CVS
Caremark to Acquire Longs Drugstores Conference Call
August
12, 2008, 5:30 PM ET
This transcript contains
certain forward-looking statements. These forward-looking statements may be
identified by words such as ‘believes’, ‘expects’, ‘anticipates’, ‘projects’,
‘intends’, ‘should’, ‘seeks’, ‘estimates’, ‘future’ or similar expressions or by
discussion of, among other things, strategy, goals, plans or intentions. Various
factors may cause actual results to differ materially in the future from those
reflected in forward-looking statements contained in this announcement, among
others: (1)
macroeconomic condition and general industry conditions such as the competitive
environment for retail pharmacy and pharmacy benefit management companies; (2)
regulatory and litigation matters and risks; (3) legislative developments; (4)
changes in tax and other laws and the effect of changes in general economic
conditions; (5) the risk that a condition to closing of the transaction may not
be satisfied; (6) the risk that a regulatory approval that may be required for
the transaction is not obtained or is obtained subject to conditions that are
not anticipated; and (7) other risks to consummation of the transaction,
including the risk that the transaction will not be consumated within the
expected time period.
The tender
offer described in this transcript has not yet commenced. This transcript
is for informational purposes only and does not constitute an offer to purchase
or a solicitation of an offer to sell Longs’ common stock. Investors and
stockholders are urged to read both the tender offer statement and the
solicitation/recommendation statement regarding the tender offer when they
become available because they will contain important information. The
tender offer statement will be filed by CVS Caremark with the United States
Securities and Exchange Commission (the "SEC") and the
solicitation/recommendation will be filed by Longs with the SEC. Investors
and stockholders can obtain a free copy of these materials (when available) and
other documents filed by CVS Caremark or Longs with the SEC at the website
maintained by the SEC at www.sec.gov. The tender offer statement and
related materials may also be obtained for free by contacting Nancy Christal at
(914) 722-4704. The solicitation/recommendation statement and
related materials may also be obtained for free by contacting (925)
979-3979.
PRESENTATION
Good day,
ladies and gentlemen, and welcome the CVS Caremark and Longs Drug Store
transaction conference call. My name is Eric and I'll be your coordinator for
today. Now, at this time, all participants are in a listen-only mode. We'll
facilitate the question-and-answer session at the end of the conference.
[OPERATOR INSTRUCTIONS] I would now like to turn your presentation over to Ms.
Nancy Christal, Senior Vice President, Investor Relations for CVS Caremark.
Please proceed.
Nancy
Christal - CVS Caremark
Corporation - SVP, IR
Thank you.
Good afternoon. Thanks for joining us today on such short notice to hear more
about our definitive agreement to acquire Longs Drug Store.
We are
very excited about this transaction and the opportunity it offers CVS Caremark
to acquire a significant presence in important new markets and to facilitate the
expansion of our new Proactive Pharmacy Care offerings to PBM clients. We expect
to complete the acquisition of Longs by the fourth quarter of this year. The
closing is subject to Hart-Scott-Rodino review and other customary closing
conditions.
I'm here
with Tom Ryan, our Chairman, President and CEO, and Dave Rickard, our Executive
Vice President and CFO. We also have Warren Bryant, Chairman, President and
Chief Executive Officer of Longs as well Steve McCann, Executive Vice President
and CFO of Longs with us from California.
On this
call, we will discuss two non-GAAP financial measures, adjusted EPS and EBITDA.
Adjusted EPS is defined as diluted EPS from continuing operations, eliminating
the effect of amortization only, and assuming our overall effective tax rate for
the amortization. EBITDA is defined as operating profit, plus appreciation, plus
amortization.
This
announcement contains certain forward-looking statements, which may be
identified by words such as believe, expects, anticipates or similar expressions
or by discussion of, among other things, strategy, goals or plans. Various
factors may cause actual results to differ materially from those reflected in
these statements, including, among others, macroeconomic and general industry
conditions, regulatory and litigation matters and risks, the risk that a
condition to closing of the transaction may not be satisfied or that a required
regulatory approval is not obtained or is obtained subject to conditions that
are not anticipated and other risks to consummation of the
transaction.
Our
attorneys have also asked me to read the following. The tender offer described
in this announcement has not yet commenced. This announcement is for
informational purposes only and does not constitute an offer to purchase or a
solicitation of an offer to sell Longs common stock. Investors and stockholders
are urged to read both the tender offer statement and the solicitation
recommendations statement regarding the tender offer when they become available,
because they will contain important information. The tender offer statement will
be filed by CVS Caremark with the United States Securities and Exchange
Commission and the solicitation recommendation will be filed by Longs with the
SEC as well.
Investors
and stockholders can obtain a free copy of these materials when available and
other documents filed by CVS Caremark or Longs with the SEC at the website
maintained by the SEC at www.sec.gov. The tender offer statement and related
materials may also be obtained for free by contacting my office at 914-722-4704.
The solicitation recommendation statement and related materials may also be
obtained for free by contacting 925-979-3979.
This call
will be simulcast on the Investor Relations portion of our website at
investor.cvs.com and archived there for one month. Following the call, feel free
to call me with any questions.
And now,
I'm happy to turn this over to Tom Ryan.
Tom
Ryan - CVS Caremark
Corporation - Chairman of the Board, President and CEO
Thanks,
Nancy, and thank you all again for joining us on short notice.
Obviously,
I'm very pleased to discuss this exciting development, because we think it's an
excellent opportunity for our Company and our shareholders.
As
outlined in our press release, you see we've entered into a definitive agreement
under which we will acquire Longs Drug Stores for $71.50 a share in cash for a
total purchase price of $2.9 billion, including the assumption of net
debt.
We will
acquire Longs' 521 retail drug stores in California, Hawaii, Nevada and Arizona
as well as its RxAmerica subsidiary, which offers PBM services to over 8 million
lives and prescription drug benefits programs to 450,000 Medicare beneficiaries.
We will also acquire four distribution centers in California and Hawaii as well
as Longs' headquarters facilities in Northern California.
I think,
many of you know, Longs' fiscal revenues for the period ending January '08 were
$5.3 billion.
This
acquisition will be effected through a cash tender offer to be launched shortly
by a subsidiary of CVS Caremark for all outstanding Longs' shares. The tender
offer will be subject to and, among other things, the condition that at least
two-thirds of the outstanding Longs' shares be tendered.
We
believe, this transaction has compelling benefits for CVS Caremark and advances
our long-term strategy in important ways. First and foremost, the acquisition
accelerates our expansion into Central and Northern California and Hawaii. These
are highly attractive regions of the country, where, as you know, we have -- we
are not currently represented. And they are very difficult real estate markets
to penetrate. Second, with the addition of these markets, we will now have
filled in some very important markets that will be particularly valuable to our
PBM clients as we rollout our new Proactive Pharmacy Care offering. And lastly,
Longs successful PBM RxAmerica and its standalone PDP business will complement
our Caremark business.
Before I
continue, as Nancy said, we have Warren Bryant on the line and I'd just like to
ask Warren just to say a few words.
Warren
Bryant - Longs Drug Stores
Corporation - Chairman, President and CEO
Thank you,
Tom.
On behalf
of our Board of Directors, the management and the employees of Longs, I want to
convey our excitement about this transaction. In many ways, we see today's
announcement as a very natural step for Longs.
Since our
founding in 1938, it is the great people of Longs and our strong connection to
our customers that have been our key assets and the drivers of our success. Over
the past 70 years, Longs has grown from a single family owned store to a strong
regional retail drug store chain with 521 stores on the West Coast and in
Hawaii. In the past five years, we've made the company stronger, more productive
and more profitable. We reduced our overhead, improved our processes, upgraded
our stores and focused on our product offerings. Over the last four years, our
RxAmerica subsidiary has delivered 93% compound annual growth and has become a
significant competitor in the Medicare Part D space. As a result of both our
retail and PBM initiatives, Longs has experienced a tripling of our operating
margins in just three years. We're proud of these accomplishments and could not
have achieved them without the dedication and commitment of our
employees.
Given our
changing industry landscape, we believe, this combination with CVS Caremark is
the logical step for our company in extending our legacy of customer service,
employee development and financial performance. This transaction represents an
excellent opportunity for us, not only to deliver significant and certain value
to our shareholders, but also position our stores to thrive for the benefit of
our employees and customers. I'm confident that this deal will present a
excellent opportunities for our store employees and ensure that our valued
customers continue to receive the best quality products and service. Joining
forces with the industry leader, CVS Caremark, will enable us to improve our
financial performance above and beyond what we feel we could do
independently.
As we
considered our strategic alternatives, we realized that CVS Caremark was a
natural partner for us for several reasons. CVS Caremark has a strong record of
successfully integrating drug store chains and pharmacy benefit services into
their portfolio. And also, working with employees
to improve
the performance, format and offering of stores. There's also very little
geographic overlap between our two companies. In fact, in the only two broad
markets that we share, Las Vegas and Southern California, we largely have a
complementary footprint.
For these
reasons and others, we're confident that this combination will get off to a fast
start and will be successful in both the near and long term.
In
closing, I want to take a moment to personally the entire Longs' team for their
commitment and hard work over the past several years. I'd also like to thank our
shareholders and Board of Directors for their continuous support of our
goals.
We're
excited to become part of a great organization and look forward to working with
CVS Caremark over the next several months to ensure a smooth and seamless
integration.
Tom?
Tom
Ryan - CVS Caremark
Corporation - Chairman of the Board, President and CEO
Thanks,
Warren. We're obviously -- share Warren's excitement for this combination and
what'll it mean for shareholders, customers, clients and
associates.
I've been
in this business 34 years. I've always admired Longs and its focus on store
execution and customer service. And, as Warren said, it's all about the store
and the field people getting it done. I mean, I think Warren and his team have
done an excellent job working towards centralizing some of their marketing and
merchandising processes over the past several years. We intend to ramp that up
by implementing our systems, our processes and some of our merchandising and
marketing programs, like our successful ExtraCare loyalty card
program.
We see
this as a significant opportunity for growth and we have a pretty good track
record of buying these stores and PBM assets and realizing their full growth
potential. We also have a pretty good history of working with organizations to
ensure we have career opportunities for their associates. So, we are especially
looking forward to welcoming the Longs' associates to our team.
Now, you
may recall that as we entered Southern California -- or we entered Southern
California in 2004, organically. Then, we gained immediate market leadership in
Southern California through the acquisition of a 335 Sav-On stores, which by the
way they're comping about 5% this year despite the economy. Today, the broader
LA market is the largest revenue producing market in the country for
us.
So, we
know how powerful strategic action -- acquisitions can be for driving our
business. We did it with the Eckerd acquisition in Florida and Texas. We did it
with the Revco acquisition. And we're doing it with the Sav-On Osco acquisition
in California and Chicago.
With
today's announcement, we will now become a leading player in Central and
Northern California and Hawaii. As you know, California is the most populous
state with 36 million plus people adding 300,000 alone. So, from when we entered
California in just four years, after this transaction, we will have over 830
stores in the state. More than anybody else.
Our
experience, as well as others in the real estate business, have proven that site
selection and development in Northern and Central California markets as well as
Hawaii is pretty costly and very time consuming. And this is as evidenced by the
limited amount of development. Many of these markets are mature with a minimum
supply of appropriate drug store sites. We estimate that the timeframe needed to
assemble a quality portfolio like the one we are acquiring would be at least 10
years. Development of sites, even if they become available, are time consuming,
because of complex zoning and entitlement issues and significant capital
investment. Consequently, an opportunity like this to acquire hundreds of
quality locations in these markets is rare.
More than
490 of the stores we are acquiring in Central and Northern California and Hawaii
stores are good with valuable well located sites. In fact, these sites -- these
stores will give us a leading positions in 10 new markets that are in the top
100 markets in the country. We'll have strong positions in Oakland, Sacramento,
San Jose, San Francisco and Honolulu, just for an example.
In
addition to California and Hawaii, we'll also add 24 stores in Nevada and a
couple of stores in Arizona. We will gain leadership in the Reno, Nevada market,
where we currently only have three stores. And this market's projected to grow
twice the annual average growth rate of the rest of the country.
So, in
total, following this acquisition, we will operate 6,800 drug stores in 41
states and the District of Columbia.
About 470
of those stores we are acquiring, average about 22,000 to 23,000 square feet.
That's a little bit bigger than the Sav-On stores, but not much. Sav-On stores
have -- we have some stores that size. And the rest of the stores -- the rest of
the Longs' stores are smaller stores in the 4,000 to 7,000 square foot range.
And these are located mainly in or near medical centers. And, we think, there's
an opportunity for us to put our specialty pharmacy in these
stores.
It's
important also to note that Longs owns the real estate associated with
approximately 200 plus store locations, three distribution centers and three
office facilities. We have valued these store locations alone at more than $1
billion.
As noted
earlier, these stores are located in markets, where commercial real estate and
values are among the highest in the country and prime locations are difficult to
acquire. We intend to unlock the intrinsic value of these locations as well as
distribution centers and office facilities by monetizing a substantial portion
of these assets over time. In addition, Longs' distribution centers will be
valuable additions to our distribution network.
Now, as I
said, many of you know Longs also operates a PBM, RxAmerica, which serves about
8.5 million commercial lives and it has a Med. D standalone PDP that insures
about 450,000 lives. The PBM generates about $380 million in annual revenue,
including the PDP lives. CVS Caremark will insure over 1.5 million lives through
the PDP plans. We will integrate RxAmerica's PBM and PDP business over time. And
it will be a nice complement to our PBM.
Let me
talk a little bit about the financials. Longs generates approximately $5 billion
in annual revenues and a reported EBITDA in the last 12 months of $276 million.
So, this transaction is priced at approximately 10 times EBITDA, which is
roughly what we paid for the Osco Sav-On stores in 2006. The company has a
consistent cash flow generator, reporting operating cash flow of about $200
million annually.
Assuming
completion in the fourth quarter, the acquisition is expected to be dilutive to
our adjusted EPS by $0.01 to $0.02 in '08 and by approximately $0.05 to $0.06
for the full year '09. We expect the acquisition to be approximately $0.04 to
$0.05 accretive to adjusted EPS in '10 and lower digit accretion in 2011 -- low
to double-digit accretion, excuse me. So, 2010 will have $0.04 to $0.05
accretion. And in 2011, it'll be low double-digit accretion. The impact of GAAP
EPS will be about $0.01 more dilutive than the impact to adjusted EPS this year
and approximately $0.02 more than the impact to adjusted EPS in
'09.
In terms
of synergies, we are currently anticipating cost synergies of $100 million in
'09 an approximately $140 million to $150 million in 2010. These are obviously
resulting from purchasing efficiencies as well as reduction
SG&A.
We plan to
finance the transaction with a $1.5 billion bridge facility together with
existing cash and liquidity, which will provide us with funding sufficient to
satisfy our obligations for the acquisition. The bridge loan will then be paid
down with our subsequent free cash flow. The transaction is obviously subject to
review under Hart-Scott-Rodino and to two-thirds of the outstanding Longs shares
being tendered in the tender offer and to other customary closing conditions. We
expect it to be completed in the fourth quarter of '08.
In light
of the acquisition, we expect to shift our share repurchase program to the
second half of '09. It's important to note that our $2 billion authorization
will remain in place. But, we believe, that it's approximately to somewhat delay
the repurchase activity and we remain highly committed to this
program.
In
summary, I think, you can feel it. We're excited about this transaction. We are
focused, as always, on having a smooth and seamless integration. We've done
quite a few of these over the years. As you know, we have a good deal of
experience. We know what it takes to achieve a smooth transition and we plan to
do it here again without taking our eye off the ball at CVS Caremark. We expect
to have all stores integrated in 2009. We've already selected our integration
team and its leadership and we have plans underway and we're ready to hit the
ground running once our deal closes.
To me, the
acquisition of Longs provides important strategic and financial benefits for us
both in the near and the long term. One, we're accelerating our growth into key
new markets that are difficult to enter. Two, we're broadening our geographic
reach that will help us facilitate the rollout of our new Proactive Pharmacy
Care offerings. Three, together with the management team of Longs and the CVS
management team, we believe, we can improve the performance of the stores with
our technology, our process and our merchandising. Four, over time, we will be
able to monetize $1 billion in real estate. And, five, we can still do the share
buyback in '09.
So, with
that, I think, I'll take -- open it up to questions and I want to thank
everybody for their time.
QUESTION AND
ANSWER
Thank you
for your participation. [OPERATOR INSTRUCTIONS] Your first question comes from
the line of John Heinbockel with Goldman Sachs. Please proceed.
John
Heinbockel - Goldman Sachs
& Co. - Analyst
Can you
talk to the capital program? You guys typically like to remodel most of the
acquired stores in six months. How will that play out here? And when do you
think you get that done?
Tom
Ryan - CVS Caremark
Corporation - Chairman of the Board, President and CEO
Well, we
have a plan in place, John. We've allocated about $300 million in CapEx for the
stores. I think, as Warren will tell you later, they've done some of the stores.
And you can see the performance is different in the stores that have been
remodeled. But, as you said, we don't go in and just do paint and paper. We
actually will spend a fairly significant amount of money in the store and get it
done. We have a pretty good track record. We expect it to be, if not all,
completed in certainly '09, the integration will be completed in the '09.
Remodels, the stores that we are going to not relocate will be completed in
certainly early '10.
John
Heinbockel - Goldman Sachs
& Co. - Analyst
All right.
Secondly, the front-end comp trends at Longs have not been great of late. Does
that concern you? And what have you sort of built into your dilution next year
in terms of California economy and progression of front-end comps at
Longs?
Tom
Ryan - CVS Caremark
Corporation - Chairman of the Board, President and CEO
Well, I'll
just say that I don't think we've ever missed our projections on acquisition,
either on the revenue side or the synergy side. So, we take a fairly
conservative approach. And I do think the California economy, obviously it's in
a doldrum right now, but I think it's cyclical. Largest economy in the country,
I believe it obviously will come back. Having said that, I think, there are some
things that we can do to help. Keep in mind, this is a well run organization
with a great team. But, I think, we can help on the proprietary brands that
we've invested in over the years, our private label business. I think, some of
our technology investments can help on the shrink side of the business. Our
ExtraCare card, we have California penetration -- ExtraCare's some of the
highest in the country. 70% of the transactions are going through ExtraCare. So,
I think, there's some things that we can do in the front-end of the store that
despite the economy will still help things. Now, you know as well as I do, when
we takeover and remodel a store, there's obviously a dip in front-end sales and
that's all in our projections.
John
Heinbockel - Goldman Sachs
& Co. - Analyst
All right.
And then, finally, I guess, you do think that given the productivity here,
there's no reason that EBIT margins ultimately at Longs can't be at where core
CVS is today?
Tom
Ryan - CVS Caremark
Corporation - Chairman of the Board, President and
CEO
No, I
don't see any reason why not. It's a -- it has a different mix of merchandise
obviously. It's a different mix of front and pharmacy, but I do believe that we
can get the margins to where ours are and the productivity.
John
Heinbockel - Goldman Sachs
& Co. - Analyst
All
right. Thanks.
The
question comes from the line of Neil Currie with UBS. Please
proceed.
Neil
Currie - UBS -
Analyst
Good
afternoon and thanks for taking the question. I just had just two questions.
First of all, I just wanted to make sure that the synergies that you calculated
are on the same basis as previous acquisitions, you mentioned that conservative.
In terms of buying synergies, have you just assumed the best of terms, that sort
of thing?
Tom
Ryan - CVS Caremark
Corporation - Chairman of the Board, President and CEO
We run the
synergies the way we always have Neil. It's -- listen, you've got to think about
this -- this is a $5 billion on top of our $80 plus billion. So, we're looking
at the purchasing synergies around the obvious areas in generics and private
label and some other front-end items and then also the overhead. But, I think,
it's done consistently as we've done it in the past.
Neil
Currie - UBS -
Analyst
In terms
of Longs' branding, they have quite a strong brand in the West Coast and Hawaii.
How -- will you approach it any differently to past acquisitions you've made,
where maybe you've taken over some less strong brands? Maybe you have to be a
little bit more careful about changing the name?
Tom
Ryan - CVS Caremark
Corporation - Chairman of the Board, President and CEO
Yes, this
is always the dicey question -- one for customers and two for associates. And
Longs does have a strong brand, but so did Sav-On in Southern California. And I
can remember when that was changed to Osco, there was some problem and then they
changed it back to Sav-On. I can tell you that we haven't had any pushback in
Southern California. And our preliminary plans are to over time change the
California market to CVS, but we will leave the Hawaiian market at
Longs.
Neil
Currie - UBS -
Analyst
But will
you put the CVS private label in the Hawaiian --?
Tom
Ryan - CVS Caremark
Corporation - Chairman of the Board, President and CEO
It's still
early. We're working at planning that now. But, I mean, the Hawaii market is
kind of a standalone market from a distribution standpoint, from an advertising
standpoint. And you don't lose any economy of scale by doing that in Hawaii.
And, I think, it's appropriate. In fact, I believe, the Hawaiians feel that
Longs is kind of a Hawaii homegrown chain and maybe is domiciled there. So,
anyway, that's our preliminary plan.
Neil
Currie - UBS -
Analyst
And in
terms of the quality of locations, are you happy that there are a lot of
locations that are maybe not end of strip or first to main and that you might
have to re-site some of them?
Tom
Ryan - CVS Caremark
Corporation - Chairman of the Board, President and CEO
There are
-- I think, it's all relative, right? You have to look at, we have a store in
downtown Greenwich, Connecticut that's one of our best stores and it's not
freestanding, but it's convenient in downtown Greenwich. And it's the same thing
in the Northern California markets. They don't have a lot of their stores that
are freestanding, but they have stores that are on end caps and that are in
convenience centers. And, in fact, there's some markets where you can't get --
there's some areas that you just can't get to freestanding locations. Having
said that, we think, there are opportunities for some relocations, maybe 10% to
15% of the fleet that we relocate over time to a freestanding location if we can
find it. But there's no rush in doing that. So, when I looked at and our team
looked at all of the available opportunities in the market, the Longs' real
estate locations were definitely came out on top.
Neil
Currie - UBS -
Analyst
Well, I
can certainly attest in the queues in the Greenwich store. Thanks very much and
congratulations on the acquisition.
Tom
Ryan - CVS Caremark
Corporation - Chairman of the Board, President and CEO
Thanks.
the next
question comes from the line of Robert Willoughby with Banc of America
Securities. Please proceed.
Robert
Willoughby - Banc of America
Securities - Analyst
Thanks.
Tom, did you mention any change in your own -- in CVS's own store opening plans
then? Will that slow down relative to your prior expectations with this
deal?
Tom
Ryan - CVS Caremark
Corporation - Chairman of the Board, President and CEO
Long term,
I don't think so. I mean, we didn't have any plans in Hawaii in the next few
years, so that's obviously a little bit of a change. But we're still going to
say in the three to three-and-a-half square footage growth range. We'll just
look at stores we had in the pipeline and if there's overlap, we'll make some
modifications. But it shouldn't change our plan dramatically. We still have
obviously fill-in opportunities and we still have other markets that we can go
to.
Robert
Willoughby - Banc of America
Securities - Analyst
And can
you give us any details on the PBM, just a percentage of synergies from the deal
you feel will come from combining RxAmerica? And, secondarily, what kind of mail
order penetration RxAmerica had? And any claims count at all, if you could
provide it?
Tom
Ryan - CVS Caremark
Corporation - Chairman of the Board, President and CEO
Yes, we're
not going to breakout the synergies in this, but the majority of RxAmerica is
really the auto enrollees. It's -- when you think about their business. So, it's
not a lot on the PDP side, obviously. And it's not a lot of mail penetration.
They have a little bit of a different mix. We have probably -- our mix is on the
PDP side is probably 35% walk-ins, 65% auto. Theirs is close to 85% to 90% to
auto. So, they've made some changes in some of their plan design in the past.
They've raised some of the premium. I know, obviously, there was some questions
around PDPs and the profitability of those going forward. We've obviously have
made some changes on a go-forward basis, eliminating some no-deductible plans,
changing some of the plan designs to preferred networks instead of open
networks. So, there's some things that you can do that, in fact, Longs has done
on the PDP side and we're doing it on the Caremark side. But, we think, it'll be
complementary.
Robert
Willoughby - Banc of America
Securities - Analyst
And just
any sense of intangibles as a percentage of deal value for this
transaction?
Tom
Ryan - CVS Caremark
Corporation - Chairman of the Board, President and CEO
No, we
don't -- we let others do that.
Robert
Willoughby - Banc of America
Securities - Analyst
Okay.
Thank you very much.
Your next
question comes from the line of Deborah Weinswig with Citi.
Nancy
Christal - CVS Caremark
Corporation - SVP, IR
Are you
there?
Tom
Ryan - CVS Caremark
Corporation - Chairman of the Board, President and CEO
I think,
she might have got her question answered.
Your line
may be on mute. Your line is open.
Nancy Christal -
CVS Caremark Corporation - SVP, IR
Yes, why
don't you take the next question.
Your next
question comes from the line of Meredith Adler with Lehman. Please
proceed.
Meredith
Adler - Lehman Brothers -
Analyst
Hi, I have
a couple of questions. I was wondering, the press release talks about most of
the synergies coming from procurement and SG&A. And I don't know how much
you've had a chance to begin to operating practices, but Longs has been making
changes and I was wondering whether you see that as also being a significant
opportunity?
Tom
Ryan - CVS Caremark
Corporation - Chairman of the Board, President and CEO
I think,
there are opportunities, as I said, Warren and his team have done a good job on
centralizing the distribution and the marketing plans and the [planograms]. I
think, there's still some road to hoe there, which will give us some more margin
opportunities.
Meredith
Adler - Lehman Brothers -
Analyst
And then,
just another question about financing. There is a lot of real estate value here
and I know that that was true of Sav-On as well and the company chose to finance
that real estate. But with California, there's Prop. 13 and you're going to have
real estate taxes increase, I believe. Maybe just talk a little bit about why
that's the sort of chosen method of financing?
Tom
Ryan - CVS Caremark
Corporation - Chairman of the Board, President and CEO
Well,
first of all, I'll take a shot at it and then let David jump in, but the tax --
the real estate -- the property tax in California that's factored into our
model. And when you think about the sale leasebacks that we've done and we've
done a fair amount of them over the years, I think, we were actually the first
chain to actually start that in an earnest way. And, I believe, obviously, we'll
get lower cap rates than Longs would on a standalone basis, just because of our
balance sheet strength and our history and what we have done over time. So, we
don't have to rush through it. We don't have to rush to do it. But all those
factors are balanced in the cap rates, the economy, the increase in taxes, we
have that all factored into our model.
Dave
Rickard - CVS Caremark
Corporation - EVP, CFO and Chief Administrative
Officer
But I just
-- all that's true and I just say that at this point in time, what we have in
the model is a base case. And, as we always do, we'll be looking at alternatives
-- if there are better alternatives out there. But this is course can happen and
it can happen with the kind of results that we need it to happen
with.
Tom
Ryan - CVS Caremark
Corporation - Chairman of the Board, President and CEO
And we may
want to hold onto some of these. We don't -- we're not in any rush to go out and
move these out. I mean, if they -- real estate is -- follow the economy for
awhile in California, we'll hold onto them. I mean, we don't have to rush out
and do this in the next month. We can do it over a period of time.
Meredith
Adler - Lehman Brothers -
Analyst
And I just
have one more question about drive-thru windows. I think, I've heard that it's
fairly tough to get local communities to approve drive-thrus. Is that your
experience? Or maybe that's a question for Longs' management? And is that one of
the reasons why strip center stores are something that work well in
California?
Tom
Ryan - CVS Caremark
Corporation - Chairman of the Board, President and CEO
I don't
know. Warren, do you want to jump in on that?
Warren
Bryant - Longs Drug Stores
Corporation - Chairman, President and CEO
Yes, we
have about 38 stores with drive-thru locations. But Meredith's right, it's in
some communities very difficult for us or anyone else to get a drive-thru. And
so, it's not a competitive disadvantage in many, many communities not having
one. We are finding though that some community leaders are changing their mind
about pharmacy drive-thru, while they still remain opposed to fast food
drive-thrus. So, there's becoming now an awareness in some communities of the
difference between the two and the queuing of the cars.
Meredith
Adler - Lehman Brothers -
Analyst
Thank
you.
Tom
Ryan - CVS Caremark
Corporation - Chairman of the Board, President and CEO
We started
calling them prescription pickups, instead of drive-thrus for that
reason.
Warren
Bryant - Longs Drug Stores
Corporation - Chairman, President and CEO
That is
important, yes.
Meredith
Adler - Lehman Brothers -
Analyst
Okay,
thank you.
Next
question comes from the line of Tom Gallucci with Merrill Lynch. Please
proceed.
Tom
Gallucci - Merrill Lynch -
Analyst
Thank you,
good evening. I was wondering first, could you give any background on the
genesis of the deal? And whether or not there was a sort of auction process? Or
how this came about?
Tom
Ryan - CVS Caremark
Corporation - Chairman of the Board, President and CEO
We're not
going to get into the process. You'll be able to read about it later on, but
I've had discussions and been attracted to the Longs company for a number of
years. And so, it's kind of no secret where my view was. And it was just an
appropriate time for us and obviously an appropriate time for
Longs.
Tom
Gallucci - Merrill Lynch -
Analyst
And then,
just on the financial side, pushing out the buyback about a year, I guess, from
now to the second half of next year. With the stock having been down lately, can
you just talk about sort of the tradeoff that you're making here on expected
returns from buying this versus buying your own stock back?
Dave
Rickard - CVS Caremark
Corporation - EVP, CFO and Chief Administrative
Officer
Yes, I
think, first of all, when we initially announced the share buyback authorization
back in May of this year, we said that it would be done primarily through or at
least it was our view that we would do it primarily through open market
purchases and that those would extend between 2008 and 2009. And so, we, at that
time, we're trying to set an expectation that this wasn't going to be a mad rush
through the door kind of thing. That remains the case. Share buybacks is a very
legitimate way of enhancing shareholder returns and you've seen us do an awful
lot of it over the even recent past. And so, you know that we're believers in
that. But it's also important to build a company and to build it as strong as it
can be. And, I think, this is an opportunity to do just that in a very, very
important part of the country. And so, that is the priority for the very near
term.
Tom
Gallucci - Merrill Lynch -
Analyst
Okay,
thank you.
Your next
question comes from the line of John Ransom with Raymond James. Please
proceed.
John
Ransom - Raymond James -
Analyst
Hi, good
afternoon. Could you please give us the shrink statistics comparing CVS to
Longs?
Tom
Ryan - CVS Caremark
Corporation - Chairman of the Board, President and CEO
We're not
going to share that. I will tell you that from a shrink standpoint, we've had
improvement in anywhere from 30% to 50% in the West Coast stores that we
acquired. And on a private level basis, we've had probably a 300 basis point
improvement. So, we'll get into that when we get into maybe some guidance down
the road, but we're not going to break it out right now.
John
Ransom - Raymond James -
Analyst
I mean is
it in the ballpark as -- okay, never mind. I won't ask a fruitless question. The
other question I had is, what kind of cap rate are you assuming on that billion
dollars of real estate value? What is the underlying assumption
there?
Tom
Ryan - CVS Caremark
Corporation - Chairman of the Board, President and CEO
It's a
mix. Listen, they've got about 75% of the stores are owned -- they own with the
land and building. Obviously, that's going to have a lower
cap. They've got 25% of the stores that are leased land and owned building. But
it's a conservative -- it's a decent -- a reasonable cap, let's put it that way
for the mix of stores. And it's based on what we think we can do based on our
size and balance sheet.
John
Ransom - Raymond James -
Analyst
What are
you currently doing deals for then? Maybe we can approach it that
way?
Tom
Ryan - CVS Caremark
Corporation - Chairman of the Board, President and CEO
It depends
on where it is and depends on if it's leased land or owned building. It depends
on the marketplace.
John Ransom -
Raymond James - Analyst
Is there a
range you can give?
Tom Ryan -
CVS Caremark Corporation - Chairman of the Board, President and
CEO
It's going
to be different in Florida than California. And it's different in New
York.
John Ransom -
Raymond James - Analyst
Is there a
range you can give us where you're getting things done?
Tom Ryan -
CVS Caremark Corporation - Chairman of the Board, President and
CEO
Yes, I
mean, the range is going to be in the 6.5, 7.5, 7 to 7.5.
John
Ransom - Raymond James -
Analyst
Got you.
Okay. And, lastly, what percent of the purchase price did you allocate to the
PBM and the Med. D business versus the store business?
Tom
Ryan - CVS Caremark
Corporation - Chairman of the Board, President and CEO
We didn't
separate it out.
John
Ransom - Raymond James -
Analyst
Okay.
Thank you.
Your next
question comes from the line of Scott Mushkin with Jefferies. Please
proceed.
Scott
Mushkin - Jefferies & Co.
- Analyst
Hey, guys,
thanks. I was hoping maybe Dave could walk us through the dilution a little bit
more. I mean, you guys, is the assumption there that EBITDA is actually going to
go down next year as you do things? And kind of what the interest expense ended
off the $2.9 billion?
Dave
Rickard - CVS Caremark
Corporation - EVP, CFO and Chief Administrative
Officer
Well,
we've given you the amount of financing and source of financing. Yes, EBITDA
will go down next year. We will have all the conversion costs, the one-time and
integration costs primarily fall into '09. A little bit of it gets started in
'08, but because of Christmas seasonality, we don't want to have a lot of
disruption in the stores in the fourth quarter if we can avoid it. So, our view
is that most of that happens in '09. And so, that's what propels this curve. If
we look at the adjusted EPS, the non-GAAP measure that we use, we said $0.01 to
$0.02 in '08 and $0.05 or $0.06 in '09 are the dilution numbers that we're
looking at.
Scott
Mushkin - Jefferies & Co.
- Analyst
So, Dave,
that $0.05 to $0.06 of dilution that includes these one-time costs associated
with the merger?
Dave
Rickard - CVS Caremark
Corporation - EVP, CFO and Chief Administrative Officer
Yes, it
certainly does. It includes all the one-time costs. It includes the financial
effect of delaying the share repurchase program. So, it includes everything that
relates to this decision.
Scott
Mushkin - Jefferies & Co.
- Analyst
And do you
want to share with us the amount of investment you think the one-time cost
investment will be next year?
Dave
Rickard - CVS Caremark
Corporation - EVP, CFO and Chief Administrative
Officer
I don't
think we've broken that out, have we? No, but it's included in that
guidance.
Scott
Mushkin - Jefferies & Co.
- Analyst
And two
more, if I could. The LA market, divestitures down there?
Tom
Ryan - CVS Caremark
Corporation - Chairman of the Board, President and CEO
We don't
have many. There's an overlap market in some of the LA, but they're not -- we
don't have any stores that are next to each other. So, it's -- there's limited,
if any, overlap.
Scott
Mushkin - Jefferies & Co.
- Analyst
Okay. And
then, I guess, a final question, maybe, it's a little tougher one and it's not
meant to be that way, but it may come across that and it's literally aimed Dave.
Over the years, we've talked a little bit on and off about acquisitions, it
seems to be you always shied away from Longs or maybe I misread that, but it did
seem that way. And I was wondering kind of what's changed? And then, maybe for
Tom, why now?
Dave
Rickard - CVS Caremark
Corporation - EVP, CFO and Chief Administrative
Officer
Well, I
think that you've heard it said today that Longs has done a lot of things to
improve its operations. Some of those things make the operations very much more
compatible with the way CVS does business. CVS runs a very centralized
management structure. There is some discretion at a store level or district
level, whatever. But a lot of the key decision on merchandising, pricing,
marketing, and so forth are made centrally. Some years back, the opposite was
the case with Longs. And that made it difficult to even start to consider what
it would be like to combine with Longs. Today, that's less the case and this is
a much more natural fit.
Tom
Ryan - CVS Caremark
Corporation - Chairman of the Board, President and CEO
I would
also add to that our experience with Sav-On in Southern California has helped.
Sav-On stores were bigger. We have a dedicated West Coast merchandising team out
there, so we get it. We get the general merchandise. We get the size of the
stores. We know the mix of liquor. So, we're more comfortable as a company
operating the larger store. So, a combination of -- if you look at the Longs ten
years ago, they were really decentralized and managers would price an order and
do it and whatever they wanted. So, we were a little hesitant to go with that
just one for the obvious reasons and two, just culturally. But now, I think,
it's closer to our model and we have a better experience. So, we're not going to
go in and just put a Boston CVS in San Francisco or Sacramento. We're going to
use the Longs merchandising and modeling and what they carry in those size
stores with what we've learned in Sav-On and Osco. So, that's the
opportunity.
And why
now? It came now. Right. The deal just -- we started talking and it came about
and if you look at this, we have -- it's 500 stores. It's fairly
compartmentalized. Sav-On integration is behind us. We can put a team on this
that is focused on the retail side of the integration and it does really --
doesn't affect the continued work between the CVS Caremark integration. So,
while CVS Caremark is fully integrated in the back, we're obviously we're doing
some work on the Proactive Pharmacy side of it, but the integration process of
bringing these stores onboard and all that means, it's 500 stores, we can have a
dedicated team that can do it and can compartmentalize it. And, I think, it's a
great opportunity for us that we wanted to seize the day.
Scott
Mushkin - Jefferies & Co.
- Analyst
Great,
thanks for answering my questions.
Tom
Ryan - CVS Caremark
Corporation - Chairman of the Board, President and CEO
Thanks.
Next
question comes from the line of Lisa Gill with JPMorgan. Please
proceed.
Lisa
Gill - JPMorgan -
Analyst
Hi,
thanks, I must say good afternoon. Tom, I was just trying to get some
clarification around a comment that you made that several of the stores are near
medical centers and the opportunity around specialty. Are you looking at
expanding beyond specialty pharmacy into specialty distribution to serve the
needs of medical centers? Or are you talking about patients' ability to be able
to pickup product? And then, secondly, looking at the Part D business under
Longs today. Can you just maybe compare, contrast your Dave as to have it
compares or contrasts to SilverScript? Does it primarily the same product
offering? Is it different because it's in a different region?
Thanks.
Tom
Ryan - CVS Caremark
Corporation - Chairman of the Board, President and CEO
First of
all, the 40 stores are stores that range anywhere from 4,000 square feet to
7,000 square feet. It was an acquisition that Longs had -- some of it was an
acquisition that Longs had done a few years called Network Pharmacy. And they're
basically stores that are either in medical centers or near medical centers. So,
it'll be more than just a pickup. We would tie this into our specialty network
and have these stores serve as one of our specialty pharmacies. Now, some of the
stores are downtown stores, but 7,000 square feet, because that's all the space
you can get. That would be just a full-service store and not a specialty store.
I'd really be focused on the stores around the medical centers and -- in the
medical centers and around the centers that are --. You remember the old CVS
ProCare stores that we used to have and we've converted those into CVS Care
stores. So, it'll be similar to that around the specialty side of the
business.
Lisa
Gill - JPMorgan -
Analyst
Okay.
Great. And then, Dave or Tom, either one, any thoughts on their Part D business
as it compares to the SilverScript business today?
Tom
Ryan - CVS Caremark
Corporation - Chairman of the Board, President and CEO
Well,
their Part D business, I said earlier a little bit, they're more -- the mix is
slightly different. More auto enrolled. Right. More duals then we have in
SilverScript. So, the mix is slightly different. And you do get a different
profitability on the walk-in business. They tend to be more sick. They skew to
an enhanced plan with no deductible, no copay. And I would say, RxAmerica made
some changes in their PDP plan last year around benefit changes and they
increased their premiums in a way that prevented them from having some of the
problems and some of the challenges that we had in mix utilization. So, we have
that in place for '09. They did a little bit last year in '08.
Lisa
Gill - JPMorgan -
Analyst
Okay.
Great. So, from an underwriting perspective, you feel pretty comfortable about
--
Tom
Ryan - CVS Caremark
Corporation - Chairman of the Board, President and CEO
We're
actually using the same actuary.
Lisa
Gill - JPMorgan -
Analyst
Okay.
Great. All right. Thanks very much.
Tom Ryan -
CVS Caremark Corporation - Chairman of the Board, President and
CEO
Thanks.
Your next
question comes from the line of Eric Bosshard with Cleveland Research. Please
proceed.
Eric
Bosshard - Cleveland Research
Company - Analyst
Two
questions, thanks, two question. First of all, can you give us any understanding
of the cost next year? I guess what I'm trying to figure out is the dilution by
including the lack of benefit from the repurchase that's kind of including the
lack of a positive, which is very, very conservative accounting, but I still
would love to get a better understanding of what that dilution would have been
if you hadn't considered the lack of the repurchase. I guess, just the dilution
that's directly a result of this deal and everything associated with doing this
deal, excluding the repurchase. Can you give us what that number
is?
Dave
Rickard - CVS Caremark
Corporation - EVP, CFO and Chief Administrative
Officer
Well,
Eric, let me go at it the other way. Obviously, the timing of repurchase of
shares affects the average number of shares outstanding. And what we said was
that the timing is going to shift to the second half of '09. And had the
repurchase activity been more evenly spread through the period of time during
which the authorization exists through the end of '09, you would have seen a
couple of cents of benefit to EPS in '09. Shoving it all to the back part of '09
will diminish that by approximately half. So, it's about a penny of what you're
looking at here.
Eric
Bosshard - Cleveland Research
Company - Analyst
Okay. And
then, secondly, what's the average size of the Sav-On stores that you run in
California?
Dave
Rickard - CVS Caremark
Corporation - EVP, CFO and Chief Administrative
Officer
21, 22,
something like that.
Eric
Bosshard - Cleveland Research
Company - Analyst
So,
basically, identical in size to these stores.
Tom
Ryan - CVS Caremark
Corporation - Chairman of the Board, President and CEO
They're
similar. There's always -- there's a mix of stores on both sides, but they're
close enough for government work. They're 20 versus 21 or 22.
Eric
Bosshard - Cleveland Research
Company - Analyst
And then,
the experience with the Sav-On stores of similar size, which from a
merchandising standpoint's quite different than what you're used to. How -- I
guess, if you sort of look at that experience and how it's turned out, what have
you learned from that that's made you feel comfortable in having success in
merchandising and running stores that are non-traditional versus your normal
store?
Tom
Ryan - CVS Caremark
Corporation - Chairman of the Board, President and CEO
Well, one,
I think, just our core business around beauty and health, I think, and adding
our private label and proprietary, we've seen a lift in even those core
categories in the Sav-On stores. So, although it looked like there was a full
presentation, in fact, in some cases, there wasn't. So, even the core categories
improved. Second, we eliminated some of the food and low margin items in the
store and we're continuing to do around skew utilization and rationalization in
the stores. And then, three, we have this merchandising team that's West Coast
merchandising team that does local DSD. I mean, and they keep that product in
the store. These stores will not look like a Washington D.C. CVS store. They'll
look like a California store, because the consumer uses the store differently.
They use them more as a general store. You can see the mix of pharmacy in front
in these stores. But we think we can still do that, raise the margin and also
drive customer count and revenue. And a lot of it has to also do with our
ExtraCare card.
Eric
Bosshard - Cleveland Research
Company - Analyst
And at
sort of maturity or optimal execution, how do the comps and margins compare in
this size and type of store relative to a traditional CVS store?
Tom
Ryan - CVS Caremark
Corporation - Chairman of the Board, President and CEO
Well, from
a store productivity, they're slightly less just because obviously the size of
the store. When you look at the margins, they should be similar. I mean, it
should be similar margins, because we're actually picking up some import
business and some general merchandise business as
has high
margin. We're giving it back a little on some liquor that has lower margin. But,
overall, it should be similar on an operating margin standpoint.
Eric
Bosshard - Cleveland Research
Company - Analyst
Great.
Thank you.
Tom
Ryan - CVS Caremark
Corporation - Chairman of the Board, President and CEO
I'll take
one more question.
And your
next question comes from the line of Deborah Weinswig with Citi. Please
proceed.
Deborah
Weinswig - Citigroup -
Analyst
Thanks so
much and sorry about earlier. Actually, kind of elaborate on the last question.
Longs was always, in my opinion, had a very unique kind of general merchandise
offering. How can you harness that in these stores and also maybe take some of
the learnings back to the rest of the CVS chain?
Tom
Ryan - CVS Caremark
Corporation - Chairman of the Board, President and CEO
You bet. I
mean that's kind of what we do. It's always a little tricky to do that, but we
were able to do it in the Sav-On stores. And you can see it, I think, if you
look at the CVS stores, especially around the holidays, in the fourth quarter,
you can see some merchandise mix in our stores and our ads that we would not
have had if we hadn't had some of the Sav-On stores. So, Longs does do a great
job. It's unique. We are not going in and cookie cuttering it, so to speak, but
we are going to centralize -- move to the centralization that Warren and his
team have been doing. I will tell you, Hawaii is a completely different market
and that will be handled completely different by the management team on the
Islands. So, that will look even different than the California stores look as it
does now within the Longs suite of stores. So, we feel pretty good about it. And
we're learning. And I can guarantee you what we learn from Longs in Northern
California, we will bring down to Southern California in these stores. If we
have the ability and the size and the stores, we can do it. Our constraint on
some of these -- our own stores is just size. We don't want to just force --
shoehorn some merchandise in. But we will take the learnings from Longs, believe
me, and apply it to our other California larger stores.
Deborah
Weinswig - Citigroup -
Analyst
Okay and
the -- so, this will be my last question, I'm probably could wait in the call.
So, Tom and Dave, over the last ten years, I've obviously seen you complete four
very successful acquisitions. What's unique about this deal? And what could make
it a) more successful than past acquisitions? And also, what could be a little
bit more difficult?
Tom
Ryan - CVS Caremark
Corporation - Chairman of the Board, President and CEO
Every
acquisition's a little unique. And it's usually around the culture of the folks.
I think, Longs has a good culture -- has a culture of customer service and
execution and customer loyalty. Having said that, they've been kind of a
quote-unquote family public chain for a long time, maybe less in recent years,
but --. So, that'll take a little time for people to get used to that. I think
there's just upside opportunity. I think, when we put some CapEx into the
remainder of the stores that weren't done. We put our technology into the
stores, not only our front-end technology around shrink and merchandising, but
our pharmacy technology, our new pharmacy connect system along with our PBM, I
think, we're obviously going to have some benefit on the pharmacy side. I just
couldn't go wrong. I don't know what I could go wrong. The things that go wrong
on acquisitions are technology and culture. And, I think, we're going to do fine
with the culture. And the technology that we have, I think, it's one of the
reasons that we did Eckerd so quick and others struggled a little bit with it. I
think, it's why we did Osco Sav-On so quick is because of the technology we have
in place. I don't want to say it's plug-and-play, but our people are good. They
know what to do. So, I worry about everything, so we're always have sleepless
nights, but I don't see any big worries here.
Deborah
Weinswig - Citigroup -
Analyst
Well,
thanks so much and best luck and congratulations.
Tom
Ryan - CVS Caremark
Corporation - Chairman of the Board, President and CEO
Thanks.
Okay, thanks, everyone, for your time today. We obviously think this is an
important step for our Company and we look forward to reporting to you on the
progress of this acquisition as we move ahead. If you have any questions, as
usual, give Nancy Christal a call. Thanks.
Thank you
for your participation in today's conference. This concludes our presentation.
You may now disconnect. Have a good day.