, continued contraction in the PPI growth class and a higher generic dispensing rate, all negatively impacted pharmacy revenue growth. These were somewhat offset by increase in flu vaccinations compared to LY.

Turning to gross margin. Compared to the fourth quarter of '09, we saw enterprise-wide margin expand by approximately 50 basis points to 22.1%, more or less in line with our expectations. Within the PBM segment, gross margin was down about 85 basis points, again, within expectations. This mainly reflects the elimination of retail differential within the Med D business that began on January 1 of 2010, as well as price compression associated with the one-year extension of the FEP contract. Recall that the pricing became effective in September of last year, so the fourth quarter was the first quarter in which we saw the full impact. Partially offsetting this was the positive margin impact from the 390 basis point increase in the PBM's generic dispensing rate, which grew from 68.9% to 72.8%.

Gross margin of the retail segment was flat to last year at 31.2%, slightly below expectations. This largely reflects the impact of continued pressure on pharmacy reimbursement rate. The growth in Maintenance Choice was compressed as retail gross margin that helps the overall enterprise, and the continued shift in the mix of our business towards pharmacy. These negative factors were mostly offset by the increase in the generic dispensing rates with our GDR increasing by 320 basis points to 73.8%, the benefits we're seeing from various front store initiatives and increases in our private label penetration.

Overall, operating expenses, as a percent of revenues, increased by approximately 70 basis points over last year's fourth quarter, slightly better than expectations. The PBM segment rate increased by 35 basis points to 2.1%, primarily due to costs related to the streamlining initiatives, which amounted to a little more than $30 million this past quarter. SG&A leverage was also affected by PBM revenues that were a bit lower than expected for the quarter. The retail segment saw improvements in SG&A leverage of approximately 80 basis points to 22%, surpassing our expectations yet again. Within the corporate segment, expenses were $167 million, or less than 1% of consolidated revenues. The primary drivers of the 16% growth in these expenses for the full year 2010 were an increase in professionals' fees, primarily legal, which we talked about earlier this year.

So with the change in SG&A as a percent of sales more than offsetting the improvements in gross margin, operating margin for the total enterprise declined by approximately 20 basis points to 7.1%. Operating margin in the PBM was 5%, down about 120 basis points, while operating margin at the retail was very strong at 9.2%, up about 75 basis points.

Our EBITDA for adjusted claim was $3.95 in the quarter, down 16% versus fourth quarter of last year. As expected, PBM profits declined by 27%. This decline includes the streamlining expense, as well as the full quarter impact of the price compression associated with FEP. Retail profits improved by 12.4%.

And going below the line, on the consolidated income statement, we saw net interest expense in the quarter increase by approximately $4 million to $136 million, while our effective income tax rate was 37.2%. While the majority of the tax benefit in the quarter was anticipated in our guidance, the rest was primarily due to settlements with tax authorities. Our weighted average share count was again just under 1.4 billion shares, as we did not repurchase any shares during the quarter.

Now let me walk through some of the details of our guidance for the full year 2011. We expect to deliver adjusted EPS from continuing operations in the range of $2.72 to $2.82 per share. GAAP diluted EPS is anticipated to be in the range of $2.52 to $2.62 per share. These estimates assume the completion of the $2 billion share repurchase authorization this year and closing of the Universal American transaction by the end of the second quarter. In addition to approximately $0.08 of accretion from Universal American, the addition of the Aetna business is expected to add approximately $0.02 to our earnings this year. Furthermore, this guidance includes approximately $115 million to $130 million, or about $0.05 to $0.06 per share of PBM streamlining cost.

For the PBM segment, we expect operating profit to decline by 5% to 9% for the year. We expect revenue growth of 23% to 26%, with adjusted claims of approximately 885 to 910 million claims, including about 150 million adjusted claims from Aetna and about 55 million adjusted claims from Universal American. Within the PBM, we expect a significant decline in gross margin, partially offset by modest improvement in operating expenses as a percent of revenue. As you know, Aetna's margins are lower than those in our typical book of business, and are causing about half of the gross margin erosion we expect for the year. We expect our EBITDA per adjusted claim to be approximately $2.95 for the year. If we exclude Aetna, our EBITDA per adjusted claim would be approximately $3.30 per claim. Larry provided the drivers of revenue growth and margin erosion, but let me point out that the Universal American transaction is expected to add approximately $900 million to our top line growth at a margin that will be better than our average book of business. Now this is due to the expected late second quarter close, and the fact that the Medicare Part D business is more profitable later in the year than in the beginning. Keep this in mind when modeling the full year effect in 2012 for Universal American on our business.

For the retail segment, we expect operating profit to improve by 6% to 8%, with retail growth of 4% to 6% and same store sales growth of 2.5% to 4.5%. Gross margins are expected to be moderately down, but more than offset by notable improvement in operating expenses as a percent of revenue. For the corporate segment, we expect to see operating expenses in a range of $625 million to $645 million, as we gain modest leverage against consolidated revenues.

So given all this, we expect to see a moderate decline in operating margin for the total enterprise. Revenue is expected to grow by approximately 11% to 13%, with a significant decline in gross margin, partially offset by a significant improvement in operating expenses as a percent of revenues. That is after inter-company eliminations, which are projected to equal about 9.5% of combined segment revenues

We forecast net interest of about $560 million to $570 million, a tax rate of approximately 39.3%, and approximately 1.35 billion weighted average shares for the year. We expect total consolidated amortization for '11 to be about $450 million, slightly higher than 2010 due to the expected addition of Universal American. Combined with the estimated depreciation, we project approximately $1.6 billion in D&A. We expect gross capital expenditures to be in the range of $2 billion to $2.1 billion, essentially flat to 2010 levels. This includes approximately $190 million of capital associated with the PBM streamlining project. With sale leaseback proceeds anticipated to be between $550 million and $600 million, our net capital expenditures are expected to be approximately $1.5 billion.

And consistent with our focus on the cash generation capabilities of CVS Caremark, we expect free cash flow to be in the range of $4 billion to $4.2 billion in 2011, growing by over 20% versus last year. We are keenly focused on enhancing our cash flow through solid working capital and capital expenditure discipline. We anticipate working capital improvements will drive our free cash flow performance, specifically with an inventory and accounts payable building upon a strong Q4 performance. This performance is expected to yield solid cash flow from operations in the range of $5.5 billion to $5.7 billion for the year.

Turning to the first quarter. We expect to deliver adjusted EPS from continuing operations in the range of $0.54 to $0.56. GAAP diluted EPS is anticipated to be between $0.49 and $0.51. Growth in enterprise-wide revenues is expected to be between 7% and 9.5%. For the PBM segment, we expect operate profit to decline by 27% to 30%. We expect revenue growth of 16% to 19%, with a significant decline in gross margin, partially offset by moderate improvement in operating expenses as a percent of revenues. Gross margin in the first quarter is expected to decline significantly due to the impact of renewal pricing on FEP and other contracts, the addition of the Aetna contract and the streamlining effort. Aetna should be about a 60 basis point drag on PBM gross margins in the first quarter.

We expect the performance in the PBM to steadily improve as we move through the year for several reasons. We'll cycle the impact of the FEP renewal pricing by the end of August, resulting in easier comparisons in September through December. The profitability of the Med D business is generally back-end loaded, and they expect to layer in the Universal American Med D business beginning in the third quarter, assuming the deal closes as planned in late Q2, and the net impact of the streamlining cost and benefits will improve as the year progresses.

As a result, we expect the first quarter to be the weakest quarter of the year for the PBM, and the fourth quarter to be the strongest quarter of the year. For the retail segment, we expect operating profits to improve by 4% to 6%, with revenue growth of 3% to 5%, and same-store sales growth of 1% to 3%. Gross margins are expected to be modestly down, but more than offset by modest improvements in operating expenses as a percent of revenues. Now I hope you found my commentary helpful. And with that, I'll turn it back to Larry.

Larry Merlo

Okay, thanks, Dave. Yes, as I said earlier, 2011 is the year that PBM breaks the revenue trend, and I'm focused on ensuring that the PBM will break the recent trend and achieve operating profit growth in 2012, and I'm certainly confident with the plan that we have underway. So I know we covered a lot of ground this morning, and we have Per to join us for Q&A. So why don't we open it up for questions?

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of Tom Gallucci with Lazard Capital Markets.

Thomas Gallucci - Lazard Capital Markets LLC

I guess I was hoping you could address two topics, one -- well, both of the PBM. The first one you talked about some converging PBM profitability towards industry averages. So I guess you're sort of implying that maybe Caremark had maybe over earned or something in the past. So I just wanted to explore how you're thinking about that a little bit further. And then sort of in a related question, in 2011, it's the renewal pricing that seems to be the delta versus your expectations late last year. This year, we've got, I think, a pretty sizable selling season coming up. So how do you think about pricing as you think about breaking the trend to your point, Larry, and profitability in the PBM as you head toward 2012?

Per Lofberg

This is Per. Just to your first point there, it's clear that in addition to FEP, that was mentioned specifically, we have a number of other accounts that were renegotiated in the course of this year, where margins had grown to very attractive levels and were not sustainable given the current market conditions. So as those contracts were being renegotiated to reflect current competitive market conditions, there is a resultant margin erosion, which you're now seeing in the numbers. And so that's sort of the main factor that explains those numbers. With respect to the next year selling season, I think it's going to be basically a continuation of what we've seen in this year. It's going to be very competitive selling season for sure. There is a lot up for negotiation, both our existing customers and many, many new canceled prospects out there. So I really kind of envision a vigorous and competitive selling season, which is very well equipped to participate in successfully. We just completed our national sales meeting, which is sort of our kickoff of our sales season. And we have a very strong suite of programs to offer and very high level of customer satisfaction going into this coming season.

Larry Merlo

And Tom, I think I just take on that we're certainly focused on accelerating what we're talking about as the transformation of the PBM, bringing more products and services to market and rationalizing our costs through the streamlining initiative, as well as speeding our response time to market changes, allowing us to be more nimble and being able to do things faster, better and at a lower cost. And the result of all that will be a stronger bottom line.

Operator

Our next question comes from the line of Matthew Fassler with Goldman Sachs.

Matthew Fassler - Goldman Sachs Group Inc.

I actually have one or two questions on the Retail business. On Retail SG&A, your SG&A per store per square foot came down substantially from where it had been in the past couple quarters. And what drove that expense decline? And then secondly, it seems like your Retail same-store sales forecast for 2011 is somewhat back-end loaded, more conservative forecast for the first quarter than you gave us for the rest of the year. If you could talk about how you see the cadence of comps next year evolving.

David Denton

Matt, in terms of the first question around expenses, we have certainly been able to leverage the benefits of the loans integration. And as employees in the Longs stores were more accustomed to the technology and the policies and procedures, there is certainly SG&A leverage that we saw, probably throughout the second half of the year, but certainly in the fourth quarter when you compare that to the prior year. We're also seeing some benefits as a result of the technology that we rolled out, both what I alluded to in my remarks around the completion of both the RxConnect as well as the Consumer Engagement Engine at retail. That does provide some efficiencies in our pharmacy that we did not have prior to that. In terms of your question around comps, I think that we're looking at a couple key drivers throughout the year. And one is, what type of flu season will we see. And I will say that the first month of January, we have seen flu activity. We were not expecting flu to return to the levels that we saw in 2009. We had forecasted it to be more of a normalized flu season. So we'll see how that progresses over time. And we're not expecting any improvements in the economy. We don't believe it's going to get any worse. We think it's stabilized, but we don't think we're going to see this dramatic uptick. We think that the recession has gone on for an extended period of time and that customers are developing or have developed new routines that even if things do get better, they may not revert back to the practices of two or three years ago. And I think as we move into the second half of the year, we will be comping up against some softer numbers.

Operator

Your next question comes from the line of Lisa Gill with JPMorgan.

Lisa Gill - JP Morgan Chase & Co

First off, Tom, I wish you the best of luck in your retirement. Secondly, just a few PBM questions. On the PBM streamlining, Per, can you maybe just talk about the impact around any of the renewals? Are there any customers that are having concerns that you're moving to a new platform? And then secondly, as we think about going into renewals for 2012, obviously, FEP is one of the contracts that's up for renewal. Would you anticipate that you have to take another step-down on pricing after the repricing that happened for '11?

Per Lofberg

First, the streamline initiatives are really not at all kind of a concern in the selling process at this point. I mean, the new platform that's being built to really sort of be our future destination platform, will have a number of capabilities that will go beyond what customers can use today. And there's a process in place where we can demonstrate to customers that the transition will be absolutely seamless. And so that hasn't really kind of become a concern at this point in the selling process.

Lisa Gill - JP Morgan Chase & Co

And what about FEP? Would you anticipate that -- I know that's a renewal for 2012. I mean, is your expectation -- I know we're not talking about 2012 numbers yet, but would it be your expectation that there would be another step-down on pricing?

Per Lofberg

Well, that process is going on as we speak. And it's actually, there are three separate bids being bid in the FEP program. And as it has been in the past, it's a very competitive process. So it is entirely possible that there will be some additional margin compression in that, but it's also unclear who will kind of end up with what piece. It's still sort of a work in process. But that's a normal -- that sort of step-down in margin spend across when a big contract is being rebuild, that's pretty much normal in our business. It happens all the time, and I don't expect this process to be any different.

Larry Merlo

Let me go back and just emphasize the point on the streamlining initiative. Because when you think about technology -- on the Retail side of the business, we have made integration of systems a core competency. And we are taking those processes that we've learned over the years, some from trial and error, and we're applying that to the streamlining initiatives. So that gives us a high degree of confidence that we can do this seamlessly and make it transparent for our customers.

Lisa Gill - JP Morgan Chase & Co

And then just one point of clarification. I think back, a few weeks ago, when I saw you, we had talked about the 2012 selling season being somewhere around $20 billion. Is that the right number to think about for 2012?

Per Lofberg

Yes. Close, I think, Lisa, including FEP, of course. If you take FEP out, it's pretty much a normal season for us.

Operator

Your next question comes from the line of Eric Bosshard with Cleveland Research.

Eric Bosshard - Cleveland Research

Dave, I think you talked about the five-year profit growth outlook for the PBM not being materially different than what you outlined at the Analyst Day. But the 2011 performance is, I think, a bit worse than what you had outlined there. Can you give us a better sense if '11 is just a onetime step-down due to these factors? Or are we just starting from a lower base and then growing from a lower base?

David Denton

Eric, that's a great question. I guess, we'll take it in two components. The first is the top line growth that we outlined. Keep in mind that we had a very productive selling season for 2011, and we're going to add just with Universal American and the MA-PD [Medicare Advantage Prescription Drug] business associated with Universal American. Again, some very healthy top line growth into '12. So I feel very confident in the top line of our business. Secondly, the operating profit growth that we have forecasted for the next five years from a PBM perspective, we see the pathway to get to those numbers. We feel confident that we'll be able to achieve those over time. As we said on Analyst Day, there's going to be years in which growth rates can be better. And there's going to be years in which growth rate is going to be less. But we feel comfortable for our projections from now through 2015.

Per Lofberg

And both the ramp up of the Aetna program over the next couple of years, as well as the streamlining initiatives, it should be accretive going forward.

Operator

Our next question comes from the line of Ann Hynes with Caris & Company.

Ann Hynes - Caris & Company

So going back to the last question, I know you said that you're comfortable with the 5% to 9% operating growth in the PBM. Can you actually make us comfortable with that? Because when I look at your negative 5% to negative 9% PBM growth for 2011, I was really surprised with that, given UAM [Universal American Corp.], Aetna, your new business wins. So I guess I would need a little more comfort going forward. You said you are comfortable with your plan. Can you actually give us more details of your plan? And that 5% to 9% growth, can you kind of break out the components? How much is generics are going to account for that, how much business wins or losses over the next few years will account for that, what's pricing going to be like in that environment because obviously you said pricing was worse than you expected in the Analyst Day. So how do we get comfort going forward, given what's happening this year?

David Denton

Maybe I'll kick this off in a financial perspective and kind of move it around the table here a little bit. First and foremost, as we talked about in Analyst Day, our focus for the next five years is that, one, that we'll continue to gain share and we'll continue to retain the clients that we have. We're beginning to demonstrate that now through 2011 with strong top line performance and strong retention performance. Secondly, we're investing in areas that are high growth opportunities for us, both specialty and Medicare Part D. And we think those are big opportunities as you think about growth in this segment for the next several years. Furthermore, with either health reform and/or the use of prescription medication in the grain of America, you're going to see utilization trends that are also going to be a tailwind to our business over that time frame. Again, relaying what Per just talked about, Aetna at the moment is in, I'd say, its initial phase of implementation. Over time, we believe that contract to be very productive for us over the next five years. So there's a lot of factors that we believe that can drive our performance over the next several years to achieve those targets, and we're very committed to that.

Per Lofberg

Yes, I think the one segment that I just want to add to that is the specialty pharmacy segment, which is a very high growth part of our business. And we put in a lot of effort into really maximizing the opportunity in that area for us.

Ann Hynes - Caris & Company

When you go into 2012 and you have all these renewals, will your renewal pricing strategy change since it's back [indiscernible] now? Or how should we view 2012?

Per Lofberg

I don't think it'll change materially. We're basically looking at each of these contracts on an individual basis. Our goal is to retain our business and to win business when we're confronted with new prospects. But at the same time, we're clearly committed to doing that in a rational fashion. So we're not going to buy business at a loss or anything like that. We want the business to be solidly profitable. And I really don't see the environment changing significantly next year or this coming year over what has been in the recent half.

Ann Hynes - Caris & Company

If I can ask the question another way, I think you said in your comments a lot of the contracts, some of your accounts were not on sustainable level. So maybe how much left of your book of business do you think is not sustainable that would have to be repriced?

Per Lofberg

I don't have a specific answer to that at this point. A lot of this, I think, is sort of the success of the generic wave of the past. And so many, many of those contracts have been renegotiated and are sort of now at more competitive levels. But I can't give you a specific estimate in terms of what we're looking at this coming year.

Larry Merlo

And back to your first question, I think Dave and Per sums it up well. I just want to emphasize that we acknowledge the disappointment with the results. I look at 2010 as the year where Per did a great job on organization and infrastructure. And I think it's important not to lose sight of the wins that we had, sales wins in 2010. That we have several million more lives under contract, which certainly bodes well for our future, a lot of those in the Aetna business. And the opportunity that we have to improve the profitability of that business over time. So we certainly have a good foundation that's been established and one that we can certainly build on as we move forward.

Operator

Our next question comes from the line of Deborah Weinswig with Citi.

Michael Palahicky

This is Shane Palahicky calling for Deborah Weinswig. I just trying wanted to kind of get an idea on gearing on generic inflation, and how you guys are thinking about that, maybe it's a concern? And what would you do if generic prices are increasing?

Per Lofberg

The generic business is highly competitive. So the real opportunity there is when you have multiple competing manufacturers beating down the acquisition costs. So the list price of the generic far less important than what you actually buy the generics for. And the beauty of that business is that with multiple competing vendors, it tends to get very, very competitive. And we can drive down the cost and offer significant savings to our customers.

Operator

Our next question comes from the line of Steve Halper with Stifel, Nicolaus.

Steven Halper - Stifel, Nicolaus & Co., Inc.

At the Investor meeting, you talked about the inventory reduction program. Can you give us an update on your plans there? And how much of that free cash flow expectation is a result of lower inventory?

Larry Merlo

Yes, Steve. I'll take the first part and then flip it over to Dave. But our plan focuses on three key areas of improvement across the supply chain: around people, process, technology. We've completed the people piece with new leadership as well as alignment across the supply chain to include incentives of those involved. From a technology perspective, we have all the tools in place to include our warehouse management system, where we now have a single view across all of our distribution centers. And from a process point of view, we're working today to implement changes around ordering methodology with outside suppliers as well as replenishment logic in our distribution system. And then at the same time, we're seeing benefits from the clustering initiative that we have in place. So we will see those benefits throughout the first half of the year. And I'll turn it over to Dave for the second.

David Denton

Yes. To be clear, we're very focused on improving our inventory performance, primarily in the Retail side of our business. We're targeting taking $1 billion of inventory out of the retail operations. But keep in mind that we are very focused and committed to improving working capital across all components of working capital. And you're seeing some of that results begin to take hold in Q4. We think there's a big opportunity as you go into '11 and even further into '12.

Steven Halper - Stifel, Nicolaus & Co., Inc.

But the expectation around the inventory reduction and the impact of working capital, that hasn't changed from Investor Day?

David Denton

It has not, no.

Operator

The next question comes from the line of Mark Wiltamuth with Morgan Stanley.

Mark Wiltamuth - Morgan Stanley

Per, could you give us a little commentary on the timing of when the streamlining initiatives shifts from a negative to positive? And just how that plays out over the next few years?

Per Lofberg

Yes, I think it's -- '11, I think, will still be a year where the costs outweigh the benefits, but it's going to flip the other way in 2012.

Mark Wiltamuth - Morgan Stanley

And how big and how fast does that ramp in?.

Per Lofberg

Well, it ramps up pretty quickly. I think we have said that it's go up to about $250 million per year in annual benefits down the road, or that will generate $1 billion worth of benefits over five years compared to the -- up from costs of about $250 million approximately.

Mark Wiltamuth - Morgan Stanley

And in general, did you include the AMP transition at all in the guidance? Or do you think that's going to be a 2012 event?

Larry Merlo

Well, Mark, as we've talked in the past, we think that we have been seeing the intended impact of AMP as we've seen compression going back to, I guess, the fall of 2009 with State Medicaid reimbursement. And I think with a lot of the definitional issues behind us around AMP, we're expecting that we'll be able to actually see some data in the first quarter and be able to true-up, if you will, the assumptions that we've made against the actual definition.

Mark Wiltamuth - Morgan Stanley

And now that January is complete, could you give us any feedback on how the January Retail comp looks since we saw strong number out of Walgreens today?

Larry Merlo

Yes. As I mentioned earlier, Mark, we have seen an uptick in flu activity, started the very end of December and it continued through January. That's been somewhat mitigated with a lot of the weather issues that we've been dealing with across the Midwest and East Coast. But we're pretty pleased with -- recognizing those factors, we're pleased with how January looked.

Operator

Your next question comes from the line of Kemp Dolliver with Avondale Partners.

Kemp Dolliver - Avondale Partners, LLC

My questions relate to the initiatives in Part D. And two questions are, with your own PDP and then with the UAM business, roughly what percentage of your claims will be essentially PDP? And then the second question is given that, that is risk-based business versus the traditional PBM fee-for-service model, what's the appeal of taking on that additional risk in your book of business?

Per Lofberg

Well, I think before UA, Universal American, we have about 1.1 million, 1.2 million lives. I think that represents maybe somewhere between 10% to 15% of our revenues. And then with the addition of the UA, we'll get to like 3.4, or something like that, million lives. So it basically almost tripled. It will become a very important part of the business. And if you project out, really, where people will get their health insurance or their prescription drug coverage, Medicare is rapidly going to become the biggest single payer in the country for prescription drugs. So it's clearly a sort of a growth segment going forward.

David Denton

And then I also say, just from a returns perspective, if you think about the infrastructure we have in place with our current Medicare Part D insurance company, combined that with the infrastructure we have from a PBM perspective that services those lives, we have the infrastructure in place to very productively add additional lives into that asset base without incurring a substantial amount of incremental capital, improving returns on that business. So we think it's a real opportunity for us.

Per Lofberg

And from an underwriting standpoint, it has been a profitable business, both for CVS Caremark and for Universal American. And I think both organizations have some real talent in that area that we hope to capitalize on going forward.

David Denton

And then I think finally, just with the structure of Medicare Part D and how the government overlaid essentially a risk insurance quarter on top of that business, we're not taking on substantially the amount of risk as with a traditional, let's say, health plan insurer.

Operator

Your next question comes from the line of Meredith Adler with Barclays Capital.

Meredith Adler - Barclays Capital

When you guys were going through what's going to make the next four years after 2011 look better, you didn't mention generics. And is that because you can't quantify the timing? Or do you think that there's upside? I don't really understand why it didn't get discussed, but there's certainly other PBMs that talked about it.

Larry Merlo

Well, Meredith, when we talked about why we believe 2012 will be the year that we break trends on the profit line. In the PBM, generics is certainly a key to that. And we have -- there's no question that generics are going to benefit our business just as they benefit the consumer as well as the payer. So qualitatively, there's no question that it's a benefit for us, and the biggest wave is ahead of us. We have been silent in terms of quantifying that, recognizing that there are a couple variables in play, those being the number suppliers as well as the timing of the exclusivity period. And it becomes very difficult to quantify the exact timings of the benefits without those two variables being answered.

Per Lofberg

And the customers, the PBM customers, and the consultants out there, they are also very much aware of the upcoming generics and are hoping to capture as much value from that, that they can for the customers in question. So it's a moving target. But I agree with Larry, without a doubt, it's a major tailwind for us as a business.

Meredith Adler - Barclays Capital

And then I have a question about healthcare reform. There's language about grandfathering, which we believe had some impact last year in encouraging health plans and employers not to change PBM. Do you think that was right for 2010? And do you think that will have an impact in 2011?

Per Lofberg

No, I don't think the grandfathering process really has anything to do with the PBM contracting process. I mean, that has really more to do with the types of benefit designs that they elect to put in place for their people.

Meredith Adler - Barclays Capital

And then one other question about -- well, actually, there's obviously news about healthcare reform. Can you comment at all about how you think this plays out in the next six to nine months? Is there going to be a lot more fighting going on?

Larry Merlo

Well, Meredith, anybody that can answer that question definitively is going to buy a lottery ticket tonight, I think. But I mean, I think that there is a recognition by all concerned that there needs to be some type of healthcare reform in the country. I think that we're probably going to see somewhat of a gridlock based on the change in Congress. But I believe that there will be some outcome. I'm not sure of the timing of it. But I think that there is a wide recognition that when you think about access, cost and quality, there has to be some solutions that deal with all three of those pillars of healthcare reform, if you will. And I think what's good for our industry is pharmacy is certainly front and center as being an important part of the solution. There are more and more studies being published that quantify the value of pharmacy care in lowering overall healthcare costs. And we are certainly in a unique position with our integrated assets to be a significant part of the solution.

Meredith Adler - Barclays Capital

You said you'd renewed 85% of the contracts for this coming year? Is that because some of the contracts actually have an end date of the middle of the year and so you're still negotiating for those?

Per Lofberg

That's correct. It's actually quite normal for this time of the year. There's always some that don't run on the calendar basis. But I really don't see anything else there in the remaining 15% that's going to cause any sort of disruption.

Operator

Our next question comes from the line of Larry Marsh with Barclays Capital.

Lawrence Marsh - Barclays Capital

It sounds like you're confirming the commitment to high top line growth strategy in your PBM, led by Med D and specialty. I think that's consistent. I think you said your message of convergence in margins in the industry, which I think is consistent with what you've said. So I guess and elaborate, why do you think top line is so important for you as a business versus your peers? And on the margin side, now with Aetna, even without Aetna for 2011, you're now a good bit below your peers on margin. So over time, is there any reason why your PBM should be less profitable than your peers?

Per Lofberg

Well, I can't really speculate about the other PBMs. I happen to believe that in the PBM business, you begin by capturing the lives. And then you work on making those lives as productive as possible over the span of a long-term relationship. So winning lives to me is sort of the end of the beginning, not the beginning of the end. And there's a lot that can be done to really build the profitable business once you have a solid book of business of customers.

Lawrence Marsh - Barclays Capital

And then profitability? Should we think of your business as less or more profitable than your peers?

Per Lofberg

Again, I'm going to stop short of trying to talk about our PBM competitors. I mean, we certainly believe that we can provide very strong return on the invested capital and very strong return to shareholders over time in the PBM business. As we've said several times, we are much more focused on the absolute EBIT dollars that we generate and, ultimately, the earnings per share than we are on percentage margin.

Lawrence Marsh - Barclays Capital

You specifically called that government pass-through pricing and how it influences your retail network. Why should we think of that as a new phenomenon? And I just want to clarify finally on FEP, the three bids that retail specialty mail and when do you think that gets decided this cycle?

Per Lofberg

I do think that there will be some kind of continued trend towards pass-through pricing. I think it's particularly driven by government payors. We saw it in Med D in 2009 to kind of impact 2010. If you look at the OPM [Office of Personnel Management] call letter, which is basically the directive that the federal government gives to all the federal plans, they certainly indicate that transparency is part of what they expect. And a number of the state programs, like CalPERS or some of the other big state programs, have transparency specifications. So it is a certain trend in the marketplace, and I think that'll continue over the next couple of years. And with respect to FEP, I can't really speculate about how that's going to play out. It's three separate bids, and the FEP have retained flexibility to pull it together whichever way they want, all in one bucket or distributed out among separate vendors as they have in the past. But it will be decided, I suspect, in same time frame.

Operator

Our next question comes from the line of Ed Kelly with Credit Suisse.

Edward Kelly - Crédit Suisse AG

Tom or Per, could you maybe just comment on the level of over earning on contracts that are coming up for renewal now versus last year? And what I mean by that is that some of the contracts that are coming up now, like FEP and GE, et cetera, were contracts that were signed by the company post the deal. And I even think, back then, people thought that maybe they were more aggressive contracts at the time. So it would feel like the potential margin compression of what you may enter into this year may not be as big as what it was last year, but I would just like to get your thoughts on that.

Per Lofberg

Well, I think there are some portion of the customer base where we're still benefiting from contracts that were entered into three, four years ago and which have grown to be quite extraordinarily profitable. So the realistic expectation is that we're going to have to reprice those in accordance with current market conditions. And I can't give you kind of a quantification of it, but it certainly will be a factor even going into this coming year.

Edward Kelly - Crédit Suisse AG

And then second question for you, Larry, you guys are clearly confident in your long-term 9% to 11% goal for PBM EBIT profit growth. This year is down 5% to 9%, which would imply that you're going to have years that are probably higher than that long term rate. If you were going to do that at all, it would feel like maybe 2012 would be the year, with all the increase in generic penetration. Is that something that's achievable, better in the high end of that range in '12 even with the margin compression you're talking about?

Larry Merlo

Well, it's too early to comment on any specifics around '12 other than what we alluded to earlier, that we certainly have some factors that give us confidence that we will break trend in 2012. And I think that Dave summed up the five-year CAGR pretty well earlier, in terms of there's going to be some years that'll be behind the CAGR number and there's going to be years where we'll be ahead. And we remain confident in that number, recognizing all of the factors that we've covered at one point or another throughout the call, from Aetna to Med D to generics and other things that haven't happened yet.

Operator

Our next question comes from the line of John Heinbockel with Guggenheim.

John Heinbockel - Guggenheim Securities, LLC

So Larry, if you look at the retail business earning, an EBIT margin of about 8%, how much additional upside is there to that? Obviously, that's now become a very profitable business and, some point, has to hand off to the PBM. Can you get to a 9% or 10% margin? And where is the upside? Is it all in the cost side and really very little in the gross margin side?

Larry Merlo

Well, John, I think we still have upside in the Retail business. And if you think about some of the initiatives that we've talked about that is work underway, I believe the clustering initiative that we have has huge opportunities for us as we move down the road. And as we've talked, we've been focused on the Urban Cluster. But we're looking to take that to two other clusters and beginning to experiment around the second cluster with no results yet other than it's work in progress. There's still upside from the acquisitions, especially Longs, but we haven't hit the core run rate at Osco Sav-On. We continue to improve, so there's room there. We've talked about how we continue to innovate with ExtraCare to drive top line sales profitably, and we think there is opportunity there. When you move over to pharmacy, I think with everything that we've talked about, our pharmacists are moving from being not just the dispenser of products but a provider of services. And I think that there is upside as we think about adherence programs, gaps in care, and the pharmacists will be a key part of that solution. And when you look at expenses, we're going to be able to take expenses out as a result of the inventory initiative that we have underway. So I still see opportunities in the retail side of our business to continue to grow.

John Heinbockel - Guggenheim Securities, LLC

Do you think you can grow SG&A in the Retail side consistently less than 2%, given pressures on wages and benefits and so forth?

Larry Merlo

Well, I think there's probably going to be some ebbs and flows in that. I think that in this environment, it's a little easier to do that because we're not experiencing the wage pressures that we've seen in prior years, but I'm sure that there'll be years where we will experience it.

John Heinbockel - Guggenheim Securities, LLC

And then finally, you talked about that five-year CAGR, so I'll attack it a little bit differently. If you look at -- so let's take the Corporate EBIT growth rate of 8% to 10%, if you think of the first half of that CAGR period and the back half, do you think the growth rates are kind of similar first half to back half, or by definition, they're stronger in the first half?

David Denton

John, this is Dave. I don't know if I can clarify exactly by year how those CAGRs will play out. But at the end of the day, there are some years in which generics is going to be very productive for us, and there's going to be some years in which we get the rap of acquisitions or we get the rap of some of the initiatives that we have underway, both in the PBM and Retail. So it's kind of hard to quantify that or give you a specific right now.

John Heinbockel - Guggenheim Securities, LLC

I just said it because I would've thought that longer term, there might be more pressure on margin post-generics, post-2012 gross margin would be under more pressure further down the line. I guess you don't agree with that.

David Denton

Well, I think that over time though, even post -- everybody talks about the generic wave in '12 and '13. But even post-'12 and -13, the generics can be very productive for us after that. Secondly, we're growing our business in ways that we think long term can be also very productive with Medicare Part D and specialty. So I think while -- margin pressures are a reality in our business, and we're doing what we need to do to manage productively through that.

Per Lofberg

And Lipitor, specifically, really sort of becomes sort of full-blown opportunity in 2013, because half of 2012 will be under exclusivity period. There'll be limited competition until the middle of the year.

Operator

Your next question comes from the line of Scott Mushkin with Jefferies & Company.

Scott Mushkin - Jefferies & Company, Inc.

The 1% to 3% same store sales, is that the first quarter or is that the whole year? And the $330 million in adjusted EBITDA, I think you said that was x Aetna but inclusive of Universal, is that correct? And that's down from $396 million?

David Denton

That's correct. The second part is correct. I'll let Larry...

Larry Merlo

Scott, the comp guidance, the 1% to 3% that you mentioned was for the first quarter. Our comp guidance for the year is 2.5% to 4.5%.

Scott Mushkin - Jefferies & Company, Inc.

Have you sold any Maintenance Choice into Aetna yet?

Per Lofberg

The answer to that is no, but it's part of the 2012 sale story [ph]. So in terms of what Aetna will be offering together with us to their customers going into the selling season, they will have -- Maintenance Choice will be one of the offerings.

Scott Mushkin - Jefferies & Company, Inc.

For the '12 selling season, it would go to -- underway in '11, is that what you said there?

Per Lofberg

Correct. I mean, they have start selling that as we speak. And then most of that business will be 2012.

Scott Mushkin - Jefferies & Company, Inc.

And then maybe this is not a smart question to ask, but the PDP, can you sell Maintenance Choice into Medicare Part D or no?

Per Lofberg

No.

Scott Mushkin - Jefferies & Company, Inc.

There's a lot of emphasis on '12. I guess I want to come back to '11 just briefly, and then I'll yield the floor. But if you guys are going to look at your business and, let's say, you exceeded expectations in 2011, when you look at it, what part of your business would that come from? I guess that's what I'm struggling with is some near term where the potential upside is for equity holders here? I mean, where do you think the leverage points are in your business to maybe do a little bit better than you think right now?

David Denton

Well, maybe I'll talk about it, to start with. I guess the first thing that I want to point everybody to is our free cash flow. I mean, if you think about the performance in '10 and then the accelerated performance in '11 from a free cash flow perspective, I think it's an area that the market has generally underestimated our power here. Keep in mind though, earnings, the adjusted earnings that we just outlined from a guidance perspective next year, shows an improvement of 1% to 5%, that's the range. But if you look at our free cash flow guidance, it's excess of 20%. And I think we have not yet -- the market hasn't yet fully appreciated that power in our business. And I guess from a segment perspective, as far as upside, we're very focused against both of our segments. We've made a commitment to operating performance, and we're very focused on living up to those commitments.

Per Lofberg

Just one other factor is that we obviously hope that part of our work this year is going to result in continued expansion of our flagship value-added programs, like Maintenance Choice and generic Step Therapy programs and that sort of thing. And we just sort of recently set up a new kind of alignment for our sales and account management organization to be strongly sort of aligned with our corporate goals there. So if we're successful in that area, that would hopefully provide some additional value.

Larry Merlo

And Scott, the other thing I'd mention is, as mentioned earlier, we're not expecting any improvement in the economy that could have some potential upside as well as we have a number of initiatives across both the Retail and PBM businesses. So to the extent that they produce better results than what we have in our models, there could potentially be some upside there.

Operator

Our next question comes from the line of Neil Currie with UBS.

Neil Currie - UBS Investment Bank

Larry, a question for you. It's been five years since the merger between CVS and Caremark. And 2011 seems to be a pivotal year in terms of defining whether you can actually start to show the progress in the PBM that you're looking for. If you go through the year and don't show that progress, is there a point at which you could say that this isn't working and there must be maybe a different way to try and get some value from this entire business, which you alluded to. The very first comments you made is that you don't feel as if you're getting the share price valuation that the underlying business deserves.

Larry Merlo

Yes, Neil, that's a great question, and we have no plan to consider any options. We've set financial targets over the next several years to make this a very financially productive asset and, in doing so, provide shareholder value. I think we've outlined today that we have a plan that is in place to execute against those financial targets. And as long as we continue to meet those targets, there is no reason to consider any options or alternatives.

Neil Currie - UBS Investment Bank

Dave, I have a question for you as well. Obviously, your free cash flow is set to improve again in 2011. You've got the $2 billion buyback authorized, you got the increased dividend. That still leaves some excess, maybe $1.5 billion or so. What's your plan to do with that?

David Denton

Well, keep in mind that we're starting from a point from an adjusted debt-to-EBITDA ratio a little on the high side. So we'll continue to get that adjusted debt-to-EBITDA ratio in the range of 2.7x. So I fully expect that any excess cash that we would have, we would deploy that in a way that's productive for shareholders at the end of the day, whether that be through increase our dividends or that be through improving and enhancing our share buyback program.

Neil Currie - UBS Investment Bank

And any expectation on the timing of the buyback program that you have already authorized?

David Denton

I do not. At the moment, I think about it throughout 2011.

Operator

Our final question comes from the line of John Ransom with Raymond James.

John Ransom - Raymond James & Associates

David, thinking about 2012 versus 2011, I know you guys mentioned kind of maybe a plus-$250 million PBM rationalization benefit. Could you remind us of the Aetna year two benefit? Are those targets still the same?

David Denton

Yes, they're still the same. We expect about $0.02 in 2011, and then it would grow to about $0.05 in 2012.

John Ransom - Raymond James & Associates

So you have those two things. Is there anything else in 2012 over '11? I know we're not giving guidance or anything. But as we start -- I think at this point, investors have to look at 2012. So is there anything else in '12 that would be a step up from '11 that we need to think about?

David Denton

Well, I think Larry laid out in his presentation a series of factors that are going to be driving our performance in the long term, and most of it will happen within 2012. So I'll focus back to that.

Larry Merlo

Well, listen, it was a long call this morning. We appreciate everybody's time and participation. And as is always the case, any follow-up questions can go to Nancy. And thanks, everyone.

Operator

Ladies and gentlemen, this concludes today's conference. You may now disconnect.

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