CVS Health Corp (CVS) 2013 Q3 法說會逐字稿

Ladies and gentlemen, thank you very much for standing by, and welcome to the CVS Caremark third-quarter earnings conference call.

(Operator Instructions)

As a reminder, today's conference is being recorded on Tuesday, November 5, 2013.

It is now my pleasure to turn the conference over to Nancy Christal, Senior VP Investor Relations.

Please go ahead, Ms. Christal.

Thank you Pamela.

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 third-quarter results and guidance.

Jon Roberts, President of PBM, is also with us today and will participate in the question-and-answer session following our prepared remarks.

Mark Cosby, President of the Retail Business, was planning to join us but is under the weather and not able to be here today.

During the Q&A, please limit yourself to no more than one question with a quick follow-up so that we can provide more callers with a chance to ask their questions.

I have one important reminder today.

On Wednesday, December 18, we will host our 2013 Analyst Day in New York City.

At that time, we will provide 2014 guidance and some longer-term financial targets as well as a comprehensive update on our strategies for achieving those growth targets.

You will have the opportunity to hear from several members of our Senior Management team about our PBM, Specialty, Retail and MinuteClinic businesses, along with numerous enterprise-wide initiatives that will capitalize on the evolving healthcare landscape and drive future growth.

If you did not reply to your invitation, please let us know if you plan to be there as space is filling up quickly.

The meeting will be webcast for those unable to attend in person, but we do hope to see many of you there on December 18.

Turning to this morning's news, we posted a slide presentation on our website just before this call which summarizes the information you will hear today as well as some additional facts and figures regarding our operating performance and guidance.

I encourage you to review the slides.

Additionally, we plan to file our quarterly report on Form 10-Q by the close of today, and it will be available through our website at that time.

During this call, we will use some non-GAAP financial measures when talking about our Company's performance, namely 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 before we continue, our attorneys have asked me to read the Safe Harbor statement.

During this presentation, we will make certain forward-looking statements that are subject to risks and uncertainties that could cause actual results to differ materially.

Accordingly, for these forward-looking statements, we claim the protection of the Safe Harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995.

We strongly recommend that you become familiar with the specific risks and uncertainties that are described in the Risk Factors section of our most recently filed Form 10-K and in our upcoming quarterly report on Form 10-Q.

And now I will turn this over to Larry Merlo.

Thanks Nancy.

Good morning everyone, and thank you for joining us today.

Now given that our Analyst Day is next month, our business update this morning will be brief.

However, I do want to take some time to cover some of the topics that I know is top of mind in the marketplace, such as the impact of the Affordable Care Act.

But before we get to that, let's kick things off with today's earnings.

We are pleased to report that we posted solid third-quarter results across the enterprise.

Overall operating profit increased more than 15% with the PBM and Retail businesses growing approximately 28% and 8% respectively.

And it is important to note that this excludes the benefit from a legal settlement that was finalized during the third quarter, and that settlement related to a prescription drug antitrust lawsuit with a drug manufacturer.

We recorded a $72 million gain within operating expenses, which equates to a $0.04 per share benefit in Q3.

Now that said, adjusted earnings per share excluding the legal settlement came in at $1.05 for the quarter, and that is $0.02 above the high end of our guidance.

Now we also generated a substantial amount of free cash, and year to date, the total amount stands at $3.1 billion.

And consistent with our goal at the beginning of the year, we remain committed to returning about $5 billion to our shareholders this year through both dividends and share repurchases.

Now, considering our strong operating results to date along with our outlook for the remainder of the year, we are raising and narrowing our earnings guidance for full-year 2013 to a range of $3.94 to $3.97.

And that is a change from our previous range of $3.90 to $3.96, and again, that is excluding the $0.04 benefit from the legal settlement.

And Dave will discuss our results and guidance in more detail during his financial review.

So with that, let me address some of the topics of interest that I alluded to earlier.

I think as everyone knows, the healthcare environment is changing rapidly, and there are certainly a number of moving parts from the Affordable Care Act to the private exchanges.

And collectively we expect changes within this environment to be a net positive for our business in 2014.

So let me walk you through the multiple ways that we will continue to grow our business in this evolving landscape.

First, we will participate in coverage expansion in the public exchanges as well as Medicaid.

Second, we will participate in the private exchange market for both active employees and retirees.

And I think it is important to remember that our opportunities to participate are not limited to just our PBM, but span across our entire enterprise to include both our Retail pharmacies along with our MinuteClinic business.

So let's drill down a little further through our PBM, because we will participate in the public exchanges through our health plan clients on a carve-in basis where the health plan offers integrated medical and pharmacy benefits and we provide the PBM services.

In fact, our health plan client footprint spans 25 states, covering nearly 70% of the eligible exchange population.

In addition, as the number one PBM player in the managed Medicaid space, we are also very well positioned to gain share through Medicaid expansion, and we certainly understand what these clients require.

Moving to the private exchanges, we will participate through both a carve-in basis, again through our health plan clients, as well as on a carve-out basis as a standalone PBM where we have direct prescription benefit offerings on the exchange products.

And we are well-positioned to win lives on the exchanges given our unique products and services as well as our trusted brand and name recognition.

Within the private exchanges, we will also play an important role in providing coverage to retirees through our SilverScript prescription drug plan as well as through our health plan clients' PDP and MAPD businesses.

There has certainly been a lot of speculation about what various employers are going to do with their populations, recognizing and acknowledging that large employers cannot participate on the public exchanges until 2017.

Well, the fact is that less than 1% of covered lives are expected to move to private exchange products in 2014.

And based on conversations we have had with our PBM clients and private exchange partners, we believe that most large employers are taking a wait and see approach to private exchanges, particularly with their active employees.

We recently had a meeting with our client advisory group, and they told us that they feel they can manage costs effectively in their own environment while still maintaining both control and flexibility.

That said, large employers may consider moving their retirees to the exchanges over time, and we may see more movement to private exchanges by smaller employers over the next few years because the exchanges do offer a way to reduce administrative burdens.

However, I want to emphasize the point that we are very well positioned to gain lives and market share in the exchange products.

Now recently, you have also been asking about the impact all of this will have on PBM margins, and as we stated previously, we do expect to see some churn in PBM lives as some members may move from the employer bucket to the health plan bucket.

And although this may result in margin compression in some instances, we expect this will be mitigated by cost management tools such as narrow networks, our proprietary maintenance choice offering, narrow formularies, step therapies and the list goes on.

And as a result, we do not expect a material impact on PBM margins in the foreseeable future.

In addition to tighter Pharmacy management tools, we also expect share gains from both market expansion and market churn as an additional lever to help offset PBM margin compression.

And as I mentioned again, we are well-positioned to win lives on the exchanges given our unique products and services along with our trusted brand and name recognition.

I also mentioned that it is important to remember that the opportunities from healthcare reform go well beyond our PBM, because our consumer expertise in the new business to consumer world of healthcare is being welcomed by health plans across the country.

And leveraging our Retail footprint, we can support health plan marketing initiatives, ranging from limited pilot marketing programs to full-scale educational programs.

In fact, over the next 6 months, we expect health plans to host more than 6,000 marketing events in more than 1,000 of our stores across 20 states.

Some of these health plan partnerships also include participation in preferred or restricted retail pharmacy networks, and many are taking advantage of the convenient and affordable MinuteClinic services as well as cost-saving PBM services and programs to better manage the Specialty Pharmacy segment.

And on top of these opportunities, our Retail business will obviously benefit from the expansion of coverage along with our ability to drive incremental scripts through our fixed Retail cost structure.

So while there are a lot of moving parts, all things considered, we are very well-positioned, and we will certainly provide more specific context around our assumptions for the newly covered lives and Pharmacy utilization that we expect from reform when we provide our guidance next month at Analyst Day.

So with that, let me quickly review some highlights on the PBM business.

We have had a strong 2014 selling season, despite the fact that the number of RFPs were down year-over-year.

To date, we have completed 75% of renewals, and we have a retention rate of 96%.

Our gross sales wins currently total $5.1 billion with net new business of about $1.8 billion.

And remember that this net new business excludes any impact from attrition in our Medicare part D PDP business.

With regard to the sanction imposed by CMS earlier this year, as we have talked about previously, it has prevented us from marketing our SilverScript PDP or enrolling new members.

And recall that the sanction primarily affects our individual SilverScript prescription drug product.

Today we have about 3.3 million SilverScript lives, and we expect to have roughly 3 million lives in our individual SilverScript PDP by the end of January 14.

On our last call, we said that we expected our remediation efforts to be complete sometime near the end of the year, and we expect to meet that target.

And once complete, the next step will be for CMS to conduct its review to determine whether the issues have been fixed, are not likely to recur, and ultimately CMS will determine when the sanction will be lifted.

While we are obviously disappointed that we have not been able to participate in the open enrollment period, it is important to remember that we still see significant opportunity to grow our Med D business over the long term.

And we believe that the changes that we have made to strengthen the Med D Management team along with the remediation steps that we have taken will allow us to do just that.

On the heels of the successful 2014 selling season in our commercial PBM business, work has already begun on the 2015 selling season.

And as all of you know, we have a long-term strategic agreement with Aetna to provide their PBM services.

And I'm happy to report that we have successfully completed the 2015 market check with Aetna, and we look forward to continuing our strong and mutually beneficial relationship.

I am also very pleased that we have successfully completed the migration of Aetna's commercial business to the CVS Caremark platform.

That is pretty significant since it means that more clients will have access to CVS Caremark's differentiated offerings.

And our joint efforts with the Aetna sales team have been successful to date with numerous clients adopting our unique offerings like Maintenance Choice, like Pharmacy Advisor, and we are also working closely with Aetna to implement and administer their exchange offerings in other government programs resulting from the Affordable Care Act.

Turning to our Specialty business, growth was strong, revenues up approximately 22% year-over-year.

This growth was driven by a direct price inflation, utilization, new product launches, and new PBM clients.

In our recent client forum, many of our clients expressed concerns about the rapid growth in Specialty Pharmacy costs, and they are increasingly open to new ideas and solutions that address the escalating growth in Specialty.

And we certainly view this as a significant opportunity, and you will hear more about our strategies to help clients manage the Specialty trends next month at Analyst Day.

Moving on to the Retail business, we had another solid quarter.

Total same-store sales increased 3.6%, while Pharmacy same-store sales increased a very healthy 5.7%.

Pharmacy same-store sales were negatively impacted by about 320 basis points due to recent generic introductions, and that is about half of the 670 basis point impact that we saw in Q2.

Pharmacy same-store scripts increased 1.4% when counting 90 day scripts as one and increased 4.5% on a 30 day equivalent basis.

And we have seen a greater than historical rate of conversion to 90 day from 30 day scripts, and that is being driven by the continued strong growth in our Maintenance Choice programs.

I am also pleased to report that the retention of scripts gained during last year's impasse between Walgreens and Express Scripts continues to exceed our expectations.

As you know, our goal was to retain at least 60% of those scripts this year, and we are ahead of that goal.

As for the front store business, comps decreased 1%, reflecting a decline in traffic.

At the same time, we saw a continued increase in basket size as well as modestly higher front store margins.

Our ExtraCare loyalty card continues to enable us to personalize our offers, creating more value for customers and gaining bigger share of their wallet.

In fact, this quarter we launched the myWeeklyAd, the first of its kind personal personalize digital circular experience that taps into ExtraCare insights, and the myWeeklyAd provides a unique weekly circular for every customer that is geared to their shopping preferences, saving them both time and money.

We hope you will log on and give it a try, and we will speak more about this on Analyst Day.

As for new stores, we opened 71 new or relocated stores, closed 1 during the quarter, resulting in 48 net new stores in Q3.

And this keeps us on track to achieve our 2% to 3% square footage growth target for the year.

Let me turn briefly to MinuteClinic, which posted revenue growth of 18% versus last year's third quarter.

We opened 42 net new clinics in the quarter, including clinics in two new states, Hawaii and Louisiana.

Ending Q3 was 726 clinics in 27 states and the District of Columbia.

Our long-term goal was to create a platform that supports primary care by providing integrated, high-quality care that is convenient, accessible, and affordable.

And we will talk more about that next month as well.

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

Thank you, Larry.

Good morning everyone.

Before turning to our results and our guidance, I want to highlight how our disciplined capital allocation program continues to enhance shareholder value.

And during the third quarter, we paid approximately $276 million in dividends, bringing our year-to-date payout to $829 million.

Additionally we repurchased approximately 25.8 million shares for $1.5 billion in the quarter at an average price of $58.98 per share.

Year-to-date, we've repurchased 39.6 million shares for approximately $2.3 billion, again at an average price of $57.33.

As you can see, the pace of buybacks accelerated throughout the third quarter, and we remain on track to complete approximately $4 billion of share repurchase 2013 which is also included in our guidance.

So between dividends and share repurchases, we have returned more than $3.1 billion to our shareholders through the first three quarters of this year alone.

And we continue to expect to return approximately $5 billion for the full year.

We have also generated approximately $3.1 billion of free cash flow through September of this year.

Improving our cash generation capabilities through improved working capital management remains an area of focus for us, and over the past several years, we have made excellent progress in reducing our cash cycle.

As previously noted, we have some timing issues with respect to CMS payables and receivables that may affect our working capital and delivery of free cash flow for the year.

Even so, we are maintaining our guidance of free cash flow between $4.8 billion and $5.1 billion this year while we work to offset this headwind to our target.

As for the income statement, third-quarter adjusted earnings per share from continuing operations of $1.05 per share was approximately $0.02 above the high end of our guidance after removing the pretax gain of $72 million from the legal settlement.

GAAP diluted EPS was $1.03 per share including the $0.04 gain from the legal settlement.

Earnings were higher than expected primarily due to the outperformance in the PBM, a favorable tax rate, and a weighted average share count that was slightly lower than planned.

Now, let me quickly walk you through our results.

On a consolidated basis, revenues in the third quarter increased 5.8% or approximately $1.7 billion to $32 billion.

This exceeded the top of our guidance range, again driven by the PBM.

PBM net revenues increased 7.8% or approximately $1.4 billion to $19.5 billion.

This growth was more than 225 basis points above the high end of our guidance and was driven by higher than anticipated claims volume, primarily from Maintenance Choice, as well as higher inflation within our Specialty business.

Script utilization trends were consistent with prior periods, but we saw increased utilization in the Retail network and in Maintenance Choice claims offset by declining trends in core mail-order.

Claims growth year-over-year was driven by net new client wins and increased membership within our existing book-to-business.

Specialty Pharmacy was also a key driver.

Slightly offsetting these positive revenue drivers was a strong GDR, which is obviously good for the bottom line.

The PBM's generic dispensing rate increased 170 basis points versus the same quarter of LY to 81%.

Note that starting with Q1 of this year, the sequential year-over-year rate of increase continues to slow from the high point of approximately 500 basis points in Q4 of LY to 170 basis points this quarter.

This trend is expected to continue throughout Q4 this year, given that fewer generic conversions are expected in the remainder of this year versus last year.

Revenues in the Retail business increased 5% in the quarter or approximately $780 million to $16.3 billion.

As with the PBM, Maintenance Choice adoption was better than expected and helped drive overall performance to near the higher end of expectations.

Like the PBM, new generic introductions negatively impacted Retail sales with our Retail GDR increasing approximately 160 basis points versus the third quarter of 2012 to 81.5%.

Now turning to gross margins, we reported 18.9% for the consolidated Company in the quarter, an increase of approximately 20 basis points compared to Q3 of 2012.

Within the PBM segment, gross margins increased by approximately 65 basis points versus the same quarter of LY to 6.6% while gross profit dollars increased approximately 20% year-over-year.

The increase in margin rate year-over-year was primarily driven by better acquisition costs, rebate economics, timing of our Medicare Part D PDP margins as well as the increase in GDR.

The increase in margin dollars was driven by higher volumes from new clients and new members and higher Specialty volumes versus the third quarter of last year, as well as the shift on Medicare Part D profitability from Q4 into Q3 of this year.

These positive drivers were partially offset by price compression as well as remediation and operating costs within our Medicare Part D business.

Gross margins for the Retail segment was 30%, down about 15 basis points from LY, while gross profit dollars increased 4.5% year-over-year.

Given that Pharmacy growth was stronger than front store growth in the quarter, Pharmacy revenues as a percent of total Retail revenues increased by about 135 basis points.

This shift in the business mix was the main driver of the decline in the overall Retail margin rate since gross margins and the Pharmacy business are lower than that in the front.

Partially offsetting this was the increase in GDR as the continued increase in front store margins.

Excluding the positive impact of the legal settlement, total consolidated operating expenses as a percent of revenues improved versus the third quarter of 2012 by approximately 35 basis points to 12.3%, while total SG&A dollars grew by 2.9%.

The PBM segment's SG&A rate improved by about 15 basis points to 1.5%, excluding the benefit of the $11 million settlement.

PBM expenses declined approximately $4 million from the third quarter of last year.

And this reflects reduced spending on the streamline initiative as the project nears completion.

In the Retail segment, solid expense control resulted in an improvement in SG&A as a percentage of sales of 40 basis points to 21.3%, excluding the $61 million benefit from the legal settlement.

Overall Retail SG&A expenses grew by about 3.1%.

Now within the Corporate segment, expenses increased by approximately $10 million to $179 million.

As a percent of consolidated revenues, operating expenses were flat.

Now adding it all up and excluding the impact of a legal settlement, operating margins for the total enterprise improved approximately 55 basis points to 6.5%.

Operating margin in the PBM improved 80 basis points to 5.1% while operating margin at Retail improved by 25 basis points to 8.7%.

For the quarter, we were comfortably within the high end of our guidance for operating profit growth in the Retail segment while we exceeded our expectations in the PBM.

Excluding the benefit from the legal segment, Retail operating profit increased a very healthy 8.2% while PBM operating profits increased a very strong 27.7%.

Going below the line on the consolidated income statement, net interest expense for the quarter declined approximately $12 million from last quarter to $122 million.

The debt refinancing we did in the fourth quarter of last year continues to be the primary driver of the year-over-year decrease each quarter.

Additionally, our effective tax rate was 38.2%, which was slightly better than we expected, and our weighted average share count was slightly lower than anticipated at about 1.23 billion shares for the quarter.

So now let me turn to our 2013 guidance, which we both raised and narrowed this morning.

Excluding the impact of the legal settlement in the third quarter, we currently expect to deliver adjusted earnings per share of $3.94 to $3.97 for 2013, reflecting strong year-over-year growth of 14.75% to 15.75% after removing the impact in 2012 of the early extinguishment of debt to make the numbers more comparable.

GAAP diluted EPS from continued operations is expected to be in the range of $3.73 to $3.76 per share.

(technical difficulties) Our revised guidance reflects our solid performance through the first 9 months of this year as well as our confidence in our outlook.

Embedded in this guidance are share repurchases totaling approximately $4 billion for the year, including shares from a $1.7 billion accelerated share repurchase program that we began on October 1. The details of the program will be available in our 10-Q which we file later today.

Now let me walk you through our fourth-quarter guidance.

We expect adjusted earnings per share to be in the range of $1.09 per share to $1.12 per share, down 1.5% to 4.25% from Q4 2012 after removing the impact from last year's fourth quarter resulting from the early extinguishment of debt.

GAAP EPS from continuing operations is expected to be in the range of $1.03 per share to $1.06 per share.

As I said in our last quarterly call, we expect the fourth quarter to be somewhat atypical this year, driven mostly by the timing of break-open generics and by Med D profits in PBM.

With respect to Medicare Part D, as I noted on our last earnings call, we are seeing a shift of profitability within the business from Q4, which has historically been our most profitable Med D quarter, into Q3.

A number of factors are affecting this, predominantly changes in earned rebates and the mix of the business across our SilverScript Choice versus our SilverScript Basic plan as well as the impact of the sanction.

As such, we expect the PBM segment's operating profit to decline by 15% to 18% in the fourth quarter.

We expect the Retail segment's operating profit to increase 2.75% to 4.5% in the fourth quarter, driven by gains in both the front store as well as the Pharmacy.

For the PBM segment, we expect revenues to increase 3.5% to 5% for the fourth quarter and adjusted claims be between $262 million and $265 million.

For the Retail segment, we expect revenue to increase 3.5% to 5% with same-store sales to increase 2.25% to 3.75%.

Same-store scripts are expected to increase 0.5% to 1.5% while adjusted script comps are forecasted to be between 3% and 4%.

And now as a result, the total enterprise in the quarter, we expect revenues to be up approximately 2.75 % to 4.25% from the fourth quarter of 2012.

This is after intercompany eliminations which are projected to equal about 10.6% of combined segment revenues.

For the total company, gross profit margins are expected to be down significantly from last year's fourth quarter as both the Retail and PBM segments will experience contraction.

Expectations are that gross margin in the Retail segment will be notably down, due to fewer new generics available to offset continued reimbursement pressure.

Gross margins in the PBM segment will be significantly down, due in large part to the timing of Medicare Part D profitability, but also due to fewer break-open new generics to offset pricing pressures.

These trends are occurring as expected as we lap a large amount of break-open generics and 2012.

For the total Company, operating expenses as a percent of revenues are expected to moderately improve in the fourth quarter.

PBM operating expenses should show modest improvement driven in part by a reduction of streamlining cost year-over-year.

Retail expense leverage should notably improve and upturn from recent trends largely due to the fact that there are fewer new generics and therefore less deleveraging of expenses.

And we expect operating expenses in the Corporate segment be to be between $190 million and $195 million.

We expect operating margin in the total company in the quarter to be down 60 to 70 basis points from last year's fourth quarter.

We expect net interest expense of between $130 million and $135 million and a tax rate of approximately 39% in the fourth quarter.

We anticipate that we will have approximately 1.2 billion weighted average shares for the quarter, which would imply approximately 1.23 billion for the year.

And as I said, we continue to expect to generate free cash flow in the range of $4.8 billion to $5.1 billion, and we remain focused on using our strong free cash flow to drive shareholder value now as well as into the future.

And with that, I will turn it back over to Larry Merlo.

All right.

Thanks Dave.

And just to sum things up, obviously we are pleased with our strong third-quarter results and optimistic about the outlook for this year and next.

We see the evolving healthcare environment as an opportunity for growth, and we believe we are very well positioned to gain market share across the enterprise.

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

(Operator instructions)

Robert Jones, Goldman Sachs.

Thanks for taking the question.

A lot of good detail on the PBM side, so I thought I would maybe start off on the front end.

Same-store sales down again this quarter, and I know you are citing softer traffic.

I was wondering if you could maybe share some color on whether you think this has been more macro driven, or is there some competitive changes going on that are driving a little softness on the front end?

Robert, we have discussed in the past that we continue to see a cautious consumer.

We did see some pullback in consumer spending that began in the spring timeframe, and it is manifesting itself in fewer trips.

At the same time, we have seen the promotional environment intensify in both the drug and mass channels.

At the same time, we have not made dramatic changes in our promotional strategies.

As a matter fact, if you look at our year-over-year promotional search per page count in the third quarter, it was actually down 12%.

And we continue to use ExtraCare as our point of differentiation along with delivering a way to create value for consumers.

And we have been able to drive the basket size of our customers.

And as Dave mentioned in his remarks, it is also important to point out that through these efforts, we have been able to achieve margin expansion.

So I think we are always -- on the front store sales issue, it's always a bit of art and science, trial and error.

Mark and his Retail team are certainly focused on it.

We would like our front store comps to be better, but we will be very disciplined about not chasing empty sales.

That makes a lot of sense.

And Larry, I know you talked about a lot of the major topics in this sector, specifically the exchanges.

And obviously looking forward to getting more details at the analyst day, but one of the major topics as of late has been agreements across the supply chain as far as consolidated generic purchasing.

I am just wondering if you could weigh in, given some of the activity as of late as far as your view of your current positioning and generic sourcing and whether or not you think in light of some of these moves that you would be interested in trying to garner more scale.

Our position has really not changed since we discussed this on our last call.

A generic sourcing alliance could present an interesting opportunity.

We are certainly always open to learning and evaluating opportunities in the marketplace, and if we were to determine that an alliance could drive higher returns for us, we would certainly consider that.

We believe that we could do that without expending significant capital.

So we will continue to watch it.

And there may be some incremental opportunities domestically, but we still see the global sourcing environment less clear, but again, we will be open to opportunities.

Great.

Thanks for the question.

Bob Willoughby, Bank of America Merrill Lynch.

Hello.

Larry or Dave, in light of how fast the CVS share of the Caremark accounts has grown over the past few years, does it make sense to offer any type of quarterly update where you think your share stands and to offer any targets were that could go in the next couple of years?

Bob, this is Dave.

Good question.

I think as you know, we have seen substantial growth in share within CVS within the current market.

Over the past few years we have moved from roughly 18% in excess of 31% at this point in time.

My guess is that those shares, that those are longer-term movement trends, so probably quarter by quarter would not make the most sense.

Probably year-over-year would be a more comparable perspective.

So you probably will see a little bit of that as we cycle into analyst day coming up here.

Bob, it is a great question.

I think it does make sense to look at it on an annual basis.

And to Dave's point, keep in mind that that Retail percent of the Caremark book of business, while it has grown, the pie has also grown at the same time.

There have been north of $25 billion worth of new business wins during that period of time.

Any three-year target perchance?

Not at this point.

Okay.

Thank you.

Thanks Bob.

Eric Bosshard, Cleveland Research.

Good morning.

Could you give us any color on the share in the Retail business now that it's transitioned from 30 to 90 days, where you think that might go and how you are running the business or managing capacity in the stores differently as that is taking place?

Yes.

We have seen it grow, Eric, for some time now.

Acknowledging growth off of a smaller base, but it has grown -- it has been growing north of 20%.

And I think that there are a lot of variables in play that are driving that growth from -- I will start with Maintenance Choice, but there are also more planned designs out there that have 90 day options at Retail.

And there has been a lot of information out there that 90 day prescriptions also improve medication adherence.

So I think that we will continue to see a disproportionate growth and an acceleration from 30 to 90.

Obviously, we have -- on the Retail side we have always done an effective job of managing SG&A at the store level, and the labor model we have built along with our workflow in the Pharmacy enables us to flex our labor according to those volumes.

And there are some labor efficiencies to be picked up there.

And then secondly, you talked about restricted or preferred networks.

I'm just curious what you are seeing take place, what you're facilitating through Caremark and what you are seeing take place in the market in terms of the appetite and adoption and utilization of preferred or narrow networks on the Retail front as we move into 2014?

Yes.

Eric, this is Jon.

When we have clearly seen the growth of preferred networks in Medicare.

Got off to a slow start when Medicare was first implemented, but you have seen a lot of movement, particularly over the last couple of years.

In Medicaid we are seeing restricted networks in the managed Medicaid space, and we think that continues to be something that this segment will be interested in.

In the employer space, you we have seen and Dave talked about our growth of Maintenance Choice which is a form of a narrow network.

And we are seeing interest from employers.

I would say this year probably less interest because employers were more focused on healthcare reform, changes they needed to make within their own book of business.

But it is interesting that health plans that historically have not been interested in their own networks, we are seeing a lot of interest particularly around exchange offerings.

So we have had several health plans adopt narrow networks for their public exchange offerings.

So we think it continues to be an opportunity for plans and clients to save money through either preferred or restricted networks.

And we continue to see good growth opportunities in this area.

Great.

Thank you very much.

Thanks Eric.

John Heinbockel, Guggenheim Securities.

Thanks.

Larry, two questions.

First on Maintenance Choice.

Any comment on the relative growth rates of 2.0 and 1.0 and when do you think -- how much time do you think it takes for 2.0 to start then customers migrating from 2.0 to 1.0?

Will that be a wonderful contract cycle or shorter, longer?

What are your thoughts on that?

Yes.

John, we will touch more on this at analyst day, but we have seen some adoption on 2.0.

I think that we certainly -- as we have talked, we see an opportunity to -- when you look at 1.0 and 2.0, the opportunity to cover more than 30 million lives over time.

I think that we see and adoption track where a client gets into 2.0 and then ultimately migrates into 1.0 to maximize savings.

But we will get more of the metrics in December.

All right.

And then secondly, thinking about the front end and myWeeklyAd, so if you look at -- if you could segment traffic by loyalty of customer, I don't know if you would do a [dovesyle] or a quarter tile or whatever, but is traffic down among the low most loyal customers?

Or is it down among the least loyal?

Maybe some of that is by your design.

And then over time, as myWeeklyAd gets greater adoption, what does that do to traffic?

And is that a significant incremental positive to margins as you are getting more and maybe wasting less promotional dollars?

Yes.

John, those are two great questions.

If you look at our traffic and through segmentation, we would see more of the declines among our most -- or our least loyal customers.

Okay?

We continue to see growth in our most loyal customers.

I think directionally, you are spot on in terms of the reality of, as we migrate over time and reduce our dependency on the weekly circular, there is certainly an opportunity to deliver value to our ExtraCare members.

Okay?

And create a high level of satisfaction and a bigger share of wallet, and to be able to do that so that there is a flow-through to the P&L.

And by the way, John, I think the myWeekly circular just becomes one more tool.

That is not going to be the single conduit that drives that behavior.

It will be that in addition to many of the other attributes that ExtraCare offers the consumer.

When you did ExtraCare, that helped growth.

Will myWeeklyAd help to the same degree or not as much?

John, it is early.

We are experimenting with it now.

And that is something that we will be able to talk about over time.

Okay.

Thank you.

Meredith Adler, Barclays.

Thanks very much.

I would like to just go back a little bit to the discussion about the private exchanges, and you talk about some being carve-in Pharmacy benefit and some being carve-out.

Do you have any sense of kind of what percentage is going to be carve-in and what is going to be carve-out?

And then also related to that, is there a difference in profitability when it is carve-out versus carve-in?

Yes.

Meredith, I will take the first part of that.

Meredith, acknowledging that A, it is early, B, it is a small sample size.

But what we have seen is a trend that really looks at the historical preference of the client.

So -- and by that, I mean, if the employer had Pharmacy as a carve-out option, that they are moving onto a private exchange product that continues to carve-out Pharmacy and vice versa.

If they had Pharmacy carved in with their health plans, then they are migrating to a carve-in product.

And again, that is a limited sample, but that is what we see today.

And then Meredith, on the profitability, it is really a function of what programs they adopt.

That really drives profitability, so it lowers our cost but drives up profitability, programs like mail, formulary, network programs and others.

And we think, with the consumer making that choice, there are going to be more likely to make those selections for themselves.

Right.

And then switching gears, a question back to the discussion of the front end.

Is it possible that the broad-based circular -- I do not think you will ever eliminate the circular, the one that is not tied to the loyalty card or the individual, but can you conceive of it being much less promotional and more kind of like an EDLP circular?

There are other retailers who highlight their good deals every day, but not necessarily being focused on promotional items.

Meredith, I think that you are right.

I do not think any of us see the circular going completely away.

Okay?

And I think that it will evolve over the next few years.

I can see it being smaller.

I can see it being more focused.

Exactly what shape and form that takes, I think, is probably still an open question.

We know that just because of the readership of the newspaper, the circular distribution is down from what it was five years ago.

And I think directionally, you are correct with your hypothesis.

Okay.

Great.

Thank you.

Thanks, Meredith.

Lisa Gill, JPMorgan.

Thanks very much.

Larry, thank you very much for all that comments on public and private exchanges.

But I am actually going to ask a question about Medicare Part D.

When you look at your now guidance of roughly 3 million members versus 3.3 million before, is that roughly in line with the 350,000 that you talked about last time?

And secondly, anything you are seeing in the open enrollment period that would pertain to any of your thoughts around that going into next year?

Lisa, good morning.

And in response to your first question, it is consistent with what we talked about on our last call in terms of the attrition of about 350,00 lives.

And it is early in open enrollment, but we have not seen anything that is contradictory to what we have talked about.

Okay.

And then secondly, can you may be just give us an update of where you are in RDS in conversion from RDS?

Clearly the tax benefit goes away in 2014.

And based on the sanctions that you have, and you just remind us if there are any impact at all of voting people potentially to an EGWP or any other program as they shift away from RDS?

Yeah.

Lisa, this is Jon.

We saw most employers focused on healthcare reform this year.

So most of the movement to EGWP happened the year before.

We think there will be a pick up in activity this year.

Our plan will be out of sanction, and we believe we will be able to implement anyone that wants to move into an EGWP product moving forward.

Lisa, the other thing I would mention is that we have been operating under a waiver from CMS to continue to enroll EGWP members that we had commitments to prior to the sanction.

So that is ongoing and that waiver has been extended through January of 2014.

Great.

Thank you for the comments.

Thanks Lisa.

Thank you.

Scott Mushkin, Wolfe Research.

Hello guys.

I had a quick housekeeping item, and then I wanted to get to my questions.

Flu shots, is that in your script number or not?

I cannot remember.

Yes.

Scott, flu shots we do treat as a prescription, and I will call it season to date.

So the season kicks off in the August time frame, and what I am going to share with you probably goes through near the end of October.

But we have administered just over 3 million flu shots across our Retail business and MinuteClinic, and that is up from last year.

Okay.

Perfect.

Thanks for that clarification.

So the second question I have really goes to the outlook for the PBM, you guys talked about market share.

And that you feel that with the new environment you can gain market share.

It seems to me as we look at Medicaid, I think 31% of that business, it has grown quite a bit, so I want to understand, can that go higher?

Also you commented that you are in 25 states with the exchanges.

Can you get to more states?

Can 70% become 90%?

And then the final question about next year is we have some big contracts out like tri-care.

What is your confidence that you will continue to gain share on the PBM side of the business in those three different buckets?

Yes.

Scott, I will take the first part, and then I will flip it over to Jon.

Okay.

In terms of Medicaid, and I think specifically you are talking about the managed Medicaid environment, and you are right.

We have about 30% share of the managed Medicaid market.

We certainly see more room for growth there.

We are estimating that the managed Medicaid market is going to grow by about 40% between now and 2016.

So we see that as a driver for growth.

And then, your second question --

Yes.

So Scott, as far as we are in 25 states with 70% as we continue to win in the marketplace and win health plans, which we had some wins this year, we will continue to expand our footprint.

And just as far as winning across all segments, as Larry mentioned earlier, for the 2014 selling season, we have got over $5 billion in gross wins with 96% retention.

We have had, if you look over the past several years, we have continue to be very successful selling.

Our integrated model continues to resonate in the marketplace with Maintenance Choice, Pharmacy Advisor, our integrated specialty capabilities we're launching, what we are able to do for our clients with MinuteClinic.

So we are very bullish on our growth opportunities moving forward.

And then one final follow-up.

If you continue to gain share like you have been, which is driving tremendous amount of traffic into your assets, particularly your Retail assets.

And I know you are doing the promotional stuff, but Larry, we have talked about how do you get the incremental sales in a profitable way?

It seems like there is a tremendous untapped opportunity to take that traffic and convert it to some front-end sales.

Any other color on how we get that done?

Scott, first of all, I agree with you.

And as I have mentioned earlier, I think it was the first question, our Retail team is working hard to improve our comp sales performance.

And I think some of what you are describing lies in innovation and trial and error.

And we have got a talented team focused on it, and we will continue to work and ultimately crack the code on that.

All right.

Thanks for taking my questions.

Really appreciate it.

Thanks Scott.

Mark Wiltamuth, Jefferies.

Hi.

Good morning.

Thank you.

I wanted to ask a little bit about the specialty Pharma environment, and I know you have a pilot going there to kind of join the CVS brick and mortar stores with the [males] operations on specialty.

If you could give us an update on what is going on there and how you think that will evolve as specialty trends continue to grow?

Mark, this is Jon.

So if you think of specialty today, and you think about it from an access to a member perspective, it is primarily a mail channel today.

What we have been able to do is take all of our specialty capabilities and connect them through our Retail stores, so now members that want to get access to specialty medications can go in any one of our 700 stores as we roll this out next year.

We will leverage all of the back end clinical capabilities, the billing capabilities, the fulfillment capabilities, and then we will be able to deliver that prescription either to the member's home, like happens today with specialty Pharmacy, or delivered to their local CVS Pharmacy.

And it is interesting, very similar to Maintenance Choice, half the people want to pick up their specialty prescription in their CVS local store, and the other half want it mailed to their home.

When you think about it from a Pharma perspective, historically, the adherence levels for specialty medications have been lower in the Retail channel than in the specialty channel.

In our pilots, we have been able to achieve the same levels of adherence through the integrated specialty offering that we have at mail.

So we think Pharma is going to be pretty bullish on this capability.

So we are improving access, we are achieving very high adherence levels, and we are delivering all the clinical capabilities that these patients need with the convenience that we are able to offer through an integrated offering.

And is the bigger win capturing more prescriptions at the local Pharmacy, or is it just the convenience of delivery for the consumer?

I think about it in probably two parts.

One is we think because we will have a differentiated offering, again, it adds to our value propositions as we are out trying to win new clients.

Secondly, there is a segment of the population that is open, Medicare as an example, where the patient has a choice where they get their specialty prescription filled.

So we think we have a better value proposition for those patients, so we think we will capture more share of that open business.

Mark, I think the only other point that I would make is that we can make it a seamless experience across all of the stakeholders that are involved here to include the position.

Okay.

Thank you very much.

Thanks Mark.

Ross Muken, ISI Group.

Maybe first just going back to all the stuff you laid out re reform, do feel like the more you continue to dig into this, and obviously there is a lot of things changing and a lot of unknowns, but do you feel like the integrated model you continue to figure out new services, new offerings, new potential profit drivers as things change and then you really have a structural advantage there having the full suite of capabilities versus maybe some of your peers?

Ross, I think you said it very well.

Okay?

I do not know that there is a lot that I would add to that other than agreeing with you, and I think it gets back to what we have talked about many times, that if you think about from a PBM perspective, it has largely been a B2B business.

And if you think about the new world order adding B to C segment, we have got expertise in both.

And I think that that is how we are uniquely positioned to gain share, acknowledging that we are going to go through a period of churn in terms of who is sponsoring the coverage.

But we feel that we are well-positioned, and whether you are talking about our PBM assets, our Retail assets, our MinuteClinic assets, we can do things and bring differentiation into the market that would be difficult for standalone peers to replicate.

I guess you guys have done a good job of educating us.

Maybe just quickly on the selling season, if you look at some of the net losses, can you maybe just kick through how much of that was acquisition?

And if not, what were the -- in terms of the update from Q2, what were the key reasons where you saw maybe business move away from you?

Yes.

Ross, in terms of -- the numbers that we gave to include the retention, does reflect the net impact of acquisition activity.

And recognizing that we picked up some from acquisitions and we lose some, but acquisition activity pose a headwind for us in terms of the impact of that.

And I will let Jon talk about from a client perspective.

Yes.

It is a very sticky business.

We have got retention at 96%.

You add on top of that the $5 billion in new wins.

You are always going to see some movement as people go out and evaluate the market.

But we have been very happy with our ability to retain customers, and with that 96% retention including some of the acquisitions that are moving away from us, like Amerigroup.

Thanks guys.

Thank you.

We will take two more questions.

Ricky Goldwasser, Morgan Stanley.

Hello.

Good morning.

This is Zack Sopcak for Ricky.

I just had a question on your Medicare part D preferred network, and we see a proliferation in the number of part D networks.

I was wondering if you could talk about your offering for 2014 and how it compares to some of your competitors in the preferred network area.

Yes.

Zack, this is Jon.

So I have a preferred network.

It is very similar to what we have this year.

It is about 25,000 pharmacies will get advantages number, member will have a lower co-pay if they go to a preferred Pharmacy, and then we wrap the balance of the network around that so that we have the full suite of 65,000 pharmacies participating.

So it has been very successful, and we have created enough co-pay differential to drive pretty good share into those preferred pharmacies, So we are very happy with the performance in that preferred network.

And it has allowed us to offer a very competitive product in the market place.

That will help us continue to grow as we move forward.

Also keep in mind, Zack, that we have -- use Aetna as an example, that we have an Aetna preferred Med D product on the marketplace and we are supporting them on as well.

Okay.

Great.

Thank you.

And then just a quick question on MinuteClinic.

Of the18% revenue growth that you talked about, I was wondering if you were willing to break down how much of that was organic versus new store growth and if you could talk at all about how the payor mix might have evolved over the course of the year?

Zack, this is Dave.

I do not know that number off the top of my head, but we have been comping -- if you look at it from a comp perspective-- in the teens to low 20s most recently in Minute Clinic.

Zack, your second question in terms of payor mix, we have continued to see a high rate of adoption from health plans and even government sponsored programs.

If you look at MinuteClinic visits now that have some type of insurance co-pay tied to it, if you will, that number is now in the mid-80s.

Okay.

Great.

Thanks.

Thank you.

David Magee, SunTrust.

Yes.

Hi everybody.

Good morning.

Good morning.

First question, just on the specialty Pharma, you called out inflation as being a factor, and I was curious if you could quantify that and specify whether that is in line with the trend or are we seeing a sustainable trend change there?

It is -- David, specialty inflation has been pretty consistent over the last several years, so it is generally 8% to 10%.

You have to add on top of that mix, so as new drugs come to the market, they are fairly expensive, and then utilization is the third component.

So that translates into trend or cost increases that our clients are seeing that are in the high teens or low 20s.

Clearly managing this area has become our client's top priority, and we will talk more about what we are doing in this area on analyst day.

Do you have a market share number for that business year over year?

I do not have that.

I am sorry.

We will probably touch a little bit on that at analyst day as well.

Thanks.

And my last question has to do with the promotional environment that you anticipate on the front end.

Have you baked in a significantly more promotional environment this year relative to last year as it relates to the holidays?

How do you view that this time?

Yes.

Dave, this is Dave.

As Larry indicated before, we have seen the promotional environment increase over the last several months.

I would say that while that has occurred in the marketplace, we have been a pretty diligent in our approach to this.

We have not really changed our promotional posture much.

I would say we continue to use our loyalty card program to drive performance for us.

And to make sure that there is a good balance between what is happening from a front store sales perspective but also quite frankly from what is happening from a margin perspective, and we've been consistently kind of growing our front store margin rate.

And again, there is a balance there that we will watch closely.

Great.

Thanks Dave

So let me just thank everybody for joining us this morning, along with your interest in CVS Caremark, and we will look forward to seeing many of you next month at our analyst day in New York.

Thank you.

Ladies and gentlemen, that does conclude the conference call for today.

We thank you all for your participation and ask that you please disconnect.

Thank you once again.

Have a great day.