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Executives

Nance Christal – SVP IR

Tom Ryan – President & CEO

Dave Rickard – EVP & CFO

Analysts

Deborah Weinswig - Citi

Lisa Gill – JP Morgan

John Heinbockel - Goldman Sachs

Matt Perry – Wachovia Capital Markets

Scott Mushkin – Jefferies & Company

Helene Wolk – Sanford Bernstein

Ed Kelly - Credit Suisse

Robert Willoughby - Banc of America

Meredith Adler – Barclays Capital

Mark Wiltamuth – Morgan Stanley

David Magee – SunTrust Robinson

Eric Bosshard - Cleveland Research

CVS Caremark Corporation (CVS) Q4 2008 Earnings Call February 19, 2009 8:30 AM ET

Operator

I would like to welcome everyone to the CVS Caremark Corporation fourth quarter earnings conference call. (Operator Instructions) I will now turn today’s conference over to Ms. Nancy Christal, Senior Vice President of Investor Relations.

Nancy Christal

Good morning everyone and thanks for joining us today for our fourth quarter earnings call. I’m here with Tom Ryan, Chairman, President and CEO of CVS Caremark and Dave Rickard, Executive Vice President and CFO. Tom will summarize our key 2008 accomplishments and provide a brief business update highlighting our key areas of focus for 2009. Then Dave will provide a financial review of the fourth quarter and hit the highlights of our guidance for the first quarter and year.

I want to quickly touch on one important upcoming event, we recently sent a save the date email for our annual analyst and investor meeting which will take place on the morning of Friday, May 15 at the Mandarin Oriental Hotel in New York City. We plan to send formal invitations in March so if you didn’t receive our save the date and would like to receive an invitation, please contact me. This event is the one time per year that we provide broad access to an extended group of our senior management team so we do hope you can be there.

Turning back to our year-end results, please note that we expect to file our 10-K for the 2008 fiscal year by March 2 and it will be available through our website at cvscaremark.com/investor.

This morning we will 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 reconciliations to comparable GAAP measures on the Investor Relations portion of our website at cvscaremark.com/investors.

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 Statements Concerning Forward Looking Statements in our most recently filed quarterly report on Form 10-Q.

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

Tom Ryan

Thanks Nancy, and good morning everyone. Obviously very pleased with the quarter we announced this morning particularly given the challenging environment. Let me take a few minutes to review our significant accomplishments in 2008.

We posted industry leading retail same store sales growth, 4.5% total, 4.8% Rx, and 3.6% front store on a calendar basis and we gained share in our retail business, all of these both in front and pharmacy during a difficult time. We introduced our proactive pharmacy care offerings which provide earlier, easier, and more effective pharmacy and health services that improve healthcare outcomes and reduce costs for our clients, their plan participants, and our customers.

Our PBM had an excellent client retention and achieved all time record industry leading sales and new business growth with 90 new clients and $8.2 billion in 12-month revenues. That’s $8.2 billion so for anyone wondering if our offerings are resonating, they certainly are. And for the third time our PBM call centers were certified by JP Power & Associates for providing outstanding customer service.

We also completed the acquisition of more then 500 Longs Drug Stores and the RxAmerica PBM. The integration is well underway. I am confident that the Longs acquisition will be a solid medium and long-term contributor to both our retail and PBM businesses. We also opened up 317 new or relocated retail stores adding organic retail growth of about 3.6%.

We ended the year with more then 500 MinuteClinics, more then any other operator, and we have plans in place that we expect will continue to improve the returns of these clinics. We strengthened our management team in 2008 with the additions of a new CIO, Stuart McGuigan, and our Chief Medical Officer, Dr. Troy Brennan.

And obviously our financial results were excellent across the board, revenues increased close to 15%, operating margins improved 63 basis points to a record 6.9%, adjusted EPS from continuing operations was up 18%, and we generate $2 billion in free cash flow.

So let me talk a little bit about the businesses and why we’re confident that we’ll have solid long-term growth. First I’ll touch on the PBM, following on the heels of the most successful selling season in our company’s history, our sales force again is looking to another good year. While I won’t talk about specifics this early in the season, we see significant new business opportunities in 2010.

With proactive pharmacy care we have the ability to provide our clients and their plan participants with beneficial services that really no other competitor can. We are hearing from our clients that in these tough economic times they are more open then ever to changes in plan design and other cost containment tools that save money and improve outcomes.

Our proactive pharmacy care offering includes medication management, tools like innovative plan designs, clinical programs, extra care health, along with integrated specialty Rx solutions and maintenance choice. Let me just take a minute to update you on the recent progress with maintenance choice.

Through maintenance choice rather then just relying solely on 90-day maintenance medication through mail, many of our plan members now have the convenient option of obtaining their prescription at any CVS Pharmacy at the same cost of mail for both plan participants and payer. At the end of the year I told you that we had 130 clients signed up for January 1, since then we’ve added another 74 clients that have committed with an April 1 date. That brings over 200 clients who are taking advantage of the maintenance choice option.

We are clearly well positioned to help employers, payers, and consumers achieve significant pharmacy and healthcare savings. Its very early in the 2010 selling season so we’ll have more to say about this on our next earnings call.

MinuteClinic, since its inception MinuteClinic has handled about 3.5 million patient visits. Our retail locations delivered more then 1.1 million flu shots this year and more then 700,000 of those shots were delivered at MinuteClinic. Additionally acute visits were up over 50% since the third quarter. With over 500 clinics across the country we are clearly leaders in this space. I suspect we’ll end the year with a roughly the same number of clinics we have today.

We are focused on increasing utilization, growing revenues, and right sizing the organization. Here’s what we’re doing, consumer awareness is still relatively low but customers who try MinuteClinic love it so the first thing we’re doing is focusing on leveraging our CVS retail advertising spend to drive clinic awareness.

Second we are expanding our service offerings to extend relevance. Payers recognize that our clinics provide high quality, cost effective care so we’re forming strategic partnerships that offer health and wellness services, chronic disease screening and monitoring, and incentives that divert members from using the emergency room to using MinuteClinic for common ailments.

Third we are growing our [in network covered lives] because utilization goes up significantly obviously when patients have coverage. We’ve added six million lives to our network in the fourth quarter and approximately 80% of MinuteClinic visits were third party paid in the quarter and that’s up from 70% in the third quarter.

Our goal is to improve returns on our clinic business. This year as I’ve told you we’re investing $0.05 to $0.06 of diluted EPS, we expect to invest less in 2010. Now let me touch on our retail business which continues to perform better then most retailers and we’re at the top of our industry.

Our fourth quarter comps increased 3.6%, pharmacy comps rose 4.5%, and we’re negatively impacted by 260 basis points due to generic introductions, while front store comps rose a strong 1.8%. We continue to gain share versus food, drug, and mass and when you think about the categories in the front store categories where we’re gaining share, those categories make up about 85% of our front store volume.

While we’re not without our share of challenges given this recession, I’m confident that we will continue to gain retail share because of our convenient locations and store hours, our focus on execution and customer service, our customer loyalty program, upside from our acquisitions and file [buys] and we’ll benefit from our unique PBM relationship with payers and patients.

Our front store margins continue to be very solid helped by private label, shrink control, and our extra care card. Our CVS and proprietary brands are increasing as we continue to strengthen our offerings and as in the economy consumers are more willing to try private label products. In fact in December our private label business hit a new record climbing to almost 17%.

Private label sales were almost 16% for the quarter up 60 basis points and as you know like generics, a growth in private label sales negatively impacts revenue but helps margins. We see significant opportunity to grow private label sales in the recently acquired Longs stores. Their revenues from private label sales were about 8% of front end so you can see we have a fairly significant opportunity.

With regards to Longs, the Longs integration is basically proceeding on track. We’ve recently completed the IT bridge so that our corporate offices can communicate directly with Longs stores. We expect to close down the Longs headquarters by late summer and have all the stores converted by the end of May. All store planned resets and remodels will be completed by mid October.

The integration will be complete and the stores will be reintroduced in the marketplace sometime during the fourth quarter. These are good stores in good locations but we think we can improve the sales productivity and the margins relative to our core business.

Let me talk a little bit about real estate, we opened up as I said 317 new or relocated stores. We plan to open up 250 to 300 new or relocated stores in 200, excluding Longs stores base will add about 3% square footage growth.

Before turning this over to Dave for a financial review, I want to give you some news about Mr. Rickard. He has been our CFO since 1999 and over the last few months Dave and I have some heart to heart discussions about his retirement. I know its hard to believe, he looks so young, but Dave is in perfect health and the company is in perfect health and that’s why he feels its really time.

So we’ve agreed that Dave will retire at the end of this year making his tenure at the company at just about 10 years. We will be launching an internal and external search to fill this key role. Dave has been a great CFO and a better partner with me for the past nine years and his shoes will certainly be hard to fill. But we have some terrific internal candidates that have worked side by side with Dave and we will also take time to canvass the external environment before making this important decision.

Dave is not in a rush but he does have some personal goals he’d like to accomplish and I certainly respect his decision to start making plans for the next phase of his life. He’ll talk a little bit more about this later. So with that I will turn it over to Dave for the financial review.

Dave Rickard

Thank you Tom, good morning everyone. Let me walk you through our fourth quarter financial results with an emphasis on the segment details. Afterward I’ll reconfirm guidance for the first quarter and full year 2009, then I’d like to make a few short comments on the topic Tom just announced.

On a consolidated basis revenues for the fourth quarter increased 10% over 2007 to $24.1 billion. Approximately half of that growth was due to the four additional days in 2008’s fourth quarter versus the prior year. The $24.1 billion in consolidated revenues is net of $1.5 billion of inner segment eliminations produced as a result of our PBM clients filling their prescriptions in CVS Pharmacy stores.

The inner segment eliminations as a percent of PBM revenues increased by 120 basis points over the prior year period from 11.3% to 12.5%. This provides some tangible evidence of the share shift within the PBM’s book of business from other retailers to CVS Pharmacy.

In our PBM segment fourth quarter revenue of $11.8 billion increased 1.5%, adjusting that growth rate for the impact of new generics, net revenues would have grown 7.8% in the PBM. So what drove the growth of PBM revenues? Well first we saw a positive impact from the four extra days in this year’s fourth quarter due to the calendar shift. That amounted to about 4.9 percentage points.

Our PBM’s revenue growth was also driven by an increase in PBM retail network revenues which rose 6.2% over 2007 levels to $7.7 billion. The retail network generic dispensing rate increased to 67.7% compared to 63.5% in the fourth quarter of 2007. At the same time retail network claims grew 18%. This growth was driven by the addition of RxAmerica, the net impact of client additions and terminations as well as add on lives with existing clients and Med D growth compared to last year’s fourth quarter.

Total mail revenues declined 6.7% to $4.0 billion. Within total mail revenues our specialty pharmacy unit experienced a healthy increase of 12.3% compared to the fourth quarter of 2007. Our PBM mail revenues decreased 17%. When the impact of the loss of the FEP mail businesses excluded, mail revenues increased by approximately 12% with specialty revenues expanding by more then 23%. And PBM revenues growing by more then 4%.

The mail generic dispensing rate rose to 55.2% from 49.7% a year ago, that’s an increase of 550 basis points. Our overall mail penetration rate decreased 630 basis points from 2007’s fourth quarter to 21.7%. That was primarily due to the loss of the FEP mail contract but also reflects the predominantly retail mix of the RxAmerica business.

So what about the retail drug store side of the business? Well it turned in a first rate quarter. Revenues increased 18.8% to $13.8 billion in the fourth quarter. Longs added a little more then $1 billion of the quarter’s growth. The retail segments revenue growth also saw a positive impact from the four extra days of 5.2 percentage points. Tom covered the highlights of our industry leading retail same store sales growth so I won’t repeat them here.

Moving on to gross profit the overall business did well with margin up approximately 135 basis points. Within the PBM segment gross profit margins were up approximately 10 basis points. The primary driver of the increase was the addition of RxAmerica which records retail revenue on a net basis and therefore has higher reported margins.

Excluding RxAmerica gross profit margin in the fourth quarter would have been slightly down versus 2007 as expected. The decrease in the gross profit margin is primarily related to the decrease in mail order penetration from about 28% to about 22%.

Let me mention here that in the second quarter of 2009 we’ll be changing the RxAmerica contracts to conform to the Caremark contract structure. As a result we will change the accounting from the net method to the gross method of revenue recognition. The impact of this will be to add revenues as well as a parallel increase in annual cost of goods sold so there’s no net impact on operating profit.

Revenue is anticipated to increase approximately $500 million per quarter in the second, third, and fourth quarters of this year due to the change in revenue recognition method so keep that in mind for modeling purposes.

Gross profit margin in the retail segment expanded to 30.4%, that’s up 75 basis points versus 2007’s fourth quarter. Like the PBM segment our retail pharmacy margin continued to benefit from a substantial increase in the conversion of branded drugs to generic equivalents. The retail generic dispensing rate increased 310 basis points to 68.0% even with the slight dampening effect from the inclusion of the Longs stores in this year’s number which have a lower GDR.

Concurrently front store margins improved continuing to reflect increased private label penetration, shrink improvement, and benefits from the extra care cards. Offsetting these gains somewhat was the impact of averaging in the lower margin Longs stores as well as the increase in the percentage of pharmacy sales handled by third party insurance.

And what about expenses? While overall operating expense as a percentage of revenues increased by approximately 90 basis points, each segment individually saw a slight improvement in this measure with mix causing the consolidated increase. In the PBM segment the improvement was about 10 basis points to 2.2% primarily due to the reduction in integration costs year over year.

In the retail segment the improvement was approximately five basis points to 23.4%. We demonstrated excellent cost control at the store level despite the pressures of the economic situation. This was offset to some degree by some minor initial integration costs associated with Longs. Given everything I’ve just discussed we again saw a sizable increase in operating margin driven largely by the retail segment.

The retail segment’s operating profit margin grew by more then 80 basis points over 2007 to 7.0%. That’s an all time record performance for the retail business. The PBM segment’s operating profit margin was flat year over year. Our PBM’s industry leading EBITDA per adjusted claim declined to $4.19. This was driven by two key factors, first the absence of the FEP mail contract without which we would have seen near double-digit growth in the EBITDA per adjusted claim.

Second was the impact of RxAmerica which has a predominantly retail claims mix. As expected our Med D business was more profitable in the fourth quarter then it was in the third quarter and importantly, more profitable in the fourth quarter then in the prior year period. For the year the Med D business operating profit increased more then 10% over 2007 so we had a very good year in our Med D business and we look forward to an even better year in 2009.

Moving to the consolidated income statement, we saw net interest expense in the quarter increase to $151 million reflecting an increased debt position due to Longs. Our effective tax rate in the fourth quarter was 39.7% as expected and our weighted average diluted share count was 1.47 billion shares.

What did all this mean for EPS? Well adjusted EPS from continuing operations rose to $0.70 up 19.8% from $0.58 in 2007. So we produced robust earnings growth year over year. GAAP diluted EPS from continuing operations rose 18.3% to $0.65 for the quarter. This compares to $0.55 in 2007.

Turning to the balance sheet and cash flows, we generated over $1 billion in free cash flow in the fourth quarter. That brought our total free cash flow for the year to $2 billion. That’s round numbers what we expected but would have been a bit higher except for two things. First our accounts payable to inventory ratio declined a little reflecting an increase in pharmacy outside vendor product in our sales mix.

Outside vendor has shorter terms then warehouse delivered product. Secondly some of the Longs severance was moved up to the end of 2008 versus an initial expectation of early 2009 so we’re slightly ahead of original plan on that. We ended the year with net debt defined as total debt net of cash and cash equivalents of $10.4 billion. That’s up approximately $2 billion from the prior quarter and up $1 billion from the end of 2007.

The increase over the third quarter was primarily due to the Longs acquisition. Our total debt position includes $500 million of remaining bridge financing for the Longs transaction. It also includes $2.5 billion in commercial paper, a market we have continued to access throughout even the darkest days of the past several months. Note that despite the additional debt since the end of 2007 our debt to capital remains at about the same level now as it was at the end of 2007.

So our balance sheet is in very good shape. Net capital expenditures amounted to $690 million in the fourth quarter, this was the result of offsetting the $697 million of gross capital expended with $7 million of sale leaseback proceeds. As most of you know this is not typical of our fourth quarters due to the delay of our normal sale leaseback financing from the fourth quarter of 2008 to various times throughout 2009.

Now on to guidance, since we already provided our initial thoughts last month, I’m only going to reiterate the EPS and free cash flow guidance here. All of the additional details of the 2009 guidance we provided on January 9 are still valid. And of course all of my comments include the impact of Longs.

We expect to deliver adjusted EPS of $2.53 to $2.61 and GAAP EPS of $2.35 to $2.43. There are several drivers inherent in these estimates. These include the margin investment we made in the PBM this year, the integration and one time costs for Longs, and the start up costs for new PBM contracts. Excluding Longs and additionally adjusting for three fewer days in 2009 versus 2008 this represents underlying growth of 8% to 11.5% on both an adjusted EPS and a GAAP EPS basis.

Free cash flow for the year should be around $3.5 billion give or take, some of that free cash flow is still expected to be dedicated to completing our $2 billion share repurchase over the course of the second half of 2009. For the first quarter of 2009 we expect adjusted EPS to be between $0.53 and $0.55 per diluted share. That compares to last year’s $0.55 per share.

GAAP EPS is expected to be in the range of $0.48 to $0.50 per diluted share. You should note that we expect the first quarter to be flat to down and this is not a typical expectation of ours. The key factors making the first quarter light from a growth perspective this year are these, first our PBM is not expected to grow its operating profit in the first quarter due to significant new client pricing and start up costs.

Second the timing of new generics which will be a bit more back end loaded. Third the integration costs for Longs will be heavier in the first half then in the second half. Fourth we have one fewer day in this year’s first quarter due to last year’s leap year. And finally the Easter holiday shifts out of the first quarter and into the second this year. We continue to expect all the other quarters this year to show good progress versus last year with the fourth quarter being probably the strongest quarter from a growth perspective.

Now just a word or two on my decision to retire at some point during this year, a few years ago I thought I’d stay until late 2010 but I’ve decided that I want to move my retirement up a bit. I’ve reached a point in my life where I’ve accomplished everything I want to from a career and financial perspective. Now I have some personal goals I’d like to tackle and I want to get on with them while I still have plenty of energy.

I feel comfortable with my decision because the company is in a very strong financial position and is well positioned for long-term growth. We’ve melded CVS and Caremark into a unique company that has significant competitive advantages and I’m confident that this will play out well in the company’s future financial performance.

We’ve got the strongest depth of management in the company’s history to see that through. I remain passionately committed to the growth and success of CVS Caremark and I will do whatever is necessary to promote that success including ensuring whatever transition process is helpful to the new CFO.

Now I’ll turn it back over to Tom for some closing remarks.

Tom Ryan

Thanks Dave, obviously it was a great year and a great quarter. I’d just like to take time to thank our colleagues across the company who really remained focused on customer service, execution, and expense control. I want to thank them all for their efforts. We recently had a PBM national sales meeting as well as our senior management meeting earlier this month and I’ve never seen this organization so energized and so engaged.

Since the merger was completed we’ve made significant strides in forming one culture across this enterprise that capitalizes on our unmatched breadth of capabilities. So I couldn’t be happier where we are, obviously we had a good year, and we’re looking forward to a good year in 2009 and beyond.

So with that I’ll open it up for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Deborah Weinswig - Citi

Deborah Weinswig - Citi

Tom you had talked about improving the returns of MinuteClinics and one of the aspects of that was needing to leverage CVS’s advertising spend to drive awareness of MinuteClinics, since you obviously don’t have MinuteClinics in every market can you mention some of the details there.

Tom Ryan

We actually operated MinuteClinic separately, they have a separate marketing team and we were marketing in different magazines and different media outlets, and really not leveraging the amount of spend we have in our circulars and our TV advertising and radio advertising for CVS pharmacies. So it was really a matter of simply leveraging that investment that we’ve made on the CVS retail side.

So its basically that simple. We have the clinics across 25 states already and if you look at, its interesting to see just the flu alone, the flu shots that we did to have that many done in the clinics, it was significantly more then the previous year.

Deborah Weinswig - Citi

With regards to the extra care cards, it sounds like not only for your PBM customers but for your retail customers that that’s continuing to drive traffic and ticket, any changes there, are you seeing a greater spend with regards to promotions on the extra care card.

Tom Ryan

The extra care card has been a win win, a win for our customers and a win for us as far as margin and unlike, we can track obviously our extra care card customers and traffic is up and ring size is up with our extra care card customers. We actually focus, they’re our most loyal customers, and we focus our attention and spend on those customers. So we’ve been able to manage our promotional margin better using the extra care card.

And then the extra care health card that is going to PBM members or going to all customers continues to be a real benefit for us also.

Deborah Weinswig - Citi

So it would be fair to say that not only are you gaining new extra care cardholders but also getting a greater share of wallet from existing cardholders.

Tom Ryan

Yes, around the extra care cardholders certainly, yes.

Deborah Weinswig - Citi

And then last question is can you talk about your outlook for prescription drug growth in 2009.

Tom Ryan

Well I think we gave you the outlook for script growth earlier and we continue to feel the same way. Its going to be slightly less then it was in 2008 obviously more generics in the back end. We think utilization will be 1% to 2% from that standpoint so our issue is to gain, to your point earlier, is to gain a greater share of the spend both on the Rx spend and the front end spend and that’s, so far that’s working out.

But clearly from a growth standpoint it should be maybe slightly down, in our plan its slightly down to our projections from, or our actuals from 2008.

Operator

Your next question comes from the line of Lisa Gill – JP Morgan

Lisa Gill – JP Morgan

In the past you’ve talked about [inaudible] and what you see out there as far as the landscape goes, I know you said its early in the year, but are you seeing anything from a mid year start perspective and then secondly when you talked about the PBM, are you talking about just competitive wins or are you starting to see some of the business that previously was carved in now coming back and looking to potentially carve out with Caremark.

Tom Ryan

A little bit of both actually, we have some new wins already early in 2010, early in 2009 for 2010, and so from that perspective we feel pretty good about it. And I can tell you from [finalist] meetings and what people, what we’re seeing early and what our sales team is pointing out, we feel pretty optimistic about the season.

Some of the ones that were presently carved out were people, are starting to look to, or presently pulled in, they’re starting to look to carve those out and we have some small opportunities for mid year sign ups.

Lisa Gill – JP Morgan

And then you talked about the changes to plan design, are you seeing where again where people are potentially looking to make changes to their plan design even mid year this year so that we could see some impact in 2009 or are they just having the discussions now for 2010 and then just you talked about the CVS stores taking share for the Caremark wallet, do you have a number that tells us what the total share is that CVS stores has today so that we can get an idea of what the opportunity that still remains.

Tom Ryan

From the plan design standpoint the clients are obviously more receptive, you would expect that in this economic environment and they are open to things that they would not normally be open to before. I clearly believe that’s why maintenance choice is resonating. People did not want mandatory mail before, now that they have this option with the retail option, they’re more inclined to do it. You see people looking at step therapies. You see people maybe experimenting with limited networks or for more importantly aggressive formularies. Those are the things that they didn’t do before that they’re just looking for opportunities.

There could be some of that in this year but its more of an 2010 opportunity for us.

Lisa Gill – JP Morgan

So those discussions are happening now and then the [inaudible] will change for 2010.

Tom Ryan

That’s correct.

Lisa Gill – JP Morgan

And then just the share that you have in the CVS stores today, do you have that number.

Tom Ryan

Well we don’t really, you know our retail share and the share varies by client depending on our share of retail stores in that client’s geographic coverage where their employees are, it varies so we can see that depending on what the client chooses around the extra care healthcare card that we do gain share and obviously maintenance choice helps us gain share.

Lisa Gill – JP Morgan

Is it fair to say though that there’s still a wide opportunity to continue to take share.

Tom Ryan

Yes, there’s certainly an opportunity. Yes, absolutely.

Operator

Your next question comes from the line of John Heinbockel - Goldman Sachs

John Heinbockel - Goldman Sachs

How has the retail business faired first quarter to date, any color on that given how weak the consumer has been.

Tom Ryan

Yes, well we don’t obviously provide the monthly numbers but I can tell you January was a pretty good month. We’re not, we’re impacted by the recession, but we’re somewhat resistant. We’re seeing some discretionary items slow down, whiteners you think about things like tooth whiteners, and salon hair care is slowing down but that’s people are just trading down in those areas. But our ticket sizes continue to grow, our private label is up, our general merchandise is up, consumables, healthcare, beauty, so we’re in pretty good shape.

There’s some pockets, geographic pockets as you would expect, Michigan is a little softer because of obviously what’s going on out there but we’re happy with our January numbers.

John Heinbockel - Goldman Sachs

Do you think, it looks like pharmacy really across the industry has not been impacted yet by rising unemployment, is there a magic level where that begins to happen.

Tom Ryan

I don’t know what the magic level is but we have seen some impact in pharmacy a little bit with some splitting, people self medicating a little bit which is kind of why our healthcare business is up on the front end, but its certainly not impacted as you would expect in other categories. If unemployment, our numbers, the projections that David gave you was, we had a range of unemployment rates in the country and we’re still okay with that. If unemployment goes to 12% to 15% all bets are off and we’ve got to reassess but right now we think, we feel comfortable with the guidance that we’re giving now and I don’t know what the inflection point is when that really impacts scripts.

John Heinbockel - Goldman Sachs

Where does the, when you look at Eckert and Savon-Osco EBIT margins how much below core CVS are they still running, how much opportunity is there.

Tom Ryan

When you look at similar volume stores, I think the Eckert stores are getting pretty close to our core volumes. If you look at like stores in like states and we still have opportunity with Savon-Osco, we doubled the profitability there. And then we obviously have the opportunity with Longs. Now I’m not sure Longs can get to the exact operating profit percentages as a percent of sales that the core business is going just because in fact they’re larger stores, but there is a significant opportunity.

These are great people in these stores with great locations, we just have some opportunities around private label, around our extra care program, around shrinkage, around mix. I was just out in, I did a west coast swing and spent some time in our Longs stores and spent some time with a PBM client and both were really uplifting trips because the new Longs store that we laid out really is fantastic and I think its going to drive sales productivity and margin growth.

And then the meetings that I had out in California I was excited to see the client excited about our new proactive pharmacy care programs.

Operator

Your next question comes from the line of Matt Perry – Wachovia Capital Markets

Matt Perry – Wachovia Capital Markets

Couple of questions on the theme of prescription drug demand in a recession, and you saw very strong PBM retail claims volumes in the fourth quarter and obviously you know a lot of that was the Longs addition, but I’m trying to think about whether you think there was any kind of forward buying in that fourth quarter before deductibles reset and you talked about a strong January but have you seen maybe any slackening in demand relative to a typical January.

Tom Ryan

The early buy in has been happening for a long time in pharmacy. You usually get a little uplift in December because of what you indicated. We didn’t see anything abnormal around that in our business and it’s a mix right, there’s some obviously slow down in scripts, you can see it, yet we continue to take some share so we got a situation where we’re taking some, we’re getting a bigger share of the spend of our customer and we’re taking some share from some competitors.

And as you obviously know the flu season is certainly lighter then it has been and we’ve kind of projected that in our numbers so like I said, January was a pretty good month for us across the board.

Matt Perry – Wachovia Capital Markets

And on that same theme, just want to make sure I understand your comments on the 1% to 2% utilization increase, was that your comments on what you think the industry is or what you think CVS is taking some share.

Tom Ryan

That’s kind of the overall industry.

Matt Perry – Wachovia Capital Markets

So you should be better then that, right.

Tom Ryan

We think so.

Operator

Your next question comes from the line of Scott Mushkin – Jefferies & Company

Scott Mushkin – Jefferies & Company

So I wanted to poke at the maintenance choice thing a little bit you said you’re adding 74 more clients as of April 1, how many additional lives will be one and then the second question do you expect to see the 200 clients that have adopted maintenance choice have more 90 day script penetration rate and would you start to give us that number, the 90 day penetration rate as a supplement to the mail penetration rate.

Tom Ryan

We added about half a million lives with the additional clients on the maintenance choice and I don’t think we’re going to be giving the penetration, the difference in the penetration, not yet, we’ll give you some more color on that later on.

Scott Mushkin – Jefferies & Company

And do you expect them to have a lot higher 90 day penetration rate as you move forward, I know when the Beta testers had—

Tom Ryan

Yes, we should, absolutely, there’s no question about it. Their utilization was, the utilization of maintenance choice was higher then we originally projected, the switch, so yes the 90, they will have a higher penetration, 90 days.

Scott Mushkin – Jefferies & Company

And the 74 clients, are they as much as mail heavy clients as the Beta testers were.

Tom Ryan

I don’t know if they were as heavy, it wasn’t, the delta wasn’t dramatically different. I think about maybe something around 50% of those or a little less were mandatory mail clients before. So its probably similar.

Scott Mushkin – Jefferies & Company

On the sale leaseback front, what if you can’t get these done, is there kind of a plan B in the real estate or is that not really a thought.

Dave Rickard

There is absolutely a plan B in the financings consideration, there’s no plan B in real estate, we will do the real estate, there are a variety of ways that we can finance this. Good treasury operations means having plan B, plan C, plan D and we have those.

Scott Mushkin – Jefferies & Company

And would you expect that if you can’t get the sale leasebacks done to still do the stock repurchase or would you have to do less.

Dave Rickard

I would expect that those are not linked and they are independent decisions and they have been made.

Operator

Your next question comes from the line of Helene Wolk – Sanford Bernstein

Helene Wolk – Sanford Bernstein

I have another follow-up on the maintenance choice question, I’m trying to understand the mix of clients whether they’re sort of new clients to Caremark, existing clients converting.

Tom Ryan

Its actually a mix of both from a client standpoint but I would say it probably skews more to existing clients for obvious reasons, that’s the conversation you can have with the client, they understand the history, they understand the service metrics that we provide and so you have obviously a deeper relationship so it probably skews more to existing clients.

Helene Wolk – Sanford Bernstein

On the Longs, can you give us a sense for the timeline of integration, I’m also curious if there’s any update around the timeline for realization of synergy benefits.

Tom Ryan

We’re obviously closing the offices mid June so we’ve got those overhead synergies. We’re already having discussions with both front end vendors and pharmacy vendors around the purchasing synergies so you’ll see those coming throughout the year.

Operator

Your next question comes from the line of Ed Kelly - Credit Suisse

Ed Kelly - Credit Suisse

Your retain gross margin performance has been nothing short of stellar in this environment can you just help us understand how you’ve outperformed your competitors by such a large amount, is it really all about the extra care card and can this continue into 2009.

Tom Ryan

Well it’s a lot of things, there’s no silver bullet on it. I think our merchants, our marketing team, and our operations team have just done a stellar job to your point because it is a tough thing to do in this environment. We’ve been diligent about no unplanned promotions. I think we’ve done a good job on the buys around seasonal buys, anticipating the economic downturn, the extra care card obviously has helped us as we manage the spend. And we continue to add PL and proprietary items in the front end which obviously helps us.

Also I don’t think you can diminish the fact that the work we do around shrinkage control, we have the technology investments that we’ve made, the fixture investments that we’ve made, the training that we’ve invested in for our folks I think is obviously coming home to roost. So in retail its obviously, in any business its not just one thing, it’s a lot of little things and our folks have just done an excellent job and we continue to do it.

I will say that our promotional mix the i.e. that’s the consumer coming in, our promotional mix of business in the front end is higher then it has been. So we haven’t been promoting more, the customer is skewing to that end because of this economy and the good news is we’re offsetting it with those other areas I talked about around private label, around shrinkage, and around smart investment in extra care.

We keep doing it every year, and we keep looking for new ways to do it so our folks, we’re never satisfied so we’re always looking for new opportunities whether its new categories, or a new way to go to market or a cheaper way to, less expensive way to promote, that’s what we keep doing.

Ed Kelly - Credit Suisse

Could you maybe just give us a little perspective on what you’re seeing today in the drug retailing landscape, you’ve got a large competitor and its clearly struggling, another big competitor is cutting growth, I’ve heard of a regional player who is exiting the business and the independents, attrition goes up in a recession. So to me the supply side seems to be looking healthier today then its been in a long, long time and it would be great to get your thoughts on that and maybe how you’re positioning yourself in this environment.

Tom Ryan

Well it is a tough economic environment and reimbursements, there’s going to be pressure on reimbursements and pressure on margin, and scale is important especially as you look to make investments in stores, investments in technology, and you have to stay up to date because, listen we’re going to come out of this recession. People question why we did Longs during this time, was Longs the best time to do it? Probably not given the California economy but when the economy comes back, and it will, we’re going to be in a great position because those stores are going to be retrofitted and they’re going to be up to date and we’re going to get the benefit of that while some of our competition is kind of pulling back and in fact not investing in stores and people and technology.

So we’re fortunate, you’d rather be a good company in bad times and that’s kind of where we are. We’ve been fortunate and we have great people, and we’ve kind of stayed true to our knitting and so I do think, there is going to be pressure on independents, we’ll buy an independent every day next year and there’ll probably be pressure on some regional players and you can certainly read about the national, what’s going on there.

And so we don’t have any other comment around our competition other then the fact that we just keep doing what we do, executing, providing the right customer service and the right expense control. We didn’t go, we watched our expenses, we watched the size of our stores, we watched what we put into the stores as far as payrolls and we’re in a position that I think we can take advantage of some of the uneasiness in the market.

Operator

Your next question comes from the line of Robert Willoughby - Banc of America

Robert Willoughby - Banc of America

Did you update us what’s outstanding under the bridge loan, is it still the full $1.5 billion and then just what is the minimum cash balance you would need on your balance sheet just to run the business on an ongoing basis.

Dave Rickard

At year end we had $500 million of the bridge still in place and that has a maximize duration into August of 2009 so we’re using it as in effect short-term financing. Minimum cash I’ll have to, I’d like to give you a more thoughtful answer then I would give you off the top of my head here. So I think we’re seeing each other some time next week or the week after, perhaps that’s the time when we can talk about that concept.

Operator

Your next question comes from the line of Meredith Adler – Barclays Capital

Meredith Adler – Barclays Capital

I’d just like to talk a little bit about the Med D business, which was of concern at the beginning of 2008 and I’m interested to know since it sounded like the fourth quarter came in well, in terms of the people hitting the donut hole and general spending in part D how did that come out versus where you thought you would be at the beginning of the year after you had the problem I think it was in the first quarter.

Tom Ryan

Med D came in exactly where we thought it would be in the fourth quarter and its starting out basically right on plan early this year. So there were kind of no surprises when we readjusted and made the little bit of a course correction there.

Meredith Adler – Barclays Capital

And did you win new part D members for this coming year?

Tom Ryan

Yes we did, we did, we absolutely won new part D members.

Meredith Adler – Barclays Capital

I’ve been getting questions from people about maintenance choice and the impact economically on your mail order business and on your retail business, I think people are concerned that if you shift enough [inaudible] to retail you really hurt profitability for the company, is that right.

Tom Ryan

No, absolutely not right. We’re not in the business of shifting business where we make less money. This is, the maintenance choice program is a win win win. It’s a win for the client, it’s a win for the plan participant, and it’s a win for us. There are more variable costs in the mail facility. We can readjust those down as we shift work or shift these prescriptions to the store. We also obviously save a significant amount on postage and then in the stores, its as you know there’s fixed costs and more fixed cost in the store. So your next prescription is really your most profitable prescription whether it’s a 30 or a 90 and there’s no more labor in a 30 or a 90 day prescription.

So from that standpoint it’s a win, then you add the fact that people will be more inclined and what we’re seeing is more inclined to pull their prescriptions all in one spot. If they’re close enough to a CVS store to pick up their mail prescriptions, then they’re probably close enough to get their acute medication so its just more convenient.

This is not a force fit, there’s no plan, this is letting the consumer decide and the plan participant decide what’s the easiest and most effective way they can get their medications so absolutely not. And by the way one has to realize that it has to be a plan design that is driving mail. We’re not in a situation where someone has 20% mail penetration and we’re going to move them to that, there the economics don’t work. Its someone who has a fairly deep penetration in mail already whereas on a plan design that’s going to move to deeper penetration in mail.

Operator

Your next question comes from the line of Mark Wiltamuth – Morgan Stanley

Mark Wiltamuth – Morgan Stanley

I wanted to dig in a little bit on the unique attributes of the PBM retail business model, if you look at maintenance choice and the discounts that you offer on the CVS items on the front end how far through the customer base are you on introducing these new features to the customers.

Tom Ryan

Really in the first inning, maybe bottom of the first or top of the second inning on that. We still have a big opportunity there.

Mark Wiltamuth – Morgan Stanley

With that in mind, where do you feel you are on realizing revenue synergies from the merger.

Tom Ryan

I think we obviously achieved the purchasing and cost synergies. I think we’re probably in that same area, maybe a little further along then the first or second inning but 2010 I think we’re going to see those revenue synergies ramp up.

Mark Wiltamuth – Morgan Stanley

And is the [gating] factor just the timing on contracts rolling over so [inaudible] the three year cycles—

Tom Ryan

Yes its that, its new, its new in the marketplace, it takes a while for people, no one wants to be the first. I think as it starts to take effect people will say, I get it and you can see the 90 plus new clients we’ve taken in, they get it. They’re open to it so I think it’s a combination of things. There’s just a longer lead time on this then maybe anybody expected but we’re really confident about it. People are, haven’t said they don’t like it, they may say they don’t take it, or they’re going to be a little, they’re hesitant, or maybe they’ll wait but no one says they don’t like the offering or it doesn’t make sense.

Mark Wiltamuth – Morgan Stanley

And the 204 clients you have roughly what percentage of that sales base on the PBM side would that represent.

Tom Ryan

I don’t know the answer to that, it’s a small piece now. We’ll get that for you, I don’t know the exact answer off the top of my head.

Mark Wiltamuth – Morgan Stanley

But still in alignment with your first inning comment that we still have a lot to go.

Tom Ryan

Yes, yes, exactly.

Operator

Your next question comes from the line of David Magee – SunTrust Robinson

David Magee – SunTrust Robinson

On generics and reimbursements, I believe last quarter there was some mention that you expected that this year should be less pressure on reimbursements, that maybe the pricing would improve for that part of the business, is that something you still feel will be the case this year.

Tom Ryan

I don’t recall the comment about it, there’s always going to be pressure on reimbursement but if you look at whether its states or private plans or people who want to move to more generic utilization so maybe, I don’t know, is your question will there be less generics introduced in 2009?

David Magee – SunTrust Robinson

Just the relative pricing pressures of reimbursement—

Tom Ryan

I think its going to be similar to what it was. I don’t see any increased pressure on reimbursement, no, on generics at all.

Operator

Your next question comes from the line of Eric Bosshard - Cleveland Research

Eric Bosshard - Cleveland Research

In terms of comps I think the guidance you gave a month ago or so for comps in 2009 was I think a 3.5, a 5.5 range and you reported a 3.5 for the fourth quarter can you just talk about components of what gives you confidence of that range being reasonable in light of what we’re seeing with demand, and what we saw coming out of the fourth quarter.

Tom Ryan

The plans that we have in place, right. We put plans in place to grow the business. This is just now obviously it just doesn’t happen. We’re aggressively going after new customers and both the front and the pharmacy end. So we think that the plans that we have in place kind of moderated by what we’re seeing in the economy we still feel pretty good about that number. Then obviously the [Zurtech] situation, when you look at the, that obviously helps the cycling of [Zurtech] for 2009.

Eric Bosshard - Cleveland Research

As we start to look out to 2010 and I think the PBM profit growth this year you’ve talked about as a 2 to 5% type level, can you give us any sense of a baseline to consider as we look out to 2010 for PBM profit growth.

Tom Ryan

We’re not ready, we’re not ready to give that. We just said it would be significantly better then 2009.

Thanks everybody and as usual if you have any questions you can call Nancy Cristal. Thanks.

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Source: CVS Caremark Corporation Q4 2008 Earnings Call Transcript
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