Ladies and gentlemen, thank you for standing by. Welcome to the CVS Health Fourth Quarter Earnings Call. [Operator Instructions] As a reminder, this conference is being recorded, Tuesday, February 10, 2015. .

I would now like to turn this conference over to Nancy Christal, Senior VP of Investor Relations. Please proceed. .

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

Jon Roberts, President of the PBM; and Helena Foulkes, President of Retail business, are also with us today and they'll participate in the question and answer session following our prepared remarks. [Operator Instructions].

Just before this call, we posted a slide presentation on our website. The slides summarized the information you'll hear today, as well as some additional facts and figures regarding our operating performance and guidance. Additionally, note that our Form 10-K will be filed later this afternoon, and it will be available on our website at that time. .

Please note that during today's presentation, we'll make forward-looking statements within the meaning of the federal securities laws. By their nature, all forward-looking statements involve risks and uncertainties.

Actual results may differ materially from those contemplated by the forward-looking statements for a number of reasons as described in our SEC filings, including the Risk Factors section and cautionary statement disclosures in those filings. .

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

And as always, today's call is being simulcast on our website, and it will be archived there following the call for 1 year. .

And now, I'll turn this over to our CEO, Larry Merlo. .

Well, thanks, Nancy. Good morning, everyone, and thanks for joining us today. This call wraps up 2014, and it was a great year for our company by any measure.

We delivered approximately 10% growth in consolidated revenues, 14% growth in PBM operating profit, 8% growth in retail operating profit and 13.5% growth in adjusted earnings per share on a comparable basis. .

On a quarterly basis, we have consistently posted solid financial results and the fourth quarter was no exception. Adjusted earnings per share increased 8.4% to $1.21 per share at the high end of our guidance range. And both the PBM and Retail segments exceeded our revenue expectations.

Operating profit in the Retail business grew 6.5%, just above the high end of our expectations, while operating profit in the PBM increased about 1%, right in line with expectations. .

Additionally, we generated $2.9 billion of free cash in the quarter and $6.5 billion for the full year, exceeding our expectations. Also today, we are reconfirming the 2015 earnings guidance we provided back in December, and Dave will provide the details behind our fourth quarter results and 2015 guidance during his review. .

So let me turn to the business update, and I'll start with the 2015 PBM selling season. Gross client wins for '15 currently stand at $7 billion with net new business at $3.6 billion, both up approximately $400 million from our update back in December. And this excludes any impact from our SilverScript PDP, which I'll address shortly. .

Now like the past several years, our success in the '15 selling season reflects our high levels of service and execution, competitive pricing, along with our unique integrated model.

And our model allows us to provide differentiated products and services that generate savings for our clients, while providing better health outcomes and convenience for their members. .

Now with $7 billion in new business, encompassing about 150 new clients serving millions of new members, 2015 was the largest and most complex welcome season in our history. And as we stated previously, we invested to ensure a successful welcome season, and that took months of rigorous planning.

The investments we made were well worth it and I want to take a minute to express how pleased we are with the extraordinary and successful welcome season we've had. .

The feedback we've received from clients and consultants has been extremely positive, and I'm very proud of the collective efforts of our colleagues. Now we expect our track record of success in winning and retaining business to continue in the 2016 selling season, which is now underway. .

Now many of you have asked what our clients are focused on. And the #1 priority centers on controlling their rapidly rising specialty costs. And we're bringing them an array of differentiated solutions. Our Specialty Connect offering, which was rolled out by May of '14, is gaining client interest and traction in the marketplace.

The program provides a choice to receive a member specialty script at CVS retail or mail, while preserving the central clinical expertise that leads to better health outcomes. And physicians appreciate the ease of getting their patients started on therapy, no other PBM can offer this today. .

Clients are also interested in ways to manage specialty costs that fall under the medical benefit, and our NovoLogix solution continues to resonate in the market. Overall, our specialty capabilities enable us to provide strong clinical support to patients, while managing trend for our clients in this strategy is producing results. .

In fact, specialty revenues were up a very healthy 56% versus the same quarter last year, that was driven by new business, the high-cost Hep C drugs and the addition of the Coram Infusion business.

Combined, our innovative offerings enable us to optimize cost, quality and access, and should continue to drive share gains in this fast-growing specialty sector. .

Now as you know, another way we manage trend for clients is through our highly proactive approach to formulary management. We led the market with our formulary strategy for the 2012 plan year. And since then, we've updated our template formulary on an annual basis, and increasingly, specialty drugs are part of that strategy.

Our formulary process enables our clients to provide excellent access to care, while meeting their members' needs in the most clinical and cost-effective manner. .

Now in January, Gilead's Hep C drugs, Harvoni and Sovaldi, became exclusive on the CVS Caremark standard commercial, exchange, Medicare Part D and Medicaid formularies. Harvoni is the preferred agents for genotype 1. Sovaldi is the preferred agent for the treatment of other genotypes.

And our goal was to create the lowest net cost solution for the entire population of patients with all Hep C genotypes. .

We recognize the cost challenges, and we remain committed to providing solutions for clients that choose to treat all their patients, as well as those who feel it makes more sense to prioritize patients with the more advanced stages of liver fibrosis.

We believe that our strategy meets patient needs, while delivering excellent value and clinical options for clients and their members. At the same time, our formulary strategy positions us well in the 2016 selling season. .

Now before turning to Retail, let me touch briefly on our SilverScript product. We ended 2014 with about 2.9 million individual PDP lives, that was right on plan, and very consistent with what we forecasted and communicated at our Analyst Day. We now have about 3.4 million individual PDP members, reflecting a successful annual enrollment period.

And we continue to be pleased with our progress in this growing area of the business. .

Moving on to retail, which produced solid results across the business even with the tobacco headwind. Now we've been tobacco-free since September, and here's what we've learned over the past 4 months. The negative impact to our front store sales has been slightly less than anticipated.

We know that the most heavily impacted categories are consistent with our expectations, but the magnitude of that impact on those categories has been a bit less than expected. .

Beyond the categories we expected to see impacted, other front store categories have not been negatively affected. And based on external data, it appears that our former tobacco sales have migrated largely to convenience stores and gas stations. There has been no discernible impact on our pharmacy business.

And since we launched our new CVS Health brand, customer awareness and response to the new branding campaign has been very positive, and we've seen a notable increase in customer perception of CVS as a leader. .

So let's review the fourth quarter retail results. Pharmacy same-store prescription unit volumes increased 5.3% on a 30-day equivalent basis, and we continue to gain pharmacy share. Our Retail Pharmacy market share was 21.1% in Q4, and that's up about 55 basis points versus the same quarter a year ago.

Pharmacy same-store sales increased 5.5% versus the same quarter last year. The incidence of flu did pick up a bit in the quarter, adding about 40 basis points to pharmacy comps. .

Pharmacy same-store sales also include the negative impacts of about 150 basis points due to recent generic introductions and another 190 basis points from the implementation of Specialty Connect. And you'll recall, Specialty Connect transfers specialty scripts from our Retail segment into our PBM segment.

Pharmacy margins increased again this quarter and were in line with our expectations. .

Now as we discussed previously, CVS has contracted with 20 regional and national Part D plans for 2015 where CVS is positioned as a preferred provider. And we've taken a disciplined approach to our participation in these networks, ensuring that margin compression and share analysis provide the right economics. .

Turning to the front store. We saw a continued decrease in traffic that was partially offset by an increase in the average customer basket. Front store comps were down 7.2%, and adjusting for the tobacco impact, front store comps would have been up 0.7%.

The impact of the tobacco exit was about 800 basis points, and that's about 100 basis points less than we anticipated. So again, 4 months into it, it's still early, but we're very pleased with these results. .

Front store margins benefited in the quarter from the tobacco exit. On a comparable basis to last year, including adjusting for the tobacco elimination, front store margins improved modestly.

And this underlying improvement in front store margin reflects our discipline in making responsible investments and promotion, along with the continued growth of store brands sales. In fact, we made great progress in store brand penetration in the quarter, with store brands increasing to 22% of front store sales.

And that's up about 310 basis points from Q4 last year and about 190 basis points of that improvement reflects the removal of tobacco from our mix. The other 120 basis point reflects underlying progress in our store brand penetration.

And we saw gains across health, beauty, general merchandise and edibles, and we see great opportunities to continue to garner store brand share. .

Turning to our store growth for the quarter. We opened 50 new stores, relocated 30, closed 7, resulting in 43 net new stores in the quarter.

And for the full year, we opened 151 new stores, acquired 33, relocated 60, closed 22, resulting in 162 net new stores, and we continue to enter some new markets including Little Rock, Arkansas and Seattle, Washington. So overall, our 2014 store growth equated to an increase in retail square footage of 2.4% and that was right in line with our plan. .

As for MinuteClinic, we opened 35 net new clinics in the quarter, 171 for the year, ending the year with 971 clinics in 31 states, plus the District of Columbia. And continuing on its very strong growth trajectory, MinuteClinic's revenues and customer visits increased 36% and 33%, respectively, versus the same quarter last year.

At year-end, we had 49 affiliations with major health systems across the country. We've recently added 2 new affiliations, further expanding our platform that supports primary care, both conveniently and cost-effectively. .

Let me update you on the progress that has been made at Red Oak Sourcing, our venture with Cardinal Health. And we are extremely pleased with the rapid progress Red Oak has made to date. The combined expertise of the Red Oak team, along with the simplicity of the business structure, has enabled them to hit the ground running.

They have been actively working with suppliers on strategies that create value for all parties and have now transitioned suppliers, representing more than 95% of the combined generic spend. And as expected, we received the first fixed quarterly payment from Cardinal in the fourth quarter, and we look forward to Red Oak's future contributions. .

Now before I turn it over to Dave, let me comment on the news surrounding Nexium. As you know, Teva recently received FDA approval for the generic, and we've received some questions on how that might impact our results.

And I just want to note that there are still many questions regarding the launch of generic Nexium, including potential legal maneuvers, the timing of launches, as well as the number of other manufacturers who could potentially launch. So we need clarity and answers for those questions before we can provide any more specifics. .

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

Thank you, Larry. Good morning, everyone. This morning, I'll provide a detailed review of our 2014 fourth quarter financial results and briefly touch upon our 2015 guidance, which remains unchanged from what we outlined back in December. .

First, I'll start with a wrap up of last year's capital allocation program, which would clearly demonstrate how we've been using our strong free cash flow to return value to our shareholders through both dividends as well as share repurchases. I'm pleased to say that we have continued on our steady march of improving our dividend payout ratio. .

Recall that back in 2010, that our payout ratio was approximately 14%. We finished 2014 with a payout ratio of 27.7%, almost double 2010's level and 4 percentage points higher than 2013. We paid approximately $1.3 billion in dividends in '14 and $317 million in the fourth quarter alone.

Our strong earnings outlook for this year, combined with a 27% increase to dividend that we announced at Analyst Day, puts us well on track to achieve our targeted payout ratio of 35% by 2018. .

Now along with these significant increases in our dividends, we have also continued to do value-enhancing share repurchases. For all of 2014, we repurchased approximately 51 million shares for $4 billion, averaging $77.91 per share. In the fourth quarter alone, we repurchased 14.1 million shares for $1.2 billion.

So between dividends and share repurchases, we've returned approximately $5.3 billion to our shareholders in 2014. .

And looking forward, we have $12.7 billion in authorization to repurchase shares, and we continue to expect to repurchase $6 billion this year. Our expectation is that we will return more than $7 billion to our shareholders in 2015 through a combination of both dividends and share repurchases, which is up more than 30% over last year. .

We generated $2.9 billion of free cash in the fourth quarter. In all of 2014, free cash flow increased $2.1 billion year-over-year to approximately $6.5 billion. The increase in cash generation was driven primarily by improvements in collections and payables management.

These were partially offset by growth in inventory and current assets, as well as increased investments and capital associated with technology and other corporate efforts. .

We had mentioned on our last earnings call that the 2014 free cash flow might exceed our guidance at the expense of 2015 guidance. And in fact, we did end the year $500 million above the high end of our goal. That was driven by the receipt of some late year payments a few days early.

Despite the higher-than-anticipated receivable collections in '14, the underlying strength of our cash flow allows us to maintain our free cash flow guidance for this year of $5.9 billion to $6.2 billion. .

Aside from these timing items within receivables, we continue to make strides in improving our cash cycle through better management of payables, and we remain committed to further improvements in working capital as we look forward. For the year, our net capital expenditures were $1.6 billion.

This included $2.1 billion of gross CapEx, offset by $515 million in sale-leaseback proceeds. .

And as for the income statement, adjusted earnings per share from continuing operations came in at $1.21 per share at the high end of our guidance. GAAP diluted EPS was $1.14 per share. We saw strong results across our operating segments with Retail posting results above the high end of our expectations. .

So with that, let me quickly walk down the P&L. On a consolidated basis, revenues in the fourth quarter increased 12.9% to $37.1 billion. In the PBM segment, net revenues increased 21.7% to $23.9 billion.

This year-over-year growth was attributable to specialty pharmacy, including the impact of Coram and Specialty Connect, as well as increased volumes in pharmacy network claims. .

Partially offsetting this growth was an increase in our generic dispensing rate, which grew approximately 125 basis points versus the same quarter of last year to 82.1%.

We saw strength on the top line versus our guidance due primarily to higher volumes than expected, particularly in Medicaid, drug price inflation and mix, including the new Hep C drugs. .

In our Retail business, revenues increased 2.9% in the quarter to $17.7 billion, driven primarily by strong pharmacy same-store sales growth, despite the transition of specialty revenues into the PBM segment due to Specialty Connect. Like the PBM, retail exceeded guidance due to higher volumes in pharmacy. .

Turning to gross margin. We reported 17.9% for the consolidated company in the quarter, a contraction of approximately 140 basis points compared to Q4 '13 and consistent with our expectations. Within the PBM segment, gross margins declined 100 basis points versus Q4 of '13 to 5.2%, while gross profit dollars increased 2.2% year-over-year.

The increase in gross profit dollars was primarily attributable to the increase in volumes, the improvement in GDR and favorable rebate economics. Partially offsetting these drivers was the impact of client and drug mix, as well as continuing client pricing pressures. .

Gross margins in the Retail segment was 31.4%, up approximately 65 basis points over LY.

This improvement was driven by the 140 basis point increase in retail GDR to 82.4%, the benefit to front store margins from the tobacco exit, increased store brand penetration, as well as the first quarterly payment we received from Cardinal as part of the Red Oak Sourcing venture.

Partially offsetting these drivers was the continued pressure on reimbursement rates. Gross profit dollars increased 5.2% in the quarter. Total operating expense as a percent of revenues notably improved from Q4 '13 to 11.6%. .

The PBM segment's SG&A rate improved by 20 basis points to 1.4%. We spent more on 1/1 readiness for the PBMs' welcome season than we expected. But with the over delivery of revenues in the quarter, we were able to deliver the modest improvement we had planned.

As reported, SG&A as a percent of sales in the Retail segment deteriorated by approximately 35 basis points to 21.3%. However, this was driven by the reduction in retail sales related to our decision to exit the tobacco category, as well as the impact of Specialty Connect, shifting again sales from our segment into the PBM.

On an underlying basis, SG&A as a percent of sales at Retail actually improved by approximately 50 basis points. .

Within the Corporate segment, expenses were up approximately $7 million to $205 million, again, within expectations. Operating margin for the total enterprise declined approximately 50 basis points in the quarter to 6.3%.

Operating margin in the PBM declined approximately 80 basis points to 3.8%, while operating margin at retail improved by approximately 35 basis points to 10.1%. .

For the quarter, we exceeded our estimates for operating profit growth in the Retail segment. Retail operating profit increased a solid 6.5%, exceeding expectations by approximately 25 basis points. PBM operating profit increased 0.9% in the middle of our guidance range. .

And now going below the line on the consolidated income statement. Net interest expense in the quarter decreased approximately $4 million from last year to $131 million. This was due primarily to lower average interest rates. Additionally, our effective tax rate was 39.6%.

Our weighted average share count was 1.2 billion shares, only slightly higher than anticipated. .

So with that, now let me touch on our 2015 guidance, which remains unchanged from Analyst Day. You can find the details in the slide presentation we posted on our website, but I'll focus on the highlights here.

We continue to expect to deliver adjusted earnings per share in '15 in the range of $5.05 to $5.19 per share, reflecting very healthy year-over-year growth, even after removing the impact in '14 related to the loss on the early extinguishment of debt. .

GAAP diluted EPS from continuing operations is expected to be in the range of $4.77 to $4.91 a share. We expect consolidated net revenue growth of 7% to 8.25%, which reflect solid underlying growth across the enterprise. Retail revenues are expected to increase by 1.25% to 2.5%, despite the negative impact of the tobacco exit. .

Recall that we expect the tobacco exit to have a negative impact on total same-store sales of approximately 175 basis points for the year. And it's expected to have a negative impact of approximately 575 basis points on front store comps for the year as well.

While the impact last quarter was a bit better than we expected, it's only been a few months since we became tobacco-free. So we're maintaining our initial guidance on the impact to our comps. .

We expect growth in PBM revenues of between 11% and 12.25%. We expect retail operating profit to increase 4.75% to 6.5% year-over-year and PBM operating profit to increase 6.75% to 10.75%. .

The first quarter guidance also remains unchanged from what we talked about in December. As you may recall, we highlighted several timing factors back at Analyst Day that affect the cadence of profit delivery throughout this year.

And while 2015 is expected to be a strong year, the cadence of profit growth is expected to be significantly back-half weighted. .

We expect adjusted earnings per share to be in the range of $1.06 to $1.09 a share, reflecting growth of 4% to 7.25% versus the same period of LY. GAAP diluted EPS from continuing operations is expected to be in the range of $0.99 to $1.02 in the first quarter. .

Within the Retail segment, we continue to expect revenues to increase 1.5% to 3% and operating profit growth of between negative 1.5% to a positive 0.5% year-over-year. Recall that we expect the tobacco exit to have an approximately 900 basis point negative impact on front store comps in the first quarter. .

Now revenues in the PBM segment still are expected to grow between 14.5% to 15.75%, while operating profit growth is expected to be flat to down 5%. Additionally, our free cash flow guidance for the year remains in the range of between $5.9 billion to $6.2 billion.

And I'll remind you that we are maintaining that range despite the pull forward of some receivables into 2014. .

First, I continue to be very pleased with the company's significant cash flow generation capabilities. I believe these capabilities should continue to play an important role in driving shareholder value over the longer term.

Second, and to that point, 2015 will be another year in which we demonstrate our ongoing commitment to returning value to our shareholders, increasing the dividend and share buyback programs by more than 30% over last year. .

And so with that, I'll turn it back over to Larry. .

Okay. Thanks, Dave. And let me just reiterate how pleased we are with the progress that we've made this past year in advancing our innovative health care strategies, along with rebranding our company. And I'd like to take a minute to thank our more than 200,000 colleagues who continue to work hard each and every day, executing those strategies. .

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

[Operator Instructions] Our first question comes from the line of Robert Jones with Goldman Sachs. .

On the PBM side, I noticed EBITDA per claim was a little bit light in the quarter and you're down year-over-year. I know you cited increased spending. I'm wondering if you could comment on whether or not that spending was more of a pull forward for Jan.

1 starts or something more incremental?.

I think that increased spending was really related to the 1/1 readiness efforts. So we spent, as you know, incremental money through Q4 and we talked about the incremental money that we're going to spend, actually, in Q1 as we ramp-up those new clients for the welcome season. .

And then the other thing you guys cited was price compression around the EBITDA per claim. I know you mentioned that last quarter as well. I'm just wondering if you could shed any more light on what exactly that was.

Is this something from previous PBM contracts? Or is it something more related to the new starts again?.

Bob, I think this is just the ongoing margin compression that we're continuing to see and expect to see as we move forward on both the PBM as well as the retail side. So there's nothing that is new beyond what we've been talking about probably for the last couple of years. .

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

So for Larry or Jon, if you guys dissect or try to dissect the upcoming '16 selling season in terms of size and then composition, how do you think that compares to 2015? And do you think -- are you better positioned for '16 given what we saw in '15 or about the same?.

Look, John, it's Larry, I'll start and then, Jon will -- I'm sure will jump in as well. But -- I mean, the latter part of your question, we think we're extremely well positioned for all the reasons that we touched on earlier and that we talked about in greater detail at Analyst Day.

I think that if you go back and look at the '15 selling season over '14, there was a lot more RFP activity recognizing that we thought '14 was an anomaly as people were preparing for the impact of the Affordable Care Act. So we think that '15 was kind of a return to a normal selling season, and we don't see '16 any different.

It's early, but we think it will mirror what we saw this past year. .

And John, this is Jon. I think the size and composition is going to be similar to what we've seen. Health plans, which we're seeing now, large employers that we're seeing now, you'll see the midsize and smaller employers later in the year, and we expect to see a fair amount of state government opportunities as well. .

Okay. And then just one other thing.

How do you guys think about capital allocation and buyback as it relates to share price valuation? Does that discussion come into effect at all where you might think, let's do more on the dividend side, let's consider a special dividend? Or is it really kind of a long-term view that, over the long term, buying back $5 billion or $6 billion a year is really the right thing to do?.

Yes. John, this is Dave. We've been pretty consistent in our capital allocation program for several years, and we've outlined it and all the different components of it. I will tell you though, we do look forward to the growth of our business. We look at kind of where we think we're going to be in several years in the future.

And then we make sure that we're performing what we would consider value-enhancing share repurchases based on where the growth of our business and the cash-generation capability of our business over the next several years compared to the valuation.

So we will continue to monitor that, and we will continue to flex our capital allocation program to drive value for shareholders in the short term as well as in the long term, John. .

Our next question comes from the line of Meredith Adler from Barclays. .

So Eric's going to -- Eric Percher is going to ask a question as well. I have a question just about expenses at retail. You did a good job of managing them. I'm just wondering if you actually had to make meaningful changes in labor hours or the way you had work done at the stores because you gave up tobacco and Specialty Connect.

Or was that not actually something that you had to deal with?.

No. Meredith, it's Larry. I'll start and -- we have not been doing anything out of the norm that we haven't -- that hasn't been part of our program for the last couple of years. We have always looked for ways in which we can become a more efficient operator at retail.

And that's where our focus has been this past year, and will continue to be as we go forward. .

So the improvement is impressive. I'll turn it over to Eric now, he has a question. .

Sure. A question of formulary.

As you look at the 2016 selling season, do you think your formulary decision around Hep C can stand as an advantage? I know you feel there's advantages to your formulary focus, but do you think that specifically can? And if so, does it beg the question, will we ever see PBMs move to a point where there's such a delta in what is offered by each PBM that a sponsor would choose their PBM based on product availability?.

Well, Eric, it's Larry. I'll start, and I'm sure Jon will jump in as well. I mean, as you think about Hep C specifically, our goal was to create the lowest net cost solution for the entire population of patients, recognizing that our clients have a lot of flexibility in terms of the programs that we have that meets their priorities.

And in addition to achieving the lowest net cost solution, we also evaluated a variety of factors including the current and future projected distribution of the population across the several genotypes, the average duration of therapy, of the various agents, factors that contribute to medication adherence, along with our ability to further control costs through utilization management programs.

And I go back to some of the things that we talked about at Analyst Day where, through our formulary management program since it started back in 2012, we've saved clients over $3.5 billion. There is a growing opportunity in the specialty class recognizing that, I think, we ended '14 with 31 specialty exclusions.

And there's a lot more that we can do to bend the cost curve in specialty beyond just managing the formulary. And maybe I'll ask Jon to talk a little more about that, that respective piece. .

Yes. So Eric, clearly, specialty is our clients' biggest concerns. Formulary is a piece of that, but there's also a lot of other things that you can do to help manage that trend and they're also interested in managing it under the medical side, which we have a unique solution. So I think formulary is one piece of the strategy.

Your question around the differences in formularies between the different PBM's and the impact on that as clients make decisions, we really haven't seen that as a factor in the selling season. We've been very effective at transitioning members off of non-formulary drugs.

We've been very effective at transitioning members from competitors' formularies to our formularies, and we're seeing that this selling season. So I don't -- I'm not seeing formulary as a differentiator as clients are making decisions.

I think they're really looking at what we're able to deliver there, and we're very competitive there, but they're also looking at all the other capabilities, differentiated capabilities that we have. Then at the end of the day, that's what makes the difference. .

Our next question comes from the line of David Larsen from Leerink Partners. .

Was there an impact to gross margins in the Retail division and Pharmacy Services division due to Specialty Connect? Was there a benefit to Retail and a bit of a headwind to Pharmacy Services? And can you size that, if so?.

Yes. I can't really size that. I will say that from a rate perspective, it's slightly beneficial to -- from a rate perspective to retail because think about those specialty prescriptions, they're largely branded prescriptions and branded prescriptions carry a lower gross margin than a generic prescription would.

So that would serve to lift retail gross margins when you transfer those scripts out of retail into the PBM. But it would be immaterial though in totality. .

Okay. So you had like 67 bps of gross margin expansion in Retail. We've been hearing about generic inflation. One of your competitors has obviously been talking about rate pressures. It's not like the Specialty Connect had a huge impact on it, you're just performing well [indiscernible]. .

No. That is certainly not the driver of rate improvement at Retail. If you go back, you look at what's driving the performance in Retail, it continues to be gains in prescription volume, along with the improvements at GDR and our improvements in economics as we drive down the cost from procurement standpoint. .

Our next question comes from the line of Charles Rhyee from Cowen Group. .

I have a question on the -- I think you talked about earlier the outperformance in Retail Pharmacy and that it was all the more surprising because of the Specialty Connect transition.

At this point, is all specialty drugs that someone comes into the retail outlet, into a retail store, is that all being recorded in PBM? Or are there any certain categories that you'll still end up getting dispensed out of Retail?.

Almost all. .

Then can you talk about what is -- then what was driving the outperformance at the Retail Pharmacy side then?.

Again, if you go back, if you look at what's really driving it is our continued share gains from a pharmacy perspective. If you look at the volumes of prescriptions running through our dispensing channel at retail, continues to enhance our performance from that perspective. .

And Charles, we mentioned in -- I'll go back to our prepared remarks where we saw a 55 basis point increase in pharmacy market share in the fourth quarter. We also acknowledge that there was a bit of an uptick from the flu season that we began to see in the business in the later weeks in the quarter. .

Okay. Great.

Is there anything on the mix though? Was it more on Medicare or versus commercial? Anything -- any kind of color that you can provide there?.

No. I don't think there was anything that was materially different than what we've seen in past quarters from that perspective. .

Our next question comes from the line of Ricky Goldwasser from Morgan Stanley. .

Biosimilar seems to be an area of focus in recent weeks, and they may be on the market sooner than we previously expected.

How should we think about the potential contribution of a biosimilar from coming off of PBM and a retail perspective? And maybe you can help us rank order as we think about where it falls compared to contribution of specialty drugs with kind of like nice rebates like Hep C versus kind of like generics that are on the marketplace today?.

Ricky, this is Jon. Still early in this whole arena. But as I -- what I know today, I would think about biosimilars as being more like branded competition. And so the majority of the value will come in the form of rebates. And obviously, most of that value passes along to our clients.

Now to the extent that they're able to make them interchangeable and that function more like generics in the non-specialty world, then I think you would see them act more like generics. But I think it's early to see how that plays out. .

Okay. And then just one follow-up on the specialty. I mean, obviously, you raised a very interesting point about the fact that the contribution that you're seeing in the way you can help manage specialty is not just tied to formulary and that the medical side represents a very nice opportunity.

So when we think about kind of like your customers buying specialty through you, and we think about the kind of like the NovoLogix offering in -- what do you think is -- or what is the -- what percent of your clients who buy specialty from you today ask you also to manage it on the medical side? And how do you think that ramp can progress over time?.

Yes. I mean, that's a good question. I would say on the specialty, on the medical side, most of that activity is concentrated with our health plan clients. So we're seeing a lot of interest in that space.

Obviously, as we begin to manage that, we believe it increases our dispensing opportunities as well because some of those drugs can't be dispensed through us. And we think of our Coram platform as even being an enabler to penetrate the dispensing space to even greater extent than what we do today. .

And Ricky, I think to that point, the value proposition here centers around the ability to manage the specialty patient, not simply the administration of a particular drug, okay? Recognizing that with the various assets that we have now, Jon mentioned Coram and our infusion capabilities, along with what exists in NovoLogix, we can demonstrate for the client cost-savings opportunities by simply migrating the patient to a lower-cost, high-quality site of service.

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Our next question comes from the line of Scott Mushkin from Wolfe Research. .

So more of a conceptual question. I was kind of sitting back, listening to the call, listening to you guys talk and remembering the Analyst Day. It seems to me if I like kind of look out over the next 12 to 24 months, there seems to be an upward bias to business performance, and I wanted to see if you guys agree with that.

I look at like kind of SilverScript, I look at Medicaid expansion -- I know Ohio did it, I look at the front end and the potential to upsell there with all the clinics that are coming in and just the volumes that are going into your pharmacies.

So I'm wondering if you agree with that, that there does seem to be some upward momentum to your business if you look over to the next 12 to 24 months. .

Yes. This is Dave, maybe I'll start. I think as we -- you heard at Analyst Day, despite the fact that we come from a very large base in the sense of the size of the company, we have a lot of growth outlooks and opportunities in our business.

We outlined over the next 5 years of how we're going to grow the top line fairly significantly, gaining share across both the PBM market space, as well as the Retail market space and be able -- through that share gain, be able to drive performance and operating profit.

And with the cash that we generate, be able to further enhance that through the capital allocation program.

So I do think, as we look at the marketplace, there's always challenges in every marketplace, but there's really a lot of opportunities for our differentiated model to plug-in to payers and providers and consumers in ways that add value for them, and quite frankly, add value for us. .

And Scott, I mean, it's a great question, and I think Dave answered it well. The only thing that I would add is, there's still so much flux in the marketplace.

And back to Dave's point about we've got a multitude of assets that allows us, we can be pretty nimble and I think we described it, we can pivot to additional changes that we see in the marketplace in a pretty quick and innovative fashion. .

So I appreciate that. This is a follow-up on the same line of thinking.

It also seems that as productivity is important to you guys and it does seem, even though there's margin pressure, that the outflow of money into asset doesn't have to be huge, and so we could get some continued increase in ROIC, do you agree with that as well?.

I do, I do. I think if you look at what we're trying to do here is, as we gain dispensing share, that dispensing share can be -- we can essentially leverage the fixed asset infrastructure of our business, both at the Retail segment as well as in the PBM space. And that really allows us to accelerate our returns profile. .

Our next question comes from the line of George Hill from Deutsche Bank. .

I have a question about what I'm going to call your clairvoyance. Because one of the things that I would -- I guess, you guys -- in this case, you guys seem to be able to see the future.

Because when we went to your Analyst Day in mid-December -- I'm intrigued that the PBM guidance doesn't move a basis point, despite all the gyrations in the Hep C market.

So I guess my question is, as we think about that, in early December, did you guys know this was coming? Did you guys -- did this all play out exactly how you guys thought? Other angles are, does it not move the needle? Does it not impact enough scripts? Are the rebates not big enough? Is the amount of money that you make at Hep C not big enough to move the needle? I mean, not even at the revenue line, it doesn't move the needle.

So I guess, maybe this is a planning question, maybe this is a process question, maybe this is a market question. But I guess, can you just give us some color on the background of Hep C and how it all kind of -- it all, obviously, played out exactly according to your expectations. .

Well, George, it's Larry. I'll start and then, I'm sure Dave will jump in. But I mean, we appreciate your comments, okay? I would say that as we're doing our planning, our outlook and our guidance range implies a range of assumptions.

And I think I would say it, at the end of the day, it's that's simple, okay? That we've -- as we talk about our outlook for '15, we've got, within that guidance range of $0.14, it comprehends where the market could go. And as we've talked about this morning, we're comfortable with where we're at today and that outlook remains intact. .

And I would think also, George, just from that perspective that it relates to, let's say, specialty and Hep C, we've been planning for this event for a while. This wasn't like a shock to us. We had a lot experience in this category. We were working hard from -- with clients and within our organization to better manage specialty for them.

We see the pipeline and have a good view of the pipeline. And with that, constructed a series of programs that allowed us to work to improve our performance in this area on behalf of our clients. And so this was something that was very planned from our perspective, and we kind of saw it coming to some degree. .

Okay.

And then maybe this could -- the quick follow-up then would be, is this kind of how the Hep C market evolved in late December, early January -- is there anything different from that playbook that's different from the playbook with how we thought about the statin class or how should we should think about drugs going forward? We got a lot of questions about -- I guess we've gotten a lot of questions about this space.

To us, it's just a regular PBM playbook.

I guess, from your perspective in Hep C, was there anything different in the way this kind of all unfolded?.

No. I don't think there's much different there. .

No. And George, I think, this all goes back to when we started this in 2011 for the 2000 plan year. I think that we demonstrated in that first year that this can be a cost -- a very effective cost-savings opportunity for clients.

And it can be executed with a high degree of service to the members, okay? And certainly, this whole process starts with ensuring appropriate clinical outcomes. And I think we continue to see those opportunities going forward. .

George, the only thing that I would say is different as we move into the specialty realm is there will be more complexity around managing it. So as an example, Harvoni is for genotype 1. And so that's what's on the formulary for those patients that have Hep C with genotype 1. And then you have other options for the other genotypes.

And so I think you will see a combination of formulary and utilization management programs. So that will -- just adds a little bit of complexity, but I agree with Dave and Larry, it's very similar to what we've seen in the past and our capabilities are playing out in the space as well. .

Our next question comes from the line of Lisa Gill from JPMorgan. .

Jon, I was wondering if maybe you could just talk about planned design for 2015. As we've talked to some of your clients in our annual surveys in December, people talked about MinuteClinic, they also talked about Maintenance Choice.

Obviously, we talked a lot about specialty today and that was clearly one of the things that came out when we talked the clients as well. But can you maybe just talk about some of the other things that are changing for 1/1/15. And you talked about spending a lot of dollars and time around implementation.

What were some of the changes that came about from a plan design perspective?.

Lisa, I think it was just more the same, more penetration and high deductible plans and just higher penetration of all the things that you just talked about. So we really haven't seen anything different than that. Although I will think -- I do think you'll see much more aggressive management in the specialty space around plan designs.

So much higher adoption of formulary strategies. And I think as you recall, at Analyst Day, we did talk about, of the new business we brought onboard, 35% of that did some narrow networks.

So I think you're just going to see more aggressive programs like this with plan designs as clients began to see these higher trends year-over-year growth of their drug spend. .

Okay. Great. And then my follow-up question, Dave, was around Red Oak. On the generics [indiscernible] side, you talked about the payment from Cardinal.

But did you see any incremental savings in addition to the payment that you saw from Cardinal?.

Yes, we did. As we said, we're kind of in the early stages of that effort. As we indicated back at Analyst Day, there's several different ways in which we drive economics here, part of that is lowering our cost of goods sold from Red Oak. And we did see some improvement based on the program. .

Is there a way to quantify that? Or you're not quantifying it?.

We're not -- there is a way to quantify it. But unfortunately, we're not going to quantify it. .

Our next question comes from the line of Frank Morgan from RBC. .

I was curious when you gave your guidance back in December at Analyst Day, what did you contemplate at that point in time regarding discounts related to Hep C?.

Frank, that's also a great question that, unfortunately, we can't get into that level of specificity. But we -- as we talked about earlier, our guidance as we thought about 2015 had a range of -- kind of has a range of scenarios built within it.

And at that point in time, we had some clarity around kind of how the market was going to shape up for us there. .

Okay.

And as you think -- a lot of the discussion today about the specialty and different strategies, are there any pieces that you're missing strategically that you feel like you need on the specialty side in terms of -- as new drugs come to market?.

So Frank, that's a great question. I don't know that there's any -- we don't really have any gaps from an asset perspective. I will tell you though that we've been working hard to increase our business within the medical benefit management sector, if you will. With NovoLogix as a good example.

There's probably other opportunities for us to continue to penetrate that market, so there's probably more to come there. It will probably be really early stages from that perspective. .

I mean, Frank, this is Jon. The one place that we don't play much in today is the oncology space. Most of that is administered in physician offices. We do think as the marketplace moves to more risk-based reimbursement arrangements that, that business will view the administration of drugs -- they view it as a profit center today.

And as it becomes more risk-based, it will become an expense center for them. So they'll be looking for solutions and people that can operate in that space more effectively. So we're working hard to understand how to extend into that space. And we think our capabilities give us a great, great platform to do that. .

Our next question comes from the line of Alvin Concepcion from Citi. .

Just a couple of quick ones. Just a follow-up on the Red Oak question. How would you characterize the savings that you talked about versus what you would have expected at this point in time? And then just a follow-up is on generic inflation.

What are you seeing there and what is your outlook for the year?.

Yes. Maybe we'll take generic inflation first. We -- as we have said, there has been limited pockets of inflation within the generic universe. I will say that in totality, the generic market still maintains a very deflationary nature. And we believe that, that will continue both in the short term as well as the long term.

I think as it relates to Red Oak, I think the team has done a terrific job in standing up that operation. They've met with the lion's share of manufacturers, and we continue to be pleased with the progress. I think that they're tracking consistent as we plan for them at this point in time. .

And Alvin, I think I'll just reiterate the 3 ways in which value is created with Red Oak. Obviously, one is the fixed payment schedule, which started in Q4. The second one is, there are some additional milestones that have been created that will allow for additional payments.

And then the third is what Dave alluded to on an earlier question in terms of just the opportunity to create additional reductions in the cost of goods by creating a more efficient supply chain. .

Our next question comes from the line of Steven Valiquette from UBS. .

So I don't know if I missed this, but was there any general color on the mix of the $0.4 billion in additional PBM selling season, wins that you had between health plans and employers or government contracts?.

No. Steve, it was more just general mix probably, maybe it skews a little more to the health plan side recognizing some of the true-ups that take place from their enrollment season. .

Okay.

And then separately, just quickly, the 0.5 million additional PDP lives that you mentioned for early '15, is that net of any Medicare retiree business that you talked about at the Analyst Day that you might have lost to public exchanges? Or do those particular member losses show up in a separate bucket somewhere else?.

Yes. Steve, that's a great question. And that is a net number inclusive of the variables that you talked about. And by the way, you can go back to one of Jon's slides at Analyst Day that kind of did the mapping from where we were to what we were projecting, including the shift in retirees, what we were projecting open enrollment at that point in time.

And it came -- the final net number was pretty close to that forecast. .

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

Two things. First of all, just a follow-on with Red Oak.

Curious on what inning you would say you're in, in terms of realizing the purchasing benefits from that effort?.

Eric, I would say we're probably in the fourth or fifth inning in terms of the work and the opportunities. .

Yes. Eric, this is Dave. The one thing I wouldn't -- just one word of caution there is that this isn't a game where I think there's a beginning and an end. This is process that is ongoing continuously. So while we might have gotten to the fourth inning as Larry just spoke about, we're going to start a new game soon enough.

And we continually need to work to improve our cost structure and that's one way we'll do that. .

Okay. That's helpful. And then secondly, there's some conversation earlier about that 2016 selling season and the composition. And it sounded like you suggested that the opportunity was similar to that which you enjoyed in '15.

I'm just wondering if you could talk a bit further about -- '15 was obviously a great success, if that is -- obviously, you aspire to repeat that in '16, but is that reasonable to think that you could achieve a similar level of success in '16 relative to what you did for '15?.

Well, Eric, I think there's 2 comments around that.

And first is the fact that as we've been talking a lot about over the last couple of years, the differentiation that the integrated model brings out into the marketplace and how we think that we can meet clients' needs for their business and obviously, their members in a very differentiated way and in terms of satisfying their goals.

And I think, as we're talking -- as we're thinking about the '16 selling season, I think it's based on where we sit today. It really has more to do with we expect the RFP activity to be at a similar level to what we experienced last year. So obviously, it's very early, and we'll talk more about it as we go through the year.

But we're optimistic as a result of our integrated model. .

Our next question comes from the line of Robert Willoughby from Bank of America. .

Larry, have you assumed any change in strategy at your #1 retail competitor? What might you do differently this year to take advantage of any disruption or how might you be disadvantaged?.

Yes. Bob, it's Larry. Maybe I'll start and just ask Helena to jump in as well. And Bob, listen, I think our focus continues to be on our business and what we can manage and control within the 4 walls of what we do well every day and the opportunities that we continue to see there.

And maybe I'll ask Helena just to talk more about how she's thinking about the Retail business and the opportunities that exist there within CVS. .

Yes. I think it's a good time for us, an opportunity for us just given what's going on. I mean, the one thing we haven't talked about yet this morning is just the successful launch of this new CVS Health brand, which is definitely resonating with consumers.

So we're seeing about 1,100 basis point increase in their awareness of CVS Health, and consumers are really seeing our company as a leader in health care. And so that's exactly what we're hoping for, and we're using that momentum to focus on health and beauty as we talked about at Analyst Day.

And just keeping our eye on the ball and running the business and hoping that all of that will come to a good outcome for this year. .

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

Just a couple of quick ones. First of all, assuming Nexium goes nonexclusive as a multisource, David, is there any reason to assume, as you've said in the past that, that's kind of the best of all worlds for you if it blows right through exclusivity. .

Well, I mean it's hard to say specifically. But my expectation, as we always said, is that we're most advantaged at the point in which there's many manufacturers in the market for a generic drug. And if that were to occur, I assume that, that would be best for us, yes. .

Great.

And secondly, I'm curious about, I mean, everybody defines specialty differently, but I'm curious about what you're telling your clients? And maybe just a question for Jon, once we lap the Sovaldi spike, what does specialty trend looks like from there?.

Great question. We have the PCSK9 inhibitors coming out this summer. That could be as big, could potentially be even bigger than Hep C. So pharma is really focused on the space. So I think this is going to be on ongoing challenge for our clients and opportunity for us to step in and really help them manage this area. .

We've been communicating with clients that, left unabated, you can expect to see specialty trends in the high-teens. .

Our next question comes from the line of Edward Kelly from Crédit Suisse. .

Larry, you mentioned that you've taken a disciplined approach to preferred Part D networks. I was just hoping that maybe you could give us a little bit more color on that angle given the market place does seem to be competitive.

And how important is it for you to have a material presence in that business long term?.

Well, Ed, it's a great question. And it is important for us to have a presence in that business, which we believe we have today, recognizing all the different ways in which we can engage and touch the Medicare consumer.

And you go back to some of the things that we've talked about, we coined it the "silver tsunami," the fact that you've got 10,000 baby boomers turning 65 every day. Back to your first question, the competitive environment recognizes that participation in a preferred network comes with associated margin compression.

And I think our retail organization has done a terrific job in terms of building an economic model that evaluates margin compression against forecasted share shift. And there are times when the economics make sense and we proceed, and there are other times where the economics don't make sense.

Recognizing that all Part D plans are not equal in terms of their design, whether it's copays or the makeup of that Part D plan in terms of the balance between choosers and low income subsidies.

I think, at the same time, we also have a unique opportunity recognizing that -- you saw the announcements coming out of HHS last week and the focus in terms of moving more to outcomes management. We participate today in terms of supporting our health plan clients through stars ratings.

And we know that in a PDP plan, we can effect over 50% of that stars ratings with the ways in which we engage and touch that patient. So we think that there's tremendous opportunities across our book of business to work with patients, as well as health plan clients in terms of achieving their goals. .

Our last question comes from the line of Ross Muken from Evercore ISI. .

So I'm curious, building a little off of what Helena said, and then also just kind of going back to tobacco.

I mean, what would have been sort of the key things that both the tobacco decision, as well as the rebranding have kind of given you from an enterprise perspective that maybe you weren't looking for originally? And has there been anything sort of unsuspecting that has been something that's been more challenging to sort of offset the headwind.

I'm just trying to see what was assumed and how it sort of developed either positively or negatively. .

I mean, as Dave and Larry have said, we're pleased with where we are now. There was certainly a lot of moving parts and it's hard for us to really identify what was driving what. But I'd say in terms of surprises, probably things like the extent which our 200,000 colleagues feel incredibly proud about this decision.

We thought they would, but it's really driven a very -- a sense of excitement, I would say, among the organization, a sense of pride to work for a company that would make a decision like this. The branding, I think, has been -- as I said before, it's been successful and it's making people think differently about the company.

And what we're trying to do is say to consumers, we're not just like any drugstore on any corner, we're part of a big health care company. And when they see all of the assets that we have and understand all that we do, they start to think about us very differently. So that's been a really exciting part of this decision as well.

And I also think that internally for our merchants, it's given them a sense of sort of where do we go from here. I mentioned at Analyst Day, all that we're doing around healthy food and health and beauty, and it's given them an even stronger sense of purpose to drive those businesses. So that's really what we're focused on. .

And then Ross, this is Jon. To add to that, as I'm out talking, and I'll focus on new prospective clients that maybe don't know us as well as our existing clients. It's something that we talk about, our repositioning in the marketplace as a health care provider; the discontinuation of tobacco.

And yes, there is clearly a halo effect that I see from our clients that makes them feel good about potentially doing business with a company that has taken a stand like that in the marketplace. .

And Ross, I'll just wrap it up by talking about the provider, the physician community. And I think that we've seen this come into play as we think about some of the health system affiliations that we alluded to in the call. And this certainly aligns us with their goals as well.

And I think it's opening up some doors to some saw potential unique opportunities as we go forward. .

Well, listen, again, let me just take a minute and thank everybody for their time this morning and your ongoing interest in CVS Health. And if you have any follow-up questions, you know how to reach Nancy or Mike. Thanks, again. .

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