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Express Scripts Holding (NASDAQ:ESRX)

Q2 2012 Earnings Call

August 08, 2012 10:00 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

Thomas Gallucci - Lazard Capital Markets LLC, Research Division

Lawrence C. Marsh - Barclays Capital, Research Division

Glen J. Santangelo - Crédit Suisse AG, Research Division

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

Robert M. Willoughby - BofA Merrill Lynch, Research Division

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

Ricky Goldwasser - Morgan Stanley, Research Division

Charles Rhyee - Cowen and Company, LLC, Research Division

Steven Valiquette - UBS Investment Bank, Research Division

Operator

Ladies and gentlemen, thank you for standing by, and welcome to Express Scripts Second Quarter 2012 Earnings call. [Operator Instructions] And as a reminder, today's conference is being recorded.

I'd now like to turn the conference over to Vice President of Investor Relations, David Myers. Please go ahead, sir.

David Myers

Thank you, and good morning, everyone. Welcome to our second quarter conference call. With me today are George Paz, our Chairman and CEO; and Jeff Hall, our CFO.

Before we begin, I need to read the following Safe Harbor statement. Statements or comments made on this conference call may be forward-looking statements, may include 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 filing 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 will 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 second quarter financial results.

Jeffrey L. Hall

Thanks, David. Well, obviously, we've had a few busy months here, including closing the Medco acquisition, executing our integration plan, migrating the first year of WAG, focusing on the selling season and signing a new contract with Walgreens. In addition, we're also reporting strong second quarter earnings and increasing guidance for the year. Adjusted claims for the quarter were 404.3 million, up 118% from last year. Our generic fill rate was 77.8%, up from 74% a year ago. In keeping with our model of alignment, as our clinical programs delivered savings to our clients, we also improved our gross profit. SG&A was up $80 million versus Q1 pro forma for the acquisition, as a result of an increase in management incentive compensation to reflect the increase in our expectations for the year and the reclassification of several Medco expenses from cost of goods sold to SG&A to conform with Express Scripts accounting methodology.

EBITDA for the quarter was $1.5 billion, and EBITDA per RX was up 14% versus prior year, again pro forma for the acquisition. Interest expense in the quarter was $169.5 million, as a result of the repayment of $1.5 billion of bonds at an average rate of 5.9% and continued low floating rates. Interest expense for 2012 is expected to be approximately $530 million. This quarter's effective tax rate, excluding non-recurring items related to purchase accounting, was 42.1%. The higher rate for the quarter was the result of several factors related to the closing of the transaction and a necessary year-to-date true-up.

We still expect our effective tax rate to be 39%, which means the tax rate for the second half is expected to be approximately 38%. EPS for the second quarter was $0.88, a 24% increase over last year. Cash from operations was $726 million, a 58% increase from last year. Including Medco's first quarter performance, year-to-date cash from operations is approximately $2 billion.

As a result of strong performance in the first half of the year and the accelerated realization of synergies, we are increasing our guidance range for 2012. We now expect EPS for the year, excluding transaction, integration and amortization expenses, to be in a range of $3.60 to $3.75, representing growth of 24% over 2011 at the midpoint. As we have said before, this range assumes that shares outstanding for the year will be 750 million and the tax rate will be 39%. If the share count or tax rate changes from these assumptions, our EPS forecast could change.

We are in the process of reviewing the strategic alternatives for several of our adjacent businesses, which are not core to our PBM offering. We do not expect the ultimate disposition of these businesses to have a material impact on our financial results. In summary, integration is proceeding well, and we continue to expect to complete the integration and achieve $1 billion of net synergies in 2014.

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

George Paz

Thank you, Jeff, and good morning, everyone. Four months post closing, we are more confident that the combination with Medco provides significant opportunities to innovate, drive out waste and improve how health care is delivered. As part of our integration, we are combining Medco's clinical approach through its therapeutic resource centers and the use of specialized pharmacists with Consumerology, the application of behavioral sciences to health care. By blending the combined clinical skills with the behavioral sciences, we will be able to accelerate clinical offerings from our greater efficiencies in the health care system and better protect American families from the rising cost of prescription medications. Our shared vision is to increase therapy adherence where appropriate, lower costs and drive a better health outcome. Our previous acquisitions have succeeded through a disciplined approach to integration, including clinical programs, rationalization of our footprint and system migration. We believe operating on one platform is imperative in offering best-in-class service and meeting the market challenges and opportunities presented by Health Care Reform, Medicare and Medicaid expansion.

Just last week, we successfully moved our first-tier business to our destination operating platform. Our track record of successful integrations has allowed us to spend much more time this selling season discussing our innovative clinical offerings and cost-savings opportunities, including narrow network. As such, we are enjoying a successful selling season. Retention rates for both Express Scripts and Medco's legacy book of business exceed 95%, which is consistent with historical norms. We have won over 125 clients to date, which is consistent with prior years. None of our wins or renewals for the year require specific pharmacies to be included in our retail network. And we have begun a successful selling season in presenting narrow networks and believe this offering will continue to gain traction. We recently entered into a multi-year pharmacy network agreement with Walgreens to participate in our broadest retail pharmacy network. We will continue to design benefit programs that meet our clients' needs, including narrow networks, primary management and other clinical tools.

Our financial performance for the quarter and our outlook for the year reflects the strength of our value proposition, confidence in our ability to successfully integrate our business and our unprecedented opportunity to make the use of medicine safer and more affordable, which is exactly what our plan sponsors need now.

At this point, I'd be happy to answer any questions.

Question-and-Answer Session

Operator

[Operator Instructions] We'll go to the line of Tom Gallucci with Lazard Capital Markets.

Thomas Gallucci - Lazard Capital Markets LLC, Research Division

I have 2 questions. The first is just on the synergy side. You mentioned in the release an acceleration of the capture there. Can you talk about maybe some of the specific areas, where you're seeing progress at this point earlier than may be anticipated?

Jeffrey L. Hall

Yes. We don't like to go into lots of detail, obviously. But certainly, the primary area, where we're seeing synergy coming faster than we had previously thought, is in the SG&A line. And we'll see that move through the balance of the year. I would say in the second quarter, not meaningful amount of synergy were realized, and we expect to -- that we'll realize some of those SG&A gains through the rest of the year.

Thomas Gallucci - Lazard Capital Markets LLC, Research Division

Okay. And then George, in your remarks there, you're just talking a little bit about narrow networks or preferred networks from a benefit design standpoint. Can you maybe go into a little bit more color on what you're seeing? And there's been a lot of talk about any of your customers considering it. To what extent are you actually seeing customers would decide to implement as you're working toward your 2013 benefit design?

George Paz

I think we ought to just keep in mind that there is no one-size-fits-all in anything we do. We have a very broad array of products and solutions for our customers, so it really depends on what a customer is looking for in their, quite frankly, their economic conditions in which they find themselves. To the extent that a client needs significant savings on a relatively quick basis, we have everything from mandatory mail programs, mandatory generic programs, very, very limited networks that compete the pharmacy against each other in order to become the preferred pharmacy and drive down cost for those members, to a very open offering for those clients that are -- that have a different viewpoint with respect to the pharmacy offering, which you should also keep in mind that we had a very successful retention season similar to historical levels. And basically, when we went out and had to resign these clients, none of them was offered Walgreens as an alternative, and yet we were still maintaining 95% of our book of business. So when you think about narrow networks, clearly without Walgreens in initially, that was our modus operandi at that point. So I think going forward, now we have the benefit of including them. They are part of our larger network. So quite frankly, it's up to a client. If the client wants to see savings beyond, they could choose a more limited network. For those clients that want the broader networks, they have that option. It's our job to provide a wide array of products and offerings that meet those clients' needs and that's our focus.

Thomas Gallucci - Lazard Capital Markets LLC, Research Division

How narrow do you have to narrow your network to drive some material saving?

George Paz

It depends on geographic location. If there's -- again, these aren't just simple answer. In the market, where you have very high competition between the retail pharmacies, excluding one, means that all those numbers can be now diverted to the other pharmacy. And they're willing to drop rates for that. In other markets, where the competition may not be as strong and the client sees that they want that bigger pharmacy chain in, then it doesn't do you a lot of good to exclude them. So I think it's really on a regional-by-regional basis. But keep in mind, some people have talked about maybe you can only save $1. Saving $1 per prescription is a tremendous amount of money. We're talking with Express Scripts processing 1.4 billion prescriptions per year. $1 is $1.4 billion. You tell me a company today that's running 1 million prescriptions through their SG&A line, that if they can save $1 billion doing something that doesn't cause a lot of disruption that they wouldn't do it, $0.50 is worth doing. As an ex-CFO, when I go through our budgets and I go through our forecast with my CFO, Jeff, we're constantly looking for pennies. You got to start with pennies to get dollars. And so everything is important that really doesn't involve anything that has some material negative effect on your employees. We've been able to prove that, that limiting networks, limiting formularies, changing access, putting in clinical programs, all those things can reach tremendous desired results without employee disruption. So we're pretty excited about what we can bring to the table.

Operator

And our next question will come from Larry Marsh with Barclays.

Lawrence C. Marsh - Barclays Capital, Research Division

George and Jeff, so just following up on Tom's question about overall synergy expectations. You guys are communicating pretty clearly today that you're able to accelerate the timing of some of these savings of SG&A saves, which you haven't changed the ultimate target of $1 billion. I just [indiscernible] when you first announced Medco last July was estimated synergies of $1 billion. Back in May, you described that as net synergies of $1 billion and you're confirming that today. So just remind us what you mean by net synergies. And from a timing standpoint, when might you be in a position to revisit those ultimate synergy assumptions?

George Paz

Well, I'll take the first stab at that, then Jeff can give it proper classification and color. From my perspective of net synergy means what we're bringing to you as our shareholders. So there's going to be numbers that we're going to gain and that we're going to pass on for our clients. And synergy takes a lot of different forms, to the extent that our product people develop new clinical programs that help lower costs and drive down waste, that can be considered a synergy. And we're constantly looking to do that. Obviously, the clients are going to gain the market share -- the lion's share of those numbers. Our view today is that our operations people have worked very hard in order to make sure that as we came into this acquisition, we had a good idea where our staffing levels needed to be. As you know, last year, Medco had a bit of a tough year with the CalPERS and the FEP and some of the other situations. And so our first drive was in order to rightsize the ship and get the right level of people to meet the service levels, which our clients need in order to meet their needs and at the same time, make sure that we have the right people in place to drive the company into the future. So that was our -- that was where our focus was. Because we were given an extended period of time by the government as they reviewed the acquisition, we had more time to plan and get things in place. So once we closed the deal, we were able to go in and quickly prudently focus on getting it both rightsized, and we did that. So that accelerated the SG&A savings and some DPC savings into the current year -- into the current quarter, which helped us. There's an awful lot that still needs to be done, whether it's contracting networks, whether it's getting the formularies put together, working with all the pharmaceutical manufacturers, on and on. I mean there's a whole lot of things that need to be done in order to put these 2 companies together, one of which, which is very large, of course, is getting to one platform. We are very proud and feel great about our employees' focus that we're able to get the first tier of our membership move. We're ready to move the next tier in just a couple of weeks. And so we're well on our path continuing those efforts. The sooner we can get that done, the sooner we can eliminate all the significant costs associated with multiple platforms and development regulatory costs, and we're on that path. Now to revise the number, it gets kind of complicated, Larry, just because we are a -- we're all in the same business, so we start putting things together. Our people are very focused on continuing to drive value for our clients, and the number starts to get a little more blended together, if you will. So what the synergy versus what's truly just a pure operating gain because our operations people figured out a better way to present our prescriptions through our automated systems. Our systems people have a better methodology for processing claims. As we gain those opportunities on top of the combinations, the blurriness between the synergies gets a little bit confusing, if you will. So our view is, and I think we feel very good about the $1 billion, we'll continue to focus on that. But at the end of the day, the next quarter, 30, 90 days or so from now, we'll be in a position to give guidance into 2013. And that will be our indication, and we'll give you some more -- a better view on where we think numbers are coming in.

Lawrence C. Marsh - Barclays Capital, Research Division

Great, okay. And just a quick clarification follow-up, Jeff, maybe on interest expense, $530 million is a bit lower than I was thinking so it must be a pretty good stepdown to third quarter of maybe $115 million or so. Can you remind us what's driving that? Is that a good run rate for next year? And then the other quick clarification, in the Q, you talked about Medco's network participation with Walgreens remaining in place under existing terms. I know you don't want to talk too specific about that but you can make any comments about whether that's existing terms? Or is that all under one new agreement as you disclosed?

Jeffrey L. Hall

Yes. So interest expense, I think it's real simple. The -- we prepaid or paid off $1.5 billion of bonds that were outstanding. Those bonds had an average rate of 5.9%, and we're continuing to see low-floating interest rate. So we've got low rates on our large [indiscernible] floating rate bonds. That's what's driving our interest rate down from where it was in Q1 and Q2. $530 million for the year, we expect it to be pretty flat from Q3 to Q4. So if you fall for that and have the 2 quarters be about the same in Q3 and Q4, you can get pretty close to the right numbers. I'll let George take the second part.

George Paz

Yes. As far as the Walgreens contract, keep in mind that we just entered into a new contract with them, and it covers the entire book of business, both Medco legacy and Express Scripts. But it doesn't take effect until September. While the contracts, of course, [indiscernible] our current membership don't access Walgreens until September. So for those legacy numbers, we still have the Medco contract that's operational and working.

Operator

.

And we'll go to the line of Glen Santangelo with Crédit Suisse.

Glen J. Santangelo - Crédit Suisse AG, Research Division

Just a couple of quick questions. George and Jeff, I was kind of curious to ask about the gross margins. The gross margins look particularly strong. And I guess I'm trying to figure out how much of that was driven organically, I guess, by incremental contribution from generics this quarter? Or how much of that was synergy driven? Because yes, I noticed the generic dispensing rate was a little higher than we thought and maybe the mail order rate -- mail order claims were a little bit higher than what we would have thought. So any clarity around that?

George Paz

Well, I'll put a couple of things and then Jeff can give you some of the number stuff. But clearly, the generic is a strong driver, as you know, through our model of alignment, getting where we can pull through additional opportunities, both through clinical programs and generic fill rates, drugs losing their patent protection, all add to value for our clients and to us -- for our shareholders. So those are all very positive things. The other thing, which we already talked about, was our operations people are very diligent. Pat McNamee brought his team together and made sure that we were focused on day 1 of getting this -- the right people and the right job and the right headcount, and we've been working very diligently at that. So as we bring out -- as we rightsize the boat again, it took a lot of cost out of the equation and allowed us to bring down our TPC cost, again, which I guess, clearly, is synergistic. But it's also things we do constantly to make sure that we're on the right track here. So that's going to continue to be our focus, as we continue to look forward and drive numbers. I don't know, Jeff.

Jeffrey L. Hall

No. I think that's right. I mean, obviously, the mode of alignment we talked about a lot has worked really well for us over the years. When generic fill rates go up, when mail penetration goes up, when clinical programs start to execute, we're saving our clients money on the drug spend. We're now starting to save them money on the medical spend as well. And in keeping with that model, that helps our gross profit. So that's the primary driver. As I said earlier, we didn't see much synergy the second quarter coming through gross profit. We do expect to see some in the third and fourth quarters, especially gross profit.

Glen J. Santangelo - Crédit Suisse AG, Research Division

And Jeff, maybe if I can just ask one follow-up question on generics, and I understand you guys don't want to comment at all on fiscal '13 at this point. But what I'm trying to gauge is, obviously, you saw a bunch of big generics lose their exclusivity in the first half of this year, and as we look to the back half of calendar '12, there's a fair amount of generic introductions that are coming. And so I'm just trying to think, from a very high level of perspective, how I should think about generics in '13 versus '12? Is it fair to say that you're obviously going to get the full 12-month contribution from all these big generics next year in '13, so it could actually be bigger than '12. Is that a fair way to characterize it?

Jeffrey L. Hall

Hard to answer that question without providing '13 guidance, which I'm not prepared to do today. We're, at this point, focused on executing on the year. We're happy with where the year is going. We're seeing positive uptick in the year. We're happy with the execution of integration and synergy, and that's our focus. And you're going to have to wait a little while longer to get us to comment specifically on '13.

Operator

And we'll go to the line of Lisa Gill with JPMorgan.

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

I was wondering if maybe you could just talk about the underlying mail trends that you're seeing. Obviously, they're stronger in the quarter. As we go through the Q, you talked about mail conversion. So George or Jeff, can you comment on what you saw around mail conversion, perhaps related to the dispute with Walgreens or any other programs that you have in place, that are going to continue to drive mail? And then secondly, can you give us an idea of what your underlying mail growth was in the quarter?

George Paz

We can both take on parts of that, Lisa. First of all, the dispute with Walgreens clearly helped mail. Those members who -- people -- as you know, from our whole discussion around behavioral sciences, getting people to move off of a status quo is not easy. And when an event occurs, such as losing Walgreens out of the network, that was a real motivator and driver for people to take action. And so as they were looking at the possibilities obviously, we informed them of the benefits of mail order. There's no question our services, undeniably the best in the industry, and as we lever that to provide the value back to the membership, they've taken advantage of that, and that's driven mail. The other thing we shouldn't lose sight of is joining me on my senior staff as part of the acquisition was 2 very, very sharp individuals from Medco, who grew up in a business that was very, very good at driving mail. And so both Glen and Tim have that focus. They know the value. They bring a fresh new look into how we can promote mail in front of our clients. And so it fell through the account management and sales side, as well as the product development side. These 2 individuals have been able to really take us to a new level, and we'll continue to focus on that. So we're excited about how our staff has come together with some new ideas, some new focuses using therapeutic resource centers in combination, with our Consumerology, has added a lot of value to our clients and will continue to drive mail.

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

Do you have any numbers on the underlying mail growth?

Jeffrey L. Hall

No, we're not going to break it out. I think I'm just -- I mirror what George says. There's a couple of things we know. Adherence goes up at mail, price to the member and to the client goes down. We got a lot of great ideas. We're going to keep driving it, and we're confident that we can continue to improve outcomes and lower cost by getting more people into our mail program.

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

And obviously, much figure. And then secondly, no one has asked thus far about the selling season. George, can you comment on how the selling season has gone thus far? How receptive clients are to the new offering? You have potentially the 95%, but can you maybe talk about how you've been able to win any new customers as well in the selling season?

George Paz

Yes, we're -- on our prepared comments, I mentioned we had 125 new wins to date this year. I think we feel very good about where we stand. We historically -- new wins are very important to us. But quite frankly, retaining the business and growing what we do and adding value is the most important thing we can do. I think it's always a little dangerous if you just focus purely on sales, especially when you get to a fairly large size. Because keep in mind, winning new business, there's lower margin. There's a lot of start-up costs. There's a lot of effort that goes into that. That doesn't mean it's not worthwhile. But clearly, the focus has to be on maintaining what we have and growing it and bringing value to those clients. That's going to be the biggest drivers of value enhancement. And when we look out to the future, obviously, we always want to have new wins, because new wins validates our business principles and who we are. But it's also we're not willing to -- we -- as you know, Lisa, we've always walked a very fine line between making sure that the value we add to our customers and the price we're going to deliver so that we can add value to our shareholders has to be balanced. And we're going to maintain that discipline, and we're going to maintain that balance in everything we do. And our job is to make sure we grow best in class for our shareholders on our share value, and that's where our focus is and to make sure we perform for our shareholders and at the same time, perform for our clients. So we feel good about our selling season, and we feel good where we stand. And obviously, this has been an interesting year without Walgreens in the early part of the year. That really wasn't a big negative, though, at the end of the day. For -- as I said in the past, in certain areas such as managed care, it's a little bit harder because often, they have a different type of offering that they're reselling our services out to the public. So that's a little tougher, which clearly on the commercial side, the commercial clients are really looking for savings and what's good for their membership. So again, I think we feel very good about where we sit.

Operator

And we'll go to the line of Robert Willoughby with Bank of America Merrill Lynch.

Robert M. Willoughby - BofA Merrill Lynch, Research Division

George, do you have an early read or some type of internal target on how many of your customers will bring Walgreens back into the network next year?

George Paz

We do, but I'm not going to mention it. I don't think -- because they're a public company. I don't think we should be the one driving them. I think that from my perspective, I'm incredibly appreciative of what all of other retail pharmacies did to help us through that period. I'm also very appreciative of what Walgreens has done to come back into our network. So we -- our clients are working with our account teams, and they're deciding where they want to go. We, obviously, track that. But I prefer not to get into that level of detail.

Robert M. Willoughby - BofA Merrill Lynch, Research Division

Okay. And maybe, George, just to be difficult, when Express Scripts had been buying stock, it's historically been a signal that there's no open deal coming. Why are we rolling this time around?

George Paz

Bob, we just closed on this 4 months ago. Can you give me a chance to get a breath? Well, we are -- we -- as you know, we really have a focus here of making sure we deploy our capital and manage our capital structure in the best way possible for our shareholders, and we will continue to do that. And we won't lose sight of what our drive is, which is to increase shareholder value every year. So we've got to focus.

Operator

And we'll go to John Kreger with William Blair.

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

Just a quick follow-up on the selling season, George. On a net basis, do you expect at this point to be up or down for -- as you move into January of '13?

George Paz

We -- net-net, it should be up. But it's still kind of early because we haven't gotten through all of the renewal season, and we still haven't gotten through all of the new sales opportunities. You also got to be careful because some of my competitors would count things like utilization and inflation and net new win. And we've never done that. So you really have to parse apart what's driving it. If one of my clients -- the reason we lose a lot of the business that we lose is because companies combine, and we'll find ourselves having half the business, somebody else having the other half and then they make the decision. More times than not, the company that's -- the buying company goes with their -- they had chosen who they had wanted to work with, and so the survivors choose the winner. And that typically is what happens here. Now if you gain a whole bunch of scripts through that method is that net new business? This is -- a lot of people would count it that way. It just really depends, so what we really try to do is look at script growth over a period of time and again, balance that between new business wins, again, to validate our model versus enhancing shareholder value to our shareholders. So it's really too early to get too deep into this conversation. Hopefully, we'll be in a position on the next quarterly call to give you a little better color as we project out next year's script count.

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

Very helpful. That's actually a good segue. The follow-up was, if you look at your legacy business, are you seeing any changes in per-capita utilization, given the -- all the headlines about the economy at present?

George Paz

That still is a very troubling factor. When I have a chance to talk to our Chief Medical Officer, Dr. Miller, and we look at what's taking place in the underlying numbers. It's very scary, John. It's troubling when you see people with diabetes and heart conditions and some pretty severe situations that aren't taking their medications to the level that they should be. I assume it's the economy driving it, we've faced it now for 3 years, kind of caught us a bit by surprise last year. As you know, we thought we saw in early in the year that trends were starting to warm up and things were starting to take off a little bit and then they fell back flat again. We're seeing it again this year. Trends are -- utilization trends are remaining relatively flat. At the same time, the manufacturers, because they're not getting the pull-through with all of the utilization we've historically seen, have been raising prices on an unprecedented basis. And so both in oral solids and in specialty products, we're seeing inflation rates that are quite large. And so we're doing everything we can to work with our clients to give them alternatives through clinical programs, prior authorizations, step therapies, primary management and other programs to try to help them combat the ever-increasing cost of those drug therapies. So it's a good and it's bad. Obviously, our tools are needed more than ever to help clients to control their costs. At the same time, it's a bit frustrating when we see costs rising at 4x and 5x the cost of inflation. So it's a difficult situation.

Operator

And our next question will come from Ricky Goldwasser with Morgan Stanley.

Ricky Goldwasser - Morgan Stanley, Research Division

Last quarter, George, I think you highlighted Medicare -- Medicaid business as a driver to performance in the quarter. And it's been an important growth driver for your clients obviously. Have you seen any impact this quarter? And how do you think about this business segment going forward? And then on the Walgreens side, to your point, Walgreens wasn't a big negative for you throughout the year. So what has been client reaction to the announcement that Walgreen is back in the network, if any?

George Paz

Medicaid will continue to be a very important component of our business. It's mostly managed through our health plan side, our managed care division. And many, many of our clients have a focus on both Medicare and Medicaid. Our job is to produce the tools and reporting and the information that they need to meet the needs of the different states as they roll out their programs. So it clearly, end of this year, Medicaid has been a big driver for us, and I suspect it's going to stay that way as we go into 2013 and '14. It's an area of growth -- of significant growth. So it's something we're very focused on. As far as Walgreens is concerned, again, this is like anything else, whether it's formulary or whatever. It's really a client-by-client decision. Our job isn't to go to in and suggest or force clients to choose mail, to choose formularies, to do anything. Our job is to lay out choices. Our job is to just come in and lay down -- here's, okay, what is the need of the client? There are some companies that are in the professional services business and you are highly contesting for employment. Chances are you're going to have a pretty open flexible plan design. If you're in a very difficult business facing tremendous competition and your margins are declining, then you're going to be much more focused on cost. So our job is to roll out and give clients the option to make the decisions they need to meet their cost objectives. So again, the answer is different for every client. Some clients are excited to have the opportunity to go back into Walgreens. And other clients are, quite frankly, because of [indiscernible], are more willing to sacrifice that access in order to keep the cost savings that they can enjoy. So it's really a client-by-client decision.

Operator

And the next question comes from Charles Rhyee with Cowen and Company.

Charles Rhyee - Cowen and Company, LLC, Research Division

Actually, maybe just some housekeeping questions. Jeff, you kind of mentioned that you're evaluating some of the businesses that you have going forward. As you know, we look at the segment breakout. Obviously, it looks like the other revenue in the core PBM is probably a little bit lower. It looks like you kind of moved some things around. Can you just talk about sort of what's kind of moved and maybe what you're looking at as non-core?

Jeffrey L. Hall

Sure. The -- so yes, you're absolutely right, we did change our segments around. It made a lot of sense to kind of recalibrate the segments based on what we have now. So essentially, we're in 2 segments: the PBM and the PBM businesses, which for the most part is the U.S. and the Canadian PBM, and the specialty businesses are in the PBM segment and then everything else is in the kind of other businesses segment. And so that is -- and it's detailed in the Q, but it is our international businesses, both the historic Express Scripts international, as well as the Medco international. It's liberty, it's UBC, it's the other subsidiaries that legacy Medco organization had, as well as the distribution business that we have and other businesses. So we're -- looking at strategic alternatives, we think it's too early to really go into details and name names. But a lot of these businesses aren't core and don't have the kind of return on invested capital metrics that we'd like to see. And therefore, we are going to sell them or just exit them over the next several quarters. And just to be clear, we don't expect these sales or these exits to have a material impact on the overall results of the company.

Charles Rhyee - Cowen and Company, LLC, Research Division

Okay, that's helpful. And also maybe on the share count here. You're still guiding to about 750 million. We're actually getting 324 million a quarter. Can you talk about how we should expect that to ramp up in the back half? [indiscernible] in the third quarter [indiscernible]? Or is it kind of the ramp that you expect people to exercise options as part of, I guess, maybe of severance packages?

Jeffrey L. Hall

The truth is I don't know. You were using 750 million. That's our best estimate. The big swing factor here and is how legacy Medco employees exercise their stock options, and there's no easy way for us to predict that. 750 million is our best example. I would expect it probably to ramp slightly over time. That's how I'm modeling it internally. But I think just for modeling purposes, we're forcing the model at 750 million for the year. If it comes in different than that, then the EPS could change. But quite frankly, it's hard to predict how that's going to come through.

Charles Rhyee - Cowen and Company, LLC, Research Division

Okay. So then one last follow-up question, on tax rate, obviously, you're saying 37%, 38% for that back half or I guess I'm sorry, regarding full year 38% to 39%, which kind of imply the back half is sort of 37% to 38%. Shall we think of that back half really -- is really the more normalized tax rate going forward.

Jeffrey L. Hall

No, we think the -- as I said in my prepared remarks, the effective tax rate for the company is 39%. Our goal over time is to get that as low as possible, although I don't expect that rate to change significantly over the next year or 2. So I think 39% is the rate. We've got a lot of integration, other things to do to get that rate down a little bit. And of course, it's always dangerous to talk about tax rate, given all the legislative potential on that. But our current view is 39% as the rate for the year and going forward. And that as a result, the second quarter had some year-to-date catch-up, some other purchase accounting related items in it, which forced the rate up, which means to get 39% for the year, we end up with kind of 37.5% to 38% in the back half. That's what gives us 39% for the year.

Operator

And your final question this morning comes from Steven Valiquette with UBS.

Steven Valiquette - UBS Investment Bank, Research Division

George and Jeff, so just -- I just had a question just on the synergies for 2012 and for 2013. When you talked about that for calendar '12, SG&A will be the bigger synergy opportunity. And obviously, what's been visible to the investment community is the new drug wholesaling contract starting October? You obviously have a new retail pharmacy reimbursement contract for the large chains starting mid September. So I guess my question is, as we kind of think about going into 2013, should we see more synergy from COGS versus SG&A? And also just overall, when we think about retail pharmacy network pricing, again, without getting too granular, is that a meaningful part of the overall synergy opportunity tied into the merger? I just wanted to get more color on that as well.

George Paz

Yes. The -- we're not prepared to talk about '13 today. The numbers that we hope to gain or we will gain through the course of the next -- the third and fourth quarter are embedded in the guidance range that Jeff gave you. So that's where we're at for those numbers. As we look out to 2013, there's a lot of things that drive synergy. And that's why it starts getting clouded when we look out into the next year because again, clients are going to -- a lot of it is going to depend on where the economy is as well. If the economy doesn't improve, things remain relatively tough. More and more clients are going to be looking at more and more options to drive out cost. As those realizations or those things -- events become real, then they're going to be coming out to look for those opportunities. And clearly, narrower networks are going to be an option. So the question is it's very important for us to go and look for the best pricing between the 2 different, so if we each have a contract with retail pharmacy, a, we look at who's got the best deal and try to get all the business into the better deals. We're going to do that over time. In addition to that is also the new products that Glenn and his team are going to be rolling out and that we're going to be offering to our clients. They're going to help us to help drive value for our clients and drive value for our shareholders. So it does get a bit blurry as you move into this, but we are very, very focused on continuing to drive value, and we look forward to the next quarter when we can give you guidance into '13.

Steven Valiquette - UBS Investment Bank, Research Division

Okay, maybe just one real quick -- just a clarification question. That 95% retention rate, there's always nuances on the definition of that. So I'm wondering for your 95% that you're disclosing, is that just number of customers? Or is that percentage of revenues? I want to make sure that we understand that percentage properly.

George Paz

Yes. We've always done this the same way here, and it's 95% of all claims that we look at. I think when you start getting the small clients, some undecided to carve in, some carve out, it's this kind of clients that can be pretty misleading. So we look at claim counts, and we've always done it the same way since we've been in business so...

All right. Well, thank you, all -- everyone for joining us on today's second quarter earnings call. We're really excited about where we sit. We believe that as pharmaceutical manufacturers have continued to raise prices, as clients continue to look for opportunities, what's really been fun, I think, over the last 14, 15 years that I've been here is to watch the clients as they've grown, and they've had a better understanding of value that comes through the PBM. And our tools have only gotten sharper and better, and the clients have become more receptive. Years ago, trying to roll out, go from 2-tier formularies to 3-tier formularies, was a huge undertaking. Now most plans have them. And when you look at narrower networks or you look at mail programs or you look at other savings opportunities, the receptivity of our teams to roll out new and exciting engaging programs that help take down costs, while improving health outcome, is growing with momentum. And we're excited about the position we sit in. We're excited about our future. We look forward to keeping -- continually updating you on our synergy quest, as well as our integration progress. So until next quarter, we'll talk again soon. Take care. Thank you.

Operator

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

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