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Express Scripts (NASDAQ:ESRX)

Q4 2011 Earnings Call

February 23, 2012 9:00 am ET

Executives

David Myers - Vice President of Investor Relations

Jeffrey L. Hall - Chief Financial Officer and Executive Vice President

George Paz - Chairman, Chief Executive Officer and President

Analysts

Lisa C. Gill - JP Morgan Chase & Co, Research Division

Lawrence C. Marsh - Barclays Capital, Research Division

Thomas Gallucci - Lazard Capital Markets LLC, Research Division

Robert M. Willoughby - BofA Merrill Lynch, Research Division

Michael Cherny - Deutsche Bank AG, Research Division

Ricky Goldwasser - Morgan Stanley, Research Division

Steven Valiquette - UBS Investment Bank, Research Division

John Kreger - William Blair & Company L.L.C., Research Division

Charles Rhyee - Cowen and Company, LLC, Research Division

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Express Scripts Fourth Quarter 2011 Earnings Conference Call. [Operator Instructions] As a reminder, today's conference is being recorded. And I would now like to turn the conference over to our host, Vice President of Investor Relations, Mr. David Myers. Please go ahead.

David Myers

Thank you, and good morning, everyone. Thank you for joining us this morning. With me today is George Paz, Chairman and CEO; and Jeff Hall, CFO.

Before we begin, I need to read the following Safe Harbor statement. Statements or comments made on this call today may be forward-looking and may include, but are not necessarily limited to, financial projections or other statements of the company's plans, objectives, expectations or intentions. These matters involve certain risks and uncertainties. The company's actual results may differ significantly from those projected or suggested in any forward-looking statement due to a variety of factors which are discussed in detail in our filings with the SEC.

For clarity purposes, all numbers we talk about today will be on an adjusted basis. Please refer to the tables in our press release for a reconciliation of GAAP to the adjusted numbers we'll be discussing. The reconciliation of EBITDA to net income can also be found in our earnings release, which is posted on our website.

At this point, I'll turn the call over to Jeff, who'll discuss our fourth quarter results.

Jeffrey L. Hall

Thanks, David. Last night, we reported fourth quarter EPS of $0.82, up 15% from the prior year. EPS for the year was $2.97, up 19%. Cash flow from operations was $532 million for the quarter and $2.2 billion for the year.

Since our last call, we continue to make progress towards completing the Medco acquisition, including securing the remainder of the financing, obtaining shareholder approval and certifying our substantial compliance with the FTC's second request. As a result of this progress, we maintained high levels of project spending to free up capacity for integration activities in 2012, and delayed cost savings opportunity, keeping staffing at higher levels to support integration planning.

SG&A cost were up $17 million year-over-year, reflecting the increased spending and an accrual for tax items, partially offset by lower management compensation. Despite this increased spending, gross profit margin was 7.4%, in line with last year's fourth quarter. EBITDA was up 8% over last year. EBITDA per adjusted Rx rose to $3.66, up 6%, and EPS grew 19% for the year.

Although EPS was strong, it was below our target due to lower claims volume, driven by utilization and increased attrition as a result of poor economic environment, increased spending on projects and higher staffing levels to prepare for integration, and investing to support clients and members as they changed retail pharmacies. Because EPS was below target, management bonuses were 0 in 2011. During the quarter, we settled $725 million of the remaining $750 million accelerated share repurchase, resulting in the receipt of 2.1 million additional shares. These shares are excluded from our outstanding shares this quarter.

The ASRs have resulted in the retirement 33.4 million shares of this year.

As we've been saying for the past several months, we plan to provide combined 2012 guidance after the closing of the transaction when we have had a chance to review and consolidate our forecast for the year. Our view of the transaction remains unchanged. We believe the acquisition will be slightly accretive to adjusted EPS in the first full year after closing and moderately accretive once fully integrated. We expect to realize $1 billion in net synergies once fully integrated.

And at this point, I'll turn the call over to George.

George Paz

Good morning, everyone, and thank you, Jeff.

The actions we took in 2011 demonstrated our ability to advance healthcare through innovation, execute on our unwavering alignment with clients and position ourselves to address the national mandate for more affordable healthcare, higher quality healthcare through our merger with Medco. We succeeded by helping our clients solve for issues in an industry that's ever-changing and ever-challenging, which positions us well for 2012 and beyond. Our research in new solutions lab continues to deliver innovative products and solutions that addresses our clients' pain points, such as poor adherence, which leads to $300 billion in healthcare waste each year. We launched Screen Rx, a new product offering, where predictive modeling is employed to determine which members are likely to be non-adherent in the future and tailor an intervention to best suit each individual. We are setting a new standard in healthcare by fighting non-adherence before it begins.

Another tool that continues to gain traction in the marketplace to specially benefit services, and an innovative offering that addresses the skyrocketing cost of specialty drugs across the pharmacy/medical spectrum. We can forecast, guarantee and deliver measurable savings by applying proven tools for specialty drugs, regardless of where patients receive the medication.

Our innovative approach to the marketplace, ability to drive positive clinical behavior and unwavering commitment to alignment contribute to a strong selling season with 97% retention, 3 signature wins and positive script growth expected for 2012. And as we expect that this momentum will continue into the current selling season, one reason for our confidence is successfully had in executing our retail strategy. We're planning execution and significant client support, we execute the largest retail market share movement in the history of pharmacy. We accomplish this with very little disruption, while delivering savings to our clients and patients by eliminating a high cost provider from our network.

We continue to make progress towards closing the transition -- transaction with Medco. The combination of our complementary strengths will accelerate our clinical offerings, which will reduce healthcare costs and improve health outcomes. By blending the combined clinical skill with the behavioral sciences, we'll be able to accelerate efforts to promote greater efficiencies in the healthcare system and better protect American families from the rising cost of prescription medications. Our shared vision is to increase therapy adherence, lower costs and drive the better health outcomes.

At this point, we'll be happy to answer any questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question today comes from the line of Lisa Gill with JPMorgan.

Lisa C. Gill - JP Morgan Chase & Co, Research Division

My first question, George, would just be around your comments on Walgreens and the success around this strategy. Can you maybe just update us? You said little disruption, but were there cost in the fourth quarter and do you have cost in the first quarter associated with moving people away from Walgreens? And then secondly, what has been the feedback as you start to move into the next selling season around more narrow networks and around Walgreens in general? And then I guess my last question would be, are you in current discussions with Walgreens or have you had discussions since your last earnings call with Walgreens around coming back together?

George Paz

Okay, I'll try to remember to hit all those points and hope you're well, Lisa. If I miss something, just remind me. Yes, we ramped up our call center associates, both in our from pharmacy help desk and our patient care advocates, significantly in the fourth quarter and the first quarter. Keep in mind, we had a huge wins in our Medicare -- from our Medicare clients that brought a lot of new lives in, in the fourth quarter. That, coupled with all the Medicare changes that normally take place, plus all the benefit design changes that occur on 1/1. And then, quite frankly, roughly 20% of our book had been in the Walgreens stores, and almost all of that was scheduled to move, and so we wanted to make sure that this 11 went flawlessly. We decided we would over expend in order to make sure that the client experience and the member experience was the best that we could have. And I think we were rather successful at that, and quite frankly, we did over staff. But again, I think it was the right answer. The clients, although very incredibly supportive -- we had an obligation to them to make sure this went off without a hitch. And we needed to make sure that every member who calls in, that was looking for a convenient outlet or a way to process their prescriptions, whether it was a movement to mail or to another retailer, that we would make sure we could handle that and give them top-class service, and our operations people executed in an exemplary manner. I would tell you that there was -- the movement has been very good for us. It really does endorse the fact that, especially narrower networks, in fact do work. At the end of the day, taking out a large retailer like this, in effect speaks to a narrow network. We don't have them in. And 98.5%, 98.4%, somewhere in that range, of our book is now in a narrow network. So we feel very good about it. Our clients are very supportive. I think what really speaks to it is the fact that this did go off. Our phones aren't ringing. People aren't concerned, our clients aren't upset. So this has been a -- truly has been a good move for us, and in our cost for our clients, get better year-over-year. So we're excited about it. Now to the extent that Walgreens wants to come back, wants to have a relationship, wants to help drive down the cost of healthcare, it can't be -- I appreciate the fact that they are trying to do some very good things with respect to clinical offerings and other avenues to try to impact the overall healthcare spectrum. But quite frankly, that hasn't been proven to reduce cost. And many of the things that they're offering in the pharmacy are being offered by many others out there. So I don't see them as differentiated. And it just came with a good conscience, pay them a significant premium for something that everyone else is doing and doing it just as well. So we are quite content where we sit today, and to the extent that they want to get a relationship and be in line with the rest of healthcare cost then we're willing to entertain those conversations.

Lisa C. Gill - JP Morgan Chase & Co, Research Division

And George, I know it's early on in the selling season. Some of the managed care pieces of business are up for renewal right now. Are they interested in talking about narrow networks? I mean, obviously, you've been successful in this. We've heard mixed things in the market as far as perceptiveness to moving to a narrow network. I'm just wondering what you've seen in the early days.

George Paz

I think part of it is may be a little bit of self-selection as well, right? Because we do have an offering without Walgreens. So people that are coming to us -- we've probably have eliminated some clients from an offering. I mean, someone that really gnats Walgreens in isn't going to call us up. But there's thousands and thousands of clients and millions and millions of Americans out there, so the market's plenty, big enough. And the book we have certainly isn't concerned. And I think the fact that we just picked up Catalyst, and I'll refer to that, I mean, have picked up the client from Catalyst in Maryland because that publicly have been put out there, speaks to the fact that people are willing to make those decisions if it saves money. This is a tough economy. And if you see your cost going up and somebody's giving you an option that can reduce your cost further without compromising healthcare outcomes or still improving health outcomes, why not take advantage of it? And I think that's what we offer and that's the same thing for even narrowing the network further. It does provide an opportunity to save money. And we may -- if you talk about a buck of scripts as being irrelevant, well, if you got 1 million scripts, that's $1 million a year. I would do a tremendous amount of things for $1 million a year. I don't know by you, but that's a lot of money to me. And especially if I haven't done anything to compromise the outcomes. If everything is status quo, people are still getting their pills, people are still getting their drugs, people still have convenient access to pharmacists. What have really the changed? All we've done is put $1 million into our shareholders pockets. That seems like a pretty smart thing to me. I don't laugh at $0.10 and $0.15 a script, and especially when you start talking $1 script. That's real money.

Lisa C. Gill - JP Morgan Chase & Co, Research Division

All right. So, George, just so -- I don't want to belabor this, but just so I understand, you're saying the door is open if Walgreens wants to come back. At this point, you're not in discussions and you don't know that they offer anything that's differentiated in the marketplace, so you're willing to move forward without them? Is that the right characterization?

George Paz

Well, I don't want to negotiate with Walgreens over the telephone with my investors. What I would say is that we are always open to a conversation and a negotiation, but it's got to being in the area best interest of our shareholders and patients.

Operator

And we do have a question from the line of Larry Marsh with Barclays Capital.

Lawrence C. Marsh - Barclays Capital, Research Division

George and Jeff, just a couple of quick ones. Just elaborate a little bit on the selling season. It seems to us, given over half your business is long-term relationships which will be continuing, the amount of position you have up bid for the '13 selling season is pretty modest in that sort of $5 billion to $6 billion range. I know it'll be too specific, but is that the right ballpark, first of all? And then, along with that, and then also some discussion about potential change of control provision with Medco. It seems to be somewhat in dispute, so I was curious if you can comment on that, with a successful completion of Medco?

George Paz

Well, I don't want to really get into a lot of details about Medco. We haven't closed yet. Know that we do due diligence, we put a team together, we look at -- we can only see certain things because we are under specific rules set out by the FTC and others, that limit what we can actually see. So we've been diligent, we've looked at the company. We've got a history of doing acquisitions and making them work, and so I think we are pretty careful as to what we're going to get into. I feel good about -- I feel very good about this opportunity. I think it's the right thing for us. It brings together 2 very strong clinical companies that, putting together, can create even better clinical outcomes, and those things are going to speak tons for our clients and their ability to drive better health outcomes for their employees and patients. And I'm excited about this, Larry. I think it's a great opportunity, and we wouldn't enter into a deal and all of a sudden all the clients be gone. So I think we're pretty smart about that.

Lawrence C. Marsh - Barclays Capital, Research Division

Okay, thanks for the clarification. Second is follow-up. As Jeff mentioned, one of the hallmarks of Express over the years is if budgets aren't made and exceeded, then management feels that, and obviously, that was triggered this past year. And historically, usually that budget is set on some parameters of the company's guidance following your give or take. So I'm just curious, given we're in transition here, how are management's incentives going to be structured this year around a budget given you're not -- you haven't given guidance yet? Is that yet to be determined or is there been something already set that we'll get more details on?

Jeffrey L. Hall

Well, yes. Let me answer that in a couple of ways. First of all, you're right. We feel ourselves to be very much accountable to our shareholders. And if we make statements that make projections and then don't live up to them, we don't feel it's right to reward ourselves, as management, and have our shareholders miss out. So yes, we take our bonuses down accordingly when we miss, and this was a big issue for me, personally. I thought the economy was turning in the fourth quarter of last year. Things were going to improve. I didn't think that we could see 3 or 4 years in a row of 0 utilization increases. I thought that I saw employment trends starting to pick back up. Bells did not occur. So between utilization and member attrition inside of our current book of business that caused us to miss earnings -- once we get into that situation, we have a tremendous opportunity, such as Medco in front of us, we decided the right answer was to accelerate spending and get ahead of a lot of the Medicare and Health Care Reform projects that were staring us in the face. So we've significantly increased our IT budgets, as I talked about a few minutes ago, we also added a lot of staff in to make and sure that we were ready for 11 and we're prepared for the huge migration of members away from Walgreens. And so we were very well positioned for that and I think it was the right thing to do, and likewise, we didn't take bonuses. As far as 2012 is concerned, for me, 2012 we're spending a lot of money trying to get ready for Medco. There's a lot of hidden money, if you will, that you don't see because we have consultants in, we have -- our teams are working on projects. Normally, we'd be looking at other opportunities, but instead, people are focused on meetings around integration planning and so things are a little bit on the back burner. We also know the importance of client. So while we have a group of people that are focused on integration, we have to really double-down on client service because we have to make sure our clients understand that this is going to be status quo for them through this integration, and that they will not miss a beat in service while we integrate Medco into our books. So it takes a lot of people and a lot of effort to get all those things done. On that note, we've put together a sketchy preliminary budget for 2012, which we have internally. That numbers is what we will base our bonuses on an unlikely event we didn't close Medco, we would release those numbers out to you if that event were to occur. But I don't see that as happening. Instead, as soon as we close and we get our numbers together, we will come forward with a combined budget. To me, coming out with the '12 numbers is fairly irrelevant because it's too much dependent upon money we're spending without a return, without the Medco deal. So it's just not all that relevant. It becomes relevant, obviously, if the deal doesn't close. So we, at that time, we would disclose it.

Operator

And we do have a question from the line of Tom Galluci with Lazard Capital Markets.

Thomas Gallucci - Lazard Capital Markets LLC, Research Division

Just a couple of follow-ups on some topics you've already addressed, George. I guess, you just mentioned, in '11 utilization in particular was light compared to what you had anticipated. I saw your consolidated guidance for '12. Just wondering, sort of baked in there, what you're thinking about the underlying market and your expectations for any improvement or deterioration as we think about the year?

George Paz

You constantly hear about employment trends and that it's going the right direction and that jobs are, in fact, picking up. But we're not seeing a whole lot of that, unfortunately. I think what we're seeing is that people are employing people, but they're doing it in a more -- on a temporary basis, consulting basis and not necessarily bringing people back into permanent positions the way we've seen on a recession -- when you come out of recession in the past. So employment pickups has not been overwhelmingly large in our book of businesses and I just haven't seen it. Likewise, utilization continues to be very concerning. It's concerning to me as a citizen of the United States because if people aren't taking their medications, we know people aren't getting skinnier and we know they're not getting healthier, and if utilization isn't going up as the baby boomers are getting into those later years, there's something fundamentally wrong here. And all that is going to relate into higher ER visits and higher doctor and hospital costs in the future, which is not a good thing for our country, but that's what we're headed. So we remain, for our 2012 in our planning, we're assuming that job growth won't come about, but it's not going to decline. It's going to stay relatively flat. And the utilization trends are going to stay below 1% or right at close to 1% for this year which is, again, very concerning but we figured that's the prudent thing to do at this juncture.

Thomas Gallucci - Lazard Capital Markets LLC, Research Division

So a little more conservative, it sounds like, than you were a year ago this stage of the game?

George Paz

Yes.

Thomas Gallucci - Lazard Capital Markets LLC, Research Division

Okay. And then just back on the Walgreens issue. Two quick follow-ups. One, you said you had maybe overstaffed a bit. Has call volumes sort of dropped off that you can tweak those costs down or is it still sort of prudent to keep that staffing level up? And then I think it's really adding some, maybe, random numbers earlier on savings. Do you have any better idea of what clients actually are seeing, in terms of savings, at this stage?

George Paz

Yes, we're going out to the clients and it flows through to the client. So were dealing with clients, on off, each and everyone. I don't think we've aggregated or made a public yet. But maybe as we get further into the year, we'll give those numbers out. As far as the -- the other question was around Walgreens -- oh, the staffing levels. Yes, what we do, over time -- is we wanted to make sure we cleared January 31 and got through all that. So once we got beyond that date, then we start letting attrition and taking out the less productive employees and going on to giving people some time off and what-have-you. We also want to make sure we're probably geared up for the whole Medco integration situation. As you probably know when you go through a merger, a lot of people get nervous and they leave and so some employment trends can get hurt. And we just want to make sure we were properly staffed for that as well. So we're being cautious here as we progress through this year.

Operator

And we have a question from the line of Robert Willoughby of Bank of America.

Robert M. Willoughby - BofA Merrill Lynch, Research Division

George or Jeff, you've obviously mentioned the cost structure somewhat inflated with the pull-forward of cost. There's a $20 million number floating around here for the magnitude of cost that maybe you did incur ahead of that deal close. A, could you comment on that? And B, does that includes the $11 million tax items that you mentioned as unusual in the quarter?

Jeffrey L. Hall

Yes, Bob. So the $20 million number is not a number that came from us. So it's hard for me to comment on it. We haven't been specific on what we said the increased costs are. What George said, I'll concur with, is that certainly there's a lot of cost brought on in the fourth quarter. That cost is continuing into the first quarter as we really gear up for integration, but we haven't been specific. As we think, just in broader terms, I'll reiterate what George said a little bit earlier, 2012 is going to be a year where there's just going to be more people around and more spending around as we focus on integration. Really, the focus on 2012 is going to be driving integration, getting to the synergy and as a result, those are our top priorities, not squeaking every last penny out of EPS. So much more focused on integration synergy, making it all flawless to the clients and, much less focus on earnings.

Robert M. Willoughby - BofA Merrill Lynch, Research Division

Okay. And on a separate issue, you cited Medicaid in Canada volumes as reasons for some upside to the script trends here, and not really better adherence from the behavioral and some efforts that you have. I mean, when does that coiled spring of potential really going to kind of uncork here?

George Paz

Well, that's a great question. We are actually very focused on adherence and following it. We've got several -- we've been at this for a couple of years. We rolled out several pilots. And I think, with those clients that we are working with in either a pilot format or have actually rolled out some programs, we're seeing some improvements but it's not across the book of business yet. The real issue for us, Bob, is although we are still investing heavily in consumerology and positioning ourselves, we are still -- we're looking forward to the day when we close the Medco transaction. And they've got a lot of great clinical programs as well. So we want to make sure that we don't get too far out in front of our skis so that we can't incorporate their best practices as well. So although we're doing some infrastructure build-out to allow our systems and our people to have great access to information so we can monitor and project things, we're also going a little bit slower from a client rollout perspective so that we can make sure we have the right offering when we hit the marketplace.

Operator

And we do have a question from the line of Ross Muken with Deutsche Bank.

Michael Cherny - Deutsche Bank AG, Research Division

It's Mike in for Ross today. So you guys, have addressed, obviously, a lot of what you've done so far with Medco and the limitations you have in terms of being able to get in from an information perspective. But given the fact that you're 3 to 4 months further down the line in terms of integration planning, can you give a little compare-and-contrast in terms of what you're seeing from an integration perspective for Medco versus what you did with an NextRx? And, George, you mentioned you guys have a strong track record of being successful with integration. So, I guess, how does this compare to that and what other challenges do you think that could make this a little more complex than the NextRx integration?

George Paz

Well, this is going to be quite a bit more complex than that. When we brought up NextRx, there was a single client we had to deal with, WellPoint. And WellPoint is a great partner. We've done great things together and we cherish our relationship. But at the end of the day, we had a single point of contact. So we could work with their people in order to figure out our direction, we're where going and make sure that we are doing the things that benefit our company's. When we look out at Medco, here we're talking about thousands of clients. And we've got to make sure that what we do is meeting their needs and positioning ourselves properly for our combined book of business going forward. So it's going to be a lot tougher. There's a lot more plan designs, a lot more specialization to clients. Many of them do things different than others and so we're going to have to really make sure that we have an offering that allows us to get to our synergies yet meets the needs of those clients, and that's going to be our focus once we close.

Michael Cherny - Deutsche Bank AG, Research Division

And then just, Jeff, quickly. Obviously, you guys, got the debt rate done recently. Can you talk about how you characterize the financing environment for the deal relative to what you had originally expected back when you first announced it in July?

Jeffrey L. Hall

Yes, so I did reiterate that we have now completed all of our financing for the deal. Certainly, we're happy with how that came out. And I guess, the debt markets look at this deal and they're as excited about it as we are and think it's got good potential, and as a result, we were able to complete the financing and we stand ready to close.

Operator

And we do have a question from the line of Ricky Goldwasser with Morgan Stanley.

Ricky Goldwasser - Morgan Stanley, Research Division

Just one question that I think wasn't addressed yet. And that's around the Medicaid business. So do you think that this is a trend that we're going to continue to see in the future, where your managed care partners will have more exposure to kind of like a Medicaid book of business? And if so, what's the margin profile associated with this business longer term?

George Paz

The states are in an incredibly difficult spot. Revenues have been constricted as the economy has gone south and the costs have become greater and greater as more and more people have been unemployed. Many states are in very difficult situations and that fee-for-service programs of Medicaid haven't been proven to work very successfully. And what seems to -- what does work is managing the overall cost through a program. So we see more and more clients having those opportunities. You saw in New York went out, they took theirs out for some managed Medicaid, and I think that's going to be the trend. We should see that area as a growth opportunity and so we had to have an offering and help our clients get their share of that business and that's a big focus of ours.

Ricky Goldwasser - Morgan Stanley, Research Division

Okay. And as far as just kind of like the margin mix or the margin profile?

George Paz

Yes, larger clients typically have lower margins. And our managed care clients have our -- they're larger and so they typically have lower margins.

Ricky Goldwasser - Morgan Stanley, Research Division

Okay. And do you think that some of the reduction in the volumes that you might see on part of your book are kind of like off or kind of like you see them coming Medicaid business given just the overall economy? Is that one way to think about it?

George Paz

I'm sorry, I couldn't follow the question.

Ricky Goldwasser - Morgan Stanley, Research Division

I guess the question is, you're obviously seeing pressure in utilization that's related to the economy and unemployment, and then you're seeing kind of this uptick in the Medicaid business. So should I think about it as volume going from kind of like one bucket and flowing through a different one?

George Paz

Well, utilization is a different issue. Utilizations, what we're looking at, a group of numbers we had in the past and what's happening with their drug spend into the future. And both from a conversion to retail, as well as -- I'm sorry, conversion to generic, as well as an overall -- how many prescriptions they taking. So that's one issue. And that's remained relatively flat when historically it grew at 3% to 5% a year. So that's a big drain on growth when that utilization trend has flattened out. From a growth perspective, yes. So we've lost the growth objective of the utilization side and it's been supplemented or partially offset by the growth in Medicaid. So as we've seen that, especially in the fourth quarter, was very strong.

Operator

And we do have a question from the line of Steven Valiquette with UBS.

Steven Valiquette - UBS Investment Bank, Research Division

Maybe just a big picture question for George on Medicare Part D. It seems, historically, that PBMs were -- you're maybe a bit hesitant to want to bid directly to Part D members just to -- like competing against managed care customers. But it did seem, in its last enrollment period, in that PBMs may be expressed but also the company you're trying to acquire become a little aggressive. I'm just curious if there's a change in mentality around Medicare Part D direct enrollment, not at yourselves and maybe even just from a PBM industry perspective. Any color or commentary would be helpful.

George Paz

Well, as this part of the business is growing and is proven to be a very successful program, we continue to look at ways to help, so our Medicare business is made up of several different buckets. We offer a PDP program for our clients that want to take advantage of or get the opportunities. So when the government cut back on the tax benefits attributable to self-insuring the programs, PDPs became a tremendous opportunity as an offering to get a better tax opportunity out of the plans. And so we have a very good strong offering there. We continue to grow that. I think we've seen significant growth in that area. Our managed care clients themselves are outgrowing their own Medicare business and we're supplementing that and helping them. Historically, we have not had a direct-to-consumer business on our own. That something we didn't get in to. As you referenced, Medco does have that business, and we will closely look at it and look at the opportunities there once we have an opportunity to merge.

Operator

We do have a question from the line of John Kreger with William Blair.

John Kreger - William Blair & Company L.L.C., Research Division

Could you give us an update, George, on the contract dispute that you guys disclosed earlier in the quarter? It looked like you took an allowance for that. Any progress towards resolving the dispute?

George Paz

Again, I just want to -- John, I just want to make I just mention -- typically, we wouldn't disclose these types of things, it's just that we had a bond offering going and we thought it was prudent to make sure that, before anybody invested in our bonds, that we put all the situations we had on the table. And that was the reason for the original disclosure. Once that occurred, and then as we move further, we've come to some preliminary discussions around settling it. This is where we think our best thoughts are where we should be and so we decided to accrue a number in for that. I want to make sure that there isn't a misperception out there. I think still have a very strong relationship with the client and we work very well together. It's just that there's a bit of a disagreement and we'll work our way through that and I'm confident we will do that in short order.

John Kreger - William Blair & Company L.L.C., Research Division

And then a broader question. I think you mentioned earlier in the call that the concept on narrow networks was being validated. And if you just -- I think, historically, one of the issues the clients have had is that the savings were not large enough in their eyes to justify a change. As you've gone through this process, have you found that the savings have actually been larger? And how does that sort of trickle down to the clients?

George Paz

Well, let me answer that in a couple of ways. First of all, when we're out competing for business. We often find out we lost business because we were $0.10 a script out of the market, and people move on $0.10. And so I sit there and I struggle with, what does it really mean then when narrow networks aren't worth it? If I'm willing to move and disrupt my entire book of business and change formularies for $0.10, if I can save $0.50 to $2 depending on how narrow I want to make the network or even more if I really narrow down the network, then that's a lot more than $0.10. And so it's hard for me to get my arms around that issue. I think the concern though, by many, was if I'm going to save $1 by narrowing this network or $2 by narrowing the network, whatever the number is, is that enough because there was this feeling that denying access to a given pharmacy may play havoc on my HR department and what disruption this might be and how upset are my employees going to be? Well, what we just figured out, through this process, was there was virtually none. That doesn't mean that somebody that wasn't really tied to Walgreens, an individual, didn't have to learn a new pharmacists at Kroger or CVS or wherever they ended up going and become friends with a new pharmacist, and that is where it is. But it really did go off without a hitch. At the end of day, as I said earlier, NEXIUM is NEXIUM, LIPITOR is LIPITOR, drugs are drugs and it shouldn't matter that much whose counting to 30. And I just believe that we should be able to make sure that we put the right person in front of the right cost and make sure that we serve our clients properly. Taking cost out of the healthcare system is of paramount importance to us and that's what we’re going to do. And I do think that the narrow networks speak to that and serve that occasion. And depending on what happens with the economy, when the employer is looking at laying off hundreds and hundreds of people, if I'm an HR director and I come in with a proposal that saves a $1 million, how welcome is that going to be? Nobody, as a CEO, I don't particularly like to lay off people. I don't think any of my peers like to lay off people. And we all have our demands and needs to meet our shareholders' expectations, so there's a lot of pressure on a CEO. And if you can deliver them without disrupting your client base, I think that's critically important. So we are absolutely focused on that and we believe that the community pharmacists severe a very important role in healthcare, that they do a tremendous amount. But we just don't see that 1 pharmacist does it that much better than another pharmacist, at least not by change. And so we're just not going to pay those premiums.

Operator

And we do have a question from line of Charles Rhyee with Cowen.

Charles Rhyee - Cowen and Company, LLC, Research Division

I know there's really limited things that you can say about the process that we're waiting, the FTC's decision at this point, but maybe to get a sense though. If there were any type of remedies required, the timing of that, would that have to be within the time frame that the FTC makes a decision or that could be sort of subsequent after a decision is made as part of any type of potential concern in order that those can be resolved over time, over the next several months instead, and have no impediment on the deal itself?

George Paz

From our perspective, we're working very diligently and focused on getting this through the FTC, making sure we meet their needs. The FTC is doing their job. They're trying to make sure that the American public is going to do better because of this acquisition. And we're right there with them. We believe that this acquisition speaks to what this country needs more than anything, which is a reduction in the cost of healthcare. And we're there to show them that through our previous acquisitions, that has occurred, and through this acquisition, it will continue to occur. At the end of the day, there's a lot of pushback from the retail pharmacists because they're worried about us the cost of reimbursement. Well, that's our job. The job is that the cost of branded products go up at roughly 10% a year. If we're not in there trying to negotiate part of that 10% for our clients, then all that goes back to the pharmacies. That can't occur. People can't get a 10% per unit increase each and every year. It's okay if you can move people from brands to generics from a higher cost drug to lower cost drug and save that patient money to make more money. But not just by standing still and all of a sudden, on December 31, I fill 1 prescription and then on January 2, I fill the next one and all of a sudden I make 10% more. That just doesn't make any sense. And we had to be that insulator, that filter that takes some of that inflation out of the equation, gives it back to our clients. And that's a very important role. That's the problem with what we had have with Walgreens in this situation, it is that they wanted us to hold rates flat and hold them flat over a 3-year period, and that can't occur. That lines the pockets of Walgreens by a 10% increase each and every year ever, at the time our clients are then facing not only a 10% on brand, they're not getting the benefits from the generics, because they wanted to hold those flat as well. And they also wanted to get all the utilization increases. And that's just -- we just can't stand there and allow that to happen. So our job is to make sure our clients can maintain reductions in prices. If you look at our industry, year in and year out, as clients come up for renewal, their prices come down. That's what we do. We go out and get we get better discounts for our clients and I think it's an important role. As far as what we might have to do or anything else, that's not a pertinent question at that time because we're in the process of trying to solve and make sure the government is comfortable with this, what we're doing, and we're going to get through that first. And we have any -- if there's anything we need to discuss later, we'll be happy to make sure you are all informed of that. But we feel good about where we stand and were going to move this to conclusion.

Charles Rhyee - Cowen and Company, LLC, Research Division

And if I can just squeeze one more in here. In this early part of selling season, obviously, as you guys have testified in front of Congress, that this a very competitive industry, a lot of players, it's not as limited at some people might think. As we've gone into the early part of the selling season, at least, have you started to see some of the other players getting into sort of later rounds like the SXCs and Catalysts of the world?

George Paz

Absolutely. Catalyst over the -- hats off to them, they've done an incredible job of growing their company and really being a key player in our industry. SXC a very formidable competitor. Mark does a great job out there. United is a strong competitor with their size and strength, and they've got strong offerings. That's what makes this industry great. We can't sit still and just do what we did yesterday, we've got to continue to innovate, create and come up with new opportunities to take costs out of the systems and stay ahead of our competition. And I believe we do a good job at it, that's why we've been able to grow. And we will -- and our commitment to our shareholders and our patients is to continue down that path.

Well, thank you everyone for joining us on our year-end conference call and earnings, and we look forward to keeping you posted as we progress towards our culmination of our closing with the transaction with Medco. Thank you very much.

Operator

And ladies and gentlemen, that does conclude your conference for today. Thank you for your participation and for using the AT&T Executive Teleconference service. You may now disconnect.

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