Highlights From CVS's Q3 Conference Call: Guides Slightly Higher for FY - Still In-line with Estimates

November 5, 2009 3:17 PM EST

CVS CaremarkCorporation (NYSE: CVS) reports Q3 EPS of $0.65, 1 cent better than the analyst estimate of $0.64. Revenue for the quarter was $24.60 billion, which compares to the estimate of $24.61 billion.

Highlights From CVS's Q3 Conference Call:

• (CFO) Now, on to guidance for the year, for the Retail segment, we continue to expect revenue growth of between 12 and 14% for the year, with total same-store sales in the range of four to 6%. For the PBM segment, revenue should be up between 16 and 18% for the year. For the total company, we expect revenue growth of around 12 to 14% of the full year after intercompany eliminations of $7.5 billion.
  
• We expect to deliver adjusted earnings per share from continuing operations, excluding the effect of the tax benefit, of $2.61 to $2.64, up from our previous guidance of $2.59 to $2.64. (Consensus is $2.62)
  
• (CEO) Total revenues increased 18%.
  
• Our PBM revenues increased 23%, while retail revenues were up 18. Retail comps up 5.7 and I should point out without any benefit from flu shots, our adjusted EPS from continuing operations was $0.76. If you exclude the $0.11 tax benefit, adjusted EPS was $0.65, up more than 8%.
  
• Maintained a healthy balance sheet and generated more than 490 million of free cash flow for the quarter.
  
• Total same-store sales increased 5.7% in the third quarter.
  
• Our share in markets in which we operate grew over 100 basis points.
  
• Pharmacy comps increased to solid 8%, better than the last quarter, and in fact the highest we've seen in two years, and I guess almost close to twice the industry average.
  
• And that occurred even as our generic dispensing rates surpassed 70% on the retail side. Our pharmacy comps will negatively impacted by about 380 basis points due to recent generic introductions and further generic expansion.
  
• We saw approximately 250-basis point benefit in pharmacy comps from Maintenance Choice, that's up 190 basis points in the second quarter and 120 from the first quarter.
  
• Comp scripts increased 4.9% in Q3. And you should recall that our 90-day Maintenance Choice scripts billed at retail, we count as one script rather than three.
  
• Excluding Longs in Q3, private label accounted for 17% of Front store sales, up 120 basis points versus last year.
  
• We added about 250 new private-label items and we expect to add over 900 for the full year.
  
• Let me update you on the Longs integration. We completed the system integration in May, we closed the headquarters in July and we completed all store remodels in October, we are right on track, we are introducing the stores to the marketplace with a multimedia advertising blitz, as we speak. Even before the promotions however, the early results of store remodels have been very encouraging.
  
• So right now we have private levels of about 11% of Front store sales. That's obviously lower than our core business, but up 700 basis points than since the second quarter.
  
• In total, we opened up 87 new and relocated CVS Pharmacy stores in the quarter and closed six others, resulting in 59 net new stores in the quarter. Year-to-date, we opened or relocated 236 stores, so we're right on track there had about 3% retail square footage growth for '09. We also completed 37 file buys in the quarter, and we expect to do about 250 for the year, which is up about 10% versus last year.
  
• We opened up eight new clinics during the quarter and now we have 565 clinics across 25 states. About 100 of those operate seasonally. The third quarter, we saw better than expected growth in the clinics and this growth was really excluding the flu shots. So we had traffic of 77% in MinuteClinic and that's not counting the flu shots.
  
• Third-party coverage leads to higher Utilizations, we added another 4.5 million additional lives to the network in Q3. So now 80%, slightly over 80% of the visits are third-party paid. We're focused on improving the returns at MinuteClinic.
  
• The cost of this move is approximately $0.01 a share, which will be primarily in 2010. We remain very enthusiastic about the prospects for MinuteClinic. Were investing about five to $0.06 in MinuteClinic this yar. We expect somewhat less next year, maybe four to five, and we expect to break even in 2011 on an all-in basis.
  
• Now, let me turn to the PBM business, which also had a very good quarter, let me give you some highlights. Pharmacy network revenues were up 28%. Mail Choice revenues were up 14.8. And recall that Mail Choice is our metric, which includes mail order plus 90-day claims filled at retail via Maintenance Choice.
  
• Our generic dispensing rate increased 320 basis points to a best-in-class 68.3 versus LY. Operating profit in the PBM was up 13%, and EBITDA per adjusted claim increased 8% to 489 on an apples-to- apple basis, you have adjust out RxAmerica, which was not in last year's results.
  
• As I mentioned earlier, our new products are gaining traction. Today, I'm pleased to report that we now have 417 clients representing over 5 million lives, who have adopted Maintenance Choice or will adopt it in the first quarter '10. That's up from 270 clients in the second quarter and 200 at the beginning of the year, so clearly Maintenance Choice is gaining acceptance in the marketplace. The 470 clients adopting Maintenance Choice represent only about 13% of our book, so there is clearly room to grow.
  
• We had $1.7 billion that we lost in Med-D business. This was the 500,000 lives that we lost in the duals, and once again, this was since the last call. So net-net, it's about $4.8 billion in loss -- in net loss for 2010 and approximately almost 3.7 billion since the last call. If you look at the losses, total the losses with Med-D and the $4.5 billion contract losses. They really come from four contracts plus the Med-D lives.
  
• We were not in a position to provide 2010 guidance at that time, which we weren't, because we hadn't done our budget. But I also said I'd be disappointed if we didn't have an EPS growth of at least 13 to 15% next year for the enterprise. To get that 13 to 15% growth rate, I expect that strong double-digit growth in our retail business, which I still do, and I expected low-to-mid single digit in our PBM business, which is not going to happen.
  
• Given all of that, it now looks like operating profit in the PBM will decline in 2010, perhaps as much as 10 to 12%
  
• While our retail business is still expected to achieve strong double-digit operating profit growth in 2010, which will likely be -- the retail range would likely be in the 13 to 16% range.
  
• (CFO) Pharmacy network claims grew 9%. This growth was driven by the addition of RxAmerica as well as the impact of net new business. Total Mail Choice revenues grew by 14.8% to 4.2 billion. Our overall Mail Choice penetration rate of 23.8% was up approximately definitely 50 basis points from the rate in the third quarter 2008 on a reported basis.
  
• However, our ex-Americas claims mix, which is heavily weighted towards retail and network claims
  diluted the Mail Choice penetration rate by 240 basis points. So adjusting for this factor, our underlying Mail Choice penetration rate grew from 23.3% to 26.2%, up 290 basis points.
  
• Now what about the retail drugstore side of our business. We saw revenues increased by 17.9% to $13.6 billion in the third quarter. Longs contributed approximately 1.0 billion of that growth during the quarter or one extra date this year added that approximately $167 million.
  
• So the underlying growth rate was 7.5%. As Tom mentioned, the third quarter comps increased by 5.7% with pharmacy comps up a very solid 8% and Front store comps up 0.8%.
  
• Moving on to gross profit, the overall dollars improved by 14% despite percentage margin dropping by 75 basis points.
  
• The gross profit margin in the retail segment declined by approximately 100 basis points in the third quarter to 29.4%.
  
• Overall, operating expenses as a percentage of revenues, improved by approximately 10 basis points. The PBM segments percentage stayed flat at 1.8%.
  
• In the retail segment, the improvement was approximately 20 basis points to 22.7%.
  
• Moving to the consolidated income statement, we saw a net interest expense in the quarter increase to $123 million, largely reflecting the increase debt position due to Longs.
  
• Our effective income tax rate was 29.1% in the third quarter. The large improvement was due to the recognition of approximately $155.7 million of previously unrecognized tax benefits relating to the expiration of various statutes of limitation and settlements with tax authorities.
  
• So we ended the quarter with total debt net of cash and cash equivalents of $10.8 billion. That's up
  approximately $400 million from year-end and largely reflects normal swings in our working capital.
  
• (Q&A) Thank you. I guess just to be clear then, Tom, relative to 13 to 15% for next year that you had initially discussed, when you talked about the PBM being down 10 or 12% on an operating profit, are we looking at something more like 2.75 or 2.80 number on an EPS basis? (A)Well, you can -- we're not going to obviously give you the totals, but you can kind of roll it up and get to the number. But it's -- as I said, when we did this and I gave you those projections. It was basically single to mid digit -- single mid digit -- low to mid digit single growth for the PBM. So we were looking in the 2 to 4, 2 to 5% range for growth when we give you those numbers. And obviously, it's going to be less than that as I said in the 10 plus range. So you can kind of roll it up to getting the ballpark.
  
• Obviously, we clearly [indiscernible] for the stock and certainly it looks like for next year in terms of the overall growth is going to be the selling side on the PBM business. Can you give us maybe some more granularity as to why, in the long run, you're still optimistic about sort of the combined model? And maybe sort of what's going wrong in the last year or two and why you think that's going to get better in the next year or two? (A) The reason I saw confidence and we continue to have confidence in the combined model is because of what we're seeing in the marketplace from new clients. And the money and the time that we're saving, not only the plan, but the members, so there is uptake on it. And listen, this is all about results so I'm not pollyannic here. We get it. We got to produce better results on
  the PBM side. Having said that, I think it's important to segment the pieces.We had some big losses.
  We had a lot of wins, we renewed contracts, we're getting more share of the spend from those contracts. But we, in fact, -- when you lose -- we lost Coventry, which -- we lost the Med-D business, and then we obviously expected to lose the commercial business. Chrysler, we lost the retirees. It's a
  smallest piece of it. It went to where Ford and General Motors were with Michigan Blues. We didn't lose the actives. And then the Med-D was a really big headwind for us. That was it huge, a huge hit when you look at obviously the spread issue and also the life. I'm still not happy with it, but if you look at where we were, I mean, we were thinking that we were going to be in the three to 4% growth, three to 5% growth range for the PBM. That was with the kind of the Med -- even if you back out of Med-D, Med-D was 10 percentage points, right, the spread. So we're not going to have that headwind in '11. Obviously, we're going to have -- we believe we're going to have more time in the selling season. This
  has taken more time than we thought, right. We developed in these programs in'08. We started selling them in '09, and we got less uptake in '10, I know we got hit with some big losses and then the Med-D, so we are confident, we are making some changes, but it's -- if you look at these contracts that we lost,
  none of them were because of the model. There were varying reasons some price, one service, there were varying reasons, but none of them because of the model. Having said that, we know we've got to produce results, and we're going to produce results going forward.

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