Earnings Call: Q3 2016

Nov 8, 2016

Summary

Q3 adjusted EPS rose 28% to $1.64, while new network restrictions and retail pressures lowered FY16 guidance. FY17 adjusted EPS is projected at $5.77-$5.93; management targets ~10% average long-term growth and $7B-$8B annual free cash flow.

Ladies and gentlemen, thank you for standing by. Welcome to the CVS Health third quarter earnings call. During the presentation, all participants will be in a listen-only mode. Afterwards, we will conduct a question-and-answer session. At that time, if you have a question, please press the one followed by the four on your telephone. If at any time during the conference you need to reach an operator, please press the star 0. 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 yourselves to no more than one question with a quick follow-up so we can provide more people with the 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'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 as described in our SEC filings, including the risk factor section and cautionary statement disclosures in those filings. During this call, we'll 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. As always, today's call is being simulcast on our website, and it will be archived there following the call for one year. 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 want 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 a robust growth trajectory. You can find a detailed business and financial review of the quarter in the slides we posted before the call. 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. 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. 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 is 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-$7 billion. 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 this day'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. You know, 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. Since the first announcement, we've 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 take 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. While we continue to participate in Prime's Medicare Part D plans, in many cases, it will be as a non-preferred provider. 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. 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. 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. This unexpected loss of share will make that a difficult proposition in the short term. 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 reaccelerating 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-$5.83 per share, reflecting year-over-year growth of 11.75%-13%. We've effectively lowered the midpoint by $0.05 per share compared to our prior range of $5.81-$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-$4.90 a share. This now includes the addition of the integration cost 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. In the fourth quarter, we expect adjusted earnings per share to be in the range of $1.64-$1.70, up 7%-10.75% from Q4 of 2015. GAAP diluted EPS from continuing operations is expected to be in the range of $1.52 per share to $1.58 per share. 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%-14%, driven primarily by PBM growth. Total same-store sales at retail are expected to be flat to down 1.75%, and adjusted script comps are expected to increase 1%-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%-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-$5.93 in adjusted earnings per share, with results contracting a half a percent to up 2.5%. It will be a tale of two parts. Our PBM is 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. 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 is taking a little longer than expected to realize all of the benefits. 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 at 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 want 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 are 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 the 10%-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. We expect that growth to generate $7 billion-$8 billion in free cash flow per year on average. Again, we will provide more details at our Analyst Day coming up. 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. With that, I'll now turn it back over to Larry. Well, thanks, Dave. Well, obviously, we are not satisfied with next year's growth projection. We have a plan in place to return to healthy operating profit growth. 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'll 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. As the healthcare market continues its evolution to a value-based environment, the clinical capabilities that are resident today at CVS Pharmacy will become increasingly important, making us a clear partner of choice. Second, we'll 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, they have attempted to mimic the success of our programs, such as Maintenance Choice. 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. 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. 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. Fourth, we'll 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'll 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'll continue to do that as the healthcare market evolves. We're 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'll 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. 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. With that, let's go ahead and open it up for your questions. Thank you. Ladies and gentlemen, if you'd like to register a question, please press the one followed by the four on your telephone. You'll hear a three-tone prompt to acknowledge your request. If your question has been answered, you would like to withdraw your registration, please press the one followed by the three. If you're using a speakerphone, please lift your handset before entering the request. Again, to register questions by telephone, please press the one followed by the four. One moment, please, for our first question. Our first question is from the line of Lisa Gill from JPMorgan. Please proceed. Thanks very much for the detail, and good morning. 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 makeup of the 40 million prescriptions you're 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? 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've 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, hey, you know what? They might be taking away some market share from others, but we've got this really big business that we've won over the last few years, and we can pull it into our own store. Yeah, Lisa, it's Larry. Let me start, and then 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 makeup of that, it's probably about 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. It's really a function of the restricting of those networks. Yeah, and Lisa, this is Dave. Just to be clear, this is not necessarily a 90-day offering. These are restricted networks, which takes CVS fully out of the network offerings. No, I understand that. But I understand that, but I'm just saying that I think you made the comment that that's specific to this, but you're not really seeing any shift in the 90-day. Is there the risk, Dave, that we do start to see some of these 90-day programs pick up, and so it would be more than 40 million scripts that need to come out next year? That's what I was trying to get at. Oh, Lisa, I think we've 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, those are fully contemplated. 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? Yeah, 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. Certainly, the results prove out that CVS Pharmacy drives better outcomes and better overall performance as a result of our integrated model. We look to aggressively sell that to our clients to help them achieve better outcomes and lower overall costs. 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 years, especially last year, as we have talked about it. It is a longer tail, if you will, on the health plan side of the business than the employer side. But we have seen steady progress there, and there is certainly more opportunity that remains. Thank you. Thanks, Lisa. Our next question is from the line of John Heinbockel from Guggenheim Securities. Please proceed. So, guys, 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? 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. Yeah, John, it's Dave. Obviously, we do expect to return to healthy growth in 2018 and beyond. 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, if you look at the past practices, these 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. John, keep in mind, to Dave's last point, 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 is flowing through the PBM segment in our reporting. When you think about restrictive 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? You talked about going after enterprise-wide cost reduction. Does that tie in at all to how you think about attacking restrictive networks? Well, 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. We have 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. As I mentioned in the prepared remarks, leveraging many of the investments that we have made in technology over the last few years, we have another opportunity to do that. Again, as Dave mentioned, we will outline the details around that at Analyst Day. Okay, thank you. Thanks, John. Our next question is from the line of Robert Jones from Goldman Sachs. Please proceed. Great. Thanks for the questions. I guess just, I have to imagine the retail network rates needed to shift this level of share away from CVS would obviously have to be pretty meaningful. Can you guys give us any sense of the discounts that you've seen offered in the marketplace to exclude CVS pharmacies? And then I guess as it relates specifically to the Prime example, were you given the opportunity to match the pricing that was offered to create these restrictive networks? Yeah, 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 kind of caught a little bit off guard. Understood. 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 guys highlighted. 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 kind of see the end of this or more of a stabilization of this as we move beyond 2017? Yeah. Well, I think a little bit around that, if you look at some of the competitive pressures that we're seeing right now are not necessarily new. We've faced reimbursement pressures and network changes on an ongoing basis. You think about it, the way we've all said 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'll continue to launch a new program this year to further improve the efficiency across our network. 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're really nicely positioned in a world of which networks begin to narrow and outcomes become more important. 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. We believe that we can enhance our value with other PBMs, okay, not just Caremark, in providing those or in making those services available that will be very much aligned with their 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. Thanks, Bob. Our next question is from the line of George Hill from Deutsche Bank. Please proceed. Yeah. Good morning, guys, and thanks for taking the questions. Maybe just to look at the PBM side a little bit from this angle. I guess, Larry, Dave, can you talk about what you're seeing in the PBM selling season as it relates to pricing? What I'm wondering is, has Walgreens harmed these PBM competitors, ESI, Optum, Prime, with lower network rates that are going to pressure you on that side of the business as well and make it harder to retain the PBM business? Well, George, it's Larry. I'll start. Others may want to jump in. Listen, as we've said for probably the last couple 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're beginning the 2018 selling season as we speak, so obviously, we'll be talking more about that as we get into the new year. It seems to be lining up very consistent with prior years. Okay. Maybe a quick follow-up would be, I guess, 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 market share gains and these pricings and these multi-year contracts, it's going to be hard to 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%? Yeah. We'll 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 then turning that share into dispensing channel share gain in our network, we've been quite productive at doing that. 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. 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. Again, then finally, not 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, guys. I appreciate the call. You are welcome. Thanks, George. Our next question is from the line of Eric Percher from Barclays. Please proceed. Thank you. Another question related to the profitability of the 40 million, and maybe I will come at it this way. If you had not seen the unexpected or kind of not competitively bid pieces move away, would your earnings growth have been within shouting distance of the 10% guidance that you are providing? Yeah, Eric, as you think about the answer to that, it brings us back to going, I guess it would have been 2012, 2013, when Walgreens and Express Scripts 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. Again, factoring that in, we certainly would have been within striking distance of that 10% target that Dave outlined. Yeah, Eric, just keep in mind too that if you look at the as we cycle into 2017, there were really three, I guess, topics that I outlined that were headwinds. One is obviously the loss of prescriptions in the marketplace. Two is a slightly less accretion in the two acquisitions. Third, I will say the competitive reimbursement pressures in the mix in our business. All three of those contribute to our slower growth or lack of growth in 2017. That is helpful. 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? Yeah, 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. Eric, obviously, we're in the annual enrollment period, so it's open for another month. From early indications, we've gotten off to a good start. Obviously, we'll provide a recap once the season closes, and we'll 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. Our next question is from the line of David Larsen from Leerink Partners. Please proceed. Hey, can you talk about the timing of these retail network contracts? How long do they last for, and are there any other sort of large, I guess, PBM contracts on the retail side that are up that would perhaps enable you to win all or some of that business back over the next year or two? Well, 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. 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, today, we have 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 is great. Then in terms of drug pricing, let us say there has been a deceleration in brand inflation, there is generic deflation. Has that had any impact on your 2017 guidance or not? Then, is there any update to the net new wins for the PBM and also your retention rate? Thanks. Yeah, David, this is Dave. From an 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 as we cycle into 2017. So, that is not really a factor in all the prepared remarks that we just talked about. David, in terms of the update on the selling season, I believe we have a slide in there. It is 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 have seen in terms of some of our health plan partners exiting the exchange business. But it is not really material, and our retention rate remains right around 97%. Thank you. Next question. Our next question is from the line of Scott Mushkin from Wolfe Research. Please proceed. Hey, guys. Thanks for taking my question. Hopefully, I can articulate it well. I guess I'm kind of going back to Lisa's question and some of the questions earlier in the call and trying to understand why your vertical model appears to have lost some 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. So, 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 advantage to you guys when you look at it with your PBM retail model attached to a health plan? I'm just trying to understand where the model stands and how you guys are viewing that. Well, Scott, there's probably a couple questions in there. Let me start, and then I'll 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, okay? As you heard Dave mention 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. 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. Back to Lisa's question, we continue to see opportunities beyond that. 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, okay? 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. I think we're all very confident that that will make a difference. 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 that migration has been slower than what everyone would like to see, but it is happening. All right, that was it for me. Thanks, Larry, for the answer. Our next question is from the line of Priya Ohri-Gupta from Barclays. Please proceed. Great. Thank you so much for taking my question. Dave, just given some of the moving pieces that we have over the short term, and then given your sort of 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 hear that in your prepared remarks. Thank you. Sure. We're very committed to maintaining our high triple-B 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 is very helpful. Thank you. Our next question is from the line of Peter Costa from Wells Fargo. Please proceed. Thanks for the question. 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 the start of a price war from Walgreens 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 the 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, continuing to be the most efficient and productive provider of care and then growing our share. Unfortunately, that third lever of growing share will not happen in 2017. Again, as we've been talking this morning, we have a response plan to the market dynamics and a plan to re-accelerate our growth there. That's how we see the marketplace, and probably not changing beyond that dynamic anytime soon. So, 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 just see them as vertical networks that have been separated away from you? Well, Peter, again, as we talked about in our prepared remarks, and I don't want to be redundant, but we're 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. Our next question is from the line of Alvin Concepcion from Citi. Please proceed. Thanks for taking my question. Just to follow up on that, just so I am clear, beyond TRICARE and Prime, are you seeing the differentiation of your model, your integrated offering, is that weighing less on the decision of payers, or are they just more motivated by price at this point? Do you need to consider lowering your threshold on margins, or are you sticking with your plan? Alvin, this day, I think our value proposition continues to resonate in the marketplace, both from a PBM perspective and a retail perspective. These 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 is still quite relevant in the marketplace, is getting a lot of traction, and we continue to perform well from that perspective. I think the outlook beyond 2017, as we get into 2018 and the years out, I think is quite strong. Great. Just my follow-up, I do not know if you are planning on providing color on sales longer term relative to the 9%-13% target. I know that the losses are probably impacting that, so I am wondering if you could give any more color on that. We'll probably give a little bit more color on Analyst Day, but I expect to kind of walk through the model at a macro level as I've done in prior years, and we'll make sure everybody understands kind of our growth algorithm. Okay, thank you. You're welcome. Our next question is from the line of Mohan Naidu from Oppenheimer & Company. Please proceed. Thank you so much for taking my questions. Larry, you talked about you giving your clients the option of various network coverages. Can you talk about what portion of your business has restrictive networks where CVS is exclusive? You know what? We have not provided it as a percentage. We've talked about the number of clients and members in Maintenance Choice, and I believe that number is now over 23 million lives. And Maintenance Choice would constitute our most restrictive network. Okay, got it. Maybe if we can, one quick follow-up for Dave. So, Dave, you're talking about the 40 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 kind of in late Q3, early Q4 as you cycle into next year. 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. You're welcome. Our next question is from the line of Charles Rhyee from Cowen. Please proceed. Hi, it's James Auh from Charles. My question is, you mentioned that you plan to introduce new PBM products in the future to drive growth. What kind of solutions can we expect? One of your competitors is taking a risk on price with inflation protection. Do you plan to provide a similar solution? Well, Gene, 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 and traditional pharmacy, and 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 a new generation of Maintenance Choice. Again, we will provide a lot more details next month at Analyst Day, but that is how we are thinking about it. By the way, there are elements of risk that we take today, whether it is in Medicare or some aspects of what we do with NovoLogix in terms of managing that portion of pharmacy flowing through the medical benefit. 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 our 35% payout ratio by 2018. That expectation is still consistent with our thoughts. All right, great. Thank you. You're welcome. Our next question is from the line of Ricky Goldwasser from Morgan Stanley. Please proceed. Yeah. Hi, good morning. 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. Can you just give us some context in how much business you have up for renewal? How much PBM business you had up for renewal for next year, i.e., for the 2017/18 selling season? Yeah, Ricky, it is Larry. We have $22 billion-$24 billion up for renewal. Keep in mind that that is 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 that I think what is probably important to step back, and you talked about the PBM being the growth engine, and while it is, we need to really think about the enterprise. Our business is so integrated now that you need to really look at it in totality from that perspective. Okay. Larry, in response to one of the questions, you really talked about the fact that you think that 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 OptumUnited model developing further. Can you talk a little bit about how you think about that managed care model, partnership versus ownership? Obviously, Anthem talked last week about putting an RFP out early next year. How important do you feel Anthem-like contract for your long-term strategy? Well, 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've done the last couple years. I do think that there is an ongoing evaluation of, does the health plan in-source their pharmacy PBM functionality or do they outsource it? We continue to believe that whether you're 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 and Medicaid businesses, we think that it makes a lot of sense for folks to outsource that business. Quite frankly, that's what we've seen this year, this past selling season, where I think everyone was trying to figure out that, "Well, wait a minute, how can everybody grow?" Okay? 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. That gives us the opportunity to partner with health plans, whether we're the PBM or whether we're 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. Lastly, one last question. You talked about Target and Omnicare and the integration there. Can you maybe give us some more specific color on what's holding back Target and Omnicare from meeting your near-term accretion expectations? Yeah, Ricky, maybe I will take Omnicare and ask Helena to comment on Target. With Omnicare, Ricky, it is certainly not a question of if, it is more a question of when. 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 am confident that we will capitalize on the synergies once that work is complete. Yeah, and I would say we are actually very happy with Target. As we discussed earlier in the year, the integration certainly led to some disruption, which we expected. We have been through a lot of integration, 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 have delivered to them. So, the service levels in those pharmacies are quite strong. We are seeing them come out of the integrations and the system changes at a very strong pace. What we are starting to do now is turn on our patient care programs, which CVS historically had and Target did not. Given their ability to execute and how well they have done all year, we are actually feeling quite confident that they will be able to do that well into 2017. Thank you. Okay. Thanks, Ricky. Our next question is from the line of Michael Cherny from UBS. Please proceed. Good morning, guys, and thanks for all the details. I want to dive in a little bit on, the question came up about the assets that you have in place. Obviously, you spent a lot of time about focusing on the enterprise approach and driving commercial services in 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 is the most sense to bundle in outside of specialty that you are already doing relative to the acute care base that you already touch? Well, Mike, I do not think there is one answer to that question. I think that 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. I actually think that will be an advantage to us. Okay. That is all I have for now. Thank you. Okay. Thanks. Our next question is from the line of Steven Valiquette from Bank of America Merrill Lynch. Please proceed. Oh, thanks. Good morning. I guess just with TRICARE obviously as a government contract and then Prime Therapeutics as sort of a different type of entity tied to Blues plans, just curious if you see differences in appetite for restricted pharmacy networks among different customer types in the market. I guess just when thinking about government versus commercial employers versus health plan customers. Yeah, Steven, 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 insured, that may be a catalyst for the rest of the market. 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. 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 to confirm again, this is 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 how some of these stocks are reacting today. I think people are worried about irrational pricing, but would you characterize these last two changes as rational competition? Well, Steve, I would say, as we've 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, and listen, we're 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. I am assuming that as part of those arrangement, there was some network participation agreement that was confirmed through Prime. So, I think that might be a little bit of a unique animal compared to kind of other network changes in the marketplace. Steve, again, I think Dave mentioned this in response to one of the earlier questions, that in the two cases that we've talked a fair amount this morning, we became aware of the network changes after the fact, and were not given the opportunity to respond. So, in an irrational pricing environment, you would expect a different type of process associated with that. Okay, got it. Okay, thanks. Okay, we'll take two more questions, please. Our next question is from the line of Eric Bosshard from Cleveland Research Company. Please proceed. Thanks. 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? Yeah, 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've grown the company substantially. This is probably a deeper conversation than we probably have time for on the call today, but it is something that we'll talk about more at Analyst Day. I will say, though, that if you just look broadly, I don't believe the fundamentals of our growth algorithm has 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. 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'll see more of our growth coming out of government-sponsored plans over time. Again, I think we're nicely positioned with all of our assets to compete successfully and gain share in that marketplace. So, that's probably the biggest, I'll say, underlying change, is to, as we pivot, to make sure we service that need of the segment of the market. Okay. Thank you. You're welcome. Our final question is from the line of Todd Duvick from Wells Fargo. Please proceed. Good morning. Thank you for the question. 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? 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 a little short-term borrowing to just accommodate the timing of that. We will not be issuing debt to support a share repurchase program into 2017. I cannot really comment about our debt maturities. I do think, at the end of the day, we will be expected to be delevering over time as we grow our way out of our current capital structure, just a little bit over three times, so probably 2.9 times at the end of the year, down to 2.7 times in a reasonable amount of time. Okay, that is helpful. Thank you very much. Okay. Well, let me just thank everyone for your time this morning. Just wrapping up, obviously, we are 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. We are confident that our response and our actions will allow us to reaccelerate our growth going forward. 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.