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Executives

Larry Merlo - President and CEO

Jon Roberts - EVP and President, CVS Caremark Pharmacy Services

Analysts

Ricky Goldwasser - Morgan Stanley

CVS Caremark Corporation (CVS) 2013 Morgan Stanley Healthcare Conference September 10, 2013 10:00 AM ET

Operator

Ricky Goldwasser - Morgan Stanley

Good morning, everybody. It's my pleasure to introduce our next management team. To my left we have the entire CVS group. We have Larry Merlo, CEO. We have Dave Denton, who is CVS CFO and we have Jon Roberts, who is President of CVS Caremark Pharmacy Services. So good morning, gentlemen. Thank you for coming. Thank you for attending. And Larry, if you can just take the opportunity and just kick the discussion off, which is couple of minutes of update as where we're today.

Larry Merlo

Sure. Thanks, Ricky. And just thank all of you for being here and good morning. I thought I’ll just provide you with a brief overview for those that are (inaudible) with our company and then I'll turn it back to Ricky for Q&A. But CVS Caremark is the largest integrated pharmacy company in the U.S. We have offerings across the entire spectrum of pharmacy care. And when you think about our company, we really brought together a suite of assets to better drive pharmacy innovation and deliver pharmacy services in ways that are unmatched in the marketplace by our standalone competitors.

We’ve also had a very successful start to 2013. We’ve had consolidated operating profit up 18%, along with adjusted EPS growth of 23.5% and we anticipate continuing success throughout the rest of 2013.

Our PBM business is performing well. The 2014 selling season is off to a pretty good start. On our second quarter call those that may have listened in back in early August, we reported a gross new wins totaling $4.4 billion and with net new wins at 1.7 billion along with strong client retention and our unique offerings in the marketplace programs such as Maintenance Choice, Pharmacy Advisor. They continue to resonate as they are enhancing access to care, lowering costs and improving health outcomes. And as a result, they are driving share gains for CVS Caremark.

Today we hold leadership positions in some of the fastest growing segments of the PBM market, including Medicare Part D, Managed Medicaid and Specialty Pharmacy. And we believe that our differentiated approach at Specialty will continue to lower cost for clients and drive future share gains in this important and growing space.

In the Medicare Part D space, we currently serve about 6.8 million members, about half of those are captive lives serve through our own SilverScript Insurance PDP. And while the current sanction does limit our ability to grow Medicare lives in 2014, we do continue to see significant opportunities and grow the business over the long term. You think about the fact that we have got 10,000 baby boomers becoming Medicare eligible every day. The drug spend is estimated to grow at 8.5% annually and we are leading player in this market and it is an important part of our long-term strategy.

In our retail business, we are growing and gaining share in both the front end as well as front end as well as pharmacy. We are driving more fruitful consumer engagement and more profitable sales through targeted promotions and we are doing that by leveraging our more than 70 million active ExtraCare cardholders. And those efforts are really helping us deliver expanded front-store margin even during this period of softer front-store sales growth.

In the pharmacy, as you’ve heard us talk about, we captured more than 24 million prescriptions back in 2012 as a result of the impasse between Express Scripts and Walgreens and the retention of those scripts has exceeded our expectation since their resolution and we continue to remain a very confident in our ability to retain at least 60% of those scripts through 2013.

In terms of new store growth we plan to add 2% to 3% square footage growth this year that is consistent with our historical estimates.

And then, finally just I mentioned on MinuteClinic another important part of our integrated strategy. MinuteClinic is both the largest and fastest growing retail clinic business in the U.S. We currently operate just under 700 clinics across 25 states in the District of Columbia. We’ll open about a 150 clinics in 2013. And if you think about 30 million Americans gaining some type of healthcare coverage over the next few years along with a shortage of primary care physicians, expanding the MinuteClinic footprint will meet that growing demand and alleviate a physician shortage problem and we expect to have about 1500 clinics by 2017.

So I think hopefully you can see that we are very well positioned for a strong growth in our core businesses. And at the same time as all of you know healthcare is going through this period of intense change as we begin the implementation of the Affordable Care Act. And we are very focused on leveraging our integrated model to drive innovation, and at the same time serve the changing needs of our clients and customers.

And then just finally, in addition to our focus on building sustainable competitive advantage, we continue to generate significant free cash flow and we are certainly committed to enhancing shareholder value through our disciplined capital allocation program. And between dividends and share repurchases we expect to return about $5 billion to our shareholders in 2013.

So with that, Ricky, I will turn it back to you.

Question-and-Answer Session

Ricky Goldwasser - Morgan Stanley

Thank you, Larry. And IBM’s recent decision to move their retirees to defined-benefit plan put a lot of light on the whole topic of private exchanges. So, can you just talk little bit about what this private exchanges really mean and how does it fit within CVS and within Caremark Services?

Larry Merlo

I will start and Jon may want to jump in as well. Let me just to Ricky’s point about the IBM announcement over the weekend, the impact of that is reflected in the sales numbers that I acknowledged a few minutes ago. When you think about the private exchanges, we will continue to participate in those exchanges with our products. If you look at the carbon model through our health plan relationships, we will be in the carbon exchange products.

And as you think about the carve-out products, for those over 65 we have our own PDP product. And again acknowledging the sanction we will begin to market to those potential members once that sanction is listed. And then as you think about the under 65 population, we certainly have carve-out products that will meet those customer needs.

I think the other thing that’s important to acknowledge is, as we go through this period of healthcare reform, we will see churn in the marketplace. We will see members migrate from one type of plan to another. We think that with our integrated assets that we are in a very good position to meet the needs of a broad cross-section of both clients and member needs.

Jon Roberts

But I think the thing to add to that is most of the large benefic consultants are operating their own private exchange and they are going to be competing for business. And so they are going to want to have products and services that meet the needs of employers that are considering moving into a private exchange. And some of those employers like carved-in models which we can grow through health plans and some of them like carved-out models which we will be to offer products there. So you see most of the large private exchanges actually offer both options.

Ricky Goldwasser - Morgan Stanley

And then Larry you kind of like you mentioned ACA and reform. And when we think about exchanges retirees kind of like one part of it, and I think one patient that we are concerned with is, what would employers over time decide to also look at their active employee base and move then either to a public or private exchange. So, can you just provide your perspective on that?

Larry Merlo

Yeah, I think that there is going to be a lot of learning that takes place in 2014. And I mean to Ricky’s point about the large employers, whatever decisions they make, they won’t be able to migrate employees onto the public exchange products until 2017. I think that again if you look at the current CBO estimates, I think the latest ones that we saw look at about $13 million in [release] in 2014, about $8 million of those will come from Medicaid expansion.

So I think that we're beginning to see some change that will take place over the next few years. I think that again recognizing the suite of products and services that we have in the marketplace, we can meet a wide range of needs for those clients.

Ricky Goldwasser - Morgan Stanley

And when you think about exchanges, obviously open enrollment is picking in a few weeks. What CVS role in the process? Obviously we talk a lot about direct to consumer, you’re in a very good position right to address that consumer. Can you talk about the strategy and who you are partnering with?

Larry Merlo

Yeah, I think that again the beauty of our model is that we can communicate from both a B2B as well as a B2C perspective. And you will see us active in the marketplace in terms of, I'll describe it as educating and informing consumers around the benefits of the exchanges and what they need to do to enroll in those product.

I think it's very similar to the role that pharmacy played back in the mid 2000s with the roll out of Medicare Part D for seniors. Pharmacists across the country played a key role again in education and providing information, with which how those seniors could go about enrolling in a Med D product, I think we'll see the same thing with the exchange product.

Ricky Goldwasser - Morgan Stanley

Okay. And let me stop here and see if there are any questions. So in the prepared remarks, you talked about three growth drivers on the PBM segment, Medicaid, Medicare and Specialty. So, can you spend some time talking about Specialty, contribution of Specialty to CVS both to the segments but also to CVS as an enterprise?

Larry Merlo

Yes, so we clearly see specialty as a growth driver for us moving forward. And if you think about this segment, the growth and spin in 2016 is going to be a third of the drug spend. And then when you add in the specialty spin on the medical side for payers, that actually approaches about half of the spend. And so the generic pipeline has masked the growth in cost of the specialty area for the last several years.

As you see, the generic pipeline begin to soften from where it was over the last couple of years. Specialty is clearly emerging as the highest priority for our clients. And so they want us to not only manage patients in delivery of clinical care and billings that PBMs have historically done, but now they want us to manage the trend that they are seeing and trends have been averaging about 20% over the last couple of years.

And so we really think about managing this area in three ways. One is we’ve made some investments around capabilities and managing the specialty spend on the medical side of the benefit, and so that is in areas such as prior authorization, making sure that the claims are paid appropriately and that we have the [edits] looking at site of care for infused patients moving on a high cost, hospital sites or outpatient clinics, either in to a home or an infusion suite. And so this technology platform enables us to manage that spend that historically has not been well managed. So, a lot of interest in our capabilities on the medical side.

We also have been able to pick out integrated model. Specialty typically has been a mail order type service. The vast majority of our employers actually take the majority of their specialty spend and funnel through our specialty channel. And so we’ve been able to integrate our retail sites into specialty, so a member can now come into any of our 7600 retail pharmacies, drop off their specialty prescription or the physician can call it in and we can leverage all the back-end platforms and the fulfillments, so we don’t have to carry this very expensive inventory across all our stores, and either mail it to the members home or mail it to the CVS Pharmacy.

And we see about half the people just like Maintenance Choice wanted picked up on the retail pharmacy and the other half wanted picked up that at home. So that program will be rolling out early in ‘14, a lot of interest from our clients in that capability because it improves access for the numbers.

And the last area, where we are seeing a lot of interest is really around more tightly managing the formulary. It’s about 1.5% to 3% of clients’ members or specialty patients is driving about half the spin in the past. They pretty much allowed open formularies, but now we see a lot of interest in narrowing the formularies, been able to negotiate rebates or discounts for manufactures that brings down the overall cost.

So we see a lot of receptivity to all these programs and capabilities. We believe our integrated model is differentiated from what other options payers have in the market. And quite frankly, it’s led to a lot of the or several of the large client wins that we’ve seen this year.

Ricky Goldwasser - Morgan Stanley

And if there are no questions, let switch gears. Out there is one question over there.

Unidentified Analyst

Just going back to the private exchanges, I am wondering if a corporation is going to send its employees or retirees to a private exchange, why would they want to keep the PBM piece as a carve-out model?

Larry Merlo

So the carve-out PBM offering will be part of the exchange offering. So if have a member as an example that is on our Maintenance Choice program, they are very likely going to want to keep that service. And so if they may very well select a separate medical benefit, a pharmacy benefit these exchanges are also going to offer dental benefits and vision benefits, what’s going to be a menu of options for members to select on these exchanges, but our PBM offering will be part of the exchange offering.

Ricky Goldwasser - Morgan Stanley

Which induce to the retail segment, front end comps area with a lot of focus, we get a lot of questions about. It seems that the comps across retailers right have been slowing down. Can you talk a little bit about your expectations for this trend? And also how important our front end comps really for you to achieve like your goals?

Larry Merlo

We for some time now have continued to see a cautious consumer and we don’t see anything in the near term that changes that, because as we reported in early August our front-store comps were slightly negative in the quarter. And that said, for quite some time now we have always noted that we can achieve healthy growth with front-store comps that are flat to up 1% or 2%. And keep in mind that our front end business now represents less than 15% of our enterprise revenues.

I think it’s also important to acknowledge that in the second quarter we saw front end margins expand nicely and that reflects our strategy to drive profitable sales. We are not going to chase, I refer to on this empty sales that don’t have a flow through to the bottom line. And for the last several years we have continued to use our ExtraCare royalty program as the market differentiator with which to do that.

And we can use the tool in a very personalized way to drive profitable sales growth, and there is always a balance there when you think about the investments that you make in the weekly circular program as well as ExtraCare. And our circular investments have actually been flat to down year-over-year as we have looked to ExtraCare as a primary tool with which we can create more personalization.

So I think we are happy with how that’s performing. And again we are not going to react irrationally in the marketplace based on with some competitors have been doing in terms of ramping up promotional activity.

Ricky Goldwasser - Morgan Stanley

So obvious take away from here is that you keep, when you think about the disciplined pricing and really focused on margins rather than the top line comp. Is that fair?

Larry Merlo

Yeah, I mean look there is the balance there. And again we are focused on profitable sales growth, where we don’t want to chase those empty sales that have no flow-through and then a year from now we are explaining why we are copying up against that.

Jon Roberts

And I would just add one component to that is as Larry indicated, as we use ExtraCare and we target those promotions to our individual consumers, we can make better and more productive use of those promotional dollars, so we can spend and growing more by kind of ratcheting it up I'll say our basket size with our best consumers. And we still have a substantial amount of market share room to grow there.

If you look at our top quartile customer and you think about the share of per wallet in the drug store categories, we have approximately 30% share. So we have a lot of the work that we're doing through ExtraCare is trying to expand that share profile and promote trial of different categories across the front of our store.

Ricky Goldwasser - Morgan Stanley

Question here.

Unidentified Analyst

Thanks. Can you talk about product design for the exchanges both private and public and the profitability profile relative to your existing business?

Jon Roberts

What are I think the profitability first, so first and foremost these are relative new so that you don't have a part of experience on this, so I would say that as you think about the exchanges for the most part, I look them as somewhat somewhere to kind of our health plan business, because typically from a PBM perspective, we're plugging into a health plan.

And so I think the margin profile will behave a little bit more like the health plan business versus the employer business which is from a margin profile perspective a little thinner compare to a employer book of business which is not atypical what we thought was going to happen in this market. We continue to believe that there is, that will continue to grow for the next several years. The pace of change is probably a little uncertain, but the fact that it is willing to change is probably not so uncertain.

Larry Merlo

I think from a design perspective, you are going to see different levels of coverage so that the members can make their choice. What we've seen is that as people go on to exchange and now they are paying for that we're actually seeing them take a less rich coverage. I think as time evolves I think you will begin to see products offer restricted networks from a medical perspective, from a pharmacy perspective, narrower formularies. I think these markets will be competitive and the providers will be looking for ways to effectively compete. So I think it will evolve over the next several years.

Jon Roberts

And I'll go back to just to be clear about this too. We do believe that over time the Affordable Care Act will -- is a tailwind for our business. Despite the fact that you have some churn, you may have some business move from high margins to lower margins profile, we just talked from a change perspective. It's hard to argue that over the next several years, something like 30 million Americans will have now coverage and coverage will drive additional utilization from a prescription drug perspective and that’s good for our business at the end of the day.

Unidentified Analyst

So follow-up, other than your managed care partner, how do you plan on assessing this exchange opportunity?

Larry Merlo

So we will be able to grow through our health plan partners and we will also have, many of the exchanges have carve-out options. And so as members go to select their healthcare and prescription coverage, we are a known entity. We're a brand that people recognize and we think will effectively compete. And we've been on the private exchanges for the last couple of years and we've seen employers move retirees in to these private exchanges and we've been very successful.

Ricky Goldwasser - Morgan Stanley

Okay. In the most recent Analyst Day, you provided some slides to talk about your capital allocation goals. And when you at target, I think there is and then [placed] assumption there that you’re going to deploy some pretty significant dollars into M&A potentially I think, because the numbers somewhere between $7 billion to $8 billion that could be allocated toward M&A. So, can you talk about your M&A strategy and really what type of assets CVS needs to enter the portfolio to complete respectively in this changing world of healthcare?

Larry Merlo

Great question. I think just to make sure, everybody is clear, back at Analyst day, we said that over the next several years of between 2010 and ‘15 we would have in excess of $30 billion that we can invest back into our business and return to shareholders in some fashion and that was a really a compliment of increase in our dividends, doing increase in substantially our share buyback program, but also invest in back in our business from an M&A perspective.

There is some portion of that just be cautious of that number as far as total spend in M&A that was a number not all that capital is allocated, completely across those buckets, so that capital is available to support both dividend and share repurchase as well. I will say from an M&A perspective, if you look at our business and you look at the assets that we have across both of our business segments, we don’t really see a whole that we have as far as an asset that we need to effectively compete in the marketplace.

I do think there are opportunities where we can acquire what we call bolt-on acquisitions that we can have clear line of sights to synergies that we can harvest from those activities and really drive enhance returns for our shareholders and we’ll continue to look across both the retail business and the PBM business to do that and quite frankly into the specialty business as well.

I think you know that a lot of the consolidation in the drug store space from a retail perspective is done, so there is not probably as much opportunity there as there might be in probably in the healthcare space.

Ricky Goldwasser - Morgan Stanley

Okay. And when you think about M&A and expansion and building scale, I have to bring out the issue of just globalization of the supply chain, a topic that I am sure you have been getting a lot of questions on and we do as well. Maybe it’s not really about globalization of supply chain because I think sourcing is already global, but it’s more about just continuing to grow scale in order to get more competitive economics from your suppliers. So, do you feel that you -- how do you add that additional scale and do you envision a world where the FDC would allow for an integrated supply chain model to exist in the U.S.?

Jon Roberts

Ricky, I think in response to your last question, I certainly can’t speak for the FDC, but I think one of the evaluators would be as a result of consolidation our cost coming down. And I think if that can be demonstrated, then certainly I think there is an argument and a discussion to be made there. We do have an awful lot of size and scale today, we will dispense over 1 billion prescriptions this year and we have been able to leverage our size and scale purchasing for the entire enterprise.

I think the Walgreen strategy is an interesting one. I think that it’s something that we are watching very closely. If it proves up to be successful, I think that there is certainly a fast follower strategy that can be replicated. And I think that there are partners out there with which we could execute that strategy without capital outlay at several (inaudible). I think it remains to be seen.

Larry Merlo

And the other thing I would add is our supply chain for pharmaceuticals in this country is very secure. And when you move outside of this country, you see cross-border training and Europe is an example that I talked to one pharmaceutical manufacturer that says in the UK a branded drug that has been cross-border traded that’s changed hands 30 times. So what is the integrity of that product in that kind of environment, so I think the FDC is going to be continued to focus on a very secure supply chain.

Ricky Goldwasser - Morgan Stanley

And we have a few more seconds to go, so why don’t just touch upon the MinuteClinic, and I think MinuteClinic is a very interesting part of your strategy, you built it for a while and I think that we are now kind of the like the cut of MinuteClinic really making it a real impact in the marketplace. So you talk about, I think growing MinuteClinic by about 150 clinics per year, what’s the limiting factor here?

Jon Roberts

I am not sure, Ricky, that there is a rate limiting factor. I think that we have as I mentioned earlier a goal of 1500 clinics by 2017. I think that there is certainly an opportunity to position MinuteClinic as a national primary care provider. And it’s interesting to see how that businesses evolve over the last few years. We accept over 200 health plans today, commercial, government.

About 80% of our business are covered by some type of third party that is a complete paradigm shift from where we were four or five years ago when that number was 20% to 25%. We have developed partnerships with now 27 leading health institutions and we're collaborating and actually [utilizing] patients back and forward. So I think we're excited about the solutions that MinuteClinic is bringing into the market in terms of both reducing cost as well as performing at a very high quality level as well.

Larry Merlo

And then as we talked to either existing clients or perspective clients, we talk about the ability to take MinuteClinic and offer either a zero copay or reduce copay for their members and this is a benefit they can offer, it's no cost to them, it's up to making give their employees and it lowers their overall healthcare cost.

And then with health plans that are moving, evolving these primary care medical homes, we're partnering with them to strategic replace MinuteClinic. So that those primary care physicians have a place to send their patients on weekends and nights and they will send them to a MinuteClinic as opposed to emergency room or urgent care center. So, a lot of interest from all of our clients across all segments with MinuteClinic.

Ricky Goldwasser - Morgan Stanley

Okay. Well, thank you very much.

Larry Merlo

Okay. Thanks, Ricky.

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