CVS Health Corp (CVS) 2016 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by.

Welcome to the CVS Health third-quarter earnings call.

(Operator Instructions)

As a reminder, the conference is being recorded, Tuesday, November 8, 2016.

I'd now like to turn the call over to Nancy Christal, Senior Vice President of Investor Relations.

Please proceed.

Thank you, James.

Good morning, everyone, and thanks for joining us today.

I'm here this morning with Larry Merlo, President and CEO, and Dave Denton, Executive Vice President and CFO.

Jon Roberts, President of CVS Caremark and Helena Foulkes, President of CVS Pharmacy are also with us today and will participate in the question-and-answer session following our prepared remarks.

We want to leave as much time as possible for questions today.

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

We have a lot to cover this morning, and we plan to make only brief remarks about the third quarter, so we can spend the majority of our time talking about our guidance for the remainder of this year, our 2017 preliminary outlook, and our longer-term targets.

You can find all the usual details of the quarter on the slides we posted on our website just before the call.

We also filed our Form 10-Q this morning, and it's available on our website, as well.

I have one quick reminder.

Our annual analyst day is scheduled for Thursday, December 15 in New York City.

You'll have the opportunity to hear from several members of our senior management team, who will provide a comprehensive update on our strategies for driving long-term growth.

The meeting will be webcast, for those unable to attend in person.

In addition, note that during today's presentation, we will make forward-looking statements within the meaning of the Federal Securities Laws.

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

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

During this call, we will 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 reconciliations of these non-GAAP items 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.

Okay, thank you, Nancy and good morning everyone, and thanks for joining us.

While we announced solid results this morning for the third quarter, as Nancy mentioned, we wanted to spend most of this call addressing the recent changes in the marketplace, what they mean for CVS Health in the short term, and most important, our plans to address these issues so we can resume our robust growth trajectory.

And you can find a detailed business and financial review of the quarter in the slides we posted before the call.

So let me touch briefly on our strong third quarter we announced this morning.

Net revenues increased 15.5%, rising 19.2% in the PBM, 12.5% in the retail/long term care segment.

Adjusted earnings per share increased 28% to $1.64, including approximately $0.05 related to a lower tax rate, primarily due to the resolution of certain tax matters previously anticipated to occur in Q4.

So this is basically a timing shift benefiting the third quarter at the expense of Q4.

Our results in the third quarter also include another $0.01 related to below the line items.

So putting those benefits aside, we posted strong adjusted earnings per share growth, at the high end of our guidance range.

The PBM performed slightly above the high end of our expectations, mostly due to Medicare Part D profitability, while the retail/long term care segment performed at the lower end of our expectations.

Retail same-store sales grew 2.3%, with pharmacy comps up 3.4%, and comp scripts up 3%, and that's on a 30-day equivalent basis.

Script growth was at the low end of our expectations, reflecting the slowing script growth trend in the overall market, and a soft seasonal business.

However, our retail pharmacy share grew more than 200 basis points to 23.8% versus the same quarter last year, and that was driven by the addition of Target, along with core CVS share growth.

In the front store, we posted a 1% decrease in same-store sales, while achieving a nice improvement in front store margins, as we continued to execute successfully on our personalization strategy.

We generated $3.7 billion of free cash during the quarter, $6.6 billion year to date, and we are raising our forecast for the year to a range of $6.8 billion to $7 billion.

And we will continue to use this cash to create value for our shareholders.

Now let me address what has changed in the marketplace, and the near-term implications for our business.

As you know, there have been numerous headwinds over the past couple of months facing our industry, that have impacted the overall sentiment on the Company.

The negative sentiment, largely misplaced in our view, included competitors winning PBM business and the perceived impact on Caremark, broad industry concerns about drug pricing and the value of the PBM, and concerns about what the results of today's election might mean for the healthcare industry.

None of those are significant factors in our view of the current marketplace, or of our performance.

However, very recently, there have been some unexpected marketplace actions that will have a negative impact on our results for the fourth quarter of this year, and a more meaningful impact on our outlook for 2017.

Let me go into further detail.

Over the past few months, Walgreens has been establishing various network relationships with a number of other PBMs.

For example, they have 90-day offerings in the marketplace through both Express Scripts and OptumRx.

And since the first announcement, we have said these are not expected to have a major impact, and we continue to believe this.

Very recently however, we became aware of additional network changes that are putting a significant number of our retail scripts at risk, beginning in the current quarter.

For example, there are new restricted network relationships between Walgreens and Prime Therapeutics, as well as within the Department of Defense TRICARE program, that in both cases takes CVS Pharmacies entirely out of those networks.

In total, we believe these network actions will result in more than 40 million retail prescriptions shifting out of our stores on an annualized basis.

The DoD TRICARE action begins on December 1, but they have already notified members, and we expect to begin seeing these prescriptions migrate out of our stores.

The Prime network changes will begin on January 1, and impact CVS Pharmacy's participation in selected fully-insured networks in several key states.

And while we continue to participate in Prime's Medicare Part D plans, in many cases, it will be as a non-preferred provider.

Now as you know, we have always said that our last script is our most profitable one, given our ability to leverage our fixed costs with incremental volume.

And unfortunately, this means that the scripts we lose will tend to be our most profitable scripts.

And as a result, we will delever, as a result of losing more than 40 million prescriptions.

And as we've stated many times in the past, margin compression is a factor in the business, and our strategy of driving more share through our channels is a key element to achieving our overall retail growth objectives.

And this unexpected loss of share will make that a difficult proposition in the short-term.

Now I'm going to turn this over to Dave to walk you through our updated guidance for 2016, our preliminary outlook for 2017, and our longer-term outlook.

And then I'll be back to provide a high-level outline of our plans for responding to these marketplace changes, and re-accelerating our growth.

Thank you, Larry, and good morning everyone.

I'll start today with our revised guidance for this year.

We currently expect to achieve adjusted earnings per share for 2016 of $5.77 to $5.83 per share, reflecting year-over-year growth of 11.75% to 13%.

We've effectively lowered the midpoint by $0.05 per share compared to our prior range of $5.81 to $5.89 per share.

This takes into account the recent competitor actions restricting us from pharmacy networks, as well as current trends in the retail business.

Including the slowing script growth in the overall market, and a soft seasonal business, which is affecting both the pharmacy as well as the front store.

GAAP diluted EPS from continuing operations is expected to be in the range of $4.84 to $4.90 a share.

This now includes the addition of the integration costs in the third quarter, which we explicitly excluded from our prior guidance.

Keep in mind that our GAAP guidance for the remainder of the year excludes the impact of acquisition-related integration costs, and we will update for those costs at year-end.

Before moving to the fourth-quarter guidance, let me quickly remind you of the timing factor affecting Q3-Q4 profit cadence.

As Larry mentioned, we had a timing shift related to a lower tax rate that benefited Q3 by approximately $0.05 a share, primarily due to the resolution of certain tax matters.

These matters were previously anticipated to occur in Q4, which I talked about on our last earnings call.

So in the fourth quarter, we expect adjusted earnings per share to be in the range of $1.64 to $1.70, up 7% to 10.75% from Q4 2015.

GAAP diluted EPS from continuing operations is expected to be in the range of $1.52 per share to $1.58 per share.

And you can find the details of guidance in the slides that we posted online early today before the call.

But let me take a moment to point out a few items.

For the fourth quarter, we expect enterprise revenues to be up 12.25% to 14%, driven primarily by PBM growth.

Total same-store sales at retail are expected to be flat to down 1.75%, and adjusted script costs are expected to increase 1% to 2%, a sequential decline that reflects the impact of the network changes and retail trends.

Additionally, enterprise operating profit is expected to grow by 2% to 5.5%, again driven primarily by the PBM.

The network changes and other factors will impact our business next year, so we want to provide you some early clarity on our outlook for 2017 today.

In 2017, we currently expect to deliver $5.77 to $5.93 in adjusted earnings per share, with results contracting 0.5% to up 2.5%.

It will be a tale of two parts.

Our PBM is it still expected to deliver healthy growth, while the retail business is challenged.

We currently expect an increase in PBM EBIT of about 8%, and a decrease in retail EBIT of about 8%.

As you know, we had another very successful PBM selling season, with significant new business wins, and a retention rate of about 97%.

Importantly, we have continued to win in the marketplace, while maintaining our pricing discipline.

Our specialty business is expected to deliver strong growth next year, and our SilverScript business is also expected to continue to perform very well.

So the PBM continues its healthy growth trajectory into next year.

In the retail business, we completed the integration of the Target pharmacies and clinics, and are now better positioned to drive growth.

With CVS systems and branding in place, we are ramping up our patient care programs, along with our marketing and member engagement campaigns, that are expected to increase awareness and utilization of CVS at Target.

We also completed the vast majority of the Omnicare integration, although there is still much to do to sell our innovative new programs to the market.

In the front store, we continue to drive health and beauty sales, private label sales, and to build upon our personalization strategies as we drive value for customers.

However, as we cycle into 2017 our retail business will be challenged in a few areas, so let me review them now.

First, the combination of all the network changes that Larry discussed earlier are causing a significant headwind, as more than 40 million prescriptions are expected to cycle out of our stores next year.

Secondly, although both the Omnicare and Target pharmacy acquisitions are performing well, the ramp-up in the level of accretion is slightly slower than anticipated.

Between them, the year-over-year improvement in accretion was initially forecasted at $0.26, however we now currently expect the year-over-year incremental accretion to be about $0.17, which includes the script impact on the CVS pharmacies within Target, related to the network changes that we discussed.

We are making good progress on these acquisitions, but it's taken a little longer than expected to realize all of the benefits.

And finally, we continue to see ongoing margin declines related to both reimbursement pressures, and the mix of business.

The offsets to margin pressures, as you know, are lumpy, and they relate to the anticipated timing of generics, along with the timing of share gains.

Recall that our growth model has been based on driving share through our channels to offset the ongoing reimbursement pressures in the business, which we have been very successful in accomplishing for the past several years.

Given the recent network changes, it has become more difficult to grow our share, and therefore offset the ongoing margin pressures in the near term.

So 2017 will be a challenging year from that perspective.

As you know, we are committed to driving shareholder value, and our cash generation capabilities are a real asset to our shareholders.

We will continue to increase our dividend on an annual basis, and do value-enhancing share repurchases after considering strategic opportunities.

To that end, our Board has just approved a $15 billion share repurchase authorization.

Combined with what we have left on our prior authorization, we now have $18.7 billion available for buybacks.

Our adjusted earnings per share estimates for 2017 assumes that we complete $5 billion in share repurchases.

In addition to providing our primary outlook or preliminary outlook for 2017, I wanted to provide a high-level summary of our long-term financial targets, particularly in light of today's news.

Back in December of 2013, we provided our five-year financial targets, which included many assumptions.

If you look at our cumulative performance from our jump-off point in 2013, we're tracking to the higher end of our adjusted EPS targets, with a compounded annual growth rate of about 13.6% from 2013 through 2016.

Given the sheer scale of our enterprise, with about $180 billion in revenue and more than $10 billion in EBIT, we want to acknowledge that maintaining a 10% to 14% adjusted earnings per share growth rate off a much larger base is becoming more challenging.

So going forward, we are targeting enterprise adjusted earnings per share growth of approximately 10% on average.

Some years may be higher than 10%, while some years may be a bit lower than that.

And we expect that growth to generate to $7 billion to $8 billion in free cash flow per year on average.

And again, we will provide more details at our analyst day coming up, and we continue to believe that we are very well-positioned in the healthcare marketplace, and we will continue to work diligently to deliver on these targets.

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

Thanks, Dave.

While obviously we're not satisfied with next year's growth projection, we have a plan in place to return to healthy operating profit growth, and let me provide a high-level outline of that plan.

First, we will leverage our enterprise capabilities and CVS Pharmacy's compelling value proposition to partner more broadly with other PBMs and health plans.

We have capabilities that generate results that other retail competitors simply cannot match.

So we will begin to offer a suite of bundled services, including exclusive capabilities, such as MinuteClinic services, infusion, and long-term care capabilities, as a component of the CVS Pharmacy value proposition.

And as the healthcare market continues its evolution to a value-based environment, the clinical capabilities that are resident today at CVS pharmacies will become increasingly important, making us a clear partner of choice.

Second, we will focus on driving growth through new PBM product introductions that capitalize on the benefits inherent in our unique integrated model.

Some offerings by others in the market have attempted to mimic the success of our programs such Maintenance Choice.

And while they may get part of the way there, we don't believe they can extract the full value that we do through our truly integrated model.

Our ongoing innovations will encompass clinical solutions to support all stages of care, new value-based contracting approaches in specialty and traditional pharmacy, including partnering with pharma in different ways to drive savings, new CVS Caremark retail network strategies including performance-based networks, as well as a new generation of Maintenance Choice that will offer even more convenience and help drive further adoption.

Third, in this environment, it's critical to continue to be a low-cost provider.

And to that end, we've begun work on a new multi-year enterprise operations improvement initiative that will generate significant annual savings beginning in 2017, and accelerating beyond.

And while we've been efficient and productive in our business, we do see additional opportunities to leverage the technology investments that we have made to further improve enterprise-wide efficiencies.

And fourth, we will continue to be very thoughtful with respect to using our strong cash generation capabilities to return value to our shareholders.

We expect to continue to evaluate opportunities for acquisitions that meet our strategic and financial criteria, and we will be disciplined about investing in the right opportunities that drive long-term growth.

So before closing, let me reiterate that we continue to be confident in our business model, and our ability to drive long-term growth.

We've always said that the beauty of our model is that we can pivot to address changes that take place in the market, and we will continue to do that as the healthcare market evolves.

We are the only company with the ability to impact not just patients, but also payers and providers, with channel-agnostic solutions.

Furthermore, our goals around achieving higher-quality at a lower cost are very much aligned with our partners, and we will continue to find new and innovative ways to drive value for patients, payers, and providers, by making care more accessible, more affordable, and more effective.

And we certainly look forward to speaking with you in greater detail about all of the initiatives that I just outlined at our analyst day next month.

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

(Operator Instructions)

Lisa Gill from JPMorgan.

Larry, I just want to better understand, competitively what's happening on the retail side of the business.

You talked about Walgreens and their new relationship with Prime and Department of Defense, but yet said these 90 day programs not really having much of an impact.

One, can I just better understand the make-up of the 40 million prescriptions you are talking about?

Is that just Prime and Department of Defense or is there some assumption around these 90-day programs, or any other restrictions around network?

And then secondly, can you maybe just give us a better understanding of what the opportunities are in your own Caremark book of business, to try to replace some of this volume over time?

I know you have talked in the past that especially with health plan business, it takes time to work these programs in, but is that an incremental opportunity over the next couple of years, of they might be taking away market share from others, but we've got this really big business that we won over the last few years and we can pull it into our own store?

Lisa, it's Larry.

Let me start and I'm sure others will jump in here.

Lisa, if you go back to the 40 million scripts that we talked about, and if you looked at the make-up of that it's probably about 40%, 40% of that 40 million is the TRICARE impact, and then the Prime impact.

And the balance of that is just the normal churn that takes place in any particular selling season.

So it's really a function of the restricting of those networks.

Lisa, this is Dave.

Just to be clear, this is not necessarily a 90-day offering these are restricted networks which take CVS fully out of the network offerings.

No, I understand that, but I'm just saying that I think you made the comment that's specific to this, but you're not really seeing any shift in the 90-day.

Is there at the risk, Dave, that we do start to see some of these 90 day programs tick up, and so it would be more than 40 million scripts need to come out next year?

That's what I was trying to get that.

Lisa, I think we contemplated that into our outlook for 2017.

As you know, when we sell in a 90-day network with co-pay incentives either into our book, or somebody sells into their book, there is movement of scripts, and that's contemplated in our script forecast for next year.

So that's fully contemplated.

And then what about on the other side though?

For your own book of business, do you see an opportunity, I just look at how much business you have won in the last few years.

Is there that opportunity to start pulling more of that into your store?

Maybe not in 2017 but beyond 2017?

Yes Lisa listen, we think that we compete very effectively on price and our network strategies are a critical part of that value proposition.

We always offer our clients a variety of network options to meet their specific needs of their members, and certainly the results prove out that CVS Pharmacy drives better outcomes, and better overall performance as a result of our integrated model.

And we look to aggressively sell that to our clients, to help them achieve better outcomes and lower overall costs.

And at the end of the day, we have multiple network options, and the choice is up to our clients.

We have continued to see steady progress, alluding to the new business that we have picked up over the last couple of years, especially last year, as we talked about, it is a longer tail, if you will, on the health plan side of the business than the employer side, but we've seen steady progress there, and there's certainly more opportunity that remains.

Thank you.

John Heinbockel from Guggenheim Securities.

So if you think about that 10% growth rate long term, that would suggest I think mid-single-digit EBIT growth.

Is it fair to think the PBM would grow faster than retail, and any thought on where you think retail can grow?

I assume you would think after 2017, you would be back to gaining share and leveraging the retail business?

Yes John, it's Dave.

Obviously we do expect to return to healthy growth in 2018 and beyond.

And yes, I think if you look at our long-term growth rate at approximately 10%, the Company generates significant amount of cash.

That cash can be effectively utilized to return value to shareholders through value-enhancing share repurchases, which you look at the past practices, we have delivered somewhere between 4% to 5% to 6% adjusted earnings per share growth, just from the cash that we generate out of the business, which is significant.

Obviously, we do believe that the underlying business organically is going to be able to grow healthy.

We don't really provide guidance by segment, because our businesses are really integrated today, but we do expect to return to that healthy growth outlook in 2018 and beyond

And John, keep in mind to Dave's last point, we've got, as you look at our model, some of the dispensing channels that may fall traditionally under the retail umbrella in other businesses, like specialty or mail, that's flowing through the PBM segment in our reporting.

Do you think, when you think about restricted networks and your approach to them, do you think about that a little bit differently going forward, or pretty much the same as you had?

And you talked about going after enterprise wide cost reduction.

Does that tie in at all to how you think about attacking restricted networks?

John, listen in the environment in which we are all operating, being the most efficient and productive, that continues to be a key guiding principle, if you will.

And we've done a number of things over the years.

We have historically been a very efficient and productive provider when you look at our cost metrics, and as I mentioned in the prepared remarks, leveraging many of the investments that we've made in technology over the last few years, we have another opportunity to do that.

And again, as Dave mentioned, we will outline the details around that at analyst day.

Okay, thank you.

Robert Jones from Goldman Sachs.

I have to imagine the retail network rates needed to shift this level of share away from CVS.

It obviously would be pretty meaningful.

Can you give us any sense of the discounts that you seen offered in the marketplace to exclude CVS pharmacies?

And as it relates to specifically to the Prime example, were you given the opportunity to match the pricing that was offered to create these restricted networks?

Bob, this is Dave.

Maybe I'll start with that.

I think what was interesting about these couple of market moves is that typically we see a pretty competitively bid process.

These major network changes quite honestly happened without a chance for us to actively engage, and really tell our value proposition, as these changes were contemplated in both Prime and with TRICARE.

So from that perspective, we were caught a little bit off guard.

Understood.

And then I guess just looking at the math for 2017, it seems like the majority of the below long-term EPS growth is really from this share shift, these 40 million scripts you highlighted.

But you did then put out the long-term expectation for 10% growth.

Given that there does seem to be this price for volume trade-off occurring in the marketplace, how can you get comfortable that we really see the end of this, or more of a stabilization of this, as we move beyond 2017?

I think a little bit around that.

If you look at some of the competitive pressures that we are seeing right now, are not necessarily new.

We've faced reimbursement pressures and network changes on an ongoing basis.

And if you think about it, the way we've offset it really is three ways.

One is, we've lowered our cost of goods sold and our Red Oak joint venture is a great example of that.

We've improved the efficiency, and we will continue to launch a new program this year to further improve the efficiency across our network.

And then finally, we've been able to increase the capture of share, dispensing share, into one of our channels.

Obviously in 2017, that lever is not really available to us.

But I do think if you look at how we're positioned in the marketplace and our ability to plug in and really add a lot of value to the payers that we serve, I think we are really nicely positioned in a world of which networks begin to narrow, and outcomes become more important.

And Bob, it's Larry.

Just a couple other additional points.

As we mentioned in our prepared remarks, the point about CVS Pharmacy's ability to provide incremental offerings leveraging the assets that emanate out of CVS Pharmacy, besides simply dispensing, I think that becomes an important component of the story.

Recognizing the cost savings opportunities that result from MinuteClinic, or infusion as it relates to site of care management, and now long-term care pharmacy.

And we believe we can enhance our value with other PBMs, not just Caremark in providing -- in making those services available, that will be very much aligned with our clients in an effort to provide high quality, and at the same time, lower costs.

So we believe we can be a partner of choice as we go forward.

Makes sense.

Thank you.

George Hill from Deutsche Bank.

Maybe just to look at the PBM side a little bit from this angle.

Larry, can you talk about what you're seeing in the PBM selling season as it relates to pricing?

And what I'm wondering is that Walgreens pharmacy's in these PBM competitors, ESI, Optum, Prime, with lower network rates, they're going to pressure you on that side of the business as well, and make it harder to retain the PBM business?

George, it's Larry.

I'll start, others may want to jump in.

As we've said for probably the last couple of years now, pricing certainly is competitive, but we've seen it remain rational in the marketplace.

We haven't seen anything on the horizon that changes our view of that.

We are beginning the 2018 selling season as we speak, so obviously we will be talking more about that as we get into the new year, but it seems to be lining up very consistent with prior years.

Okay, and then maybe a quick follow-up would be, anything you can give us to make us more comfortable with that medium-term earnings growth profile of 10%?

Given that these issues in retail are likely to persist, because these markets share gains and this pricing in these multi-year contracts it's going to be turn in one year or even two years.

Maybe how do we think about the mix of operating earnings growth versus capital deployment, just how do we get to the 10%?

We will talk, I'm sure, a little bit more about that in December.

But I will go back to say if you look at our past track record, and you look at our ability to gain share, both from a PBM perspective and turning that share into dispensing channel share gain in our network, we've been quite productive at doing that.

And I think the outlook for that remains strong.

Keep in mind, we still have a very robust specialty business.

It continues to perform well.

We have a very large Medicare Part D business that is performing quite well, and we've done two fairly sizable acquisitions in the form of Omnicare and Target, both while are not being as accretive as we once thought as we cycle into 2017, but as we look long-term, have a real opportunity for us to grow and develop that business in a meaningful way.

And again, and finally, not to put this -- to minimize this if you look at the cash that our organization throws off, we can get a substantial amount of accretion just from the share buyback program as you look at deploying that capital in a very effective way.

Keeping in mind we might also deploy that capital from a strategic lens, to make sure that we bolt on the right businesses to enhance the infrastructure that we have today.

Okay, thanks.

I appreciate the color.

Eric Percher from Barclays.

Another question related to the profitability of the 40 million, and maybe I'll come at it this way.

If you hadn't seen the unexpected or not competitively bid pieces move away, would your earnings growth have been within shouting distance of the 10% guidance that you are providing?

Yes, Eric, as you think about the answer to that, it brings us back to, it would've been 2012, 2013, when Walgreens and Express had a dispute, and certainly many capitalized on that in the marketplace.

If you looked at the profitability associated with those incremental scripts at that point in time, it parallels what we talked about this morning.

Extracting from that the advertising and labor investments that we made, in an effort to gain a disproportionate number of those scripts.

So again, factoring that in, we certainly would have been within striking distance of that 10% target that Dave outlined.

Eric, just keep in mind too, that if you look at the, as we cycle into 2017 there were really three topics that I outlined that were headwinds.

One is obviously the loss of prescriptions in the marketplace.

Two was slightly less accretion in the two acquisitions, and third, updated competitive reimbursement pressures in the mix of our business.

All three of those contribute to our slower growth, or lack of growth in 2017.

That's helpful.

And on the third one, if we look at the PDP performance, it looks like this quarter was in line with what you expected.

We see fewer preferred relationships next year.

Can you speak to the way in which that may be impacting the next year, and the outlook on PDP?

Yes, we have I think a very nice growth plan for 2017 in SilverScript.

Our PDP business continues to take share and perform well both this year, and we expect the same next year.

And Eric obviously, we are in the annual enrollment period, so it's open for another month.

And from early indications, we've gotten off to a good start.

And obviously, we will provide a recap once the season closes, and we will probably talk a little bit more about that at analyst day.

Eric on the retail side, I'm not sure if your question was really looking at SilverScript or CVS Pharmacy's presence in the Medicare Part D networks.

It would be on par with our various relationships this year, absent some of the changes that took place in the Prime sponsored Med D network.

That's helpful.

Thank you.

David Larsen from Leerink Partners.

Can you talk about the timing of these retail network contracts, like how long do they last for, and how are there any other large PBM contracts on the retail side that are up, that wouldn't perhaps enable you to win all or some of that business back, over the next year or two?

David, as you look at the retail contracting cycles, they are probably, I would describe them as more frequent than they once were, acknowledging that the Medicare space is an annual cycle.

And some of this gets back to, in our prepared remarks, our plan to respond to these marketplace changes, the opportunity that we see us having with other PBMs, recognizing our goal of providing more bundled services.

So we have, today we have contracts with retail contracts with all the PBMs, and we will be working with those goals and objectives in mind that we outlined again in our prepared remarks, to enhance our offerings with them.

Okay, that's great.

And then in terms of drug pricing, let's say there's been a deceleration of brand inflation and there's generic deflation, has that had any impact on your 2017 guidance or not?

And then is there any update to the net new wins for the PBM, and also your retention rate?

Thanks.

Yes David, this is Dave.

From inflation standpoint, no real material change to our outlook in both branded and generic, and that is not presenting either a headwind or a tailwind if we cycle into 2017.

So that's not really a factor in all the prepared remarks that we just talked about.

And David in terms of the update on the selling season, I believe we have a slide in there, it's pretty much on par with what we reported on the second-quarter call.

The net business is slightly lower, reflecting some of the changes that you've seen in terms of some of our health plan partners exiting the exchange business, but it's not really material.

And our retention rate remains right around 97%.

Thank you.

Scott Mushkin from Wolfe Research.

But I guess I'm going back to Lisa's question, and some of the questions earlier in the call.

I'm trying to understand why your vertical model appears to have lost steam in the marketplace compared to what Walgreens is doing with some of their partnerships.

And why those partnerships seem to be having more success on restricted networks, at least right now, and more success on the 90-day retail?

I'm understanding Texas is going to have a 90-day retail component in that contract.

Is Walgreens and the healthcare plan attached to a PBM cost advantaged to you, when you look at it with your PBM retail model attached to a health plan?

And I'm just trying to understand the model, where the model stands, and how you are viewing that.

Scott let me there's probably a couple questions in there, and let me start and then I will ask others to jump in.

First of all, from an integrated model perspective, Scott, I don't believe that we have lost any steam whatsoever.

As you heard Dave mentioned in our prepared remarks, Caremark once again had another very successful selling season.

Despite some of the publicized losses that occurred back in the spring timeframe, with net new business well over $4 billion, compounding prior successful selling seasons.

And as we talked, we continue to grow enterprise dispensing share.

Obviously for the reasons that we mentioned earlier not enough share growth to offset the 40 million script headwind, but we continue to make progress, and back to Lisa's question, we continue to see opportunities beyond that.

In your question, Scott, around, is Walgreens making some headwind here?

Listen we can hypothesize that there may be a perception out there that CVS Pharmacy is not a neutral platform.

And by the way, that's reflected in our response to this environment, in our efforts to demonstrate that we are the best partner to all PBMs and health plans, given our unique suite of capabilities, along with our track record of delivering results.

And I think we are all very confident that will make a difference.

And obviously, as you've heard us say many times, we believe that we have the right assets in terms of the healthcare environment moving forward.

I'm not talking about 2017, now, recognizing this retailization of healthcare, and the role that the consumer will play, and the migration from a fee-for-service system to one that's more value-based, acknowledging that migration has been slower than what everyone would like to see, but it is happening.

That was it for me.

Thanks, Larry, for the answer.

Priya Ohri-Gupta from Barclays.

Dave, just given some of the moving pieces that we have over the short term, and then given your moderation in terms of EPS growth over the medium term, how should we think about your balance sheet usage, leverage target, ratings target?

Just was hoping to get your thoughts on that, since we didn't have that in your prepared remarks.

Thank you

Sure.

We are very committed to maintaining our high BBB rating.

We are still very committed to returning to the 2.7 times adjusted debt to EBITDA.

As you heard, as our cash flow performance this year has been quite strong, we're going to probably delever a bit more this year than we thought we were going to in our original plan, given that strong cash flow performance.

As we cycle into 2017, given all the moving parts and I'll say the headwinds that we have, our leverage will probably, year over year, our leverage will be essentially constant.

We will not delever as we cycle into 2017.

We will work to get back down to that leverage target in a reasonable amount of time.

Thank you, that's very helpful.

Peter Costa from Wells Fargo.

Larry, do you see this as more of a response to your verticalization of the industry, in terms of the industry becoming more vertical, or do you see this as a start of a price war from Walgreens taking -- trying to take more share and fixing their pharmacy counter?

Well Peter, listen, there's certainly been competitive pressures.

That's nothing new to the healthcare environment.

As you've heard us talk many times, we've experienced them for several years now in both retail and PBM segments.

We have several ways in which we manage against those reimbursement pressures, whether it's lowering our cost of goods, and we've gotten some nice synergies from the Red Oak model and that team continues to work to bring even more innovation.

As we talked, being -- continuing to be the most efficient and productive provider of care and then growing our share.

And unfortunately, that third lever of growing share will not happen in 2017.

And again, as we've been talking this morning, we have a response plan to the market dynamics, and a plan to reaccelerate our growth there.

So that's how we see the marketplace, and probably not changing beyond that dynamic, anytime soon.

Just as a follow-up, do you see yourself then responding to this by trying to lower price, to re-win some of those customers that went away from you, or get into those networks again, or do you see them as vertical networks that are been separated away from you?

Peter, again, as we talked about in our prepared remarks, and I don't want to be redundant, but we are very confident that in responding to these market dynamics, the ability to enhance the CVS Pharmacy value proposition, and include other services that have been proven to drive down costs, we believe will be appealing for PBMs, because it's very much aligned with the goals for their clients.

Thank you.

Alvin Concepcion from Citi.

Just to follow-up on that, just so I'm clear, beyond TRICARE and Prime are you seeing the differentiation of your model, your integrated offerings, weighing less on the decision of payers?

Or are they just motivated by price at this point, and do you need to consider lowering your threshold on margins, or are you sticking with your plan?

Alvin, this is Dave.

I think our value proposition continues to resonate in the marketplace, both from a PBM perspective and a retail perspective.

A couple of network changes obviously went the other way on us here.

But I do believe that the power of our integrated model, and the things that we can offer to payers when we are not the PBM, or the things that we can offer to the ultimate payer when we are the PBM really still quite relevant in the marketplace.

It's getting a lot of traction, and we continue to perform well from that perspective.

And we think the outlook beyond 2017, as we get into 2018 and the years out, I think is quite strong.

Great.

And just my follow-up, I don't know if you're planning on providing color on sales longer-term relative to the 9% to 13% target.

I know that the losses are probably impacting that, so I'm wondering if you could give any more color on that?

We will probably give a little more color on analyst day, but I expect to walk through the model at a macro level, as I've done in prior years, and make sure everybody understands our growth algorithm.

Okay thank you.

Mohan Naidu of Oppenheimer.

Larry, you talked about your giving your clients option of various network coverages.

Can you talk about what portion of your business has restrictive networks where CVS is exclusive?

We have not provided it as a percentage.

We have talked about the number of clients and members in Maintenance Choice, and I believe that number is now over 23 million lives.

And that is, Maintenance Choice will constitute our most restrictive network.

Okay, got it.

Maybe if I can, one quick follow-up for Dave.

Dave, you're talking about the 14 million scripts for next year, and that includes the TRICARE and Walgreens.

How much of that is unknown that you have baked in for further changes as you go into 2017?

I think as we sit here for 2017, we have a pretty good handle on -- I'll say network changes.

Keep in mind, most network changes happen in late Q3 early Q4, as you cycle into next year.

So we have a pretty good line of sight to our network participation and volume outlook, as a network participant, as we cycle into 2017.

So I think we're pretty good there.

Okay, thank you.

Charles Rhyee from Cowen.

It's James Auh for Charles.

So my question is, so you mentioned that you plan to introduce new PBM products in the future to drive growth, and what solutions can we expect?

One of your competitors is taking risk on price, with inflation protection.

Do you plan to provide a similar solution?

We have that today in our offerings, where we have price protection for our clients.

In our prepared remarks, we talked about the four areas of new product innovation around clinical solutions, new value-based contracting approaches, both in specialty in traditional pharmacy, and then a new retail network strategies that would include performance-based networks.

We have that a little bit today in Medicare Part D, but we see an opportunity to go further with that to be very much aligned with value-based reimbursement and outcomes management.

And then a new generation of Maintenance Choice.

So again, we will provide a lot more details next month at analyst day, but that's how we're thinking about it.

And by the way, there are elements of risk that we take today, whether it's in Medicare or some aspects of what we do with NovoLogix, in terms of managing that portion of pharmacy flowing through the medical benefits.

Also, how much capital deployment is assumed in the preliminary 2017 guidance?

We have $5 billion in share repurchase is within that guidance range, and we will talk more about the dividend on analyst day.

But we do expect over time that we will be deploying, raising our dividend up to 35% pay-out by 2018.

That expectation is still consistent with our thoughts.

Great, thank you.

Ricky Goldwasser from Morgan Stanley.

Two questions here.

First one obviously, it seems that growth on the PBM side is going to be key to achieving the 10% long-term earnings growth.

So can you just give us some context in how much business you have up for renewal?

How much PBM business you have up for renewal for next year, for the 2017 2018 selling season?

Yes Ricky, it's Larry.

We've got $22 billion to $24 billion up for renewal.

Keep in mind that's off a much higher denominator, so as a percentage, it would be pretty much on par with prior years.

Okay, thank you.

Ricky I would just add I think it's probably important step back, and you talked about the PBM being the growth engine, and while it is, we really need to think about the enterprise.

Our business is so integrated now that you need to really look at it in totality from that perspective.

Okay.

And then Larry, in response to one of the questions, you really talked about the fact that you think you have all the assets that you need in your portfolio to succeed longer-term.

Obviously, health plans are key to longer-term success, as we see the Optum-United model developing further.

So can you talk a little bit about how you think about that managed-care model?

Partnership versus ownership?

And obviously Anthem talked about last week putting an RFP out early next year.

So how important do you view an Anthem-like contract for your long-term strategy?

Ricky, it's Larry.

As you know, we typically do not talk about specific contracts or specific RFPs.

As you think about the healthcare business broadly, or health plan business broadly, today we have over 70 health plan relationships with the PBM.

Obviously it's an important growth component of the business, and there's nothing that prevents us from adding to that list, as we have done the last couple of years.

I do think that there is an ongoing evaluation of, does the health plan insource their pharmacy PBM functionality, or do they outsource it?

And we continue to believe that whether you are looking at size and scale, or the fact that pharmacy is our focus, and the clinical capabilities that we bring to that, along with the challenges of the regulatory environment from a compliance point of view, and the investments that need to be made to comply with that for the Medicare-Medicaid businesses, we think that it makes a lot of sense for folks to outsource that business.

And quite frankly that's what we've seen this year.

This past selling season, where I think everyone was trying to figure out, wait a minute, how can everybody grow?

And part of the answer to that is that the pie got bigger because there were some health plans that outsourced their PBM, their pharmacy business.

Ricky, I think the only other point to add to that is we see opportunities that we have, recognizing the assets that we have assimilated, are the ones that largely touch the patient or the consumer.

And that gives us the opportunity to partner with health plans, whether we are the PBM, or whether we are not the PBM.

Obviously, if we are the PBM, there is enhanced offerings that we can provide as a result of the integration, but there are also capabilities that we have that we can partner with health plans in a very differentiated way, without having to be the PBM.

Okay.

And lastly, one last question.

You talk about Target and Omnicare and the integration there.

Can you maybe give us a more specific color on what's holding back Target and Omnicare from meeting your near-term accretion expectations?

Ricky, maybe I will take Omnicare, and ask Helena to comment on Target.

With Omnicare, Ricky, it's certainly not a question of if, it's more a question of when.

And one of the things that we learned this past year through our pilots in the assisted living space, is that we found that we had to target both the needs of the residents in those facilities, along with the facility operator needs.

In doing that, we need to make some additional and incremental technology investments.

Those investments are underway, and they really need to be completed for us to broadly sell the value proposition that we can bring to the assisted living space.

So we will be getting that work done in 2017, and I'm confident that we'll capitalize on the synergies once that work is complete.

And I would say we're actually very happy with Target.

As we discussed earlier in the year, the integration certainly led to some disruption which we expected, we've been through a lot of integrations.

And we are on track to achieve the performance we were looking for this year.

The most exciting thing I would say is that the Target team has responded in a tremendous way to the new systems and programs that we've delivered to them.

So the service levels in those pharmacies are quite strong.

We're seeing them come out of the integrations and the system changes in a very strong pace.

And what we are starting to do now is turn on our patient care programs, which CVS historically had and Target did not.

And given their ability to execute, and how well they've done all year, we're actually feeling quite confident that they will be able to do that well into 2017.

Thank you.

Michael Cherny from UBS.

I want to dive in a little bit on -- the question came up about the assets that you have in place.

You obviously spent a lot of time focusing on the enterprise approach, and driving incremental services to the business.

As you think more broadly about those services, and this can be obviously the thought process on organic versus inorganic, and maybe using for example MinuteClinic and acute care as an option, what's the most sense to bundle in outside of specialty, are you doing relative to the acute care base that you already touch?

Mike, I think there's -- I don't think there's one answer to that question, and I think the benefit that we have is that we have a series of assets that we can bundle in a whole variety of ways, that would meet the needs of that particular client and their members.

So I actually think that will be an advantage to us.

Okay, that's all I have for now.

Thank you.

Steven Valiquette from Bank of America Merrill Lynch.

TRICARE obviously is a government contract, and then Prime Therapeutics is sort of a different type of entity, tied to Blue's plans.

Just curious if you see differences in appetite for restricted pharmacy networks among different customer types in the market, just when thinking about government versus commercial employers versus health plan customers?

Yes Steve this is Jon Roberts.

With the employer clients, we clearly have seen a big appetite to restrict networks, narrow networks.

So Maintenance Choice with 23 million members has been very successful.

When you move over to health plans, you've seen a big appetite in Medicare with preferred networks, most preferred networks.

Most part D plans have preferred networks.

In managed Medicaid, we see many of those plans willing to restrict networks.

I think where there has been a reluctance historically has been in the fully insured market, and I think with Prime making a move to narrow their network and fully insure, that may be a catalyst for the rest of the markets, so we view that as an opportunity.

And I think with the government programs, it's a little bit of a mixed bag.

We see some willing to move into either restricted or Maintenance Choice networks, and others like full access.

So different parts of our client base really do have different priorities, and willingness to narrow or restrict networks.

Okay, so there are some changes in the market, maybe some growing appetite.

But maybe just confirm again, this was asked a bunch of different ways, but do you characterize these most recent changes as rational competition, just to try to confirm that?

Just given some of these stocks are reacting today I think people are worried about irrational pricing.

But just would you characterize these last few changes as rational competition?

Steve, I would say, as we talked many times, whether it's on the PBM or retail side, we've continued to see margin compression.

And I would say that we have not seen anything that we would put under the heading of irrational.

This is Dave, I would just look at the Prime decision, and it appears to us a little bit of an observer here, is that Walgreens acquired their specialty pharmacy and their mail-order pharmacy, or at least partnered with them from that perspective.

And I'm assuming as part of the arrangement, there was some network participation agreement that was conferred through Prime, so that might be a little bit of a unique compared to other network changes in the marketplace

And Steve again I think Dave mentioned this in response to one of the earlier questions, that in the two cases that we talked a fair amount this morning, we became aware of the network changes after the fact, and we were not given the opportunity to respond.

So in an irrational pricing environment, you would not -- you would expect a different type of process associated with that.

Okay, got it.

Okay, thanks.

Okay, we will take two more questions, please.

Eric Bosshard from Cleveland Research Company.

In terms of the updated long-term growth target, Dave, I understood some of the measures that you outlined, the size of the Company.

But curious if there's anything that you could help us with today in terms of different assumptions, if this is a different rate of you gaining share, if this is a different rate of underlying market growth, or an assumption that's different about profitability opportunities?

Just curious if you could give us a little bit more color behind what's different with the long-term growth rate going forward?

Yes Eric, obviously as I said, we're jumping off a lot bigger base at this point in time, given where we were in 2013, as we have grown the Company substantially.

This is probably a deeper conversation than we probably have time for the call today, but it's something that we will talk more about at analyst day.

I will say though, that if you just look broadly, I don't believe the fundamentals of our growth algorithm have substantially changed.

Obviously the marketplace has moved a bit, and there's been different offerings in the marketplace, but I think our ability to compete in the market hasn't changed in a substantial fashion.

And we do believe that if you look at the market, probably where it was a few years ago to where it is now, obviously the government-sponsored plans and health plans have grown, and they continue to be a growth area, whereas the employer book has been relatively modest and flattish from a growth perspective.

So we will see more of our growth coming out of government-sponsored plans over time.

And again, I think we are nicely positioned with all of our assets to compete successfully in gaining share in that marketplace.

So that's probably the biggest underlying change, as we pivot, to make sure we service that need of the segment in the market.

Okay, thank you.

Todd Duvick from Wells Fargo.

Dave, I had a follow-up for you with respect to your guidance about free cash flow.

Given that free cash flow is a little stronger this year and you talked about delevering in 2016, and probably flat in 2017.

You have a debt maturing in December, a $750 million note.

Should we assume that you're going to pay that note off, as opposed to refinance it?

And then with respect to share buybacks in 2017, should we assume that those are going to be fully funded from free cash flow, as opposed to partially debt-financed?

Yes, they will not be debt-financed, other than we might need to do some short-term borrowing just to accommodate the timing of that.

But we will not be issuing debt to support a share repurchase program into 2017.

I can't really comment about our debt maturities.

I do think at the end of the day, we will be expected to be a delevering over time, as we grow our way out of our current capital structure, just a little bit over 3 times, probably 2.9 times at the end of the year, down to 2.7 times in a reasonable amount of time.

Okay, that's helpful.

Thank you very much.

Okay, let me just thank everyone for your time this morning, and just wrapping up, obviously we're not happy with our outlook for 2017.

At the same time we outlined our actions in response to some of the marketplace dynamics that are taking place, and we are confident that our response and our actions will allow us to reaccelerate our growth going forward.

And we look forward to seeing all of you next month at analyst day where we will provide additional details on many of the things we talked about this morning.

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

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

Thank you.