CVS Health Corp (CVS) 2009 Q2 法說會逐字稿

Good morning and welcome to the CVS Caremark earnings call.

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

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

(Operator Instructions).

Thank you.

Ms.

Nancy Christal, Senior Vice President of Investor Relations for CVS Caremark Corporation, please begin.

Thank you, Rachel.

Good morning everyone, and thanks for joining us for our second quarter earnings call.

I am here with Tom Ryan, Chairman, President, and CEO of CVS Caremark, who will provide a business update, and Dave Rickard, Executive Vice President and CFO, will provide a financial review and guidance.

During the Q&A that follows we ask that you limit yourself to one to two questions including follow-up, so we can get to as many analysts as possible.

Please note that we expect to file 10-Q by end of day today, and it will be available through our website, cvscaremark.com/investors.

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

In accordance with SEC regulations, you can find the definitions of the nonGAAP measures that I mentioned, as well as reconciliations to comparable GAAP measures, on the Investor Relations portion at cvscaremark.com/investors.

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

Before we continue, our attorneys have asked me to read the 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 risks and uncertainties that are described in the risk factors section of our most recently filed Annual Report on Form 10-K, and that you review the section entitled cautionary statement concerning forward-looking statements, in our most recently filed quarterly report on Form 10-Q.

With that, I will turn this over to our CEO, Tom Ryan.

Thanks, Nancy.

And good morning, everybody.

I am very pleased with our second quarter results, as you can imagine, which were at the high end of our expectations.

Let me give you some highlights from the quarter.

Total revenues were up 17.6% to almost $25 billion.

Our PBM retail network claims increased 8.8% in the quarter, while mail choice prescriptions were over 10%.

You will recall mail choice is our new metric, which includes mail order scripts plus 90-day scripts filled at retail, via our Maintenance Choice program.

Specialty pharmacy revenues increased 20.5%, and our EBITDA per adjusted claim increased 4.6%, to $4.12 on an apples-to-apples basis.

Retail same-store sales increased a healthy 6.1%, and once again, topped all our retail competition.

Pharmacy comps were up 7.5%, and our front-end comps were up 3.0.

Our generic dispensing rates in our stores increased 260 basis points to 69.6.

In our retail network, GDR rose 340 basis points to 68.9%.

So once again, the CVS stores are outperforming the retail network.

And our mail GDR rose 180 basis points to 56.3%.

Adjusted EPS from continuing operations was $0.65, up 8% versus last year.

And we maintained a healthy balance sheet, generating approximately $425 million in free cash flow.

So obviously a pretty good quarter all around.

So with our strong first half results, as you saw in the press release, we are raising and narrowing our 2009 guidance.

We now expect to deliver adjusted EPS from continuing ops of 2.59 to $2.64 for the year, up from our previous guidance of 2.55 to $2.63.

GAAP EPS from continuing operations is projected at $2.41 to $2.46, up from our previous guidance of 2.37 to $2.45.

As always, Dave will go into more detail in a little while.

While we are not giving guidance for 2010, I know there are some questions with respect to Med D regulatory changes, and its impact on our 2010 earnings, and we received a lot of those questions at our Analyst Meeting.

Well, we have now finalized our Med D bids, and have really had a chance to do some early handicapping on the various regions, and what we think we would keep and get, so now we think the net impact of the elimination of the Med D network differential next year, will be in the range of $0.05 to $0.07 a share.

So once again the elimination of Med D network differential, net/net in total be in the range of $0.05 to 0.07 a share in 2010.

Now even with this, I would be very disappointed if we didn't have an EPS growth of at least 13 to 15% next year.

As I said, we haven't completed our plan for 2010, and it is too early to give specific guidance, but I did want to give you some visibility on the Med D impact.

So we expect a great '09, and we look forward to an even better '10.

Now let me touch on the PBM business.

Our Maintenance Choice offering continues to grow in popularity.

Through Maintenance Choice rather than relying solely on mail for their 90-day maintenance medication, many of our plan members now have the convenient option of obtaining their prescriptions at any CVS/pharmacy store.

It is really just an extension of our mail offering.

It lowers costs for patients and payors.

We currently have 270 clients that have signed up for Maintenance Choice.

This subpoena from 200 in the first quarter, and about 25% of the additional clients were new clients to our PBM.

The feedback has been extremely positive among the clients that have participated in it, or are already using it, and we expect more clients to adopt Maintenance Choice going forward.

We are still in the middle of the 2010 selling season, so we will have more on the third quarter call.

But we have had some good successes, and we have had some disappointments.

We now have over 3,000 clients under contract, and our retention rate for 2010 is 96%, which is slightly higher than 2009.

As previously reported, we lost the Coventry commercial contract, which was worth $1.4 billion, which was widely expected.

And recently the newly formed UAW VEBA group decided to consolidate all of the autos under one contract.

As a result, we lost the Chrysler UAW retirees to Blue Cross/Blue Shield of Michigan.

Given the fact that Chrysler contract was $400 million, and was the smallest of the Big 3 autos, we really weren't surprised that it consolidated into the other two.

It is important to note that the renewed Chrysler actives, as well as their non-union employees, will stay with us.

On the flip side, we won gross new contracts worth $1.1 billion.

At the Analyst Meeting, we announced $1 billion of new business.

So some of you may be asking, why just a small increase.

Well at that meeting, when we announced $1 billion of new business, that included an oral commitment from a large insurer.

This insurer focused on individual markets, and this was worth about $300 million.

Since then, the insurer pulled it's commitment, and this is rarely done, and it is a first for us, which is why sometimes we don't announce until the contract is signed, but we had a verbal commitment, and were convinced they were coming with us.

Turns out that the incumbent PBM offered a very aggressive pricing offer, which we reviewed and decided to pass on for economic reasons.

So with this if you back out that insurer, we have actually added $400 million of new business since the Analyst Meeting.

We are optimistic about additional wins this season, but the remaining opportunities are probably not sizable enough to offset the losses, since the term contracts I reviewed totaled about $2 billion.

Our new clients are very excited about what we bring to the table, and our existing clients are giving us high customer satisfaction scores.

The fact that both clients and their members love our integrated proactive pharmacy care offerings, gives me great confidence going forward.

We will update you further on our progress on the selling season on the third quarter call.

Let me touch on our disease management business.

As you know, we have Accordant Rare, the premier disease management business in the specialty arena.

We also have Accordant Common, which deals more with the more everyday chronic diseases.

This morning we announced a strategic alliance for our Accordant Common business with Alere, a leader in health services for medium and high-risk patients and complex case management.

Alere is a subsidiary of Inverness Medical Innovations, a publicly traded company that is a worldwide leader in rapid diagnostics.

As part of our agreement, Alere intends to had a access to MinuteClinic nurses, as one of its methods of increasing member and patient engagement, and making access to healthcare more convenient.

In turn, MinuteClinic will have access to extensive rapid diagnostic solutions offered by Inverness.

Alere will provide our clients with access to an expanded suite of services, such as wellness and prevention programs.

We believe that the combination of our ability to counsel patients in our retail stores and health clinics, along with Alere's state-of-the-art clinical prevention services, will allow us to engage the member in unparalleled fashion.

The expanded offerings can be made available to other customers and health plans as well, because the agreement is non-exclusive to both companies.

This alliance will be neutral to earnings initially, and we look forward to working with Alere to strengthen our clinical offerings to clients as we grow the business.

Let me touch on MinuteClinic.

Last week we announced a new President and Chief Operating Officer for MinuteClinic, Dr.

Andrew Sussman.

Dr.

Sussman will be joining us in September.

He was recently Senior Vice President, and he will also be Senior Vice President and Associate Chief Medical Officer of CVS Caremark.

He was most recently EVP and COO of UMass Memorial Medical Center, and also served as an Associate Professor of Medicine at UMass Medical School.

Dr.

Sussman has an outstanding background and expertise in both the clinical practice of medicine, as well as healthcare system management.

He will be a tremendous asset to our Company.

Andy succeeds Chip Phillips who has done a tremendous job at MinuteClinic, and Chip was recently named President of TheraCom, our Company that supports biotech and pharmaceutical manufacturers, to help ensure commercialization of their specialty products.

In the second quarter, MinuteClinic serviced our four millionth customer.

Traffic was up 51%, comp visits increased 33% year-to-date, and we are moving to drive utilization.

We have expanded our service offerings to reduce seasonality, and generate multiple visits for each patient.

We have already had national launches for the treatment of acne and various other skin conditions, and we expect to introduce additional acute services in the second half, and more importantly, we are moving to treatment of chronic diseases, such as diabetes, coronary heart disease and hypertension.

We have added over 16 million additional lives to our network in the second quarter, and now 80% of our visits in the quarter were third-party paid.

We continue to grow in-network covered lives.

With that, utilization goes up when people have coverage.

We are investing $0.05 to $0.06 of diluted EPS in MinuteClinic this year.

We expect MinuteClinic to be less of an investment in 2010, even less in 2011, and to break even in the first half of '12 on an all-in basis.

Now let me talk about our retail pharmacy business.

Even in this economic environment, we continue to grow revenues at an industry leading rate, and we have for the last four or five quarters.

Programs that we have put in place over many years, in fact over the last four or five years, like ExtraCare card, our pharmacy service initiative that improved service and lowered costs, our new life store layout, that makes it easier for customers to find what they want, are all bearing fruit.

We have multiple new retail revenue and cost initiatives, that will continue to drive retail revenue and profits well into the future.

As I mentioned, our second quarter comps increased 6.1%, just above the high end of our expectations.

Pharmacy comps jumped 7.5%.

That is the highest level we have seen in two years.

So what is driving our success, obviously in this economic environment?

I think there are four key drivers.

One, our retail team is at the top of its game.

They are executing on all cylinders, and our customer service metrics are at an all-time high.

Two, we are gaining shares from our competitors, both regional and national competitors.

Three, our acquisitions continue to overperform.

And lastly, we are gaining a bigger share of spend from our PBM clients members.

Our new services save them time and money, so they choose CVS/pharmacy.

Comped scripts increased 5.4% in the quarter, once again leading all competitors.

Even though we count our 90-day Maintenance Choice scripts, as one script, as opposed to three scripts.

If we count 90-day scripts as three scripts, like some others report, then our comp scripts would be 8.1%, not 5.4.

Despite the soft economy, front store comps increased a healthy 3%.

In our core CVS stores we continued to gain share in front store categories that account for 90% of our business.

Customers are very sensitive and aware of promotional opportunities.

So while we are not promoting more, customers are in fact selecting products on promotion to a greater degree than in the past.

On a comp store basis, in fact, our front store traffic was slightly down, but our average ticket was up.

Private label sales were 15.4% in the first quarter, 15.4% of front end sales, about 40 basis points higher than last year.

We expect to add over 900 items for the full year.

So the combination of adding additional items, plus the consumer psyche around the economy and trying new private label products, is continuing to drive our private label business, which is obviously a higher gross margin for the Company.

We are seeing continued growth in sales and transactions using the ExtraCare loyalty card.

In the second quarter, 63% of front end transactions, and 70% of sales were using the ExtraCare card.

As for the Longs stores, we officially launched the ExtraCare program last month, which should lead to substantial increases in customers using the card over the next few quarters.

Speaking of Longs, we have made a lot of progress on the integration.

We have completed store systems and conversions in May, we have closed down the Longs headquarters in early July, we have completed over a third of the merchandising resets, which has begun to move the needle on the sales in the front end, especially our private label sales.

As a percentage, I think we have talked to you about this before, but private label sales increased from 5.1%, to 8.4% in the second quarter.

So still half of what we have in CVS stores, but we are moving the needle, and we have significant upside to go.

We have also remodeled about a third of the Continental US stores to look and feel the CVS, and we complete all plan resets and remodels by mid-October, and will reintroduce the stores in the fourth quarter.

I am happy to say that Longs is exceeding our expectations, in terms of both sales and margins, so it will be probably less dilutive this year than we originally thought.

As for new stores we have opened up 77 new and relocated stores.

We closed 14, resulting in 63 net.

We plan to open 250 to 300 new and relocated stores in '09, and we will add about 3% square footage growth to our stores.

We have also completed 76 file bys in the second quarter, and we expect to complete about 250 this year, which is up about 10% from last year, and I expect those file bys to continue for the foreseeable future.

Now before turning this over to Dave for the details on the financials, I just want to quickly touch on the healthcare reform agenda, and discussions that are going on in Washington, which we certainly have been front and center on in our discussions in Washington, and local members of Congress.

We have actively been involved in it.

We strongly support expanding coverage, but we also believe that with expanded coverage, there has to be some reform measures, that both improve healthcare and reduce costs.

Retail pharmacies and PBMs are on the front lines of healthcare, and CVS Caremark is in a great position to help with the healthcare solution.

Our clinical focus on disease management and adherence programs and wellness programs, fits nicely with many points of healthcare reform.

We believe some form of coverage for the uninsured will obviously also be good for our business, and any healthcare reform initiatives that drive physician adoption of E-prescribing will also be a plus for us.

In fact, we fill 17% or 18% of the retail scripts in the country.

We fill about 30% of the E-prescribe scripts.

So we are out ahead of it.

Obviously E-prescribing is good for the consumer, good for the payor, good for safety and effectiveness.

So we will continue to participate in this debate and make sure that our voice is heard, obviously in Washington, and then in local governments.

Now I will turn this over to Dave for a financial review.

Thanks, Tom.

Good morning, everyone.

This morning I will walk you through our second quarter financial results, then I will provide initial guidance for the third quarter, and the details behind our updated full-year 2009 guidance.

So let me start with revenues.

Tom covered the highlights of sales, but let me add a couple of notable details.

The $24.9 billion in consolidated revenues is net of $1.9 billion of intersegment eliminations.

Those are produced as a result of our PBM clients filling their prescriptions in our stores.

The intersegment eliminations as a percent of PBM revenues increased by approximately 280 basis points over the prior year period, from 12.1% to 14.9%.

This is up sequentially from last quarter's 230 basis point increase, as well as the 120 basis point increase we saw in the fourth quarter.

With increases like these, it is hard to dispute the growing tangible evidence that there is an expanding base of Caremark customers choosing CVS as their retail pharmacy.

In our PBM segment, second quarter net revenues of $13 billion increased 22.1%.

Drilling down a little deeper, PBM retail network revenues in the quarter rose 27.4% over 2008 levels to 8.8 billion.

That was largely due to the change in revenue recognition method for the RxAmerica contracts beginning this quarter.

Retail network claims grew 8.8%.

This growth was driven by the addition of RxAmerica, as well as the net impact of new business and terminations.

Total mail revenues grew by 12.5% to $4.1 billion.

Our overall mail penetration rate of 22.9% was down from the rate in the second quarter of 2008 on a reported basis.

However, there are two important adjustments you need to make to understand the underlying growth in mail penetration.

I highlighted both of these during our first quarter call, and they of course recurred in the second quarter.

First and most importantly, RxAmerica's claims mix, which is heavily weighted toward retail network claims, diluted the mail penetration rate by 225 basis points.

Second, the shift of some 90-day scripts from mail to retail via Maintenance Choice, separately reduced the mail penetration rate by another 90 basis points.

So adjusting for these two factors, our underlying mail penetration rate grew from 23.5% to 26.1%, up 260 basis points.

Now what about the retail drugstore side of the business?

It saw revenues increase by 17.2% to $13.8 billion in the second quarter.

Longs contributed approximately 1.1 billion of that growth during the quarter, so the underlying growth rate was 7.8%.

As Tom mentioned, our second quarter comps increased 6.1%.

Pharmacy comps rose 7.5%, and were negatively impacted by about 480 basis points, due to the recent generic introductions, but positively impacted by approximately 190 basis points due to Maintenance Choice.

And the front store comp increase of 3% was helped by the Easter holiday shift, to the tune of approximately 130 basis points, and by another 85 basis points, due to the Federal excise tax on cigarettes.

Moving on to gross profit, the overall dollars improved by more than 15%, despite the percentage margin dropping by approximately 40 basis points.

Within the PBM segment gross profit margins were down approximately 90 basis points, which was expected due to the change in the revenue recognition method for RxAmerica, as well as the pricing decisions we made last year for a few key contracts.

Gross profit margin in the retail segment stayed flat to last year's second quarter at 29.9%.

That reflects the impact of averaging in the lower margin Longs business, as well as customers opting for more sale-priced items as a percent of total purchases, as Tom mentioned.

Offsetting those was the increase retail generic dispensing rate, and the growth in private label in our core stores, which was up 40 basis points versus the prior year quarter.

And what about expenses?

Overall operating expenses as a percentage of revenues increased by approximately 20 basis points.

The PBM segment's percentage stayed flat at 2.2%, despite the impact of the elimination of the Universal American joint venture, the income from which was historically booked as an offset to expenses.

We also saw some integration expenses for RxAmerica flow through in the second quarter.

So excellent expense control there.

In the retail segment, the increase was approximately 40 basis points to 23.0%.

That was primarily related to Longs integration costs, and simply averaging in the Longs business for the full quarter, which has a higher SG&A percent of sales profile.

In fact, excluding Longs our operating expense ratio improved moderately.

So good spending discipline in retail as well.

Given everything I have just discussed, we saw operating margin decline as expected.

It was down approximately 55 basis points to 6.4% of revenues.

The PBM segment's operating profit margin was down by approximately 90 basis points year-over-year, to 4.9% for the reasons discussed.

In the retail segment, operating profit margin was 7.0%, down approximately 30 basis points, but still at a very healthy rate in the absolute.

In fact, that result was industry-leading compared to the other large chains.

Moving to the consolidated income statement, we saw net interest expense in the quarter increase to $128 million, largely reflecting an increased debt position due to Long's.

Our effective income tax rate in the second quarter was 39.6% as expected, and our weighted average diluted share count was 1.47 billion shares.

Of course, our $2 billion share repurchase program, slated to take place in the final two quarters of this year, would not have impacted the second quarter count.

I can tell you that the program has begun, and that we have repurchased a little over 20.5 million shares for $659 million through the end of July.

That gives us an average share cost of $32.08, including commissions.

As Tom said, adjusted EPS from continuing operations was $0.65, an increase of 8% over last year's second quarter, and at the high end of our guidance.

Recall that the quarter includes the one-time integration expense associated with Longs, our planned investments in MinuteClinic, and the short term margin investments we made in key PBM contracts to generate long-term gains, all of which should help drive our future growth.

GAAP diluted EPS from continuing operations came in at $0.60 for the quarter.

That is also an 8% increase over last year.

Turning to the balance sheet and cash flow, we generated $424 million in free cash flow in the second quarter.

That compares to 256 million in the prior year's second quarter.

So nice progress here.

Net capital expenditures amounted to approximately $128 million in the second quarter.

That was the result of offsetting the 625 million of gross capital expended, with approximately 497 million of sale-leaseback proceeds.

As you can see from this, the sale-leaseback market has reopened.

We were the first to do a significant deal with the sale of the new properties that had built up from last year, and we did so at a reasonable rate.

Barring any new and currently unforeseen financial market problems, we still expect that we will be able to complete the sale of the remaining $1 billion or so in properties we had planned when the year began.

The largest portion of this will likely be in the fourth quarter.

Lastly, we ended the quarter with total debt net of cash and cash equivalents of $9.8 billion.

That is down approximately $600 million from year end.

Now on to guidance detail for the year.

For the retail segment, we expect revenue growth of between 12 and 14% for the year, up from a previous expectation of 11 to 13% growth, as total same-store sales are now expected to be in the range of 4 to 6%.

That is a 50 basis point improvement over prior comp guidance, driven by strong script growth, stronger than we had previously expected.

For the PBM segment, revenues should be up between 16 and 18% for the year.

That includes growth in the mail choice scripts of approximately 10%.

For the total Company, we expect revenue growth of around 12 to 14% for the full year after intercompany eliminations of nearly $7.5 billion.

Gross profit margins are still expected to be modestly below 2008, with retail flat to up and the PBM segment down.

We expect total company operating expenses as a percent of revenues will be modestly up, reflecting the integration and one-time costs of Longs, the increase in litigation reserves we saw in the first quarter, as well as first year economics of a large amount of new PBM business.

All of that will lead to operating profit margins for the total Company which are moderately below the record levels of last year.

We continue to expect EBITDA per adjusted claim to be down slightly on a reported basis, but up mid-single digits when normalizing for RxAmerica, Maintenance Choice, and the increase in litigation reserves.

We continue to forecast net interest of about 540 million to $560 million.

We expect our tax rate to approach 40%.

And we are forecasting approximately 1.45 billion weighted average shares for the year, including the completion of the share buyback program in the second half of 2009.

We expect total consolidated amortization for 2009 to be almost $450 million projected depreciation is just under $1 billion.

Net capital expenditures are expected to be in the range of 1 billion to $1.2 billion for 2009.

Free cash flow is expected to be in the neighborhood of $3.5 billion.

Tom recapped our earnings raise for the year.

Now let me fill in the third quarter guidance.

In the quarter, we expect revenue growth for the total Company to be in the range of 19 to 21%.

This significant growth is being driven by strong growth in our core businesses, topped up by the RxAmerica accounting change in the PBM segment, and the addition of Longs and RxAmerica to our businesses.

We expect total same-store sales growth to be between 6% and 8%, and we expect third quarter adjusted EPS to be between $0.62 and $0.64 per diluted share, compared to last year's $0.60 per share from continuing operations.

GAAP EPS is expected to be in the range of $0.57 to $0.59 per diluted share.

I want to take a few moments at this point to tell you about two improvements in our segment reporting, that we plan to implement in the third quarter of this year.

We have spoken with many of you over the last several quarters, about our desire and your encouragement, to present our financial statements in the clearest possible way to make it as easy as possible to understand the results and the health of our businesses.

Some extent this is a never-ending journey, but I think the two changes I am about to tell you about, represent a major step in this direction.

Both are changes to our segment reporting, and of course will have no effect on our consolidated results.

The first change involves the segregation of corporate costs into what will amount to an additional segment.

Currently we report our business in two segments.

The retail segment captures the retail drugstores, the MinuteClinics, and CVS.com, as well as associated administrative expenses, and a large portion of corporate overhead.

The pharmacy services segment captures the operations of the PBM, which includes among other things, mail order, specialty pharmacy, and Accordant, our disease management business, as well as certain corporate overhead.

The additional segment will be the corporate segment.

It will carve out from our existing segments those administrative expenses and corporate overheads that benefit both operating segments and are non-revenue producing in nature.

This change aligns with our continuing effort to capitalize on the shared service efficiencies available to us through the CVS Caremark merger, and it further supports how we internally manage the performance of our integrated company.

The corporate segment will exclude all revenue, margin, margin related expenses, and store and field expenses.

This segment will include such things as executive management, and portions of other costs related to corporate relations, legal, and compliance, human resources, corporate IT, and finance.

It will include audit fees and benefits and depreciation associated with the above departments.

We believe that this modification will give better visibility to the operating dynamics of both our retail and our PBM segments.

It will eliminate any distractions caused by necessarily somewhat arbitrary cost allocations.

Now for those who prefer the current format, we will provide footnote disclosure of the amounts that could be allocated for each operating unit for all reporting periods through the end of this year.

But I anticipate that the corporate expenses will be fairly modest, likely in the neighborhood of 3 to 4% of our total SG&A.

The second change involves how we record profit at the segment level.

Currently in our reporting the segment which dispenses a product or service records the profit generated by that service.

That is regardless of which segment owns the customer relationship and makes the sale.

For Maintenance Choice, as an example, this results in the retail segment recording the profit, whenever a PBM customer chooses to pick up his prescription at a retail store.

We and I believe many of you, feel that situations like this, don't clearly portray the true performance of the individual operating segments.

To better demonstrate segment performance, beginning next quarter we will record profit related to intersegment activity on both segments, regardless of which segment dispenses the product or service.

We will essentially double count the profitability at the segment level, just like we double count the revenue when Caremark processes a claim filled at CVS.

Of course this double counting will be eliminated when we consolidate, just as revenues are today.

Finally, also beginning third quarter, we will report mail choice volumes, as opposed to mail volumes.

That will provide a clearer picture of our business.

We believe that by adopting these modifications, we will be presenting financial statements for each business segment, that more appropriately reflect the true performance of each business, and as I said, these changes will go into place with our next quarter's reporting.

These changes in segmental reporting do not trigger a need for restatement, but we will conform the presentation for historic periods presented.

And when we make this change next quarter, we will provide you with the historical detail for each of the three segments for the previous four quarters as well, to help you build your models.

Now I am going to turn this back to Tom to lead the Q&A.

Okay, thanks, David.

Obviously we had a very good quarter, and we look forward to a good rest of '09.

So with that, I will open it up for Q&A.

(Operator Instructions).

Your first question comes from Eric Bosshard.

Can you talk a little bit more about the progress and penetration you were making with Maintenance Choice, and whatever other quantification for the success that you see, or having with that effort?

The fact that we have 270 clients signed up for it, you remember in the past, Eric, I have talked about the fact, that some companies and benefit managers were a little hesitant to try something new.

Now I think that it has been out in the marketplace, they are realizing, from talking to peers and others, consultants, that in fact, the payor is actually saving money, right, the payor saves money, the client, the participant saves money, and all-in-all it is a good program.

So the fact that we added 70 since just our May meeting, 70 more clients, and as I said, 20 to 25% of those were new clients, and we are winning clients because of it.

It is affecting, obviously it is affecting our pharmacy comps.

You can see almost 200 basis points just from Maintenance Choice.

Basically think about it, any time you look at mandatory mail that has been out in the market for 10 plus years, it really never got over 20%, and with this we are at 10%.

We have gotten great uptake already, and I think we expect more to come.

Within the clients that have adopted this, do you have any math on the increased mail penetration with the business?

I guess Maintenance Choice in theory should drive mail utilization?

You can see our growth at 10% when you combine it, right?

You can see the growth when you combine mail and our 90-day scripts at retail.

It is growing significantly.

And if an employer has a mail penetration of 20% or 30%, and they change plan design, they typically will drive penetration up in the 50 to 60% range, and that is why they are saving money, and that is why it is good for the plan and the payor and the patient.

And then us.

And then secondly, you talked about, Dave, you talked about a 6 to 8% retail comp in the third quarter.

What is driving the improvement there?

What is going on there?

Better pharmacy trends.

We are just seeing more scripts.

You can look at our numbers that we have had in the past month, and while we are not going to give numbers for obviously July, we are pleased with the results in July across the business.

The other thing, Eric, is that in past recessions we have actually seen reporting periods where front store comps are negative.

We haven't seen that yet.

So we are doing a better job in the front, and scripts are holding up better than we had any reasonable expectation they would.

Obviously the cigarette tax puts a little artificial top spin on that as well.

Thank you.

Your next question comes from Tom Gallucci.

Good morning, thank you.

Regarding Maintenance Choice or regarding any other newer services that the customers have implemented, the impact on you all you have explained pretty well.

You said it saves money for the clients.

Do you have any specific examples, even if you didn't name the client, on a client's penetration went from X to Y, and they saved X amount of dollars, so we could really get a sense for what it it looks like from the customer standpoint, and how that could change the PBM pitch over time?

Well, obviously it varies, I mean, it is a good question, and it is why clients really choose Maintenance Choice, obviously to save money and make it more accessible for their, and convenient for their members.

But it depends on the client.

Really the size of the client, the previous mail penetration, the mix, but in general, it is anywhere from 4 to 6% savings, I would say.

We have had some a little lower, we have had some a little higher.

And that is based on the price differential that they are getting a discount going to the 90 day?

Yes, that is moving to mail.

I mean, they are always hesitant.

There has been kind of a flat line on maintenance on mandatory mail, and now that they are able to move to mail, they pick up those savings.

All right.

Then at Longs, you said it is doing a little better than you were looking for.

Obviously the state of the economy in California is probably worse than people were predicting, so what is really driving that upside from your standpoint?

Thanks.

I think there is always, we have done a fair amount of acquisitions, and we always kind of estimate what we think the hit will be when the stores are disrupted, and changes in systems.

We have seen less of a valley when we have changed these stores over.

I think one is because we just keep getting better at doing it, and it is less disruptive to the consumer.

I think our ops team and marketing and merchandising team has done a great job, in spite of your point, which is a good one about the California economy.

We continue to perform well in pharmacy and in front, and the point about private label sales, right?

Private label sales going from 5 and change, to 8 and change in front end sales, is help driving the profitability.

Our in-stock position is better, our promotional margins are better.

So it is just a combination of things, and now I think obviously with the introduction of ExtraCare, it is only going to improve.

Your next question comes from Simeon Gutman.

Tom, last quarter it looked like secular demand just from an industry standpoint was starting to come back?

You cited some adherence to, pharmacy customer adherence just picking up, but also people were cutting back a little less.

Can you talk to that again in the second quarter, and maybe even what you are seeing so far in the third?

Yes, I think I mentioned this the other day in the public arena.

Maybe six to eight weeks ago, or two quarters, three quarters, we saw some slowdown in pharmacy a little bit, because people were splitting some of their medications, and stretching out their medications.

We are not seeing that now.

We are making a concerted effort in our proactive pharmacy program, to keep people adherent to their medication, both the work that we are doing in our mail facilities, and the work that we are doing in our retail stores.

And the reason is, it is cost effective.

Any kind of study you look at, a dollar spent on drugs is a $7 savings on healthcare.

So the fact of the matter is people are becoming more adherent.

I always question some of the data that was out there around the slowdown in pharmacy and script units, because we didn't see it.

Maybe because we were gaining share and others, but we continue to see that trend early in the third quarter, that pharmacy prescription usage and utilization continues to grow, as we improve adherence and take share.

And then just in your results, if you take the printed number, the retail scripts filled, it looks like they were up about 14% year-over-year.

First quarter up about 9.

I think both would include the Longs business in there.

So the incremental pick up is about 500 basis points.

Can you break that apart between Maintenance Choice, maybe core demand adherence, I don't know if you have cut it out that finely?

No, we don't.

We don't cut it out that finely, because there are a lot of moving parts.

Your point is right on, that we are gaining share from a variety of sources, and some of it is just execution of stores, some of it is Maintenance Choice, some of it is adherence, but it is a combination of factors.

That has always been my point.

We are looking to gain share, and if we gain share and grow share, take more spend of the PBM members lives, that is a good thing for us overall, and a good thing for our Company, and I think now that you are going to see it, as David pointed out, in some of the reporting changes that we have in segment reporting, I think you will get a better sense of it.

Okay, thanks.

Your next question comes from Lisa Gill.

Thanks very much.

Good morning.

Tom, I think you made a comment that CVS has about 17% market share of scripts in the US.

If I look at the amount of the Caremark business, it looks like it is just under 15% of scripts.

How quickly do you think you can get it up to your average penetration, and where do you think that could go, firstly.

And then secondly, when you talked about Maintenance Choice, you talked about adding 70 clients.

My guess would be that would be for July 1st.

Do you have any indication for where it is going for 1/1/2010?

The 70 clients, some of that is July, and some of that is '10.

We are still in the selling season.

We are still out, as you know, selling clients, and our sales team continues to project more clients coming in, just from June, I think from June or July '09 to December '09, are about 60 clients or so of that 70 to your point, and we expect obviously, that to continue to grow in '09 and '10.

I am not clear, Lisa, on the 15%?

If I look at your inter-company elimination, right, that tells me that 14.9% of your PBM revenue went through a CVS store, and you said that you have 17% of the prescriptions in the US.

So is there a correlation between those two numbers, and is your goal to get that in-line with, or obviously greater than, and over what period of time do you think you can do that?

Yes, obviously, number one, the goal is to get it greater.

I mean, to the point I made earlier, and doing it in a way that customers choose it, because they have options in the marketplace.

We have 60,000 network pharmacies.

We are going to continue to have all network pharmacies.

We want all retail pharmacies, and I can see other retailers participating in some of the programs.

The issue now is consumers are choosing it, and members are choosing it because it is easy and cost effective.

Now there are some obviously areas where we don't have stores where we have PBM business, that I think you get a little, it is a little dangerous to look at the mix on the 15 and 17%, because there are markets where Caremark has a disproportionate share of the business, versus what we would normally get on a retail share.

So I think the answer is, our goal is to drive a larger share of spend at retail, from the PBM client.

And you think that we will continue to see improvement in that?

Also we are driving mail, right, as they move to Maintenance Choice, it is not obviously all going to the retail store.

These are clients, as I said earlier, that are going from 30% mail penetration, to 60 to 70% mail penetration.

Some of that is going to the store, but some of that is obviously going to mail, and our mail operations, the mail facilities, which is obviously also gaining share, and you can see the growth.

And then just one follow-up.

I was wondering if there is any update on the replacement for Dave?

We hate to see you go, Dave.

Thanks, Lisa.

But you keep asking.

It is progressing.

I can tell that you we have had some good candidates.

As I have said in the past, Dave is tough to replace, but I think we are going to be in good shape, and we have good internal candidates, and we have good external candidates, and it is proceeding along appropriately.

As you can imagine this is a big decision for us, and we want to make sure that we vet all of the opportunities.

Do you have a timeline, Tom?

I mean, would you expect that we will hear something next quarter, or --?

I would suspect you would hear something before year end.

Okay, great.

Thanks very much.

Your next question comes from Meredith Adler.

Thanks for taking my question.

I would like to just talk a little bit about some changes that are coming to the way AWP is going to be calculated, that could actually reduce reimbursement if there aren't other adjustments.

Can you talk about whether you have already started to make some adjustments, or are set to make adjustments to contract language when the change happens?

Yes, Meredith, we have talked about this a little in the past, and it is still, I guess, still in the courts, and the question is whether the challenge is going to be upheld, and whether the appeals will be upheld, but putting that aside, we have made progress, and we have, in our contracts and in negotiations on the PBM side of the business, or on the retail side of the business with others, we understand that it will have a minimal, and certainly not a material impact at all on our business as we go forward.

There are some puts and takes, but overall we are in pretty good shape.

Okay.

Does that mean that everybody understands when this change happens, that the gross profit dollars per script have to stay flat?

The clients understand.

You can't change the definition in the game, in the middle of the contract of the game.

We bid it on a certain definition, and if that changes, we have to look at it, and clients for the most part, and PBMs and third-party payors, certainly understand the implications.

Like I said, we don't think it is going to be certainly material.

And then the EBITDA per script in the PBM was good.

Does that have something to do with the mix of business, as specialty continues to grow very strongly?

Yes, it is specialty, it is generics, it is mail penetration.

It is all of that.

We continue to kind of lead the league in the EBITDA per claim, and it is all part of the pieces, as we continue to drive mail, as we continue to drive generics, so from all of the pieces around it, and we continue to reduce costs.

There is a lot of work done.

We keep talking about the revenue side of the business, which we should, because obviously that is the driver.

But there has been a lot of discussion in the marketplace around lowering costs from competitors, and we have done that on a regular basis.

If you look at our cost structure, on our SG&A as a percent, it is some of the lowest in the industry.

And it continues to be.

So we continue to drive costs and get more efficient in both our retail operations, and obviously in our PBM operations, which contributes to the EBITDA per claim.

And if I could just ask one final question, with Express buying the Wellpoint PBM, does that change the competitive landscape for the largest contracts?

Are they in a position to handle contracts with a lot of members?

It changes, obviously ESI's landscape, they become a bigger player in the marketplace, but it also creates some opportunities for others in the marketplace.

Any time you have a big change like that, there are opportunities for changes within those clients.

So we think it is an opportunity for us, but obviously we have a lot of good competitors on the PBM side of our business, and we continue to compete.

Great.

Thanks very much, and good quarter.

Thanks.

Your next question comes from Robert Willoughby.

On the AWP change that is coming, do you foresee any IT challenge, or other inefficiency associated with that change happening for you, or possibly other people in the supply chain?

No, we don't.

It is something that obviously we have known about for a while.

We looked at this 12 to 16 months ago, so any changes that we had to make from an IT standpoint, we are pretty well set.

I can't comment on others.

And on, I guess, the Medicare numbers, you cited a 5 to 7% hit.

Is that all from your own PDP, or does that include any lower reimbursement coming in from some of the PDP plans you support?

Just for clarity, that is $0.05 to $0.07 that we said for '10, and that is net/net.

That is everything rolled in, net/net/net.

And that is net of pricing changes?

That is correct.

Okay.

Thank you.

Thank you.

Your next question comes from Deborah Weinswig.

Good morning.

Tom, can you provide an update where you are with RxConnect, and the benefits that you are realizing thus far?

RxConnect is rolling out.

I think we mentioned that it was going out into the Longs stores first, because we didn't want to change the Longs stores to the old format, and then come back, and it has actually gone quite well.

I can tell you that we are doing a great job.

We are doing a better job in our Company around communicating with our 220,000 colleagues, and I get a lot of feedback, directly and indirectly on the RxConnect from our pharmacists and technicians.

They love the new system.

It is easy, it is effective, it helps them run their business more efficiently, and now when we obviously when we tie in our consumer engagement engine to that, we are going to see some significant opportunities, as we have the face to face interaction with the client and the member.

So it is rolling out.

It contributes.

At the end of the day, we think we are doing this with our existing system.

We think it can only get better when we roll out RxConnect.

And on the MinuteClinic side, when should we expect to see you ramp up clinic growth, and also what is the road block in terms of breakeven, you said we won't see breakeven until 2012?

I think I mentioned, the issue around MinuteClinic, first of all, it is well received in healthcare reform.

It's the best possible, you look at MinuteClinic, it is a microcosm of what you want in healthcare reform.

It is accessible, affordable, and good quality, which is all of the things that the Administration and Congress are talking about.

If you look at any customer feedback, patient feedback on MinuteClinic, it is consistently, on a rating of 1 to 5, mostly 5s, and the only time we get 4s is when we don't give a prescription out, because the customer is disappointed.

The nurse doesn't write a prescription.

So from a customer service standpoint, it is off the chart.

The challenge for MinuteClinic is to drive utilization.

And that is where we are focused.

And I talked a little bit about the new programs, you are starting to see it.

You are going to see it with the new leadership in the program.

Dr.

Sussman is going to work with Troy.

We are working with health plans.

We're working with position groups.

But the real rate limiting step here is utilization, and we are driving it through one, getting more third party plans, we are at 80-plus percent now coverage, and two, we have to offer some more services.

If we offer more services, MinuteClinic will obviously drive the way.

So we are really not focused on opening a lot more clinics.

We are focused on making the clinics we have more productive, and on a fully loaded basis, we expect that early in '12, or maybe sooner to breakeven.

Sounds like traffic was down slightly at retail, but ticket was up.

Sounds like you are getting a greater percentage of your customers wallet.

What is driving that?

I think it is just ExtraCare.

We are getting more from our best customers.

We are targeting our best customers, we are focused on it.

The traffic is less, but when they come in, they are buying more.

So I think that is the real focus, and if the programs that we put in place, as I said, four and five years ago, are really helping us weather this storm, and in fact, actually grow.

Congratulations.

Best of luck.

Thanks.

Your next question comes from Helene Wolk.

Good morning.

I just wanted to follow-up on a question of healthcare reform first.

On the question of the House Bill around the disclosure and transparency amendment, any comments, reaction, thoughts, about what ultimately transpires, in terms of handicapping, what comes out of the final legislation?

Yes, that is always dangerous to handicap what comes out of Washington.

As you said, it is in the House Energy and Commerce Committee.

It is just in committee mark-up.

The details are still sketchy, but we know that the data requirements are aggregated with limited distribution, so it is really too early.

I will say this.

If you look at history, there was a Cantwell Amendment a while back in 2003, that the CBO actually scored it a $40 billion increase over 10 years.

And this is a similar amendment.

We will have to see what, the FTC has said this would be anti-competitive.

We think when the CBO scores this, I am not sure it will survive.

People keep talking about transparency, the real issue is the lower cost, and make healthcare more competitive, and in some cases, transparency doesn't do that, because people have confidential information, and clients are less inclined, and suppliers are less inclined to give you different prices.

So the devil is still in the details, a lot to shake out coming out of both the House and the Senate.

That is kind of our position on it.

Thank you.

The second question, as the largest purchaser, I believe, of generics products, have you seen any change reimbursing, now a number of quarters where the manufacturers are reporting better pricing, and it is affecting their performance?

Any change in terms of impact on you, or margins on generics?

Not on our side.

I think some of them are getting benefit from maybe some of the consolidation, some of the synergies, some of that is going around, or maybe some smaller players, but not from our standpoint, given our size and scale, and our ability to move share and product, we have not seen any major increases.

Thank you.

Okay, I will take two more questions.

Your next question comes from John Heinbockel.

Tom, the insurers that backed out of the verbal commitment, have they told you why they picked you originally?

Yes, well, one, they had been with the incumbent for a while.

There were some service issues.

They liked the model.

They liked the fact this is an independent, or an insurer that really focuses on individuals.

There are a lot of stories there.

We got apologies from the consultants.

We have never seen it, but I guess the pricing was so good, it was hard to pass up, and we obviously looked at it and passed.

So a lesson learned, and I know everybody on the call always wants to hear information on new clients, and maybe we pushed the envelope too far before we had it signed up, because we had the May conference that we wanted to tell you about.

We have never add situation where someone has committed and walked away, so we told you, a lesson to be learned from our side.

But at the end of the day, the economics didn't work for us the second time around.

Do you think that in the short run, anyway, can pricing from competitors overcome the benefits of Maintenance Choice, such that it may be hard at least in the short term to pick up a lot of new business, or do you think competitors would do that?

I don't know if it is irrational or not, but how do you think price weighs against the model, as you look to the next selling season?

It is always price.

I think marketplace is fairly rational.

I can tell you, I have mentioned it before, we were kind of the driver early on, especially for some key clients, but I think the market is fairly rational now.

Now could someone come in and drop a low ball price on something that an existing client has, and you got a client that maybe is in trouble, given this economy?

Sure, that could happen.

But I think in the long run, when they think about how they are going to lower their overall healthcare cost in this model, how it addresses lowering their overall healthcare costs because it engages the consumer, and not just on the phone, or mail, but face to face, in a variety of ways, and offers a lot more options, they make the decision.

But, yes, John, price is always going to be a factor.

Would you think next selling season the business wins, the aggregate amount of business wins would exceed this year, given the maturation of Maintenance Choice, or no?

That is the goal.

Obviously, yes, that is the goal.

We are going out after it, and we are going to look at each client, and get new clients, and get more share of existing clients.

So, yes, that is the goal when we start the year.

Finally, maybe for Dave, inventory looked a little high to me.

Is that all the impact of the excise tax increase, or something else?

It includes the impact of the excise tax.

It also includes obviously the addition of Longs, and it also has a, frankly, opportunistic buy that will work itself out as we go through the year.

On what, the pharmacy front end?

I am not going to tell what you it is, but it was --

It is a bigger piece of our business.

Thanks.

One more.

Your final question comes from Scott Mushkin.

Hi guys, thanks for taking my question, I wanted to get into Maintenance Choice quickly, I know you talk about it a lot.

You usually give out lives.

I was wondering if there is any additional, I think it was 2.8 million lives as of July.

Is that still the right number?

Any idea how many lives we will get into the program in 2010, and what percentage of those lives will be non-Caremark mandatory mail?

Those are a lot of questions.

I think we added over, almost 600,000 lives to that number you had talked about.

So we should be close to 3 million lives I guess now in total.

It is hard to project, Scott, what 2010 will be, and the mix of clients that take it, but I can tell you it is resonating with existing clients, and as you can see, or heard me say earlier, it is 25% of new clients.

So like I said, 3 million lives and growing, and we expect to continue to grow in the second half of this year, as we continue to sell clients.

Not to raise expectations, Tom, but is it possible we could get 5 to 10 million people in as of January 1, or is that just way outside the bounds of possibility?

We are going to increase it, but that is way outside the box.

These are big changes.

Remember, I talked earlier about benefit managers.

They are slow to change in some cases.

They are changing now, but when you start adding 500,000 lives, that is significant.

So I think you won't see that kind of a jump, but you will see a steady progress going forward that people like what they see.

Like I said earlier, if you look at any new product, it is the fastest penetration we have ever seen in 10 years in the industry, and at the end of the day, the proof is in the pudding.

Participants like the program.

And the work of I think John talked about this the use of working capital seemed like it jumped a lot.

Will that unwind, Dave, and how about interest expense?

Also seemed your forecast seemed a little high given where you ran this quarter?

Just a quick call on that, and I will jump, I am sure everyone is sick of being on the call.

Well, working capital did take a little bulge, for the reasons I talked to John about.

We also have a timing thing in the receivables cycle in the PBM side of the house.

And on the interest expense, we are engaged in a pretty serious share repurchase program here, so that will cause interest to rise, relative to if we didn't have that.

So it has just begun.

We are off to a good start in July, and we will continue it as we go.

Sounds good.

Thanks.

Okay, thanks a lot.

I appreciate everybody's participation, and if you have any questions, as always, you can call Nancy Christal.

Thank you.

Thank you for your participation in today's CVS Caremark second quarter 2009 earnings conference call.

You may now disconnect.