CVS Health Corp (CVS) 2008 Q1 法說會逐字稿

Good morning.

My name is Amanda, and I will be your conference operator today.

At this time, I'd like to welcome everyone to the CVS Corporation first quarter earnings conference call.

All lines have been placed on mute to prevent any background noise.

After the speakers remarks, there is will be a question-and-answer session.

(OPERATOR INSTRUCTIONS)

I would now like to turn the call over to Nancy Christal, Senior Vice President- Investor Relations.

Please go ahead ma'ma.

Thank you, Amanda.

Good morning, everyone, and thanks for joining us today for our first quarter earnings conference call.

I'm here with Dave Rickard, Executive Vice President and CFO, of CVS Caremark who will provide a business update, a financial review of the first quarter and guidance.

Also with us is Howard McLure, President of Caremark Pharmacy Services, who will participate in the question-and-answer session.

First I'll note that we expect to file our 10-Q by the end of the day today, and it will be available through our website at investor.cvs.com.

This morning we will discuss some nonGAAP financial measures in talking about our Company's performance, namely free cash flow, EBITDA and adjusted EPS.

Free cash flow is defined as earning after taxes plus noncash charges, plus changes in working capital less net capital expenditures.

So free cash flow excludes acquisitions and EBITDA.

EBITDA is defined as operating profit plus depreciation plus amortization.

Adjusted EPS is defined as diluted EPS eliminating the affect of amortization only and assuming our overall effective for the amortization.

We will provide guidance today using adjusted EPS as we did on our last call.

In accordance with SEC regulations you can find the reconciliation of the nonGAAP items I mentioned to comparable GAAP measures on the investor relations portion of our website at investor.cvs.com.

As always today's call is being simulcast on our IR website, it will also be archived there for a one month period following the call to make it easy for all investors to access the call.

Following our remarks we'll have a q-and-a session and we ask that you limit yourself to one to two questions including follow-up so that we can get to as many analysts and investors as possible.

Let me quickly touch on a couple of items before turning this over to Dave.

First a reminder that our annual analyst and investor meeting will take place on the morning of Wednesday, May 21st at the Mandarin Oriental Hotel in New York City.

We've had an enormous response at the meeting and we look forward to seeing several hundred of you there.

If anyone else would like to attend and needs the specifics on the meeting, please call my office and we'll do our best to fit you in.

The presentations will also be available via webcast.

This is the one time per year that we provide broad access to an extended group of our Senior Management team, so we do hope you can be there in person.

Given that we have our big meeting in a few weeks, today's business update will be somewhat more brief than usual.

We will focus primarily on the quarter's results.

There's one item that I'd like to address with respect to disclosure going forward.

Many of you have asked me what our practices will be with respect to announcing PBM contract wins.

And I want to share with you our intentions in that regard.

First of all, keep in mind that many clients do not give us permission to announce or discuss the details of our contracts publicly.

So we will provide summary updates on our overall selling season on our quarterly earnings call.

We'll generally not provide information regarding factual wins and losses between calls.

However, in rare instances we may make an exception between quarters and announce a contractual event for unusually large contracts that is a subject of market rumors or speculation that may affect our share price.

Hopefully that gives you some sense of our intention.

Now before we continue our attorneys have asked me to read a-- our Safe Harbor Statement.

During this presentation we will make certain forward-looking statements that are subject to risks and uncertainties that could cause actual results to differ materially.

Accordingly for these forward-looking statements, we claim the protection of the Safe Harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995.

We strongly recommend that you become familiar with the specific risk and uncertainties that are described in the risk factors section of our most recently filed annual report on Form 10-K.

And now I will turn this over to, our CFO, Dave Rickard.

Thanks, Nancy, and good morning, everyone.

I hope you've all had a chance to read through the terrific financial results we reported this morning.

If you did, you may have noticed that we posted record first quarter sales, operating profit, operating profit margin, net earnings and diluted earnings per share.

Before I run through these results in detail, I want to touch on a few key areas we've been getting questions on.

These include the PBM selling season, MinuteClinic, pharmacy and front store trends in our retail business and our new store program.

So how is the PBM doing?

Well the 2009 selling season is going very well, and we're pleased with our progress to date.

As most of you know about a third of our contracts come up for renewal each year.

For 2009 we've already renewed more than half of our business that's up for renewal this year.

These include some marquee accounts such as AT&T, Banc of America, 3M and the state of Connecticut.

As previously announced in the case of AT&T, we picked up some incremental business as well as they consolidated all of their PBM business with CVS Caremark instead of having the BellSouth piece separately contracted.

Our clients are telling us that we've kept our focus on service, which was their primary concern following our merger.

They've also expressed their enthusiasm for our new model because they understand that our unique combination can lower their overall cost while improving access, convenience and health outcomes for their members.

We'll provide many more details in our new value proposition at our May 21st analyst meeting.

So our retention thus far has been terrific.

What about new PBM business?

Well we've already had some early successes this selling season as well.

It was previously announced that we won the PBM contract to service the employee retirement system of Texas, or ERS, and the BellSouth portion of the AT&T contract.

Those two contracts together are worth nearly $1 billion in annual revenues.

In the aggregate, we've already won the right to serve about 40 other clients, most beginning in January of 2009.

I'm delighted to report that these new contract wins to date in total should have first year revenues of about $3 billion.

Included in that number I'm very pleased to note we've been selected to provide specialty pharmacy services for a large Top 10 Blues plan beginning during the second quarter of 2008.

We'll provide a fully integrated specialty model including not only specialty mail, specialty retail and disease management problems, but also access to care through CVS retail pharmacies.

They've chosen this integrated approach as an enhancement to their current solution.

We'll use the vast resources of our enterprise to help them control their specialty pharmacy costs most affectively, improve patient access and deliver better health outcomes.

Over all our progress and momentum in this PBM selling season are just what we'd like.

It's very clear that our new model is resonating in the marketplace.

Let me move on to an update on MinuteClinic.

We treated 300,000 patients during the first quarter alone.

And customer feedback on our clinic's continues to be highly positive.

We're providing quick and cost affective access to high-quality health care professionals for every day common illnesses.

MinuteClinic leads the industry and has 350 clinics more than our nearest retail clinic competitor.

We operated 510 clinics at the end of the first quarter.

Our initial goal for the MinuteClinic business was to gain first mover advantage, building our lead in selected markets and we've done that.

Now we've made the strategic decision to reduce the number of clinics we add this year so that we can better focus our efforts in 2008 on expanding services, contracting with additional third party payors and working with PBM clients to offer new products and services.

We now expect to add approximately 100 clinics in 2008, and end the year with between 550 and 600 clinics compared to the approximately 700 we'd previously forecast.

Also, we may close some clinics not currently in CVS stores or Caremark client locations.

We remain very optimistic about the prospects for MinuteClinic and believe we're taking the right steps to best position it for long-term success.

Now let me touch on the retail pharmacy side of our business, and again it's a good story.

IMS status shows CVS steadily gaining share, we're up again this quarter versus the fourth quarter of 2007.

We hold a 17% national retail market share and a 22% share across the markets in which we operate.

Our scrip growth in the first quarter versus the fourth quarter of '07 is ahead of all other chain stores.

Pharmacy comps for the first quarter were 3.7%.

That included approximately 450 basis point of negative impact from new generics.

So adjusting for new generics, we would have reporting 8.2% pharmacy comps.

The flu had a negligible impact on pharmacy comps in the first quarter.

Our generic dispensing rate in our retail segment was 66.6%, up from 61.7% last year.

Pharmacy comparisons were influenced negatively by the deceleration of med D growth compared to last year when it was still ramping up.

In addition, the switch of ZYRTEC from a prescription to an over the counter product, obviously reduced prescriptions filled.

On a positive note, however, we had a private label over the counter version immediately available upon the switch.

So the overall impact of the ZYRTEC change, while negative to pharmacy, was beneficial to front store sales and especially margins.

Our front end business continued to demonstrate healthy growth in both customer traffic counts and average dollar spent for transaction.

Front store comps increased 4.3% in the first quarter.

That included a benefit from the Easter shift of approximately 115 basis points.

I'd like to touch on our same-store sales results for the combined March/April period in light of the Easter shift, which of course impacts front store sales in the second quarter as well as the first quarter.

For the combined March/April period, front store comps were 3.4%.

In March, front store comps were 6.5%.

And in April front store comps were minus 0.2%, due to the impact of the earlier Easter.

So you should factor that in when building your models for second quarter sales.

We've told you in the past that the front store business now makes up only about 15% of our revenues and profits and that only 20% of that is considered discretionary.

Many of you have been asking what if any impact we're seeing from the softer economy on our front store business.

And I can report that we recently looked at the discretionary versus nondiscretionary categories to evaluate whether there was any change in trend.

Our data shows no evidence of a consumer slowdown based on this analysis.

My interpretation is that consumers are making tough choices on big ticket purchases but they aren't yet not focused on Snicker's bars.

And how does all this stack up relative to the competition?

Well I'm pleased to report that we continue to grow share in the key front store categories that make up the vast majority of our sales, OTC, beauty, private label and digital photo.

In fact we experienced share gains versus food,drug and mass competitors in categories representing more than 90% of our front store sales volume.

In addition, our private label business continues to grow across our store base.

In the first quarter, private label made up 14.8% of total front store sales.

That's up 90 basis points versus the prior year.

We continue on our path to achieve our goal of private label and proprietary brands to represent 18% to 20% of front store sales in the next three to five years, and that will help drive margins.

In both the front store and the pharmacy, comps in the former Osco Sav-On stores acquired in 2006, continue to out pace our core stores in the first quarter.

So we're very pleased with the continued good progress in our acquired stores.

I'll also note that our front store margins continue to improve.

That's importantly driven by the use of our ExtraCare loyalty program to drive more profitable sales, more than 65% of our front sales across the store base currently use the ExtraCare card.

We have well over 50 million active card holders and we continue to find more ways to use the data to drive better results.

Before diving into the financials, I'll touch briefly on our real estate program.

In the first quarter we opened 94 stores including 41 new and 53 relocations.

We closed 19 others.

So we added 22 net new CVS Pharmacy stores in the quarter.

For 2008 our plan remains to open 300 to 325 stores, about 175 to 185 will be new and the rest will be relocations.

And we expect to achieve approximately 3.5% retail square footage growth.

Now let me turn to the details of our financial performance in the first quarter that we reported today.

After that I'll provide guidance for the second quarter as well as the remainder of the year.

I'll start by reminding you that we lapped the one year anniversary of the merger of CVS and Caremark at the end of March.

So the March 2008 quarter is the last quarter in which the absence of Caremark in the reported prior year results skews our growth statistics.

Going forward our reported results will be apples-to-apples comparisons with the exception of integration and other one time costs.

Let's turn to our first quarter income statement.

Total revenues on a consolidated basis increased 62% to $21.3 billion.

This figure is net of interest segment eliminations of $1.3 billion.

In our retail drugstore segment revenue increased 5.4% to $11.8 billion, same-store sales for the quarter were 3.9% in line with our guidance.

And how about the PBM segment?

Well net revenues of $10.8 billion increased 2.3% over the comparable 2007 first quarter figure.

Adjusting that growth rate for the impact of generics, net revenues would have grown 10.6% for the PBM.

The impact in the change in PharmaCare's revenue recognition method on the first quarter was the addition of approximately $710.5 million in reported revenues before inter-Company eliminations or about $555.4 million after eliminations.

So on a comparable basis what grow drove the growth of PBM revenues?

Total retail network revenues were $7 billion, rising 12% from 2007 levels.

Setting aside the increase from PharmaCare's revenue recognition retail network revenue increased 0.6%.

At the same time, retail network claims grew 5.7%.

This was predominantly driven by new business including the growth spurt in our PDP, which experienced healthy growth in med D lives this year.

The PBM's retail generic dispensing rate increased to 65.2% compared to 59.9% in the first quarter of 2007.

This significant increase in the generic dispensing rate explains the despairety between retail network revenue growth and retail network claims growth.

As expected mail claims decreased for the quarter by 17.7% on a comparable basis.

The impact of new clients was more than offset by previously announced terminations, namely FEP, State of New York, and Ohio State teachers retirement system.

As a reminder the portion of the FEP business that we no longer service is the mail order piece including PBM mail and specialty mail.

We continue to service FEP's retail net works.

Total mail revenues declined 12.4% to $3.6 billion and within total mail revenues PBM mail was down 21.1% compared to the first quarter of 2007 while our specialty mail revenues increased 4.6%.

If you exclude the FEP business from last year's data, total mail revenues increased 4% and specialty revenues grew 14.4% in the first quarter.

The mail generic dispensing rate rose to 52.8% from 45.8% a year ago.

That's a healthy 700 basis points of growth.

Excluding FEP the increased drops to 600 basis points, still very significant.

Our overall mail penetration rate decreased 5 percentage points from 2007s first quarter to 23.1% again largely as a result of the absence of the FEP mail business.

Moving on to gross profit for the total Company.

The overall business did extremely well thanks to strong performances within both segments.

Within the retail segment, gross profit margins were up 200 basis points over the first quarter of 2007 to 29.6%.

The primary drivers of this on the pharmacy side continued to be the substantial margin expansion we experienced from the increased utilization of generic pharmaceuticals as well as merger related purchasing synergies.

At the same time, front store margins improved.

That reflected not only an improved product mix and reduced shrink in our acquired stores, but also the benefits of the ExtraCare card that result in a lower percent of products sold on promotion.

Offsetting these gains somewhat was continued pressure on generic reimbursement rates as well as an increase in the percentage of pharmacy sales handled by third party insurance.

Gross profit margins in the PBM segment on a comparable basis expanded to 7.3%.

That's up 10 basis points versus 2007's first quarter and includes the 52 basis point drag from the conversion of PharmaCare's contracts.

Like the retail segment our PBM pharmacy margin continued to benefit from the purchasing synergies derived form the merger as well as an increase in the conversion of branded drugs to generic equivalents.

And as I mentioned on our last call, we anticipate a grater impact from new generics in the second half of the year.

In addition, recall that I also told you that our PBM would see higher profitability later in the year from the med D business in light of the widened risk corridors and the related accounting.

So what about expenses?

Overall operating expenses as a percentage of sales improved due to the change in mix between retail and PBM.

In the retail segment operating expenses increased as a percent of sales from 22.1% to 22.5%.

This was primarily caused by the significant growth in generics which pressure sales dollars while improving profitability.

Adjusting for the growth in our generic dispensing rate as retail, operating expenses as a percentage of sales for the retail business actually improved by more than 80 basis points.

In the PBM segment, comparable operating expense as a percentage of revenues improved by 10 basis points to 2.3%.

So I'm very pleased with our continued solid expense control in both our retail and PBM segments.

All things considered we saw a notable expansion of our operating margins, particularly in the retail segment.

The retail's segment operating profit margin grew by 150 basis points over 2007 to 7.1%.

While the PBM segments operating profit margin improved by 20 basis points over 2007's comparable results.

Our PBMs industry-leading EBITDA per adjusted claim increased to $3.41 excluding integration costs in the first quarter or 6.9% over last year's $3.19.

Excluding the FEP mail business we would have add double-digit growth in EBITDA per adjusted claims.

So the underlying growth of the business is excellent.

Moving onto the rest of the income statement.

We saw quarterly net interest expense on the consolidated income statement increase to $131 million reflecting additional interest from our increased debt position due to the merger as well as our balance sheet restructuring.

Our tax rate was 39.6% in the quarter in line with expectations.

And our diluted share count was 1.47 billion shares, of course that's up significantly from last year's first quarter since last year's first quarter shares were only weighted with merger-related shares for the final ten days of the quarter.

So what did all this mean for EPS?

While adjusted EPS rose 18.3% to $0.55 up from $0.46 in 2007 and at the high-end of our guidance.

So we produced solidly robust earnings year-over-year despite the additional financing costs.

GAAP diluted EPS rose 17.4% to $0.51 for the quarter compared to $0.43 in the first quarter of 2007.

Turning to the balance sheet and cash flows.

We generated $346 million in free cash flow in first quarter.

Net capital expenditures were $395 million in the quarter which reflected proceeds from sale lease back transactions of $5 million netted against the gross capital spend.

Now during our last conference call I announced that in November we had entered into a $2.3 billion accelerated share repurchase agreement which we expected to complete during the first quarter.

We did just that.

And while the outflow of cash happened entirely during the fourth quarter, we received an additional 5.7 million shares in the first quarter to complete the transaction.

So we placed those shares into our treasury account.

We are now finished with the authorized repurchase programs that were born of the merger.

Now let me turn to guidance for the second quarter and full year 2008.

In the second quarter we expect revenue growth for the total Company to be in the range of 3% to 5%.

We expect PBM revenue to be up slightly in the second quarter.

And we expect retail revenues to be up 5% to 7%.

On the retail side we had the positive impact of the Easter shift in the first quarter so of course in the second quarter we get the reverse affect of that in our front store sales.

We anticipate second quarter adjusted EPS of between $0.59 and $0.61 per diluted share up from last year's $0.51 per share.

That equates to adjusted EPS growth of 16% to 20%.

GAAP EPS is expected to be in the range of $0.55 to $0.57 per diluted share up from last year's $0.47 per share.

Given the continued strength across our businesses we remain optimistic about our growth for the full year.

Let me walk you through our current guidance assumptions.

For the total Company we expect revenue growth of about 13% to 16% for the full year after inter-Company eliminations of approximately $1 billion per quarter.

For both segments, generics will play a role in dampening top line growth.

For the PBM segment on a comparable basis, we expect revenues to be flat with 2007.

This the an improved outlook and reflects some contract wins starting later this year as well as a higher level of price inflation than we originally anticipated.

But, we expect reported revenue growth of over 20% for the year since the merger closed in late March of 2007.

Remember, this revenue estimate also includes an impact of approximately $2 billion year-over-year from the change in PharmaCare's revenue recognition methodology from the net to the gross basis, and for the full year as opposed to a partial year.

For the retail segment, we expect revenue growth of between 7% and 10% for the year.

Same-store sales are expected to be in the range of 4% to 7%, for the retail segment for the year.

For the total Company, gross profit margins are still expected to be down modestly due to the mix impact as we average in a full 12 months of Caremark.

However, gross margins are expected to increase by roughly 25 to 50 basis points for the PBM segment on a comparable basis, despite the gross up of the PharmaCare contracts.

And we now expect gross margins for the retail segment to increase 50 to 75 basis points.

In part that's due to the delay in implementation of the medicaid A&P cuts.

As we said on the fourth quarter call, we're assuming fewer new generic introductions in 2008 than in 2007.

We also continue to believe that these introductions will be backend loaded, as such we won't see the bulk of them until the third quarter.

So our 2008 outlook assumes that generics do help our gross margins but are less favorable to margins than they were in 2007.

Additionally our gross margin will be helped by purchasing synergies, we still expect more than $700 million in synergies in 2008 much of which is from purchasing.

As for expenses, we still expect total Company operating expenses as a percentage of revenue to improve significantly, that's largely due to mix.

The total operating expenses as a percentage of sales for the PBM segment on a comparable basis may be in the neighborhood of last year's numbers as general good housekeeping could be directionally offset by the 2008 start up cost of all that new business Howard and his team have been bringing in for 2009.

The retail segment has no such headwind and we still expect it to show moderate improvement.

We expect total consolidated amortization for 2008 of approximately $400 million and depreciation of about $850 million.

All of that again leads to solid improvement in operating profit margins for the total Company as well as for each segment.

As I said on the last call, we could nicely exceed 6.5%, our current operating margin high water mark which we achieved back in the year 2000.

We forecast net interest of about $475 million to $500 million and a tax rate approaching 40%.

We expect approximately 1.49 billion weighted average shares for the year and no further share repurchases are included in this guidance.

All things considered we are raising the low end of our full year guidance range by $0.01.

We currently expect to deliver adjusted EPS of $2.44 to $2.50 and GAAP EPS of $2.27 to $2.33.

That represents growth of 18% to 21% on both an adjusted and GAAP EPS basis.

Net capital expenditures are expected to be in the range of $1.3 billion to $1.4 billion for 2008.

Free crash flow is expected to be around $3 billion, driven largely by the strong earnings growth we expect to deliver in 2008.

As you can see our business is very strong and we remain optimistic about 2008 and beyond.

So in summary, in the first quarter, we delivered strong revenue growth, significant margin expansion, 18% adjusted EPS growth and healthy free crash flow.

Our retail business continues to grow strongly and gain market share in the front end and in the pharmacy.

The PBM selling season is off to a great start and shows every indication of a terrific year.

Our new offerings are catching on.

Payers increasingly understand that we can improve convenience and access for their members while lowering their overall healthcare costs.

And our guidance confirms that our confidence and continued robust business growth and financial performance.

Now we'd be glad to take your questions.

Thank you.

(OPERATOR INSTRUCTIONS) Your first question is from John Heinbockel with Goldman Sachs.

Dave, I wanted to drill down a little bit on retail and PBM EBIT because retail looked incredibly good, and PBM looked a little light.

On the, just on the retail side to start, (inaudible) I would assume had a modest but not overwhelming benefit.

Is that fair?

And did you see-- it looks like you're continuing to see a fairly good generic environment, despite the comparisons?

Yes.

The Easter period, because it was several days shorter than last year, we had actually planned to be down, and it was down but not as much as we planned.

So you could say it had a benefit in the way it played out versus our expectation.

We had a good sell through, we had a good season, but it was simply a shorter number of days.

As far as generics yes, we had good, very good performance in generics on both the retail and the PBM side.

Did it surprise you on the retail side how good the lift was from generic, or it's pretty much what you thought?

Actually on both sides of the business, we were generally in the territory that we expected to be.

All right.

And then on the PBM was there any adverse hit from FEP in New York state, that would be abnormally large, because it's the first quarter and you're transitioning away from that business or was that a-- not much of an impact?

Well I'd say this, you have to keep in mind that FEP, the mail side of FEP, was in the third year, last year 2007.

So third year is always the most profitable year in a PBM contract.

And so the comparison is tough for that reason.

It was also a substantial specialty business.

So again, that means that it had more profitability than some.

And simply the absence of that in comparison obviously is a year-to-year reduction.

Now had we bid and won the contract we would have had a significant reduction anyhow because of the fact of new rates and so forth in the new contract.

But nonetheless the absence of it was a significant factor.

I would say though, that we didn't have a substantial number of incremental costs in the first quarter related to stepping away from that.

We obviously to the degree that we had obligations and announced termination and such provided for those by accrual in the fourth quarter of last year.

So there wasn't any clutter in the first quarter if that's your question.

Well I was just trying to get at how representative is-- was the one quarter performance for Caremark because the margin and the EBIT just looked light relative to trend.

I wanted to see, is it, what was impacting the performance versus we're we were coming out of '07 and is the first quarter representative.

And I guess it's kind of representative but you think for a variety of reasons the margin is going to get a lot better as the year goes on.

Yes, I'd say the one factor that we talked about importantly when we gave the initial guidance for the first quarter was that the med D program was evolving as CMX intended it to and as everyone knows that it was going to.

And an important part of that was the widening of the risk corridors.

Given the fact that we have to account for the insurance piece of the business, in each quarter as if it were a full year, we can't-- we end up recording our worst performance in the first quarter when we have many costs and not as much revenue pro rata.

So the pattern of earnings gets worse when you add insurance business or you add risk to an existing insurance business, which we did this time.

A third factor that impacts-- and that we talked about some in the last call.

Third factor that impacts this significantly is the pattern of generic conversions and where as we did have some in the first quarter we also expected, and still expect, that the big quarter this year's going to be the third quarter.

Last year we had proportionately more in the first quarter.

So there were two or three things here that structurally would have resulted in the pattern that you've seen.

Okay, thanks.

Now obviously we came in $0.01 better than the mid-point of our range and we were very happy with that financial outcome.

Thank you.

Okay.

Your next question comes form Lisa Gill with JPMorgan.

Hi, thanks very much for the detail.

Just first a follow-on, Dave, just so we understand on the part D side.

Does-- are you really talking about bringing up your reserves around part D because of the change in the risk corridors for this year and therefore as you move throughout the year you can potentially start to take down the reserves?

Is that how we should think about that component of the business?

Well it's not, it's not a voluntary change in reserves, it's a mandatory accounting that in affect says, all of the revenues and all of the costs get booked within each quarter discreetly as if it were a full year.

Many other parts of accounting allow you to look at the full year and take a pro rata portion.

This particular accounting has its own specific rule that we have to abide by and that's how we have to account for it.

So the upshot is we can't smooth higher loss ratios that are incurred early in the program before we get into the donut hole.

Okay, great.

And then just a couple of other quick PBM questions.

When you talked about the $3 billion of new business is that on a net basis or on a gross basis for 1-1-2009?

Yes, that's on a gross basis.

What I'm trying to help you to understand is how the year is going, but we're not yet at a point where we have a very very clear fix on what 2009 is going be.

And so I would encourage you not to fire up the model for 2009 based on these very very early results.

But is that the plan over time to do-- to give us a net number is that--?

Yes, we'll give you as much shape as we can in the third quarter call as we usually do.

That's when we know 95% of what's going to happen and we can give you an accurate read.

All we can do right now is just indicate how the year is going, and it's going quite well.

Okay, great.

And then just lastly, I know you haven't done this in the past but do you want to give us any kind of guidance as to how we should be thinking that EBITDA prescript?

I think what John was trying to get at is that most of us were pretty far off in the first quarter and obviously I think FEP being in the third year was more profitable than many of us thought it was.

Any way we should be thinking about that that as we go through out the year?

It sounds like it's going to get better as it progresses but is there anything else that's unusual as we move through out 2008?

Well obviously that is also affected by a mix of contracts and so forth and that's still evolving, so it's a little bit of a shot in the dark.

But I would expect that you should expect pretty consistent improvement in that as we go through the year.

But that's a general expectation and I could well be wrong.

Great.

And then just one last follow-up, when you talk about clients and new clients that you've signed on, we all been waiting to hear about some of the programs that they're really looking forward to.

Can you maybe just give us some color around some of the things AT&T liked or some of these new 40 clients that you've signed on that they've really liked about the combination of the two entities?

Thanks very much.

Yes, I could do that, but Howard can do it better.

I'm going to ask Howard to take the podium here.

Okay, excuse me.

Lisa, how are you doing?

Hi, Howard.

The May meeting, the analyst meeting that Nancy referenced we'll have a lot more detail on.

And without talking about what any specific client found meaningful, I think what clients are seeing resonating is the value proposition from the unique and integrated health model that we're putting together.

One thing that is in the marketplace today is what we call ability often times clients or participants don't get their mail order prescriptions in on a timely basis and they can't get it turned around, consequently they're left with a gap in care.

One of the products we have introduced, we introduced on April 1st is the ability for them to go to a CVS store and get that five days worth of medication, no incremental cost to either the patient or the participant-- so, excuse me, or the client.

So those are the types of programs and you'll hear more in May, so I don't want to go in to a lot of detail on them today.

But that's-- those are the types of programs that are out there sponsors are seeing.

The component that we've all talked about that you've heard over and over is the ability, the consumer basing availability that we have is really unique to our PBM retail model.

Great, thank you.

Your next question is from Ed Kelly with Credit Suisse.

Good morning, Dave and congratulations on a strong quarter.

Thank you, Ed.

Dave, could you just give us some color on the decision to cut back on the MinuteClinic growth?

Maybe just providing more details on the variables that led to that decision?

And then is there any real meaningful EPS benefit from not opening up as many clinics this year?

I'm sorry I didn't get the second part of your question, can you repeat that?

Is there any meaningful EPS benefit relative to your prior guidance--?

Okay.

Well I tell you this, in any new business you learn as you go and you adjust priorities accordingly.

Early on, we focused on expanding the footprint, we've now brought it to a point where we think we have a basis for a very good business and now we really need the team to focus on enriching the platform while it continues to expand at a more balanced rate.

It also-- the Management team needs to finalize agreements with some plans in certain markets and continue our marketing efforts.

So it's more an enrichment now than it is expansion although we will continue to expand.

And in terms of the financial affect, we're actually-- this strategy change is actually going to be a little bit more expensive than the original strategy as it turns out.

But we think it's the right thing.

We think it's much more likely to lead to a terrific successful little business that's an important adjunct to our PBM efforts than simply the land grab that we were in for awhile there.

Has-- have staffing issues have anything to do with this?

We haven't run into any significant staffing issues yet, that's not to say that we won't.

We would expect to down the road especially as our competitors also are expanding quickly.

But that hasn't yet been an issue.

Okay.

And your retail gross margin obviously was very strong this quarter up 200 basis points, Walgreen's gross margin was flat.

Your front end gross margins up, theirs was down.

This might not be a fair question, but could you maybe help us to understand how you're producing such strong results when your biggest competitors not?

Well, I don't want to comment too much on my competitors results.

But I understand that they have said that they are finding a need to spend more promotionally.

We're finding the reverse of that, we're not having to expend as much promotionally.

We also have favorable mix change, the growth in our private label is a good example of that.

So we've got a lot of things going positively in that business.

And ExtraCare is a unique weapon, it's something we have and they don't have, and it permits us to manage our promotional spend more precisely and to much greater effect than broad campaigns or circulars.

We've known that for years it's an advantage we have in our business it's structural.

We also are getting some benefits in purchasing that they may or may not be getting.

So all I can tell you is that the programs that we have in place are working.

And I don't know really any details about their progress.

Okay, thank you, Dave.

Your next question comes from Eric Bosshard with Cleveland Research.

Good morning.

Good morning, Eric.

A follow-up on MinuteClinic.

Is the terminal or long-term target for MinuteClinic's any different and can you give us any reminder of the concept of what that number might be?

We said early on that we expected about 1500 to 2500 MinuteClinics across the system.

We really haven't revisited that.

So I don't have new news on that.

We still would expect it'll be something like that.

But we'll solve the very long-term in due course.

Right now we want to make sure we're having as great an impact as we possibly can with the model.

So this would suggest that you're maybe going slower but still going in that direction, is that the right way to think about this?

Yes, I think that's the right way to think about it.

Obviously we're expanding the services that we're offering, so it's going to be a richer content as we roll it further.

But we also have to back fill now with that richer content into the first 500 stores.

Secondly in terms of pharmacy profitability, I know there's a lot of talk on the last call about changes in the pace of drugs being maced in generic reimbursements.

Can you give us an update of what you see going on in terms of underlying pharmacy profitability especially on the generic side of the business?

I'd say that what we have been experiencing for the last several quarters continues, with no acceleration or change really.

But the last several quarters are faster [macing] than a few years ago.

But that trend continues, it's not accelerating.

And then lastly the cash flow target you gave out suggested a significant amount of free cash flow this year, can you give us sense of what the Board is thinking or Management is thinking in terms of using the cash flow?

Well, I think that we don't have any new announcement to make today, new programs there.

Obviously it's a lot of cash.

I've said before that we wanted to put ourselves in a little bit more flexible position from a strategic standpoint relative to cash capacity.

But after that it would be appropriate to find appropriate ways to get it to shareholders.

Okay, thank you.

Okay.

Your next questions from Mark Wiltamuth with Morgan Stanley.

Good morning, Mark.

Good morning.

I wanted to dig in a little more on those new PBM contract victories.

There was-- there's a lot of chatter out there in the marketplace that these were just priced focused wins.

Is there anything you can really relay to us that indicate that that is not the case, that there were actual attributes that they liked about the new combined offering?

It's been my experience as we've gotten more deeply in to PBM dynamics that the loser of contracts always says that.

And there have been a lot of losers out there.

We think that the reality is that we do have to be competitive in terms of price.

But that what we are bringing to the table is value.

We are bringing a better product, that we can uniquely deliver because of our structure.

And our customers certainly are cognizant of that and are very enthusiastic about that.

So I think what we're seeing here is the beginnings of what we expected to see when we talked about this combination of CVS and Caremark originally.

That is the ability to add service and convenience and ease for customers, improve outcomes and lower costs for clients.

And that's what we're doing, and they are responding.

And did those contracts include any discounts for on the front end or any flexible prescription capabilities or anything like that yet?

Howard is saying that they don't.

I know that before the merger we had a couple of programs like that, we had a feature like that in the state of Connecticut contract and the Daimler Chrysler contract.

So it's certainly something that is available to us as a tool, but it's not a primary tool.

And just to ask about the prescription trends out there.

We have seen some softening in the prescription volume trends across the industry.

Can you give any insights on what's going on there?

And do you think there's any component of this that is consumers reacting to the economy.?

We don't see at this point evidence or market research that would suggest that consumers are changing behavior more pill splitting or things like that.

We do monitor that.

The ZYRTEC phenomenon certainly is a piece of it.

The absence of the growth that we had in last year's numbers due to med D is a piece of it.

But the PBM utilization rate is up.

And our share is up.

So we're still seeing reasonable trends on the pharmacy side.

I'm not going to rule out the possibility that consumers will start to adapt differently to a new economy.

But we just haven't seen it yet.

Okay, thank you very much.

Surely.

Your next question comes from Neil Currie with UBS.

Good morning, Neil

Good morning, Dave, good morning, Nancy.

I wonder if you could just give us some color on the synergies that you've been getting?

Because the retail performance really was outstanding against expectations.

And I wonder if you could walk us through how you allocate those synergies on a accounting basis?

Is it somehow skewed more towards the retail part of the business over and above the make up of retail as a percentage of sales?

Well first of all, the way that those synergy benefits come through the P&L is simply by having lower prices on purchased goods as each retail and PBM use the inventory.

So it isn't an allocation decision, it's not something that we sit here and say okay now how much should we put here and how much should we put there.

It just flows through cost of goods like any other cost or benefit.

So it's not an allocation.

Both retail and PBM, therefore, are getting very, very substantial benefits out of the purchasing synergies which is, as you know, the bulk of the $700 million.

On the overhead piece, the $100 million or so goes disproportionately to the PBM because it just so happens that there were call centers and things that that were able to be closed and those run-- those were costs to the PBM, and so those floated the PBM disproportionally.

But the purchasing goes both ways.

Would it be fair to say that in the inventory that was ordered in the first quarter that the retail side of the business benefited more from the lower costs as a result of the synergies than they--?

I wouldn't have said that.

I don't believe that's the case.

Okay.

Remember that you have the big PharmaCare gross up in sales that has no profit impact and you did have the FEP contract.

And if you factor in those two things you pretty much can explain the trends that we're looking at here.

That you're seeing such an outstanding first quarter for the retail side and I was just looking for any sort of simple explanation between the what you did against expectations.

So congratulations on that.

I will pass along your thoughts to Larry Merlo, I'm sure he will appreciate them.

In terms of the Sav-On Osco stores how much have they helped to contribute as well to an improved performance?

And are you looking now to accelerate more aggressively into Northern California, Pacific Northwest, mountain west, and will that be organic or will you consider acquisitions?

Osco Sav-On outperformed core CVS both in sales and in margins.

It has the advantage that it started with a shrink opportunity that we are rapidly capturing.

And so that's helping the margin comparisons and simply the sales is the result of really bringing the CVS discipline to the way those stores are run.

It's a mature base now.

The management, the systems, everything is in place.

And it's working better.

In terms of Northern California, we are anxious to be in Northern California but it is an extremely tough real estate environment and we will be doing in and are doing now the ground work necessary for organic expansion.

So if we stumble across some acquisition along the way, certainly we'd want to consider it.

But right now our view and our plan is to do it organically.

I should point out, let me circle back to the Osco Sav-On question.

I don't want to over emphasize the size of that.

I recall it was 700 stores in total.

And so--

It's just that when you look at the population for store, the Sav-On Osco store, it's twice that of the CVS average.

Yet the scripts per-- the scripts for week seem to be quite similar.

I'm just wondering what-- do you see a significant opportunity for the stores to exceed the average because of the population densities?

Well the actual sales per square foot over all are lower than core CVS by a meaningful amount.

And so yes, we do see, we do see a very substantial opportunity there both front and pharmacy.

And we're getting it, I mean it's coming along.

Thank you.

Okay.

Your next question is from Meredith Adler with Lehman.

Thanks very much.

I wonder if you could just talk to us a little bit about what impact the PharmaCare growth have had on the PBM numbers?

You made a comment just now, but I-- it would be helpful if you'd just sort of flush that out.

Is that one of the reasons that it's optically you seem to see better results in retail than on the PBM?

Yes, I think that's absolutely true, Meredith.

It's an increase in sales without of course finding increase in profitability at any line.

So it is going to have an optical affect that would appear to make the PBM results less impressive than they actually are.

Couple that with the med D phenomenon and you have a very-- you have two very sort of nonoperational negatives, if you will, in the first quarter for the PBM.

PharmaCare gross up, by itself, cost 52 basis points in reduction to margins.

So had it not been for that you would have seen the margins 50 basis points higher.

And I know that you didn't change the accounting for PharmaCare like the day you closed the transaction.

So how long do you think we should expect that that will be a dampening affect and would you also say, I mean my understanding of the PDP is you might actually have another quarter where it's the accounting forces is to be the drag as well.

Well you're quite right.

The second quarter will have a similar phenomenon.

And actually if you recall, we did the conversion of those contracts and therefore the accounting starting in September of last year.

So it'll have a full quarter affect in the second quarter and a partial quarter affect in the third quarter.

Okay.

And then another question I have is just to talk a little bit about the start up costs for the new contracts in the PBM.

Yes.

I don't, I don't know too much about what kind of magnitude we should be thinking about?

Well you think about the nature of those costs.

If a contract as typically is the case calls for a call center, you have to have that call center ready to go on day one.

Typically January 1 contract, so you're hiring and training you're providing for the space needs, you may have to rent additional space depending on the circumstances.

You have to hire some medical professionals within the mix of that.

You need to put in place a management structure to manage it.

So these are the kinds of costs.

And of course we're talking about contracts which in the aggregate are in the billions of dollars.

So there's a lot of activity and there's going to be a lot of bodies associated with servicing those contracts.

We also, with this kind of expansion would expect that we will need more client service people.

And they tend to be higher cost professionals, if you will.

So there are those kinds of costs.

So on $3 billion plus of additional revenue, you certainly should expect several million in costs to get ready.

Okay.

And then a question maybe if you could talk about, I mean explained that the slowdown in scrip growth is not a function so far that you can see of changes in consumer behavior.

But we have seen a slowdown and I was wondering if you have any sort of view, opinion about what might be causing that slowdown?

Well again, we don't see any major individual factor for that.

We've talked about ZYRTEC going OTC.

That affects us on the margin.

That affects the percentage disproportionately.

Absence of new product introductions of any size is certainly a factor.

But we've also seen IMS data that shows a slowdown in the past that didn't turn out to be as much of a slowdown as we actually thought at the time.

So this could be one of those little dips as well, hard to know.

All I can tell you is we have decent trends in our business, we're happy with the share growth that we've achieved and overall we are satisfied in tracking at a level that we were quite comfortable with and within the ranges of our plans.

Okay and I just have one more.

All right, I'm going to take two more questions.

Your next question is from Deborah Weinswig with Citi.

Good morning, Dave, and congratulations on a great quarter.

Thank you, Deborah.

And you talked about increases in terms of specialty mail revenue growth.

Can you elaborate on that?

And also anything new on the disease management side?

Well specialty mail, as I said, on a comparable basis adjusting for FEP grew about 14.5%.

That is in the neighborhood of where it has been growing.

But I suppose a couple of hundred basis points lower than at about this time last year.

But it's still a very high growth attractive market for us.

Did you have a second part to that question, I'm sorry?

Yes, and anything new on the disease management side which also has-- I know it's been a big focus in terms on driving specialty revenues?

Can you also just elaborate on what you're doing there?

Okay, I'm going to ask Howard to jump in on that one.

Thanks, Howard.

Excuse me.

Well there's nothing necessarily new on the disease management front other than the capabilities that we're getting out of bringing together to two entities.

We're starting to see some folks who are-- Dave talked about the specialty win that we have.

One of the big factors there was the ability to bring the retail environment in to helping manage the care of these individuals.

These individuals are using very high-priced medications, they have a number of different (inaudible).

So that's an area that we think one of the reasons we looked at this transaction and liked it, was the consumer facing component of this and we saw that in this particular contract discussion that (inaudible) were pleased with the viability of bringing that together.

Thank you, Howard.

Operator, we'll take one more question.

Your final question's from David Magee with SunTrust Robinson.

Good morning, David.

Good morning, Dave, Nancy and Howard.

In under the wire here.

Just a quick question about the, just the retail side.

The-- you mentioned you're not seeing the consumer impact, is that true for all the regions including Florida?

And then the second part of the question would be just given the success you're seeing in retail right now, sounds like it's being driven by the ExtraCare card to a large degree and the cash flow you're generating this year.

Could we see some-- maybe bump up in the growth rate organically of next year or so?

On the first question, one of the frustrations in looking at the data for me is that several people are saying Florida and California are the markets in which the consumer slowdown has occurred most or fastest or most viably.

And of course those for us are newer markets.

And so we are still enjoying the extra growth that you get from being relatively young in a marketplace.

And so we're not seeing weaker trends in those markets than the overall business.

So I can't help you there.

And it may well be that a slowdown is being experienced there but it's simply masked by the vibrant growth of the relatively young fleet that we have in both of those cases.

In terms of acceleration of growth as we go in to '09 and '10, it's hard to judge that from here.

It's hard to know how long this economy is going to wobble as it has been doing here.

We do think that a major influence on our economic well being is going to be the pace of generics.

2009 may be similar to 2008.

And it's broadly expected and I expect that 2010 and '11 are going to be pretty big years.

So I guess right now as I said 2009 looks like a very solid year, it probably is going to be economically a bit better on average than 2008 on average.

So I look at 2009 with moderate optimism.

So-- but for the time being we should just expect 3.5% organic square footage growth until we hear differently?

But (inaudible) option though.

Yes, I think that is absolutely right.

3.5% is our comfort zone.

And we haven't obviously done our plan for 2009 at this point.

But if I were laying a base assumption, that is certainly the one I would use.

Great, thanks, Dave.

Good luck.

Okay, thank you very much.

At this time there are no further questions, I'll turn it back over to Management for further remarks.

Thanks everybody.

And we look forward to seeing many of you on May 21st.

Thank you for participating in today's conference call.

You may now disconnect.