CVS Health Corp (CVS) 2001 Q1 法說會逐字稿

Good day everyone and welcome to the CVS Corporation first quarter conference call. Today's conference is being recorded. At this time, for opening remarks, I would like to turn the call over to the Vice President of Investor Relations, Ms. Nancy Christal. Please go ahead.

Thank you. Good morning everyone, and thanks for joining us today for our first quarter 2001 earnings conference call. I am here with Thomas M. Ryan, Chairman, President, and Chief Executive Officer of CVS Corporation, and Tom will cover highlights of our first quarter results, and David B. Rickard, Executive Vice President and Chief Financial Officer, who will provide a financial review as well as our earning guidance for the second quarter and full year of 2001. There are a few administrative items I need to cover with you before turning the call over to Tom. First, just a reminder that we'll be hosting our hosting annual analyst and investor meeting in New York City next Thursday, May 10. We'll have a continental breakfast and meeting registration beginning at 7a.m. with the formal presentations beginning at 8:30. During the registration and breakfast period we'll have a couple of healthcare services available to anyone who's interested, so you may want get there early. First, we'll have healthcare screenings including blood pressure and cholesterol readings. We'll also have a pharmacist available if you have questions about any medications that you or members of your family may be taking. There will be presentations by six members of our senior management team followed by a question and answer session. We expect the meeting to conclude at about 12 noon. If you haven't already signed up and you're interested in attending, please call my office at 914-722-4704 and ask for my assistant, Linda Pierre. Second, I want to remind you that in light of we will only accept analyst models for review within the one-week period following each quarterly earnings call. As I have said in the past, this review and comment will be limited to suggesting changes based on information disseminated to the public on the call. We'll simply check analyst models for appropriate interpretations of what we've said. Now before turning to this morning's news, our attorneys

have asked me to read this safe harbor statement. During this presentation we will make forward looking statements that are subject to risks and uncertainties that could cause actual results to differ materially. For these statements we claim the protection of the safe harbor for forward looking statements contained in the Private Securities Litigation Act format of 1995. We strongly recommend that you become familiar with the specific risks and uncertainties that we have outlined for you under the caption "cautionary statement concerning forward looking statements" in our annual report on form 10-K for the 2000 fiscal year ending December 30, 2000. As always, today's call will be simulcast and archived on our Website for a period of one week, and this morning's earnings press release is also available on our Website, cvs.com, which will be reviewed along with the information on this call. I look forward seeing many of you at our meeting next week, and now here is our chairman, Tom Ryan.

Thanks, Nancy, and good morning, everyone. I should point out that at next week's meeting, the number of blood pressure cuffs will be inversely proportional to the market performance the previous day. I am extremely pleased with the our first quarter results. Sales increased 13.6% while same store sales increased 11.3. Earnings per share for the quarter increased 15% to 54 cents versus 47 cents in last year's quarter. Let me just give you a few highlights on the quarter. The ExtraCare loyalty program is off to a terrific start. We launched the program company wide in February and have already signed up more than 12 million people, well ahead of our target. As you know, the primary goal of our ExtraCare is to reward our best customers and garner a larger share of their purchases and their loyalty. While we don't expect to see immediate impact on our front door comp, we certainly are encouraged by results we saw in our test markets that we've done for the last year and a half. We've learned that our top 30% of

our customers represent 80% of our business. ExtraCare's targeted loyalty-building efforts should promote higher average purchases and more frequent trips to our store. For example, data shows that our top customers shop three-and-a-half times more frequently than our average customers. The ExtraCare card is more than just a frequent shopper card; that's not our intention. This program is highly customized. People can elect to receive healthcare information which is targeted to their interests and their needs. They will also receive vendor-supported coupons that are personalized for each customer. This is a win-win for CVS, for our suppliers, and our customers. This is also a great example of how we intend to differentiate CVS from our competition. With regards to inventories, we continue to make progress on inventories. Our turns improved from 4.1 at year end to just under 4.2 in the first quarter, and we are on track to achieve our goal of 4.3 for the year. We continue to make significant investments in our proprietary AIM system, or our assisted inventory management system, which we intend to begin actively rolling out this year. As you know, the AIM system will improve our in stock position in the front end and continue to improve our inventory turns and drive sales. Chris Bodine, our Senior VP of Merchandising, will provide more details at our meeting next week in New York. Procare, our specialty pharmacy business, continues to make steady progress. We recently opened up three Procare stores, one in Boston in Deaconness Hospital, a new store in LA in West Hollywood, and a relocation of an acquisition site in Orlando near the North Florida Hospital. Today we operate 48 Procare stores and are on

track to open and operate about 60 to 65 by year end. The Stadtlander integration is proceeding right on plan, the main change was completed in March. We are actually ahead of our receivables collections and we realized our planned overhead synergy, so I am very, very pleased with the work that's been done on the acquisition of Stadtlander as we have not had any stutter steps and we're well ahead of our plans. We continue to target opportunities for Procare to gain exclusive or preferred distribution rights for new biotech drugs, and we'll have some more announcements on this in the coming months. Denis Burton, the president of Procare, will be discussing his company's promising growth strategy at next week's meeting. As I said, Procare will be a credit to earnings this year, and I'm extremely pleased with where we are in this emerging and fast growing sector. Our PBM, PharmaCare, continues its healthy growth. In late March, PharmaCare acquired United Provider Services, UPS, a different UPS, our PBM headquarters in Dallas with a national client base. The acquisition added 800,000 lives to PharmaCare through approximately 2000 clients. UPS operates in PharmaCare's core market segment, the small employer and the third party administrator. In March, PharmaCare completed the integration of Claims Pro operation into PharmaCare, and with both these acquisitions, PharmaCare continues to grow and grow significantly with not only its member base but also its contribution to CVS. In addition to these acquisitions, PharmaCare has won several new contracts including the Department of Defense retirees in region 1, about 200,000 lives; Advantage Pro Health, which is about 25,000 lives; and the

Harvard University Health Services, which is about 8,000 lives. So today PharmaCare has about 9 million lives under management and we are projecting about 10 million by year end. Let me talk about the pharmacy business in the quarter. Pharmacy business represented 67% of our sales in the quarter, third party now represents 90% of our pharmacy sales, generic scripts account for 43%. We expect to see some increases as BuSpar and Pepcid come off patents and other major branded drugs such as Prozac, Prilosec, and Glucophage come off patent this year. Pharmacy same store sales increased 17.6% in the quarter, and this was versus a very strong comparison last year. We continue to take share from independents, regional chains, and the drug sector. To keep up with our strong pharmacy volume, we've been rolling out our Epic pharmacy system across the chain. The rollout is now 80% complete. We will continue to make refinements, but I am very pleased with the rollout to date. We expect increasing benefits from Epic over the next year and a half including improved productivity, lower costs, better inventory turns, reduce wait times, better quality of life for our pharmacists and technicians, and most important, better customer service. This is critical to maintaining our pharmacy leadership. We are extremely focused on this project. Let me talk a little bit about our front end business. Our front end comps in the quarter were about 1%; that despite the negative impact that we've had from severe weather in the Northeast and Mid-Atlantic, where obviously the highest concentration of our highest volume stores are. Winter storms had a

negative impact of about 1% on our front door comps. Underlying our performance in our front end is the broad-based growth in most core categories. In fact, of our top 28 categories which make up 80% of our front end sales, we are seeing growth in 27 of the 28 categories, and the one exception is vitamins. Vitamins is an issue that is, across all trade channels, vitamins are softening. We're seeing some increase in the nutritional and the bar segments, but vitamins per se, vitamins and herbs, are relatively flat to down across all segments. On the flip side, we're starting to fine tune our seasonal and general merchandise offerings to only produce and sell the most productive items. As you know, we've had the promotional forecasting and allocating system, which has helped our sell throughs, we've also had the seasonal forecast and allocating system, which we're using to refine all our seasonal offerings. You will see less sweatshirts, in fact no sweatshirts, and home décor items in CVS stores going forward. We found out that obviously in our size stores and the way customers use our stores, these items just don't move. So we're refining our general merchandise mix, and early indications are sales are up and sell throughs are much, much better. Our photo business is building share at every market. Our strategy of being number one to market with new products and services has really established us as a leadership and given us leadership image in the photo area. We remain the photo finishing market leader in our trading areas in one-hour photo, in digital and on-line processing. As I said, we continue to see excellent performance in our front end categories across the board; private labels, beauty, skin care,

hair care, diet, nutritional, consumables and candy, and we had an excellent Valentine's Day sell through. Larry Zigerelli, our EVP of Marketing, will talk more about our front end strategies next week in New York. I'd also like to add that we have a renewed focus on service in our stores. Many of you have heard me talk, we've been focused on acquisitions, making sure that we assimilate the stores that we've acquired appropriately and effectively. We've got a program now that we're focusing back on service in our stores, service that has made CVS what it is in the past and what will make us what we are going forward in the future. We call it the Triple S program, it focuses on in stock, shopability, and service. A significant portion of our bonus program at all levels in the organization will be tied to this program. I can assure you it is all hands on deck for the Triple S program at CVS. It's more than a program, it's going to be the way we do business at CVS, and Larry Merlo, our EVP of Stores, will talk more about this at our meeting next week. We'll talk a little about recent trends. Obviously, Easter was a little tougher than Valentine's Day this year. This probably reflects both the lateness, the cold weather, and the rocky economy. Our April comp sales, which we will announce on May 10, will be a little light by our standards at approximately 8 to 9%, with pharmacy comp increasing 13 to 14%. Now let me reiterate, last year's pharmacy comps were over 18%, including a very strong flu season the first half of the month in April. This year's flu-related sales were down 8%

versus the first two weeks in April. That clearly had an impact on our pharmacy values in April. We also dropped the Humana plan, which is a plan that's in Kentucky, Ohio, and Tennessee. We dropped this plan for one reason and one reason only, inadequate reimbursement. We will continue to work Humana, and as in the past, we've typically gotten back into plans with better reimbursement after the negotiation. Let me touch a little bit on new store development before turning it over to Dave. During the first quarter we opened up 14 new stores, relocated 24, and closed 20 others. Six of the closings were mall stores, and three other stores were two-for-one reloads into CVS Pharmacies. We continue to be extremely pleased with our results in new markets. The Chicago market is doing extremely well. In these markets where CVS has known name recognition we're building prescriptions at rates exceeding our original plans, and our average final transaction is higher than planned. We'll be opening our first store in the Loop in Chicago later this month at 175 West Jackson Street, and we continue to believe and we continue to feel that we'll do well without significant name recognition in Chicago. We plan a major event sometime later, in the late '01 or early '02, which should end the year with about 15 to 18 stores in Chicago in '01. In February we opened up our second store in Orlando. Mickey loves us. The store is in Kissimmee, it's right near Disney World. Results in this store are phenomenal. We hit our second year plan right out of the block. The Florida markets are obviously huge opportunities for CVS. We have outstanding name recognition obviously from

people of the Northeast and the Midwest. The Tampa and Orlando stores are significantly exceeding our expectations. Customer traffic is very robust and we clearly have, as I said, significant name recognition. I can't tell you the number of calls that we get from people who are just so happy that we're in Florida because now they don't have to switch pharmacies when they go down during the winter season. So this, we feel, will be an enormous opportunity for us both obviously in Florida but also in our Northeast and Midwest markets. CVS brand products have been successful in our new markets. In Chicago, private label sales are running right up company average despite being newcomers to the city. In Florida, CVS brand products are, in fact, exceeding company average by 200 basis points, and that may reflect the budgets of many seniors as well as their trust in the CVS brand. Photofinishing is another high margin category, it was also significantly higher than the company average for obvious reasons in Florida. And we are receiving very high marks from customers on the all important measures of service, in stock, shopability. We opened up our first store in Fort Lauderdale in early April, and we are already doing over a thousand scripts a week. As I previously mentioned, we'll be entering Las Vegas market this year. We should have four stores opened by the end of 2001, and we're already on the ground in Phoenix and we'll have six to eight stores open in the first half of '02. We are actively pursuing other high growth markets and expect to announce additional markets later this year. As you know, there are overall 40 of the top 100 drugstore markets we're not in, so we have a fair amount of running room left in the US. As I said at our last quarterly earnings conference call, I expect to open about 50 new stores in new markets in '01. Our plans for '01 include opening up 150 to 160 new

stores, relocating about 140 to 150 stores, closing an additional 60 to 70 stores, for a net new store growth of around 90 new stores. This will equate to about 3% square footage growth this year. Our plan is to increase net new openings going forward, which will yield about 4-1/2 to 5% growth in '02. Now let me turn it over to Dave for his financial review and discussion of earnings segments, then we'll come back for some Q&A.

Thanks, Tom, and good morning, everyone. I'll get to the income statement first. As Tom said, total sales increased 13.6%. Our overall gross margin declined 44 basis points versus last year's first quarter. This decline is more than explained by the mix shift, as the pharmacy business continues to grow faster than the higher margin front end business and therefore makes up a larger percentage of our total sales. Pharmacy sales represented 67% of our total sales this quarter compared to 62% in the first quarter of last year. Partially offsetting the impact of mix shift was an increase in both cash pharmacy and third party pharmacy margin rate while front store margin rates were flat. I continue to be very pleased with our SG&A expense controls, which resulted in a 46 basis point improvement in total selling, general and administrative expenses for the first quarter. This is the first time in our history that we've started out the year with a first quarter SG&A below 20% of sales. This was driven by our ongoing productivity programs and an improvement in in-store labor efficiency. We also closed or relocated 34 stores in the quarter versus 107 in the same period last year. That change in closed stores helped our SG&A. Our

SG&A improvements continue to lead the industry and more than offset the gross margin decline. As a result, our operating margins improved by 2 basis points in the quarter in line with our guidance. Going forward, I think the Epic Pharmacy project will generate benefits on the cost side while at the same time fulfilling its primary purpose of improving customer service. Our newly developed e-procurement practices as well as our strategic sourcing initiatives should also provide incremental savings that will help drive continued SG&A to sales leverage. During the quarter we received $14 million pretax in litigation proceeds relating to some anti-trust litigation. This game was entirely offset by a $14 million pretax charitable contribution to the CVS Charitable Trust, Inc. This trust was established in part to fund the charitable activities of CVS as a responsible corporate citizen. This is especially important as we looked to fund new or standard pharmacy school programs and as we enter new markets. The contribution will enhance the funds available for charitable purposes. Since these two one-time items were both recorded in SG&A and precisely offset each other, there was no impact on our margins or profits in the quarter. Other interest expense amounted to $15.7 million in the first quarter, below our previous expectations. We benefited from lower rates on our short-term debt and better management of inventories, which I'll touch on in a minute. Our tax rate was 39.4%, as expected. Now let's move to the balance sheet and cash flow. As Tom said, we continued to make good progress on inventories. Our inventories grew 4.5% versus the same quarter last year, while sales increased

13.6%. Again, as Tom mentioned, we achieved closed to 4.2 turns in the first quarter and expect continued improvement. We are on track to achieve inventory turns of at least 4.3 times this year. Our progress in 2001 will move us nicely toward our three-year goal for inventory turns of 5 times. Now to cash flow. For those who may be new to CVS, we define free cash flow as earnings after tax, add back non-cash charges, less working capital change, less net fixed asset additions. Free cash flow therefore excludes acquisitions and it excludes dividends. With regard to free cash flow, the first quarter is historically a negative quarter due to the seasonality of our business. As expected, we experienced negative free cash flow in the first quarter of $219.3 million. That represents a 23% improvement over last year, which was driven by stronger earnings, slightly lower capital expenditures, and improved working capital results. We are on track to achieve positive free cash flow of at least $400 million for the year consistent with our previous guidance. Net capital expenditures amounted to 126 million in the quarter and we still expect to spend 400 to 450 million in net capital for the year. Let me remind you that net capital expenditures does not include the capital we spend developing stores which is later recovered through sale lease back transactions. So our growth cap ex will be higher before sale lease back transactions. Our depreciation and amortization was $78.6 million in the quarters, consistent with our guidance. We expect approximately 330 million in D&A for the year under current accounting

rules. Note that amortization totaled 21.1 million, of which 7.6 million was for good will in the first quarter. If the new accounting rules in the FASD exposure draft on business combinations and intangible assets are implemented during July as currently proposed, this would add approximately 1 to 2 cents per share per quarter to our earnings outlook. But as we now understand this new standard, obviously it's not yet issued and therefore it could change in its final version. As we announced in March, we priced a private placement of $300 million of 5-5/8% notes due in 2006 through a 144-A offering on March 19. This was an opportunistic move in which we took advantage of the favorable interest rate environment. Both treasury rates and corporate investment rate spreads have been moving favorably since the beginning of the year. Everyone expected the Fed would be announcing a rate reduction at the March 20 Open Market Committee meeting. We knew there were many companies waiting on the sidelines, which could have driven up spreads. We executed quickly and the result was very good. We got an effective yield of 5.73%, about the bottom of the market. The notes were used to repay outstanding short-term debts, so we basically shifted short-term debt to long-term debt at favorable rates. Now, in light of regulation it's important to take a little time in this open forum to provide guidance for the second quarter and the full year of 2001. We have not previously guided you on the second quarter so let's get into that. Total sales should increase in the range of 12 or 13% in the second quarter with comps in the 9 to 11% range, a bit lower than the first

quarter. We expect a mixed driven decline in gross margins, partly offset by some improvements in SG&A expense. Interest expense in the second quarter should approximate $16 to $18 million dollars. Remember that I mentioned to you on our last conference call that we have front loaded expense activity in 2001. There are two key programs that impact the second quarter. First, the ExtraCare program will impact the quarter, given the promotional startup expenses associated with that program. As Tom said, the ExtraCare rollout is exceeding our expectations. Second, as Tom mentioned also, we continue to invest in the assisted inventory management, or AIM, system, which will provide significant benefit to our in stock position in the front end, drive sales, and improve inventory, so it's important to keep the focus there. In light of all these factors, we never planned the second quarter as aggressively as the first call consensus. Given these costs as well as our recent sales trends, I would expect EPS for the second quarter of 52 to 53 cents, whereas a year ago we provided guidance last quarter of $2.10 per share. We're not changing that guidance for the year. That represents 17% growth over the $1.80 reported in 2000 when you adjust for the one-time litigation proceeds last year. We actually reported $1.83, as you'll recall. Now let's cover the details of the full year. Total sales should increase more than 13%, with total costs in excess of 10%. Overall gross margin should continue to decline as our mix continues to shift to a higher proportion of pharmacy sales. SG&A as a percent of sales should continue to offset the decline in gross margins to add 5 to 10 basis points to our operating margins for the year. We expect interest expense to be lower

than our previous guidance, probably 60 to 70 million versus our original value of around 80 million, reflecting both the rate and the level impacts that I mentioned earlier, continuing through the balance of the year. As I said in the past, our tax rate will be 39.4% in 2001, and our diluted share count is expected to be about 412 million shares. Our investment in cvs.com will continue in 2001 but we expect cvs.com to become profitable by 2002. Procare will be solidly accreted this year for the first time. In summary, the first quarter was a great quarter. January and February exceeded our expectations, while March was a little lighter due to the weather. We were able to once again deliver on our guidance. That's the 19th consecutive quarter of meeting or beating expectations every quarter since we became a public company, and unlike many other retailers, we continue to experience solid comp store sales growth, excellent expense control, further improved operating margins, EPS as promised, continued improvements in inventory turns, strong annual free cash flow and new store growth. With that, let me turn it back to Tom.

Okay. Thanks, David. Now we'll open it up for Q&A. Thank you.

Our question and answer session will be conducted electronically. If you would like to ask a question, you may do so by pressing the star key followed by the digit 1 on your touch-tone telephone. Again, if you would like to ask a question, please press star 1 on your telephone. We'll go to our first question from Debrah Levin with Morgan Stanley.

Good morning. I know you commented about the front end same store

sales and the impact from the weather and such, but do you have a sense that there's more of a saturation issue in your markets because at one point you would have seen same store sales on the front end at 2 to 4%, and we certainly seem to be at the low end of that now?

Deb, this is Tom. No, we don't see a saturation issue at all in our markets. I think it was just a combination of the weather and some of the changes in our seasonal offering. We had a great Valentine's Day, and as I said, our core categories are up significantly and ahead of plans. And when you look at our share numbers versus food, drug, and we continue to take share, we continue to be up at the higher end, so... As a matter of fact, we just had a meeting with most of our major suppliers last week looking at the share numbers so that, in fact, we don't think there's any of the saturation.

At what point do you think the loyalty card program will have an impact on the same store sales and front end?

Well, clearly right now it's basically neutral. I mean, from the standpoint of neutral in this respect, the customer doesn't see a true benefit at this point and they're getting the sale price. As they continue to build up points in purchases over the next six months they'll start to see rebates, they'll start to see bonus dollars, they'll start to see information related to their particular disease condition if, in fact, that's what they want. I should point out that these individuals opt into this. If they don't want information regarding their individual health conditions, they don't get it, so we're not forcing this on anybody. So the benefit right now is really getting those individuals who, in fact, were getting sales prices and didn't really even want them or know they were getting them, so we're seeing some benefit there. I would think that kind

of six to nine months out, that's what our test market showed.

Okay. And just one further on the sales question. Historically you've said former stores have been stronger on the front end sales. Is that still true?

That is still true.

Okay, thanks very much.

We'll take our next question from Meredith Adler with Lehman Brothers.

Hi, Meredith.

Hi, guys, congratulations on the good quarter.

Thank you.

Just a couple of questions about sort of your plans for relocations, and you have said in the past that relocations have good returns, and yet you have slowed it quite a bit this year with a little more emphasis on new stores in the market. Could you talk about kind of what your thinking is on relos? And on the new stores, are you seeing, markets, any shortening of the time to reach break even? And then I have one more followup question.

The roles, our plan has always been to obviously balance the relocations and the new market entries. As you know, the relocations, we take a hit in the first year we relocate the store because of the unused lease that we have to write off immediately, so our plan has always been to balance that for appropriate earnings growth over the next, you know, four to five years, and, you know, we think, you know, obviously we're still going to get to 80% of our stores being freestanding. And at this pace we'll have a consistent relocation program that'll last for the next four to five years as we enter new markets. So it's really a..., don't forget most of the relos we did earlier were around the acquisition, now it's a systematic plan that we have in place both for not only the stores we acquire but also the core CVS

stores. As far as new markets, you know, not all new markets are obviously created equal, to my earlier comments, so we clearly to have make a larger investment in marketing and name introduction in a Chicago market or a Phoenix market or a Las Vegas market than we would in any of the Florida markets. So, you know, I still feel pretty comfortable on balance that, you know, the new markets, you know, break even in the, you know, the four-year range, but obviously that varies by markets, Florida breaking earlier and the Phoenix and Vegas markets breaking later.

And in terms of the time to reach break even for a new store in an existing market, because you're doing a lot of that, how does that work and has it improved it all?

Yes, those markets, those are, you know, in the two range, two years range, and that's basically been consistent. Obviously as we add density into the new market, it drops a little less.

Okay. And my follow up question, this is more for Dave, I guess, is since you did slow the relos, is it possible to quantify what the impact was on SG&A, the benefits of doing fewer relos this year versus last year?

As you can imagine, that's a level of detail that we haven't gone into publicly, Meredith. You know, it's possible to make some estimates around that, but I don't think we'll disclose that.

Okay. Thank you very much.

Thanks.

Our next question comes from John with Goldman Sachs.

] Two things, Tom. Tell us a little bit about your using the ExtraCare card. These are your pharmacy

files, your pharmacy customers, and being able to cross sell. You know, if pharmacy customers that don't currently shop use the front end or front end customers that don't have their prescription with you, where is that going to be most lucrative and can you logistically do that today, do that wash and figure out who those customers are and market to them? And do you think that'll move the front end at all?

John, we're in the process of working on that. Obviously our main concern when you have this front pharmacy customer is to ensure that when the customer wants to participate in the program... This issue is around privacy is obviously... People have a heightened awareness about it, and I'd like to talk a little about that at some point, if not on this call, at the next week's meeting. But the issue for us now, we will have some cross selling opportunities around, you know, individuals who may be photo customers and not prescription customers, individuals that may be, to your point, front store customers but not pharmacy customers, or in fact, I think there's an opportunity for us to get a bigger share of the prescription purchase because many customers, more than most people think, use multiple pharmacies. And if we can get closer to those customers that are our best customers, I think we can limit the number of times individuals would use multiple pharmacies because now they'll want... they'll have information in one spot and we'll be able to do some cross selling. I mean, the obvious example I've used before is the diabetic or the postmenopausal woman. So the data mining on this is going to be, I think, a real big opportunity for us, and as I said, for not

only obviously our top line and our margin but also just building loyalty for our customers and also getting a bigger share of the suppliers' marketing balance.

] And do you think that time-wise that you'll be in that position, is that next year?

Yes, I think it's more late fourth quarter, definitely by the end of the second half of '02. But I couldn't be happier to have 12 million people signed up in, you know, under six weeks. And you can imagine, obviously there were some stops and starts, but overall when you think about 4,000 stores and 125,000 associates doing this day in and day out in the stores, it went very smooth. I think our operations people did a great job, I think our marketing people did a great job. You know, we had some push back by some individual customers, but to get, I think, you know, 5 million customers signed up in six weeks kind of speaks for itself. And people are understanding that this is different than a food card.

] Okay, and then secondly, can you give us a little sense... You were talking about 50 new store openings and new markets this year, how will 50 roughly break down among the markets you've identified? And then what's the early thought on next year in terms of what's feasible as you build on that 50?

Yes. Next year obviously we're going to up that number. As I mentioned, we were going steady into this year. We'll have 13 to 15 stores in the Chicago BMA and we would have 4 to 5 in Vegas and then the rest throughout Florida. I don't want to get into specific market for obviously competitive reasons, but just in

general, that's directionally where we're headed and you can fill in the remainder in those in the Florida markets. And then each year it'll ramp up, and the exact number I don't want to get into right now, but certainly it'll be more than 50, probably, you know, 75 plus.

] Okay. Thanks.

Our next question comes from with

] Yes. Could you just be at all specific about the smoothness or lumpiness in your store opening plans for rest of this year?

The rest, as far as the stores opening in the third and fourth quarter back and in March?

] Right.

Yes. That's always been the plan. That's kind of just the way it happens. It happened like that last year and we hit the number, and it's going to happen like that again this year. And it's just sort of more of an issue around zoning and requirements for allocation or assemblage of parcels. But we're quite comfortable, and obviously, we know it when we have deals signed, but more importantly with, you know, we're in the ground on these stores so we're comfortable with the numbers in the back end, and it'll probably be consistent like that the following year.

] Okay. And would the same be true of the relos?

Relos, yes. The relos are, I guess, a little more evenly spread than new stores, but yes.

] Okay. Thank you.

You're welcome.

We'll go next to George Thompson with Prudential Securities.

Good morning. I have basically three pretty simple questions, I think. Number one is when you look at the card, the sign up for the card, how far, you said you were ahead of plan, how far ahead of plan were

you? The second question relates to generic; you said 43% of the prescriptions are now generics at this point in time, how would you expect that to ramp out, ramp up, say, next year and the year after in terms of total scripts? You talked about the pharmacy sales being weak; was the weakness geographic in nature or was it sort of throughout the system? And finally, for Dave, you talked about getting to the 2.10 number this year. How would you expect that to be weighted in terms of the last two quarters of the year?

Okay, let me take first piece. The cards, we're at least 30% higher ahead than we thought we'd be as far as signup, so that obviously speaks to the people's receptiveness to the program and also the job our people did in store and in our support center. As far as the generic percentage, you know, that really is conditional on what happens with the FDA and the process of approving generics. As I said, there are some big ones coming off patent so we expect that to move, you know, we're in the 43, obviously we'd expect that to move into the 44 or 45.5% range; I don't have an exact number for you. But I think the bigger issue, there is an awareness in Washington now that many of these pharmaceutical manufactures are using tactics that are, I think, questionable with regards to delaying the introduction of generics. And I just saw recently that John McCain, Senator McCain, has

introduced some legislation to speed up the process of generic introductions. So I think all of that is obviously good for us. As you know, generics drag down the top line slightly but more than offset by gross margin improvement. As far as the sales softening, that sales softening in the pharmacy in April, don't forget, we're coming up against, you know, 18% comp. If that wasn't at the top of the industry, I won't go back and look in April of others, but if that wasn't at the top of the industry it had to be pretty close. I know some of our other competitors were in the 12 to 14 range, so 18 is pretty significant of what we're coming up against, and really the first two weeks in April was really where we had the problem with the flu. I mean, significant. Flu was ahead of in the first quarter but behind the first two weeks of April, and that was basically generally across our markets. We looked at what the Atlanta Center for Disease Control publishes, and it's public information that obviously anyone can get, and you can look at our markets and see the CDC flu index was down in the Northeast, Midwest, and Southeast, where obviously we are, so it's fairly consistent across the markets. And obviously the, you know, Humana had that second impact; we dropped Humana as of March 28.

I hate this. I get in the position of being the guy that says we don't disclose that, but we've adopted this practice of commenting on the quarter just past and then giving guidance for the following quarter and for the full year. And, you know, as we know

as we work our way through and so forth, I just want to leave it there for now.

And the fact is the 2.10 that we gave for the full year is consistent, it's never changed.

Right.

Okay. Thank you.

Thank you, George.

Our next question comes from Mark Husson with Merrill Lynch.

Good morning. Two questions. Firstly on sales, on the front end. Can you talk about your in stock position during the quarter? I know you're rolling out software that's going to help that. Anecdotally we've heard in stock positions sometimes at CVS aren't all that they should be on front end and perhaps even on the back end. If you could talk about trends in both of those areas. And the second question, Tom, if you could just give us a brief review of where you think we are in the budgetary process for some kind of Medicare drug benefit or a Medicare drug benefit for elderly poor on Capitol Hill right now?

Yes, Mark. Let me say we've made headway in our inventories but we're certainly not trying to make headway in our inventories at the expense of our in stock position. I'd be less than honest if I didn't say we didn't have in stock problems, particularly in the New York metro area. It was around promotional activity more than regular merchandise, and I think we've gotten our arms around that. And obviously the AIM system will help. It's always a balance between having the right product in the right time and the right amount in the right store, but I feel pretty comfortable that our in stock position will improve. And to that point the Triple S is really focused, as I said, on shop ability, the ease of shopping our stores, uncluttered aisles. We've make significant progress, and that's one of the hallmarks of CVS is when the people, one of the issues that consumers consistently tell us they like about CVS, we have to make sure we maintain it, the service level

at the front and in the pharmacy. You know, there's obviously different metrics around each of those. You know, whether it's three in line at the checkout or waiting time in the pharmacy. And lastly, the in stock position both in pharmacy and front, and we obviously are never happy where we're at, but clearly that's an area that we're working on and I'm happy with the progress we've made, albeit certain pockets of problems. As far as the pharmacy goes, our service level from our warehouses is very high, and as you know, we do get daily deliveries from our wholesalers. Now industry-wide there are the major product or two from Shearing that, you know, they just have trouble producing. It was an asthma drug and it's consistently been a problem not only for CVS but the industry, and we had some shortage around some allergy medication with the ramp up in the allergy season, but other than that, that seems to be it in the pharmacy.

And then on Capitol Hill?

Capitol Hill, I think now that the tax cut is at least agreed to, now they'll start working on the programs, and that's where the rubber will hit the road. I do think, you know, I met with some people on both sides of the aisle just in the last two weeks, and indications are nothing will happen around prescription drug coverage this year. This is, you know, anybody's best guess, but, you know, the pundits are saying that nothing will happen around this

year, but certainly something in '02 because, as I've indicated, certainly the Republican majority, I guess in the House anyway, doesn't want to go out in the elections, in the 2002 elections, without some form of prescription drug coverage. So I think they're going to do something. My guess, I think they'll do something around means testing for coverage for seniors and more to come.

Yes, that's what we hear, too. Okay. Thank you, Tom.

Thanks.

We'll go next to Lisa Cartwright with Salomon Smith Barney.

Good morning. Just a question on guidance. You lowered interest guidance but you're keeping the number at 2.10. Obviously you're probably accounting for the rollout of AIM and the card, but that would into your plan at the beginning of the year, so is there some conservatism there or are you seeing that the card is working so well that you've kind of set up that rollout?

Well, Lisa, I think we try to have some conservatism in some of our forecasts, but I'd say also that another factor in there obviously is the April sales, which we don't expect to be a long-term trend, but they were light, so you balance to some extent those sales and the interest and you're pretty close. We see no reason to change the full year guidance at this point.

Okay. And in terms of... I know Tom you said that you expect the cards, the benefits, to kick in in, say, six to nine months' time. Would that coincide with kind of the ramping down of the expenditures on AIM and the card or do you expect that to actually happen sooner in terms of the costs falling off?

No. The AIM system, we're going to continue to have investments in AIM. I mean, it's an inventory management

system and will continue to be obviously one of our focuses, but as we roll out something we're going to continue to have enhancements on it. So if your question is, is it going to be a ramp up in comp sales because of the card with a decrease in SG&A because of AIM? No, that will not happen.

Okay. And just to go back to the front end sales, you mentioned that out of all the categories there was only one category that you're seeing some share loss in and that's vitamins. And I realize that there are some, you know, there are some few there that are just sales, like melatonin and that's a high margin category. Do you see maybe tying that into the card somehow or do you think you're just going to not focus on vitamins as much, or?

Lisa, just for clarification, we're not seeing share loss in vitamins. What we're seeing is, you know, sales flat to down in vitamins, but in fact our share is if anything is flat to up when you look at the category. The whole category in the industry is down and the only piece that's up in some cases are body building pieces in some of the specialty stores with, you know, some of the specialty stores are doing better in that small section of the body building component. We're working on it, we're looking at it, I think you'll see us trim our offering slightly. You know, this is one of those areas that if it's not in USA Today or on Dateline or 60 Minutes, you don't get a hot product, it tends to flatten out. So we'll take

advantage of those "fad items" as they come out and we'll be able to respond and react quickly to this from an in and out standpoint. But overall the category, I think, is a category that, you know, still contributes a fair amount to the top and bottom line but it's not growing like it has. Having said that, we will focus more on the diet and nutritional, and as you are seeing in our upcoming adds we'll be focusing a little more on some of the single-source vitamins. So I think your point about the card and the postmenopausal women and calcium, there are some opportunities around that end.

Okay. Well I know Walgreen's, I guess it was a year or so ago, had to, they went to what they call flat pricing or they tried to not match but be just slightly above Wal-Mart on pricing of vitamins because they had seen similar trends. And do you see the opportunity to use the card to maybe, especially with when you're focusing on the postmenopausal woman, focusing on deals around vitamins that enhance health?

Right. I think that's more the issue. It's not a price sensitivity issue. The vitamin story for the industry as whole is not a price issue. You will see that whole category is flat in food, drug, and so it's not price sensitive or price related.

Okay. And just finally, real quickly, could you give us an update on where you are with private labels and if you're planning on tying any of those items in to the card?

Yes. Thank you. Our private label business continues to grow and outpace the industry as a whole. I think our category

managers and the folks in marketing are doing a great job selecting the right items, not all items are right for private label. And as you know, on the signup for the card, one of the initial benefits that consumers did get was a discount on private label vitamins for a period of time. So we continue to see private label as an opportunity for about, you know, 12% of our sales. And, you know, depending on what happens to the economy, we think private labels holds an opportunity and also our control label. Our control labels, back and body, are doing extremely well; in fact, we're going to add some new categories and expand the offering of our private label, of our control, and we'll talk some more about it next week.

Okay. Thank you very much.

Our next question comes from Deborah Weinswig of Bear Stearns.

Good morning. Dave, you mentioned that SG&A improvement had been driven by productivity programs and improving in-store labor efficiency? Could you discuss some of the key factors behind this initiative?

Well, it's the things we've been working on and talking about. It's implementing the Epic systems, we're starting to see the initial benefits of that, not in the first quarter but those will be coming. It's our e-procurement activities, whether it be with the Webwide retail exchange or whether it be through some of the other consortia and such that we're doing, you know, so there's a variety of them.

Could you also talk about the trends that you're seeing in shrink?

Shrink seems to be holding steady versus last year,

always more than we want, but there's not a working trend, it's a steady trend.

We'll also talk a little bit about that next week and you'll see a proprietary system that we'll demonstrate that can actually target shrink by store, by crew member, by ring, from our office, which we would hope, you know, will start to show some turning of the needle perhaps in the second half of this year. But as Dave said, we're never happy with the shrink. It's an oxymoron, but we've had improvement in our shrink the last three years.

Okay. Thank you very much.

The next question comes from Edward Comer with Credit Suisse First Boston.

Good morning. Not to be a dead horse about the second quarter, but you've got a, I know you said you planned it to be, I guess, below where the consensus is overall, but is there any reason why the second quarter would be... You know, I know you indicated April sales were a little light, but in the, I guess, you know, low to mid teens growth rate in earnings, and then what does that say, I guess, that you look out in terms of having more of a back load at second half of the year in regard to, you know, you know, picking up trends, or are you seeing a lessening of expense trends from ProCare and other things like that that will help you get to the number?

Well, and as I said, we actually planned the year to be less than 54 cents. Consensus formed around 54 cents with no guidance from us, so I can't be responsible for the spread between our plan and consensus. The simple layout of the programs that we're trying to implement this year called for somewhat higher expense in the second quarter and gives us a somewhat uneven earnings pattern, and I

know that's inconvenient from an analyst's standpoint, but, you know, we've got to do these things at the times that they can be most effective. And, for example, the ExtraCare card promotional push. If we introduced the card in February and then didn't promote it in the second quarter pretty aggressively, you know, it wouldn't be the kind of punch that it should have. So it's really just a matter of the way things laid out.

Okay. And then, I guess, the second thing is in regard to cutting back, I guess, on a lot of the general merchandise categories that maybe you probably were a little more exposed than you like to last year, sweatshirts and the like, is there any impact that you'd anticipate in regard to your front end costs versus, you know, you sort of tighten up what you're carrying in the store. I know probably the margin impact will be positive net, but just in terms of the activities that you had last year versus this year in those categories on the front end?

Yes, sure, there'll be some, you know, some slight sales impact that you cycle against some of these items because obviously even though we're getting out of them, they had obviously some sales, but it really gets back to this issue of, you know, deciding what you don't want to sell. And as I said before, we could sell almost anything in our stores with the traffic we have, but when you add, you know, shopability and in stock and what customers expect, some of these items, and I don't want to leave anybody with the impression that we're getting out of the general merchandise. I mean, general merchandise is an important driver for us, not only on sales but margin, so it's more fine tuning the mix of the general merchandise. But you're right on, but having said that, it will have a slight negative impact on us. And just to follow up on

Dave's point. You know, we built our number and, you know, the only guidance we really gave was really the 2.10 for the year and none of that's changing, and we've got investments that we're making in the second quarter on ProCare and dot com, ExtraCare, AIM, and we're very comfortable where we are.

Okay. Thank you.

Thanks, Ed.

We'll take our next question from Frank Brown with Robinson-Humphrey.

Hi. Good morning. Just checking on the front end comp. I guess in the comp that you did mention for the second quarter in the year, it seems that we could infer something like a 1% front end comp in that, and we have a sense that there is more inflation in the front end recently than there has been in the recent past, and just wondered if you would comment on that? And, you know, obviously you're removing some merchandise or fine tuning some merchandise in the front end. Are there other factors at play there?

Yes, there are other factors. We're not seeing significant price inflation at all in the front end. In fact, as we, you know, fine tune our pricing and, you know, not really fine tuning, I guess, it's just normal course of business. We're taking some prices down and we have over the last three years, and we'll consistently do that. And we think it's more important to do it by item than category. Customers don't shop categories, they shop particular items in a store, and certain items are price sensitive and others aren't, so we're not seeing... If, you know, you combine that with kind of lack of price inflation in the front end and also the increase in private label sales, I think taking all those things

together, we feel pretty comfortable with that number.

Okay. So units would probably be a bottom line with the comp number in kind of a zero percent inflation?

Probably true, yes.

Just one followup, kind of a bigger picture. Some of the drug distributors have reported strong results and they have institutional parts of their business and what have you. Do you have any sense on the pharmacy side that they have parts of their business that are performing better than the drugstores? I understand the drugstores have very strong comps in the pharmacy, but are you seeing anything different there and would there be any implications that some part of their business was getting better that could spill over into the drugstore business, you know, over the next year or so?

When you say drug distributor, are you talking about wholesalers or manufacturers?

Wholesalers.

Wholesalers. Well, you've got to look at the individual wholesalers. There's, you know, obviously the main players, a few of the main players have other businesses around the hospital, around dispensing units, around some retail stores. Cardinal, for instance, has Medicine Shoppe. So I think their growth is basically consistent with ours and, you know, maybe the trend doesn't overlap on a month to month basis, but if you look at it from a, you know, quarter to quarter, year to year, I think you'll see a fairly equal overlap.

Okay, great. Thank you.

We'll go next to Mark Miller with William Blair.

Hi, good morning. You probably touched on this earlier actually. I wanted you to elaborate on some of these regulations and legal discussion regarding privacy rights. And my specific question would be, if notification is required in these file buy situations, do you see that changing

the economic returns of these file buys? And, you know, I'm sure there's still some uncertainly here, would this change, you know, CVS activity in doing file buys, I think you did something like 300 of them last year?

Right. The file buy piece is, just without going into lot of detail on this call, just to get people up to speed on what's happening and, more importantly, what's not happening. The incident occurred in New York, and the State of New York basically has a large regulation regarding the acquisition of files and essentially it states that anybody purchasing the prescription files from a pharmacy, all those files must go intact to the particular buyer and must remain there for five years. So that's a state pharmacy regulation. Then there are certain federal regulations around controlled drugs. The files have to remain and inventory has to remain in that store. So in this particular scenario, an individual who's obviously involved in the suit would come in and said he was disappointed that he didn't know about the transfer of prescription files to CVS. There is no regulation or requirement in the State of New York to notify individuals. There are three states that require notification, and that notification varies. It may not have to be individual notification, it could be a general notice, either one, in the paper, or two, in store. And in fact, we think notification would actually help us. If an individual knows that CVS is buying the files, our feeling is they start shopping the store sooner, that's one piece. So I think the

notification, while it may be a little onerous or logistically difficult depending on how they do it for the seller, I think it'll help CVS. So I don't think it'll reduce the number of file buys. The second piece around privacy, the individual whose prescription is transferred to CVS or any other pharmacy in this country, if that individual chooses not to go to that store, we would never know anything about the individual because it wouldn't be put into the computer until the individual came into the store. So I think it's, as I said, it's a topic that's top of mind; privacy issue is obviously an emotional issue we respect, and we spend a lot of time protecting the privacy rights of our patients and we will continue to do so. But I think it's more of a press issue and it has more kind of form than substance in this particular case. And in fact, the judge has basically thrown out half the case and we haven't even made our case yet. So it's a long-winded answer, obviously it's one that we're sensitive to because is in terms of, you know, people misread it when they read the press clippings. So I do not think it's going to impact file buys. What we are concerned about is whatever the regulations, wherever they change, they hopefully will be fairly consistent throughout the country.

Then on a federal level, I know there's some discussion here on a go forward basis that you may need to update your database or make some changes to the systems. Can you just kind of put that in perspective?

Yes. The real onerous piece of the new privacy in HIPA regulations for retail pharmacy, whether it's independent or community, is the notion that an individual will have to sign a waiver every time they come in the

pharmacy to pick up a prescription. Well, that's okay for 60% of the people who come in to pick it up and who are actually the ultimate user. Unfortunately, 40% of the time someone else is picking up the prescription, whether it's for a child or a mother or a neighbor, so that would obviously present problems. And we've had a lot of discussions with, you know, the key leaders. Senator Dodd is one of the prime sponsors of this, we've had discussions with Tommy Thompson at HHS, and they are acutely aware of this. They both said this is clearly not the intent of this privacy legislation, so, you know, their issue was let's just get it out. It's got two years to be implemented, they just wanted to make sure that they get something out on the books and then they'll be modifying it. So you can never be sure in Washington, but we feel pretty good that we'll get some relief in that area.

Okay. Thanks.

We'll go to Bob Summers with Bank of America.

Good morning. Could you talk about the mail order business at PharmaCare? And then also, looking at the pharmacy sales mix, it looks like non-pharmacy sales actually declined on the year over year basis, and with PharmaCare comps being up, could you talk about maybe where the shortfall occurred?

Our mail business at PharmaCare, you know, continues to grow. It's a small piece of our business. Don't forget, when PharmaCare started off it was not really in the mail business like some other retailers. PharmaCare started off as a true pharmacy benefit management company dealing with formulary design, plan design, generic utilization, putting the network together, claims processing; it was not really in the mail business. So

it's a smaller piece of our business than others, than obviously the big three.

Any interest on trying to expand that going forward? It seems like that's a piece of business that people are increasingly trying to get their hands on?

Yes, we will; we'll selectively expand that. Our issue is driving our core business. And we think in some cases the plan design which forces to go to mail is, in fact, detrimental not only to the correct or appropriate pharmaceutical care but also increases costs by overutilization. But I think one of the things you'll see in the industry as we go forward is, you know, the ability to dispense, you know, maintenance medications, 30-, 60-, 90-day supply at retail and, you know, we can make the pretty strong case that community pharmacy is as effective or more effective than mail. When you take away the plan design or unlevel playing field, if you will, that allows or offers the consumer the ability to go get or have a mail order prescription at a significantly reduced co-pay, if you take that away, the consumer will time and time again choose retail over mail. So, it's kind of a double-edged sword in how we're looking at it. But, you know, clearly our business is retail and we use mail at PharmaCare to supplement their offering.

Okay. Thank you.

Our next question comes from some Steve Just with J.P.

Morgan.

Hi, guys. Thanks. I just... Tom, if you could clarify, with the dropping of Humana, I just want to make sure I understood. Did you say that for your April costs with dropping that plan, that was

Yes, that along with the flu. I mean, Humana, you know, it was in three states, Kentucky, Tennessee, and Ohio, you know, pretty big plans. But, you know, I don't want to mislead you and say that was the main driver of the reduction. I would say it was a combination of factors and that was one of them.

Alright. Now is that something that kind of is a little bit of an overhang as you get into the future months or, I mean, how do you comp against that. I mean, I imagine...?

Yes. We have that all the time. You know, we... Harvard, you know, PharmaCare lost Harvard a year ago, Harvard Pilgrim, and then it was also opened up to a wider group, so this puts and takes on every month, every quarter, every other plans that we'll pick up, and it will offset it.

Right. Okay. Alright, and then I guess another thing is, as you look at your market entries with your real estate strategy, and thus far have you seen any potential opportunities to maybe make, you know, some type of acquisition to penetrate big markets, whether it's, you know, a group of, you know, a smaller chain or a group of smaller stores, or even maybe a piece out from under a larger multi-regional or national chain; maybe they might be willing to sell off drugs. Are you seeing anything like that or is it more likely that you're going to be going in organically?

The trend right now is to go in organically and we feel very confident in our numbers and so doing it through self-development. Obviously, we're a company that thinks acquisitions are appropriate and we also feel it's one of our

core competencies. So if there ever arose, if there were acquisition opportunities, certainly we'd look at them with the right criteria.

Okay.

Okay, I'd like to take one more question. Okay.

We'll take our final question today from Jack Russo with AG Edwards.

Hey, Tom. I know you've been watching the Walgreen situation with Medicaid and the State of Illinois, and I tracked down some data, and there's a lot of other states proposing Medicaid reimbursement reductions this year, a lot of them in your back yard, Connecticut, Kentucky, Indiana, and so forth. I'm just curious what your thoughts are on this whole pattern, and Medicaid doesn't look like they're going to back down very much. Is the federal government going to have to come in and provide more funding? Do you think the drug chains could walk from this business? And this seems to be an escalating battle between these two parties. I'm just curious what your thoughts are.

Yes. This is, obviously it's an issue that's not just relegated to or contained in Illinois as you suggested. It's going on in other states. We clearly support the Walgreen's position. And it's not, you know, chain pharmacy against independents, this is affecting all of community pharmacy. And there's two issues. One is the actual payment dollars, two is the payment terms. I mean, Illinois, if it's not last it's close to last in the time it takes to receive payment. So there's a cost of money issue, there's a receivable issue. You know, a lot of these states are not on the cutting edge of technology investment. I mean, I can give you an example. South Carolina just recently went to claims and online adjudication. Before that, up to last year, you know, we were at a high rejection rate, so that's another piece. So there's pieces of it that involve obviously the dollar reimbursements but also the payment

terms. And I think, you know, states are going to grapple with it. The cost of health care is increasing, the cost of pharmaceuticals are increasing, it's going to be a higher piece of their spend. But I think if you talk to them, they know it's an appropriate spend. Their issue is where do they save it on the other side? And I do think there are opportunities for the states around formularies, around use of generics, around the appropriate use of retail pharmacy versus mail. So we are working obviously through our associations, not only at the federal level but the state level, to make sure our voice is heard. And, you know, they're not going to win this, they're not going to save this on the backs of retail pharmacy. When they look at the economics and they look at the margins, that's not where the savings are going to come from. And I think, you know, it's kind of a knee jerk reaction to just lower the reimbursement rate. In fact, long [term] it's very short sighted, so I think we'll be okay in that area.

Okay. Thanks, Tom.

Okay. Thank you all for listening and we hope to see you all next week in New York. Thanks. This does concludes today's conference. Thank you for your