CVS Health Corporation (CVS) CEO Larry Merlo presents at Evercore ISI HealthCONx Conference Call (Transcript)

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CVS Health Corporation (NYSE:CVS) Evercore ISI HealthCONx Conference Call November 28, 2018 8:45 AM ET


Larry Merlo - President and Chief Executive Officer

Eva Boratto - Executive Vice President and Chief Financial Officer


Ross Muken - Evercore ISI


Ross Muken

So I have got with me on stage here Larry Merlo who all of you know is CEO of CVS. Larry is going to do a quick 10 minute-or-so presentation just on some of the updated views in terms of some of the exciting things that are going on given where we are relative to the Aetna merger and then Eva who many of you know recently joined in terms of CFO. She was promoted from Chief Accounting Officer. She'll join us here on the dais and participate in sort of the Q&A session. So, Larry, thank you so much and why don't we get into the presentation, so we can go through some of the questions.

Larry Merlo

Well, Ross, thank you. And it's great to be here and see everybody. As Ross mentioned, I thought I'd spend about 10 minutes just providing a high-level overview of why and how this combination of CVS Health and Aetna can transform the healthcare industry, and at the same time define a roadmap for value creation. Importantly, I think all of you saw the announcement last week. At that point we had 26 of the 28 state approvals in hand and over the past week really thrilled to be able to say that we got approval in the remaining two states.

And as we sit here this morning, we expect to close the transaction within the next few hours. So as Ross mentioned, it's a really exciting day for both companies and we're really anxious to get started. There's page number one. I know you're all speed readers page number two, okay, and as we - if I start with just looking at today's healthcare industry, obviously, there are many challenges. We look at the industry and we define it as one that's fragmented and often times care is uncoordinated. It's certainly complex in terms of --it's the confusion associated with using and navigating the system.

We describe it is a system that was designed for episodic care and a fee-for-service environment, and as a result it does not place enough of a focus on outcomes or managing the patient in a holistic way. And all of that leads to pick the adjectives that you want to use, wasteful, avoidable, preventable spending that amounts into billions of dollars. Now many of you be may be sitting here saying this is a $3.5 trillion industry, 18% of GDP, growing at an unsustainable rate. I've been hearing that for the last several years. What is it that's different today?

In a few years ago many of you will recall we coined this phrase that we're beginning to see the retailization of healthcare or consumerism in healthcare. And what is the driver behind that and from our perspective one of the big drivers is the growth of consumer directed or high deductible health plans. Those plan designs are pushing accountability and decision making to the consumer of healthcare, but yet whether it's the education, the decision making tools with which to make the appropriate decisions are lagging behind the expectations of those planned designs.

You look today in the commercial market, there are about a 150 million Americans that are covered by employer sponsored care. And the latest numbers that we've seen which are about a year old that I think it goes through the beginning of 2017 estimated that nearly a third of covered employer-sponsored lives are now in one of those types of plan designs. So we see an opportunity with these two companies coming together to transform the consumer experience, create a new front door to healthcare, if you will, and our belief that you improve the consumer experience, you're going to improve engagement. And if you improve engagement with the right products and services you will improve health outcomes. And in improving health outcomes we have the opportunity to reduce overall healthcare costs.

And it in its simplest form that's what this combination is out to do in terms of creating a new healthcare model that places the consumer at the center of their care. We see three priorities in terms of how we go about doing this. And the first priority is the need to be local. You look at consumers of healthcare today and they want to access and use the healthcare system where, when and how it's convenient for them. Whether that's in the community and you think about the role of bricks and mortar CVS Pharmacy or in their home. Okay or the fact that today there's a growing opportunity to do that from the palm of their hand with digital devices.

The second priority is to make it simple. I touched on this earlier, okay. And whether you're a patient or a caregiver for a patient, I'm sure that everybody here has a story of the complexity associated with that in terms of trying to play a role as someone is convalescing care from a recent episodic event. And we see an opportunity to create a more connected system where consumers can readily access the resources, the services, the information that they need. The third priority is to improve health. What does that mean? We believe that we can help people achieve their best health at a lower cost.

And a lot of that is the focus that we can bring to the management of chronic disease, and I'll touch more on that in just a bit. But you can see that there are five areas where we have begun to do some work in terms of where we see real opportunities to satisfy one, two or all three of those imperatives. Whether it's managing common chronic disease. Today about 60% of all Americans suffer from one or more chronic diseases, and it's estimated that chronic disease is accounting for about 80% of healthcare spending. I just mentioned people convalescing from an episodic event. You look at their studies out there; you look at the senior population.

Seniors who have been discharged from the hospital within 30 days about 20% are being readmitted. And it's estimated about 50% of those readmissions can be avoided with more coordinated care. I know many of you have heard us talk a lot about site of care management. And we would say that is a huge opportunity that when you look at where care is administered today, the cost associated with those care settings is not prioritized enough as a variable in terms of where care is directed. And that's why we have the indiscriminate utilization of the emergency room or what we've learned from our quorum infusion property that we have the opportunity to provide that care in the home at a reduced costs.

So you think back to those imperatives once again a being local in it and at the same time the opportunity to provide lower cost care in that setting versus the cost that would be associated in an outpatient center of the hospital as an example. If you turn around and ask the question why CVS? Why can CVS Health do this? Okay with the combination of CVS and Aetna. Well, first of all, I want to emphasize again that our strategy puts the consumer at the center of their care and the consumer at the center of our strategy. But the consumer is surrounded by a variety of community based assets. The role of digital capabilities which are resonant in both companies and some exciting work going on today in both companies. The role of data analytics and technology and the opportunity that we will have to extend and broaden partnerships that can exist within the market.

The other point that I want to emphasize here is you have to believe that the healthcare industry can and must be transformed from within itself. And I would respectfully argue that's one of the things that are getting lost in this combination of CVS health and Aetna coming together. Okay and by the way it's fair to turn around and say, well, many of the things Larry that you started with folks have been talking about that for several years and nothing has happened. Okay, so why today? Well, I want to bring us back to the point that I made that we are seeing consumerism in healthcare.

And by the way we have begun to talk about when to you use the term patient. When do you use the term consumer? And, listen, if we're in the doc's office or heaven forbid if we're in the hospital, there's no question that we are a patient of care in the hands of a very trusted professional. But think about all the activities leading up to that or the activities that would follow a medical event, we are a consumer of healthcare and the choice making decisions more and more of that as being placed in our hands. And I would sit here and say that dynamic is what's different today than what existed five, six, seven years ago.

This just takes this slide one step further and when you start to look at the capabilities and the resources of the combined company what it entails. The fact that will interact with over a third of Americans all across the country will be in more than 10,000 communities across the country. Will have 45,000 healthcare professionals that are resident within a few miles of where 75% of the US population lives. And by the way, we can go on and on with that list. When you talk about the dollars and I'm sure many of you have seen some of these numbers. This is looking at healthcare broadly. I mentioned the estimated spending on chronic disease at over $2 trillion. And you can pick up a variety of studies out there, and it estimates anywhere from 20% to 25% of that spend can be considered preventable or avoidable or wasteful.

Again, pick the adjectives that you want to use. The point that I'd like you to take away from this slide is that we don't have to be a 100% to make a meaningful difference in the cost of care. And you can see if we're 5% to 20% successful it's $25 billion to $100 billion. And by the way, if we took at the numbers and put it on this inverted pyramid, the opportunity would still start with the B is in billion. And the last slide that I'll just wrap up on and then Ross turn it over to you, okay, is when you ask the question what are the areas for value creation. We see five areas where we can create value.

I've talked about medical cost savings. And I'm sure that you can appreciate the ability to drive down cost and improve health would allow us to bring a differentiated product into the market that we believe will grow membership. You think about all those community assets that exist, okay, and the opportunity to expand customer value by having increased utilization of those CVS community assets creates value. We know that you increase customer satisfaction you're going to improve retention. In this last one and again you've heard us talk a lot about this over the last year, our goal is to create an open platform model that will allow for partnerships broadly in the marketplace with other health plan clients.

And there will be a value tag to owner economics that there will be things that will work because of the sole ownership of the combined entity. And by the way, we saw, we proved that out with CVS and Caremark. You look at maintenance choice as a product today, it's been in the market since 2009, it continues to grow, and it's over 25 million lives. And, yes, that product from a competitive point of view has grown or has resulted in growth in 90 day plan designs. But there is not an exact replica of Maintenance Choice in the market. And the reason behind that is the value of owner economics.

At the same time, there are products and services that we've been able to create that we are using in the marketplace today, the partner broadly with other PBM relationships as it relates to CVS Pharmacy. So we have those learnings from CVS Caremark and we believe that we'll be able to bring the same thought process and the same reality around products and services that truly differentiate this combined model and products and services that we'll be able to use and partner broadly in the marketplace.

So, Ross, with that I'm going to ask you to join us up here and I'll turn it over to you for questions.

Question-and-Answer Session


[Operator Instructions]

Ross Muken

So I'm going to kind of kick off where you left on. When you were part of the Caremark CVS merger, you sort of essentially redefined how drug benefit functioned in the US and you provided kind of unique capabilities through your CVS assets in terms of the retail function of pharmacy. And you changed pharmacy and how it worked for individuals. Now you have a much grander scope, right. You're going to influence the entire kind of medical cost continuum and the ability to sort of transform delivery in the US and kind of the consumer experience.

I guess as you think about sort of the parallels of the two, this is obviously a much grander scale. How should we think about the phasing? You gave five or so kind of initiatives or pieces that are going to be really important to the strategy of the business. How should we think about the sort of timeframes by which we can judge how well this is going? Because I think initially as I think back and there's some skepticism on maintenance choice and other pieces and we know there was sort of this remarkable period after you took over CEO of performance in that business.

And, obviously, we know maintenance choice was a huge success. So my guess is five or ten years from now we'll look back and look at the number of these initiatives and a few of them will jump out and have been also sort of substantial successes, but some things take time or some things you can do sooner. Help us phase it out just in terms of what we should expect from you maybe on kind of a 12 -months, 36- months and longer-term basis?

Eva Boratto

I'll start and I'm sure Larry will jump in. As you've heard us talk about this transaction, you think about the near-term, right. We've committed to more than $750 million in synergies in the second full year of the transaction. And I would say in the near term they are the opportunities that we are focused on. But while we're delivering on those synergies, we will also be doing is developing a path towards generating those medical cost savings to drive the growth, the reinvestment in the business and fuel the company longer-term.

So if you think about the past there we will focus on integrating the company in the near term, developing pilot programs, the data and analytics that we need to generate some of the outcomes to deliver the medical cost savings. We will be piloting those programs in the near term, but as you think about the opportunity for the medical cost savings I would think about that in the longer term as we've seen with other programs that we've rolled out, having proof points through the pilots that we develop enables us to engage clients more directly, more positively to enable them to adopt those programs.

Ross Muken

Okay. I was just saying so that makes total sense to us and clearly as you outlined small chain MLR can have massive implications both for consumers as well as your bottom line. I guess you would it sort of seems to me that that over membership growth would probably be the bigger needle mover or you think essentially by driving one it's sort of almost like maintenance choice on what you did on the pharmacy benefit costs and trend side if you're able to drive one it will sort of drive the other. And, if so, what parts of the Aetna business do you think you can kind of influence faster?

Larry Merlo

Yes. Ross, you're right with where you're going with the question. And I do think that there is a multiplying effect, okay, to what we'll see in the marketplace and listen, the thing that if you go back to that slide that I had that put -- had the consumer in the center and then had the different assets around the consumer. The opportunity that we have is to connect those assets in a differentiated way. And if you look at what resides within Aetna today, they've got a tremendous amount of information about the members that they serve. And as Aetna describes it, they're pretty good at identifying what is the next best action for that member that we're serving.

But whether it's Aetna or another insurer, okay, when you think about how do they activate that? they typically they would activate it through a phone call or if they have a cell phone number trying to reach the member that way okay or through a letter and those things have been proven to be marginally effective at best. So one of the things that we're going to be working on tomorrow, okay, is how do we define those patient journeys. Again, connecting the dots on that slide so that in engaging with that member around the next best action, we can actually create an outcome, the customer doing --the patient doing something different that they wouldn't be doing today.

Whether it's an activity or perhaps even a behavior change. And I think that's a good example of how this-- how this comes to life and what potentially can differentiate us from other strategies or other models that are out there. And, Ross, I think that's --that becomes a huge unlock that all of a sudden we're able to do that, you think about the opportunity to lower medical costs and does that provide an opportunity to you look at a fully insured client, does that provide an opportunity to see it show up on the margin line or perhaps underwrite a lower-cost product that drives membership growth. And that's a little bit of a dynamic that we saw with maintenance choice.

And to Eva's point, it'll be a multi-year effort, okay, where I think that's the good news to this. I mean I talked about maintenance choice, maintenance choice nine years later continues to grow.

Unidentified Analyst

I have to follow up on that. What's going to get patients engaged and or get them in the door to use some of these new services that you are using. Is it the convenience or the experience or to what degree is it actually integrated into the benefit design giving them lower copay or even some other like incentive in the store. What that --what's that mix of incentives?

Larry Merlo

Yes. Mike, it's a great question. And I think those are things that we're going to pilot and learn, okay, and in the coming weeks and months in terms of what is it that the consumer finds the most interest in. Okay and listen, we have some level of understanding based on our experience today in terms of being able to utilize MinuteClinic as in avoidance to the emergency room for low acuity issues. It's interesting. Today 50% of the visits that we see at MinuteClinic are in nights and weekends. So I think we've got a number of hypotheses that is it plan design. Some of it ties back to we know we're local. We know that that is important in terms of meeting consumers where they are.

So I'm confident that we will find that right balance in terms of what is it that the consumer finds value in, okay, that they'll want to capitalize on the opportunity in front of them.

Ross Muken

So, Mike, sort of hit on what we've been thinking a lot about which is sort of through concept of that the store the future and it seems like you have a lot of services or other functions you can bring to bear within that community level. I'm not sure we necessarily need all of them in one box. You can probably do it in different places of a community basis, but if you're thinking about all the chronic diseases you can touch right.

There's a lot you can do within that store that probably influence cost, and so should we think about essentially over time one that service piece taking up a greater percentage of square footage in some percentage of boxes and that's probably a relatively low capital cost but pretty good return? And then two, as we just think about some of the fears people have on the front end, does that help address maybe the generation of cash flow for the box because all of a sudden now you're introducing a new service that isn't under threat, it's actually lower priced and more competitive. And so the cash flow you'll generate from that per square foot will be probably there for the foreseeable future as you've got a huge structural advantage versus potentially the industry.

Larry Merlo

Yes, Ross. Maybe I'll take the first part of that question and ask Eva to comment on the financials associated with that. For the last couple years, we've been talking about what we would refer to as our front of stores evolving from not just a bunch of products, but a combination of products and services. And as you look at the product side, we will absolutely have a focus on health, beauty, personal care and elements of convenience. But we do see the opportunity to repurpose some areas of the store and to bring in more services.

Early next year, we expect to have a handful of, I'll call them concept stores where you will see at least our early thinking in terms of services that would be offered that would include an expanded role for MinuteClinic. Other services that would help engage the consumer in terms of how they can best use their benefit design almost a concierge, if you will. And let's say you've heard Mark Bertolini talked a lot about the social determinants of health. And we believe that having this community presence, we can be this integrator of activities. We know that there are elements that absolutely affect you could define it in an indirect way.

The quality of care whether it's transportation, access to food. We can play that role in the community in terms of creating partnerships with others that we can be that one-stop-shop, if you will. So, Ross, I would say our thinking is 15% to 20% of the front store gets repurposed with services in mind but again we're going to learn from that. Our goal is to not turn every store into that that we're thinking about this hub-and-spoke concept where every store may have a core set of offerings, but the hub's if you will would have the complete suite of services available.

Eva Boratto

And I think, Ross, going back to how we think about capital and I think your points were right on. If you think about we're going to use the 15% to 20% of these stores more productively, driving some of the outcomes we said here. And from a capital deployment perspective, I would think about it as we do normal store refreshes each year, right, that we are going to shift some of those legacy dollars to develop these new formats they'll see a real substantial step up there.

Ross Muken

Make sense. Maybe as we think about some parts of the core business and through the evolution of some of the legacy CVS assets on the pharmacy benefits side, I would say the focus the last 24 months a lot of it had been around rebates and things of that sort that seems to be dying down modestly. Although, we saw I guess some things from CMS this week although not particularly owners. I guess as you think about the evolution of that benefit in sort of the next phase of CVS, it feels like now as we go to more of this integrated model, we're going to stop talking about sort of the pharmacy benefit sort of separate from other elements. It'll become apart or essentially a lot of your healthcare offering will become a lot more sort of put together as one.

I guess how are you sort of thinking about what that looks like the conversations you've had with your largest customers or key customers around sort of where that's moving? And how that sort of reshaping happens in the form of kind of the new entity?

Eva Boratto

Let me start, Larry, and you can jump in there. There is multi-prong question there. Ross, so I'm trying, in terms of how our largest health plan clients are thinking about this. I think they're curious, obviously, some of the discussions we've had around reducing medical cost and our open source platform. I would say there's a curiosity. There's a level of interest, but there's a cautious wait and see, if you will. I think that played itself out in this year selling season which across the PDM sector was, I would say smaller than it's been the past years. And with a lot of clients are speaking to with all of the M&A with all the disruption there was a bit more of a wait-and-see approach.

And so we'll --I think at the end for our clients as we go embark upon this journey continuing to provide high service levels to them, being competitive in the marketplace will continue to be top priorities. And then things will evolve as new products and services are rolled out.

Larry Merlo

Yes. And, Ross, just picking up on where Eva left off here. I do think that you'll see new offerings come to market, and I think one of the --everyone here has heard us talk about this for the last several years now that the addition of Aetna does not change the thinking that we will manage the company at the enterprise level. And we've done things historically where we'll sub-optimize one of the business units because there is a net benefit to the enterprise. Our specialty connect product is a good example of that. It sub-optimizes our retail business, but it has allowed us to grow share in the specialty space.

We will have that same opportunity with this new company. And in that -- and, Ross, that's how we'll think about products and services that we bring to the market. It will be through that enterprise lens.

Unidentified Analyst

Make sense. And the same go to for -- we mentioned partnerships earlier with other payers. Do you see those relationships just being on a fee-for-service basis where their patients are utilizing services in the store or where you be offering like as a packet, a broader package of perhaps pharmacy benefits plus some broader like care management services as a package.

Larry Merlo

Yes, Mike, I think that is an open question for us to answer as we get our proof points up in the market, but we would be open, certainly open to that. Our belief has always been that, listen, our partnership and joint venture; it allows you to get part of the way there, okay. The value of owner economics allows you to go one step beyond that. So I think that there are probably different ways in which we can create some things in the marketplace. And that's to be determined.

Ross Muken

Maybe before we turn to the retail side, I'm just concluding on PBM or just in drug pricing in general. I mean would you sort of agree I felt like the rhetoric initially was sort of aggressive coming out of some members of government relative to businesses that you operate. It feels like over time that's lessened and it's become a more balanced discussion, although obviously there are still some things out there that are sort of disruptive or potentially disruptive in nature. Although, they seem to be somewhat put to the backburner. Do you feel like you've had reasonable success kind of helping educate those in DC on sort of the role you play and the value proposition? And how you play into sort of managing drug cost as opposed to driving inflation et cetera?

Larry Merlo

No, Ross, listen, it's critically important question in terms of separating fact from fiction. And I do believe that we have had success in doing that. I do believe the tone and the rhetoric have changed. You look at the announcements from HHS this week that we would say on balance that whether you look at the recent announcements, the President's blueprint, there is more in there that broadens the role of PBMs and expands on the tools that are available today. Whether we're talking about the protected classes, whether we're talking about the management of Part B or eliminating some of the, I'll say practices that have limited competition like abusing rents programs, limited competition from getting to market.

Ross, I think on the rebate question, I think it was important for us to separate fact from fiction in terms of the value of retained rebates which we did back in August. And I think it was also important to with data refute the belief that the value of rebates is tied to high drug prices because you saw a white paper back in the summer that showed the inverse relationship that therapeutic categories like anticonvulsants or rheumatoid arthritis. Those categories because a limited competition has the lowest value of rebates, but yet are experiencing the highest price increases.

So as we sit here today, we look at rebates as the form of discounting and it's been driven by competition within therapeutic classes. If rebates were to take some other form, I don't believe that we will see the value of discounting going away, discounting being tied to size scale and the ability to manage formularies.

Eva Boratto

And, Ross, you've heard us speak perhaps a little bit on our earnings call around introducing a new pricing model in the PDM segments. And for many years and decades, right, the PBM pricing model has been focused on discounts off of AWP, discounts off of --off of lack and that perhaps doesn't drive the optimal outcome as you're not focused on the lowest net cost. So as we continue to evolve to Mike's point take on more risk in order to be focused around really looking at pricing models that can drive the lowest net cost. And not focused on the Delta between an AWP and net prices.

Unidentified Analyst

I think I would appreciate if you could comment on since your largest competitor is also exploring on a much smaller scale some partnerships with health plans. What's the advantage that you have with ownership from Aetna and just in terms of like --of like lead time of making a more definitive volume and bet?

Larry Merlo

Yes, Mike, if all of those things are true, I do think that it's another exclamation point on some of the things that we started the discussion with around consumerism in healthcare. And the evolving role of retail pharmacies that it's not just the store anymore. It has the opportunity to become a healthcare destination. Mike your question on, as you look, I'll go back to the concept of owner economics. There'll be investments that we'll want to make in the business. I think owner economics allows you to do that in a broader way than what you would be able to do in the form of a partnership or a joint venture. That has always been our belief and we've seen that proved out.

Ross Muken

How are you feeling right now about sort of the state of retail pharmacy, right? I mean, obviously, 2017 was sort of challenging year, 2018 has been I think much better. I don't think you're declaring victory yet but certainly your --the shared dynamics and the like are much improved. So it feels like we've kind of, we had sort of this brief downturn and now we've got at least more stability and there's a lot more things now you can bring to bear vis-à-vis as we discussed in the new combined entity, but how are you feeling about sort of the core there?

Eva Boratto

I think from an overall pharmacy perspective regarding the core, you've seen our script performance this year right. Nearly 10% in terms of overall script growth and we continue to expect to outpace the market as we look ahead to 2019. On the pharmacy side, we're making investments in our capabilities around clinical program servicing the customer that consumer experience around convenience, home delivery and same-day delivery. Those types of things that we think are critically important as we move forward in providing the pharmacy experience.

Larry Merlo

Ross, I would say to Eva's point, I do see and I don't think this happens overnight, but it can happen over the near term where today I would say by and large all pharmacies are looked at as being equal, and pharmacies are defined by convenience. They're not defined by performance in terms of what is driving outcomes. I think there's a theme to much of what, many of the things that we were talking about today that you will see those that are making investments whether it's improving medication adherence for the customers that they serve or other roles that pharmacists can play in terms of helping, once again helping consumers to achieve the better health outcome.

And I think that you'll now see pharmacy is defined by those performance measures which are different than what exists today. And I believe that certainly, we-- I believe Walgreens, I believe Walmart perhaps Kroger, well, those are competitors that have historically made investments in pharmacies. I don't know that you'll see everybody look at it in that way. And whether it's some of the regional food operators that will begin to look at pharmacy differently. So I think you'll see a bifurcation of pharmacy is --it's from how it's defined today.

Ross Muken

Make sense. And maybe just in terms of capital allocations, obviously, the near term a lot of focus is going to be on debt pay down right given the leverage levels post transaction, but the cash flow generation capability of this business is massive, right. And that'll be probably a hallmark defining piece of this equity post the deleveraging and you've talked about some targets by 2020. I guess conceptually as you just think about historically, CVS, very return focused. You were taking up your payout ratio; you had very strong share of purchases and kind of a commitment there.

Is there any reason to think that post the deleveraging that shouldn't remains sort of the focus here and again today, just given sort of what the combined entity free cash flow could maybe look like that seems like a fairly substantial amount of return.

Eva Boratto

Yes, Ross. I think post the deleveraging right our priorities in the near term will be, a; to service the business and invest in the normal capital that those companies have done, integrate the companies and pay down the debt. And as we get --as you know we've put out our targets of 3.5x in two years and then an ultimate target of getting to low 3x and once we achieve that goal re-looking at whether return to shareholders through share repurchases, dividend or what-have-you certainly we will. We will reevaluate that at that time.


Well, great. So I think in the interest of time we have to end there. I want to just point out we have Mike here who runs the Investor Relations effort. If you need any follow up Mike is fantastic and we'll be happy to follow up with you. Otherwise thanks everyone for joining us. Eva and Larry, very exciting day. We're happy to be a part of it and congratulation.

Larry Merlo

Thanks, Ross.

Eva Boratto

Thank you.