Highlights From CVS's Q4 Conference Call: Issues Mixed Guidance for Q1 and FY10

February 8, 2010 1:21 PM EST

CVS Caremark Corporation (NYSE: CVS) reported fourth-quarter earnings of 79 cents per share, a penny higher than the analyst estimate of 78 cents per share, on profit of $1.05 billion. In the same quarter last year the company earned $949 million, or 65 cents per share. Shares are up 6.15% today.

Revenue for CVS in the quarter was up 7 percent to $25.82 billion from $24.14 billion. Wall Street had estimated sales of $26.22 billion.

Highlights From CVS's Q4 Conference Call:

• We expect to deliver adjusted EPS from continuing operations in the range of $2.74 to $2.84 and GAAP diluted EPS of $2.56 to $2.65. (Consensus is $2.78)
  
• We expect Q1 adjusted EPS from continuing operations to be between $0.57 and $0.59 vs. consensus of $0.62
  
• (CEO) While we reported another solid quarter this morning, rounding up 2009 ahead of our initial plan, we did accomplish a lot last year and while we were not happy with our overall PBM selling season, our enterprise wide financial performance was very good.
  
• For the full year, net revenues increased 13% to a record 98.7 billion, adjusted EPS from continuing operations, excluding the tax benefit, increased 7.3% and we generated more than $3 billion of free cash flow.
  
• Last week, we completed one $2 billion share repurchase program and then also began another.
  
• Our generic dispensing rate is up 200 basis points and sizeable growth within our specialty pharmacy, which was up 14%.
  
• We achieved industry-leading results again in our retail business with total comps for the year up 5% and pharmacy comps up 6.9%. The integration of Longs was successfully completed and will drive improved profitability in 2010 and the years ahead.
  
• We opened up one retail call center that will eliminate 85% of the call volume in our busiest stores.
  
• We had net revenues, up 14.5%, our pharmacy revenues are up 19.1 and mail choice revenues, up 6.3%.
  
• Our generic dispensing rate, as I said, is up 220 basis points versus last year to a record 68.9%. And our EBITDA per claim -- per adjusted claim is up 7%, which was up $4.89 and this is on an apples-to-apples basis, excluding RxAmerica.
  
• So now we have about 550 million remaining for renewal in 2010. These contracts started various points through 2010, but mostly in the last quarter.
  
• Let me give you an update on maintenance choice. We have 412 clients that represent about 5.1 million lives already implemented on maintenance choice. We've an additional 70 clients and over 400,000 lives in the process of being implemented. So now we'll have over 470 clients and almost 5.5 million lives on maintenance choice. That's up from 130 clients at the beginning of 2009.
  
• While 17% of the lives adopting maintenance choice in 2009 came from voluntary mail plans, about 41% of the lives adopting it in 2010 came from these voluntary mail plans.
  
• Our latest data shows that on an annual basis, our specialty guideline management program has saved clients over $200 million in avoided drug costs.
  
• We currently have about a 60% penetration in our PBM book.
  
• Another tool that will help broaden our clinical capabilities across our asset base is what we were calling consumer engagement engine or CEE, which provides us with a single view of the patient. The CEE started rolling out in Q4 of last year, where we implemented it first in our PBM customer care center.
  
• This quarter, our retail business delivered significant margin improvement, driven by pharmacy and front store margin increases and disciplined expense control. We continued to gain pharmacy share.
  
• Our retail share, excluding Longs, grew 68 basis points nationally versus last year 's fourth quarter and our retail share in markets in which we operate grew 85.
  
• And as we expected, the inclusion of Longs had a slightly dilutive impact on our fourth quarter comp performance. We expect that to continue through the first half of 2010 and it should turn positive in the second half.
  
• For Q4, total same-store sales increased 4.9% and the Longs stores had a 66 basis point negative impact on comps in the quarter. Pharmacy comps increased a solid 7.3%, and that was despite 34 basis point impact from the inclusion of Longs.
  
• We had good growth in most of our core categories across the chain. In light of the high incidence of H1N1 virus, we had especially strong growth in the cough and cold category in October and November.
  
• We had a very successful Christmas selling season with sales margin and sellthroughs up versus last year. Our merchants really did a great job, placing a heavier emphasis on the value of traditional gift giving products with less emphasis on life sets [ph] and gift wrap.
  
• Private label accounted for 17.6% of front store sales in the quarter, we introduced 108 private label items in the fourth quarter and added 913 items throughout 2009. In the Longs mainland stores, private label increased to nearly 16% of front in sales. That's up over 1,000 basis points from last year's quarter.
  
• Front store traffic and averaging ring 178 basis points and 137 basis points respectively compared to Q4.
  
• So Longs' acquisition adds over 4 million extra care cardholders and our active card base is now 64 million people. I'm extremely pleased with our progress of Longs and I fully expect the acquisition to benefit us in 2010 and beyond.
  
• Let me update you on some real estate. We opened 31 new or relocated stores in the quarter, closed six resulting in 17 net new. For the full year, we opened up 287 stores resulting in 102 net new stores were 3% square footage growth.
  
• We completed 200 file buys for 2009, expect to do the same number in 2010. We'll open about 250 to 300 new stores, a 100 of these will be relocations in 2010, once again 2000 square feet or 2% square footage growth. We entered some new markets, St. Louis in January, Memphis in late January.
  
• Let me provide a quick review of MinuteClinic, which has now surpassed 6.2 million patients since its inception. We opened seven clinics during the fourth quarter and now have 570 clinics in 56 markets. Traffic was up 50% versus last year's quarter for acute visits. We continue to expand our third party coverage adding about 9.9 million lives and now over 80% of the business in the quarter are third party paid.
  
• (CFO) On a consolidated basis, revenues in Q4 increased 7% to $25.8 billion. Revenue growth was muted by the calendar impact, but that benefited from a full quarter of sales in 2009 for both Longs and RxAmerica versus a partial quarter last year. These two factors more or less offset each other.
  
• In our PBM segment, fourth quarter net revenues increased 14.5% to $13.5 billion. RxAmerica contributed approximately $1 billion to that growth largely due to the change in revenue recognition method from net to gross, a change that began in the second quarter of 2009.
  
• Drilling down a little deeper, PBM's pharmacy network revenues in the quarter rose 19.1% to $9.1 billion. Pharmacy network claims were down 5.6%.
  
• So without RxAmerica, our core PBM mail choice penetration rate grew from 23.2% to 26.1%.
  
• In our retail business, we saw revenues increased 4.5% to $14.5 billion in the quarter.
  
• Turning to gross profit, the overall dollars for the company improved by 7% despite percentage margin dropping by 8 basis points. Within the PBM segment, gross profit margin was down 69 basis points.
  
• The gross profit margin in the retail segment improved by 81 basis points in the quarter to 31.2%.
  
• Within the corporate segment, expenses were $140 million, less than 1% of consolidated sales. So, with improvements in SG&A as a percent of sales outpacing the slight decline in gross margin, operating margins for the total enterprise improved as expected. It was up 17 basis points to 7.3%.
  
• Moving to the consolidated income statement, we saw net interest expense for the quarter decline by $18 million to $133 million, largely reflecting lower interest rates on our floating rate notes as well as the retirement of the bridge loan associated with the Longs acquisition.
  
• Turning to the balance sheet and cash flows, we generated over $1.8 billion in free cash flow in the fourth quarter. That compass to 1.1 billion in the prior-year period.
  
• For the full year, we generated free cash flows in excess of $3 billion, lower than we had forecasted.
  
• (Guidance) For the PBM segment, we expect operating profits to decline by 10 to 12%, while we expect operating profit to grow by 13 to 16% in the retail segment. We expect operating margins for the total company to be modestly up from 2009 levels.For the PBM segment, we expect revenue to decline 4 to 6% for the year.
  
• For the retail segment, we expect revenue to increase 5.5 to 7.5%, and same store sales to increase 4 to 6% for the year.
  
• For the total enterprise, we expect revenue to be roughly flat to 2% up from 2009 level. That is after intercompany eliminations, which are projected to equal about 7 to 7.5% of combined segment revenues.
  
• We expect total consolidated amortization for 2010 to be roughly equivalent to the levels in 2009. Combined with estimated depreciation, we project approximately $1.4 billion in D&A. We expect gross capital expenditures to be in the range of 2.4 to $2.7 million essentially flat to 2009.
  
• In light of the lower amount of sale leasebacks, we expect free cash flow to be in the range of 2 to $2.5 billion in 2010.
  
• For Q1, we expected revenue growth for the total company to be in the range of three to 4%. In the retail segment, we expect total is same-store sales growth to be between three and 5%.
  
• (Q&A) Tom, I wanted to get your take on what's happening out there in the front end space. One, the start there since there seems to be a lot of confusion, your traffic and ticket were up in the fourth quarter. You had the same canopy set for your fairplay drug store competitors. Also sounds like CVS took an interesting approach to holiday. What do you think is really setting you apart, your ExtraCare loyalty card is often pointed out as one of the best and in retail, do you think it's ExtraCare, do you think it's some of maintenance choice, can you maybe just [indiscernible] on the details for us today?(A)Yeah. Listen, retail is a lot of detail and it's a lot of different initiatives in the market place. And we've spent a lot of time in the last few years, changing our front end stores, looking at different layouts in our stores. As you pointed out, using the ExtraCare loyalty card to maybe direct our promotional spend a little better. And I think the merchants and our operators have just done a great job. It's about execution in the stores and people come into our stores they find what they need, they find it at the right value. When you think that the average person in our stores buy in three or four items. So they are in and out and I think we have done a great job. I think the merchant has got ahead of it through an holiday season. And they saw what was happening with the economy and how people were thinking about their spending patterns, and we bought differently, we lowered expectations on some of the gifts giving items as I mentioned earlier. So I think it's really a combination of things. And then lastly would be Maintenance Choice. Maintenance Choice has certainly helped our overall comps and increased our traffic, but if you bring people in the store and you don't have the right product and the right merchandise at the right price, doesn't matter what you do. So I think it's really a combination of things and I couldn't be happier.
  
• Okay. And then my follow-up question. We've spoken with several different consultants and the overall theme seems to be that RXConnect is a real differentiator for CVS. Can you potentially elaborate on that?(A)Well, the RXConnect is really the new retail pharmacy system, right, we've rolled out -- we rolled out a system six years ago and now we've rolled out the latest development of our new pharmacy retail system RXConnect that we're still in the process of rolling it out. As I mentioned earlier, we started with the Longs rollout, and then -- because we don't to put the old system in them, put a new one in and as you can imagine. So the Longs system is in place and we continue to rollout our existing stores. But the real the lynchpin after that will be the consumer engagement [indiscernible] which really allows us to essentially leverage our clinical capabilities across our asset base. And we can do all that we can do in the mail center and our call centers around are hearing some gaps in care and improve generic dispensing and preferred formulary. This will allow us to leverage it across the retail base easier right and the pharmacists will have messaging that's easier and direct it'll be included in network process flow. And people always ask how can you do this in the stores and how pharmacists are busy, how can they possibly do these clinical interventions? This is in some cases 10, 20, 30 people a day in the store that takes two or three minutes. So it's not like we have to pull some people into a consultant booth [ph] and talk to them for half hour. This is about making it easy and simple in our stores to address what the clinical opportunities we have for patients whether it's diabetic patients or hypertensive patients or asthma patients. So that's the real win for us to be able to leverage our clinical capabilities across our asset base.
  
• And then I just want -- if Per could follow up on his opening remarks there. You said you haven't really deducted any service issues or other major areas of dissatisfaction among customers. What kind of feedback are you getting from customers? What can create maybe from a positive standpoint, and what kinds of things are they asking about as you think about the upcoming year in benefit design changes, et cetera?(A)Yeah, I think for the most part, everyone who is -- health benefits is under pressure to maintain the funding for their programs and to maintain programs within financial constraints. So I'd say customers are very much focused on how they can kind of control the costs of their benefit programs going forward. They're looking for new benefit designs and sort of innovative programs that can help maintain control over those kinds of costs. They're also obviously looking for flawless execution in the way we and other PBMs are interacting with their organizations. The -- the other couple of areas that are very important I think in this upcoming season is the growth in specialty pharmacy. As you guys know, that's probably the fastest growing part of the drug expense today for pay orders [ph] maybe 15, 20% year-over-year growth rates. So some of the same techniques and principles that have helped PBM to control costs for regular medication, we play an increasingly important role in the growing field of specialty and that's an important focus for us and for our customers. And finally I can sort of comment briefly on Medicare-D as I think many of you know -- many health plans out there are actively engaged in the Medicare-D program and the ability to support them in that field is also an important factor in what they are looking for in this upcoming season.
  
• Okay. And then the gross margin has been fairly choppy over the less couple of quarters, I mean it was great this quarter, it was disappointing in Q3. Can you help us understand the volatility of that a little bit and then how do we think about that as we go through 2010, I mean the inventory build up in cough, cold and flu, does that impact you in the first half of the year, some color there would be great?(A)Certainly the inventory buildup, I don't know that will help or hurt us, but we are positioned well to the extent that a flu season does materialized of any substance, we're in great position there. Secondly, as far as gross profit margin and a spread of that is -- a lot of that's based on introductions and timing of generics throughout the year. So when those generics are available and as we overlap those generics year-over-year, it does have implication on our margin rate.

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