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CVS Caremark Corporation (NYSE:CVS)

Q1 2009 Earnings Call

May 5, 2009 8:30 am ET

Executives

Nance Christal – Senior Vice President, Investor Relations

Tom Ryan – Chairman, President and CEO

Dave Rickard – Executive Vice President and Chief Financial Officer

Analysts

Eric Bosshard - Cleveland Research Company

Lisa Gill - J.P. Morgan

Deborah Weinswig - Citigroup

Robert Willoughby - BAS-ML

Edward Kelly - Credit Suisse

Matt Perry - Wachovia Capital Markets

John Heinbockel - Goldman Sachs

Helene Wolk – Sanford Bernstein

Scott Mushkin - Jefferies & Co.

John Ransom - Raymond James & Associates

Simeon Gutman - Canaccord Adams

Meredith Adler - Barclays Capital

Operator

Good morning and welcome to the CVS Caremark first quarter 2009 earnings call. (Operator Instructions)

Nance Christal, Senior Vice President of Investor Relations, you may begin.

Nance Christal

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

I'm here with Tom Ryan, Chairman, President and CEO of CVS Caremark, and Dave Rickard, Executive Vice President and CFO.

First let me provide a quick reminder. Our annual analyst and investor meeting will take place next Friday morning, May 15th, at the Mandarin Oriental Hotel in New York City. We've had a big response to the meeting and look forward to seeing several hundred of you there. If anyone else would like to attend and needs the specifics of the meeting, please call my office and we'll do our best to fit you in. The presentations will also be available via webcast. This is the one time per year that we provide broad access to an extended group of our senior management team, so we do hope you can be there in person.

Given that we have our big meeting next week, today's business update will be somewhat more brief than usual. We'll focus primarily on the quarter's results.

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

Turning back to our first quarter, please note that we expect to file our 10-Q by the end of day today and it will be available through our website at CVSCaremark.com/Investors.

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 just mentioned as well as the reconciliations to comparable GAAP measures on the Investor Relations portion of our website at CVSCaremark/Investors.com.

As always, today's call is being simulcast on our 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.

Now before we continue our attorneys have asked me to read this safe harbor statement:

During this presentation we'll make certain forward-looking statements that are subject to risks and uncertainties and 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 revenue the section entitled Cautionary Statement Concerning forward-looking statements in our most recently filed quarterly report on Form 10-Q.

And now I'll turn this over to our CEO, Tom Ryan.

Tom Ryan

Thanks, Nance, and good morning, everyone.

I'm obviously very pleased with our first quarter results, which were at the high end of our expectations. Let me review some of the highlights:

Total revenues increased 9.7%, with PBM revenues up 7.2% and Retail revenues up 13.9%. And that's even with one fewer day than last year.

Mail Choice prescriptions - Mail Choice is our new metric, which includes mail order scripts plus 90-day scripts filled at Retail via Maintenance Choice - Mail Choice prescriptions were up 6.6%.

PBM retail network revenues rose 6.8%, while mail service revenues rose 8.4%.

Our EBITDA per adjusted claim - adjusted for Rx America, Maintenance Choice, and the increase in litigation reserves - increased 3.2% to $3.46. David will give you some details later on.

We achieved a best in class generic dispensing rate.

Our Retail comp's up 3.3%, once again leading the industry. While the Long's stores are not included in our comps, sales in those stores are performing well overall despite the California economy.

SG&A increased, as we expected, due to the Long's integration expenses and to the dissolution of Universal American joint venture and other items which Dave will review in detail.

Adjusted EPS from continuing ops were up $0.55 at the top of guidance and we maintained a healthy balance sheet, generating approximately $311 million in free cash.

Let me touch on our PBM. As Nance said, you'll hear a lot more about this next week from Howard and Dave Joyner and others.

As far as the selling season goes, in 2009 we reached a new record level of $8.9 billion in annualized new name sales. That's up previously from the announced $8.2 billion. On a 2009 impact basis, our gross new revenues are $7.6 billion - this is up from previously reported $7.0 billion - and our net new 2009 revenues are $3 billion, up from previously announced $2.5 billion. The primary driver here is an increase in Med D revenues due to higher enrollment. We've also seen some gains in the employer and health plan segment as our sales force remains active in the market.

While we won't talk about specifics this early in the current selling season, we see plenty of new business opportunities for 2010 and we're very pleased with the early results of the season. In addition, clients are more open than ever to changes in plan design and other cost containment tools to save money.

As you probably heard, last week we lost the Coventry Commercial contract, which is about $1 billion in revenues and a relatively low mail penetration account. This was not unexpected. In fact, as we began to set our goals for 2010, the loss of this account was considered. We have a lot of irons in the fire. We'll provide more details later on as the selling season progresses.

Our Maintenance Choice offering has really taken off. The number of scripts being filled at Retail 90-day is well over our plan. Through Maintenance Choice rather than relying solely on mail for their 90-day maintenance medications, many of our plan members now have the convenient option of obtaining prescriptions at any CVS pharmacy using mail order pricing discounts for both the plan participant and the payer. This is really just an extension of our mail service offering. As of April 1st we had over 200 clients actively using Maintenance Choice and the feedback has been extremely positive. We are in the process of finalizing commitments for Maintenance Choice for July 1st starts and we're excited about those prospects as well as the clients that have expressed interest for a start in January '10.

Dave will review the impacts of Maintenance Choice and some key metrics for our PBM and Retail segments and we'll talk in greater detail about the economics of Maintenance Choice at our meeting next Friday, but the short story is Maintenance Choice is profitable to our overall enterprise.

Let me touch a little bit on MinuteClinic. In the first quarter we saw traffic up 42% on an overall basis. As we said before, our focus is on raising awareness, expanding our services, and increasing third-party insurance coverage.

First we're leveraging our Retail advertising spend to drive clinic awareness through messaging in our circulars and in-store signage and ExtraCare communications.

Second, we are expanding our service offerings to extend our relevance. For example, TB testing as well as injection training were recently launched nationwide. Troy Brennan, our new Chief Medical Officer, will provide many examples of some new services that we're introducing at MinuteClinic at our analyst meeting.

Third, we're growing our in-network covered lives because utilization goes up significantly when patients have coverage. We've added 17 million additional lives to our network in the first quarter, putting us over 100 million lives in the third-party network for MinuteClinic. I should point out that more than 81% of our visits were third-party paid in the quarter.

As I said on the last call, we're investing about $0.05 to $0.06 of diluted EPS in MinuteClinic this year. I expect MinuteClinic will be less of an investment in 2010.

Now let me turn to our Retail business, which continues to perform at the top of the industry. Now, while our business is certainly not entirely recession proof, it's pretty defensive and we continue to gain share. As I mentioned, our first quarter comps increased 3.3%, pharmacy comps rose 4.6% and front store comps increased 0.7%, even with the later Easter. I think these are great results in a very difficult economy. In fact, if you look at our March/April comps, which we should really think about because of the Easter shift, our front store combined March/April comps were 3.4% and our total comps were 6.9% when you think about March and April together.

In our core CVS stores we continued to gain share versus food, drug and mass competition, that's both in pharmacy and front store categories which make up about 90% of our front store volume. Private label sales were 15.4% of front sales, up about 60 basis points - and that's excluding Long's - and to take advantage of the growing willingness to try private label, especially in this economy, we're introducing a store brand proprietary try me section in over 4,500 stores. We're also adding new private label products. We've introduced 200 in the first quarter alone and I expect private label to grow to be about 20% of our front end sales over the next several years.

People are asking about the Long's integration. I'll tell you it's proceeding extremely well. We're right on track in every aspect of the integration. Our store operations team has done a great job. We'll have all store systems converted by the end of May. We'll be closing down the Long's headquarters in late summer. We'll have all the store plan resets and remodels completed by probably mid-October, and then the stores will be reintroduced in the marketplace during the fourth quarter. And I'm convinced we can clearly narrow the gap between the sales and productivity margins that these stores had versus our core stores, similar to what we did with Eckerd and Sav-On.

As far as new stores go and the real estate side, we've opened up 92 stores or relocated stores in the quarter, so 92 new and relocated stores, and we've closed about 50 others. Approximately 40 of those closings were Long's closings. We plan to open about 250 to 300 new and relocated stores in 2009. Excluding Long's from our base, that'll add about 3% square footage growth.

Now before I turn it over to Dave let me give you a little update on the CFO search. As I said on our last call, Dave will be retiring some time towards the end of this year. We're conducting an internal and external search to ensure that we have the best candidate for the job. We've engaged an executive search firm and we've identified a lot of interest in the position. Obviously, you can imagine with a search at this level it takes some time, I would say probably six to eight months in a situation like this, so we'll have more to report later this year. In the meantime, I can assure you Dave Rickard is fully engaged and committed to stay until his replacement is up and running.

So with that, I will turn it over to David.

Dave Rickard

Thank you, Tom, and good morning, everyone.

This morning I'll walk you through our first quarter financial results, noting the segment detail where appropriate. After that I'll provide initial guidance for the second quarter and update our full year 2009 guidance. So let's dive right in.

On a consolidated basis, as Tom said, revenues in the first quarter increased by 9.7% over 2008 to $23.4 billion. Having one less day this year reduced our top line growth by approximately 150 basis points. Putting that aside, a bit more than half of this quarter's growth over the comparable period last year was due to the addition of Long's.

The $23.4 billion in consolidated revenues is net of $1.6 billion of intersegment eliminations. Those are produced as a result of our PBM clients filling their prescriptions in our stores. The intersegment eliminations as a percent of PBM revenues increased by 230 basis points over the prior year period from 11.9% to 14.2%. This is up sequentially from last quarter's 120 basis point increase, providing further tangible evidence that there's a growing base of Caremark customers choosing CVS as their retail pharmacy, with unmatched offerings like Maintenance Choice and ExtraCare Health contributing to the list.

In our PBM segment first quarter net revenues of $11.5 billion increased 7.2%. Adjusting that growth rate for the impact of new generics, net revenues would have grown 11.4% in the PBM. So what drove the growth of PBM revenues? Well, first we saw positive impact from the addition of Rx America. It contributed almost a third of the growth in this year's first quarter. Also we benefited from net new client additions. Offsetting these, we saw a negative impact from the one fewer day due to the calendar adjustment.

Given this backdrop, PBM Retail Network revenues rose 6.8% over 2008 levels to $7.5 billion. The Retail Network generic dispensing rate increased to 68.8% compared to 65.2% in the first quarter of 2008. At the same time, Retail Network claims grew 4%. This growth was driven by the addition of Rx America, offset to some degree by the net impact of new business and terminations.

Total mail revenues grew by 8.4% to $4 billion. Within total mail revenues, our specialty pharmacy unit saw a strong increase of 16.7% compared to the first quarter of 2008. The mail generic dispensing rate rose to 55.5% from 52.8% a year ago. That's an increase of 270 basis points.

Our overall mail penetration rate of 23% was essentially flat to the rate in the first quarter of 2008 on a reported basis, however, there are two important adjustments you need to make to understand the underlying growth in mail penetration. First and most importantly, Rx America's claims mix adversely affected the mail penetration rate by 220 basis points. Second, the shift of some 90-day scripts from mail to Retail via Maintenance Choice reduced the mail penetration rate by an additional 50 basis points. Adjusting for these two factors, our mail penetration rate grew from 23.1% to 25.8%, up 270 basis points. So we're aggressively driving mail penetration in our book of business despite some scripts moving to Retail via Maintenance Choice.

And what about the Retail drug store side of the business? Well, it turned in a first-rate quarter. Revenues increased 13.9% to $13.5 billion in the first quarter. Long's made up approximately $1.2 billion of that growth during the quarter. The Retail segment's revenue also saw a negative impact from one fewer day. That amounted to about 150 basis points year-to-year.

As Tom mentioned, our first quarter comps increased 3.3%. Pharmacy comps rose 4.6% and were negatively impacted by about 310 basis points due to recent generic introductions. Front store comps increased 0.7%. The later Easter had a negative impact of approximately 115 basis points on front store comps and approximately 40 basis points on total comps.

And there's a new impact I'd like to highlight. Maintenance Choice had a positive affect on our Retail comps, benefiting pharmacy comps by approximately 120 basis points and total comps by approximately 80 basis points. We're really pleased with the strong adoption of our groundbreaking Maintenance Choice offering, which I'll talk more about next week.

Moving on to gross profit, the overall business improved, with margins up approximately 20 basis points despite each segment being down individually. That's because the overall business reflects the impact of the intercompany elimination, which reduces revenues while margin dollars remain constant.

Within the PBM segment, gross profit margins were down approximately 45 basis points. The primary drivers of the decrease were the margin investment we made this year with certain key contracts as well as the startup costs of a significant amount of new business, as expected.

Additionally, let me remind you here that in the second quarter we'll begin to change the Rx America contracts to conform to the Caremark contract structure. Rx America contracts are currently accounted for using the net method. As these contracts changeover to Caremark's structure the accounting treatment changes from the net method to the gross method of revenue recognition. The impact will be to add revenues as well a parallel addition in annual cost of goods sold, so there's no impact on operating profit dollars.

When we told you about this in February there were some contracts for which the accounting was not yet clear. Those have been resolved and they bring the total expected gross up to approximately $700 to $750 million per quarter versus the earlier estimate of about $500 million per quarter beginning in the second quarter of this year.

Gross profit margin in the Retail segment declined to 29.3%. That's down approximately 30 basis points versus 2008 first quarter. That reflects the impact of averaging in the lower-margin Long's business for the first full quarter, less cough and cold due to the weak traditional flu season, and customers opting for more sale-priced items as a percent of total purchases. Partially offsetting all that was the fact that the Retail generic dispensing rate increased 260 basis points to 69.2% and our private label percent of front store was up approximately 60 basis points versus the prior year quarter.

And what about expenses? Overall operating expenses as a percentage of revenues increased by approximately 70 basis points. The increase overall is a lot higher than the increase in each segment. It is again exaggerated by the intercompany elimination, which reduces revenues while expenses remain constant.

In the PBM segment the increase was about 25 basis points to 2.7%, including the impact of the elimination of the Universal American joint venture, the income from which was historically an offset to expenses, and an increase in litigation reserves related to pre-merger matters.

In the Retail segment the increase was approximately 20 basis points to 22.7%. That's primarily related to Long's integration costs and simply averaging in the Long's business for the full quarter, which has a higher SG&A percent-to-sales profile.

Given everything I've just discussed, we saw operating margin decline as expected by approximately 55 basis points. The PBM segment's operating profit margin was down by 70 basis points year-over-year to 4.2%.

Our reported EBITDA per adjusted claim was $3.03 versus $3.35 last year, but to put it on an apples-to-apples basis you need to adjust this year for three things - the inclusion of Rx America, which is virtually all retail claims and wasn't in the number last year; secondly, the shift of some mail scripts to Retail via Maintenance Choice, and finally the litigation reserves taken in this quarter in the PBM related to pre-merger matters. Those adjustments result in an EBITDA per adjusted claim of $3.46 this year versus $3.35 last year, up 3.2%.

In the Retail segment operating profit margin was 6.6%, down from last year's all-time record high, 7.1%. Recall that we accomplished this even with the one-time expenses associated with the Long's integration.

Moving to the consolidated income statement, we saw net interest expense in the quarter increase to $142 million, reflecting an increased debt position largely due to Long's.

Our effective income tax rate in the fourth quarter was 39.8% as expected.

And our weighted average shares count was 1.47 billion shares.

As Tom said, adjusted EPS from continuing operations was $0.55, flat to last year's first quarter and at the high end of our guidance. Recall that the quarter includes the one-time integration expenses associated with Long's, our planned investments in MinuteClinic, and the short-term margin investments we made in key PBM contracts to generate long-term gains, all of which should help drive our future growth.

GAAP diluted EPS from continuing operations came in at 51% for the quarter, also the same as last year.

Turning to the balance sheet and cash flows, we generated over $310 million in free cash flow in the first quarter.

Net capital expenditures amounted to $461 million in the first quarter. This was the result of offsetting the $466 million of gross capital expended with approximately $5 million worth of sale-leaseback proceeds.

In January we announced an increase in our quarterly dividend of 10.5%, marking the sixth consecutive year of dividend increases for our company.

And we ended the quarter with net debt, defined as total debt net of cash and cash equivalents, of $10.1 billion. That's down approximately $300 million from the prior quarter.

Now on to guidance. All of my comments here include the impact of Long's.

For the Retail segment we continue to expect revenue growth of between 11% and 13% for the year. Same-store sales are expected to be in the range of 3.5% to 5.5% for the Retail segment for the year.

For the PBM segment we've revised expectations for revenue growth primarily to capture the additional gross up of Rx America contracts as well as the increased Med D business Tom mentioned earlier. As a result, PBM segment revenues should be up between 15% and 17% for the year.

As for growth in mail order volumes, we said on our last call that we expect growth of over 10%. Given the uptake of Maintenance Choice and the share gains we have made to date as a result, we expect to do even better this year. Combining our mail order prescriptions with those from Maintenance Choice, we expect to see growth in our new metric - Mail Choice scripts - of more than 11%.

For the total company we expect revenue growth of roughly 12% to 14% for the full year. That's after intercompany eliminations of approximately $7 billion, which is higher than the guidance we last provided, again, partly because of the Rx America accounting change.

Also impacting the larger intercompany elimination is the better-than-expected momentum we're seeing from the Maintenance Choice offering as well as the ExtraCare Health Card, both of which are driving incremental scripts to our stores.

We continue to forecast that new generics will be beneficial to our gross margins but to a lesser degree than in 2008. We continue to expect our Med D business to be more profitable this year than last year. For the total company, gross profit margins are expected to be modestly below 2008, with Retail slightly up and the PBM segment down.

We forecast that total company operating expenses as a percentage of revenues will be modestly up, reflecting the integration and one-time costs of Long's, the increase in litigation reserves as well as fiscal year economics of new PBM business. All of that will lead to operating profit margins for the total company which are moderately below the record levels of 2008.

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

We forecast net interest of about $540 to $560 million, slightly up from our prior guidance due to our terming out $1 billion in March to pay off the Long's bridge loan and reduce commercial paper balances.

We expect our tax rate to approach 40%.

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

We still expect total consolidated amortization for 2009 to be approximately $450 million. Add in projected depreciation and the number becomes about $1.5 billion.

Net capital expenditures are expected to be in the range of $1.1 to $1.3 billion for 2009.

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

We still expect to complete the sale-leaseback transaction we deferred from 2008 as well as the normal 2009 transactions.

Adding it all up, we're raising our guidance for the full year. We now expect to deliver adjusted EPS of $2.55 to $2.63 and GAAP EPS of $2.37 to $2.45.

This increase of $0.02 over our prior guidance comes largely from the better performance we're experiencing in the Long's business, including Rx America, for the full year from both a sales, margin and SG&A perspective. We had previously guided to Long's dilution this year in the range of $0.06 to $0.07 per share. We now expect the Long's dilution to be in the range of $0.04 to $0.05 per share. As with our previous acquisitions, our integration and operations teams are turning in another stellar performance.

Now let me give you second quarter guidance.

In the quarter we expect revenue growth for the total company to be in the range of 16% to 18%. This significant growth is being driven in part by the Rx America accounting change in the PBM segment.

We expect total same-store sales growth to be between 4% and 6%. As the first quarter comp was negatively impacted by a later Easter, the second quarter will benefit from the shift of holiday sales into the quarter. We also expect to see a positive impact from the cycling of Zyrtec, which went over-the-counter during the first quarter of 2008.

We expect second quarter adjusted EPS to be between $0.63 and $0.65 per diluted share compared to last year's $0.60 per share. GAAP EPS is expected to be in the range of $0.59 to $0.61 per diluted share.

So stepping back from it all, here we are in the worst economic environment we've seen in most of our careers, yet we're turning in very respectable results. The company is gaining share across all markets and segments, generating significant revenue growth and free cash flow, raising our earnings guidance, increasing the dividend, and at the doorstep of a substantial share repurchase program. So we continue to deliver significant shareholder value.

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

Tom Ryan

Thanks, David.

Obviously, we're pleased with the results and our position in the marketplace. And, as I said, we'll give you some more details around some of that next week in the analyst meeting in New York.

Okay, we'll open it up for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Eric Bosshard - Cleveland Research Company.

Eric Bosshard - Cleveland Research Company

First of all, the Retail comp improvement that you talked about in March/April, the combined number, seems like the 2Q comp guidance may be a little bit conservative. Can you just talk about what's going on there?

And then secondly, can you talk about how the year-over-year PBM profit should play out as we move quarter to quarter through the year?

Tom Ryan

For the front end comps, I told you our front end comps for March and April were 3 - 4. Obviously, we had a very good Easter selling season and we think it's fairly reasonable, our projections, for the quarterly comps.

And the second piece was what?

Eric Bosshard - Cleveland Research Company

I think you had originally talked about 2% to 5% profit growth for the PBM this year. It was down in the first quarter. I know there was some noise in the number here in the first quarter, but can you talk a little bit about how we should expect that to play in? Is the profit going to be down again in the second quarter and then turn up in the second half?

Tom Ryan

No. The 2 to 5, we're still comfortable with the 2 to 5 and the profits should kind of ramp up through the year.

Eric Bosshard - Cleveland Research Company

Can you give us any sense should the profits be up in the second quarter in that business?

Dave Rickard

Well, Eric, you know that we don't actually disclose -

Tom Ryan

They're going to ramp up through the year, Eric, 2 to 3 to 4 each quarter. They typically ramp up each year anyway in the beginning to the end, so it would be consistent with typical PBM performance.

Operator

Your next question comes from Lisa Gill - J.P. Morgan.

Lisa Gill - J.P. Morgan

Can you talk on an enterprise-wide basis, is Maintenance Choice more profitable, less profitable or equally as profitable to mail order scripts? So not comparing PBM to Retail, Tom. Let's talk about the whole enterprise when you get a person into the store and tell us is that more profitable?

And then secondly, a customer of yours, Chrysler, looks like it's going to go through bankruptcy. There's some question around what's going to happen with the VEBA trust. Can you maybe talk about what's happening in your customer base right now as companies like this try to work through bankruptcy and what it means for somebody like CVS?

And then just one clarification. I'm wondering if Dave can just talk to us about what that litigation reserve is for as it pertains to the PBM side.

Tom Ryan

I'll hit all three, actually. The Maintenance Choice program is definitely more profitable for the enterprise when you look at the entire book of business and Dave will go into that. Now keep in mind you have to make sure that either it's a mandatory mail program or it's a mail program that has a plan design that drives mail to make sure that happens. But once you have that with a client when you think about what's picked up in the store and then the ancillary purchases, the overall, the acute scripts, it is more profitable for our enterprise around Maintenance Choice. We pick up share.

As far as Chrysler goes - and we'll give you kind of the walkthrough next week, Lisa, on the details of that because I know people are questioning it and we've had some in the marketplace say listen, it's just a temporary process, they're just trying to drive it to retail. That's not the case at all; this is a mail order offering that we've extended to retail. It's kind of that simple. So think about it - it's kind of the mail business in the store - and overall it's certainly more profitable for us.

Chrysler, obviously, has its problems and, you know, the problems are certainly not due to its PBM contract. They have certainly other matters to deal with. But we think obviously they're going to emerge from this. The employees need prescription benefits during this time, so it would seem likely that they would maintain their pharmacy benefit program.

You know, unemployment, obviously, is a challenge for the economy and for us and for all retailers and PBMs alike. The good news is that we have COBRA extension. When you look at our book of business, it's a very small percentage of our business around the layoffs. But we're watching it closely. Obviously, the VEBA process is moving forward and there should be some resolution on that in the near future, but we're pretty confident that Chrysler will keep the benefits as they go through, even if they go through the bankruptcy, and then we'll see obviously what happens with Fiat.

As far as the litigation, we don't obviously disclose the litigation reserves, but I will tell you that it's all pre-merger; it's got nothing to do with CVS, nothing to do with Caremark. It's three-plus years back and it's an old case.

Operator

Your next question comes from Deborah Weinswig - Citigroup.

Deborah Weinswig - Citigroup

Can you go through your expectations for specialty pharmacy growth and new initiatives to drive increased distribution and how the integrated specialty management program is going so far?

Tom Ryan

Yes, our specialty business - and you'll hear a little bit more about this also on Friday - but our specialty business continues to meet our plan. It's obviously the fastest-growing piece of the pharmacy business. We have a few things going on with injection training around specialty in our MinuteClinics and we also have the program that you mentioned around Retail mail pickup that was just kind of introduced.

And that's actually a big plus. You know, once again, think about it like the Maintenance Choice program. It's about access and it's about ease and it's about low cost, so you have a situation where typically you'd have to call to make sure someone was home as we're delivering this medication because of the storage requirements, etc. Now they can pick it up in the store.

So it's early on that, but it's going well and overall we expect, I think, specialty to grow in the 14% range.

Deborah Weinswig - Citigroup

On Long's, is the timeline progressing as expected? It sounds like things might be going a little better. And I know it's early, but are there any best practices that are impacting the CVS stores as of now?

Tom Ryan

It's actually going a little better than we expected. We've gotten pretty good at predicting how the integrations go. Interestingly enough, I mentioned that we had closed some 40 stores. We've retained more customers in those closings than we originally thought, so that's been helpful. Most of the work that we've done has been around the back end, so to the customer it's been relatively transparent, which is good news.

And we'll have obviously some disruption when we redo the stores, but it's going very well and especially considering the California market, which we're starting to see some activity coming back. You probably recently read about some housing starts and people starting to come back and spend in the California market. So we're pretty happy with the performance there.

Yes, we are learnings some things around seasonality, particularly in the Hawaii stores. We continue to learn there. As I said, we'll maintain those stores separately and we'll apply some of those learnings to the rest of our stores.

Operator

Your next question comes from Robert Willoughby - BAS-ML.

Robert Willoughby - BAS-ML

You did close more of the Long's stores than we thought, as well as some of the specialty and mail facilities. I guess I'm a bit surprised why profitability wouldn't have ticked up a little bit higher on some better capacity utilization, assuming that was the rationale behind closing the stores. Is that the case?

Tom Ryan

No. I mean, we close stores when we do acquisitions all the time. We look at store location. We look at the performance of the store. We look at the location of like stores. We look at the location of if and fact in some markets there's other CVS stores; obviously that would be the case in the Southern California and Arizona markets, in particular, Phoenix, etc. So our closings are basically right on plan that we expected for Long's. In fact, we got obviously, as I said earlier, a little better retention of some of those customers.

Robert Willoughby - BAS-ML

On the mail and the specialty side, though, are you done with that infrastructure consolidation or is there more to go there?

Tom Ryan

There's more to go there. Yes, we're still looking at that. Obviously, when you start looking at those facilities, different than store locations, there's obviously logistics implications around that, so, no, there's more to go as we look to rationalize that network.

Operator

Your next question comes from Edward Kelly - Credit Suisse.

Edward Kelly - Credit Suisse

Tom, could you discuss your current thoughts on acquisitions given that it sounds like other captive PBMs may be for sale following the Express-WellPoint deal? Medco's indicated that it may have some interest; I would curious what your thoughts are.

Tom Ryan

We obviously look at all opportunities. I can't comment on individual acquisitions, but I think with any acquisition we've said it time and time again that we look at acquisitions we can grow. One, you've got to make sure that you pay the right price. If people overpay for acquisitions, it's a problem, people can't integrate the acquisitions, whether it's the retail side or the PBM side.

So we'll continue to look at those appropriately in both segments of our business and we'll do obviously the proper due diligence and look for the opportunities.

Edward Kelly - Credit Suisse

And then on the Maintenance Choice side it looks like the impact to reported mail claims was about 400 basis points. If you just do some math on that from an EBITDA per claim basis it seems like it may be $0.15 to $0.20 or so for this quarter. Is that ballpark?

Tom Ryan

I don't know if that's ballpark.

Dave Rickard

We haven't disclosed that kind of detail, so I don't think this is the time to start.

Tom Ryan

I know David did say the impact on our front store pharmacy comps -

Dave Rickard

It was about 120 basis points.

Tom Ryan

Overall, what, 70 or 80 or something?

Dave Rickard

About 80, yes.

Edward Kelly - Credit Suisse

I guess if we think about it qualitatively, that impact, whatever it was, to EBITDA for claims will likely ramp throughout the year.

Tom Ryan

Yes, that's correct. We've had more clients reach for it and then the utilization is also higher than we expected.

Edward Kelly - Credit Suisse

Does that impact in itself - how much do you think it grows by? Is it something that could double by the end of the year or is that much too aggressive?

Dave Rickard

That sounds high to me.

Tom Ryan

It sounds high, but it's certainly going to increase, which is why I'm trying to talk about the enterprise-wide growth when you think about the company because there's going to be intercompany transfers, there's going to be pieces back and forth, and we're moving people between divisions now. Our bonuses are incentivized around the enterprise when you look at how people are paid at the highest levels and also at the middle management, our middle management teams, who are the closest to our customers.

So we're thinking about this from an enterprise-wide standpoint. And yes, it will certainly ramp up.

Operator

Your next question comes from Matt Perry - Wachovia Capital Markets.

Matt Perry - Wachovia Capital Markets

Tom, just a couple questions on health care reform. You guys kind of sit in a unique position with both the PBM and Retail pharmacy business. I'm wondering what your thoughts are on some of the current proposals and your views on reform in general.

And then if we think about where you might benefit more in your business from reform plan that covers the uninsured, if you could just talk about that, too.

Tom Ryan

I wish I had a crystal ball on health care reform. I think there's obviously an appetite for the administration to do it. They certainly have the votes to do it. And, you know, the question is what will happen in the House versus the Senate and that debate's just starting now. I think the House certainly seems to be more aggressive in some of the pieces of the reform legislation they're looking at and the Senate may be a little more conservative, but more to be seen.

But just from a kind of broad brush standpoint, we think at the end of the day health care reform will be good, one, for the country, and good for us because, one, you're going to have more coverage - anytime you have coverage that's obviously good for us and we think pharmaceuticals are the best return in health care when you think about what they do, so people will think about that as they look to expand it and think about wellness and prevention, they're going to strengthen that, which obviously plays in with our disease management and MinuteClinic approach. They've invested, I don't know, $165 billion in technology. We think that's a real opportunity for health care in this country.

I think we do 17% or 18% of the retail scripts in this country and we do about 25% to 26% of all the electronic prescriptions in this country, so we are really pushing around electronic prescriptions, electronic medical records, so that we can obviously improve safety, improve access and improve outcomes.

And then obviously the push on the biotech drugs. These are drugs that are off patent that have generics in Europe and there are opportunities for us here that can lower payers' costs, lower patients' costs and is good for us.

So overall there are obviously puts and takes. People talk about this public plan, what does that mean, will it be truly a public plan or will it be a public plan that looks like a private plan. We don't know about that and that, I guess, will be the biggest discussion over the next coming months, what that quote-unquote public plan looks like, so there's a lot of devils in the detail there, but overall I think the system will be good for pharmacy in general and certainly our company as we're integrated.

Matt Perry - Wachovia Capital Markets

You did mention the public plan. Does that idea concern you at all, if the public plan doesn't really compete on a level playing field with private, no private sector, that that could be a negative for your business?

Tom Ryan

Yes. I mean, my philosophical bent on where the government should be, but it's hard to have an equal playing field with a government-run plan. Are they going to be taxed on it? Are states going to tax it? Are the regulators who are going to run it the same people who are going to manage it? Are they going to have the same requirement on reserves? All of these issues have to be fleshed out.

To me - this is my just personal opinion - if you have a public plan that mimics a private plan, well then it's just another private plan and, you know, the question is do we need another private plan in the marketplace? So I just think if you have the appropriate regulations - and maybe we need some enhanced regulations around some of the private plans - I think that's enough. I think it'll get done.

But like I said, those are my personal opinions and from a business standpoint the Draconian public plan would be neutral, I think, to us at best.

Operator

Your next question comes from John Heinbockel - Goldman Sachs.

John Heinbockel - Goldman Sachs

Tom, in the past you may have talked about you win new contracts on price and you keep them on service. Is the dialogue now because of Maintenance Choice and the new model, where does it stand where you can win on service or the new model as opposed to price? Are we getting there, are we close, where are we on that?

Tom Ryan

Well, in this economy, especially in this economy, price is always going to matter. I mean, that's kind of the ticket to the game to get in. But when people are making these decisions, especially the big employer groups and big health care plans, they're looking at how can this company help me lower my health care costs, not just drug costs? How can they help me engage my members or my employees?

And that kind of discussion, we're seeing more of that. Once you have the price discussion kind of out of the way - what is your price for generics, what's your price on mail, retail, specialty, etc. - now the discussion comes around how can we help them lower their overall health care costs and one of the ways is Maintenance Choice.

I mean, we just came from a client conference and I can't tell you the number of people that have come up to me and just said we were thinking about mandatory mail, we didn't want to do anything mandatory, moving our people to more mail order prescriptions; this is a perfect opportunity for us, it's kind of the best of both worlds - so I think that, combined with our proactive pharmacy care program, where we're trying to intervene earlier and help our payers, help our clients lower their overall health care costs, that kind of discussion is happening more certainly in the last six months to a year than it happened obviously before that. Certainly we never had that discussion before, really.

John Heinbockel - Goldman Sachs

And do you think because you've repriced so many of those contracts and don't have a lot coming up here, how much freedom do you have for you to go out and cultivate new business aggressively on price? And you don't want to over rely on price, but it seems you do have more opportunity to win some business here on price over the next year than lose it because you've locked up a lot already.

Tom Ryan

Yes. I think price is fairly rational in the marketplace now. Listen, if you look at it, people understand their costs, people understand what they need for a return, and so do clients. So I think there's rationalization in the marketplace. The issue is what are the services, what are the services you can offer and the scale that you can apply? When you look at our prescription drugs, I mean, even with the latest acquisition in the PBM industry, you look at our purchasing power compared to that entity, we purchase five times the prescription medications than this new combined entity in the marketplace. So I think scale is important for a variety of reasons.

We'll look at clients on an individual basis and you'll see, I think, maybe some lower pricing in certain markets for certain clients, but overall the issue, the real tenor and tone of the discussion is around the services that one can provide and how it can lower overall health care costs and not just pharmacy.

John Heinbockel - Goldman Sachs

Is Maintenance Choice yet helping 30-day scripts?

Tom Ryan

Yes. We believe it is. We have evidence that it is. And, once again, it's the customer's choice. People talk about the network and the pharmacies; we have 64,000 pharmacies in our network. I mean, we have, I believe, as many or more than most and we haven't cut it down since this merger, so the issue for us is letting the customer decide. And we're seeing some uptick in acute medication, also.

Operator

Your next question comes from Helene Wolk – Sanford Bernstein.

Helene Wolk – Sanford Bernstein

A follow up on the Maintenance Choice, the statistic that you referred to around the contribution to pharmacy comps, that 120 basis points, does that include both the mail conversion as well as the acute scripts uptick?

Tom Ryan

Yes.

Helene Wolk - Sanford Bernstein

And can you give us a dimension or a sizing for what's the relative contribution of those?

Tom Ryan

It's hard. It's obviously more mail, but it's hard to break it out.

Helene Wolk - Sanford Bernstein

And how about in terms of the contribution of existing client conversion versus sort of new client enrollment in Maintenance Choice?

Tom Ryan

Well, it would be mostly existing clients, but I will tell you we've had some significant wins with clients, new clients, that one of the reasons they came or they cited was the ability to have this offer. So it was initially mostly mandatory clients and now it's moving kind of up the scale to clients that have plan designs that are moving to more mail. So the first pass was really mandatory mail clients and now it's moving down the line.

Helene Wolk - Sanford Bernstein

And a second question about the sustainability of the retail script growth, particularly in light of IMS's revised guidance around negative growth in '09. Any sort of comments or helping us understand the dynamic at play.

Tom Ryan

Well, there obviously is a slight slowdown. We're obviously benefiting from the Zyrtec wraparound, but we're also taking share, I believe. When you look in the marketplace, we're taking share in the front end of our business on the Retail side and we're also taking share on the pharmacy side from a variety of areas. So we think that's obviously offsetting some of the quote-unquote slowdown in the pharmacy trends that you see. But our numbers for the last certainly four quarters plus have kind of led the industry.

Operator

Your next question comes from Scott Mushkin - Jefferies & Co..

Scott Mushkin - Jefferies & Co.

Kind of along the same lines with the Maintenance Choice program, Tom, do you have enough data now - I know there's been some resistance in the consulting area to Maintenance Choice and actually running those numbers through as a comparison - do you have enough data now to show people that have like kind of shunned mandatory mail programs, if they choose Maintenance Choice they will actually save quite a bit of money per script?

Tom Ryan

Yes, I think there's less skepticism in the market than there was now that people - not only from consultants, but also from our clients; no one wants to be on the leading edge, they want to see how this thing plays out - and what they're seeing with the number of clients that have taken it and signed up not only now but also in 2010.

But we can show clients; I mean, the reason clients choose it is because there's better savings. The early clients chose it because of better access and convenience; they already had mandatory mail. The clients that are moving towards it are moving towards it for savings and convenience. So we can show them anywhere from a 10% to 15% savings and they get it.

Scott Mushkin - Jefferies & Co.

And how much uptick do you expect in July? I know you said there's going to be another bunch of clients coming on in July. I think it's 2.5 million now. Where is that going to go as we get to July?

Tom Ryan

I can't quantify that, but we have more coming on in July and we have obviously others coming on in January of '10, so that's the ramp up.

Scott Mushkin - Jefferies & Co.

And then as a percentage, of that 2.5 million, do you have any percentage of how many are new to Caremark and how much was mandatory mail? Are you going to give us any percentages there?

Tom Ryan

I tried to quantify it. It was definitely mostly existing customers and mostly mandatory mail customers initially. Now that pendulum has swung on both sides, so less mandatory mail customers and it's trending more towards new customers. But the bulk of it is existing customers.

Listen, from a penetration standpoint we still have a lot of runway to go. If it's a nine-inning game, just in penetration of our existing business, we're in the second or third inning.

Scott Mushkin - Jefferies & Co.

So as we do this - and not to get too excited here - but as you pull things from other PBMs and win contracts and they come into Maintenance Choice, it was talked about the enterprise pharmacy of someone like that. It seems to me that that is just amazingly profitable business for your company as non-CVS people, non-Caremark people start rolling through the CVS Retail platform. Is that incorrect?

Tom Ryan

It will certainly be beneficial for our company.

Operator

Your next question comes from John Ransom - Raymond James & Associates.

John Ransom - Raymond James & Associates

Dave, could you help us frame the Part D improvement this year versus last year? What's kind of the ballpark EPS impact from doing better in that line of business this year versus last year?

Dave Rickard

Well, we haven't broken out the EPS of individual components of PBM profitability, but the year-to-year profitability improvement is high single digits. It's related to both the way we bid the business for this year, it's related to the enrollment, which is up versus prior year. A number of things are going in the right direction there.

John Ransom - Raymond James & Associates

And secondly, on the Long's revenue, obviously you're doing better on the cost side and the integration side, but given what's happened in California, when you roll Long's into the comp base at this point do you anticipate that to be a positive, negative or neutral affect on your comps?

Tom Ryan

I would say it would be initially neutral to negative actually because you've got disruption, right? I mean, so it kind of runs the same. Now the wild card you have here is your point, the California economy, right? We didn't have that, obviously, with Revco, we didn't have it with Eckerd, we didn't have it with Sav-On per se, so you do have that wild card. But overall we always know that there's a little bit of a trough on that and so it's kind of neutral to negative and then it ramps up.

Dave Rickard

The only thing to keep in mind there is the effect of the net-to-gross markup of revenues and that'll play through there. But in terms of the business trend, Tom's exactly right.

John Ransom - Raymond James & Associates

Would that affect the Retail comps?

Tom Ryan

That wouldn't affect the Retail comps.

John Ransom - Raymond James & Associates

Just the PBM, okay, I got you. Right. And then thirdly it looks like the debt market is starting to unstick a little bit. Do you have any new thoughts about monetizing some of your Long's real estate holdings and is there a better shot you might do that sooner rather than later or is the cap rate still not [inaudible]?

Tom Ryan

It's loosening up, but it's still relatively tight. We're going to look at some sale-leaseback offerings. Obviously, we have some inventory built up besides the Long's stores, but I would say we'll have other opportunities from a sale-leaseback standpoint in other markets prior to the California market.

John Ransom - Raymond James & Associates

And the last question - thank you for this - this is an educational question, at least for me, but let's say we continue to move a little bit left on the political spectrum and the government starts talking about quote-unquote negotiating pharmaceutical prices, i.e., dictating pharmaceutical prices, and using a big stick as part of a public plan to drive down pharmacy costs, etc. It's not clear to me, at least, what role a PBM plays if the government starts dictating those prices and especially as the low-end group study suggests we start seeing some migration from private plans to public plans because of the lower cost.

I know philosophically we have a view, but mechanistically do you have any insight into how that would work and what kind of efforts you might be making to communicate your views to the policymakers about what that might do to the network of private contracts that are already out there?

Tom Ryan

Yes, obviously we think the free market is the way to go and I think if you look at Med D, it's kind of really a perfect example of that. That was a program that really was driven by the private sector and we enrolled a significant number of seniors; there's significant savings. The savings is improving each year. Now they may have been off a little on their projections on prescription utilization, but when you look at the total overall return I think the government is pretty happy.

It's hard to speculate on where they're going to go on that area, but I just think you will always need the PBM when you think about the overall clinical programs, the monitoring of the network, the rebates, the best price issues, working with them on the specialty side of the business, so it's more than just setting the price. And I'm not making the assumption it's going to go that far left because I don't think that's where the marketplace goes; I don't think you ever get kind of the best price.

Operator

Your next question comes from Simeon Gutman - Canaccord Adams.

Simeon Gutman - Canaccord Adams

Tom, can you diagnose the customer both pharmacy and the front end, and in particular the pharmacy? Putting the IMS forecast aside it looks like script volumes have been ticking up. Are you seeing anything that would tell you maybe compliance is improving as people are taking their drugs again, as they should? And then anything observable at the front end?

Tom Ryan

Yes, our front end business, I'll start with that, our front end business in the last few months is actually increasing, I mean, across our main categories. And we have a slight uptick in promotional mix, not that we're promoting anymore but customers are obviously, in this economy, leaning towards it. So we're starting to see our best customers are spending more in the categories that we emphasize.

Around the pharmacy side of the business, we've done a lot of work around adherence in the stores and now we're obviously combining it on the PBM side of the business. There's kind of two opposite pulls here, right? You have the consumer in this economy cutting back a little bit, cutting drugs in half, maybe skipping a dose, yet on the other hand the pilot programs that we're putting in place, the calls that we're making to customers to restart, to stay on their medication, working with clients, in particular, we're seeing a pretty dramatic increase.

So I wish I could give you one silver bullet, but it's not. You've got a combination of factors there. I think adherence in the programs that we're putting in place is improving script unit growth. I think the share that we're taking because of performance vis-à-vis some of our competitors is improving script growth, and then the flip side, you still have people I think maybe cutting back less than they did before, but still cutting back.

Simeon Gutman - Canaccord Adams

And then the follow up, to clarify on the Maintenance Choice offering I understand that a lot of it's coming from existing customers, but that's existing to the PBM. Can you separate out how many of these customers are first time to the CVS store? Of course there has to be something captured in there because you're citing it in the numbers, but I'm curious if there is a bigger mix of people that are first-time CVS pharmacy customers as opposed to enterprise-wide customers.

Tom Ryan

Yes, there's a percentage of that. We won't disclose that now because it obviously varies, but there are certainly a percentage of customers that haven't been into a CVS store or haven't used our store for acute medications, right? They're maybe going somewhere else for acute medications. But it's a combination of Maintenance Choice.

And don't forget we also have the ExtraCare Health Program out there, where we have 8 million cards and another 8 million coming up by middle of '10, where people get 20% discount. So you have a lot of that are also new customers. And then MinuteClinic, we've cited that, where 15% to 20% and 25% in some cases are new customers to CVS. So I think we're pulling them from a variety of sources.

Operator

Your final question comes from Meredith Adler - Barclays Capital.

Meredith Adler - Barclays Capital

First I'd just like to ask you if you want to comment on your wholesale contract. I think there were some discussions with McKesson and Cardinal.

Tom Ryan

Yes. We won't comment on our negotiations with our wholesalers.

Meredith Adler - Barclays Capital

And then another question about the business that you believe will be available for the PBM for 2010. Do you think that there are a significant number of contracts that are up and how does that compare between what you have to renew and what your competitors have to renew?

Tom Ryan

Well, I told you last year obviously we renewed a fairly significant amount of renewals, more so than we typically did in the past, and we obviously invested in [price.] You've heard me talk about that. So just of that nature we probably have less renewals than some of our competitors.

As far as 2010 pipeline, overall kind of reasonable from last year, $8 billion plus, maybe, $10 billion out there. We're obviously aggressively going after the appropriate business, but we think when you think about renewals where we are right now at this point in the season we're essentially on plan and in good shape. And obviously we feel comfortable where we are with some of the new business going on.

Meredith Adler - Barclays Capital

The economics of Maintenance Choice kind of assume that you have excess capacity at Retail, so the marginal cost of labor is not high. Can you talk about how many stores or what percentage of the store base in fact doesn't have excess capacity? And I know you had talked about centralizing some of the functions. Is that still going on or is that part of how you see the economics of Maintenance Choice working?

Tom Ryan

Yes. You have to look at Maintenance Choice, it's coming from a few mail facilities being spread across 7,000 stores, so on a store-by-store basis it may not be a lot. There are, I guess, some stores, Meredith, that have capacity problems that you may need to add technicians, but don't forget we're working on taking work out of the stores with our call centers.

But where we are now and the uptake that we've had, which is pretty aggressive and more than we thought that would move from the mail to the Retail, we haven't seen any dramatic need to add any incremental payroll in the stores because of that.

Don't forget, you'll hear people talking about the costs that they're taking out of the system. We've been taking costs out of our system for a number of years. We did a whole workflow project a few years back in pharmacy that took significant savings out of the pharmacy and improved service. So you had significant savings come out, you had improved service, and you had better-engaged pharmacists. So we've already done that and now we're taking it to the next level with the call centers and taking out some of the back end costs.

But overall just keep in mind these scripts that are going to the stores are spread over 7,000 stores and, fortunately, we do have capacity.

Meredith Adler - Barclays Capital

Okay, great. Thank you. That's very helpful.

Tom Ryan

Thanks. Thank you very much. Obviously, if you have any questions you can call Nance Christal and we hope to see you all next Friday. Thanks.

Operator

Thank you. This does conclude today's CVS Caremark first quarter 2009 earnings call. You may now disconnect.

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Source: CVS Caremark Corporation Q1 2009 Earnings Call Transcript

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