Despite market share losses for Medco Health Solutions, Inc. and uncertainty over its impending acquisition by Express Scripts, Inc., those two major PBMs posted healthy fourth-quarter and full-year 2011 financial results, earning favorable marks from analysts as they prepare to create the largest PBM in history. CVS Caremark Corp., meanwhile, recovered from lagging earnings in time to continue its growth trajectory in the Medicare Part D space.

And the highly publicized dispute between Express Scripts and retail giant Walgreen Co. dominated conference calls held by company officials to discuss quarterly financial results, as securities analysts wonder how narrow networks have to be to deliver meaningful savings.

While Express Scripts’ earnings fell slightly below analysts’ expectations, Morningstar Inc. securities analyst Matthew Coffina said the company demonstrated “solid growth” from the prior year and is now the most profitable of the big three PBMs, given several years of steady margin improvement.

In a Feb. 23 conference call to discuss 2011 earnings, Express Scripts Chairman, CEO and President George Paz maintained that the Jan. 1 departure of Walgreens from the PBM’s pharmacy network has had minimal impact on client retention (DBN 10/7/11, p. 1). Express Scripts retained 97% of its clients for 2012, Paz said, with 95% of accounts moving forward without Walgreens in their networks. Paz asserted that this is evidence that “narrow networks do work,” and pointed to the company’s long-fought contract with the state of Maryland (DBN 2/10/12, p. 8). “The fact that we just picked up the client from Catalyst [Health Solutions, Inc.] speaks to the fact that people are willing to make those decisions if it saves money,” stated Paz on the call.

“In our view, this is a powerful demonstration of Express Scripts’ expanding economic moat (and Walgreen’s declining moat),” said Coffina in a Morningstar research note, referring to the term coined by Warren Buffet to describe a company’s ability to maintain its competitive advantage against rivals. “If the merger is allowed to proceed, there is a good chance that the combined company could have a wide economic moat, in our view.”

Both Express Scripts and Medco reiterated in their earnings calls that they expect Express Scripts’ acquisition of Medco to close within the first half of this year, with the combined company delivering an additional $1 billion in annual client savings. Morningstar maintains a 40% probability that the purchase will be completed. The Federal Trade Commission’s decision is expected later this month.

Express Scripts reported fourth-quarter net income of $290.4 million, or 59 cents per share, compared with the prior year’s $329.6 million, or 62 cents per share. Chief Financial Officer and Executive Vice President Jeffrey Hall noted that was below target “due to lower claims volume, driven by utilization and increased attrition as a result of [the] poor economic environment, increased spending on projects and higher staffing levels to prepare for integration, and investing to support clients and members as they changed retail pharmacies.” Net revenues for the 2011 quarter were $12.1 billion, up from $11.3 billion the prior-year quarter. Annual revenues were $46.1 billion, compared with nearly $45 billion for 2010.

Medco Bounces Back From Client Losses

Medco, meanwhile, was “reasonably well positioned” despite market share losses, noted Coffina. While the PBM suffered several high-profile client departures (e.g., Blue Cross and Blue Shield plans’ Federal Employee Program and Universal American Corp.), “most of them involved some unique circumstances and were not necessarily indicative of a broader trend,” he contended.

The PBM reported record net income of $424.4 million, or $1.08 per share, for the fourth quarter of 2011; excluding merger-related expenses, net income increased 19.4% over the same quarter last year to a record $451.9 million. Fourth-quarter 2011 revenues reached nearly $19 billion, a 12.2% increase from $16.9 billion reported for the prior-year quarter. The growth reflects “new business wins, as well as higher prices charged by brand-name pharmaceutical manufacturers, partially offset by a higher mix of lower-priced generics,” explained Chief Financial Officer Rich Rubino in a Feb. 21 conference call.

Medco also grossed $2.6 billion in new client wins for 2012, “which is particularly impressive in light of the uncertainty around the Express Scripts merger,” added Coffina.

While some analysts expressed concern over CVS Caremark’s sluggish growth in 2010, the company demonstrated a “pretty remarkable turnaround,” says Barclays Capital research analyst Elliot Feldman.

Revenues in the pharmacy services segment grew 32.4% to $15.9 billion in the fourth quarter of 2011, up from nearly $12 billion the same quarter a year before, primarily due to the addition of a 12-year deal with Aetna Inc. and the acquisition of Universal American’s Part D business, according to the company. Net income for the 2011 quarter was $1.06 billion, or 84 cents per share, up from $1.026 billion, or 74 cents per share, for the prior-year quarter.

Narrow Networks Still Generate Buzz

Given the still-fresh exit of Walgreens from the Express Scripts network, the concept of limited pharmacy networks was a prominent topic of discussion during recent earnings calls. Several PBM execs agreed that savings have to be at least 2% off pharmacy costs to justify potential member disruption.

“Obviously, the more restrictive the network is, the deeper the savings are that you can propose. It’s a sliding scale,” said Per Lofberg, president of CVS Caremark’s PBM services. Medco Chairman and CEO David B. Snow estimated that clients could see improvements of 2.5% to 3% by using a network of fewer than 50,000 pharmacies. Snow categorized restrictive networks as part of an “ongoing conversation” — but not something Medco plans to force on clients.

“The concept of narrow networks certainly is not anything new, but when you have the biggest retail chain pulling out of a ‘big three’ network, it obviously becomes more of a conversation,” observes Feldman. “And during this upcoming selling season, it’s certainly going to be a bigger conversation.”

While it may be too soon to tell whether the Express Scripts-Walgreens split has made any significant impact on the marketplace, SXC Health Solutions Corp. said it has just won its first account as a direct result of that dispute. In a Feb. 23 conference call, Chairman and CEO Mark Thierer told investors, “There are a good number of employers and health plans evaluating what is the impact on the network, and there is a level of discomfort around the notion of not having Walgreens in the network, and for many, many buyers, that’s a big problem. So it is, for sure, creating opportunity and not just for us, [but also] for others in the middle market.”

CVS Focuses on Maintenance Choice

A strategic focus for CVS Caremark this year is the revamping of its flagship mail-order program, Maintenance Choice, considered one of the first restrictive network designs in that it extended mail-order pricing on maintenance medications to customers using CVS pharmacies when it was first introduced in 2009. Maintenance Choice 2.0, which will be rolled out on a limited basis this year and more broadly in 2013, does not require clients to adopt restrictive benefit designs. One of the company’s new clients, Pennsylvania Employees Benefit Trust Fund, which begins its contract with CVS Caremark in July 2012 (DBN 2/10/12, p. 8), cited Maintenance Choice 2.0 as one of the primary reasons for selecting the PBM, said CVS Caremark President and CEO Larry J. Merlo.

Mergers and acquisitions will continue to be a major growth driver for PBMs this year, especially for smaller players like SXC and Catalyst, adds Feldman. “They have been quite acquisitive, obviously on a smaller scale, but we expect them to continue to be acquisitive in 2012,” he tells DBN.

Named the No. 1 fastest-growing company in the U.S. by FORTUNE Magazine, SXC just completed its third PBM acquisition in a year with the $250 million purchase of HealthTrans LLC. Thierer said that deal and its 2011 purchases of MedMetrics Health Partners, Inc. and PTRX, Inc. are a “continuation of [SXC’s] strategy to roll up the middle market.”

SXC reported year-over-year consolidated revenue growth of 155% from $1.9 billion in 2010 to $5 billion in 2011. PBM revenue grew 170% from $500 million in the fourth quarter of 2010 to $1.3 billion in the same quarter of 2011, primarily due to increased prescription claim volume as a result of new customer wins, conversions of clients from its health care IT business to full-service PBM contracts, growth in specialty spend and revenues generated from acquisitions, according to the company. Net income for the fourth quarter was $26.7 million, or 42 cents per share, up from $16.6 million, or 26 cents per share, for the fourth quarter of 2010.

Catalyst reported fourth-quarter 2011 net income of $19.1 million, or 39 cents per share, compared with the prior year’s net income of $22.6 million, or 51 cents per share. Revenues were also up 38% from $1.12 billion in the prior year’s fourth quarter to $1.54 billion for the 2011 quarter, partly due to additional prescription volume from the acquisition of Walgreens Health Initiatives, which was completed in June.

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