CVS Health Corporation (CVS) Q1 2013 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by. Welcome to the CVS Caremark first quarter 2013 earnings conference call. During the presentation, all participants will be in a listen-only mode. Afterwards we will conduct a question-and-answer session. (Operator Instructions) As a reminder, this conference is being recorded, Wednesday, May 1, 2013. I would now like to turn the conference over to Nancy Christal, Senior Vice President, Investor Relations. Please go ahead, ma’am.

Thanks, Suzy. Good morning everyone, and thanks for joining us. I’m here with our President and CEO Larry Merlo, who will provide an update on the business. After Larry, our Executive Vice President and CFO, Dave Denton, will review our financials and guidance. John Roberts, President of PBM, and Mark Cosby, President of our retail business, are also with us today and will participate in the question-and-answer session following our prepared remarks. During the Q&A, please limit yourself to no more than two questions so we can provide more callers with the chance to ask their questions. Just before this call, we posted a slide presentation on our website that summarizes the information you will hear today, as well as key facts and figures regarding our operating performance and guidance. I encourage you to take a look at that. Additionally, we plan to file our quarterly report on Form 10-Q by the close of business today and it will be available through our website at that time. During this call, we’ll use some non-GAAP financial measures when talking about our company’s performance, mainly free cash flow, EBITDA and adjusted EPS. In accordance with SEC regulations, you can find the definitions of these non-GAAP items as well as reconciliations to comparable GAAP measures on the Investor Relations portion of our website. And, as always, today's call is being simulcast on our website and it will be archived there following the call for one year. Now before we 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 in our upcoming quarterly report on Form 10-Q. And now I'll turn this over to Larry Merlo.

Well, thanks Nancy. Good morning everyone and thanks for joining us today. Let me begin by saying that we are very pleased with the strong first quarter results. As expected, the influx of new generic drugs was a key driver of our year-over-year profit growth across the enterprise. And that said, both our retail and PBM segments delivered operating profit growth well above our expectations for the quarter. And this out performance was driven by stronger than expected script volumes due in large part to the strong flu season, strong specialty growth and favorable purchasing and rebate economics. Adjusted earnings per share from continuing operations for the quarter came in $0.83, that $0.03 above the high end of our guidance. And we also generated $1.3 billion in free cash flow and we remained committed to our disciplined approach to capital allocation, continuing to focus on returning significant value to your shareholders through dividends and share repurchases. Now given our strong results in the first quarter and the fact that it is still very early in the year, we are narrowing our guidance range for 2013 by raising the low-end of the range $0.03. And Dave will provide the details of our guidance during his financial review. But please note that this guidance takes into account the expected impact on our Medicare Part D business from sequestration. And it also includes costs in our Med D business associated with resolving issues that arose following plan consolidation at the beginning of the year. We now expect to achieve adjusted EPS for '13 in the range of $3.89 to $4. And with these first quarter results, the year is off to a great start. So with that, let me provide a business update and I will start with the PBM. As it relates…

Thank you, Larry, and good morning everyone. Today I will give a detailed review of our first quarter results, then I will provide the guidance for the second quarter and update our full year 2013 outlook. But before I get to that, I want to highlight how we have been enhancing shareholder value through our disciplined capital allocation program. During the first quarter, we paid approximately $277 million in dividends and given our continued strong earnings outlook this year, we remain on track to achieve our targeted payout ratio of 25% by the end of this year, two years ahead of our original schedule. Additionally, we have purchased approximately 7.4 million shares for approximately $393 million at an average price of $53.24 per share. And we still expect to complete $4 billion of share repurchases for the full year 2013. So between dividends and share repurchases, we returned approximately $670 million to our shareholders in the first quarter alone and we continue to expect to return approximately $5 billion for the full year. We generated approximately $1.3 billion of free cash in the first quarter, and we have made excellent progress in reducing our cash cycle. In fact, through the first quarter, we have taken nearly two weeks out of our cash cycle over the course of the last nine quarters. The improvement has been greatest within inventory but all drivers have benefited from our increased commitment to extracting value from our value tree. We remain committed to further improvements as we look into the future. Now given the issues we experienced following our Medicare Part D consolidation earlier this year, we may have some timing issues with respect to CMS payables and receivables that affect our cash flow delivery for this year. While we are maintaining our guidance for…

Thanks Dave and I think as you just heard it, Dave described this was a very solid quarter with strong financial results across the board and again the year is off to a great start. We continue to be excited by the opportunities to bring meaningful solutions to today’s healthcare challenges and we strongly believe we are very well positioned to do so. And with that, why don’t we go ahead and open it up for your questions?

(Operator Instructions) Our first question coming from the line of Dane Leone with Macquarie. Please proceed with your question.

Congrats on a great quarter. I was just wondering if you could put out a ballpark EPS from sequestration just to help us understand how that hedge flows through the P&L and the direct reflection into the guidance update that you said.

This is Dave. I can answer that generally. We’re not going to give a specific number to that. I think what’s important is that it doesn’t affect all of our lives. It only affects those lives that are directly subsidized by the federal government and part of our capitated program which is about 3.6 million members.

I guess we can work through the math there. This is more of a high level question, so not to anyone specifically, but food for thought. We’ve seen a very tepid employment recovery in the U.S. Sequestration is posing an additional headwind. We’ve seen the overall unemployment rate hold steady but the labor participation rate has been dropping essentially implying that there would be more individuals on insurance population right now and that’s actually increasing. When you speak about the 50% horizon in MinuteClinic, are you seeing a higher amount of uninsured come through clinic that’s driving the demand volume there? And I guess maybe any broader color on how you see the cyclical strength in unemployment impacting the business would be great.

Yeah. As it relates to MinuteClinic, actually it's the opposite. We are seeing a growing number of MinuteClinic visits accompanied by some type of health insurance, which I think is really representative of the fact that it becomes a high quality lower cost option for employers, for health plans, and I remember in the early days we had about 20% of visits that were covered by some type of insurance. That number is approaching, it's not there yet, but it's approaching 90%. In terms of the unemployment, I think we continue to see on the retail side a cautious consumer and we continue to look for differentiated ways to bring value to that consumer through our ExtraCare program. And I think on the PBM side, we have projected that utilization would be relatively flat and that’s pretty much what we are seeing.

Thank you. Our next question is coming from the line of Robert Willoughby with Bank of America Merrill Lynch. Please proceed with your question.

Larry or Dave, can you comment just on the renewal process for Caremark's pharmacy agreements with Walgreens. What's really changed in the dynamics here, what do bring new to that table that might afford you some leverage?

Well, Robert, I think while we don’t talk about specific contracts, okay, I think we have continued to work with all of the providers in terms of bringing value to the overall equation in terms of providing access, and at the same time insuring that we are working on behalf of our clients to make pharmacy care affordable. And I think that that our management team has done a very effective job in that regard.

Any sense of how big Walgreens is in your pharmacy networks today from a volume perspective versus three years ago?

We are not going to get into these specifics. We haven’t disclosed that.

Thank you. Our next question is coming from the line of Matthew Fassler with Goldman Sachs. Please proceed with your question.

Two quick questions, if I could, on the PBM side. First of all, you maintained your claims guidance for the year I think despite somewhat better first quarter. If you could talk about the drivers thereof, I don’t think sequestration would rally factor into volumes but any color there would be great.

Yeah, this is Dave. Sequestration will not factor into volumes. So I think as you saw, we had a very solid first quarter from a volume perspective. I think you know, we are only a few months into the full year so I think our trends look promising but we don’t see a trend that is changing substantially other than the fact that we again had a very solid flu season for the first -- like in the January- February period.

That’s helpful. And secondly, just any update you can give us on the selling season to date and any impact that healthcare reform might be having on your clients as they think about [switching] renewing etcetera?

Yeah, Matt, this is John. As we talked to our employer clients, they are clearly focused on the administrative requirements for healthcare reforms. As an example, tracking hours for part-time employees. So I think as a result of that, we are actually seeing fewer RFPs in that part of the marketplace than we did a year ago. But when you look at the overall dollars that have come to the market, it's actually up a little bit.

Thank you. Our next question is coming from the line of Steven Valiquette with UBS. Please proceed with your question.

A couple of questions here. First, is this carry from the moratorium on the marketing for Part D, just to clarify, does that apply just Silver Script individual Part D or does that potentially impact some of the group Part D EGWPs as well?

No. it applies to the SilverScript. And keep in mind that we manage for our health plan customers their products and this does not apply to that segment.

And then also just -- go ahead.

I‘m sorry, this is John. The other thing I would add is on EGWPs clients, they have people aging into their plans throughout the year. And so if we are able to administer that and enroll those people in Medicare.

Just a quick question on the Medicare eligibles within the employer clients. The RDS or Retiree Drug Subsidy conversions to -- I’m assuming you would probably convert either to EGWPs or to individual Part D just given your footprint. But just curious where we stand on that process, whether most of that may have already occurred by 1/1/13 or some of that is still ahead of us for 1/1/14?

This is John, Steve. So we did see some migration in 2013 to EGWPs. I think with the advent of thee healthcare reform, I think employers are going to continue to or will take a wait and see attitude to see how the exchanges perform, but over time we do expect to see a subset of the employer market either continuing to move their members into EGWPs or moving them potentially directly into the exchanges.

Steve, just to add one further point of clarity as it relates to your Med D question around SilverScript. We continue to work with employer customers who have an EGWP or who are planning to implement an EGWP to keep them updated on the status of the sanctions. We cannot market say to those EGWP clients until the sanction is removed.

Most of those conversions presumably would happen on 1/1/14, right? So as long as you resolve it sometime in the next call it three to six months like you’d talked about it shouldn’t really impact the business at all as long as there is decent time before 1/1/14. Is that the way to think about that?

That’s correct Steve and as we mentioned in our prepared remarks we have made great progress on our plan and that’s exactly our goal, working closely with CMS.

Our next question coming from the line of Tiffany Kanaga with Citigroup. Please proceed with your question.

I'm calling from Deborah Weinswig's team. What do you expect for the cadence of share repurchases for the balance of the year in order to hit your $4 billion full year target?

Tiffany, this is Dave. We’re very committed to returning significance back to our shareholders, both in the form of dividends and share repurchases. I think our share repurchases were a tad light in the first quarter. We said that generally speaking that the cadence would follow the same pattern as last year. so I would anticipate if you just looked out, looked at last year, that cadence and compared it to what’s left of the remaining of this year is probably the best way to model it at this point in time.

Can you give us an update on how digital initiatives are driving topline and margins and how your strategy's evolving now that you appointed Brian as Chief Digital Officer?

This is Mark Cosby. I’ll come from a couple of angles. Just overall digital a number of new things that have come into play over the course of the last little while. At the end of the last year we updated our digital site itself and it’s significantly easier to use. We’ve also done a couple of things from a mobile standpoint that have been big drivers for us. We launched a five star rated mobile application towards the tail end of last year that is performing very well for us. And then most recently this last month we came up with a version for the iPad which is essentially a virtual store. If you haven’t used it I would encourage you to get on and try it. But it’s also coming out with some rave reviews. So, all of these things in addition to some other initiatives that we have coming forward are enabling personalization. Digital is just one mechanism that we’re using to drive that effort.

Tiffany, I’d just add one point. I think that some of the things that Mark is alluding to has really advanced our digital capabilities. More from a utility or a utilization point of view versus a product point of view. And we have gotten very high marks from consumers on some of the more recent releases in terms of how this is making it easier for them to shop both in the front-store as well as the pharmacy.

Thank you. Our next question is coming from the line of John Heinbockel with Guggenheim Securities. Please proceed with your question.

Two things, Larry. So when you think about the renewal of the wholesales relationships with McKesson and Cardinal, what was the thought process behind that, we are dealing with pretty basics, but the thought process, what you might be doing differently in those contracts that you weren’t before? And then promise of daily delivery and whether you are playing around with that today?

John, I mean, as you know, we remain one of the largest purchasers of pharmacy in the country. We essentially buy all of our generics directly from manufacturers and consolidate the vast majority of brand purchases with our wholesalers and then engage them for deliveries to our stores between fill-in deliveries from our own distribution centers. And we are pleased with the results of the wholesaler RFP and was announced last week, we have contracts with both Cardinal and McKesson. They both do a great job for us and we feel that we are getting the best economics this way if it allows us to create, I will say, the most efficient network. And it also provides for us a safe, continuous and cost effective supply chain. So we have always looked at the ways in which we can provide further innovation. And I am sure that we have got some pilots that are in the planning process, and, again, we are always open to ways in which we can take costs out of the supply chain and we will continue to push the envelope around that.

Is daily delivery a thing of interest to you?

John, we have experimented with that in the past and we -- keep in mind the arrangements with our wholesalers provide daily delivery today. So, quite frankly, we are pretty pleased with the process that exists today. But, again, we will continue to push the envelope and look for new ways or perhaps changes in the marketplace that creates new opportunities.

And then lastly, just on the front-end, would it be fair to say that front-end growth is basically flat and if you then think going forward -- because we keep hearing rumblings, competitive activity picking up a little bit. A lot of people are unhappy with their traffic. What do you see now and where do you think that goes if traffic remains light for a lot of these guys, lot of your competitors?

Look, John, maybe I will start here and then as Mark to jump in. The first quarter was -- on front traffic it was probably a little lumpy. We had acknowledged it was down overall. We got some benefits from the flu season early in the quarter but that was compromised by a lot of uneven weather patterns and then of course we were going up against having an extra day last year from leap day. And all that Mark talked about, some of the things that his team is working on, acknowledging that we continue to have this cautious consumer who is looking for value.

I think the other thing just to add, and Larry had it in his comments, was that the share, you know we picked up share in both, in drug world as well as outside in the multiunit world. So from that perspective it was good. The number one thing we are working on in the front to get traffic into a better place falls under the headline of personalization. I mentioned a few things when we talked about digital earlier. But it's all about providing unique engagement to the customers through all the ways that they use it. From service, products and promotion. ExtraCare is the piece, really the center piece of all that. As you know, we have a 15-year history with that program. It’s very effective and we know through that 15 years that it’s more than just issuing cards. That’s the easy part. It’s about the data that we use and how we engage with customers given what we know and been very successful over years, but not resting on our laurels. We had a couple of programs coming out over the last couple of years that have been effective for us. The Beauty Club that launched has been very effective. We also just two months ago launched a pharmacy and health rewards program which is about encouraging adherence, retention and acquisition. And then the biggest thing that we’re doing that we talked about at Analyst Day was this program we call Conversion which is customer specific opportunities to drive frequency basket and profit growth. Two growth drivers there, what we call Pure Conversion, getting customers who are in our store today to buy more broadly across the store. And then the other piece that we call Share of Wallet which is about getting people to buy…

Hey John, let me just underscore one point because we’ve gotten a lot of questions because the royalty space is a lot more active today than it was a couple of years ago. And Mark mentioned that issuing the cards is the easy part and we know that because we’ve probably issued more than 300 million cards over the life of ExtraCare. But what’s a lot harder is driving real changes in consumer behavior and I think that Mark outlined an awful lot of activities that we have underway that really allow us to optimize our promotion and maximize incremental sales to drive share in a very effective and efficient pattern. And we have not seen any declines in our ExtraCare activity as a result of some of our competitors getting into the royalty space.

Our next question coming from the line of Ricky Goldwasser with Morgan Stanley. Please proceed with your question.

Have a couple questions. First of all on the selling season, John, I think you talked about the fact that the overall dollars are up a little this year despite the fact that RFPs are lower. So can you talk a little bit more, can you expand on what type of clients are you seeing this year. And yesterday it was reported that you won Blue Cross Blue Shield contract. Are you expecting to see more movement within the managed care side?

Ricky, so we have seen some health plans early on. I’m not sure you’ll see a lot more moves this late in the season, but CareFirst was a good example of a very sophisticated health plan. Very pleased to have been awarded the business for a 1/1/14 start and it’s a full service contract for retail mail on specialty. So that being said it’s still early in the season and we’ll have more to say on our next call about how things are going. But fewer contracts. I think the contracts that are out there are obviously bigger if the dollars are slightly up.

So should we assume that it's just a bigger contract or not necessarily a large employer, but more --?

Yeah. I think you could assume that.

Ricky, I think one of the things we heard at the client forum that I alluded to, was that clients are very consumer with input -- with doing all the things that need to be done as part of the implementation of the Affordable Care Act in January. So I think we walked away with the sense that maybe there is some -- people have a lot on their plates right now.

Okay. And then one technical question. When we model the impact from sequestration and the costs that are associated with the Part D, how should we think about it, like of where would it flow through your P&L? Does it flow through the PBM segment and if so, should we adjust kind of like the top line for sequestration? And then cost of goods for Part D?

It does. Ricky, keep in mind that it was effected I think April 1, so it's really a nine month affect to it. I would say from a modeling perspective, it's probably -- you are probably not going to see it, it's just not big enough to call out that much.

Okay. So based on the number that you gave in the beginning of the call, we kind of like [did that standalone] somewhere on like the $0.02 to $0.05 drain. So are we in the ballpark or is the impact more muted than that?

Ricky, I can't comment on that. But I think what would be important to do is, kind of go back and understand the fact that it covers nine months, it affects only the direct subsidy that we receive from the federal government for our Silver Script plan. And if you just kind of went back and look at the national bid, look at the member premiums and kind of do the math, you could get into the amount that’s affected by the 2%. So I would encourage you maybe to do that math.

Thank you. Our next question is coming from the line of Ross Muken with ISI Group. Please proceed with your question.

So you guys had a number of new innovative solutions on the PBM side over the last couple of months. With the 2.0 program and sort of what you are doing around specialty and specialty retail, I mean where are you seeing the most interest from the customer base particularly on the employer side for several of these offerings. And then also on the exchange side, as you think about some of the reform coming down the line, how do you feel like MinuteClinic is kind of playing into that piece? And do you feel like that strength there gives you any advantage for that sort of opportunity?

Yeah, Ross, let me start here and then John will jump in. But, again, just coming back from our client forum a few weeks ago, I was very excited in terms of, some of the things that you have mentioned, whether it's Maintenance Choice 2.0, all of the specialty initiatives that we have underway and as well as the interest in MinuteClinic, I came back and said, the things that we are working on are very, very much aligned with what clients are most worried about and looking for solutions. And I will let John pick it up from there to get little more specific.

So when we talk to clients on what their priorities are, it's obviously managing cost for both the plan and the number. So I think that’s why Maintenance Choice has been so embraced by the marketplace. And Larry talked about the growth from where we were in '12 up to $16.3 million numbers in '13. Combined with Maintenance Choice we are seeing interest in narrow networks, preferred networks. Again, I think clients are looking for ways to manage their direct cost. The other thing that clearly is a top priority is specialty. And we have talked about the trends in specialty, the clients are seeing that it's becoming a bigger part of their overall drug spend, and half of it is somewhat hidden under the medical benefit. So as we talk to clients about our capabilities to manage specialty across both pharmacy and medical, there is a high level of interest. And we actually have employer clients that are working with us with their health plans to move programs forward to manage that. And I think the last thing I’ll mention is employers get the value of keeping their members on medication and lowering overall healthcare costs. So that’s really our Pharmacy Advisor program and everything we’re doing around adherence. The fact that we’ve expanded. We now have 10 conditions on our Pharmacy Advisor program. We now have Pharmacy Advisor in Medicare to help our clients with their Stars programs. And then just to what Larry said around MinuteClinic, for our clients we can offer a reduced copay or a zero copay for their members. So we’re able to extend the benefits to their members at no additional cost, make primary care more accessible for them. So it’s really a win, win, win. But that’s what we’re hearing from our clients around what their priorities are.

Our next question coming from the line of Lisa Gill with JPMorgan. Please proceed with your question.

Larry, I was wondering if could you maybe give us your initial thoughts around ACA from the drug retail side and maybe if Mark wants to chime in, are you signing early preferred type relationships on the Retail Pharmacy side, whether it's with managed care entities or some of the private exchanges? How should we think about Retail in 2014, 2015, as these exchanges are rolling out?

Lisa, it’s a great question and obviously there are an awful lot of discussions taking place. And I would talk about the fact that those discussions are being had in CVS Caremark, that we can do much more than just provide a retail distribution point for exchanges in their members. And it really picks up where John left of in terms of an awful lot of very robust conversations in terms of the role that retail pharmacy plays along with the role that our MinuteClinics play when you think about providing primary care and chronic care support. So I think we’re probably still a little early to talk about anything definitive. But an awful lot of interest in terms of what CVS Caremark can offer. I think specifically as you think about retail, I think that if you go back to the implementation of Medicare Part D I think pharmacists across the country played a key role in terms of educating and helping seniors enroll in the Medicare Part D program. And I certainly see a role that our pharmacists can and will play around education and information for members or potential members as they think about what it is that they are going to need to do to enroll in exchanges. And we’re certainly looking to be very active from an education and infuriation perspective.

So Larry, would you anticipate that we will see -- we have talked to some of the managed care guys that have said hey there's 68,000 retail pharmacies, we probably don't need that many. They can envision doing half of the retail pharmacies and having someone like a CVS as an anchor. Are those the conversations that you're having at this point and do you think that's the direction it will move in or is it too early to say because we're very early in the discussion?

Yeah, I think it’s still too early. I think that the discussions that we’ve had probably across the gambit of all different possibilities. My sense is that at least for this first year it’s going to be a learning laboratory for everyone. And I think that there’s probably -- my sense is that there’ll probably be a little more conservatism in terms of how people think about it until some of those learnings kick in and people can be perhaps a little more definitive in terms of where the market is headed.

And then I guess my second question just would be around specialty. Clearly great growth in specialty. Continues to be something that plan sponsors are looking for. Can you help us understand how many of your customers buy specialty from you today on the PBM side? So what are the future opportunities? One, is it expansion to the rest of your PBM customers? Two, opportunities for restrictive networks around specialty? How do we think about that opportunity over the next couple of years? Thanks.

So Lisa, I would think about it in two buckets. One is with our employer clients, the vast majority of employer clients have exclusive arrangements with us around specialty. So all of their specialty spend is going through our channel. With health plans, they tend to take an approach of having several specialty providers and we work with those health plans to make sure that we are getting not only our fair share, but with our capabilities, more than our fair share. And so they may limit it two providers to half a dozen providers. And then you have the open market where those numbers can really go really anywhere. And I think that links in to what we are doing with our integrated specialty solution. And we have got people that are calling on these specialty positions talking about our capabilities and working with them to get those referrals into our channels because we are easy to do business with, for the physician and for the member. So I think you are going to see -- we think specialty is going to be one of the fastest growing areas because if you look at the drug pipeline, in 2016 eight of the top ten drugs by revenue are going to be specialty. That’s clearly where pharmas focus from a pipeline perspective. And I think you are going to see not only new drugs in the same categories but I think you are going to see the expansion of the drugs into new categories of specialty. So I see tremendous growth which is why we are as focused as we are on a holistic approach and solution to specialty, so that we can manage the member as they progress in their disease state from a pharmacy benefit to a medical benefit than in managing appropriate care, appropriate therapy and making sure they are getting their specialty med at the most cost effective site.

Thank you. Our next question is coming from the line of Meredith Adler with Barclays Capital. Please proceed with your question.

I think I am still a little bit confused about things you expect to happen in Medicare Part D at the end of the year. Obviously, there is sequestration. I think you have been clear about which of your members will be impacted by it. I guess I am little less clear about the guidance you have given and what that reflects in terms of the sanctions from CMS. Is there something in your guidance that is assuming some probability that you don’t get this resolved before the next selling season? Or are there just other costs associated with that in the numbers?

Meredith, first and foremost, I think that is largely a 2014 topic as it relates to our ability to accept auto assignees in the back half of the year. So it's not really more but it's not really a '13 issue, it's more of a '14 issue. Clearly, our guidance is comprehensive of all the cost and effort that we think is required to, one, correct the situation, and two, insure that the situation will never happen again, and three, go through any remediation effort that we need to get done to make sure that our members are served appropriately and CMS is satisfied that we are fully in compliance and we have no issues. And, finally, it does assume that we are not adding any additional lives. Because we at this point of time cannot mark it from a Silver Script perspective and so there is no lives being added to our book. In fact lives, due to attrition, are slightly declining month over month. And it maybe -- Meredith, the sequestration question keeps coming up. So maybe I will take a step back and give you a little bit of color on that. And just to put this in perspective, sequestration as it relates to our Silver Script insurance business for the nine months, is probably going to impact us to the tune of $0.01 to $0.02, somewhere in that ballpark is probably a good estimate at this point in time. As it relates to -- again, that's the effect of government sequestration on business for this year.

Well, I guess I am just so struggling to understand, you have had a fantastic first quarter, and congratulations, and guidance for the second quarter is above where the Street is. So I am just kind of struggling to know why the year didn’t change, it's not very big impact from sequestration unless you think the cost in terms of the sanctions are going to up substantially --

Well, Meredith a couple of things. First and foremost we’ve said very clearly that our performance for this year is going to be somewhat front half loaded versus back half loaded due to the influx of generics and the timing of the break open status of those generics. And so you’re seeing that play out. Secondly we do -- as we said, we do have some costs in the back half of the year and the first half certainly through the first quarter a lot of that was related to the incidents of flu volume being pretty high, driving volume. We’re again just a few months into the year. I think our outlook looks very solid. But I think it’s just too early to predict how the rest of the year is going to play out. We’re very comfortable with where we stand, but we’re -- I think as you know we’re one quarter in to a four quarter year and we’re going to play this out.

That's very helpful.

And Meredith, as you know, we have not raised guidance based on first quarter results for the reasons that Dave mentioned in terms of we still have most of the year still ahead of us. And as Dave mentioned, we remain very confident in our guidance and outlook for the year. But that’s something that we’ll continue to obviously talk about as we get more of the year behind us.

Our next question coming from the line of Edward Kelly with Credit Suisse. Please proceed with your question.

Nice quarter. Dave, just to start off, a quick question for you on the free cash flow guidance. I guess the tone of your voice sounds like maybe there is a little risk around that if you can't mitigate the CMS stuff. Is that fair? Are we talking about a material number or is it small?

Well, I think as you know we had -- we’re not changing our guidance from a cash flow perspective. As we said clearly at the first of the year we had some systems issues that affected our Medicare Part D business and the result of that is really changing where we anticipated our receivables and payables to be at the end of this year with the federal government. So it’s really more of a timing issue as it relates to ’13 versus ’14. I’d say we’re working hard to offset those and we’re optimistic that we can do that, but I just want to make sure that everybody understands where we stand at this point in time.

And then Larry, just a question for you on adherence. You talked about the savings. My question for you is how do you really measure that? How do you market that to clients and actually get paid for it? Is it just in your scripts or is it in additional PBM wins or is there some other way?

Let me start then. Again John will jump in here. But we have built a pharmacy care economic model where we can actually evaluate on a client by client basis, looking at claims. The opportunities that we believe we have to improve adherence and a corresponding benefit in terms of overall healthcare costs. And we’re actually beginning to guarantee savings associated with that. And quite frankly it’s very consistent with what you’re seeing in the star ratings in the Medicare program in terms of this aspect of clinical if you will being a component of that evaluation.

This is John. To add to that, PBM traditionally have managed bad trends and we continue to do that and clients want us focused on that. But they also realize the good trends or having their members take more medication lowers overall healthcare cost. So we’re able to as Larry said show into a specific client and with the pharmacy care economic model show where their members are, what the opportunity is and if we get them in here what the medical savings are. There’s buy-ups for certain programs and we guarantee returns for their investments. And clearly when you say are we seeing more wins in the market? As the market moves to taking more risk for overall healthcare costs, we believe this program offers a competitive advantage. We publish our results around Pharmacy Advisor in peer reviewed journals. Troy Brennan, I think has done a terrific job, our Chief Medical Officer, in validating our activities and publishing those results so that they are credible from a client perspective. I think that does lead to more wins in the marketplace, particularly for those clients that are assuming more risk with healthcare reform.

And I think what we are talking about here is really the beginning of what will be a new, I’ll call it reimbursement model, okay. That really ties to outcomes management, people have been talking about this for years, but no one has figured out a way to quantify it. And we believe -- not believe, we know we are on the leading edge of actually building the underpinnings with which to do that as we go forward. And it think that we are probably in the first or second inning of the nine inning game here, but we believe that this is a big idea in where the market needs to head when you think about the rising costs of healthcare and what clients are expecting from us. And, quite frankly, what they pay us to do for them and their members. Maybe, we will take two more questions, I think.

Thank you. Our next question is coming from the line of Tom Gallucci with Lazard Asset Management. Please proceed with your question.

I guess first question is on the purchasing and the rebate economics. I am not sure I heard you really get into what some of those drivers were. Are we talking about some of the formulary changes that you made or other benefit design changes that the clients are making? Can you help us understand where that’s coming from?

Again, we continue to -- this is Dave, and I will ask John to chime in here a little bit. We continue to push each and every day on how to more (inaudible) for the clients and members that we serve. Part of that is through how they go back and work with either branded manufacturers or generic manufacturers to lower cost or increase the rebate yield. And I think we continue to be pretty successful in that area. And this is probably not one answer at the end of the day. There is a lot of things that are across our business that we are doing. Whether that be changes in our formulary, whether that be changes in our UM program, whether it be how we tailor our programs to drive value in this area.

Yes. So there is two ways to drive value. One is through rebates, which the vast majority of that value gets passed to our clients and we do that through our formulary strategy which has been very successful. And making sure appropriate branded drugs area available but we negotiate very aggressively with manufacturers to bring the net cost down for our clients. The other thing is, with all the generics that have come to the market over the last couple of years, there are now, in most therapeutic categories, enough generics that provide appropriate level of care. So we also have available for our clients, what we describe as a value formulary which limits even further branded drugs that are available and boosts the overall generic fill rate across that clients book of business and deliver savings in that way. So we offer programs that have a lot of flexibility that deliver a lot of savings and value for our clients and we continue to work very hard to bring them new value each and every year.

And then another topic, you have touched on a little bit but I wondered if you could go a little bit more in depth. You are hearing a lot more out there, especially with some of the competition about having the medical benefit and the pharmacy benefits under one roof to more effectively manage, particularly the specialty area. I thought it was interesting I think about CareFirst release, they talked about your supported integrating pharmacy data and their data. Can you talk about some of your capability as how you sort of sell against the in-house model in this area?

Yes. So our capabilities allow us, and I will talk about CareFirst because we think supporting our clients in this integrated model makes a lot of sense. And PBM is traditionally managed specialty under the pharmacy benefit and the health plan has managed specialty under the medical benefit. And as that member moves across those benefits there's handoffs that have taken place. So our capabilities now allow us on behalf of CareFirst, to manage that specialty part of their spend and those members much more effectively than they were in the past. I think as a standalone PBM, we can do the same thing. And we can integrate with employers’ health plans to do the very same thing. So it really, with large employers they have multiple health plans. So, we think our model resonates because they have one provider managing that overall spent. With the smaller employers that may have a single health plan, we think partnering with our health plans to provide those same services makes sense for that book of business too. So we can support both ways and we think both ways are very effective.

Thank you. Our last question is coming from the line of Eric Bosshard with Cleveland Research. Please proceed with your question.

In your prepared remarks you talked a couple of times about favorable rebate economics. I am curious if you could give us a little bit of color or further color on what that is referring to? And also interested if the generic payback period and where that trend goes from here in terms of generic benefit, how that should play out from here as we work through year and into next year?

Well, this is Dave, Eric. Maybe I will kick it off and ask John. Again, I think from a rebate perspective, again, it's a lot of little things that we are doing across our book of business to drive favorable economics for our clients. And this gets back to very specifically focusing on the formulary verse specifically focusing on the _ leveraging all the programs that we have in place to drive value for our members and the clients. And that drives again rebate performance. That drives back a little bit to reducing cost of goods sold for our clients. And we shared some of that. I think from a generics perspective we’re in a very heightened time period which the generic utilization continues to expand. The generic pipelines do look robust for quite frankly for the next several years. We’re working very effectively across our book of business, not only to drive economics in generics, but also improve performance from a generic penetration adherence perspective. And I think all of those drive value for us and for our clients.

Eric, let me just add one point to what point Dave mentioned and it goes back to the formulary because we still get questions every now and then. We had a lot of noise two years ago when we made the formulary changes that as we’ve acknowledged many times that the strategy was absolutely spot on and I think that your question is really an extension of what clients are now experiencing at the benefit of that strategy. I think what we had acknowledged was right strategy. We needed to do a better job from an execution point of view, largely tied to the timing of the communication. So the clients have certainty around the new plan year and all the changes that would take place. So that was a good learning for us. But I think that we’re seeing the financial benefits of that as we speak. Listen, I’ll just wrap up here. And we certainly appreciate everyone’s time today, appreciate the questions. I think the questions had been very much aligned with where we’re making investments in the business, investments that are aligned with our clients’ expectations and needs. And while we know we have many challenges ahead of us in the healthcare space we are certainly excited by the opportunities that we have to bring meaningful solutions. So thanks for your time again this morning and we’ll talk to you soon.

Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines. Have a great day.