CVS Health Corp (CVS) 2010 Q2 法說會逐字稿

Good morning.

My name is Brooke and I'll be your conference operator today.

At this time I would like to welcome everyone to the CVS Caremark Corporation second quarter earnings conference 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).

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

Ms.

Christal, you may begin your conference.

Thanks, Brooke.

Good morning everyone and thanks for joining us today on short notice.

We're very excited to tell you more about our new 12-year contract with Aetna.

In light of the Aetna news, we thought it made sense to accelerate our earnings announcement so we could get all of the information into the market place at once.

I'm here with our senior management team.

Tom Ryan, Chairman and CEO of CVS Caremark, will discuss the strategic rationale and financial value of the Aetna agreement, walk through our quarterly business update and touch on our revised 2010 earnings guidance.

Dave Denton, Executive Vice President and CFO, will provide a financial review of the quarter as well as the details behind our revised guidance for this year.

And Larry Merlo, President and COO, and Per Lofberg, President of our PBM business, both are here with me as well and they will participate in the question and answer session that follows our prepared remarks.

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

In accordance with SEC regulations you can find the definitions of the non-GAAP items I mentioned as well as the reconciliation to comparable to GAAP measures on the investor relations portion of our website at info.CVSCaremark.com/investor.

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 it.

Let me also note quickly that we sent out invitations last week via e-mail for our 2010 Analyst Day, which will be held on the morning of Friday, October 8 in New York City.

If you did not receive an invitation and you're interested in attending, please contact my office.

Please note that in light of the accelerated earnings announcement we won't be filing our 10-Q today but we do expect to file it by the end of this week and it will be available through our website at that time.

Now, 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 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 Statements Concerning Forward-looking Statements in our most recently filed Quarterly Report on Form 10-Q.

And now I will turn this over to our CEO Tom Ryan.

Thanks Nancy and good morning everyone.

As you know, last night we announced a 12-year strategic PBM agreement with Aetna which we believe is the largest and longest term new contract ever to have been negotiated in the PBM industry.

It encompasses approximately $9.5 billion of annual drug spend for nearly 10 million lives.

Before I review the strategic and financial benefits of the agreement, I want to get right into our earnings guidance for the year.

As noted in our press release, we're lowering our 2010 guidance for adjusted earnings per share from continuing operations to a range of $2.68 to $2.73 from a previous range of $2.77 to $2.84.

It is obviously very important that you understand what is behind the numbers, so let me briefly explain the three reasons for our 2010 earnings guidance revision and the relative importance of each.

First, as all of you know, we continue to gain share and outpace all retail competitors in pharmacy.

Having said that, there is certainly some softness showing up in the retail pharmacy sector as a whole and it is due to a variety of factors.

Our analysis shows that baseline script trends across the industry have been impacted by three main issues.

First, the year-over-year decline in the flu has accelerated in the second quarter versus the first quarter.

The rapid decline in the PPI category; recall that Prevacid went over the counter in November 2009.

As a result, we have seen the payer community change plan designs around that category and really force more members to the OTC product.

And lastly, new maintenance script starts are down across the industry and this is due to fewer physician visits.

Recent reports by IMS have indicated that fewer people are visiting doctors.

We see this data on the fourth quarter versus the first quarter of this year and we're expecting to see the same in the second quarter.

They're visiting fewer primary care docs and specialists.

Obviously the sluggish economy and continued high unemployment have impacted people's ability to afford physician visits.

Therefore in light of the projected Rx trends, and to a lesser degree our front store trends, we are lowering our retail comp sales guidance from 3.5% to 5.5% down to 2% to 3.5% growth.

So retail comp guidance now is 2% to 3.5% growth.

That accounts for about $0.04 to $0.05 of the guidance change.

The second reason for our earnings guidance revision is we are experiencing higher than planned legal expenses across the enterprise that are expected to continue in the second half, as well as the accruals recorded in our Retail segment in the second quarter for anticipated legal settlements.

Now, I cannot speak to the specifics of the legal matters since they have not been resolved, but they relate to previously disclosed items in our quarterly and our annual SEC filings.

The second quarter accruals for anticipated legal settlements plus the higher legal expenses expected for the remainder of the year account for about $0.04 of the guidance change.

And the last reason is that given the Aetna agreement we will now have some implementation costs this year as we prepare to commence this large contract, and that is probably in the $0.01 to $0.02 a share range for 2010.

Dave will give you the detailed assumptions by segment a little later, but if you just look at the segment our Retail operating profit before the second quarter legal accruals will be up 10% to 12%.

Our PBM operating profit we still expect to decline 10% to 12%; that is before the Aetna costs.

So, to recap, the reasons for our guidance revision relate to one-time legal matters of $0.04; the softness in the overall retail pharmacy environment, which is about $0.04 to $0.05; and the Aetna implementation, which is about $0.01 to $0.02.

Now let me talk about the Aetna announcement.

As you know, we announced a 12-year contract with Aetna which is effective on January 1, 2011.

We're really excited about the opportunity for the clinical integration of Aetna's medical information and our pharmacy data to truly impact healthcare outcomes.

By deploying the collective assets of medical and pharmacy data of both organizations, we will be able to provide significant benefits for payers and plan members.

We are delighted that Aetna has chosen to partner with us.

They have told us that following a comprehensive review there were several key areas that drove their decision.

First, our integrated delivery model which allows us to better engage members across multiple points of care, especially face-to-face.

Second, our innovative products and services such as our Pharmacy Advisor program, which is our unique member engagement platform that is powered by our consumer engagement engine; our convenient and flexible options for driving 90 day prescription utilization, adherence and cost savings; our state-of-the-art pharmacy platform when you think about the consumer engagement engine and one view of the patient across retail, mail, specialty and MinuteClinic.

Third, our reputation for service excellence, and fourth, our overall value proposition that will help lower healthcare cost and improve outcomes.

Aetna will benefit over time from our unique ability to interact with patients face-to-face in our retail pharmacies as well as MinuteClinics, online, specialty and mail.

This will allow Aetna to communicate important customized information to their members at the point of care.

This information will include drug safety, evidence-based protocols and relevant clinical programs.

As you know, under the agreement Aetna will retain its PBM and manage the clinical programs and protocols.

Aetna will transfer approximately 800 PBM employees to us and we will provide the following -- prescription fulfillment for Aetna's sizeable mail-order and specialty operations; clinical program administration, i.e.

prior authorization and adherence programs; claims adjudication; retail pharmacy network management; management of customer and member service functions; pharmaceutical purchasing and inventory management; innovative technology enabling the rapid integration of pharmacy data into Aetna's medical care management systems; and physician engagement through e-prescribing, real time physician support and pharmacist support.

The long-term nature of this agreement also enables us to collaborate on various projects, such as consumer behavior research pilots, to shape the opportunities presented by healthcare reform including progress on health information exchanges, the utilization of electronic medical records and the promotion of cost effective quality care.

Now, the transition of services between our companies will occur over the next 18 to 24 months to minimize client disruption.

We will have a dedicated team devoted to the transition process to assure all continued service performance for all clients and members is kept at the highest level.

We see significant long-term financial benefits for this strategic agreement.

As I noted earlier, we expect implementation cost to be slightly dilutive this year in the $0.01 to $0.02 range.

We expect the Aetna agreement to be $0.01 to $0.03 accretive to the overall enterprise in 2011, to be accretive in excess of $0.05 a share in 2012, and to generate more than double that level of accretion in 2013 once the contract is fully implemented.

Again, this is a contract encompassing just under $10 billion in annual drug spend and nearly 10 million lives.

We have a long-term strategic agreement that both companies believe will be beneficial to our clients, members and shareholders.

With our shared vision for pharmacy healthcare, CVS Caremark and Aetna will work together to deliver quality outcomes with lower overall healthcare costs.

We could not be happier with this new agreement.

Now, let me switch gears and update you on the second quarter results and recent trends in our business.

In the second quarter we reported adjusted earnings per share from continuing operations of $0.65 including approximately $0.03 a share related to accruals recorded in our Retail segment for anticipated legal settlements.

So if you adjust our reported EPS for legal accruals, we would have been well within our guidance for the range for the quarter, and that is despite the fact that we missed retail comp expectations due to industry factors I highlighted earlier.

Legal accruals aside we were able to control expenses in the Retail segment which offset some of the top line miss.

Our results also benefited from slightly lower interest expense and weighted average shares outstanding.

Let me talk briefly on the legal update and Larry Merlo is here obviously to answer any detailed questions.

We opened 78 new and relocated stores.

We closed four others in the quarter, resulting in about 46 net new stores.

For the year we plan to open up 250 to 300 new stores and that includes about 100 relocations.

We will add 2% to 3% square footage growth for the year and that is consistent with our plan.

Retail same-store sales grew at 2.1% in the quarter, which is below our 3% to 5% guidance for the reasons I outlined earlier.

Pharmacy comps were up 2.9% which continue to lead the industry.

On a two year stack basis our pharmacy comps were well over double that of our nearest competitor.

When you count 90 day scripts as one script, our script comps were up 1.6%.

If 90 days scripts are treated as three scripts, our script comps were 4.5% this quarter -- nearly double our closest retail competitor.

Our pharmacy comps were negatively impacted by 180 basis points from new generics.

We are positively impacted 290 basis points due to continued growth of Maintenance Choice.

I should note that we saw -- relative to MinuteClinic I will also note that we saw a 36% increase in visits to MinuteClinic in the second quarter.

That's significant growth given that last year's second quarter included the impact of H1N1 illness which lasted I guess through early June.

We believe MinuteClinic's strong growth this quarter reflects our expansion of services and the improved awareness around our clinical offerings.

In the front end of our stores, front end comps increased 0.4% in the quarter which reflected a negative impact from Easter of about 84 basis points and a negative impact from the inclusion of Longs of 33 basis points, which was expected.

Both customer counts and average ring improved notably in the Longs stores in the second quarter, up 190 and 284 basis points respectively.

We also saw continued margin improvement so we continue to make solid progress at Longs.

As you know, last quarter we talked about some initiatives we had underway that would drive our second half sales results in the Retail segment.

All of these initiatives, including the urban cluster program, the expansion of consumables, the adherence programs are on track and meeting our expectations.

The rollout of RxConnect is also going well.

It's in about 5800 stores now.

We expect to complete the rollout by the summer.

We're running at a rate of about 430 stores a week, so we're on schedule.

Given where we are with RxConnect, the deployment of the consumer engagement engine has begun in the retail channel.

Consumer engagement engine was launched in the second quarter of last year, as you know, in our customer care, our outward bound mail centers and our IBR systems.

It is generating clinical messaging and cost savings for clients and members.

We're excited about the rollout to retail and it has certainly generated a fair amount of enthusiasm from our clients.

Now let me turn to the PBM.

Given the rather public issue that we had with one of our retail network providers during the second quarter, we obviously have gotten many questions as to what that may have had as an impact on our selling season.

First, as you know, we were able to resolve this issue quickly with a multiyear agreement signed within two weeks of the problem surfacing publicly.

While some clients and consultants were concerned about the 30 day termination period, they understood that the short window helped resolve the situation quickly and they respected our ability to negotiate a quick mutually beneficial resolution that eliminated any disruption to their employees or their members.

Now while the timing was unfortunate and curious, fortunately the impact was minimal.

Our sales and account teams did a terrific job of keeping clients and key consultants informed throughout the situation.

So while we may have lost a couple small opportunities in the midst of the short-term discussion, the impact on our selling season was not significant.

Our PBM selling season is going very well.

Even though it is still early in the season and many decisions have not been made yet, I wanted to outline for you where we stand as of today.

First, I will summarize the progress on renewals.

As you are aware, we have a smaller than normal book of business up for renewal in 2011.

Since we locked down FEP and two other health plans earlier in the season, we renewed roughly one-third of that business to date, so one-third of that $7.5 billion that we had out there.

If you take into account FEP and the two health plans that we completed early on, essentially we renewed more than half of our total book of business up for 2011.

To date, our retention rate exceeds 98%.

As for new business excluding Aetna that we just obviously announced, we have so far won $1.2 billion of gross new business and $350 million of net new business.

The net new business reflects, one, a handful of small accounts that will terminate in '11; the transition of Health Net's Northeast business that was previously sold to United, it was about $400 million; and the wrap-around effect of contracts that were lost in last year's selling season.

Given the timing of the conversion, we expect the Aetna agreement to add about $8.2 billion in 2011 revenues.

So including Aetna we have won $9.4 billion in gross business and $8.6 billion in net new business for 2011.

There is still a way to go.

We will have more to say at the analyst meeting in October.

But we are very pleased with the selling season.

We continue to gain traction on Maintenance Choice, which is resonating very well in the market place.

Since our last call, we have signed up additional clients.

We now have about 525 clients or plans representing 6.3 million lives and we have more in the pipeline.

We're seeing increased adoption in our high-performance generic step therapy plan.

We've already signed up 70-plus clients representing 3.5 million lives.

This saves a significant amount of money in their total pharmacy costs.

In addition to these plan designs, we continue to be focused on clinical programs that will promote compliance and lower overall healthcare costs.

We are currently piloting a new plan design where plan sponsors provide financial incentives to members to fill their prescriptions on time.

In addition, we have already launched a pilot for some select clients on our genetic benefit management program which will be broadly available in January of next year.

We believe our investment in Generation Health positions us to take a leadership role in the utilization management of genomic testing.

And finally, I want to briefly mentioned that Per and his team have been working on a plan to streamline our PBM operations in order to achieve greater efficiencies and cost savings.

It will require some upfront investments and some transitional expense at some point and we're in the process of formalizing those plans, quantifying the impact and working on the appropriate timing.

The cost and associated benefits will occur over a multiyear period.

We will have more to say on this at our annual analyst meeting in October.

Now, I will turn it over to Dave for the financial review.

Thank you Tom and good morning everyone.

Today I'll provide a detailed review of our second quarter financial results and outline our 2010 guidance for both the year and the third quarter.

But before reviewing our operating results I want to update you on our capital allocation practices.

As I stated previously, we expect to use the majority of our free cash flow in the near-term to enhance shareholder returns and we continued to do that throughout the second quarter.

As we previously announced, we completed our November 2009 authorization to repurchase $2 billion worth of our shares during the second quarter.

We bought back approximately $613 million worth of our stock and as a result reduced our outstanding share base by approximately 17 million.

Year to date we have repurchased about $1.5 billion worth of our stock.

Combined with our dividends, we've returned more than $1.7 billion to our shareholders thus far in 2010.

Now, as most of you know, in June the board authorized another share repurchase program also for $2 billion.

We have not bought back any shares to date under this new authorization.

Practically speaking, I did not have an open window in which to repurchase shares due to the timing of our earnings announcement.

We delivered adjusted EPS of $0.65 for the quarter, GAAP diluted EPS at $0.60.

If you adjust for the legal accruals in our retail business, results this quarter were well within our guidance.

Concentrating on revenues, our enterprise-wide net revenues decreased in the second quarter by 3% to $24 billion.

Drilling down by segment, as expected net revenues dropped 9% in the PBM to $11.8 billion.

Sequentially, this is lower than the first quarter as we lapped the revenue accounting changes related to RxAmerica.

The decline year to date was driven by the net impact of previously announced new business and terminations as well as the decrease in Med D lives resulting from the 2010 Med D bidding process.

PBM pharmacy network revenues in the quarter decreased 12% from 2009 levels to $7.6 billion while pharmacy network claims declined 13%.

Total mail choice revenues decreased by 3% to $4.1 billion while mail choice claims declined by 4%.

In addition to the reasons I just provided for the revenue decline, the network claims loss also was impacted by the increase in mail choice penetration as claims continue to move from network to mail choice.

Our overall mail choice penetration rate of 25.9% was up 190 basis points from the rate in the second quarter.

Additionally, network claims were negatively impacted by the soft prescription utilization trends throughout the industry.

In our retail business we saw revenues increase by 4% to $14.3 billion in the quarter.

This increase was primarily driven by our same-store sales increase of 2.1% and net revenues for new stores which accounted for approximately 150 basis points of the increase.

While we did grow revenues year-over-year at a healthy rate, the growth was more modest than we had expected due to macroeconomic trends.

I will speak a bit more about this in my discussion around guidance.

Pharmacy revenues continued to benefit from incremental prescription volumes associated with our Maintenance Choice product.

Maintenance Choice was responsible for 290 basis points of the comp sales growth in pharmacy.

A weaker flu season, the H1N1 outbreak in last year's second quarter and a higher generic dispensing rate negatively impacted pharmacy revenue growth, all of which was somewhat offset by a stronger allergy season compared to last year.

Turning to gross profit, compared to the second quarter of 2009, we saw enterprise-wide margin expand by approximately 60 basis points to 20.9%.

It was slightly less than expected due primarily to soft retail sales and the resulting impact on the mix between higher-margin retail and lower margin PBM.

Within the PBM segment, gross margin was down about 20 basis points, again as expected.

This mainly reflected the elimination of retail differential within the Med D business that began on January 1 of this year.

Partially offsetting this was the positive margin impact from the 320 basis point increase in the PBM's generic dispensing rate.

It grew from 67.8% to 71%.

Gross margin in the Retail segment declined by approximately 40 basis points in the second quarter to 29.6%; well within expectations.

This largely reflects the impact of continued pressure on pharmacy reimbursement rates, especially those associated with state Medicaid programs; the growth in Maintenance Choice, which compresses retail gross margin but helps the overall enterprise; and the continued shift in the mix of our business toward pharmacy.

These negative factors were partially offset by increased generic dispensing rates, the benefits we're seeing from our various front store initiatives and increased private-label penetration.

Our GDR in the Retail Pharmacy increased 310 basis points to 72.7%.

Overall, operating expenses as a percent of revenue increased by approximately 80 basis points over last year's second quarter.

The PBM's SG&A rate deteriorated by approximately 15 basis points to 1.9% primarily due to the decline in revenues.

The Retail segment saw improvement in SG&A leverage of approximately 40 basis points to 21.9% despite the impact of the legal accruals I mentioned earlier.

Retail again benefited from the absence of Longs integration expenses, a reduction in Longs depreciation and the leverage we gained from disciplined expense controls.

Within the corporate segment, expenses were $156 million or less than 1% of consolidated revenues, growing 9% versus last year.

There were several puts and takes but the primary drivers of growth was increases in professional fees, mainly legal.

So, with the change in SG&A as a percentage of sales more than offsetting the improvements in gross margin, operating margin for total enterprise declined by approximately 20 basis points to 6.2%.

PBM profits declined by 15%, within our guidance, while Retail profits improved by 4%.

If adjusted for the legal accruals, Retail profit growth was at the low end of our guidance range at 8.2%.

Going below the line on the consolidated income statement we saw net interest expense in the quarter increase by $7 million to $135 million while our effective income tax rate was 39.8%.

Our weighted average share count was just under 1.4 billion shares.

During the quarter we generated approximately $190 million in free cash which compares to $425 million in last year's second quarter.

The decrease in free cash flow generation year over year was driven by the absence of sale-leasebacks in the quarter.

This year's second quarter is a more typical second quarter for us in terms of sale-leaseback activity.

Remember that in 2009 we executed several sale-leaseback transactions throughout the year to make up for 2008 activity that was delayed due to the inaccessibility of the markets in the fourth quarter of that year.

Gross capital spending during the quarter was approximately $465 million, down from $625 million last year mostly due to the absence of Longs integration expenses.

Given that we had no sale-leaseback activity in the second quarter, this was also our net capital spending.

Now let me turn to our guidance for the full year 2010.

As Tom indicated, we're lowering our 2010 guidance for adjusted EPS from continuing operations to a range of $2.68 to $2.73 from our previous range of $2.77 to $2.84.

GAAP diluted EPS is now expected to be in the range of $2.49 to $2.54.

Please note that this guidance does not assume any additional share repurchases for the balance of this year.

We are very mindful of our balance sheet and still focused on maintaining a high BBB credit rating.

To that end, we are targeting an adjusted debt to EBITDA ratio of approximately 2.7 times.

We will continue to monitor our cash progression and may repurchase some shares later in the year.

But again, for modeling purposes, our guidance does not assume any additional share repurchases this year.

For the PBM segment, excluding the one-time implementation costs associated with the Aetna contract, we continue to expect operating profit to decline by 10% to 12%.

Including the one-time cost, PBM operating profit will decline an additional 1 to 2 percentage points.

For the Retail segment, excluding the second quarter impact on the legal accruals, we now expect operating profit to increase 10% to 12%.

Including the legal accruals, Retail operating profit would increase 1 percentage point less in the 9% to 11% range.

Please keep in mind the legal accruals are not tax affected like other operating expenses and amounted to approximately $45 million to $50 million in the second quarter, which equates to approximately $0.03 per share.

For the PBM segment, we still expect revenue to decline by 4% to 6% for the year.

For the Retail segment we now expect revenue to increase 3.5% to 5% and same-store sales to increase 2% to 3.5%.

As a result, for the total enterprise we now expect revenue to be down 1% to 3% from 2009 levels.

This is after intercompany eliminations which are projected to equal about 8.5% of combined segment revenues.

For the total Company, gross profit margins are expected to moderately improve relative to 2009 levels.

Expectations are that gross margin in both the Retail and PBM segments will be modestly down.

For the total Company, operating expenses now are expected to be approximately 14.5% of consolidated revenues with the PBM essentially flat and the Retail segment improving notably.

And we expect operating expenses in the corporate segment to be in the range of $600 million to $615 million, slightly delevering as a percent of consolidated revenues compared to last year.

The increase from last quarter reflects the higher than planned professional expenses across the enterprise.

As a result, we now expect operating margin for the total Company to be flat to slightly higher than 2009 levels.

We've lowered our forecast for net interest to better capture our current thinking in regards our cash and debt needs as well as the current interest rate environment.

We now expect net interest to be in the range of $555 million to $565 million.

We are forecasting a tax rate of approximately 40% and approximately 1.38 billion weighted average shares for the year.

We continue to expect total consolidated amortization for 2010 to be roughly equivalent to the levels in 2009.

Combined with estimated depreciation, we still project approximately $1.4 billion in D&A.

As for capital spending, we expect gross capital expenditures to be between $2.3 billion and $2.5 billion and proceeds for the sale-leaseback of approximately $500 million to $600 million for the year.

On the last call I said that I wouldn't be surprised to see our cash cycle contract slightly before improvements we currently have underway take hold.

In the second quarter we did indeed see that happen.

While days sales and payable outstanding held their own during the quarter we saw inventory days deteriorate a bit further.

Let me reiterate that improving working capital performance is one of our top priorities.

It will take some time, and even though we have launched several initiatives focused on improving our performance in this area, the results will not be instantaneous.

We will have more to say about our specific plans on improving working capital at our analyst day in October.

Turning to free cash flow, given the reduction in earnings guidance, we currently expect to generate approximately $2.5 billion in free cash this year -- still within the range we provided on the last call, but at the lower end of the range.

And we continue to expect free cash to accelerate in 2011 and beyond.

In the third quarter we expect total Company revenues to be down 1% to 3%.

In the Retail segment we expect sales to increase 4% to 5.5% and total same-store sales to be up 2.5% to 4%.

In the PBM segment, revenues are expected to decrease by 6% to 8%.

We expect adjusted EPS from continuing operations in the third quarter to be between $0.63 and $0.65 per diluted share compared to last year's $0.76 per share.

Recall that last year's third quarter benefited from the recording of approximately $156 million or $0.11 per diluted share of previously unrecognized tax benefits.

GAAP EPS is expected be in the range of $0.58 to $0.60 per diluted share.

We expect the PBM segment operating profit to decrease 11% to 14% in the third quarter.

We expect the Retail segment's operating profit to grow 8% to 10% in the quarter.

With that, let me turn it back to Tom.

Thanks Dave.

We obviously covered a lot of ground this morning.

So before opening up for questions, I thought I would just recap some key takeaways from the call.

First, when you adjust for legal accruals we reported an in-line quarter despite the challenges of the macro economy impacting the industry.

Two, our operating profit guidance for the full-year is unchanged for our PBM and slightly lower for our Retail business in light of the cyclical trends being felt across the sector.

Yet, even with those challenges, we still expect a healthy 10% to 12% operating profit growth in our Retail segment excluding the legal accruals.

Third, our new EPS guidance also takes into account the anticipated Aetna implementation costs and slightly higher legal costs for the remainder of the year.

Fourth, we still expect to generate a significant amount of free cash flow this year; approximately $2.5 billion.

Five, we are in the midst of a very successful PBM selling season.

And finally, the 12-year agreement with Aetna will have significant financial and strategic benefits for our Company in the near and long-term.

So, with that, I will open it up for questions.

As Nancy said earlier, Larry and Per are with us today, so they will be happy to jump in on the questions.

(Operator Instructions) Eric Bosshard, Cleveland Research.

When you look at the Aetna, or when they looked at the combination or this opportunity with you, where do you see or where did they see the sort of single greatest opportunity to really create value out of this?

And I guess related to that, as you think about the accretion expanding in '12, what is the underlying assumption that you can accomplish with that book of business that is not being done presently?

Well, I think they outlined it and we outlined it.

They saw some value in our integrated model, the fact that could they could touch their patients across our book of business in ways that they couldn't do previously.

They looked at our service levels.

They looked at ways we impact their member experience and then ultimately the value that we bring.

Think about taking the execution of the clinical protocols, combined with their medical information and our pharmacy data, we can truly impact their clients and their members.

So, I think it was a combination of things.

They saw the opportunity, and then the long-range opportunity we have to work together on some new programs.

As far as opportunities, obviously our Pharmacy Advisor program, our consumer engagement engine, we think we have opportunities around the specialty side of the business.

We think we have some opportunities around Maintenance Choice.

Obviously these are all dictated by their clients and the payers.

But the issue is to use our total arsenal of weapons, if you will, in the pharmacy area and the clinical area to improve patient outcomes and lower costs.

So, in kind of a short way that is how they thought about it, I believe.

Secondly, on the Retail side you are doing a lot of things to try to improve the Retail business and are improving the Retail business, and you're dealing with headwinds.

As you look out on the horizon, how do you get comfortable in seeing an improvement or a recovery in comp sales growth there?

And how do you think about managing the business in light of what we're enduring now within the channel?

I'll just state briefly and let Larry get into it.

But listen, this is -- we are obviously -- it's a tough time in the macro economy, and we continue to obviously take share and look for ways to be more productive in our business, continuing to lower cost.

And all the programs that we have in place, we're very happy with the programs.

There are some obviously headwinds, but those are one timers, right.

People are going to continue to go to physicians.

We're going to cycle the RX to OTC in the PPI category.

So those are one timers and we think we are well positioned with the initiatives that we have in place.

Larry?

I think Tom summed it up pretty well.

The issues that we outlined this morning, again, we think are cyclical in nature.

And we are pretty pleased with where we are at with the initiatives, both in the front end of our business -- things like our clustering efforts that we have initiated in our urban stores first as well as the strategy that we have with consumables.

Then you look at some of the initiatives that we have in the pharmacy around our adherence programs and the fact that completing our RxConnect rollout over the next few weeks, and being able to layer on top of that the engagement engine is going to help us execute those programs to an even higher level.

So we think that our initiatives are well on track and I think that's what gives us the confidence going forward, recognizing that we are dealing with some cyclical headwinds.

Thank you.

Tom Gallucci, Lazard.

Good morning.

Thanks for all the information.

I guess just on the Aetna side of things, one quick housekeeping question.

What is the rough mail penetration there?

10% approximately.

And then as you are thinking about a 12-year deal, obviously it offers a level of visibility.

But how do you go about, or can you just give us a framework for how you go about pricing that?

And is there any floor, if you will, if Aetna were to get smaller or any pricing that would improve for them if they were to get bigger through an acquisition or something like that?

Without getting into the details there, it essentially is structured in a very conventional way.

It is obviously bigger and has a longer time frame than many PBM contracts.

But from the standpoint of the structure of the pricing arrangement, it's very comparable to every other PBM arrangement.

Okay.

And then if you could maybe just offer an update on the status of the implementation of the consumer engagement engine?

I know you mentioned that earlier, Tom, so where that implementation stands would be helpful.

Thanks a lot.

Larry, go ahead.

The engagement engine was rolled out in the second half of last year in the mail facilities and call centers.

As I mentioned, we're beginning the rollout in our retail stores.

And it is in a group of stores from a pilot perspective right now, just to make sure that we have all the bugs worked out in stores that have already completed their RxConnect rollout.

We expect to roll it out more broadly over the next probably four to five weeks.

We'll have that complete in all of the retail stores some time later this year.

Mark Wiltamuth, Morgan Stanley.

Good morning.

I wanted to ask a little bit about the Aetna contract.

You mentioned, Tom, in your comments about flexibility and adherence to 90 day programs in the agreement.

Does that imply that Maintenance Choice is a part of this?

Is there an opportunity for you there with Maintenance Choice?

Yes.

Maintenance Choice is definitely part of it.

It's all of it.

Per can talk to the particulars.

But once again this is about going to the payer and giving the payer some options, all the options that we talked around; around formularies, around plan design.

And that plan design includes mail, Retail, Maintenance Choice, limited networks -- all of the pieces of the puzzle that are out there.

And Aetna obviously in our discussions liked the opportunities and our ability to offer some of those services, but Maintenance Choice is definitely in.

Even though they own the mail business they are still okay with customers shifting to Retail for Maintenance Choice?

Well, we are essentially taking over the whole back end of the mail-order pharmacy operations.

They are technically keeping their pharmacy license and they are preserving certain front end functions in those pharmacies, especially clinical functions.

And then we're basically handling the back end.

The Maintenance Choice option will be available to them and all of their customers just like all of our other programs.

And I think it's a fair bet that a number of their customers just like our own customers find that an attractive way to generate cost savings and provide convenience for their members.

Okay.

And you said their mail penetration was how high?

I think you just mentioned that (multiple speakers)

(multiple speakers) about 10%.

Okay.

About 1 billion out of 10 billion.

Okay.

Then to dig in a little more on the Retail softness, it seems to me that you should lap out of the difficult comparisons on flu and we're looking at almost no flu season from December onward.

Is that fair that we'll start seeing easy year-agos on flu by December?

We're going up against not the seasonal flu now, but the H1N1.

And we actually saw in the second quarter our flu related prescriptions actually decline at a rate that was almost 2X that of what we saw in the first quarter.

That is not something that we had anticipated in our modeling.

So, that is going to continue through probably up until November of this year and then I think at that point we will cycle it.

Okay, thank you.

Lisa Gill, JPMorgan.

On -- Aetna earlier today talked about pricing guarantees in this contract as well as a favored nation.

Tom or Per, does that trigger any changes in any of the other contracts you might have with someone else that may have a favored nation's pricing today?

No.

This is pricing that is just comparable for this size contract.

Obviously what is important, too, to Aetna in all of this is that over the span of a long-term relationship like this that they have access to very competitive terms.

So that when they include pharmacy programs in their offerings to their customers they can offer that in a very competitive way compared to other insurance companies that they maybe compete against.

I think many of us thought that perhaps they would sell their PBM rather than sign a long-term agreement like this.

Can you maybe just give us any kind of background at all as to how long you have been in discussions with them?

I think they talked about on their call that they went through a very detailed process looking at every option in the market place and that CVS Caremark was the best option for their long-term relationship going forward.

So any background on your side would be helpful.

We have had discussions for a fairly long time, actually before Per came on board.

And then we had -- when Per came on and healthcare reform started taking shape we had, obviously, some more discussions.

As they said, they looked at the landscape and their options and they felt this was the best option where they could still have some control of some of the protocols and the clinical aspects of the business, and then leverage our ability and our capabilities to go to market.

So, they did a fairly extensive research around this and due diligence.

I think it's important also to recognize that we're not buying their PBM.

They're keeping their PBM and we are outsourcing certain capabilities and certain functions in all of this.

But the transaction is, as a result, structured differently than might have been the case if it was a sale of a portion of their business.

And quite candidly, for us that is a far preferable structure.

That's the one we were aiming for and we're delighted that they agreed to the same type of structure that we were hoping for.

Great.

We think this is a great deal for you as well.

One just last follow-up; Per, I know you've been out of the PBM industry for a while.

And Tom, this is what, your third selling season?

Can you give us any kind of perspective as to where you see pricing this year?

I know that there's been a lot of talk out in the market place, at least from a sell side perspective, around pricing.

Do you feel that it is different this year than what you've seen over the last couple years?

Not in a kind of a trend break type of sense, Lisa.

I think it's intensively competitive like it always has been, but it's fundamentally very similar to the past.

When plans go up for bid, they are always looking for better economics and that is a very important part of the negotiation.

But I don't think there is any real significant difference this year versus any other year that I've been involved in.

I haven't seen any, Lisa, since the time that we have owned Caremark.

Okay, great.

Well, I appreciate all the comments, and again, congratulations on this Aetna deal.

I think it's great.

Neil Currie, UBS.

Good morning, thanks for taking the question.

I just wanted to ask a question about the Aetna deal.

It seems that there's obviously no up front money, but Aetna looks like they are keeping the rebates.

I just wondered if you could give us any guide as to what sort of EBITDA per claim you would be looking at as part of this deal and whether you would get anywhere near the current $4.00 level that you currently have?

We're not going to get into the EBITDA per claim on this particular contract.

Okay, well, thanks.

Secondly, I just wondered about Longs if you can give us an update on Longs and also why depreciation is going down there.

Neil I think that Tom alluded to this in his comments, but we continue to see improvements in sales and margin.

And as a result of productivity improvements we're able to leverage and reduce our operating expenses in the stores.

With that being said, I think Longs is experiencing some of the same topline pressures that we alluded to earlier.

I would say that we are pretty pleased with the progress we're making.

But when you ask about accretion we have said that Longs would probably be at around $0.10.

It's probably closer to $0.09, recognizing some of the topline pressures that we alluded to earlier.

But we're pleased with where we're at.

You mentioned depreciation going down at Longs; is that a percent of sales or is that in dollar terms?

This is Dave.

It is in dollar sense, and it really was driven by the purchase price accounting finalization last year.

Okay.

And then just finally, Dave, you mentioned about working capital and doing some work on that and you hope to update us in your conference later in the year.

But I was just wondering whether any improvements that you might see would come as early as this year, and if so, is that within your guidance?

The guidance includes our forecast for the balance of the year in inventory.

I don't anticipate any significant improvement this year.

Keep in mind that really the big opportunity from my perspective is mostly on the retail inventory front.

We're sitting here facing some headwinds from a topline perspective in retail, and when you have topline headwinds it affects our inventory performance.

So I think that any gains that we have might be offset by the headwinds we'll see on the topline, so I'm really anticipating next year being the opportunity period.

Okay, thanks very much.

Ann Hynes, Caris & Company.

I just wanted to drill down on the script utilization comments.

I guess when you -- you highlighted three; flu, PPI and then the new scripts are down.

I guess which one of the three is probably the bigger driver in the reduction of guidance?

Probably the bigger driver is the year-over-year change that we're seeing in new maintenance scripts.

We touched on the fact that there is a correlation to the unusual drop in physician visits.

I think it is important to note that as we model that, keep in mind that with maintenance scripts there is a compounding effect, as you run the risk of not seeing the refills associated with the prescription.

Okay.

Any geographic area that is on more of a decline?

No.

I think we're seeing that apply across our geographies.

I don't see where any one market is being impacted by that any more than another one.

Okay.

And just around 2011, I know you have not given guidance yet obviously.

But when we look at new generic introductions for 2011 they're less than 2010.

So, can you -- when we're doing our models, can you give us any type of guidance on what would be the negative impact on growth rate of just the lesser new introductions for generics year-over-year so we don't overestimate that?

We're not going to give that now.

But you're right; on a topline basis there's less coming out in '11 than '10.

Perhaps when we get closer to maybe our analyst meeting or on the fourth-quarter call, we can give you some better feel for that as we know how they're coming out.

Okay.

Thanks.

Scott Mushkin, Jefferies & Co.

Do we have any idea of the percentage of the people -- the Aetna -- the 10 million that actually utilize CVS retail pharmacies now?

Probably equal to the average of the country, more or less.

Typically it's right in line with our share.

So you are talking like 20%, 25% something like that, about 20%?

20%.

Okay.

Then when we look at the accretion numbers, and I know we've talked a little bit about Maintenance Choice and the opportunity.

When you talk about 2013, Tom, are you assuming some benefits from Maintenance Choice?

Or is that just purely the PBM side of the equation?

It's purely the --

We have not built in any assumptions around that at all.

It's just purely the PBM projections.

And so I know Aetna mentioned on their call what excited them about CVS Caremark was in part the retail facing, and you guys have talked about the opportunities for 90 day.

Isn't more 90 day, whether it's called Maintenance Choice or whether it's -- isn't more 90 day at retail almost a lay-up here?

It depends on -- it's the client, right.

It's individual payers have individual requirements and likes and dislikes.

So, it's totally up to the payer.

But there's certainly an opportunity.

There is an opportunity in mail, right; it's an opportunity whether it is Maintenance Choice or mail.

As a general trend in the market there are more and more customers who are interested in taking advantage of the 90 day pricing for maintenance medication, whether it is in mandatory mail programs or Maintenance Choice programs.

So Aetna and its customers are likely to be dealing with that customer demand just as much as we are.

Thanks Per.

Then when we look at -- I know Maintenance Choice obviously had a nice quarter again with -- I think you said 6.3 million lives and 525 accounts, which is up significantly.

When we look at the new people being brought in, is the mix continuing to go to maybe people that were not mandatory mail programs already and accounts outside of the Caremark customer?

Or how is the mix when we look at the additional Maintenance Choice people?

There's a growing number of customers that are not mandatory mail customers but that are what we might call incentivized mail order customers, where there is -- in order for this program to work, there has to be some kind of copayment incentive for people to take advantage of the 90 day plan.

That is a pretty common set of benefit designs today.

So we're now dealing with a growing number of customers that are not mandatory but are, quote unquote, incentivized.

Perfect.

Then one last one for Dave.

Your free cash flow comments, are they -- in taking the comments I think Tom made about the extra spending we're going to be doing to take -- to put the PBM platforms together, are those free cash flow comments including the idea that there is going to be additional spending you guys are going to go over at your conference?

Yes it does.

All right, thanks.

Thanks for taking my questions.

Robert Willoughby, Bank of America.

What is the disconnect between the $9.5 billion drug spend and the $8.2 billion you indicated you thought you would book in revenues next year for Aetna?

It is simply the implementation timeline associated with putting that -- migrating that business onto CVS Caremark.

Okay, and just to the earlier comment about the PBM and some efforts to address some inefficiencies there going forward, I know that is maybe a highlight from the investor day.

But what inefficiency specifically are we looking to streamline there?

Is there anything anecdotal you can point us to?

I think it is really in two major areas.

One has to do with the adjudication platforms.

And we have talked about that in the past and certainly we see a major opportunity for our Company to reduce the complexity associated with operating multiple adjudication platforms.

And then also on the pharma specialty and mail order pharmacy side, we have a pretty widespread network of pharmacies around the country.

We see some opportunities to basically consolidate some of that and gain efficiencies on the pharmacy side.

Thank you very much.

Meredith Adler, Barclays Capital.

Thanks for taking my question.

I want to start by talking about Retail.

I was interested that you didn't really mention the front end at all.

Is that because the front end, what it is doing is pretty much what you expected it to do?

It's not robust, but no surprises?

Yes, Meredith.

I think our front end is pretty much on par.

I don't think that a lot has changed from the last time we talked about it.

We still see the consumer being very cautious and looking for value, and buying more on promotion and trying store brands.

We continue to see double-digit growth in our store brand sales.

We continue to leverage ExtraCare to help deliver that value and drive profitable sales.

Okay, great.

And then a question about the Aetna contract, it's a very long contract.

Are there actually some kind of incentive fees that will go to you guys if you demonstrate that you can lower, say, medical costs for some of the payers?

No.

This is a pretty conventional PBM contract.

Occasionally we get into those types of opportunities down the road, and that could very well happen here too, but it's not part of the terms that have been -- that forms the basis of this agreement right now.

Okay, great.

Then my final question actually is about -- back to Retail about some of the cost cutting initiatives.

Maybe you guys could, Larry, you could talk about how you have been managing expenses as you've seen weaker sales?

Meredith, I think we've always been a very disciplined organization in terms of being able to flex our variable expenses up or down based on our trends for the business.

We're continuing to do that.

At the same time, we're continuing to invest in our initiatives that we think are important for our future growth.

Okay, great.

Thank you very much.

Steve Halper, Stifel Nicolaus.

Just as a follow-up, are there any specific incremental capital expenditures that you're committed to on the Aetna contract?

No major capital expenditures to speak of.

There are some implementation costs, but in terms of headcounts and so on that would be required to begin this transition.

But it's not like you have to go out and build a whole new call center.

No.

No call centers, no mail centers.

Great.

Thank you.

Okay, we'll take two more questions.

David Magee, SunTrust Robinson.

Just on the Retail side, could you talk a little bit about your assumptions now regarding the ongoing profitability of the generic business?

And also what sort of H1N1 flu experience are you expecting this fall compared to last year?

I'll take the H1N1.

We're really not forecasting much of a flu season for the balance of the year.

We do have what I would consider to be a robust program for the latter weeks of the year that would tie to our retail stores and MinuteClinics providing flu vaccinations as we embark upon the next flu season.

I think you will see that in the market place over the next couple weeks.

This is Dave.

Concerning generics just in broad terms, I think generic profitability substantially has not changed in the way we think about it.

I will say that, as I think asked earlier on the call, as we look out for the next 12 months the generic pipeline is a bit weak.

So I think in totality, the profitability associated with generics there are some headwinds due to the fact that that pipeline is not as robust as it has been in the past.

Yes.

Thanks and good luck.

Helen Wolk, Sanford Bernstein.

Good morning and thanks for taking the question.

A quick question on the Aetna contract; you mentioned that the pricing is typically or conventional PBM pricing.

Does that mean when we look at the acceleration or the accretion estimates that we should expect that this moves in tandem with the usual sort of suspects -- generic utilization, mail penetration, those sort of conventional PBM metrics?

Yes, basically.

Basically.

And then from a timeline for implementation, can you give us a sense for what the boundaries are, what milestones we should look for along the way?

It is basically a phased implementation that will begin in January and will basically go for two years.

So, various aspects of the relationship will migrate over to our system in the course of that 18 to 24 month period.

Great.

Then lastly, question on Maintenance Choice; I think the compares get more difficult as the year progresses.

Are you still seeing enough new interest and growth in the program to sustain the kind of strong contributions that has been Maintenance Choice throughout the year?

I do.

We have a robust pipeline of customers that are available to us for that program and that are evaluating it and that I think we should expect to convert over the coming months.

Great.

Thank you.

Thank you all for joining us today.

As always, if you have any questions you can contact Nancy Christal.

Thanks a lot.

Thank you.

This concludes the conference.

You may now disconnect.