Goldman Sachs 37th Annual Global Healthcare Conference

Jun 8, 2016

Summary

2016 earnings were on plan, with delivery weighted to H2 through Part D growth, generic launches, repurchases, and tax benefits. Longer-term growth priorities included procurement and operating efficiency, acquisitions, and dispensing-share gains.

All right. Good morning, everyone. Welcome to the CVS session. I'm Bob Jones. I'm joined on stage by Nathan Rich, who works with me at Goldman. We cover the drug retailers. We're very pleased to have CVS Health with us today. Most of you are probably well aware CVS is a leader in retail pharmacy benefit management, specialty pharmacy, and now long-term care pharmacy. Very excited to have Dave Denton, CFO, he's been in the role since January 2010, joining us on stage today. The format, as I think you're all well aware, is pretty interactive here, so to the extent that you have questions, please feel free to raise your hand. We'll be sure to get you a microphone. So I thought, Dave, just to dive in, given where we are in the year today, I was hoping you could maybe talk a little bit about how the year has played out relative to your original expectations thus far. It does seem like there's a bit of a ramp implied in the back half relative to the guidance, something maybe you could also just share with us your thoughts on the drivers that ultimately get you within that original guidance range. Sure. First, thank you for hosting us today. Very pleased to be here, and thank you for your interest in the company. As we articulated back at Analyst Day in December, our earnings delivery for 2016 is very back half weighted. Year to date, our performance has been very consistent with our internal plans, so we're very much on plan as we think about the year at this point, at this stage of the game. Keep in mind that earnings delivery back half weighted is a handful of things that are driving that. First is Medicare Part D is an important piece of our business and growing pretty rapidly. The profit delivery of that business is always back half weighted, and as we grow in that business, more earnings come out in the back half. Secondly, the timing of break open generics are weighted very much to the back half of the year. Break open generics are important as when those generics break open, it increases the profitability within our business and increases the gross margin in our business. Thirdly, we have about $4 billion a share repurchase that we're doing this year. We have front-end loaded that share repurchase in 2016, so the benefit of that accrues to the back half of 2016. Finally, we do have several tax benefits that we expect to settle this year. We have planned for them to happen the back half this year. So all of those together creates this cadence of earnings growth second half versus first half. Again, we're very much on plan to that. One of the areas you mentioned that gives you line of sight into the back half of the year was around generic launches and break open generics. There have been a few drugs, it seems, recently that maybe have played out a little bit differently than the classic generic launch maybe has played out in the past. I am just curious if you could comment on what you are seeing in the marketplace as far as generic launches and how they behave when they come to market relative to historically. Yeah. Keep in mind, we think about drugs kind of in three big categories. We have branded drugs that are high cost, low profit. We have generic drugs that are during the exclusivity period. They behave a lot more like a branded drug. They still have maybe lower cost, but the costs are relatively still pretty high, and again, thin margins. Then we have break open generics when there is multiple suppliers in the marketplace, usually typically three or more. At that point in time, our scale enables us to drive the cost of goods sold down in that molecule pretty dramatically, expanding gross margin. That overall trend continues to hold within the marketplace. In some cases, there have been indications that when a generic during the exclusivity period, the branded manufacturer has maintained their market share during that exclusivity period, and they have done that because they have essentially increased the rebates to buy down the net cost of that drug down below the exclusivity period cost of the generic. That has happened on rare occasions, but does happen occasionally. So I think you have seen that play out a bit in the marketplace. Again, the good news is consistent with our plans, so nothing out of the ordinary from that perspective. There has been a lot of focus in the market around pricing and specifically generic pricing. You guys have a pretty wide lens, just given your footprint in pharmacy and in the PBM. I am wondering if maybe you could comment just on what you are seeing from generic pricing overall, and I guess importantly, how does that affect the P&L of the enterprise, if you will, as you see changes in generic pricing? Yeah. Just year to date, generic inflation has been a little less this year than it was last year. Having said that, generic inflation is very modest, and it has been very modest for quite some period of time. Some inflation has happened a little bit over the last several years as new generics have come into the marketplace at a higher price point, therefore the basket of generics in totality has increased. But the year-over-year cost of generics have been essentially flat to slightly up to slightly down. The inflation aspect of generics has been really a pretty immaterial effect on the company as an enterprise. I know you did not ask about this, but many people have asked about branded inflation. That was the next question. Does branded inflation kind of help or hurt the enterprise? Because of where we sit from a market perspective, it is essentially a wash across our business units. In some areas of our business, it helps, some areas of our business, it hurts. Where it hurts, and this is probably the piece that most people do not fully appreciate, is we are the largest Medicare Part D PDP in the nation, so we are the insurer. If costs go up, we pay more. So we bear the burden of those costs, those drug price increases, dollar for dollar through our Medicare program. So the effect of those increases or decreases across our enterprise washes through from a materiality perspective. What are you seeing specifically on branded inflation? I mean, there seems to be a thought that, given the current political environment, that there could be pressures on the ability to take price on branded drugs specifically. We haven't seen a change this year versus last year. We're still seeing branded inflation, low double digits, high single digit year-over-year growth, which has been pretty consistent for the past several years. Dave, I just wanted to touch on a couple of recent announcements on the PBM side. I guess two customers unfortunately decided to leave Caremark in 2017. I'd just be curious from your perspective, what drove their decision, and have you gotten any feedback from them on that? Yeah. Just to put this in context, there are two customers that we were notified that we will lose beginning 1/1/2017, both CalPERS and ERS of Texas. They're state government programs, essentially. These programs operate in a competitive bid situation where they produce an RFP, people respond to that RFP, and those RFPs are pretty massive, as you can imagine. You are scored, and then a committee makes a decision based on the scoring mechanism of who is awarded the contract. There's no kind of give and take. You're kind of one and done. Unfortunately, we lost both of those contracts, were notified that we will lose both of those contracts. Each of them are probably a little less than $1 billion annually from a drug spend perspective on the top line. So, they're not huge contracts from that standpoint. We obviously hate to lose a contract. We certainly don't plan for 100% retention. Each one of our contracts and prospects and renewals, we actively underwrite, and we price it accordingly, hopefully to kind of clear the table and hopefully put enough services and service offerings in the marketplace such that we meet the qualifications and standards from that perspective. But unfortunately, those two, we lost. I don't know if I have anything new about that. That's kind of where we stand. Okay. One thing we found interesting in the release that CalPERS put out is they talked about price transparency being more important for them going forward, and that was probably one of the deciding factors in who they decided to go with. I mean, do you see that as a bigger trend in the industry overall, clients wanting more transparency in pricing? I don't see it dramatically changing. There's been a trend to transparency for many years. We've embraced that in large part. Our clients do have transparency to many aspects, most aspects of our business, and we, on very rare occasion, have seen that feedback. Yeah. One of the other interesting things that came out of one of the losses you mentioned was that they discussed having a Maintenance Choice-like offering replicated from Optum and Walgreens. Maybe not even just specifically to that particular account, but in general, do you see this new offering as a change in the competitive landscape? Does it level the playing field at all in your mind? Because you guys have obviously been able to have a lot of success based on the Maintenance Choice offering. Yeah, this is not the first time we've had a Maintenance Choice-like offering in the marketplace, a lookalike, if you will. We'll be actively competing against it, trust me. I would say that a couple things to keep in mind is, part of this is about price points of having mail economics at retail, but part of this is about service delivery. We've spent probably hundreds of millions of dollars clinically enabling our pharmacists at the touchpoint and in the face-to-face interaction with our patients to drive adherence, to close gaps in care, to enable better service delivery for the members of the plan sponsors that we serve day in and day out. I think that that integration will also carry weight over time as you think about outcomes. I don't think there's a product in the marketplace that actually has that today. Secondly, we are the only market participant that is truly agnostic to where that prescription's filled, whether that's filled in mail or retail. We're agnostic to that. Other market participants will have some relationship, some share gainer relationship between the two, I would think. Over time, it'd be interesting to see how that plays out, because someone will be a winner in that, and someone will be a loser in that. Finally, Maintenance Choice isn't our only weapon here. We've invested, we have Specialty Connect, which is really an opportunity to enhance the experience for specialty patients and improve performance for our plan sponsors. We have Pharmacy Advisor. We have a MinuteClinic offering that wraps around this. So I think there's many tools that we have and service offerings that we have that we'll be able to successfully compete against a Maintenance Choice-like product in the market. I just wanted to go back to generic purchasing for a second. You guys have obviously done very well with Red Oak. Looking forward, especially as Teva and Allergan look to kind of close their merger and might become a more important supplier for you guys, does that change the dynamic at all as you guys go to market in terms of being able to continue to lower the cost of generics? Well, scale is really important in the generic procurement market. When we put Red Oak together between Caremark and even CVS and Cardinal Health, we really looked at enhancing our scale and be able to do that in a very efficient manner, in a very simple manner. At the same time, the generic marketplace still is pretty robust. Even despite the consolidation that either are announced or have been completed over the past several years, there are more generic manufacturers today than there were 10 years ago. So, at the moment, to be a buyer in the generic marketplace is a pretty good place to be. I do think the continued combination in that marketplace presents both risk and opportunities for us. I think a bigger supplier, we can partner more deeply, drive more value for them and more value for us. I think that's an opportunity. At the same token, we're not beholden to one manufacturer for a given molecule. I wanted to go back to just the performance to date, and specifically on the retail pharmacy business. The core retail pharmacy gross margins obviously trended a little bit below what we had experienced in 2015. I was just curious if you could talk about what the drivers were on a year-over-year basis that have weighed on the core pharmacy margin. Yeah. Again, they are down year-over-year, but again, very consistent with our plans. Not outside our ordinary expectations from that perspective. A couple things that are driving that. One is we continue to have reimbursement pressure in the marketplace, and typically the first of the year, reimbursement rates reset, and so you're seeing the effect of that. Secondly, there's not as many offsets from a generic pipeline perspective in the first half of the year. Again, going back to our generic break-open discussion, we started the conversation with those break-opens are largely weighted to the second half of the year, so you didn't have them in the first half to offset that. Then finally is, if you look at the Caremark selling season for 2016, while we had a terrific selling season, 80% of those gross wins were in the health plan space. Health plans typically, out of the gate, don't move a lot of share into our channel. So those new wins were not really helpful to offset from a share gainer perspective in the first half of the year as they came online with us. We think longer term, that's an opportunity for us. If we can begin to move some of the share in those health plan wins into our channel, that's an opportunity for us to enhance our business over time. Stop there and see if there was any questions from the audience. If not, I was going to shift into Part D. It kind of relates also to the previous question. It seems like clearly gaining share in Part D specifically at the retail setting is a focus for you and your competitors. You guys have taken a very disciplined approach to preferred networks. So I was hoping you could maybe just talk a little bit about what your strategy is in trying to gain share in Part D. How does it differ from some of your competitors' approach? Then just, I guess, ultimately, how does the profit from the Part D offering and your strategy kind of play through the retail pharmacy business? Yeah. I would say that we're growing our share in Medicare Part D, but we're not growing our share at all cost in Medicare Part D. What I mean by that is we've been very careful as CVS Pharmacy where we've chosen to partner with Medicare plans in a preferred relationship. We underwrite each one of those relationships very carefully. Let me step back and give you an example. If a Medicare plan has a large book of low-income subsidy lives, those lives do not experience copays because the federal government pays for their copays. A copay differential between different pharmacies does not move share from one pharmacy to another because the member doesn't feel the effect of that. We've chosen not to participate in preferred relationships where there's a large book of low-income subsidy lives that by lowering your rate, you don't have any offset from a share gain perspective. If there's an opportunity to partner more deeply in a commercial or in a plan that doesn't have low-income subsidy lives or a small portion of low-income subsidy lives and the copay differential is meaningful enough to move share, we understand the dynamics. We've underwritten a bunch of these, so we know how much to give to offset that, and we will partner deeply with that. We've been very disciplined from that perspective. Relative to your competitors, you feel like you're gaining as much share, if not- We're probably- to your bigger competitors, you feel like you're gaining as much share, if not more? We're gaining share in this marketplace, and we're at the same time doing it in a financially disciplined manner. Given that, if you think about the profitability per Part D script over the last few years, even though you're taking a more disciplined approach, could you just talk about what that profit has looked like on each Part D member over the years? Yeah. On each Part D script, the profit per script has been going down because reimbursement rates have continued to decline. The challenge here has always been is to get more scripts. These Medicare lives typically take 45, 46 prescriptions a year versus an under-65 life that typically takes seven, eight, nine prescriptions per year. So winning the life's important, but not winning the life at all cost is important. By the way, being in the retail network is one way to do that. The other thing we're doing is really through our specialty platform, we have a program called Specialty Connect, and it faces off both to the payer market, but also to the, we call it the patient-centric market, which is really the open market, the Medicare market. It is a way for us to intake those specialty patients more efficiently and setting them up onto specialty therapies through our stores. That has been a way for us to, one, capture the specialty patient, but more importantly, make that specialty patient a CVS Pharmacy customer from a pharmacy perspective. I think that is another way that we are gaining lives in the marketplace, and not having to be a preferred pharmacy participant. Dave, you guys have obviously done a good job, like you just mentioned, growing scripts above the market, getting people into the stores. You talked about working on some front-end initiatives for later in this year that I think would maybe rationalize promotions, kind of shift the focus to different categories on the front end. Could you talk about what you are doing there, and are there any programs to get the pharmacy customer to shop more on the front end? Well, I guess at the end of the day, if we win the pharmacy customer, because pharmacy is such a destination category, if we win the pharmacy customer and we become their pharmacy home, they naturally bleed into the front. I think pharmacy is the front end of the pad, if you will, from a customer attraction perspective, or acquisition perspective. The things that we are doing from a front store perspective is largely centered on personalization. It is anchored within the ExtraCare program. We currently have about 70 million members today, or a little bit over that. Been at the game 18, 19 years. The idea here is to take essentially promotional dollars out of mass circulation and mass circulars and invest them back into personalization to get our best customers to shop more completely the store. Enhance that from a digital perspective, really taking that program and putting it on a digital application. If you have not downloaded the app, folks should do that and try it because people really enjoy using the app. We have even a weekly circular that is tailored to you as a customer in the categories that you shop and your family shop. That is a big focus. Secondly, a big push within healthy foods and into elevated beauty. So we have reset about 500 stores with a focus against winning in those two categories, and also winning in the OTC healthcare category. At the end of the day, if we can win in those three areas, we can be successful in the front, and that is really where our focus is. We need to be relevant in some other categories, but we don't need to necessarily win in those other categories. Have you ever shared any metrics on, if a customer shops both the pharmacy and the front end, their relative profitability versus one who might just shop one or the other? We have not, but what I will say is that one in three trips to get a prescription does someone shop the front. So it's not as tied together as you might think. However, again, if you win the pharmacy customer when they think about needing something from a drug store, they will be back at CVS as their home. Okay. I wanted to change over to specialty. Pretty impressive growth there, share gains over the past few years. You guys have talked about more Caremark clients using you exclusively for specialty. So I was hoping you could maybe just talk about what you think is resonating around the specialty offering with your Caremark clients, and what type of savings can you offer your clients who are using you exclusively for their specialty? Yeah. So again, I think we think about the specialty space in two areas, is the patient-centered model, which is largely Medicare, the open model, and I talked about how we compete in that sector. You are talking about from a payer market perspective, we plug into both employers and health plans. Clearly, as we plug into employers, we offer exclusive specialty, which really narrows the network into our channel, and they can even use Specialty Connect to engage their members into our channel in a very efficient way. What we offer there is a tight clinical overlay, a tight formulary that allows us to buy down the cost of those drugs, and then a wraparound of adherence programs enabled both by our pharmacists, but importantly through our nurse practitioners who are essentially disease manager care coordinators who we wrap around that patient as well. Because the one thing that if you are spending $10,000, $15,000, $20,000 a month on a patient on a specialty drug, if you are going to spend that money, you do not want to waste it. You want them adherent, you want them taking it correctly, you want to monitor their progress. So plowing resources into making sure that happens, our clients really appreciate and expect us to do. We probably have more assets than anyone to do that, including our infusion business if that indication needs to be infused. That also holds true in the health plan space as well. So all those are available to health plans. They typically are a little bit different, and they may not adopt our entire suite of formularies. They might pick and choose or design their own. I think this is where the infusion business is really important to them, because we can now help them get the site of care out of an institution or a physician's practice into the home where it is much more cost-effective for them. Secondly, we plug into them on the medical benefits side, a program called NovoLogix, which allows us to essentially split apart the medical DRG payments and look at the specialty spend within those DRGs and identify either pricing outliers and/or dosage outliers by location or by physician so that we can go back and either rebuild it correctly or go identify programs to take cost out of the system. That has been very well embraced across our health plan book and is driving a lot of value for them. One other thing that has come up recently from the wholesalers has just been around a potential change to the pricing model around specialty. We have heard some of the distributors talk about going back to their portfolios and identifying drugs. I think these are specifically drugs that are largely ending up at the specialty pharmacy, but could also end up at the retail counter. Yeah. I'm just curious if it's something that you've experienced in the market or you've seen in the market to date, and how do you guys think about changes in the pricing model around specialty drugs? Yeah. We have not seen that in our book of business. That probably is not, given the relationships that we have and the tenure of our relationships and the contractual relationships that we have with our suppliers in the marketplace, it's probably not something that can be done. We're pretty locked in where we are. We have not seen that. We have not seen that change in our book. Okay. On the formulary management opportunity, you guys have done a great job over the past three or four years identifying drugs and excluding them from the formulary. As we look going forward, has most of the, I guess, low-hanging fruit been captured? Are there certain categories of drugs that you guys are focused on where there might be additional opportunity? No, there are more opportunities, and there's more opportunities even today because if you look at how we approach formulary management, our clients ultimately select the formulary. We have a series, we have, I say, the template formularies, our base formulary. Clients have the opportunity to move up the spectrum to get to more restrictive formularies that drives more savings. I say the vast majority of ours are still at, I'll say, level 1. I do believe over time people are going to migrate up into higher and more restrictive formularies over time, and I think that's still ahead of us largely. Great. Wanted to make sure we touched on Omnicare, obviously, a big integration effort ongoing. Something maybe you could just touch on where we are with procurement savings, cost reductions, and then maybe any operational opportunities that you see. Yep. From a synergy perspective, from a procurement standpoint, very much on track. We are using Red Oak from a sourcing perspective. That will be complete this year. From an operational perspective, back office operation, that integration is well on track, also be complete this year. Probably, I do not know, 70%-80% complete today. Still focused very aggressively there. From an operational perspective, Omnicare operates hub and spokes. When we look at those operations, they look a little bit like a mail order center to us, but a less efficient mail order center than what we operate today. There are technologies and processes that we think we can bring to bear to that, and that is beginning to take place. That is probably a multi-year improvement opportunity. There are cost savings that we are taking out today in the operations, really around their immediate fill needs. Today, Omnicare runs a truck maybe 100 miles or a couple hundred miles between their hub and spoke to a facility for immediate fill of a prescription that a newly intake patient might need when we have a pharmacy down the street. It is a big opportunity to take cost and improve service from that perspective. From a revenue perspective, we are out and operating five or six pilots today, mostly in the ALF setting. Keep in mind that Omnicare has about a 30% share of the ALF beds, but only captures about 50% of the prescriptions coming out of those beds, largely because they do not have a brand name recognition, they do not have a good delivery system, they do not have a product or service offering that those clients can appreciate and understand, and they have not partnered as deeply with the operators they probably could. We think there is an opportunity over time to enhance our script capture in those markets, and that is probably a multi-year effort. And I don't know if you'd be willing to touch on the last several quarters that Omnicare reported, they were having a tough time kind of maintaining beds and scripts, and the business was under a little bit of pressure. Would you be kind of willing to share, I know you don't report it anymore, but just kind of organically how that business has done since you've acquired it? Only qualitatively, not quantitatively. I think we feel very good about the business. I do think that many of you know Rocky Kraft, he now runs that business. He's done a nice job. He's taken out a layer of management. He's a lot closer to the clients. I think that our products and service offerings are really beginning to resonate even more completely. I think there's no secret the Omnicare name in the marketplace wasn't always pristine. I think the management team over the last five years has done a great job in improving that, but I think the CVS name enables it to the next level. So I think that will help us gain share in that market over time. So I think we feel good about where we sit. We feel like we have a good runway there, but more to come on that. Just in the time we have left, just check in to see if there was any questions from the audience. If not, Dave, I just had There's one in the back. Oh, I'm sorry. There's one in the back. Could we maybe go back to specialty, and could you give us an idea of the importance, if any, of the fees that you get from the drug companies to help them with their kind of drugs in the specialty segment? Yeah, it's pretty modest at the end of the day. We do receive fees from them in support of clinical programs, but it's a relatively immaterial piece of our business. Obviously, disclosed to our clients as well, so it's not something that's hidden from our clients. Great. Dave, I just had two big-picture questions in the time that we had left. One was just around kind of the business models that exist today within the supply chain. I mean, you guys obviously have successfully established the retail PBM model. There's still the large PBM standalone competitor. There's standalone large retail competitors. Managed care, in our view, seems to want to take back, at least directionally, a little bit more control over some of the spend that maybe historically had been managed outside their four walls. Particularly, I'm thinking about on the specialty side and on the pharmacy benefit side. As you fast-forward into the future, how do you see these different business models playing out? Do you think one becomes more clear than the other? Do you think some will have trouble surviving in the future world? Yeah. Listen, I think we're very nicely positioned from a business model perspective. I do think there's more that we can do as we think about services that we can offer into the healthcare marketplace, either to plan sponsors, the health plans, or even to providers to help them be more efficient as risk gets shared through the enterprise or through the system. I do believe that if you really look at what's important from pharmacy's perspective, having the connection to the patient is critically important, and also having the large scale and the breadth of services. If you look at the market participants today, we're the only ones that have that complete package. I know that they're all a little bit different in the services they offer, but at the end of the day, you need to be right on price, but you also need to get that member engaged so that he or she is adherent to the medication, on the right therapy, and then there's no gaps in care. I think the best way to do that is that interaction with that pharmacist. Then just the last one I had to close out, the 10%-14% long-term guidance, I'd imagine, depending on what year you're looking at, the building blocks are going to be different. That's right. But I was hoping maybe you could just walk through it. As you sit today and you look into the future and you think about that 10%-14% EPS growth, what are the building blocks in your mind, the major building blocks in your mind that keep you within that range? Yeah. As we talked about, generics are still important to us. They still represent a tailwind to our business, despite maybe being a little bit less of a tailwind than what they've been over the past five years, just given the size of the new introductions over the next several years. Secondly is we have to be more efficient in our business model, and I look at that in two ways. One is with our scale, we need to leverage Red Oak and buy down the cost of goods sold of generics aggressively, and we're working hard to do that. We also need to be more efficient as we fill prescriptions in our stores and in our mail and specialty centers, and we're working hard at that, and we continue to progress there. Thirdly, we've just invested in two acquisitions that is both an Omnicare and Target. Omnicare enters a new space for us, from a care setting perspective, that we think we can be successful and grow that business aggressively over time. And obviously, the Target asset presents synergies for us, but more importantly, access points as we sell in our services to plan sponsors and we really expand our reach. And then finally, all those together, we need to be able to garner additional dispensing share in the marketplace, and we think we're, over time, we'll be a share gainer, both from a lives perspective, but also within those lives, making those lives more productive as we get more of their share of spend through one of our dispensing channels. And we've been very successful at that, and we continue to focus against that. Our specialty business will be a component of that as we wrap that in. So, I think we're nicely positioned from that perspective. Great. I think that's about all the time we have. I wanted to thank Dave and CVS for being here today.