CVS Health Corp (CVS) 2014 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the CVS Health third-quarter 2014 earnings call.

(Operator Instructions)

As a reminder, this conference is being recorded Tuesday, November 4, 2014.

I would now like to turn the conference over to Nancy Christal, Senior Vice President of Investor Relations.

Please go ahead ma'am.

Thank you, Carlos.

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, as well as guidance for the fourth quarter and year.

Jon Roberts, President of the PBM, and Helena Foulkes, President of the Retail Business, are also with us today and will participate in the Q&A session following our prepared remarks.

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

Now I want to take a moment to remind you that our annual Analyst Day will take place on the morning of Tuesday, December 16 in New York City.

At that time you'll have the opportunity to hear from several members of our Senior Management team who will provide 2015 guidance, as well as a comprehensive update on our growth strategy.

If you'd like to attend and haven't already signed up, please contact me as soon as possible as remaining space is limited.

The meeting will also be simulcast on our website for those of you who are unable to be there in person.

Now I have another important item for you to note.

Please keep in mind that, in order to provide a better view of our underlying performance, our results and guidance for the full year, as well as all of the year-over-year growth rates we discuss today are calculated after excluding two items.

These include the gain from the legal settlement in the third quarter of last year and the loss from the early extinguishment of debt in the third quarter of this year.

As a reminder, the debt extinguishment and the associated costs in this year's third quarter were not included in our guidance.

Now just before this call, we posted a slide presentation on our website which will footnote where these adjustments have been made.

The slides summarize the information you'll hear today as well as some additional facts and figures regarding our operating performance and guidance.

Additionally, our quarterly report on Form 10-Q will be filed by the close of business today and it will be available on our website at that time.

Please note that, during today's presentation, we'll make forward-looking statements within the meaning of the Federal Securities laws.

By their nature, all forward-looking statements involve risks and uncertainties.

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

Well thanks, Nancy.

Good morning, everyone, and thanks for joining us to hear more about the terrific third-quarter results we posted this morning.

Overall, we met or exceeded our expectations on every key measure of performance.

Our adjusted earnings per share increased 9% to $1.15 per share, $0.01 above the high end of our guidance range.

Both the PBM and Retail segments exceeded our revenue expectations along with the Retail business delivering expanded gross margins.

Operating profit in the Retail business grew 8.8% at the high end of our expectations, while operating profit in the PBM grew 8.5% exceeding expectations.

And the PBM out performance was primarily attributable to stronger than expected claims volume and favorable purchasing economics.

Additionally we generated $1.4 billion of free cash in the quarter.

And given the favorable tax affect of the debt extinguishment, we are increasing our guidance range for free cash flow for the full year by approximately $200 million to $5.7 billion to $6 billion.

Now, given our strong performance, we are also narrowing this year's adjusted EPS guidance to a range of $4.47 to $4.50.

And that's from a range of $4.43 to $4.51 and again excludes the cost this quarter associated with the early extinguishment of debt.

And Dave will provide the details behind our financial results and guidance during his review.

So with that, let me turn to the business update and I'll start with the 2015 PBM selling season, which I'm pleased to report has continued its growth trajectory.

Gross wins for 2015 currently stands at $6.4 billion, and that's up $1 billion from our last update with net new business standing at $3.1 billion, up $500 million from our previous report.

And let me point out that this excludes any impact from our SilverScript PDP.

Now pricing this selling season remained competitive yet rational and our business wins reflect growth in the employer, health plan and government sectors.

And our success again reflects our track record of generating savings for our clients through our suite of unique capabilities.

Now when you look at $3.3 billion in business we lost, it's important to keep in mind that about 50% was lost through acquisition and another 25% was attributable to clients moving some of their members, primarily retirees, into the open market.

And through our strategic relationships with health plans, along with our competitive SilverScript product offering, we believe we are well-positioned to capture beneficiaries enrolling in open market plans.

So we're very pleased with the selling season and our team is already ramping up for what we expect to be another successful welcome season for early 2015.

Now as for 2015 renewals, we've completed more than 80% of the $26 billion in business up for renewal with a retention rate of just over 96%.

Our clients continue to be very focused this season on achieving better control of specialty spend.

And we continue to differentiate our specialty offerings to provide a high level of clinical support to patients, while managing trend for our clients and driving continued share gains in the business.

Specialty revenues were up about 53% year over year driven by new business, the high cost Hep C drug Sovaldi, along with the addition of the Coram infusion business.

Now through Q3, numerous clients have signed up for our site of service management product that's enabled by the acquisition of Coram earlier this year.

And we also continue to see client interest and adoption of our medical pharmacy management offering enabled by the acquisition of NovoLogix.

So we remain optimistic that we can continue to gain specialty pharmacy share, and you'll hear a lot more about our strategies to capitalize on existing opportunities at Analyst Day.

Now before turning to Retail, let me touch briefly on our Med D product SilverScript.

As expected, we currently have about 3 million lives in our individual PDP and we expect to end the year with about the same amount with monthly add-ins from new chooser enrollments and dual auto assignments expected to offset normal monthly attrition.

And we'll update these numbers early next year as we get the results of open enrollment along with a low income subsidy of signees.

But we continue to see significant opportunity to grow the individual PDP business over the long term and are pleased with our product positioning in the market for 2015.

Now moving on to the Retail business, which again produced solid results and let's talk first about the pharmacy.

Continuing the strong trend that we saw in the second quarter, we once again gained pharmacy share in Q3.

Year over year our pharmacy market share increased about 40 basis points on a 30-day equivalent basis.

Pharmacy same-store sales increased 4.8% versus the same quarter last year, while pharmacy same-store scripts increased 5.1% again on a 30-day equivalent basis.

Now these strong pharmacy same-store sales include the negative impacts of approximately 190 basis points due to recent generic introductions.

And another 190 basis points from the implementation of Specialty Connect, which transfers specialty scripts from our Retail segment to our PBM segment.

As expected, we have seen no discernible impact on our pharmacy business from the decision to exit the tobacco category, and I'll come back to that in a minute.

Regarding health reform, not much is new since our last update.

And we continue to see a modest positive benefit to our script transform reform and that's largely from the expansion of Medicaid.

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

And on our last call I talked about the impact of generic inflation and pharmacy reimbursement pressure.

And given all the market commentary, I want to reiterate those comments again today, which are reflected in our third-quarter results.

Recall that when we gave our 2014 guidance last December we told you that we expected continued pressure on pharmacy reimbursement.

And the market is generally consistent with what we anticipated.

As to generic inflation, while cost of goods inflation does exist on selected generic items, the deflationary nature of the generic market remains intact and within our expectations.

Now there's also been a lot of discussion in the market about Medicare part D plan designs that impact retail pharmacy networks, so let me touch on that as well.

First let me remind you that this is an annual process.

And in 2014 CVS is preferred in 5 of the top 10 Med D plans and that's based on lives.

For 2015, CVS has contracted with 20 regional and national part D plans where CVS is positioned as a preferred provider.

Now we have taken a disciplined approach to participation in these networks ensuring that margin compression and share analysis provides the right economics.

Now turning to the front store, we saw a continued decrease in traffic that was partially offset by an increase in the average customer ticket.

Front store comps were down 4.5%.

And adjusting for the tobacco impact, comps would have been approximately 480 basis points higher.

We are tracking in line with where we expected to be with respect to the front store impact of our decision to exit tobacco.

And if you normalized this quarter for the tobacco exit, in the second quarter for the Easter shift, our pro forma front store comp performance reflects a modest sequential improvement from Q2.

Additionally we produced a solid improvement in front store margins in the quarter.

It is important to note that less than one third of our front store margin improvement was driven by the absence of lower margin tobacco sales, with the rest of the improvement reflecting our strategy of driving store brand sales and making responsible investments in promotions.

Now for the past two years now we've been talking about utilizing extra care and differentiated ways to balance sales and margin growth.

We continue on that trajectory and you'll hear more about our plans next month.

As for store brand sales, we saw notable gains in Q3.

Store brands represented 20.1% of front store sales and that's up about 210 basis points from Q3 last year with gains across health, beauty, general merchandise and edibles.

Now roughly half of the improvement in store brand penetration relates to the exit from tobacco as there is zero store brand penetration in the category.

And we see significant opportunities to continue to expand our share of store brand products by building on our core equities in health and beauty, while also seeking opportunistic growth in other categories.

Now turning to store growth, on September 4, we completed the acquisition of Navarro, the largest Hispanic-owned drug store chain in the US.

In addition to acquiring the 33 Navarro stores, we also opened up 45 new CVS pharmacies, relocated 13, closed 4, resulting in 74 net new stores in the quarter.

And we're on track to achieve square footage growth of 2% to 3% for the year.

As for CVS MinuteClinic, we opened 76 net new clinics in the quarter, adding two new states, New Mexico and Nebraska, and several new markets.

We ended the quarter with 936 clinics in 30 states plus the District of Columbia and we expect to open more than 30 additional clinics in Q4.

Now CVS MinuteClinic has steadfastly continued on its strong growth trajectory.

In the quarter revenues and customer visits increased more than 25% and 30% respectively, versus the same quarter last year.

And we also added 8 new health system affiliations throughout the quarter, bringing the total number of affiliations for CVS Health to 44 across the country.

So CVS MinuteClinic continues to build a platform that supports primary care by providing integrated high-quality care that is convenient, accessible and affordable.

Now before turning it over to Dave, I also want to update you on the progress that has been made by the very talented team we've assembled at Red Oak Sourcing; our venture with Cardinal that formed the largest generic sourcing entity in the US.

With its combined volume and capabilities, this new relationship will help spur innovative purchasing strategies with generic manufacturers along with enhancing supply chain efficiencies.

To date, Red Oak has met with about 40 suppliers covering more than 90% of the cumulative generic spend.

Manufacturers continue to be transitioned from the legacy purchasing programs of both CVS and Cardinal to the new Red Oak purchasing platform.

And we're extremely pleased with our progress to date and we look forward to Red Oak's future contributions.

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

Thank you, Larry, and good morning, everyone.

This morning I'll provide a detailed review of our solid third-quarter results, followed by an update on our guidance, including the first look at our fourth-quarter guidance.

But before I do that though, let me begin as I typically do and highlight how our disciplined approach to capital allocation continues to enhance shareholder value.

During the third quarter, we paid $324 million in dividends to our shareholders.

We have already surpassed the 25% dividend payout level and we're making continued good progress toward achieving our 35% payout target by 2018.

Additionally, we repurchased more than 10 million shares for approximately $800 million at an average price of $78.51 per share.

Year to date we've repurchase more than 37 million shares for $2.8 billion and we still expect to complete at least $4 billion of share repurchases for the full year of 2014.

So between dividends and share repurchases, we have returned more than $1.1 billion to our shareholders in the third quarter alone, and returned more than $3.7 billion during the first three quarters of the year.

Our goal has been to return more than $5 billion in 2014 and we remain on track to meet that goal.

As Larry said, we generated more than $1.4 billion of free cash in the third quarter, bringing our total for the first nine months of the year to approximately $3.6 billion.

The key driver continues to be our healthy growth in earnings coupled with continued improvements in our retail cash cycle fueled mainly by performance in payables.

All in, we now expect to generate free cash flow of between $5.7 billion and $6 billion in 2014, up from our prior guidance of $5.5 billion to $5.8 billion driven in large part by that tax benefit associated with a loss on the early extinguishment of debt.

I want to note that there is a chance that our cash flow delivery for the year may come in even stronger than our new guidance that I set today, as we may receive some late year payments a few days early.

However, anything we generate for 2014 above our new guidance is likely to be simply a pull forward from 2015.

We will keep you posted on our progress and update you with any new information on Analyst Day.

Now turning to the income statement, adjusted earnings per share from continuing operations came in at $1.15 per share, up 9% year over year and $0.01 above the high end of our guidance range.

As anticipated in our guidance, this includes a $0.03 negative impact to earnings per share from our decision to exit the tobacco category.

As Larry said, our earnings reflects strong growth across both of our operating segments.

GAAP diluted EPS was $0.81 per share.

Now, as you know, in September we retired some long-term debt replacing it with debt at lower interest rates.

We bought back $2 billion at an average rate of 6% and replaced it with 5 and 10-year notes totaling $1.5 billion at an average rate of 2.74%.

By replacing this portion of our debt at lower rates, we are likely to see a $0.01 benefit this year from a reduction of interest expense and should see an incremental improvement in our annual interest expense of about $0.03 next year using today's share count.

There was a cost of $521 million in the third quarter associated with the retirement of these outstanding notes, or approximately $0.27 per share.

And as Nancy said, this debt extinguishment and the associated costs were not included in our prior guidance.

So with that, let me quickly walk you through our underlying results.

On a consolidated basis, revenues in the third quarter increased 9.7% or approximately $3.1 billion to $35 billion.

PBM net revenues increased 15.7% to $22.5 billion.

This strong performance was driven by net new business, specialty pharmacy growth, branded drug inflation and product mix.

Offsetting this to some degree were lower mail choice claims reflecting the continued decline in traditional mail order volumes and an increase in generic dispensing.

The PBM's generic dispensing rate increased approximately 180 basis points versus the same quarter of LY to 82.5%.

Compared with our guidance, PBM revenues were slightly favorable to the high end due to stronger network volumes and the delay in a couple of generic launches that were expected to occur during the third quarter.

As we noted last quarter, with the implementation of Specialty Connect, we have transferred revenues out of the Retail Pharmacy segment and into the PBM segment as the PBM took over the dispensing of nearly all specialty prescriptions filled by CVS Health.

Given the high cost of specialty drugs, this transition had a larger impact on sales dollars than script volumes as expected.

The impact on sales dollars in the third quarter was approximately $210 million and we expect a similar impact in the fourth quarter.

As expected, this shift enhanced year-over-year top line growth in the PBM by approximately 115 basis points, while dampening revenue growth at Retail.

As Larry said, it had a 190 basis point negative impact on Retail pharmacy comps.

But keep in mind that it had an insignificant impact on Retail script volumes.

Overall revenues in the Retail business increased 3.1% in the quarter to $16.7 billion.

Sales in the Retail segment were better than expected driven primarily by product mix, volumes and the delay of the generic launch -- launches that I just mentioned.

Compared to the third quarter of last year, Retail GDR partially offset these positive factors increasing by approximately 180 basis points to 83.3%.

Retail revenue growth was also dampened by the exit from the tobacco category that was fully complete at the beginning of September.

As anticipated, front store comps would have been approximately 480 basis points higher if tobacco and the estimated basket sales were excluded from both this year and last year.

In fact, looking at the Retail segment total revenues and adjusting for both the impact from tobacco, as well as the impact from Specialty Connect, pro forma growth would have been 6.5%, a pretty solid performance.

Turning to gross margin, the consolidated Company posted an 18.5% margin for the quarter, a decline of approximately 40 basis points compared to Q3 of 2013.

This margin decline was the result of a mix shift as the lower margin PBM segment grew faster than the Retail segment.

Furthermore, this trend with accelerated as we experienced a modest decline in the PBM's gross margin.

And within the PBM segment, gross margin declined approximately 40 basis points versus the same quarter of LY to 6.2%, while gross profit dollars increased approximately 8.4% year over year.

The decline in margin year over year was primarily driven by typical client price compression and mix, which was only partially offset by the increase in GDR and better purchasing economics.

Now gross margin in the Retail segment was 31.3%, up 125 basis points over LY.

Gross profit dollars increased 7.4% year over year.

The margin improvement was largely driven by an increase in pharmacy margins, which benefited from the increase in GDR and better purchasing economics, partially offset by continued reimbursement pressures.

At the same time, we saw front store margins expand in the quarter, driven mainly by a change in product mix, including higher store brand sales and our strategy of making responsible investments in promotions.

As Larry stated, less than one third of our front store margin improvement was driven by the absence of tobacco.

Total operating expenses as a percent of revenues improved by approximately 30 basis points from the Q3 of 2013 to 12.1%, while total SG&A dollars grew by 7%.

The PBM segment expenses grew by 7.9% and its SG&A rate was 1.4%, an improvement of approximately 10 basis points from LY.

Now in the Retail segment, SG&A as a percent of sales increased by approximately 75 basis points to 22.1%, while expenses grew by 6.8%.

This growth in expense primarily reflects higher legal and operating costs.

And within the corporate segment, expenses were up $17 million to $196 million.

The increase was primarily related to our strategic initiatives, as well as IT investments.

So adding it all up, operating margin for the total enterprise declined approximately 10 basis points to 6.4%.

Operating margin in the PBM declined approximately 30 basis points to 4.8%, while operating margin at Retail improved about 40 basis points to 9.1%.

For the quarter, PBM operating profit was strong growing 8.5%, which was higher than we expected.

Retail operating profit increased a very healthy 8.8% at the high end of our expectations.

So going below the line on the consolidated income statement, net interest expense in the quarter increased approximately $32 million from LY to $153 million.

The debt we issued in the fourth quarter of last year was the primary driver of the increase, although we did see some benefit from the debt extinguishment at the end of this quarter.

Our weighted average share count was 1.16 billion shares.

And finally our effective tax rate was 39.7%.

So with that, let me shift and turn to our 2014 guidance.

I'm going to concentrate on the highlights here but you can find the details of our guidance from the slides that we posted on our website earlier this morning.

For the year we expect to deliver adjusted earnings per share of $4.47 to $4.50 per share, reflecting strong year-over-year growth of approximately 12.75% to 13.5%.

And to be clear, as Nancy noted at the start of the call, our guidance and the year-over-year growth comparisons remove the impact of the loss of the early debt extinguishment in the third quarter of this year, as well as the impact of the gain from the legal settlement we recorded in the third quarter of last year.

This makes the numbers more comparable and better demonstrates our underlying performance.

GAAP diluted EPS from continuing operations is expected to be in the range of $3.93 to $3.96 per share.

In effect, we've narrowed our adjusted earnings per share guidance range, taking the bottom end up $0.04 and the top end down by about $0.01, thereby increasing the midpoint by about $0.015.

Our revised guidance reflects our solid performance through the first nine months of this year, as well as our confidence in our outlook.

As expected, this guidance also assumes share repurchases totaling at least $4 billion for the year and a $0.01 benefit from our debt transaction.

In the fourth quarter, we expect adjusted earnings per share to be in the range of $1.18 to $1.21, up 6% to 8.75% from Q4 of 2013.

GAAP diluted EPS from continuing operations is expected to be in the range of $1.12 to $1.15 per share.

This fourth-quarter guidance includes a negative impact from the tobacco exit of approximately $0.03 to $0.04 per share, consistent with our initial expectations and bringing the impact for the year to approximately $0.07 to $0.08 per share.

As you'll note, sequentially Q4 profit growth is expected to be somewhat lower than what we've experienced year to date.

So before walking through the details, I'd like to point out a few factors influencing the quarterly profit cadence across our business.

First, the timing of the impact of break open generics presents a tough comparisons versus Q4 of LY.

Second, Q4 is the first quarter that we'll see the full financial effect from our decision to exit the tobacco category.

And finally, due to the success of the 2015 selling season, we are investing incrementally in our welcome season to ensure a successful migration of new customers.

Now I'll go through the details of our fourth-quarter guidance.

Within the Retail segment, we expect revenues to be up 0.25% to 1.75% versus the fourth quarter of LY.

Adjusted script comps are expected to increase in the range of 3.5% to 4.5%, while we expect total same-store sales in the range of down 1% to up 0.5%.

We expect front store same-store sales to reflect a negative impact related to the tobacco exit of approximately 900 basis points in the fourth quarter.

We expect to see another significant improvement year over year in Retail gross margins in the fourth quarter.

This is expected to be driven by a number of factors such as better purchasing economics, which includes the quarterly payment from Cardinal, as well as the exit from tobacco.

As we noted, the tobacco exit drove only a small portion of the margin expansion we saw in the third quarter.

The impact is expected to ramp in Q4 once we see a full quarters impact.

We expect the Retail segment's operating profit to increase 4.5% to 6.25% in the fourth quarter.

And now for the PBM segment.

We expect revenues to increase 16.75% to 18.25% for the fourth quarter and adjusted claims to be between 270 million and 275 million claims.

And we expect to see a notable decline in PBM gross margins during the fourth quarter, again, due to price compression and drug mix.

In addition, the expected margin decline reflects the additional investments in our people, processes and technologies we're making to ensure another successful welcome season given the sheer number of new clients we're taking on for 2015.

As a result of our success, we've made some investments during the third quarter and expect to continue to invest through the first quarter of next year.

Combined with the strong revenue expectations, we expect the PBM segment's operating profit to be flat to up 2% over last year in the fourth quarter.

As a result, for the total enterprise in the quarter, we expect revenues to be up approximately 9% to 10.5% from the fourth quarter of 2013.

This is after intercompany eliminations, which are projected to equal about 10.8% of combined segment revenues.

This elimination ratio has been trending higher due to the tobacco exit which obviously does not affect pharmacy revenues.

For the total Company, gross profit margins are expected to be down significantly from last year's fourth quarter driven largely by mix.

Operating expenses as a percent of revenues are expected to notably improve in the fourth quarter.

PBM operating expenses as a percent of revenue should show modest improvement driven in part by the growth of high cost specialty drugs year over year.

Retail expense leverage should moderately decline given the loss of tobacco related sales with only a small amount of associated reductions in expenses.

And we expect operating expenses in the corporate segment to be between $200 million and $205 million.

We expect operating margin for the total Company in the quarter to be down 30 through 40 basis points from last year's fourth quarter.

We expect net interest expense of between $125 million and $135 million.

And a tax rate of approximately 40% in the fourth quarter.

We anticipate that we'll have approximately 1.15 billion weighted average shares for the quarter, which would imply approximately 1.17 billion for the year.

And as I said, we now expect to generate free cash flow in the range of between $5.7 billion to $6 billion for the year.

So in summary, this was a very solid high-quality quarter with strong financial performance across the enterprise.

And importantly, our outlook remains strong.

We continue to remain focused on using our strong free cash flow to provide value for all of our stakeholders both now, as well into the future.

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

Okay.

Thank you, Dave, and I just want to say again that I'm very pleased with our performance year to date.

And I do want to take a moment to thank our colleagues across the CVS Health enterprise for everything that they're doing day in and day out to serve our many customers and stakeholders while driving results.

And as a pharmacy innovation Company, we're focused on our growing role in shaping the future of healthcare.

And with our unmatched enterprise assets we are very well positioned for today.

And at the same time, we're still hard at work on the next innovations that will prepare us for tomorrow and drive value well into the future, and we look forward to sharing those with you next month at our Analyst Day.

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

(Operator Instructions)

John Heinbockel, Guggenheim Securities.

So guys, I wanted to drill down a little bit on the Retail gross margin performance.

Is there any more color front end versus pharmacy on a relative basis one versus the other, because either pharmacy was up a decent amount or X tobacco front end was up a very considerable amount.

And so I'm thinking about the two of those.

And then what impact would Specialty Connect transfer have on your pharmacy margins?

Yes, good morning, John.

It's Larry and I'll take the first part then I think Dave will go ahead and jump in.

But John, as we described in our prepared remarks I think we talked about some of the variables in play that impacted both front store and pharmacy margins.

We saw growth in both of those areas.

But I think as you know we have not historically broken those out.

And other than qualitatively or directionally talking about the factors that are impacted.

And obviously in the front store we -- there's going to be some adjustment because of eliminating the lower margin tobacco products.

And we talked about the fact that that represented about a third of the improvement that we saw.

And as we've been talking now for quite some time, I think our Retail team has done a very effective job in terms of walking that fine line.

We've described it as the balance between art and science in terms of how do you drive traffic and sales in a responsible way so that it has a flow through to the P&L?

And part of that is also reflected in the growth and store brands as well.

And I think in the pharmacy segment, again, there's been a lot of cross currents in the market.

But similar to what we talked about in the front, we've brought that same level of discipline as we're thinking about participation in preferred or restricted networks.

And at the same time some of the factors that are in play in terms of driving generic utilization and formulary management, et cetera, et cetera.

Yes, and Specialty Connect on pharmacy, I assume that's --

John, this is Dave.

In general, specialty drugs are typically branded drugs or almost exclusively branded drugs.

They as you know carry a lower gross margin rate, so it would have a slightly positive effect on Retail pharmacy as you strip those drugs out and move them to the PBM, but it's very modest.

And then lastly on -- with regard to what you're doing promotionally, are you -- what are you learning about promotional elasticity?

Because it seems like you're promoting a little less, you're not seeing a traffic drop off, so is promotional elasticity in a lot of cases not as great as we thought it was?

Hi John, this is Helena.

I think we've spent a lot of time over the last year so really using our extra care data to look at promotional effectiveness.

So what we're doing there is understanding when we promote which products who are you inviting into your stores essentially.

So we've been using that just to balance ourselves and make sure we're making the right promotional investments.

George Hill, Deutsche Bank.

Larry, I was wondering if you could talk a little bit more about moving some of the specialty business outside of the medical benefit and into the pharmacy benefit.

And I don't know if you're able to quantify either the types -- quantify the success you're having there or can you talk about which types of clients do you think are most likely to want to rethink how they manage debt that specialty benefit that's executed under the medical side and maybe think about it on the pharmacy side?

Yes, good morning, George.

It's Larry, I'll start then ask Jon to jump in here.

But John this -- we -- again this is something we've spent a fair amount of time talking about at Analyst Day last December and the capabilities that the NovoLogix technology -- that really serves as a driver to being able to do things on the medical side of pharmacy that we think have been largely unmanaged.

And we -- I think we're at a point now where we can sit down with a prospective client and look at their claims data, if you will, and actually show them the opportunities that we can bring and the savings that are derived as a result of that.

Yes and George this is Jon.

So I would think about this in two ways.

One, is the ability to move some of the specialty drugs out of the medical benefit and into the pharmacy benefit, rheumatoid arthritis is one good example.

So then we can use our existing capabilities, tools, utilization programs to effectively manage those for our clients.

And we do have clients that have an interest in doing that and it's something we continue to recommend.

For the balance of the specialty drugs that are managed under the medical benefit we have what Larry talked about the, the NovoLogix capability to essentially do everything we're doing on the pharmacy side today, prior authorizations, repricing, utilization programs and manage those programs under the medical benefit.

We're primarily seeing interest from our health plans with the NovoLogix tool, and we've got a lot of success there in growing that business.

Okay, that's interesting color and it's helpful to hear that you're seeing success on the plan side.

I might have thought it would have been more with the employer sponsors.

A real quick follow up for Dave and Larry, I'm sorry for dispensing with the pleasantries to start the Q&A.

But Dave how about -- is there any thing -- any numbers you can give us to characterize where we are coming up the curve on Red Oak and trying to quantify success there?

Thanks and I'll hop back in.

Well, George, I -- as you think about Red Oak as we mentioned in our prepared remarks, I think the team has gotten off to a terrific start and I do want to emphasize that we essentially airlifted, if you will, very talented individuals from CVS and from Cardinal that were performing those functions within each Company respectively.

So we don't have a brand-new team that is doing this work.

So I can tell you it's a very talented team.

If you sat with these individuals, you wouldn't know which individuals came over from CVS and which one came over from Cardinal.

So I think they've -- the management team there has done a terrific job in terms of blending the cultures and so on.

I think as we talk about value being created, George, there's really three ways that value gets created.

One is from the fixed payments that Dave alluded to in his prepared remarks, and the fact that we'll see the first of those payments flowing through the P&L in the fourth quarter this year.

The second is based on a set of predetermined milestones that if they're achieved there is the opportunity for additional payments to CVS.

And again I want to emphasize that those are milestone driven.

If those milestones are not achieved, there aren't additional payments.

But if they are, there will be.

And then the third is this is where scale and expertise and knowledge comes into play that we believe that there will be opportunities to further lower our acquisition costs from what exists today.

Scott Mushkin, Wolfe Research.

I had a housekeeping item and then I wanted a strategic question.

And Dave, was the debt retirement part of the guidance originally or no?

I think you said it and I just missed it and I apologize.

No, Scott it was not part of our guidance originally.

Okay, perfect.

And this isn't much more of a strategic question maybe we'll hear more about it when we get to Analyst Day, but it seems to me taking a step back that the Retail business is a little bit at a crossroads.

And I'm specifically talking on the front end.

You've obviously taken tobacco category out, but photos diminished a lot, the cards are not what they once used to be.

You guys are adding a lot of clinics in which means not only for pharmacy but people are coming in for health reasons.

And then we got the change in the healthcare business where more consumers are going to be making their choices.

And then I overlay that with lots of assets tied up in Retail and wondering where you think the business is going on the Retail side and how do you manage all this dynamic?

Scott, I'll ask Helena to talk a little more about that.

Okay, good.

Yes, I think we're thinking very holistically from the customers perspective just in terms of the experience and how we want to use our assets.

And certainly we mentioned before we're focused on driving profitable growth.

We think when the customer thinks about CVS, she's thinking first and foremost about pharmacy, and health and beauty is a really important part of that.

So you'll see us continue to invest in health and beauty and elevate our presence there.

We're also spending a lot more time talking about digital and thinking about the connection between stores and digital and really enhancing the experience for our customers around digital.

So I'm excited about the work we've got going up on there.

It's again particularly focused in the pharmacy, but the front store is an important part of that as well.

And then Scott, this is Jon.

From a client perspective, they view the Retail locations as really synergistic to their goals of being able to reach the consumer, influence that consumer, change that consumers' behavior and lower overall healthcare costs.

So I think you have to think about it really as an integrated model not just as a standalone Retail pharmacy bolted onto a pharmacy because we integrate all of these channels.

Thanks guys, appreciate it.

David Larsen, Leerink Partners.

Can you please talk about these relationships that you've developed with these larger health systems?

What value is CVS bringing to these health systems that's unique to the Retail channel?

And then can you touch on the goal of the in-store clinics and how you see that expanding overtime potentially with more specialty services and potentially lab and is that helping you win on the PBM side?

Thanks.

Yes, Dave, that's a great question.

And I think as I mentioned we now have 44 of those affiliations.

And I think we've got a number of pilots underway with several of those health systems where we're actually transmitting the patient's EMR back and forth.

I think that it is a synergistic opportunity where both parties see the opportunity as a referral source.

There are patients that we're seeing that have to be referred to for more comprehensive work up and further diagnosis.

And at the same time recognizing our focus on acute care, there are services that we can provide high quality at a much lower cost of care.

And as we've talked many times getting the visit out of the emergency room.

So I think it starts there.

I think that we're in the early innings of the capabilities that we have.

I think, as the second part of your question, there we are doing point of care testing in our clinics today and we're evaluating the various technologies that exist in terms of playing a deeper and bigger role.

And we're excited about a pilot that we now have underway in one of our Texas markets where we're actually performing infusion services in one of our clinics.

So again I think you'll hear us talk a little more about that at Analyst Day but I think there are a number of opportunities that we have there.

Great, thanks a lot.

Lisa Gill, JPMorgan.

I had a couple of follow-up questions on the PBM selling season.

Larry or Jon, can you talk about plan design changes for 2015?

And then secondly there's been a lot of question in the marketplace of is CVS winning because of this combined offering Jon that you talked about today as being fully integrated, or have you been winning because of merger-related activity and some other things in the marketplace?

So if you can give us some of the color around that as well as your thoughts on plan design changes for 2015.

Yes, Lisa, good morning.

And let me take the second question and I'll flip the first question back to Jon.

But Lisa, I think as -- again as you've heard us talk in the past, you've got to be right on and competitive on price and you've got to deliver service.

So I think those are ticket to the games.

But beyond that, I think we have an awful lot of differentiators and it's a cliche to say that when you see one client you've seen one client.

But they all have different priorities and I think that we have a growing list of services and products that meet the needs of very diverse clients.

Whether it's Maintenance Choice, Specialty Connect, Pharmacy Advisor, we just talked about MinuteClinic.

Our leadership and growing position that exists in specialty and as well as the consultant services and -- that exist within our Medicare Part D assets.

Whether it's providing that service for a health plan or our standalone SilverScript products.

So we can go on and on with that, but I think that we're all very confident and bullish on the fact that our integrated assets are making a meaningful difference in the marketplace in terms of reducing the cost of care, and at the same time improving the quality of that care.

So I'll flip it over to Jon, if he wants to add anything to that and then talk more about plan design.

Yes so, Lisa, I'm out in front of a lot of new perspective clients, have been over the last year.

Obviously very pleased with the results of this selling season.

I would say service issues that they may be experiencing get them to look at what else is available in the marketplace.

But it's clear once we sit down and talk about everything that Larry covered, they see our value proposition and that I think has led to a lot of our success.

I think as far as plan design changes, we're obviously seeing more movement consumer driven health plans where the member bears more financial responsibility particularly upfront.

So we're seeing providers, a high interest of providers, matter of fact north of 50% providing coverage of generics so that there isn't a negative impact on adherence, which we're very pleased to see.

I think other things around plan design are I think you're going to see more interest in narrow networks as we're returning to higher trend, I think plans are going to be looking to lower cost in ways like that.

And I think when you think of narrow networks you really have to disaggregate the different segments.

You look at Medicare Part D, clearly we're seeing a lot of preferred networks there.

Managed Medicaid we see them narrow networks.

Employers have been great adopters of Maintenance Choice, but we're also seeing movement into narrow preferred networks.

And commercial health plans really have been I would say the slowest to adopt these plan designs, but I think with the advent and growth of exchanges I think you're going to see movement there.

So when you look at the new business wins that we've brought on this year, we have about a third of our new wins adopting different plan designs and moving into narrow networks as an example.

Robert Jones, Goldman Sachs.

To follow up on the PBM and the net wins you mentioned over $1 billion better relative to this update this time last year.

Can you talk a little bit more about where you're winning and any sense you can give us on mix around profitability of where you're winning?

I know you mentioned some shifts in where people are looking to go with narrow networks, just curious on how that all impacts the profitability of the pretty successful season you've had this year.

Well, Bob, again I think we mentioned in our prepared remarks that we're very pleased in that the wins have come across all sectors of the business.

We've seen it on the employer side, on the health plan side, as well as the government sponsored side.

So we're pleased with that.

The dynamic in terms of the profitability, I don't think that dynamic we've seen materially changed.

That typically over the life of the contract, you see profitability of those contracts improve and typically it is at its low point in that first year of a new contract.

And Bob, this is Jon.

As trend continues to grow and there's been a lot of discussion about that, the slowing down of the generic pipeline, the growth in specialty.

I think the good news is that we're seeing this and we're seeing this in the new business wins, these clients are going to be adopting our programs which help them lower our cost but are also good for us and improve our profitability.

So we think it's a win, win and there's good alignment there.

That's helpful.

And if I could sneak one in on the preferred networks, a big focus around part D this year.

As somebody with a fairly unique vantage point on both as a part D provider, plan provider and then also has obviously a retail network, can you talk about what you're seeing as far as the rise in the appetite for preferred networks?

And any notable change in the economics in participating in these preferred networks?

Well Bob, I think that obviously we have seen an accelerated growth in Med D. I think from our retails provider side, as I mentioned earlier, there's going to be a step down in margin associated with participating in those networks as one of the preferred providers.

And once again I think our Retail team has done a very effective job in terms of evaluating the step down in margin against the anticipated share shift.

And as a result of that, there are plans that make sense to participate in a preferred way.

There are other plans where it doesn't make sense.

Keeping in mind that all Med D plans are not equal.

When you look at the co-pay delta that exists for the beneficiary, the consumer in terms of preferred, not preferred as well as the makeup of that Med D plan in terms of if it has a high percentage of low income subsidies, they're not subject to the co-pay differentials that I'll refer to them as the chooser beneficiaries are.

So I use of those as just two examples as well as geographic strength and presence that go into that evaluation.

Great, thanks so much.

Eric Percher, Barclays.

Eric Percher and Meredith Adler here for Barclays.

So question on Specialty Connect.

Now that you have a couple of months under your belt, as you focused on providing access to the open market, the market where you don't have captive payer lives, have you focused on actually investing to market to the physician or the patient?

Or is this more a matter of simply being able to capture scripts that walk into the doors of the store, and I imagine you would have an advantage in that marketing effort given your name brands?

Yes.

So Eric, great question.

Very happy with how Specialty Connect is performing.

We're seeing a very high level of patient satisfaction and it's been deployed across all our retail stores and specialty pharmacies.

Yes, let me start because there is a client component to this also and our clients value this capability and they see this as another differentiated service that we offer.

And it's similar to Maintenance Choice that has been very successful where we see about 50% of the people want to pick their specialty script up at the local CVS and the other half want it sent home.

And so realizing most of our employer clients are exclusive with us, this is a big benefit that they can give their members.

Now when you go to the open market, and these are physicians and patients that get to choose their specialty pharmacy, they value service and convenience that Specialty Connect offers.

And we have, and have had for years, well north of 100 people out working with physicians and talking about the services that we provide and getting their patients started on specialty medications.

And so this -- we think this gives us an added advantage in the marketplace because it's going to be more convenient for their patients and it provides a high level of service for their physicians.

So we're very bullish on this in both the open market and also the market for our clients.

We think it gives us an advantage.

What's interesting is that our pharmacy team's love it because it's leveraging our integrated assets so that no one in the marketplace can and it allows them to serve their patients and their local pharmacy.

And pharma is also very happy with it the inherent results they see with this program because it's equal to or better than what they see in traditional specialty pharmacy and better than adherence that they see in -- normally see in Retail pharmacy, so overall very happy.

It sounds like the value to your commercial base is quite strong and your feeling on the open market is not that this is so much something new but it captures -- allows you to capture incremental lives.

Where I'm going is that some of the players without captive lives have seen a lot of growth in the open market but it doesn't sound like you think that you've left a lot of that on the table.

No, we've seen a lot of growth in the open market as well, so we're growing both segments.

So very happy and this gives us we think an advantage over the traditional open specialty pharmacy players.

Mark Wiltamuth, Jefferies & Company.

On the specialty story, you said 53% growth here in the specialty business.

What's the organic growth excluding the Coram acquisition?

And give us a little more color on the drivers behind that growth because that's a very large number relative to the 20% growth that's expected in the broader marketplace.

Hi, Mark, this is Dave.

If you exclude Coram, I think our growth in specialty is about 44% for the quarter.

So while Coram did contribute to the growth it was not an overwhelming driver of that performance.

So flip it to Jon.

Yes, we've added (multiple speakers).

So is it mostly Sovaldi?

No, that was one product but certainly that was not the lions share of the growth.

But yes, we've added new business.

We're seeing existing clients, primarily health plans, narrow their networks they normally have several preferred pharmacies.

So we're seeing more interest and pushing more share into our channels.

And we're growing the open business as well that I talked about.

So very happy with the performance in specialty.

And what's your sense on the awareness out there in the marketplace?

Because we did a survey earlier this year and some of the employers still weren't completely tuned into the coming wave of specialty spending.

Clients that I speak to are very aware of it and they're seeing it in their trend growth.

So and it was something we talked about at our client forum this year.

Specialty is their number one priority.

They're looking for ways to control those costs.

As an example, very high interest in formulary strategies that four years ago there wasn't a real strong interest in.

Very interested in some of our capabilities around site of care that we can do with NovoLogix.

So yes, I think they're very aware of specialty.

And Mark I think that has been a step change over the last let's say 12 months, and I think for the reasons that Jon mentioned they heard it was coming.

And now that they're seeing the impact of drugs like Sovaldi, they're very anxious about ways in which we can bend that cost curve, if you will.

Steve Valiquette, UBS.

So seeing the topic of exchanges had thankfully moved to the back burner, but with your disclosure that's roughly $800 million or so of business that was lost to exchanges for 2015, at first (inaudible) it seems like a big number but then the fact that it equates to just under 1% of your total annual PBM business it seems pretty manageable when you put it in that context.

So I know it's hard to predict this, but I'm curious do you think that roughly 1% attrition is a reasonable run rate for exchange risk over the next few years?

Or could that change higher or lower for any specific reason that you foresee right now?

Thanks.

Well, Steve, I think it's important to put this in context.

I think the rhetoric around people migrate, active employees migrating over to the exchanges, the rhetoric around that has quieted down tremendously.

And other than perhaps small employee organizations, we're not hearing any of that in the mid and large-sized companies.

I think as we alluded to in our prepared remarks, I think that -- and it's not inconsistent with what we've talked about in the past.

I do think that if there is any trend emerging, it is employers getting out of the retiree business.

And I think that that's what we're seeing back to our earlier comments and it's hard to put a number on that, but I don't see anything migrating beyond that at this point in time.

And Steve, this is Jon.

And just remember we have an opportunity to recapture those lives through our health plan relationships and also for retirees through our SilverScript product that as you can see is very competitive this year.

So we think we'll do well as some people move into that exchange.

Yes, Steve this is Dave.

One other comment and maybe harken back a little bit to some of the comments we made several quarters ago.

If you look at the exchange market and you look at the assets that we have in place across our enterprise, we're very well positioned from an exchange perspective in the sense that one, you obviously can plug in from a PBM perspective.

I think about plugging in from a specialty perspective, from a retail perspective, from a clinic perspective, there's a host of assets that we have here that really we can plug and play and really meet the needs of the exchange population.

And really with our touch pay -- touch points with consumers across the marketplace, really allow us to utilize those assets in meaningful ways to drive value for both consumers, also planned sponsors in the exchange market.

Okay.

All right, that's great color.

Thanks.

Charles Rhyee, Cowen and Company.

Had a couple of follow ups.

On that clinic -- sorry, on the MinuteClinic side, can you talk about any metrics in terms of what your same-store visits are looking like for stores that have been open longer than a year?

And also any metrics around what are the referral benefits from your earlier health lines partners been looking like?

Yes, Charles, we have not broken out your second question in terms of referral visits.

I think in our prepared remarks we talked about the fact that year-over-year visits were up 30%.

Now that is not a comp number, we have not broken that out.

But I can tell you that that growth did not come just from new clinics.

And we're continuing to see healthy growth in clinics that have been open for a couple years now.

Okay, that's helpful.

And then secondly a follow up on the preferred networks and Medicare Part D, it seems like the issue with the contracting here is where you've set this overall effective rate on the pricing.

It seems like from your comments that you guys have not had as much of an issue in Medicare Part D as you've negotiated your way into these preferred networks or have chosen not to be in them.

My question is really around the overall effective rate.

It seems like this is a negotiated rate, what are the puts and takes on when you go to health plans to negotiate this, in particular is this -- do you give up something for a higher overall effective rate?

What do you gain for negotiating a more aggressive one?

Thanks.

Hi, Charles, this is Dave, I'll take that.

One comment, I think we've been very disciplined and I think apply somewhat of a sophisticated lens to this activity.

As you can imagine, as Larry stated earlier, it's not all Medicare Part D products and benefit designs are created equal.

And I think we look at each one of those designs, we analyze the utilization impact and the shared movement impact based on the design and the co-pay differentials.

And we understand what makes sense for us and what makes sense for our plan sponsor.

And we also compare and look at the makeup of that membership base and understand whether it's a low income subsidy base or a chooser base and that creates different dynamics in the marketplace.

So we factor all that in and essentially underwrite our performance there and make choices that we think are economically in the best interest of CVS Health.

But also in the best interest of our health plans and best interest of the consumers that we serve.

And I think we've been very disciplined around our approach there.

Great, thank you.

Robert Willoughby, Bank of America Merrill Lynch.

Dave how much of the cash flow benefit for the year might you consider one-time in nature, i.e., tobacco inventory reduction?

And then secondarily, what's driving the higher accounts receivable days, is there any opportunity to bring that down?

Yes, a couple things.

One is I don't think there's anything that is necessarily one-time in nature per se of any material nature absent the normal cadence of recoveries from Medicare Part D which is baked into our run rate.

So I don't see anything abnormal from a cash flow delivery perspective.

And I think both from a receivables and payables perspective, I think we continue to work on the payable side and there's probably still some opportunities.

On the accounts receivable side it's really just -- we're probably constrained a little bit as it relates to Medicare Part D and the performance and requirements around CMS, which probably not a lot that we can do to influence that specifically other than just make sure that we're fully on top of it and managing it effectively.

And that's on the Retail side?

It's mostly on the PBM side quite frankly.

Really?

Okay, thank you.

John Ransom, Raymond James.

Man, I was nervous, I didn't think I was going to get in there.

(laughter)

But you made it, it's all right.

(multiple speakers)

Something about the best for last I think.

Two questions.

What are you guys saying or is it too early in terms of the specialty trend for 2015?

And how much of that will be affected by the lapping of Sovaldi?

And I had one follow up.

I think it's probably a little too early to chat about the specialty trend in specifics as it relates to 2015.

I would say that Jon and his team have been working with clients to outline what -- if you don't manage specialty trend over the long term, that you can see trend in the mid teens level over the next several years.

But I think that what we have been working with our clients to do is go back and outline a series of steps and activities that they can implement with us that can actually help them manage that trend down to very reasonable levels if they chose to do so.

And we've been very explicit with our clients and working very diligently with them to make sure they understand those trade offs.

John, the only thing I would add to what Dave said is that when you look at the 2014 specialty trend, it is going to be double digits and Sovaldi is going to play a big role in that.

And there's -- we actually saw in the back half of this year the utilization and the Hep C market primarily driven by Sovaldi plateau.

We've seen Harvoni launch already and we're actually seeing an uptick in utilization.

And most of the uptick is coming at the expense of Sovaldi.

But also there's a new AbbVie product coming out in December that will compete with Harvoni.

And so our plan is to leverage our formulary strategy and bring costs down.

And we'll determine which products, one or more, actually are on our 2015 formulary.

So I think you're going to have a little different dynamic as we move into 2015 because we're now seeing competition in the Hepatitis C category.

Right.

And my other question was the pushback of Nexium a needle mover in terms of your original guidance for this year and what you're now thinking about for fourth quarter?

It is a pushback and it is a change to our expectations but I -- that shift and that change is fully contemplated in our guidance for this year.

I think the actual launch date of that as we cycle into 2015 is still up in the air quite frankly and uncertain.

So we keep -- we'll keep posted on that, we'll keep a watchful eye on that.

We may know more by Analyst Day, quite frankly, we may not.

But we'll see where we are.

Okay so with that, once again, let me thank everyone for your time today and for your ongoing interest in our Company and we look forward to seeing hopefully all of you next month in New York.

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

We thank you for your participation and ask you to please disconnect your lines.