CVS Health Corporation (NYSE:CVS) Morgan Stanley Global Healthcare Conference September 13, 2018 12:35 PM ET
Larry Merlo - CEO
David Denton - CFO
Ricky Goldwasser - Morgan Stanley & Co. LLC
Ricky Goldwasser - Morgan Stanley & Co. LLC
So, good morning everybody, and welcome to Day 2 of the Morgan Stanley Global Healthcare Conference. We are pleased to have here with us this morning CVS CEO, Larry Merlo and CFO, David Denton. 2018 has been a transformational year for you guys. You picked up market share and you are in the process of closing the Aetna deal which will create obviously unique platform of integrated PBM, retail and managed care asset.
So the opportunities that were embedded in the enterprise prompted us to upgrade CVS stock earlier this year really on the basis of the near term synergies and also the longer term opportunity to change the healthcare delivery and to change benefit design as we know today.
So Larry why don't I pass it to you to just help frame for us the opportunity and the discussion we'll have today.
Yes Ricky. First of all good morning, everybody. Thanks for your interest in CVS Health. Ricky touched on 2018. We're really pleased with our first half performance that reflected solid performance of the business and it really validates the strength of our model and the solid foundation that exists as we bring CVS Health and add it together as one company.
Ricky to your point, as we look at the healthcare landscape it continues to evolve but this challenge around cross-quality and access continues for many and it's a challenge every day and the need for change is clear. We envision the combination of CVS and Aetna to be a leader of that change and we intend to transform the consumer health experience through a model that is easier to use a model that's less expensive and a model that puts consumers at the center of their care.
So obviously we're excited about the potential that exists. There is an integration team that was formed earlier this year that has done a tremendous amount of work. Our goals out of the gate are really two-fold, how do we ensure a seamless transition on day one. And in the pathway for the $750 million synergy target that we talked about as part of the announcement that we expect to achieve in the second full year of operation post-close. The second goal is to begin to outline the pathway for longer-term growth and that work has recently begun and we look forward in the coming months to talk in greater detail about that.
Ricky maybe I'll just wrap up these remarks and then we can get into the questions with where we’re at around the regulatory process. We continue to have productive conversations at the Department of Justice. There is a parallel path that is taking place at the state level with the Department of Insurance and that too is going well.
We have approvals for many states and think as many of you heard us talk there are also other states that have begun the process, but they have been very clear that they won't complete the process until the DOJ renders its decision. And all of that was reflected in our second quarter comment that we expect the transaction to close by early fourth quarter.
So we’re pleased with how all that's going. And Ricky I’ll turn it over to you. We’ll jump to the questions.
Great. So if we think about the integration in your guidance in regard to the synergy the $750 million. Can you just think apart what's embedded into that synergy guidance and what you’re not potentially not incorporated into it as we can think about where we can gain more visibility post deal close?
Yes, so Ricky maybe I'll touch upon that. As we laid out the close of the transaction - a synergy target of $750 million by the second full year of operation with the businesses together. Think about those targets - those synergies coming in a few buckets. One is kind of natural overlapping corporate overhead, some component of SG&A takeout. The second piece is really more of a operationally focused in a sense that we and Aetna have a longstanding relationship but now we're kind of vendor and supplier relationship.
Now, under one umbrella there's natural hand offs that can be eliminated, so we can improve our processes and operational components in those areas. Also adopting some of our formularies more broadly across our book-of-business will unlock some additional synergies.
And then finally there is a little bit of medical cost reductions really in the avoidance of ER visits across our book-of-business but that's a relatively small component of it.
One thing that we didn't touch upon in those synergy target is really the long-term opportunities we have in - the cost curve and actually grow wide under management over time. I mean, that's the next turn of the crank as we think about synergies over the next planning horizon.
So one of the pushback's that we get from investors, Larry, you're smiling, only one pushback - is that back in the day when you combined Caremark with CVS, the integration took longer. So what is the difference this time around and when you think along these buckets that they outlined for us, were you might have fell short back then and why you have more confidence now?
Ricky, it's a great question and maybe I'll just start with our starting point as two companies coming together. I think what has gotten lost in the dialogue is the fact that CVS, Caremark, and Aetna have had a business relationship for about eight years now.
And when you look at integration activities that speak to the connectivity of systems especially as you think about the role that Caremark place for the Aetna business today, we've already built the infrastructure or I'll call it the plumbing if you will here, where we could transfer data back and forth. So, that is a huge risk element off the table and we can hit the ground running on day one with that aspect of integration being largely complete.
I think the second thing, and it picks up a little bit on what Dave was talking about. Rick, if part of your question is, "Hey, what did we learn from the Caremark acquisition?" That applies as we think about, these two companies coming together that we jumped out with some synergy goals without having a complete perspective and full visibility of all the information and the work that was going to be required, okay. And a complete understanding of selling cycles, if you will.
So, the reality of all that was that we got out in front of our skis and absolutely it took longer to achieve those synergy goals than what we had expected. Though, as Dave pointed out, we have been very deliberate and disciplined in terms of as we think about the long-term opportunities we have a lot of work to do. That work has begun, there's more work to do upon closing as we get through the regulators and get more information that quite frankly isn't available to us today, but I want to be clear that we will complete that work as quick as we possibly can and communicate that in the markets.
And I think Ricky, there's a lot of elements that kind of fall underneath that that are important learning as we go forward that absolutely apply to the two companies coming together and we feel very good about the work that has been done. To Dave's point on the $750 million in synergy, there are 22 different work streams that have dedicated resources that fall under the buckets that Dave talked about.
And again, we feel good about the work that's being done to achieve those goals and we have teams that have recently begun to work on the long-term targets.
So we had HHS Secretary Azar here as our keynote speaker. Message was the administration is very, very focused on lowering drug prices and changing the payment model and making sure that payments are not tied as a percentage to cost of drugs.
The feedback we received after Azar's session was but how is that going to get done? How do you control drug prices in the U.S. market? What do you think the administration might do or what type of a solution would you propose?
Yes Ricky, maybe I'll start and I know Dave will jump in on this. First of all, as you look at the President's blueprint, we absolutely agree with the objective of lowering drug costs and importantly lowering out of pocket costs for consumers. We see that every day. We serve 5 million customers a day in our CVS pharmacies, I think that's one of the dynamics that often gets lost because we focus on the Caremark book of business. We see it through the client lens but we also see through the consumer lens because it's an important part of our business as well.
As you go through the details of the President's blueprint, there are many elements of that blueprint that we absolutely support and we firmly believe will lower drug costs. The opportunity to speed the entry of generics and biosimilars both in terms of quantity as well as speed to market is an important enabler. We were very pleased that in the President's blueprint in many respects it broadens the availability of the tools that exist with PBMs to do even more. An example of that is increasing the flexibility for formulary management within Medicare Part D.
And then we saw recently CMS's announcement in terms of that component of pharmacy that falls under Medicare Part B moving it to D to bring some of the tools that have control drug costs in Part D from again B to D.
Ricky, I think the big debate is what happens to rebates. And it's hard to answer that question because there isn't a specific proposal from which we can react to. If we look at rebates today from our perspective what are the facts around that. First of all, let's acknowledge that rebates are form of discounting.
We disclosed on our August our second quarter earnings call the retained value of those rebates and Dave can talk more about that from a definitional perspective. But the fact that 98% of those rebates go directly back to clients and the retained value of that to the business is about 300 million for 2018.
I think the third important fact is why do rebates exist and why have we seen the growth in rebates. Well a lot of that has been the development and the expansion of formularies as a cost savings tool and that too has been proven to be effective.
So Ricky now back to your question, what is that they were trying to solve for. And I think one of the dynamics is today we know that whether you're looking at Medicare Part D or whether you're looking at the commercial space that as those rebates are pass back to plan sponsors, more times are not those discounts are being used to buy down the monthly premiums.
In our commercial book, we've got about 10 million lives where the plan sponsor has made a conscious decision to apply those rebates directly at the point-of-sale reducing the consumer's out-of-pocket costs at the pharmacy counter.
And we encourage clients to do that as often as they possibly can. I think there's a bigger opportunity there. I think the utilization of HSA in terms of providing first dollar coverage beyond preventive care especially for those that have high deductible offerings, that's another opportunity that we've talked about.
So at the end of the day we’re confident that whatever transpires here, there's going to be some form of discounting. And the value that PBMs bring to the marketplace in terms of managing formularies are not going to go away. And we can pivot to whatever those dynamics are in the interest of lowering drug costs.
So Ricky there continues to be a lot of dialogue and questions about this whole notion of rebates and the economics that lead to CVS. So let me just put that in that context. When we think about rebates, we think about all the revenue that we receive from a pharmaceutical company in the context of putting a drug on or off the formulary that includes a classic rebate, as well as admin fee. So it’s a 100% of those economics number one.
Number two as Larry said, 98% of everything we collect go back to our clients in the form of reduced our costs for them. Number three, this year the estimated rebates to our business the economics to our profitability is about $300 million or about 3% of our operating profit. So, just to put that in context, it's the size of the impact of this on our business.
As Larry indicated, the PBM model and certainly our business model creates substantial value in the way in which we go to market and use our formulary management tools and breath and size and scale truly buy down the cost of those branded drugs, and our clients benefit from that in a material fashion. In that process while maybe the mechanics of how it gets done might change but the value that we create and the value that we can create going forward I think it's going to be retained.
So Larry, I want to dig a bit further into the idea of lowering consumer cost because it seems that this is really at the heart of the issue here. In many of the programs that are in place and the ones that you mentioned that address cost to members depend on whether the plan sponsor chooses to adopt and chooses to subsidize them.
But broadly speaking, what if plan sponsors don't buy into that benefit design, right? Because you're offering them something that might potentially bring their cost up. Do you see an opportunity you will now have kind of like the Aetna asset in your portfolio, so do you see an opportunity to introduce a benefit that will leverage on your enterprise approach and sort of a differentiator in the marketplace?
Ricky, it's a great question. And maybe I'll begin by just talking about our starting point because some of this goes back to what I had alluded to a few minutes ago that the business model that exists today for CVS, we do have a unique perspective that we see millions of customers every day in CVS pharmacy and we have more than 2,000 clients that we serve.
So we've got a surround sound view of, I'll call it the supply chain if you, okay. And the consumer at the center of that and we've got a great foundation of innovation where we have brought products and services that create a win-win not just for consumer but for payer as well, maintenance choices is a great example of that.
And we continue to see growth of that product in the marketplace and it's now what, Dave, eight years old?
Okay. And but at the same time, Ricky, that surround sound knowledge - everybody is talking about transparency today. And we're sitting here asking ourselves the question, what does that mean for our clients, what does that mean for their members, how do we make transparency actionable?
And the answer to that question resulted in what we had rolled out earlier this year in terms of what we call real time benefits, that if you think about transparency it really begins at the prescription pad, at the point of prescribing in the physician's office, and by the way I shouldn't call it a prescription pad today because 80% of scripts are being prescribed electronically.
But the dynamic has existed for years now that when that physician writes that prescription, he or she has no idea of how the benefit designs for the folks sitting here in this room differ. It's impossible for them to understand that, keep track of that, and by the way we as individuals can't answer that question.
So taking your individual plan design, embedding it in the physicians EHR, so when he or she goes to write that prescription, they now have visibility to your out-of-pocket cost, that's an important dynamic change, and what we're seeing is that physicians acknowledge that as a variable of care your out-of-pocket costs are going to affect your health.
So the results that we're seeing from that is, if the product is not - if the drug is not formulary the physicians are switching 85% of their time. Even if it is in the formulary, acknowledging that we're providing visibility to up to five therapeutic alternatives and the associated cost of each, even when the drug is in the formulary they're switching between 30% and 40% of the time with an average consumer savings of up about $120. That's huge.
So, the opportunity to again bring more innovation around that, that meet the needs of consumers and plan sponsors, I think there are certainly more opportunities the two companies coming together, I think are going to broaden the horizon around that. And Ricky I can see one of the opportunities where we’ll have more risk bearing products. And our confidence in what those products can deliver will provide - I'll call it a money back guarantee if we don't.
And Ricky I think it’s important to realize that if you talk to our clients it’s not just about shifting costs the burden of costs between them and the members of the insurer. I think they are talking about what products and services and plan designs can we bring to the market that actually takes real cost out of the system.
So at the end of the day it's not so much shifting between a member and the plan sponsor is what can we design, what we can put to market that actually lowers the overall cost in the system. And I think that's really the next advancement that we have in our business model we think about the future and the combination having these two companies together.
Let me take that point a little further, when we think about the overall cost of the system the drug and medical. One of your competitors has PBM and a health plan. They have an idea of doing that but we haven’t really seen it in the marketplace. Are you looking to introduce the benefit that's really going to look at the overall cost, is this kind of like the 2020 selling season goal or this more of a longer term. So do have the capability the integration today upon deal closes to offer this differentiating solution to the market?
A - David Denton
So Ricky I’ll kick it off and turn it to Larry. Think about our business model longer term around the plan design. Think of coming to market really with two solutions one is, okay, we can create a platform for care delivery that's more efficient i.e. we can have an expanded clinic offering across multiple platforms across the U.S. in our stores. And that will be high quality low-cost, immediate care chronic disease management and I think that’s a big opportunity we have to bend the cost curve.
I think as important if not more importantly as we have 10,000 touch points today and probably nowhere else in healthcare system can a patient walk up to a counter and engage in a dialogue with a medical professional i.e. in this case of pharmacist to be able to help that patient navigate the healthcare system in a more effective way.
So the patients today are struggling on where best to get their care and we through the technology and platform we have, we can help engage those consumers and those patients directing in the most efficient care settings going forward. And again really been the cost curve in creating networks that are very productive around that. I think that’s the real opportunity we have both near-term and long-term to take cost out of system.
Yes. And Ricky just picking up on what Dave was talking about, we're confident from what we have learnt to-date okay that this integrated model has the face-to-face engagement. We’re out there with in more than 10,000 communities across the country where people live. We're trusted resource and we've been able to demonstrate for ourselves that our health plan can send out an engagement through telephonic outreach, through email, text message it's a faceless message.
Taking that same message and delivering it through the assets that we have today. We've been able to see exponentially better results in terms of changing the behavior of that consumer of healthcare. I think that's huge, I think that's an untapped resource and an untapped capability that as folks have talked about an integrated model.
What we believe that has been lacking from that is the face-to-face engagement that ultimately changes the behavior of the consumer especially when you look at the fact that today the incidence of chronic disease is more than 80% of healthcare dollars.
We've got more than half of all Americans today that are suffering from one or more chronic diseases and that number is continuing to grow and you can pick up any of the research papers out there and it will quantify the amount of avoidable or wasteful spending in terms of the management of chronic disease that is well into the billions.
So the bottom line to all this is - the percentage points will matter in terms of back to Dave's point about and Ricky your question about how do we take meaningful costs out of the system instead of just this cost shifting that has taken place now for many years. And we have the infrastructure and the confidence that we’ll be able to do that.
So thinking about that retail infrastructure, this year your growth outperformed the market, and you're leading competitor you took share, how sustainable is this type of growth going forward?
I think if we go back in history, absent one year over the last 10 years, we've essentially outperformed the market in a fairly substantial way from a unit growth perspective in pharmacy. And I think that's because of our unique model in the way in which we engage patients.
If you look this year, we are again growing our script volume in the high single digits much more rapidly than the market itself, but having said that, those are really coming about because of three mechanisms.
One is, we've adopted some really enhanced patient care initiatives that's driving utilization and adherence into the marketplace and we continue to focus on that.
Secondly, just organically out in the marketplace we are winning share from our competitors from a retail perspective really across all markets at this point in time, again, given our strong level of service across our enterprise.
And then third, we have used our assets and plugged into peers in a very robust manner. We cycled into 2018. That is allowing us to disproportionately win a greater percentage of those peer scripts into our channel. And that's also driving performance.
I do think over time those three components will still play a very important factor and a role as we think about growth going forward.
Let me pause. We have three minutes. We'll see if we have any questions.
Q - Unidentified Analyst
All right. E-commerce and the whole, we'll call it, the Amazon shadow that looms over everything; how do you respond to that? Are you just taking this asset you have, the 10,000 stores and communities and just adding an e-commerce component or is there something more fundamental and strategic you would do with it?
No. As you look at the environment today, we have an e-commerce component and one of the things in our focus on pharmacy first, that, historically our customer would be defined as your retail customer, your mail order customer. And what we've been working to do is, you're all of the above and you get to decide who you want to be when you want to be that.
You can be bricks-and-mortar and come into the store, or you can pick up your prescription through the drive through, we can mail it to your home, we can deliver it to your home or office. And we truly want to be agnostic with the consumer in charge recognizing that I'm all of the above depending on what is happening at that given point in time.
And I believe that that creates a point of differentiation for us and acknowledging that pharmacy in its end stage is a product and at the same time before it gets to that point, it's also a service that has an important clinical component.
So, yes there are things that we can do to improve the user interface and improve that experience from what exists today, and we're working hard on that. And our goal is to make sure that we don't leave any wide space for others to disrupt. So that's how we think about it.
Can I extend that question a little bit further? So, thinking about the hard physical assets that you have, and I completely buy into the better service that I'm getting going to CVS pharmacy at the counter, but the retail piece of the business and the size of those assets on a square footage basis, the capital tied up per se, can you talk about that toggle because it makes perfect sense that I'm going to go to CVS to get better service and everything you said; what about the rest of the business? To speak again to this Amazon point that we're all concerned about?
I'll take your question and put it into the front-of-store, okay. And I'll start and Dave will tag on to this but, we see the front-of-our store evolving from not just selling thousands of products but certainly they'll be a product component but they'll also be a service component. And the products will have a focus on health, beauty, personal care, and elements of convenience and the service component will be an element that's hard to replicate online. And we've got some pilots and experiments in market that we’re learning from and you’ll hear more about that in the coming months.
But I do think to the degree that we have assets today from a front of store that maybe we’re not optimized completely in the front. If we can add a service component i.e. in expanded clinic that actually can drive traffic into the store and supplement the health quadrant of the front of the store sales. So I think there's a way in which even despite the fact that we might shrink our retail footprint in our front from a store assortment perspective, we might actually make the store more productive as we complement it with service - and I think there's many markets that we have that can do that. There are certain markets like here in Manhattan that is probably going to be more difficult to do, we have to think differently and more creatively about those markets like such as that.
And by the way you should - and Ricky I know we’re out of time but just one final point on that. You should think about this evolution as a hub-and-spoke model. That we can have a core set of offerings in every store and then a subset of those stores would have enhanced services.
So Larry just in closing, a year from now we chat here at our conference, what do you think investors will better understand about your business?
Ricky I think, some of those we had alluded to today in terms of some of the work that has begun but not completed. As we sit here a year from now, we’ll certainly have more clarity around our long-term goals. We'll also have more clarity around the initiatives that will drive growth as we go forward. And we'll have the opportunity to begin to talk about the results of the concepts or the pilot programs that we have underway. And Ricky we plan to host an Investor Day in the first half of 2019 probably in the second quarter and we'll go from there.
Great. So Larry, thank you very much. Dave, thank you very much for all your help and support over the years and good luck with the next adventure. I’m sure many of us will continue to enjoy your really high professionalism, I mean, I have to tell you, you really stand out.
Thank you very much, I appreciate that. Thank you.