Morgan Stanley 16th Annual Global Healthcare Conference

Sep 13, 2018

Summary

Integration targeted $750 million in synergies by the second full year after close, with closing expected by early Q4 2018. Priorities included drug-cost reduction, consumer-centered care, omnichannel pharmacy and expanded clinic services.

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