8th Annual SVB Leerink Global Healthcare Conference

Feb 28, 2019

Summary

2019 pressures include pharmacy margin compression and rebate guarantees, which peak this year and ease in 2020. Integration, new contracting, selective HealthHUB expansion and care-delivery tools are key growth and savings opportunities.

All right. I am going to get started. Thanks, everyone. Good morning. I am Ana Gupte. I cover managed care and facilities, as well as payer service. Larry Merlo, CEO, Eva Boratto, the CFO. We have Mike McGuire, who heads up IR, and Jen Gilligan as well. We just have a fireside chat format today, so I am just going to dive into the questions. Feel free, Eva and Larry, to give me color, each of you. I am going to start first with the financials and the 2019, the guidance that you gave us a week ago. The stock responded pretty negatively to the guidance. Can you give us any color, firstly, on the headwinds and tailwinds that you had been talking about for the last month or so? How many of those headwinds and tailwinds, firstly, if you go into the break-open generics, we had the rebate guarantees on brand inflation, the Omnicare headwind. How much of that is recurring, and we should be viewing that as recurring into 2020 versus a transient headwind? One time, those legacy headwinds will be out of the way, and you can start on your way to integrating Aetna and driving EPS growth into 2020. Yeah. Ana, maybe I will start, and Eva will jump in. Maybe what I will do is just summarize the headwinds and tailwinds, and then talk about the transient nature of those. As you look at the headwinds, we talked about, this time last year, about making investments from the tax reform, and that, along with the Omnicare performance, is impacting the retail segment. The other headwinds set around, we continue to have ongoing pharmacy margin reimbursement pressures in both legacy businesses. It is more of a question around what are the offsets in any given year to that margin compression. We are experiencing a lighter year from a year-over-year contribution of generics. The second, as you look at a lower brand inflation, that is placing some pressure on our client contracts as it relates to those client commitments around rebate guarantees. As you look at the transient nature of those, acknowledging that in the PBM space, we typically have three-year contracts, those rebate guarantees, they peak this year. We will continue to have some headwind in 2020 to a lesser extent than 2019, and then it rolls off after 2020. As we look at the generic space, in any given year, you can have peaks and valleys. As we see the generic year-over-year contribution for 2020, we see that much better than the benefit that we are experiencing in 2019. Then, obviously, as you look at the investments in tax reform, that rolls off this year. We have an action plan in place to improve Omnicare’s performance. We are working to accelerate that. So, we see that business stabilizing and improving from this point forward. As you look at some of the tailwinds in the business, we continue to have strong top-line growth at retail, not just in pharmacy, but in front store as well. We expect that to continue. You look at the performance of pharmacy, we are seeing the benefit of our network configurations, as well as the clinical programs that we have brought to the market. We see that continuing as we move through 2019. The other things, we are introducing new contracting models in both legacy businesses. You've seen some press around the Guaranteed Net Cost pricing model in the PBM, which we believe creates absolute alignment with our clients in terms of what's most important. There are many variables that ultimately get you to the net cost of the drug, which is what clients hire us to do. This new pricing, this new contracting model puts the focus on that net cost element. We also believe there's opportunities with what we have done at retail, that one of the things that we've learned as we get deeper into the Aetna business, that about 50% of the claims that they're paying have some type of value-based reimbursement model tied to it. Now, that's largely in the provider space. We see an opportunity to gain traction in pharmacy. So we're going to begin to move that needle. That is not an overnight change. I think it'll take several years, but there are many elements of pharmacy that improve HEDIS measures, improve STARS performance, and we think we can begin to create more of an outcomes-based model that goes beyond just the price of dispensing. Then, of course, there's opportunities to continue to take costs out of the business. So, those are things that we're putting in place in response to the headwinds, as well as the nature of, Ana, to your question, many of those headwinds are transient nature. Okay. So it does sound like the rebate guarantees will subside or taper off into 2020. You'll have less pressure from break-open generics, Omnicare. Going into the tailwinds, because I'm trying to get a sense for, will you be able to say there's net growth in 2020? Which is the top-of-mind question, if you will, for investors. So let's start with the tailwinds or not on the top line. You talked about retail pharmacy, retail front store. Can you comment on the PBM selling season? You had really strong retention for 2019. How does this play out in 2020? You have Anthem onboarding earlier than expected, for us anyways, as investors, and then Centene, though, is beginning to roll off. So on a net basis, what is this going to look like for the PBM, as well on the top line? Yeah, Ana, your point, we're very pleased with the 2019 selling season in a year in which there was not a lot of new business changing hands. We had about $37 billion-$38 billion up for renewal. We had a 98% retention. At the same time, we did grow incrementally with new business in the market. It's early in the 2020 selling season. To your point, we're excited to be in a position where we can onboard the Anthem business earlier than what was anticipated. We've got a great team dedicated to that. They started probably about 15 months ago, and the work is well underway there. I should remind everyone that the nature of that contract, that business will be reported on a net basis, not a gross basis on the revenue line. I think as everyone knows, Centene made a significant investment in the RxAdvance business and notified us of their intent to begin to migrate that business onto the RxAdvance platform. That will begin in 2019. We expect that to be a multi-year process. We don't have a firm defined timetable around that. It's early in the selling season. As we've done in past years, we'll provide updates as we move through the coming months, and more to come on that. Moving to the final business, if you will, on Aetna, where Aetna, ex the prior-year development this year and experience rating and all that, I think, was generally a decent performer for you. On the 2019 guidance, it's a completely transformed landscape going into 2020. In the same vein, do you expect to see membership growth in Aetna on a combined basis with CVS and Caremark going into 2020? Will that be a tailwind? I'll talk about the bottom line aspect of it as well. Well, maybe I'll take the first part of that, and then I'll let Eva take it from there in terms of additional financials. Listen, we are excited in terms of, as you look at the Aetna business moving into 2019, they've had strong membership growth, certainly in the government space, but across the commercial space as well. We expect that when you think about this combination and the opportunity to bring innovative products and services into the marketplace, membership growth is a key element of the value creation that we believe we'll be able to achieve as this combination takes hold. Ana, the only thing, I would add a couple of things. As you think about the government space, as you know, it's been a key area of investment for Aetna in terms of market expansion as well as capabilities. We strongly expect that momentum to continue. We had a very strong 1/1 operationally as well as the lives win, so we feel good about that. We had wins in commercial. We will continue to be prudent as we bid on the business with the actuarial discipline, how Aetna has approached the markets in the government and commercial space. I'd add another point. Recall on our earnings call, we indicated that we moved legacy CVS PDP over to Aetna immediately here in the beginning of the year, and that was really around the strategy of how do we have even a broader strategic platform to grow that business, to bring those businesses together far in advance of the bid season so we can have the best strategies to win. Okay. So, I think you had guided to, for 2019, 84.5%, I think, at the midpoint on loss ratio, and then that was ex the prior-year development. So, would we expect, I think from what I'm hearing you say, it's still the same mantra of margins first, actuarial discipline. You'll grow in Medicare, you'll be more prudent on the commercial side, and not just pivot to growth at the expense of margins then? That's right. Our actuarial disciplines will remain consistent. Then just talking about the synergies, which seems, to me, it seems like when I look at your print for the fourth quarter and into guidance, you sound confident about the Aetna transaction, the acquisition, the synergies. You are guiding to $300 million-$350 million in synergies for this year. You sound really confident about synergies for next year, above $750 million, maybe $800 million. You are also talking about an enterprise initiative on cost savings. Should I interpret that to mean that is on top of the synergy guidance that you are offering us? Will that be an offset to these retail pharmacy, perhaps PBM, margins as well, which seem to be continuing pressure into next year? Ana, on the additional cost initiative that we outlined on the earnings call, you should absolutely think about that as incremental to the synergy, as well as incremental to the programs that those legacy companies had in place ongoing before the companies came together. We are pleased, as you think about the initial pass of the synergies, the $750 million, and we are confident in delivering more than that, they were focused on three key areas around your corporate overlap, your operational efficiencies, pharmacy, where we can bring things together, your procurement opportunities, and some modest medical cost savings. As the companies have come together, we see even greater opportunity as you think about digital capabilities, as you think about some of the operational staffs. Onboarding, right? Back office, medical, claims processing, call centers, et cetera. There are some of the places that we continue to see opportunities, and we will have more to say about that in May and in June. The medical cost synergies, which is the big additional element, 2020 and beyond, is that baked into your synergy guidance right now, and how much of it is? They said a little. Will that continue going forward, I guess, is the question. Yeah. In the $750, I would say there was a modest piece of medical cost synergies in there. Okay. But Ana Gupte, as you think about that, listen, your point, maybe I go back to your point about, we feel very good about the work that has been done on the integration activities over the last 12 months. The team is ahead of that $750 million target that we had set a year ago. At the same time, as we think about, I will call them the transformation activities, it has been, what, 10 or 11 weeks since we closed. That team, for all the reasons that we all understand as you go through the regulatory process, there are things that you are just not going to have visibility to until you get close to the end. So, that team's work really began in detail probably about four months ago, maybe a month before the closing. They too have been moving with speed and a sense of urgency. We are excited that they have already gotten into the market some test programs. We expect that we will have some products in market for 2020, and that will continue to grow, as we test and learn, operationalize, and commercialize. So, I think we are all encouraged by the work and the early feedback in terms of that which is being tested. One final question on near term, and I know I am taking a lot of time on the near term, but the feedback I get is that there are no catalysts. Why do I need to buy CVS now? So, on the '19 number, I think, I actually, my bad, didn't notice that that was the ex-prior year development, which normally, if it was just that, and I would have been in my sleep, but it is hard when so many segments come at you all at once. But it was a 7 EPS handle, and I republished and I said there was a 70, 7 EPS handle, which there was a 7 EPS handle trade going on, and I think that is part of why your stock sold off so hard. Would you say that there was any element of conservatism in that number at all? You did not guide to any prior-year development, either in the synergy number or your estimation of your margins in retail and the pressure there, or otherwise. Your PBM segment looked pretty good. Ana, I would say it is early. I think the guidance we provided were our best projections with the information we know, taking into account risks, opportunities, headwinds, tailwinds in the market and within our control. If you are asking what could push you higher, right? Higher in your range or above your range, some of the elements that we spoke about, think about slower migration of Centene, more rapid realization of synergies. You saw the medical cost trends. It is early to have a prediction on that, but if they come in more favorable, obviously prior-year developments, and any early wins we could have on the new cost-out project. I think it is too early to make predictions on those things, but they will be some of the elements that we will look at as we proceed through the year. You said this earlier, we are pleased with the Aetna guidance that we provided, and if you looked at that on a standalone basis, what we had said was growing modestly. I think about that as low single digits. Obviously, we are not pleased with the contraction in the legacy businesses and some of the things Larry outlined earlier around the operational improvements we are making in Omnicare, the cost out there, the new cost initiative that we are embarking upon. We are examining all aspects of our balance sheet. We are laser-focused on driving those improvements, whether in 2019 or beyond. When might we get any visibility into 2020? Will we have to wait until your fourth quarter 2019 call, or might you give us something ahead of time, which investors keenly are looking for? So, we understand what investors are looking for, and what I would say is when we are in a position to provide that in a prudent way, we will certainly do that. Okay. So, thanks for your patience on all of the near-term questions. If I could then move on to all of the debate that is happening right now in Washington around the Part D plans and the PBMs and the rebate changes that have come out through HHS with the date in early April, and then the hearing with the drug company CEOs a couple of days ago. Larry, for your thoughts on that. I am trying to figure out, Ana, where to start, because I am looking at the clock. We got six minutes left, okay? We have five more than that if you want to go. Okay. All right. Well, listen, maybe I will start with the proposed rule. As we look at that, we believe that takes us a step backwards, not a step forwards. I think everyone here knows in the Medicare space, 100% of the rebates get passed back. Those rebates are used to buy down the monthly premiums. We went back and looked at what has happened to monthly premiums over a nine or 10-year period. If you go back to 2009, across all Part D plans, monthly premiums were $29. Last year, they were $32. They have grown less than CPI, let alone less than medical CPI. It is a proven fact that that is how the dollars are being utilized to the benefit of the beneficiary. The second important data point is, as you look at the Part D space, we are approaching 90% of all prescriptions that are dispensed as generics, not brands. You take those two factors and you think about, okay, if we eliminate rebates in Medicare, then the monthly premiums are going to go up. Some actuaries have pegged it as much as 52%. Costs are going to go up for everyone. Yes, there is going to be a percentage of beneficiaries who will net out, okay, to the positive. One of the questions that we have is, will we see seniors disenroll, especially healthier seniors, as a result of the increase in monthly premiums? It is important for us to not point fingers, okay, but, what do we see as solutions? We have talked and we will respond to the April 8th deadline in terms of our thoughts about what we could do. We see capabilities in the commercial space, where a portion of the rebates are passed back at the point-of-sale. You accompany that with a preventive drug list, and you can reduce costs at the pharmacy counter without experiencing double-digit premium increases on a monthly basis. We see that as a more viable solution. Ana, as I mentioned, we will respond in turn with that. I guess the other question that we get a lot is, would you see this spilling into the commercial space? Exactly. Yeah. Okay. As you look at the Caremark book today, we have about 10 million members who we manage whose plan sponsors have adopted point-of-sale rebates. That's roughly probably between 20% and 25% of our commercial book. It's clear that benefit managers in the private sector carry the same thought process as what we experience in Medicare, that they want to buy down that monthly premium. We're working to educate them on some of the other options that are available to them, like I mentioned, where it's not all or nothing. You can create a win-win here. There are a lot of folks that are listening, want to understand that more, and I do think we'll see more adoption of those types of plan designs. I guess the last question is, any comments in terms of the hearing earlier this week that Listen, we share the administration's goal of reducing drug costs and reducing out-of-pocket expenses for members. We're very pleased with the tool that we put in the market a little over a year ago, that if you're a Caremark member Because think about, it wasn't that many years ago that if you were focused on cost in the doc's office, you only had one question to ask. Are you writing for a brand or a generic? Because there was a copay for each one. Well, that's all out the window, and nobody can keep their benefit design as it relates to pharmacy straight, let alone the physician. If you're a Caremark member, we're taking your benefit design, we're embedding that into the EHR, recognizing that we define transparency as We work to make transparency actionable. When you think about this dynamic, it really starts at the prescription pad. If the physician's prescribing electronically, we're showing them your out-of-pocket expense, and we're showing up the five therapeutic alternatives. Now, quite frankly, we're all thrilled with the results that we're seeing, and quite frankly, a little bit surprised that we knew that if the drug wasn't in the formulary, the physician would switch to another alternative. But even when the drug is in the formulary, they're switching over 40% of the time to a lower-cost alternative. The average savings per script is over $100. We think functionality like that can have a meaningful improvement at the pharmacy counter, and oftentimes those things are overlooked. Right. A lot of it is about moving money from one constituent to another rather than just bending the pharmacy trend, if you will. Regardless, however this plays out, as you contemplate all the scenarios, would you say that your $300 million on rebate disclosure, that is everything that is out there, and regardless of how this works or whether it spills out into commercial, that there is no real meaningful impact to your PBM margins from where this goes? Or do you contemplate any real downside scenarios from what might happen? Well, Ana Gupte, I mean, from a financial business point of view, your comments are spot on. We worry about the unintended consequences that can occur. I mean, in the hearing earlier this week, and I read some of the reports coming out, I did not see anyone say that they would lower their list price to the level that exists today, net of rebate. I think we heard them say they would lower their list price, stop. Yeah. We are sitting here today utilizing size and scale to drive down the cost for the clients that hire us to provide that service. I do not see the use of formularies, leveraging size and scale, changing that dynamic. I would be remiss if I did not ask you about your HealthHUBs. You have rolled these out now in Houston. Can you talk about any early experience you are having there, what your target strategy is and glide path for the rest of the country, and what are the economic drivers, if either you and/or Eva Boratto want to comment on that? Yeah. Maybe I'll start, and then Eva can jump in. To be clear, we got three. Three concept stores. They've been operational now for about a month. As we've talked over the last several months, we saw an opportunity to repurpose some of the front store space. We've repurposed about 20% of that with services in mind. When you walk in the HealthHUB, you'll see an expanded MinuteClinic where we're doing phlebotomy. We have a nutritionist on site, respiratory therapist. We continue to have a focus in the front store on products of health, beauty, personal care, and some elements of convenience. But the early returns are very exciting. We've gotten terrific feedback from customers. The component that I'm really pleased with, we're all really pleased with, is we're beginning to get learnings that are helping us understand what do we need the HealthHUB to do, and what are we learning that we can apply broadly across a wide variety of stores. So we're beginning to get those learnings, and I think that's critical in terms of we've talked about this hub-and-spoke concept. Again, 30 days in, but I'm confident that we do not need a HealthHUB in every store to execute this strategy. Might you move Sorry. Sorry, Ana. The only thing I'd add to that, right, is we've gotten questions from investors around capital deployment and what we'll call so validation of you don't need a HealthHUB in every store, that you can deliver the value with these higher-risk patients in a hub-and-spoke model is an early proof point around as we think about CapEx, right, in the $2.3 billion-$2.6 billion range, right? You can think about it in select stores. It'll be a repurposing of historical refreshes, and it won't need to be done in every store. Repurposing MinuteClinics and not everywhere. Right. Yeah. One final one. Might you move away from just telemedicine with Teladoc Health into actual primary care in-store, which is believed to be an opportunity for you? Well, first of all, through virtual technology, telemedicine, we can bring the physician into MinuteClinic. One of the things that we are laser-focused on is the cost associated with the site of care. As you look at the growth of MinuteClinic in terms of the breadth of practice, no, we are not treating broken bones, we are not doing X-rays, but there is a lot that we can treat, diagnose from not just an acute, but as well as the management of chronic disease as a complement to the role of the physician. We do not have any plans today to think about staffing MinuteClinics with primary care docs. To the extent that we see the need or the opportunity from, I will say, an episodic nature, we will think about telemedicine as filling that void. Truly a pleasure. Thanks, Larry. Okay. Thank you. Thanks, everybody.