May 1, 2015
Operator
Ladies and gentlemen, thank you for standing by and welcome to CVS Health First Quarter Earnings 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 today, Friday, May 1, 2015.
And now it gives me pleasure to turn I the conference over to Nancy Christal, Senior VP of Investor Relations. Please go ahead.
Nancy Christal
Thank you, Milan. 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 first quarter results as well as guidance for the second quarter and year. Jon Roberts, President of PBM and Helena Foulkes, President of the [Audio Gap] to no more than one question with a quick follow-up, so we can provide more callers with the chance to ask questions.
Just before this call, we posted a slide presentation on our website. The slide summarizes the information you'll hear today as well as some additional facts and figures regarding our operating performance and guidance.
Additionally, our Form 10-Q 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 will 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 one year. And now, I’ll turn this over to Larry Merlo.
Larry Merlo
Okay, thanks, Nancy and Good morning everyone, and thanks for joining us to hear more about the strong first quarter results we posted this morning. Adjusted earnings per share increased 12.2% to a $1.14 per share and that’s $0.05 above the high-end of our guidance range.
Operating profit in the retail business declined 1.3%, inline with expectations, reflecting the tougher comparison due to the tobacco exit. Operating profit in the PBM increased 14.6%, well ahead of our expectations.
While we generated approximately $1.6 billion of free cash during the quarter and we continued to return significant value to our shareholders through our disciplined capital allocation practices. Now it’s still early in the year, but given our outperformance in the first quarter, we are narrowing our adjusted EPS guidance range for 2015 to $5.08 to $5.19 and Dave will provide the details of our guidance during his financial review.
So let me turn to the business update. And I’ll start with the 2015 PBM selling season.
The expected revenue impact for 2015 has grown since our last update. Gross new business currently stands at $7.5 billion with net new business of $4.1 billion.
And that’s up about $0.5 billion on both the growth in that lines from our last update. The increase was driven primarily by the growth in membership within some health plan clients, as well as some additional wins.
Now turning to the 2016 selling season, I would describe pricing in the industry is competitive yet rational and to-date we’ve completed about a third of our client renewals which is typical at this time of the year. And while it’s too early to give you specific data points for 2016, I will note that the selling season is off to a good start.
Our integrated model allows us to provide differentiated products and services that continue to provide savings for our clients, while providing better health outcomes and convenience for our members. These unique products and services continue to resonate strongly in the market and as we typically do, we’ll provide a more quantitative update on our 2Q call in August when we have a more complete picture.
Now our recently released Insights report highlights our efforts to manage trend for our clients. In 2014, growth trends was 12.7% and that’s up from 3.8% in 2013.
Importantly, the report demonstrates that there are solutions to bend the cost curve. With brand price increases the accelerating growth in specialty, we are finding more clients receptive to these types of solutions.
Our report identifies high performing clients, what we call are trendsetters and the solutions that they are using to improve the cost trend. Now we shared these results with our clients at our recent client forum last month and let me take a minute and give you just a couple of examples.
Our first formulary management solution, our trendsetter solution, we call it the value formulary, and it promotes lower cost generics and provides limited access to brands. We employ category-specific management using drug exclusions, step therapies, prior authorization and quantity limits and with the 12.7% growth trend for our overall book of business, our clients using the value formulary achieved a growth trend of only one half of 1%, more than 1200 basis point better than the overall book.
A second example is in managing specialty. Our book of business trend in specialty was 32.4%, nearly half of which can be attributed to the surge in prescribing for the new Hep C therapies.
Our underlying principles for our management solutions include condition level management, a broader approach to clinical care, and a breakthrough specialty patient experience. Our trendsetter solutions for specialty include our advanced specialty formulary, Specialty Connect and specialty guideline management and you’ll recall that Specialty Connect provides choice to receive a member specialty scrip at CVS pharmacy or through our mail channel, while preserving the central clinical expertise that leads to better health outcomes.
The trendsetter results 23.9% specialty trends, nearly 1000 basis points better than the overall book. So as I said, there are solutions and we expect more clients to adopt these cost management tools.
Now speaking of specialty, our specialty revenues continued on a very strong growth trajectory in the quarter increasing 46% and that was driven by volume, new products, inflation and the impact of Specialty Connect. Our infusion capabilities through Coram are another significant differentiator with clients and we are experiencing healthy growth in the business.
In fact, the number of infusion patients we serviced in the quarter, jumped 15.7% from the prior year and that’s after adjusting for the timing of the Coram deal close. Site of care management, another important component of managing costs for specialty patients and we offer clients solutions to effectively manage these costs.
As we previously discussed, we’ve been using our leading formulary strategies to effectively manage the high cost HEP C category and we envision employing similar tools to manage the anticipated new PCF K9 inhibitors which are expected to enter the market later this summer. However, given the significant number of people being treated for high cholesterol, they can be treated quite successfully with lower cost statins, we envision robust prior authorization guidelines to help control costs, while ensuring that the appropriate population gets access to these newer therapies.
Before turning to retail, let me touch a minute on Biosimilars with the first Biosimilar approved. This is just the beginning of a pipeline that could unlock additional savings and provide options to our clients.
We expect discounts to be available, but they will likely vary by product. And for the foreseeable future, we expect Biosimilars will behave more like brand than the traditional generics and as a result, we expect to employ our formulary strategies to generate savings for our clients.
Our retail business, it produced results that were inline with our expectations, but pharmacy same-store prescription unit volumes increased 5.1% and that’s on a 30-day equivalent basis and we continued to gain pharmacy share. Our retail pharmacy market share was 21.5% in the quarter and that’s up about 50 basis points versus the same quarter a year ago.
Pharmacy same-store sales increased 4.2% and reflect the positive impact of about 70 basis points related to the incidents of flu. Pharmacy same-store sales also include the negative impacts of about 280 basis points due to recent generic introductions and another 190 basis points from the implementation of Specialty Connect which as I mentioned earlier, transfers specialty scripts from our retail to our PBM segment.
Our initiative to unlock adherence continues to make good progress and we anticipate launching some new products later this year that will be available to both patients and their care givers in order to help patients stay adherent to their medication. Turning to the front store, our performance in the quarter was very solid and while front store comps were down 6.1%, if you adjust for the tobacco impact, front store comps would have been up about 2%.
The impact of the tobacco exit was around 800 basis points and that’s about a 100 basis points less than originally anticipated. We saw solid growth in our core health and beauty categories including the strong cough cold season and we gained share in health and beauty in both the drug and multi-outlet markets.
And while we experienced a decrease in front store traffic, that decrease was partially offset by an increase in the average customer basket. Our front store journey to position ourselves as a leading health and beauty destination continues.
This year, we are launching Phase 1 of our healthy foods rollout offering customers more healthy choices in a select group of stores. Our beauty elevation program is also launching in several thousand stores and we continue to test the multitude of changes to further enhance our front store clustering efforts including a number of store resets that leveraged the knowledge that we’re gaining from the Navarro acquisition.
Extra care continues to be an important driver of profitable front store growth as about 80% of our sales now goes through our loyalty program providing us a longitudinal view of the customer and we have developed new internal tools to ensure that promotional investments are driving the right economics while delivering value for our customers. And these tools have allowed us to further develop our personalization efforts.
Digital and specifically, mobile are also important tools in powering up our personalization reach and just as one example, today, we know that customers using our mobile app with extra care are spending four times more than our average customers. So we are encouraged by these results and believe that there is more opportunity for further innovation.
Our front store margins in the quarter continued to benefit from these efforts as well as the tobacco exit. On a comparable basis to last year, including adjusting for the tobacco elimination, front store margins improved notably.
And this underlying improvement in the front reflects our highly personalized promotional strategies, along with the continued growth in store brand sales. In fact, we made good progress in store brand penetration in the quarter with store brands increasing to 20.9% of front store sales.
And that’s up about 330 basis points from last year. Two-thirds of the improvement reflecting the removal of tobacco from our mix and one-third of the improvement reflecting underlying progress in our store brand penetration as we continue to make progress toward our 25% goal.
Turning to store growth in the quarter, we opened 38 new stores, relocated 12, closed 10, resulting in 28 net new stores and we plan to add about – to an anticipated increase in retail square footage growth of around 2%. As for MinuteClinic,, we opened 15 net new clinics in the quarter, and we ended the quarter with 986 clinics across 31 states plus the District of Colombia.
And continuing on its very strong growth trajectory, MinuteClinic’s revenues increased about 21% versus the same quarter last year and 84% of MinuteClinic visits were paid for by third-parties with MinuteClinic included in most payer networks as an accessible and cost-effective provider. Now the rollout of the epic electronic medical record system remains on schedule or expected to be complete with that by mid-year.
Additionally, we’ve now seen more than 13,000 patients since the initiation of our telehealth pilots in California and Texas with very high level of customer satisfaction. We are continuing to test various uses for telehealth and believe that can’t be part of a care model that improves access and lowers overall healthcare costs.
Just a quick note on Red Oak Sourcing, our venture with Cardinal Health. We continue to be extremely pleased with the progress the team is making, they continue to execute very well.
The expertise that Red Oak provides along with the simplicity of the business structure has enabled Red Oak to make great strides. They’ve been working with suppliers on strategies that create value for all parties and have now transitioned nearly all suppliers to Red Oak within a relatively short timeframe.
So we couldn’t be more pleased with their performance and results. And with that, let me turn it over to Dave for the financial review.
Dave Denton
Thank you Larry, and good morning everyone. Today, I'll provide a detailed review of our first quarter results, followed by an update on our guidance.
However, before I do that and as I often do, I want to highlight the ways in which we are using our strong free cash flow to enhance shareholder value through our disciplined capital allocation program. During the first quarter, we paid $399 million in dividends, our dividend payout ratio now stands at 28.7% and we remain well on track to achieve our target of 35% by 2018.
Additionally, in January, we entered into a $2 billion accelerated share repurchase program. At that time, in exchange for $2 billion, we received approximately 16.8 million shares at a price of $94.49 per share, which represented 80% of the notional [Audio Gap] received approximately 3 million shares today making the average share price of the ASR $100.64 per share.
For the full year, we still expect to complete $6 billion of share repurchases. So between dividends and share repurchases, we’ve returned more than $2 billion to our shareholders in the first quarter alone and we continue to expect to return more than $7 billion for the full year, more than a 30% increase over last year’s levels.
As Larry mentioned, we generated approximately $1.6 billion of free cash in the first quarter and we continued to expect to produce free cash of between $5.9 billion and $6.2 billion this year. Now turning to the income statement, adjusted earnings per share from continuing operations came in at $1.14 per share, $0.05 above our guidance range and up by 12.2% over LY.
GAAP diluted EPS was $1.07 per share. The retail segment performed within expectations, while we saw strong results from the PBM segment which posted profit growth above the high-end.
The outperformance in the quarter was primarily driven by stronger than expected prescription volumes as well as favorable purchasing and rebate economics in the PBM segment. On a consolidated basis, revenues in the first quarter increased 11.1% to $36.3 billion.
In the PBM segment, net revenue growth surpassed expectations as revenues increased 18.2% to $23.9 billion. This growth was driven by specialty pharmacy, as well as increased volumes in the pharmacy network plans largely from the addition of new clients.
Partially offsetting this growth was an increase in our generic expensing rates which grew approximately 150 basis points versus the same quarter of LY to 83.5%. We saw strength on the top-line versus our guidance due primarily to higher than expected volumes, drug price inflation and mix, including the new Hep C drugs.
In our retail business, revenues increased 2.9% in the quarter to $17 billion at the high end of our guidance. This growth was driven primarily by solid pharmacy same-store sales growth, despite the transition of specialty revenues into the PBM segment due to Specialty Connect.
Higher volumes in the pharmacy was fueled by a strong flu season and an uptick in 90-day prescriptions. Now turning to gross margins, we’ve reported 17% for the consolidated company in the quarter, a contraction of approximately 120 basis points compared to the Q1 of 2014 and again, consistent with our expectations.
The decline is due in part to a mix shift in our business as our lower margin PBM business is growing faster than our retail business. Within the PBM segment, gross margins declined approximately 35 basis points from Q1 of 2014 to 4.3%.
This was primarily driven by price compression which was partially offset by the improvement in GDR as well as favorable purchasing and rebate economics. Despite the decline in gross margin rate, gross profit dollars were up 9.8% year-over-year given volume increases and mix.
Gross margin in the retail segment was 31.2%, down approximately 20 basis points from LY. The continued pressure on reimbursement rates as well as the continuing mix shift towards pharmacy were partially offset by a number of positive factors.
These positive factors include a 150 basis points increase in retail GDR to 84.4%, the benefit to function margins from the tobacco exit and the increased store brand penetration. And while gross margin rates were down, gross profit dollars increased 2.1% in the quarter.
Total operating expense as a percent of revenues notably improved from Q1 2014 to 11.1%. The PBM segment’s SG&A rate improved by approximately 25 basis points to 1.2% with operating expense dollars coming in a little lower than expected despite the over-delivery of revenues.
As reported, SG&A as a percent of sales in the retail segment increased by approximately 20 basis points to 21%. However, the increase continues to be driven by the reduction in retail sales which is directly related to our decision to exit the tobacco category, as well as the impact of Specialty Connect, again shifting sales from our retail segment into the PBM.
It’s important to note that on a comparable basis, SG&A as a percentage of sales at retail actually improved approximately 50 basis points. Within the Corporate segment, expenses were essentially flat to LY at $189 million and lower than expected.
Operating margin for the total enterprise declined approximately 35 basis points in the quarter to 5.9%. Operating margin in the PBM declined approximately 10 basis points to 3.1%, while operating margin at retail declined by approximately 45 basis points to 10.2%.
As Larry noted, retail operating profit decreased 1.3% in the quarter and was within our expectations. On a comparable basis, excluding tobacco, retail operating profit increased approximately 1.7%.
PBM operating profit increased 40%, greatly exceeding our expectations. So now, going below the line on the consolidated income statement, net interest expense in the quarter decreased approximately $24 million from LY to $134 million, due primarily to lower average interest rates on our debt.
Additionally, our effective tax rate was 38.9%, slightly lower than expected. The tax rate drove less than $0.01 of the EPS.
Our weighted average share count was 1.1 billion shares, again inline with our expectations. So with that, now let me update you on our guidance.
I’ll focus on the highlights here, you can find the additional details of our guidance in the slide presentation that we posted on our website earlier this morning. As Larry said, given our outperformance in the first quarter, we are nearing our 2015 EPS range by raising the bottom of the range by $0.03.
While we are pleased with where we are year-to-date, it is still very early in the year. Our core business is performing well.
We now expect to deliver adjusted earnings per share in 2015 in the range of $5.08 to $5.19 per share reflecting strong year-over-year growth of 13% to 15.5% after we removed the impact in 2014 related to the loss on the early extinguishment of debt. GAAP diluted EPS from continuing operations is expected to be in the range of $4.90 to a $4.91 per share.
Consolidated net revenue growth is still expected to be7% to 8.25%. However, we narrowed our top-line outlook in the PBM.
We now expect PBM revenue growth of 11.25% to 12.25%, 25 basis points higher than our prior guidance on the low-end. This revised guidance reflects our expectations for stronger growth within specialty, fueled by a combination inflation and new product mix as well as the impact of the higher net new business.
We continue to expect retail revenue growth of 1.25% to 2.5% year-over-year. And inter-company revenue eliminations are now expected to be approximately 10.8% of segment revenues.
Given the narrowing of the PBM’s top-line, as well as the favorable purchasing and rebate economics that we’ve seen, we are also narrowing guidance for operating profit growth in the PBM segment. We now expect PBM operating profit to increase 7.75% to 10.75% year-over-year, an increase of 100 basis points on the low end.
Retail operating profit growth expectations remain in the range of 4.75% to 6.5%. And as I said before, our free cash flow guidance for the year remains in the range of $5.9 billion to $6.2 billion.
So with that, now let me provide guidance for the second quarter. We expect adjusted earnings per share to be in the range of $1.17 to $1.20 per share in the second quarter, reflecting growth of $3.75% to 6% versus Q2 of 2014.
GAAP diluted EPS from continuing operations is expected to be in the range of $1.10 per share, to $1.13 per share in the second quarter. Within the retail segment, we expect revenues to increase 1.5% to 2% versus the second quarter of LY.
Adjusted script comps are expected to increase in the range of 4.25% to 5.25%, while we expect total same-store sales to be down 1.25% to up 0.25%. The impact of the mover of specialty scripts to the PBM via Specialty Connect will be very muted this quarter given that we began this shift in May of last year.
Additionally, recall that we expect the tobacco exit to have approximately 800 basis points negative impact on front store comps in the second quarter. In the PBM, we expect second quarter revenue growth of between 11.25% and 12.5% driven by continued strong growth in specialty and volumes.
We expect retail operating to decrease 2% to 4% and PBM operating profit to increase 65% to 9% in the second quarter. Keep in mind that margins in last year’s second quarter benefited from the finalization of California’s Medicaid reimbursement rates.
Recall, that that this finalization of the benefits, benefited retail gross margins by $53 million in the quarter and PBM gross margins by $60 million in the quarter. After removing the impact of that from the last year’s results, operating profit growth in the PBM would be approximately 200 basis points higher and on a comparable basis, excluding the California Medicaid impact from last year’s results, as well as tobacco, retail operating profit growth would be approximately 490 basis points higher.
And again, starting with Analyst Day, over the past several months, we have been highlighting several timing factors that affect the cadence of profit delivery throughout this year. The timing of breakout for generics, our tobacco exits, and the investments that we’ve made in the PBM’s welcome seasons, are the factors expected to impact our cadence the most.
And while we delivered a very strong first quarter, the cadence of profit growth is still expected to be back-half weighted. All things considered, we expect a strong back-half of the year.
So in closing, let me leave you with three key thoughts. First, we posted solid comparable growth this quarter and we are off to a very good start for the year.
Second, our 2015 outlook for both businesses as well as the enterprise overall is strong and we continue to benefit from the unique solutions we are delivering to the marketplace. And finally, we expect to continue to generate significant free cash and we are committed to use this capability to maximize the value we return to our shareholders through a disciplined capital allocation program.
And so, with that, let me turn it back over to Larry.
Larry Merlo
Okay. Thanks, Dave and again, we are very pleased with our solid start to the year and our strong competitive position and our distinctive channel-agnostic solutions are resonating strongly in the marketplace.
Now before we open it up for your questions, just a couple comments that, we’ve all witnessed the unfortunate events unfold in Baltimore over the past several days and I think as you know, we operate countless stores in major cities and urban centers all across the country. And despite these acts of violence, we remain committed to these markets.
We look forward to working together with community and business leaders in the rebuilding process. I want to take a minute and pay a special thanks to our colleagues who have worked tirelessly this past week to ensure that Baltimore residents continue to have access to need of medications and prescriptions, I think we are – all of us are very proud of the job that they’ve been doing in a very difficult environment.
So with that, let’s go ahead and open it up for your questions.
Operator
Thank you very much. [Operator Instructions] And our first question comes from the line of George Hill, Deutsche Bank.
Go ahead.
George Hill
Hey, good morning Dave and Larry and thanks for taking the question. I guess, why would sort of first is, did the cost containment and SG&A in the PBM has been pretty impressive and the cost cuts are pretty good.
How much room should we think is left there to do considering the growth in the higher touch specialty medications and I guess, how should we think about how much lower SG&A can go?
Larry Merlo
Well, George, I’ll start and I think Jon will jump in as well, but, keep in mind that, we had embarked upon a pretty sizable initiative as part of our platform consolidation that was targeted to deliver well over $200 million in tangible SG&A savings and we have largely completed that initiative and obviously, we are always looking to being more efficient and then and identify opportunities and I’ll let Jon pick up from there.
Jon Roberts
Yes, George, so the way we are thinking about our cost structure in the PBM is continuous improvement. So, how can we leverage automation, technology, streamline processes to make those processes more predictable and deliver them faster and at a lower cost.
I think specialty is an opportunity as we look forward. PCS K9s are coming to the market.
They are going to be lower cost and then typical for the average specialty drugs in the market today. So, we are actually looking at the delivery in a more efficient way than generally specialty which is higher touch, higher cost than what we see in there.
So, it’s – we are continuing to focus on it and we make progress every year.
George Hill
Okay, that’s helpful and maybe a couple of quick housekeeping items. Larry, did you say that $4.1, that was net wins for 1-1-2016 starts?
Larry Merlo
No that’s – that was 2015, George. That was the true-up of the 2015 selling season and as I mentioned, it’s up about $0.5 billion from our update on our fourth quarter call.
And then there were some late new wins that got added to 2015 and probably for the most part mid-year introductions.
George Hill
Okay, I wrote that wrong. And then the adjustment for the California Medicaid comp, that was combined retail PBM or it’s just the retail side?
Dave Denton
On the retail side, between California and tobacco, it’s about 490 basis points, just in retail, it is about 200 basis points as it relates specifically to the PBM in the quarter.
Larry Merlo
In terms of operating profit.
George Hill
That’s helpful. Thank you very much guys.
Larry Merlo
Okay, thanks, George.
Operator
And our next question comes from the line of Edward Kelly, Credit Suisse. Go ahead.
Edward Kelly
Yes, hi, good morning guys. Nice quarter.
I wanted to ask a question actually about the PBM and EBIT growth, I mean, you actually, you meaningfully exceeded your guidance this quarter. Could you maybe just talk a little bit more about the drivers outside there relative to your expectation?
And then, just a question on the outlook, because the only raise to lowering of the outlook into PBM as well as for the company in terms of EPS, is that just conservatism, is there something we should think – we are thinking about there?
Dave Denton
Yes, hey, Ed, this is Dave, maybe I’ll touch upon that. As you know, we obviously had a very solid – we are off to a very solid start to the year.
Quite frankly of both businesses and certainly within the PBM versus our expectations. Just a couple of things, obviously, volumes in the PBM continued to be strong and we continue to be pleased with that.
Secondly, we’ve worked hard both from a cost of goods sold perspective and some of the buy side economics as well as the rebate yield has been productive for us and as you know, the vast majority – go back to our clients in the form of lower cost into their pharmacy benefit. As we see – so that’s really produced the overdelivery in the first quarter.
As we look through the balance of the year, it is very early. We’ve gone through a quarter, we had a great quarter.
I think core businesses are performing well and nicely. I think, there as you know we have a philosophy of looking through the full year.
We are still focused on delivering a very solid year. Continually, there tends to be shifts in the marketplace as relates [Audio Gap] on that as time goes on.
Edward Kelly
Okay, great. And just one quick follow-up, you did mentioned reimbursement rate pressure in the release this quarter, I don’t think – didn’t there, there is something new or different or more intense as about that or we are just reading too much into that?
Dave Denton
Ed, this is Dave. We continually talk about that.
So there is nothing new or unique about that at this point in time.
Edward Kelly
Okay, great. Thank you.
Operator
Our next question comes from the line of John Heinbockel, Guggenheim Investments. Go ahead.
John Heinbockel
So Larry, a strategic question, obviously, you have the financial wherewithal to do a lot of things, but when you think about the footprint in the US versus where you are globally. Is there a priority of you’d like to fill in and I am thinking different kinds of businesses, but filling in the US, as opposed to accelerate the global footprint or there of equal priority?
Larry Merlo
Well, John, I think, as you know, we’ve talked a lot about – we feel very good about the opportunities that we still have here domestically and we’ve been talking about that for the last couple of years and we continue to feel good about it. And as you think about the international, again as we’ve alluded to in the past, we wanted to understand and build some – I describe it as muscle in terms of [Audio Gap].
That’s what led to the Brazil decision and we’ve been added about two years now. We’ve got some very good learnings and I think it’s – any next steps there would be pursued with the same financial discipline that I think we’ve demonstrated in the past.
John Heinbockel
And just, going back to the PBM EBIT issue. Most of the time, right in the last 2.5 years, you’ve exceeded expectations, this has been our quarter where you haven’t been in line, but have exceeded pretty significantly and that sort of dovetailed with volume.
Is it really sort of that simple that as you can beat on the volume side, you will handily beat on the bottom-line and does that speak to, I guess, the – right, the incremental flow through margin is simply that high.
Dave Denton
John, this is Dave. I don’t know that that’s exactly should – within, as you know, within the PBM business, obviously, volumes certainly helps, but there is a lot of factors that drive profitability in that business and I’d just take a good example, Medicare Part D within our insurance company additional volumes and categories there, actually you heard of profitability from an insurance perspective.
So there is a lot of different lever there. I’ll just conclude with saying that, we’ve had a great first quarter.
I think our outlook for the year remains extremely strong within the PBM and quite frankly within retail.
John Heinbockel
Okay, thanks.
Larry Merlo
Thanks, John.
Operator
Our next question comes from the line of David Larsen, Leerink. Please go ahead.
David Larsen
Hi, congratulations on a very good quarter. Can you just talk about the 2016 and 2017 selling seasons?
Where are you? Is the 2016 selling season, are you largely through it, most half – most of their decisions, and what are they looking for this year that maybe new relative to last year?
Thanks.
Larry Merlo
Dave, it’s Larry. I’ll go ahead and start and then, I am sure, others will jump in, but, Dave, I think we mentioned this in the past that, if I start with our renewals, we said that this is 2016 renewal season with typical recognizing we didn’t have the big FEP contract.
We said it was around $14 billion to $16 billion and as I mentioned in our prepared remarks, we are about a third of the way through the renewal process which is, typical at this time of the year. I would say, the selling season again has gotten off to a solid start.
We are seeing RFP activity pretty similar to what it was last year, which was a big increase over the prior year recognizing the, two years ago, there was – I think there was kind of a [Audio Gap] in the 2016 selling season and we’ll have a lot more talk about on the second quarter call.
Jon Roberts
Hey, David, just to build on what Larry has said, this is Jon. We are through most of the health plan opportunities, probably half way through the large employer opportunities and then you move into the balance of the market.
And as far as, what people are looking for, they are obviously looking for us to be competitive on price and we have to be delivering good service to our members and clients. So the – has helped us from a service reputational standpoint, and obviously we continue to be competitive, rational on price.
And then you add to that, all the things that we can do that are unique to our model that quite frankly is, it supports our clients with where healthcare is going. The fact that we’ve integrated assets and can deliver capabilities like maintenance choice, Specialty Connect, MinuteClinic, our leadership position in specialty.
So our ability to manage specialty, it’s been not only under the pharmacy benefit and the medical benefits and this is as we talked about a very fast growing parts of the overall spend. And then third, our leadership in consultative services and Medicare Part D.
So, as I am out talking to clients, they are looking for somebody that they know can deliver great service, deliver savings, and then all these unique offerings we bring, I think has really had a lot to do with our success. 2017, we are beginning to see some activity in 2017, again, large health plans, but I would say, we are very, very early with any 2017 opportunity.
David Larsen
Thanks a lot.
Larry Merlo
And David, I’ll just emphasize one other point, we had our client forum back in April. We had record attendance.
There was an extremely high level of engagement recognizing as I mentioned, clients have seen cost trend to go from around 4% to double-digits. So, we have – to Jon’s point, we have solutions for them and there was an awful lot of engagement and education and understanding in terms of what that can specifically mean for their respective business.
So there is certainly a lot of follow-up for it from the client forum, but I think, we feel very good about the tools and products and services that can be an important part of the solution for our clients.
David Larsen
Terrific. Thank you.
Operator
And our next question comes from the line of Meredith Adler, Barclays. Please go ahead.
Meredith Adler
Hey, thanks for taking my question and great quarter. I was wondering if there is any update you can give us on whether Specialty Connect has led to an increase in volume?
Are people responding? I know you are talking about everybody – the customers liking everything you are doing, but can you identify anything specific from Specialty Connect?
Larry Merlo
Well, Meredith, if you look at our specialty revenues, we are growing faster than the market even after adjusting for Coram. So, we believe Specialty Connect is delivering additional share and it is outperforming our initial expectations and we already have more than 50,000 patients – new patients that are utilizing the Specialty Connect product.
Meredith Adler
Great. And then, I was just wondering if you could talk about, what the benefit so far if you’ve seen anything from eliminating tobacco?
Have you seen a meaningful change in either the partnerships, or the dialog you are having with physician and hospital groups?
Larry Merlo
Well, Meredith, the answer to that is yes, I mean, it’s – I’ve said in some of those meetings where we are talking about things that we can do and then historically the question will come up about you guys sold tobacco products don’t you and literally deflects all the energy out of the room. So, I think it’s reflected in the fact that, since the announcement just over a year ago, now we’ve been able to accelerate the partnerships that are been established with leading health systems across the country.
I think we are approaching 60 of those affiliations and while it’s a category of one at this point and it did get some publicity. We’ve talked about pharmacy networks migrating to more performance-based networks and we had one particular client, City of Philadelphia that decided to – as the nucleus of that performance network tied around pharmacy providers that do not sell tobacco products.
So, I think we see some tangible benefits that they are probably more qualitative than quantitative at this point in time. But, I think we all believe that it will lead to further differentiation of our business model as we go forward.
Meredith Adler
Great. Thank you very much.
Larry Merlo
Thanks, Meredith.
Operator
And our next question comes from the line of Priya Ohri-Gupta with Barclays. Go ahead.
Priya Ohri-Gupta
Hey, thank you so much for taking my question. Dave, you guys have been pretty clear about your lease adjusted leverage, are you continuing to have some capacity in the balance sheet to manage towards that?
But can you just remind us about sort of how much flexibility you have around moderating some of your future share repurchase activity where you have to engage in some sort of strategic activity that might temporarily take you above that leverage target in order to maintain your current rating?
Dave Denton
That’s a great question. We, as you know have been very focused on our leverage target at 2.7 times adjusted debt to EBITDA.
We currently have been cycling a bit above that target, but we have additional capacity as we see here today. We – as you know have continued to have many dialogues with the rating agencies.
We are very focused on maintaining our Triple D rating status. We do think we have flexibility over time to move our leverage target.
It’s strategically at $0.08 to be a tag over that as long as we commit to get ourselves back down to that level. We’ve been very focused over time to make sure that our balance sheet maintained its leverage target at 2.7 times and we will work aggressively to get there.
We think it’s important that we have – we will maintain that rating.
Priya Ohri-Gupta
Thank you so much.
Dave Denton
You are welcome.
Operator
And the next question comes from the line of Lisa Gill, JPMorgan. Go ahead.
Lisa Gill
Thank you and good morning. I just wanted to follow-up on a couple of things.
First, you have talked about earlier Larry, about the formulary management and the trend there. Can you or Jon just give us any indication as to the penetration that you have currently with your client base around these kinds of programs?
Just to get an idea of how much future opportunity there is?
Larry Merlo
Yes, Lisa, it’s a great question and today, we’ve got about probably about half of our book that is in our formulary program, at the same time, there are – and by the way, that’s largely in the employer space. There are health plans that adopts components of the formulary programs.
So, I think there is certainly white space for that to grow and I think as our program continues to evolve and further develops and drive additional savings, I think that, there will – there is already additional dialog on those programs.
Jon Robert
And then Lisa, this is Jon. As Larry talked about our trends for 2014 at 12.7%, about 60% of that trend is really driven by brands at inflation and the best way for our clients to manage overall trend and inflation is through formulary.
So, we believe the marketplace is going to get much more aggressive, or clients are going to get much more aggressive in adopting even more aggressive formulary strategies beyond what they already have. It’s probably the best way to manage our benefits.
Lisa Gill
And so would you expect that uptick as we go into 2016? I know, I saw Jon recently, we talked about your client forum and people really focused on where costs are going and what we are seeing as far as price increases go from the manufacturers.
Should we see some kind of inflection in 2016 if you are having the conversations today? Or is it you think it’s going to be a several year play out around increase in penetration?
Jon Robert
Yes, I mean, Lisa, that’s a good question. Yes, as Larry said, our employers which is half our book of business, the vast majority of those – 80% of those have adopted our template formulary strategy that we introduced back in 2012.
So, they’ve actually taken a big step forward and then there are other opportunities for them that you can get more aggressive. With health plans, the majority of our health plans have adopted our Med D formulary strategies which again are very tightly controlled.
So the market I think is primed and I think coming off this double-digit trend year of 2014, I have never seen people more open to understanding what opportunities they have to manage and as I said formulary is going to be a big part of that. So, we are talking to people now.
I think we’ll see, I do think it’s going to take a few years to play out just like everything in our space. So I don’t know that there is going to be a single inflection point.
But I do very strongly believe that this is going to be a significant lever for our clients to manage the strength.
Lisa Gill
And if I can just understand, Dave, on the – if you think about, you hold the rebates in the first quarter, if I remember correctly, it’s usually on a lag, so should we expect rebates to get better as we move throughout the year based on the programs that Jon is talking about, just you are trying to figure out the timing. So the rebates that we saw in the first quarter, was that primarily from things you initiated in the back half of 2015 and is that part of the driver for the back-half results?
And then I’ll stop there.
Dave Denton
Lisa, that’s a great question. I am not going to get into too much detail there.
I would just tell you that, as we think about the long-term view of our business, we’ve been very focused on – from a buy side economics perspective, what can we do to further reduce the cost to our clients and think about that as our procurement efforts around generics and then secondly, how do we reduce cost and continue to control cost in the branded category and that continues to be focus from a rebates perspective and the formulary management. I expect those to be continued to be drivers for this business at some level in the longer-term.
Lisa Gill
Okay, great. Congratulations on a great quarter.
Dave Denton
Thank you, Lisa.
Operator
And the next question comes from the line of Robert Jones of Goldman Sachs. Go ahead.
Robert Jones
Thanks for the questions. I guess,, maybe just move over to the retail side, David, I know you walk through the retail gross margin, pushes and pulls in your prepared remarks.
So I wanted to make sure I understood the dynamics in the quarter, especially relative to your full year guidance for this margin to be flat. So, I know tobacco would have been a good guy year-over-year for the margins.
So I was hoping you could maybe just walk through again what weighed on the margin in the quarter? Was there anything abnormal with pharmacy reimbursement, promotional activities?
Just looking for a little more insight there.
Dave Denton
No, I don’t think there is anything that’s really unique in the quarter from that perspective. As we said many times, is that the cadence of profit delivery will be back-half weighted versus front-half weighted and most of that ties to - obviously the tobacco exit and how we overlapped that.
The California Medicaid comparison in Q2 of 2014, but probably more importantly the delivery of breakout for generics and the time to that driven really more back-half weighted versus front-half weighted.
Robert Jones
Okay, and then, just one more on a timing technical side, I was wondering if there was anything between 1Q and 2Q that maybe pulled 1Q up as far as the timing around EPS. I mean, I know the foresaid headwind from the California Medicaid reimbursement benefit a year ago will make 2Q a little bit worse off, but anything else that we should be aware of as far as just timing between 1Q and 2Q?
Dave Denton
No, I don’t think there is anything that’s really material in nature there.
Robert Jones
Okay, great. Thanks.
Dave Denton
You are welcome.
Operator
And our next question comes from the line of Scott Mushkin, Wolfe Research. Go ahead.
Scott Mushkin
Hey, guys. Thanks for taking my questions.
So I want to follow-up a little bit on John Heinbockel’s question on – but a little bit different take on it not necessarily acquisitions, but kind of looking internally, Larry, when you look at opportunities in front of you with your current assets, where do you think there is the biggest potential to kind of improve what you are already doing. I mean, obviously the business is coming along, but where do you see some of the levers to get things even better?
Larry Merlo
Well, Scott, we are always looking to do better, whether it’s to be more efficient with our business and in terms of attempting to deliver high levels of service at the lowest possible cost and we are always focused on opportunities there. And, we continue to be focused on share growth opportunities.
We’ve – and I think we’ve gotten some tractions in terms of some of the things that we’ve been able to do through our partnerships, whether it’s with health plans, or other providers. Obviously, there is a lot that we can do when we happen to be the PBM.
But, those opportunities are not limited to employers or health plans where we have to be the PBM and we’ve gotten some traction there.
Dave Denton
Hey, Scott, this is Dave. We’ve been talking a lot on the call about the PBM and some of the growth engines around pharmacy.
Maybe, we’ll just spend a minute, I’ll ask Helena to talk a bit about what we are doing to drive growth in the front of our business in the retail business.
Helena Foulkes
Yes, I think that, one of the things that I am encouraged by and it goes back to Meredith’s question as well as since we announced our exit of tobacco, I think the marketplace we are seeing, a real focus that we have around driving health and beauty and we talked about at the Analyst Day in December, but the journey that we are on to really reposition ourselves as a leading health and beauty destination. So, when [Audio Gap] one was better health made easy, elevating beauty or customer-driven personalization, My CVS Store and digital innovation and I am really pleased we are making a lot progress on each of these areas.
Just a couple examples, this year we are launching Phase 1 of our healthy food rollout that got expanded fresh offerings and healthy snacks. We’ve also have a beauty elevation program which is launching across several thousand stores this year and really there we are in the process of repositioning CVS as the leader in beauty.
We’ve always had a leading market share, but we are really sort of doubling down on the in-store experience and differentiating for our customers. We talk a lot about personalization, Larry mentioned in his speech, but I think there is even more opportunity there to grow share and be more relevant for consumers and ultimately drive traffic and profitable sales.
And then we have a focus this year, we are resetting 500 stores with something we call take high higher and these takes several of these elements together. We have expanded beauty, we’ve got this healthy food set and so this really starts to take the old photo department out and put in healthy food and give customers a very different feel.
Those stores are performing well. We’ve also within this My CVS Store piece, really been looking at different clusters, and I think the things that we are very excited about is the Hispanic dominant cluster.
We are starting to learn from our Navarro. And we’ve actually started to reset some CVS Stores to take those learnings into place.
And then we continue to invest in digital and innovation and see a lot of opportunity as Larry mentioned there to drive adoption and have people using both our stores and digital assets. So, a lot of things happening that we really haven’t talked about, I am really proud of the team and I think both the merchants and the operators have a very strong focus on how we want to be unique and different and really own health and beauty.
Scott Mushkin
That’s perfect. Thank you for such detailed answer.
Operator
And the next question comes from the line of Steven Valiquette UBS. Go ahead.
Steven Valiquette
All right, thanks. Good morning.
Dave Denton
Good morning, Steve.
Steven Valiquette
Good morning, Dave. So, I guess, just for me the, obviously the 46% revenue growth in 1Q in specialty is pretty impressive.
How do you think that stacks up versus your estimation of industry growth in specialty pharmacy in early 2015? And also, beyond Hep C, are there any other therapeutic categories worth mentioning that were growth drivers?
Dave Denton
Well, Steve, we actually see it outperforming the market growth and I think as I mentioned earlier to one of the questions even after adjusting for Coram, acknowledging that Coram was not comparable for the full quarter. I think we closed towards the end of January.
So, we are pleased with the results that we are seeing and some of it’s coming from new customer growth. Some of it’s coming from our unique products and I’ll ask Jon to comment on therapeutic classes.
Jon Robert
Yes, what we have seen over the last three years is over a 100 new indications for existing specialty drugs. So we are seeing growth really across all categories.
Obviously, Hep C is the poster trial for growth, but we are seeing growth in RA and oncology is an example. And the other factor is as the population gets older, the older population uses six times as many specialty drugs as the balance of the population.
So we are just seeing really tremendous growth across the entire spectrum of specialty and that’s going to be fueled even further by new drug introductions, 88 new drugs over the last three years, we are going to see the PCS K9s be introduced later this year. While we think that’s going to be a slow ramp, we think one in four people that are on stance today could be candidates for these new therapies are quite frankly more expensive than the generic statins that are available today.
So we really view specialty as a growth driver as we look forward.
Larry Merlo
And Steve, I’ll just conclude this question a bit which is to be just a data point. As you said, specialty in the first quarter grew by about 40% - 46%.
It’s not just Hep C, if you take away Hep C and you look at our underlying growth in specialty, it’s in the mid-30s. So we continue to perform well at the core in this business.
Steven Valiquette
Okay that's helpful. The one quick tie-in to this, I forgot if you disclosed this at the Analyst Day or not, but the - within the PBM, I forgot, are you disclosing just a rough range of what percent of the total PBM is sales that you categorize as specialty?
I am guessing it somewhere maybe in the 20%, 25% range, but is that a just a good approximation?
Dave Denton
No, there is the chart in Jon Robert’s presentation and/or Alan Lotvin's presentation that shows that number, last year's number which I believe is around $31 billion, moving to $37 billion was our expectations for this year.
Steven Valiquette
Got it.
Jon Robert
And Steve, just to add-on to that, because those are a couple important points. We talked about the addressable specialty market we described that is excluding infused oncology.
And I think in 2014, we estimated that market at $86 billion growing to more than $150 billion by 2018. So, we see a lot of opportunity for growth even without including the oncology space.
Steven Valiquette
Okay, that’s great. Thanks.
Jon Robert
Thanks Steve.
Operator
And our next question comes from the line of Ricky Goldwasser, Morgan Stanley. Go ahead.
Ricky Goldwasser
Yes, hi, good morning and thank you for taking my question. I have two follow-up questions here, first of all, about the membership growth, the script growth.
Obviously, very strong claim growth. What percent of the growth is coming from your PBM members?
Dave Denton
Ricky, are you talking about on the retail side?
Ricky Goldwasser
No, I'm talking about pharmacy network claims?
Dave Denton
Yes, Ricky, maybe we are not following the question, because we would…
Ricky Goldwasser
So you know that.
Dave Denton
I am seeing.
Ricky Goldwasser
I think that in the past, you kind of you gave some details on Caremark membership accounting for 34% or 35% of your pharmacy scripts.
Dave Denton
Yes.
Ricky Goldwasser
So when you think about kind of the growth that you've seen year-over-year, obviously it's pretty impressive, what percent of it is coming from kind of like your PBM client? Just trying to assess like the share gains within Caremark versus the rest of the market?
Dave Denton
Yes, we kind of report that on an annual basis, you can – we monitor I believe reported on an annual basis, because when we went to clients, typically, we then – the work begins in a sense of understanding how to help that client become more productive and manage our cost better and part of that might be narrowing or introducing a product and are narrowing a network in to one of our channels and so that kind of grows over time. So we’ve chosen to do that on an annual basis because of that.
I will say just from a Caremark perspective, one thing that we do disclose, you can see it in the press release, you also see in the Q later today, is that we do talk about the – just the network claims volumes that we process on a quarterly basis and so you can see that kind of within those releases.
Larry Merlo
Ricky, we have shown in the past that if you looked at on the retail side of the business if you looked at the script growth and the share growth, about half of it was coming from the Caremark book of business and the balance from the rest of the marketplace.
Ricky Goldwasser
Okay, that's very helpful. And then one follow-up on the specialty side, when you think about kind of like your membership, what percent of your PBM clients manage their specialty spend through you?
And what percent carving out? Just to kind of like understand the opportunity there, in terms of penetration?
Dave Denton
Yes, Ricky it’s about – today, it’s about 60%.
Ricky Goldwasser
Okay and that 60% of the employers or 60% of the total?
Dave Denton
Of the total.
Ricky Goldwasser
Okay, thank you.
Dave Denton
Thanks, Ricky.
Operator
And our next question comes from the line of Mark Wiltamuth with Jefferies. Go ahead
Mark Wiltamuth
Hi, good morning. I wanted to dig in a little bit on the generic drug margin swing factors you see over the next couple of years and maybe if could let us know how you feel relative to your December analyst pronouncements, because it seems like Nexium launched earlier than you expected and I am curious where you stand on - and just in general, how are you feeling about the break-open pipeline?
Dave Denton
Mark, this is Dave. I think, it obviously is as we discussed a little bit earlier, the generic launch dates obviously move around a little bit.
I’ll just characterize this is not a matter of if these drugs are going to be productive for us from a break-open status, it’s more of an issue of when they become productive for us from a generic stand – break-open status. Our main thesis, as we talked about kind of the three categories of drugs, be it branded drugs, limited supply generics and break-open generics or thesis over the long-term continues to hold as you increase both savings to customers and clients, when you move down that spectrum but also increased profitability to us as you move down that spectrum.
Mark Wiltamuth
Okay and just on generics, maybe give us an update on Red Oak, you said you transferred the sourcing over to Red Oak and where do you stand on I guess, achieving cost savings there?
Dave Denton
That’s a great question. We have transitioned all of that into Red Oak.
We now have virtually all of our generic manufacturers on our program and we continue to be very excited about where we are but off to the opportunity over time to execute it to drive value from that program. Kind of beyond that, we don’t disclose much more the math from a buy side perspective.
Larry Merlo
Mark, I’d just reiterate, we’ve talked about this, the three ways in which value was extracted from Red Oak, one is the fixed payment schedule from Cardinal which began in Q4 last year. The second ability is through some established achievement of milestones that have been established between the two parents and then the third is just further reductions in our overall cost of products.
So, and as Dave mentioned, we’ve kind of – we’ve framed that up under that umbrella, but we haven’t gotten more granular.
Mark Wiltamuth
And on that third point on the achieving of actual cost savings, is that something that ramps over like a two- to three-year period or does it happen pretty quickly?
Dave Denton
Well, Mark we have never done, okay, in terms of how to make the supply chain more efficient. So, I think it’s something that will be ongoing.
Mark Wiltamuth
Okay, thank you.
Dave Denton
Okay, thanks. We’ll take one more question please.
Operator
And our final question comes from the line of Ross Muken, Evercore. Go ahead.
Ross Muken
Thanks, guys. So I am going to ask a big picture question to close.
So, Larry, lot going on in your industry, so one of your competitors is attempting to mimic your model at a smaller scale, another one of your competitors is moving more in the direction of retail and beauty and one of your PBM competitors was acquired, another is declaring its independence. As you think about CVS's positioning and strategy, how do you continue to evolve the model?
What are the things you are looking for as the industry changes that kind of give you further confirmation that the share gains you've enjoyed are sort of sustainable and that you have all the assets and pieces you need to continue to do what you've done, which is put up tremendous results for many years here?
Larry Merlo
Ross, you did a really good job of summarizing the marketplace. But, I mean, we have always believed that the integrated PBM retail model, we think is the optimal model and I think that gets further highlighted by the fact that we are entering an era of we’ve been describing as the retailization of healthcare, others are talking about it in terms of an era of consumer directed healthcare and you think about our model.
It’s really the only one that has deep connections and expertise in dealing with both payers of healthcare as well as consumers of healthcare and we’ve talked about and we reiterated it on the call today all the different ways in which we can help solve this cost quality access conundrum that our healthcare system faces. So, I think as I mentioned earlier, we believe that we are in a great place.
And at the same time we are always looking for ways that we can be more efficient and speak to payers and customers in a more surround sound fashion. And, I think we see opportunities domestically to continue to do that.
Ross Muken
Great. Thanks, guys.
Larry Merlo
Okay, thanks to everyone for your ongoing interest in CVS and as always, if you have any follow-up questions, you can reach Nancy.
Operator
Ladies and gentlemen this does conclude the conference for today. We thank you for your participation and have a great rest of the day everyone.