CVS Corporation (CVS)

CVS 
$77.44
*  
0.54
0.7%
Get CVS Alerts
*Delayed - data as of Jul. 14, 2014 10:18 ET  -  Find a broker to begin trading CVS now
Exchange: NYSE
Industry: Health Care
Community Rating:
View:    CVS Real Time
 
 
Symbol List Views
FlashQuotes InfoQuotes
Stock Details
Summary Quote Real-Time Quote After Hours Quote Pre-market Quote Historical Quote Option Chain
CHARTS
Basic Chart Interactive Chart
COMPANY NEWS
Company Headlines Press Releases Market Stream
STOCK ANALYSIS
Analyst Research Guru Analysis Stock Report Competitors Stock Consultant Stock Comparison
FUNDAMENTALS
Call Transcripts Annual Report Income Statement Revenue/EPS SEC Filings Short Interest Dividend History
HOLDINGS
Ownership Summary Institutional Holdings Insiders
(SEC Form 4)
 Save stocks for next time

CVS Caremark (CVS)

Q4 2012 Earnings Conference Call

February 6, 2013, 8:30 am ET

Executives

Nancy Christal – SVP, IR

Larry Merlo – CEO, President

David Denton – CFO, EVP

Mark Cosby – EVP, President of CVS Pharmacy

John Roberts – Evp, President of CVS Caremark

Analysts

Dane Leone – Macquarie

Robert Willoughby – Bank of America

Steven Valiquette – UBS

Eric Bosshard – Cleveland Research

Matthew Fassler – Goldman Sachs

Greg Hessler – Bank of America Merrill Lynch

Lisa Gill – JPMorgan

John Ransom – Raymond James

John Heinbockel – Guggenheim

Edward Kelley – Credit Suisse

Ross Muken – ISI Group

Meredith Adler – Barclays Capital

Tom Gallucci – Lazard Capital

Ricky Goldwasser – Morgan Stanley

Deborah Weinswig - Citigroup

Presentation

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the CVS Caremark fourth quarter earnings call. During the presentation, participants will be in a listen-only mode. Afterwards we will conduct a question-and-answer session. (Operator Instructions)

As a reminder, this conference is being recorded Wednesday, February 06, 2013. I would now like to turn the conference over to Nancy Christal, Senior Vice President Investor Relations. Please go ahead, ma’am.

Nancy Christal

Thanks, (Suzzy). Good morning, everyone, and thanks for joining us today. I’m here with Larry Merlo, President and CEO, who will provide a business update, and Dave Denton, Executive Vice President and CFO, who will review our financials. John Roberts, President of Caremark, and Mark Cosby, President of CVS Pharmacy, are also with us today and will participate in the question-and-answer session following our prepared remarks.

During the Q&A, please limit yourself to one or two questions so we can provide more analysts and investors the chance to ask their questions. Please note that we posted slide presentation on our website this morning and it summarizes the information on this call as well as key facts and figures around our operating performance and guidance, so I recommend that you take a look at that.

Additionally, note that we plan to file our annual report on Form 10-K later this month and it will be available through our website at that time.

During this call, we’ll discuss some non-GAAP financial measures in talking about our company’s performance, mainly free cash flow, EBITDA and adjusted EPS.  In accordance with SEC regulations, you can find the definitions of the non-GAAP items I mentioned, as well as the reconciliations to comparable GAAP measures, on the Investor Relations portion of our website. And, as always, today's call is being simulcast on our website, and it will be archived there following the call for 1 year.

Now, before we begin, our attorneys have asked me to read the Safe Harbor statement. During this presentation, we'll make certain forward-looking statements that are subject to risks and uncertainties that could cause actual results to differ materially. Accordingly, for these forward-looking statements, we claim the protection of the Safe Harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995.

We strongly recommend that you become familiar with the specific risks and uncertainties that are described in the Risk Factors section of our most recently filed annual report on Form 10-K and that you review the section entitled Cautionary Statement Concerning Forward-Looking Statements in our most recently filed quarterly report on Form 10-Q.

And now I'll turn this over to Larry Merlo.

Larry Merlo

Well, thanks Nancy.  Good morning everyone, and thanks for joining us today.  Obviously we’re very pleased with the strong results we posted in the fourth quarter and full year 2012, with solid performance across the enterprise.

If you exclude the one-time cost of $0.17 per share related to the early extinguishment of debt, adjusted earnings per share from continuing operations for the fourth quarter and full year were $1.14 and $3.43 respectively, demonstrating very healthy underlying growth of 28% for the quarter, 23% for the year.

Now, you’ll recall that in December we retired some long term debt, replacing it with debt at lower interest rates, and that refinancing and the associated one-time cost was not included in our guidance.  So our fourth quarter results reflect strong performances at the high end of our expectations in both the retail and PBM segments.

In addition, below the line benefits from a lower effective tax rate and fewer shares than expected drove the outperformance, with the quarter exceeding the high end of our guidance by $0.03 per share.  We also generated $1.1 billion in free cash flow in the quarter, bringing the 2012 total to $5.2 billion, which also exceeded our goal for the year.

Now, in addition to posting better-than-expected 2012 results, this morning we’re raising our guidance for 2013, taking into account the anticipated accretion from the debt refinancing.  We now expect to achieve adjusted earnings per share for ’13 in the range of $3.86 to $4.00, and that’s up $0.02 from our previous range of $3.84 to $3.98.  And Dave will provide the details of our guidance during his financial review.

So with that, let me provide a brief business update, and I’ll start with our PBM.  Since our analyst day in mid-December, there has been no material change in the 2013 selling season.  And with nearly 85% of our client renewals completed to date, our retention rate stands at 96%.

Now, on analyst day we reported net new business wins for ’13 of about $400 million, and while we have had some additional wins since the analyst day, we expect the impact of the recent CMS sanction, which I’ll speak about shortly, to basically offset those recent wins.  So, again, our net new business for ’13 stands at about $400 million.

Now, it’s obviously very early in the 2014 selling season, but efforts are well-underway, and our differentiated offerings continue to gain attention in the marketplace.  Client interest in our unique Maintenance Choice offerings continues to be robust, and we now have about 15.8 million lives covered by more than 1,100 plans that have implemented or committed to implement our Maintenance Choice offerings.  And that number is up from 14.5 lives at our last update, and looking forward, we see the potential to increase the number of lives to an even higher level.

We are enrolling new lives into both of our Maintenance Choice offerings, with some clients opting for the 1.0 offering and others opting for the new 2.0 design.  Most of the lives are coming from plans that previously had voluntary mail plan designs, so these clients can now begin to experience the cost savings Maintenance Choice offers.

Pharmacy Advisor, our flagship clinical offering, has also made strong advances.  Five new disease states have been successfully implemented as of January 1, including asthma, COPD, depression, osteoporosis, and breast cancer.  And as we said on analyst day, we expect to have about 900 clients with about 16 million members enrolled in all, or some of our available
programs, and we have seen a very positive response from clients to the newly expanded offerings.  

We also began offering Pharmacy Advisor to our Medicare clients on January 1, and we’re excited about future opportunities to support these clients as they strive to improve their star ratings.

And I think these are two great examples of how we’re capitalizing on our integrated assets, and these programs are helping to lower healthcare costs while improving the health of those we serve.

Let me talk more about the recent CMS sanction on our Medicare Part D subscription drug plan.  The sanction means that we cannot enroll new individual SilverScript members or market our Silver Script plan to potential individual members until the sanction is lifted.

However, current SilverScript members are not affected by this action, including our EGWPs along with the new individual members that enrolled at the beginning of this plan year.  Our clients’ EGWP plans and their members are also not affected by the sanction.  This sanction relates only to our SilverScript plan and does not affect Medicare Part D plans offered by our health plan clients.

Now, that said, let me acknowledge my disappointment in these circumstances.  Our goal is to execute flawlessly across the organization every day, and in consolidating the Medicare Part D enrollment systems for SilverScript, we did not deliver on that goal.  So we’re working to resolve these issues as expeditiously as possible.  The sanction should be lifted when CMS is satisfied that the issues are fixed, and not likely to recur.  Now, let me assure you that we are highly focused on working with CMS to bring these issues to resolution as soon as possible.

So with that, I’ll turn to three important PBM growth drivers: the fast-growing specialty pharmacy business, our streamlining initiative, and the Aetna relationship.  Now, the specialty pharmacy business continued on pace, with revenues increasing more than 31% versus the same quarter of last year.  And this specialty growth was driven by new PBM clients, new product launches, along with drug price inflation.

And given that specialty costs are growing rapidly, our clients are looking for help to better manage this trend.  And our specialty guideline management program continues to garner a great deal of interest with some significant new clients adopting the program late last year.

We’re also seeing a lot of interest in our specialty medical benefit management program, especially among our health plan customers.  And we have multiple pilots underway.  We expect to close and implement several other customers during the 2013 year.  So specialty pharmacy will continue to be a key area of focus for us going forward.

As for the streamlining initiative, we are on track with our efforts to reorganize PBM operations to improve productivity, rationalize capacity, and consolidate our adjudication platforms to one destination platform with enhanced capabilities.  We now have about two-thirds of our business on the destination platform, and we expect to increase that to 85% by the end of this year.

As for the other transformation activities, we anticipate being more than 95% complete by the end of April.  So we’re on track to deliver significant cost savings from the streamlining efforts, and we expect to hit the full  run rate of annual savings - that being $225-275 million - beginning in ’14.

And then, as for the Aetna relationship, the client systems conversion continues to proceed successfully.  We have further migrations scheduled throughout this year.  And once a client’s migration is complete, we can then begin to offer our differentiated products and services.

We have had a successful selling season as Aetna has added more than 1 million pharmacy lives to their book, and we have seen interest within the Aetna client base to implement Maintenance Choice and Pharmacy Advisor, and we believe this is further enhanced at this competitive position in the marketplace.

So we’re very optimistic as to what lies ahead, as we continue to work with the Aetna team to drive cost savings for their clients.

With that, let me turn to our retail business.  We had a very strong quarter, with same-store sales increasing 4%.  Pharmacy comps also increased 4% in the quarter, with front-store comps increasing 3.9%.  

New generics had a negative impact of about 1,100 basis points on pharmacy comps, and you may recall that’s up from about 900 basis points in the third quarter.  Script cost increased 11% on a 30-day supply basis, and 9% when counting 90-day supplies as one script.  We had a slight benefit in the quarter from flu-related scripts and flu shots increasing during December.

In addition, our retention of scripts gained during the Walgreens Express impasse was also a factor.  As expected, we retained at least 60% of the scripts gained during the impasse, and we estimate the impact added about 340 basis points to our script comp, equating to about 5.5 to 6 million scripts.  And we remain confident that we will continue to retain at least 60% of the scripts in 2013.

Now, as for the front-store business, both customer traffic and the average front-store ticket increased notably in the quarter.  I’m sure you’re not surprised to hear that we saw particular strength in cough and cold, allergy, and flu-related sales.  Private label sales represented 18.1% of front-store sales in the quarter.  That’s up about 20 basis points year over year.  And we also continued to see solid sales and share growth in the beauty category, driven by skincare and cosmetics.

In addition, we estimate that the Walgreens Express impasse positively impacted our front-store comp by about 150 basis points in the quarter.  And as for the Christmas season, seasonal sales came in close to, but just below, our expectations.

When you look at market share, the latest data shows that CVS has gained front-store share versus a year ago.  Our share growth in the drug channel was 226 basis points, and against multi-outlet competitors, 17 basis points.

Now let me touch on our ExtraCare program, because it continues to be a key differentiator for us, with the scale of our program increasing dramatically in 2012, even with competitive activity in the loyalty space.

Both front-store and pharmacy transactions with the ExtraCare card increased.  We issued more personalized offers, and we saw 19% growth in the number of offers redeemed, with many now coming from the ExtraCare coupon centers.

In addition, increased engagement of our ExtraCare members is driving meaningful results.  As an example, we have doubled our email program to more than 15 million active participants.  They have received over 60 million personalized email offers.  That’s up 69% versus the prior year.  Beauty Club participation grew by 21% to 11 million customers, affording targeted promotion and profitable sales growth.

And just last week, we launched an enhanced ExtraCare program for pharmacy and health rewards. Now, this is an opt-in program, and individual enrollment versus household participation allows for more personalized communication.  We can offer members a wider range of rewards for healthy behaviors that can result in improved adherence.  So this program will be a great tool for driving prescription adherence, script consolidation, and customer retention.

And while ExtraCare has been in the marketplace for 15 years, I think these are examples of how we’re not sitting still.  These enhanced programs are geared to our higher-value customers and it enables us to focus and tailor our rewards along with enhancing the productivity of our investments.

With that, let me turn to our real estate program.  We opened 45 new or relocated stores.  We closed two, resulting in 35 net new stores in the quarter.  And for the year, we opened 150 new or relocated stores, closed 19, resulting in 131 net new stores with 2.1% retail square footage growth.

Now, before turning to MinuteClinic, I want to touch on a recent transaction.  Late last week, we closed on the acquisition of Drogaria Onofre, a privately held retail drugstore chain in Sao Paolo, Brazil with 44 stores.  This transaction is not financially material to our company.  However, it is our first foray into the international drugstore space, and we wanted to provide a little color this morning.

As you know, we have been exploring opportunities for possible international expansion, and we’ve said many times that our approach would be measured, and that we would exercise financial discipline.  We believe this acquisition is a great example of that strategy in action.

Onofre has a strong reputation in the marketplace.  They do a great job in tailoring their stores to market to different customer segments.  And we view Brazil as an attractive market, given that healthcare and pharmacy are expected to grow double digits for the next decade.  And while chains are prevalent, it is still a highly fragmented market.  So we see nice opportunities to grow the business over time.  And as we’ve said, we will continue to take a measured approach to our international growth plan.

So with that, let me turn to MinuteClinic, which recorded very strong revenue growth in the quarter.  On a comparable basis, sales were up more than 38%.  This was the same quarter last year.  And as we headed into January, with a strong flu season, our patient visits at MinuteClinic reached unprecedented daily levels.

In addition to treating [acute visit] patients in the quarter, we continued to work on wellness programs along with programs aimed at treating chronic conditions.  For example, we’ve developed a provider education program with the American Heart Association to support our hypertension evaluation visits.  And we’re also piloting enhanced smoking cessation and weight management programs, and the strong growth we’ve experienced in MinuteClinic’s non-acute services is helping us to reduce the seasonality of the business.   

We opened 31 net new clinics in the quarter, and we ended 2012 with 640 clinics in 25 states and the District of Columbia.  And as Andy Sussman noted on Analyst Day, we’re ramping up our expansion plans, and we expect to open another 150 clinics this year, ending ’13 with just under 800 clinics.

MinuteClinic is also expanding its affiliations with many of the nation’s leading health systems.  And it’s also increasing its collaboration with our PBM clients.  And through all of these efforts, we will help to transform the delivery of primary care in the U.S. as our healthcare system continues to evolve.  So with that, let me turn it over to Dave for the financial review.

David Denton

Good morning.  Thank you, Larry.  Today I’ll provide a detailed review of our fourth quarter 2012 results, and review our 2013 guidance.  But let me begin with a wrap up of last year’s capital allocation program, and how we’re using our strong free cash flow to return value to our shareholders.

In the fourth quarter, we finalized the accelerated share repurchase program that we began in September, and we also repurchased approximately 7.1 million shares for approximately $329 million in the open market.  So for all of 2012, we repurchased approximately 95 million shares for $4.3 billion, averaging $45.58 per share.

Additionally, we paid approximately $202 million in dividends in the fourth quarter alone, bringing our total for the year to $829 million.  We finished the year with a payout ratio of 21.3%, and our strong earnings outlook this year combined with a 38% increase in the dividend we announced at our analyst day puts us on track to achieve our targeted payout ratio of 25% by the end of 2013, two years ahead of our schedule.

So between dividends and share repurchases, we’ve returned more than $5.1 billion to our shareholders just in 2012, and our expectation is that between dividends and share repurchase, we will return approximately $5 billion again to our shareholders in 2013.

We generated $5.2 billion of free cash in ’12, and $1.1 billion in the fourth quarter alone, up $419 million from the same period of last year.  This was driven by our earnings outperformance as well as improved receivables and payables management and the timing of certain payments.

Regarding the balance sheet, over the course of 2012 we continued to make great strides in improving our cash cycle, especially within the retail segment.  Inventory days within retail improved by more than 3.5 days in 2012, and we reduced our retail cash cycle by more than 5 days throughout the year.

The retail team was able to reduce inventories by approximately $450 million through process improvements and while just short of our $500 million goal, we remain committed to further inventory reductions as we move forward.

In the fourth quarter, gross capital expenditures of $716 million were offset by a $102 million of sale leaseback activity.  For the year, our net capital expenditures were $1.5 billion, which included $2 billion of gross capex, offset by $529 million in sale leaseback proceeds.

As for the income statement, adjusted earnings per share from continuing operations came in at $1.14 per share, approximately $0.03 above the high end of our guidance, after you adjust for the impact of the debt refinancing.

GAAP diluted EPS was $0.90 per share, and as Larry said, the EPS beat was driven primarily by better than expected below the line performance.  But both the PBM and retail segments performed at or above the high end of expectations as well.

So let me quickly walk down the P&L statement.  On a consolidated basis, revenues in the fourth quarter increased 10.9% to $31.4 billion.  Within the segments, net revenues increased 17.4% in the PBM to $18.6 billion.

The significant number of new client starts in 2012 drove substantial growth over last year, while Medicare Part D was also a key growth driver.  Acquisitions such as Universal American and Health Net, as well as organic member growth are responsible for volume increases in Medicare Part D.

And we continue to see some drug price inflation, particularly in our specialty business, which helped to grow revenues over last year.  These positive revenue drivers were partially offset by the growth in the PBM’s generic dispensing rate, which increased 500 basis points versus the same quarter of last year to 80%.  In our retail business, revenues increased 5.1% in the quarter to $16.3 billion, driven primarily by strong same-store sales growth.

Turning to gross margin, we reported 20.1% for the consolidated company in the quarter, an increase of approximately 45 basis points compared to Q4 of ’11.  Within the PBM segment, gross margin increased by 75 basis points versus Q4 of ’11 to 7.2% while gross profit dollars increased 16% year over year.

The increase year over year was primarily driven by the big increase in GDR, higher volumes, and better acquisition cost economics.  These positive margin drivers were partially offset by client price compression.

Gross margin in the retail segment was 31.3%, up 155 basis points over last year.  This improvement was again driven primarily by the 400 basis points increase in retail GDR to 79.9%.  Additionally, we saw our private label sales as a percentage of front-store volume increase by 20 basis points to 18.1%.

Total operating expenses as a percent of revenues were essentially flat to Q4 of ’11 at 12.7%.  The PBM segment’s SG&A rate improved approximately 25 basis points to 1.6%.  This was primarily driven by strong revenue growth as well as improvements derived from the streamlining effort.

In the retail segment, SG&A as a percentage of sales increased by approximately 125 basis points to 21.6% while expenses grew by 11.6%.  As expected, this was mainly due to the deleveraging effect of the growth in generics as well as the fact that we are comparing against disproportionately lower spending in Q4 of last year.

Within the corporate segment, expenses were up approximately $30 million to $182 million.  And given all that, operating margin for the total enterprise improved 40 basis points to 7.3%.  Operating margin in the PBM improved approximately 100 basis points to 5.6% while operating margin at retail improved by about 35 basis points to 9.7%.

For the quarter, we beat our growth estimates for operating profit in both the retail and PBM segments.  Retail operating profit increased a solid 8.9%, exceeding expectations by approximately 90 basis points.

PBM operating profit grew a very healthy 42.9%, some 185 basis points above our guidance range.  Both segments benefited from the positive impact of generics and the increase in GDRs.  Additionally, the PBM also benefited from the increasing profitability as we move through the year in the Medicare Part D as well as the increasing benefits derived from the streamlining effort.

Now, going below the line on the consolidated income statement, net interest expense in the quarter increased approximately $12 million from last year to $159.  Additionally, our effective tax rate was 37.1%, lower than expected related to a nonrecurring item.  Our weighted average share count was 1.25 billion shares, approximately 12 million shares lower than anticipated due to our opportunistic repurchase of additional shares on the open market once the ASR completed.  

Read the rest of this transcript for free on seekingalpha.com