CVS Health Corporation (CVS)

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CVS Caremark Corporation (CVS)

December 13, 2012 8:00 am ET


Nancy Christal - Senior Vice President of Investor Relations

Larry J. Merlo - Chief Executive Officer, President, Director and Member of Executive Committee

David M. Denton - Chief Financial Officer and Executive Vice President

Per G. H. Lofberg - Executive Vice President

Jonathan C. Roberts - Executive Vice President, President of Pharmacy Benefit Management Business, President of the CVS Caremark Pbm Business and Chief Operating Officer of Pharmacy Benefit Management Business

Mark S. Cosby - Executive Vice President and President of CVS Pharmacy

Andrew J. Sussman - Associate Chief Medical Officer, Senior Vice President, President of MinuteClinic and Chief Operating Officer of MinuteClinic

Troyen A. Brennan - Chief Medical Officer and Executive Vice President

Mike McGuire


Lisa C. Gill - JP Morgan Chase & Co, Research Division

John Heinbockel - Guggenheim Securities, LLC, Research Division

Thomas Gallucci - Lazard Capital Markets LLC, Research Division

Ann K. Hynes - Mizuho Securities USA Inc., Research Division

Meredith Adler - Barclays Capital, Research Division

Michael J. Baker - Raymond James & Associates, Inc., Research Division

Matthew J. Fassler - Goldman Sachs Group Inc., Research Division

Scott Andrew Mushkin - Jefferies & Company, Inc., Research Division

Todd Jones - Legg Mason Investment Counsel & Trust Company, National Association

Edward J. Kelly - Crédit Suisse AG, Research Division

Deborah L. Weinswig - Citigroup Inc, Research Division

Ricky Goldwasser - Morgan Stanley, Research Division

Steven M. Hamill - Winslow Capital Management, LLC

Mark R. Miller - William Blair & Company L.L.C., Research Division

Keith Mills - Trillium Asset Management LLC

John W. Ransom - Raymond James & Associates, Inc., Research Division

Steven Valiquette - UBS Investment Bank, Research Division


Unknown Executive

Ladies and gentlemen, please welcome Nancy Christal, Senior Vice President, Investor Relations, CVS Caremark Corporation.

Nancy Christal

Caremark's 2012 Analyst Day. Looks like we have a pretty full house this morning. It's great to see so many of you here, and we do appreciate you taking the time to spend the morning with us. As many of you know, we've been hosting an Analyst Day like this once a year for many years, well over a decade. And as you can imagine, a lot of planning and preparation goes into these meetings, but we think they're important for 2 key reasons. First of all, we want to provide you with an in-depth review of our strategies for long-term growth and enhancing shareholder value; and second, we want to give you the opportunity to hear from more of our executives than you typically get access to throughout the year, so you could see for yourself the depth and breadth of our management team at CVS Caremark.

We have a great lineup of speakers for you today, and the slides that they'll walk you through as well as management biographies are in the slide books at your seats. And for those of you listening in on the web, all of that is available on our website as well. And it will be archived there for a 1-year period following the meeting.

Now before we get started, our attorneys have asked me to post the Safe Harbor statement. Please take a moment to read it. It's also in your slide books as well as on our website. In addition, please note that over the course of the morning, we'll discuss 2 non-GAAP financial measures that are posted on this slide in accordance with SEC regulations. You can find the reconciliation of these non-GAAP measures to comparable GAAP measures on the Investor Relations portion of our website.

And I truly hope you find this morning's presentations informative and helpful as you evaluate your investment in CVS Caremark.

And now I'll turn this over to our President and CEO, Larry Merlo. Thank you.

Larry J. Merlo

Thanks, Nancy, and good morning, everyone. And I also would like to thank all of you for taking the time to be with us this morning. Now this is my second Analyst Day as CEO, and I'm very happy to have a chance to update you on our progress over the past year. Now at last year's Analyst Day, we talked about the fact that we are a pharmacy innovation company, a company whose purpose is to help people on their path to better health. And we see pharmacy innovation as central to meeting future health care challenges, central to helping more people achieve their best health and central to our growth. Now along with defining our purpose, we captured our strategy in a very simple idea. We are reinventing pharmacy. And this strategy, along with our purpose serves as a filter for everything we do and is helping us to drive shareholder value. Now last year, we said we'd be focused on 3 key elements: continued leadership in our core businesses, our driving pharmacy innovation to solve key health care issues, the access, cost, quality challenge and capitalizing on the power of what we called our integration sweet spots to drive superior long-term growth and value. And we defined those sweet spots as areas where we can leverage our integrated assets to provide solutions to our client and customer needs that no stand-alone retailer or PBM can provide.

And I'm very happy to report that we have made significant strides forward since last year's meeting. Going into 2012, we set challenging, yet achievable financial targets, and we outperformed those expectations with earnings per share and cash flow expected to be solidly ahead of our initial plan. We said that we would capitalize on industry disruption, and our retail team has done an excellent job of attracting and retaining new Express members as a result of the impasse with Walgreens. In 2012, we gained over 24 million scripts as a result of that impasse, well ahead of the range that we provided at last year's meeting. And you'll hear more from both Dave and Mark about where we stand with retention.

Now we were also highly focused on returning our PBM to healthy operating profit growth, and we did just that. PBM EBIT is projected to be up about 20% this year. We said we would reaccelerate growth in MinuteClinic, and we'll open about 100 clinics this year while maintaining a breakeven profit performance at the enterprise level. And we also said we'd continue to gain traction and further develop those integration sweet spot programs, and we've added just under 4 million lives to our Maintenance Choice product in the past year. We've also added about 4 million lives to our Pharmacy Advisor program, and we expect to continue this momentum into the 2013 plan year. You'll hear a lot more about the evolution of our integrated programs throughout this morning.

So with that backdrop, where do we go from here? Well, obviously, that's what we're going to talk about today, and there are 3 key takeaways that I'd like you to have from this meeting. First, we are uniquely positioned to drive results. Our integrated model enables us to drive pharmacy innovation, and we understand the health care landscape and where it's heading. And with our breadth of capabilities, scale and agility, we can and will pivot to address significant health care opportunities however they take shape. Second, our strategic growth framework aligns our priorities with emerging health care opportunities, and we're focused on growing our total enterprise.

Now it's important to acknowledge that our core PBM and retail businesses both continue to grow and gain share on a stand-alone basis, and over the past year, we have further evolved the way we evaluate opportunities and initiatives to capitalize on our unique assets. And this allows us to begin to migrate to a more integrated view of our company. And this is a critical point is our differentiated products and services gain increasing traction in the market, and Dave will speak more about this and give you some examples as to why this makes sense.

Third takeaway from the meeting, we remain committed to enhancing shareholder value, and our unique position in the marketplace along with the enterprise growth initiatives that we'll talk about today are expected to lead to solid earnings growth over the long term. Our business is well positioned to drive substantial free cash flow, and we'll continue to employ a highly disciplined approach to capital allocation.

So let me lay out our agenda for the morning. Dave Denton will start the day off by providing a financial review, including our 2013 guidance, along with a discussion of our capital allocation plans and long-term targets. After Dave's presentation, we'll hold a Q&A session specific to that '13 outlook, and then we'll take a brief, I'll call it, BlackBerry break, so you can send out any e-mails or make any calls before we get into the more strategic discussions. After the break, I'll return to provide an industry overview. I'll talk about how we are uniquely positioned to capture share and create value in this rapidly changing environment. And I'll then lay out our strategic growth framework at a high level. That'll set the stage for the rest of today's speakers. Per Lofberg will then discuss trends affecting the PBM industry and offer his perspective on how we've positioned the PBM for long-term growth. And I think as all of you are aware, Per handed off the PBM reins to Jon Roberts this past September, and Per will continue to work with myself and our management team on PBM and enterprise strategies.

After Per, the heads of our core business segments, Jon Roberts and Mark Cosby, will each provide updates of the growth strategies in their respective areas, and then Andy Sussman, President of MinuteClinic will give you an update on that part of our retail business. Now in addition to talking about their respective businesses, our speakers will also talk about some of those key long-term enterprise growth initiatives that we're working on. And then Troy Brennan will pull it all together. Troy will talk about how we are positioned to take advantage of the changes created by health reform, what we're doing to drive clinical innovation and why this all matters. And then following Troy, we'll wrap things up and hold a general Q&A session.

So we have got an outstanding executive team, and I expect that their presentations this morning will give you confidence that we've got the right leadership in place to drive solid long-term growth. So with that, let me turn it over to Dave for the financial review.

David M. Denton

Thank you, Larry. Good morning, everyone. I'm sure you're very anxious to hear about our guidance for 2013, which I'll provide for you in just a few minutes. But my most important goal for the day is to increase your understanding of how CVS Caremark will drive long-term shareholder value. And over the past several years, we have been able to generate a significant amount of value, but today, I'll highlight how CVS Caremark will build upon that very strong history.

The presentations throughout this morning by my colleagues will discuss the specific initiatives and outline them that will fuel -- that are designed to fuel that growth, enabling us to achieve our financial targets, as well as drive long-term value. So let's begin and here's my agenda for the morning. First, I'll touch upon our financial accomplishments throughout 2012. I'll bring you up to date on how we continue to enhance shareholder value through our disciplined capital allocation strategies. After that, I'll switch gears and provide some details around our specific guidance for 2013. And lastly, I'll revisit our steady-state growth targets that we laid out 2 years ago. I will frame up for you today what we see as a strong growth outlook for our business well beyond 2013. In addition, as Larry said, I'll highlight why you should be keenly focused on our overall enterprise growth, as we used the many assets across all of our business segments to maximize the earnings potential of the entire enterprise. So let me jump specifically into our 2012 financial highlights.

We've been very focused on this roadmap for driving shareholder value over the past several years, and it includes 3 major pillars: First is our focus on driving productive long-term growth; Second is our expectations to generate significant levels of free cash flow; and finally, our disciplined approach to allocation of that capital. These, together, lead to enhanced shareholder value. And in 2012, all 3 pillars contributed significantly to our success.

And now with only a few weeks left in 2012, we are very pleased with our results. We set an achievable target, and we expect to deliver approximately $0.15 more than the high end of our initial full year EPS guidance range. We've seen solid performance and growth in our core retail and PBM businesses, and we benefited from our ability to capture more than our fair share of Walgreens patients during their impasse with Express Scripts, all while converting a good portion of these customers to loyal CVS retail customers. We expect to generate a significant amount of free cash flow, which is driven by solid growth in earnings, as well as a number of successful working capital improvement efforts.

We've returned nearly $5 billion to our shareholders through a combination of dividends and a considerable amount of share repurchases. On our earnings call in early November, we narrowed and raised our 2012 guidance range given the solid results for the first 9 months, as well as our outlook for the remainder of this year. We continue to expect to deliver adjusted earnings per share from continuing operations of between $3.38 and $3.41 per share. And while we are not changing our guidance for Q4 today, I am pleased to report that our results are trending toward the higher end of this range. And in addition and consistent with our prior guidance, we expect to generate free cash flow for the year of between $4.6 billion and $4.9 billion.

So our outlook for the fourth quarter remains solid. We continue to focus on maintaining a very healthy balance sheet with sensible yet modest financial leverage. While we carry nearly $10 billion in debt, our credit metrics today are still modestly better than they were 10 years ago prior to our major acquisitions. We are comfortable with our current credit profile and our corresponding credit metrics, and we are very focused on maintaining our high BBB credit rating.

And as I've said, we've been focused on improving working capital. Since 2010, we have been able to take more than 12 days out of our cash cycle, with most of that improvement coming from our retail segment. And as we look forward, we see additional opportunities. And as we have said in the past, we are targeting an adjusted debt-to-EBITDA ratio of approximately 2.7x, again, consistent with our credit rating targets. Our debt maturities are well-laddered over the next decade with no 1 year requiring a significant outlay of cash to meet our obligations. However, given our -- the existing favorable interest rate environment, we have undertaken a debt refinancing that will enhance our long-term debt structure and provide us with more free cash flow in future years.

And here's a quick summary of what we announced at the end of November. We have extended cash tender offers for several of our higher interest rate long-term notes. We plan to buy back up to $1.3 billion of these notes. And by the way, the books that we handed out this morning, you'll notice that it says $1 billion, but as you saw on Monday, we upsized our buyback plan given the strong interest within the credit markets. We have already replaced this debt with a new 10-year $1.25 billion note at 2.75%. By extending this portion of our debt at lower rates, we will have interest expense savings of approximately $0.02 using today's share count. There will be a onetime cost in 2012 associated with the retirement of these outstanding notes, and we estimate this to be between $0.13 and $0.17 of earnings per share and probably closer to the higher end of that range. When we report EPS, we will provide the specific impact from this onetime item.

And keep in mind that the impact from the tender offer and the refinancing is not included in the guidance that I'm providing today, both for 2012 and for 2013. The tender won't officially be finalized until later this month, so we can only estimate the impact. We'll be in a better position when we report fourth quarter earnings in February to provide you with a more informed estimate of the annual interest rate savings for 2013 and beyond.

We remain focused on enhancing our returns, and we are making good progress, and we've targeted additional improvements over the next several years. In fact, thanks in large part to the successful initiative to improve working capital performance, we have already exceeded our 2015 goal for return on net assets. So we set a new higher goal for 2015 of between 31% and 32%. And I think that's a good segue into our capital allocation priorities.

When we laid out our 5-year steady-state targets in late 2010, we said these targets would allow us to generate approximately $31 billion of cash that could be made available to enhance shareholder returns. So on average, over the time period, we would have between $5.5 billion and $6.5 billion available annually. Our focus is to deploy our substantial cash available with the goal of achieving the highest possible return for our shareholders. When we first laid out our targets, we set a dividend payout goal of approximately 25% to 30% by 2015 versus our level of approximately 13% at that time. That implied a compounded annual growth rate in our dividend of nearly 25%. We'll use additional liquidity to invest in high ROIC efforts such as bolt-on acquisitions that can supplement our existing asset base; and absent more attractive value-enhancing internal projects, we'll do share repurchases with approximately $3 billion to $4 billion expected to be available annually on average. Our cash deployment under this strategy is guided by disciplined risk-adjusted decisions. We'll invest in projects that help us grow our business with good long-term returns. And we are committed to funding these types of projects or returning the cash to our shareholders if that creates the best value.

So how have our strategies performed over the first 2 years of execution against these targets? Let's take a look at the cash we generated in 2011 combined with the cash we expect to generate throughout the end of each year across our enterprise. More than $12 billion of cash is expected to be generated in '11 and '12 from our strong growth in earnings, as well as our solid working capital performance. We expect to reinvest approximately $3 billion of this cash back into our business, and that leads us with more than $9 billion of free cash or organic cash. And putting aside the impact of a debt refinancing, our expectations are that by the end of the year, we will actually have reduced our outstanding debt by approximately $1 billion, as we work to achieve our 2.7x leverage target. That means that we'll have approximately $8.5 billion to enhance shareholder returns, a substantial amount.

So how have we allocated this cash? Combined with approximately $1.5 billion of proceeds the company has received from other financing activities, primarily the exercise of employee stock options in the sale of our TheraCom business, we have allocated approximately $10 billion among dividends, acquisitions and share repurchases. Over the past 2 years, we have increased our quarterly dividend by 86%. Our payout ratio is on target to be approximately 21% by the end of this year. We've acquired a couple of first-rate PDP businesses that are already bolstering our strategy in the Medicare Part D space. And we've done approximately $7 billion of share repurchases or $3.5 billion per year on average. So our deployment of capital has been very much in line with the targets we outlined a couple of years ago.

Over the next several years, we will continue to build upon that success. During the 5-year time horizon from 2011 through 2015, over $33 billion of cash could be generated by the earnings targets we have in place, coupled with strong working capital management. Now it is reasonable to assume that we would invest approximately 30% of this cash back into the operations of our business. And once that is used, we'd have more than $23 billion of free cash available to enhance shareholder returns, adding nearly $14 billion of free cash over the next 3 years on top of the more than $9 billion we expect to generate in '11 and '12.

An additional $8 billion of cash could be made available by issuing debt while maintaining our 2.7x adjusted debt to EBITDA leverage target for a total of approximately $31 billion. This would allow us to maintain some financial flexibility while also preserving our high BBB credit rating. And based on our targets, our intention would be to roll all upcoming debt maturities and add incremental debt as necessary to maintain that leverage target. So over the next 3 years, we would have more than $22 billion available to enhance shareholder returns.

Now I want to take just a moment and look at our solid history of enhancing shareholder returns. In 2012, we marked our ninth consecutive year of a dividend increase. We've stepped up the magnitude recently, and over the last 2 years alone, our compounded annual growth rate in the dividend has been 36%. Additionally, we have returned more than $11 billion to our shareholders in the form of share repurchases over the past 5 years, including $4 billion from 2012 alone. And what we've said in the past, we plan to continue to enhance shareholder value through a combination of dividends and share repurchases. And today, we're announcing that our Board of Directors has approved a 38% increase in our quarterly dividend for 2013. The increase translates to $0.90 per share, up $0.25 per share, and this puts us on track to meet our 2015 dividend payout ratio target in 2013, 2 years ahead of our goal. Beyond funding this dividend increase, we expect to complete another $4 billion of share repurchases during 2013. For modeling purposes, the timing of '13's repurchase program is expected to be very similar to the timing of this year's repurchase activity.

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