CVS Health Corporation (CVS)

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CVS Caremark Corporation (CVS)

December 20, 2011 8:00 am ET


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

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

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

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

Nancy Christal - Senior Vice President of Investor Relations

Unknown Executive -

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

Per G. H. Lofberg - Executive Vice President and President of Caremark Pharmacy Services


Ross Muken - Deutsche Bank AG, Research Division

John Heinbockel - Guggenheim Securities, LLC, Research Division

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

Unknown Analyst

Mark Wiltamuth - Morgan Stanley, Research Division

Thomas Gallucci - Lazard Capital Markets LLC, Research Division

Steven Valiquette - UBS Investment Bank, Research Division

Ricky Goldwasser - Morgan Stanley, Research Division

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

Lawrence C. Marsh - Barclays Capital, Research Division

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

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

Meredith Adler - Barclays Capital, Research Division

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

Edward J. Kelly - Crédit Suisse AG, Research Division

David Larsen - Leerink Swann LLC, Research Division


Nancy Christal

Good morning, and welcome to CVS Caremark's 2011 Analyst Day. I'd like to thank all of you for taking the time to be with us, especially so close to the holidays. We know it's a busy time, and we really appreciate your interest in CVS Caremark. I'd also like to welcome those listening in on the webcast. We are very excited to be here this morning to discuss how we're reinventing pharmacy for better health and better shareholder value. As promised, we'll also walk you through our 2012 guidance, so we have a lot to cover this morning.

Please note that at your seats you'll find a slide book containing all the slides we'll walk you through this morning. It also contains management biographies, and I encourage you to read those. And for those listening in online, all of that information can be found on the website, and I'd note that all of that will be available there for one year.

Now before we begin, our attorneys have asked that I post a Safe Harbor statement. Please take a moment to read it. This statement is also posted on our website and in the slide books.

In addition, please note that over the course of the morning we'll discuss 2 non-GAAP financial measures, free cash flow and adjusted EPS, and they're both defined on the slide. In accordance with SEC regulations, you can find the reconciliations of those non-GAAP measures to comparable GAAP measures on the Investor Relations portion of our website.

And with that, I hope you find today's presentations helpful as you evaluate your investment in CVS Caremark. And now, I'll turn this over to our President and CEO, Larry Merlo, who will walk you through today's agenda. Thanks.

Larry J. Merlo

Well, thank you, Nancy. And good morning, everyone. And I, too, want to thank all of you for coming today. Once a year, we hold an Analyst Day, and we do so for 2 key reasons. First, it gives us an opportunity to provide a deep dive into our strategies to drive long-term growth. And second and equally important, it gives the investment community an opportunity to see the depth of our senior management team. And actually, this year, our Analyst Day includes a third key reason, that being a timely forum for providing our 2012 guidance.

Now we know that the quality of a company's leadership team as well as its management's credibility are very important factors in your investment decision. I have great confidence in our leadership team, and I'm certain that you will leave this meeting this morning with great confidence in our ability to deliver solid growth in the coming years. We've got the right assets in place. We have the right growth strategy, and we certainly have the right people to execute upon that strategy.

So let me review today's agenda. First, our CFO, Dave Denton, will talk to you about how CVS Caremark is driving shareholder value through a disciplined approach to capital allocation as well as solid earnings growth. Dave will provide our 2012 guidance and discuss our long-term financial targets. And then before getting into our more strategic presentations, we're actually going to hold a Q&A session after our earnings outlook to give you an opportunity to ask questions specific to our financial targets. Dave and I will respond to those questions and then we'll take a quick, I'll call it a 5-minute BlackBerry break, at about 9:00, and that will give you an opportunity to send off your emails.

Then when we start back up, I'll be back up here to talk about how CVS Caremark is reinventing pharmacy for better health. We are extremely well positioned to benefit from the evolution of U.S. health care, and our capabilities are extremely well aligned to successfully address our nation's key health care challenges.

And then after my presentation, you will hear from the heads of our 3 key businesses: Per Lofberg, President of Caremark Pharmacy Services; Mark Cosby, President of CVS/pharmacy and the newest member of our senior leadership team; and Dr. Andy Sussman President of MinuteClinic. Each of them will talk about why their respective business is best in class and how they're capitalizing on what we call our integration sweet spots, those capabilities that are unique to us because of our distinctive model and integrated assets. And you'll hear more about these throughout the morning, but suffice to say that these are products and services that no standalone PBM or standalone pharmacy retailer provides to its clients, its members and its customers. Only CVS Caremark does.

And then following Andy, the final presentation of the day will be given by Dr. Troy Brennan, our Chief Medical Officer. Troy will provide the clinical perspective to tie all of this together and talk about why our integrated model is best positioned to solve this cost quality access dilemma facing our health care system. And Troy will share some very encouraging results that we have achieved today with these unique integrated offerings. Then I'll be back up for some brief closing comments and then we will open it up for your questions. We plan to conclude the meeting around 12:15.

And with that, I'll turn it over to Dave Denton for his financial review and 2012 guidance. Dave?

David M. Denton

Thank you, Larry. Good morning, everyone. Happy holidays. Thank you for joining us here in New York in this holiday season. I'm sure you're very anxious to hear about our guidance for 2012, which I'll provide to you in just a few minutes. But my goal today is also to help you better understand how CVS Caremark will drive shareholder value over the long term, both through a disciplined approach of capital allocation as well as solid growth in earnings. And the presentations throughout this morning by my colleagues will provide the context around some of the specific strategies and initiatives that provide the pathway for achieving our financial targets.

So here's my agenda. First, I'll provide some perspectives on our accomplishments throughout 2011. Then I'll discuss our focus on enhancing shareholder value through disciplined capital allocation strategies. After that, I'll switch gears and provide some specific details around our guidance for 2012. I'll go into greater detail around some of the key drivers impacting the timing of our profitability so you can get a good sense of our expected quarterly earnings cadence. I'll also briefly review the potential upside to our guidance if the Walgreens-Express Scripts impact remains unresolved. And although we are not including this on our guidance, we think it's important to provide a framework for how we might benefit should that agreement not be reached. And then lastly, I'll revisit the steady state growth targets that we laid out for you last year to frame up what we see as a strong growth outlook for our business beyond 2012.

With 2011 nearing an end, we are very pleased with our accomplishments and where we stand both competitively and financially. We executed successfully on a number of major initiatives across the company, delivering solid results in a very difficult environment. Importantly, 2011 built the foundation for long-term growth and value creation. We set achievable targets throughout 2011, and we expect to deliver the high end of our initial full year EPS guidance range. We executed on our disciplined capital allocation strategy, returning a very significant $3.7 billion to our shareholders. We remained focused on cost efficiencies across the enterprise, with substantial progress made on our PBM streamlining initiatives and continued productivity enhancements across the retail segment.

We delivered on a number of working capital improvements, including the targeted reduction in inventory in the retail segment to the tune of $1 billion. And as of the third quarter, we had reduced related retail inventories by $850 million, well on track to meet our full year goal. And finally, we completed the acquisition of Universal American's Medicare Part D business, making us a solid #2 player in the Medicare Part D space and position us to take advantage of the rapid growth in Medicare in the coming years.

On our earnings call in early November, we narrowed our 2011 EPS guidance range, giving both solid results during the first 9 months and our outlook for the remainder of the year. We continue to expect to deliver adjusted EPS from continuing operations of $2.77 to $2.81 per share. In addition and consistent with prior guidance, we expect to generate free cash flow of between $4 billion and $4.2 billion. So our outlook for solid performance in the fourth quarter remains intact.

As I mentioned, we expect to generate at least $4 billion in free cash, and we followed a very disciplined approach to the allocation of that cash throughout 2011. We acquired Universal American for approximately $1.3 billion. And the integration has proceeded as planned, and the transaction will be nicely accretive to earnings in 2011, adding over $0.08 per share. Additionally, we raised the dividend by 43% in January and should end the year with a payout ratio of between 19% and 20%. And we completed approximately $3 billion of share repurchases this year, a nice step-up from the $2 billion we completed each of the 2 prior years.

We continue to focus on maintaining a very healthy balance sheet with reasonable and modest financial leverage. Our debt-to-capital ratio at the end of the third quarter was 22.3% or 41.7% when adjusted for our operating leases. While we carry nearly $11 billion in debt, our credit metrics today are modestly better than they were in 2003 prior to our major acquisitions.

While we are comfortable with our current credit profile and our corresponding credit metrics, we are very focused on maintaining our high BBB rating. And as we have said in the past, we are targeting an adjusted debt-to-EBITDA ratio of 2.7x. The BBB rating is important to us as it allows us to participate in the sale-leaseback market at a reasonable cost, and the sale of our developed properties is an important component of cash flow.

Additionally, we believe our debt maturities are well laddered over the next decade with no one year requiring a significant outlay of cash to meet our obligations. Given our strong financial position and the significant amounts of cash we expect to generate in the coming years, we foresee a significant amount of cash being available to continue to enhance shareholder returns in a very meaningful way.

At last year's analyst meeting, we laid out a roadmap for enhancing shareholder value that included 3 main pillars. First is our focus on driving productive long-term growth, our expectation to generate significant levels of free cash and our disciplined approach to the allocation of that cash. These together should lead to enhanced shareholder value. And to help frame up this discussion, I also laid out our 5-year steady state earnings targets using 2010 as a jump-off point. And I'll review that again today after I provide 2012 guidance.

Let's take a look at the cash generation capabilities of our enterprise, which are very substantial. 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's reasonable to assume that we'll invest 30% of that cash back into the business operation, whether through working capital or capital expenditures. Once that is used, over $23 billion of free or organic cash could be available to enhance shareholder returns.

An additional $8 billion of cash can be made available to us by simply maintaining a 2.7x adjusted debt-to-EBITDA ratio for a total of approximately $31 billion. This would allow us to maintain financial flexibility while also enabling us to preserve 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 ratio.

So on average, over the time period, we could have between $5.5 billion and $6.5 billion available annually to enhance shareholder returns. The manner in which we deploy this substantial amount of cash will be guided by disciplined, risk-adjusted decisions to achieve the highest possible returns for our shareholders.

Last year, we set a targeted dividend payout ratio of approximately 25% to 30% by 2015 versus our then level of 13%. That implies a compounded annual dividend growth rate of nearly 25%. In January of '11, we increased our dividend by 43%, providing a nice head start to achieving this very important target. We would use additional liquidity to invest in high ROIC efforts. 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 and other strategy will be guided by disciplined risk-adjusted decisions. We'll invest in projects that help us grow our business with good long-term returns. We are committed to funding these types of projects while returning the cash to our shareholders if that creates the best value. And for your reference, I've included a summary of our capital allocation priorities as an appendix to my presentation this morning.

We are very focused on enhancing returns, including returns on invested capital or returns on net assets. We've already made great progress on reducing inventories in '11, and we see significant opportunities to improve working capital and capital expenditures over the next few years. Along with good working capital management, our expected earnings growth and disciplined capital investments all will be key drivers of improving our returns.

Obviously, our strategy of organic growth combined with growth by acquisition has then allowed us to properly grow returns during periods of integration, which has happened and which we've experienced over the past several years. But I believe that the era of very large acquisitions is likely behind us. And while we will continue to look for bolt-on acquisitions to support our business objectives, we don't expect these acquisitions to detract from our focus on improving our returns. By 2015, we are targeting significant improvements in return on net assets and return on investment capital.

I want to take a moment to look at our solid history of enhancing shareholder value. 2011 was a continuation of that important trend. We've marked the eighth consecutive year of increases in our dividend, with compounded annual growth of 21% over just the past 4 years. And including the $3 billion in '11, we've returned over $12 billion to shareholders in the form of share repurchases over the past 5 years. As we said in the past, we will 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 30% increase in our quarterly dividend for 2012. This increase translates to $0.65 per share, up $0.15 per share from the previous rate of $0.50. Combined with the 43% increase in '11, this puts us well on track to meet our targeted payout ratio by 2015. And as for share repurchases, we expect to complete, at a minimum, $3 billion for 2012. Between dividends and share repurchases, we expect to allocate approximately $3.8 billion to enhancing shareholder returns for our shareholders.

So those are the assumptions for dividends and share repurchases you should use in your models for 2012. So with that, I will turn my discussion to guidance for 2012. This morning, we'll provide guidance for the full year as well as the first quarter of '12. But first, let's walk through the full year details.

We expect consolidated net revenue growth of 11.5% to 13%, a reflection of strong revenue growth across our enterprise but especially within the PBM following another great selling season.

We expect adjusted EPS from continuing operations to be in the range of $3.15 to $3.25 per share, reflecting very healthy year-over-year growth of 13% to 16.5%. The estimate assumes the completion of $3 billion in share repurchases, as I mentioned before. And based on these earnings expectations, our new dividend rate translates to a 20% to 21% payout, up from 19% to 20% this year and 13% in 2010. Again, we expect to generate significant free cash flow in 2012, a reflection of the strong earnings growth and continued discipline around working capital and capital expenditures.

We expect cash from operations in the range of $5.7 to $6 billion. We expect gross capital expenditures to be in the range of $2 billion to $2.1 billion, essentially flat to this year's levels. With sale-leaseback proceeds anticipated to be between $500 million and $600 million, our net capital expenditures is -- would be approximately $1.5 billion. This translates to free cash flow of between $4.3 billion and $4.6 billion, approximately $300 million to $400 million higher than anticipated levels for '11.

For the retail segment, we expect operating profit growth of 7% to 9%, reflecting yet another solid year in solid improvements across our business. We expect net revenue growth of 2% to 3% and same-store sales growth of 0.5% to 1.5%.

You'll notice that the net revenues and same-store sales growth are at levels somewhat below those experienced in recent past. This reflects the impact associated with the significant amount of new generic introductions expected in 2012. These generic introductions will pressure the top line but will help the bottom line, especially after a post-exclusivity period, and this trend is expected to carry forward over the next several years.

Given the distortion on the top line caused by the generic wave, it's important to look at our underlying script growth. So for '12, in addition to same-store sales growth, we'll provide guidance for same-store script growth of between 3% and 4%.

We expect retail gross margins to be up moderately, driven by new generics and growth in private label, which is expected to more than offset pharmacy reimbursement pressures. We expect to see a slight decline in our expense leverage, which I'll talk more about on the next slide. And as a result of all the above, our retail operating margin is expected to expand between 40 and 50 basis points.

Given the start of the significant wave of new generics expected in '12 and beyond, I want to take a minute to touch on the significant impact new generics could have on various retail metrics next year. For example, in 2012, we expect annual net revenues could be impacted between $2 billion and $2.5 billion, while pharmacy same-store sales growth to be impacted between 500 and 650 basis points.

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