Barclays Global Healthcare Conference 2017

Mar 15, 2017

Summary

Client drug cost trend was a little over 3% YoY, while integrated pharmacist and specialty services supported health plan growth. Long-term top-line growth aspiration was about 11%, with the generic pipeline expected to exert less drag over the next five years.

All right. We'll go ahead and get started this morning. Thank you all for joining us. I'm Eric Percher. I cover the healthcare distribution and technology group, including the pharma supply chain, and it's a pleasure to have Dave Denton, CFO of CVS Health, here with us this morning. Going to go right into the audience response system questions, so please bring those up, and we'll fly through these since you've seen them for two days. I love comparing this year over year. We'll start with number one. Will changes to ACA and certainly other healthcare regulation put forth have a negative impact on the company in 2018? So, a 2018 question here. One positive, five significant negative. Well, straight down the middle. Nothing expected here for CVS. Let's go on. Question two, more interesting perhaps. What will utilization trends look like in 2017 for the company? We've spent quite a bit of time over the last couple of months talking about some of the challenges from specific customers, and expectation here is divided. I would say it's a bit of a bell curve. Let's go on to question three and see what we glean from this. This is the one I always like to focus, Dave, on. How would you like to see the company deploy capital in 2017? Please go ahead and run this from M&A through repurchase dividend. We know that CVS has always had a balanced point of view, though that dividend payout has increased. Interesting here. Invest in core growth at 43%, repurchase at 36%, M&A now at 14%, definitely lower than prior years. Go on to question four. Do you believe the company will grow earnings in 2018 faster than 2017? This one is fairly obvious here given the disclosures, but one that we do ask every year. 2018 versus 2017, it looks like we do have a bias toward the positive. Question five, the easiest one. Currently owners of the shares opportunity in the room here. 53%. We tend to average around 35%. The final bias on the name, positive, neutral, negative. We're fairly evenly split here, even with the ownership stake, which is an interesting dichotomy. It sounds like we have some work to do in discussing where we sit today and why that should move from negative to positive. We'll certainly tackle that. But Dave, thank you for joining us today. Thanks for having us. Right. I think where I would like to start is that there has always been a natural tension between the PBM business and retail because you are an aggregator of scale. CVS found a way to flip that on its head a bit several years back. The other natural area of tension has been with manufacturers, and I think there was always a bit of a detente in that there are quite a few services and access that you provide. Over the last, say, six to 12 months, there has been a change in rhetoric, and some of that has come from a desire for manufacturers to focus the attention away from themselves. I think for some period of time, there was a focus on the net price, which is something a PBM does drive, and on blaming the payer. Right. Last year, we started to see a change where it became, well, let us blame the supply chain as well. I think, in a CFO role, you are always trying to balance natural conflicts. Do you think something has changed with respect to that debate? Has there been an escalation, and what is the PBM's role in that debate? Well, there has certainly been an escalation. I think there is no doubt about that. I think what you have seen over really the past five years, the market has changed pretty significantly. Over the past five years, about $100 billion of branded drugs lost patent protection. If you think about that as now competition into the branded drug space, branded competitors are now looking for growth, and what they have done in many aspects is use the pricing tool to drive growth for their organizations. At the same time, PBMs, I think led by Caremark, created very aggressive formularies in a way to control and abate those price increases. With that increase in leverage, I think the tension between PBMs and pharma has increased. Couple that with what has happened with consumers in the sense that high deductible health plans have become pretty prevalent. Now consumers are seeing the true price of these high-cost branded drugs, and I think the confluence of all those factors has really increased the tension, increased the awareness from a political standpoint. If you go talk to our clients, I do not think you see this coming up in our clients as much as you see it in, I guess, the common vernacular from a PR perspective, both in D.C. and in the investment community as you hear about what has happened in the marketplace. I think what is important is if you really take a step back and look at how PBMs operate in the business model, we really work to control cost. If you look at our cost and our clients, they are experiencing a trend of just a little over 3% year over year, despite the fact of pretty healthy increases in branded price. At the same time, if you took a look at our client base and just ranked them from high trend to low trend, probably over a third of our clients were actually experiencing negative trend. Those clients really adopt a suite of services from us, and I think there's ways in which we can continue to innovate in that space to drive costs down for our clients. Is there a more direct response to that or answers that CVS can bring to their clients in addressing this? We've talked more of late about point of sale rebates, which would seem, particularly in an integrated model, a good starting point. What else? Where should you be in this discussion? Yeah, it's a great question, and actually, we have several solutions to abate this problem. One is we have a list of products that we offer from a plan design perspective that clients can adopt that have zero co-pays or that there's no out-of-pocket for the client. The essential drug list is what we call it. We've adopted that from a plan design perspective, which allows consumers the option to get highly utilized, effective generic drugs at no out-of-pocket cost and very nominal cost to the plan sponsor. Secondly, we have created over the last several years point-of-sale rebate capabilities. So now the payer can take that rebate and apply it back directly to the consumer when they see it at the counter. I would say that our clients haven't really adopted that too dramatically at this point in time. I think sometimes clients have different philosophies. They're like, "I don't want to advantage a consumer who happens to maybe be on a drug that has a high rebate versus a low rebate. I'd rather take the rebate back to me as an organization. Then I can use that rebate pool to buy down the cost for everybody in my plan." I think plan sponsors are wrestling with what is the best mechanism to apply those point-of-sale rebates. Very interesting. As we look at some of the areas where you've seen new growth, new expansion, I think that the success with managed care plans has really stood out. It's been interesting to watch the Part D business develop over time, but your strength really goes beyond your own Part D experience. You've been able to take some of the benefits of an integrated model and use that to extend your business much more broadly with health plans. Can you talk to us a bit about what's enabled that and some of the financial impact that you've seen in the early years of big share gain? Sure. I think probably the key to this, if you look at a health plan, typically a health plan looks at themselves as kind of a B2B enterprise. They very much want to get engaged with consumers. As they adopt Caremark as their PBM, this is a mechanism for them to really engage with consumers in a face-to-face mechanism through our pharmacist as that comes to life. I think that's critical and probably the key point of why we've been so successful. Now, if you peel back the onion a step further from that, then you look at all the products and services that we bring to bear, but those come to life via that overall, I'll say, strategic advantage as we melded the PBM and the retail and the clinic assets together. I think adherence continues to be really important in this space, particularly in Medicare Part D, because if you can demonstrate superior adherence, you can drive Star Ratings that drives financial incentives for a health plan. We've been able to very successfully demonstrate our ability to do that, again, largely through our clinical programs enabled through face-to-face interactions with our pharmacist. I think the other thing that's really important for health plans is operational excellence, particularly as it relates to Medicare Part D. You've seen health plans who have struggled in Part D that get into sanction. You can see the financial ramification of those is severe. I think our platform at the moment is extremely stable. We've done a lot to enhance it and really, I'll say, bulked up our operational excellence around Medicare Part D specifically for that purpose. Interesting. As we look at this integrated model, it does feel like you've executed on what you first put out there with Maintenance Choice. There was always an advantage, or I perceived an advantage in the fact that you had the ability to serve the 90-day at the CVS Pharmacy. You had data in a way that others would not. Over the last several months, you've embarked in a new partnership and a new focus on partnership, and one of the concerns has been, well, will you give away some of what has made you unique? I think we're all kind of trying to understand the benefits of what you have put out to the industry and said you can do for others. Help us understand how you look at both the benefits and maybe potential risks there. Yeah. Again, I'll go back a little bit. Our model hasn't changed. We are the only integrated pharmacy model which brings to life a plan design and a consumer touchpoint, so blending those two together. If you do that in an appropriate fashion, you get better results. I think the essence of our model still demonstrates that. Having said that, Maintenance Choice was a great product introduced, I think, in 2008, 2009, has grown significantly over the last several years. It's a product that still is very productive in the marketplace, but it's a product that is now mature. The good news is that's not our only product. I would say at the moment, we have much more conversations really around Specialty Connect than we do around Maintenance Choice, because at this point in time, now Specialty Connect is the engine that allows payers to really manage their specialty patients in a very robust fashion, getting them on the appropriate therapy, making them adherent to that therapy, setting up all the clinical interventions in a very effective manner, and really performing from both a cost and utilization standpoint in a superior fashion. We have a series of many products, Maintenance Choice is just one of. If you think about even going a little further, think about the wraparound of MinuteClinic into either health plans or payers, employers to be able to drive high-quality, low-cost care for them. We have a lot of tools in our tool chest, and we still see a pathway for continued growth and success at being differentiated in the marketplace from that standpoint. Okay. Maybe turning to some financial elements. I think if I go back to the investor day, there was a change to the long-term outlook, or I guess going back even to a couple months before that. What was notable in December was there was a pretty high expectation for top-line growth, and I think there was some concern that without that top-line growth, it would be harder to get to the levels of profit you had put forth. Yeah. In the last call, what I heard from you was that we haven't necessarily seen the inflation, and that was a long-term number. Now we're talking short-term. Yeah. Yet you were able to hold the guidance for the year. Yeah. I think maybe that is a question in itself. The broader question is probably how we should think about your posture relative to a highly inflationary or modestly less inflationary environment. Yeah. Maybe I'll take the long term and come back to the short term. If you think about our long-term growth aspiration of about 11% top line, and compare that's a little higher than what it's been in the past. I quite honestly was a little shocked when people started questioning that a little bit. If you think about the last five years, again, you had about $100 billion of branded drugs lose patent protection. That was a huge deflationary event for the industry and for us specifically as we thought about the revenue. Despite the fact that moving from a branded drug to a generic enhanced the bottom line, it dampened the top line. Looking forward, the generic pipeline's not as robust as it once was, so you're going to see that damping effect be minimized. I think the top line just mathematically is going to accelerate over the next five years versus the past five years, number one. Number two, back to we've always talked about the fact that modest changes in branded deflation have a pretty immaterial effect on us from a financial perspective. There's areas in which it kind of helps us a little bit, and there's areas in which it harms us financially, but the net effect kind of washes through our business. You saw us when we, in our last quarter, announced that the inflation was a little less than what we had originally planned, so we took the top line down, but didn't change our bottom line guidance because the impact of that was relatively immaterial. I just go back to, we've always talked about drugs kind of in just a general sense being in three categories: branded drugs, generic drugs during the exclusivity period, and break-open generics. But branded drugs, we've always said, was high cost but very low margin, so the effect of that from a financial perspective is pretty modest. We really make our money once that generic breaks open, and so the cost comes down, and we actually procure better, and margins are enhanced. I think what you're seeing in our last quarter is the effect of that. Mm-hmm. As we kind of think about the implications for each of these movements, what we've tried to do over the last couple of weeks is really focus investors on the different pools of profit that are created at a PBM, in part because I think you start to realize that the rebate share or the contribution is not quite what it's made out to be. We've tried to think about this in terms of rebates and fees on one side. Yeah. Then the businesses that we see, like specialty pharmacy and mail, and of course, with the integrated model, there's a retail pharmacy on here as well. But really focusing on that PBM business, from your seat as CFO, how do you look at each individual customer? Are you trying to optimize, I assume, customer by customer, and do you look at the performance in those types of pools over time, or is there a completely different approach from your seat? No, that's what we do exactly. We have a very sophisticated underwriting process where we look at each specific client individually. We model that out over years, and then we track the performance of that client. Clients have different levels of profitability based on the different levels of services that they adopt, regardless of price points that are offered to them, because many of our health plans, as an example, don't adopt mandatory mail, or they would rather have an open network. They're a little less profitable only because they don't adopt a mandatory mail program that drives a lot of share into one of our channels. We do watch that carefully and monitor it, and we watch the progression over time. I will also say that we have clients that we administer the rebates for them, and they're quite profitable for us. There are clients that we don't administer rebates for them, and they're quite profitable for us. We underwrite each one based on the services that we provide, and with a specific look to what is the financial implication for us, but importantly, how do we drive savings and outcomes for our clients? If we didn't do a good job of that, they wouldn't hire us, and they'd move to someone else. You were very clear at the investor day on your view of retention of rebates and the limited retention there and sub 10%. When we look at rebates, if you're focused on all the elements, should investors be focused on fees alongside? Do you see the programs that you create? One of your peers is very clear that they're creating programs which drive a fee, which is incremental. I tend to think that your approach has been a little bit more holistic, but there are elements like brand inflation caps, which have become new generators of fees over the last couple of years. What is the right way to look at the CVS PBM? Yeah, I think what we've tried to do around that one specifically, and I'll come back more generically, but around that is what we've tried to do, and this has probably started three or so years ago, as we began to see branded price inflation, we went back into all of our contracts or many of our contracts and put in price protection so that our clients didn't bear the brunt of an increase in branded drug price. So that if the branded manufacturer increased the price disproportionately to what we thought, that it would drive an incremental savings for the client that would get passed back 100% to the client and buy down the cost, and they'd be protected against those actions, and we've been very aggressive at that. I do think what we try to do is we don't really focus on each individual line. We look at the sum of the lines to understand how profitable a client is. We've tried to do is not be as concerned, is it coming in a fee line, or is it coming from margin from mail, is it coming from margin or retail, whatever. We're trying to figure out, okay, do we have a value proposition that works well for the client and drives outcomes for them and is actually financially productive for us? We underwrite to that. As you know, we're not always 100% successful. Our retention rates to clients today over the last few years has been in the 97% zip code. We lose clients because in some cases, we don't underwrite them perfectly. It's not a perfect science. We try to do the best that we can, and we try to come up with, again, a value proposition that's good for the client and good for us. How different is that process when you're looking at a health plan where year one, you're likely to see very little adoption? We've now seen two years, big boluses of health plans moving your way. I think we understand why and the services you've offered that bring them in. How does that impact your underwriting process, and how large is the variance of outcomes in year two or three that we're looking for? Yeah, the variance could be significant, and the reason why the variance is significant is because the health plans are different. There are health plans that they're largely Medicare dominant, have a large Medicare book. They don't have the regulatory structure to put in limited networks that allow us to move share into one of our channels. They don't have that kind of flexibility. We win lives in dispensing share a member at a time. We continue to push on that. We use them. We partner with the health plan to get that member engaged into our channel. What we've been able to demonstrate, if we can get that member into our channel, we can produce superior outcomes for them. So there's an aligned incentive for that. But the adoption is much slower than in an employer group where the benefit manager, I always say, with a stroke of a pen, can adopt something that now shifts a bunch of share into a specific channel or out of a specific channel. I think therein lies the nuance of health plans. Some health plans, if they have a big commercial book, they can make those decisions, and they have a fully insured book, they can make the decisions just like an employer. But the big health plans typically have a large Medicare book. A year, I guess we're a year and a few months past the bolus of 2016. How has that tracked relative to maybe aspiration and plan? I think pretty much in line. I think, as CFO, I always want more in the sense of it'd be great to have more members engaged to our channel. I do think that we've seen nice shift into our channel. If you really step back and say what's driving it, I think it's been mostly our Specialty Connect offering because these patients, in a Medicare book, they have options to go and fill their specialty medication wherever they choose. But if they can go to a CVS Pharmacy and be immediately enrolled into the mail order plan, they can have the assistance of the pharmacist, they have the clinical interaction with the pharmacist, that has really served us well to disproportionately grow share in that channel. By the way, when we capture that specialty patient, we also bring along all their ancillary medications into our channel as well. It's been a nice driver of share gains for us. The challenge is, it's one member at a time. It's not a group of members typically. Sure. In the minute we have left, let's touch on the Health Transformation Alliance. There's a decision made to be a part of this, and I think that right up front, they said that transparency was a big part of the goal for the alliance. But then there's also an element of customers who you may know today who are getting the opportunity to perhaps lock in lower rates. There's kind of a question of, do you know what type of volume you could see? There's no real mandate there. How do you take on all those variables? Yeah, I think there's been a lot written about this. I think at the end of the day, quite honestly, no one really knows, Eric. I do think the net effect of this is positive to us, so we're going to have the opportunity to participate. So it's modestly positive. The degree in which people adopt the programs that the alliance creates, and that we'll hopefully be at the table to help them create these programs, is yet to be seen. I do think there's opportunities, as we all have, to the degree that we can increase scale, increase an alignment from an outcomes perspective and a design perspective, it allows all of us to be more productive. We look forward to really working with them, working with the clients that we know, and maybe some clients that we don't know today, to be able to develop programs that meet their needs and drive benefits for us over time. Very good. Well, we will leave it there. We're going to continue the conversation with your questions in Point C on the three, so please join us there. Great. Thank you. Thank you.