CVS Health Corporation (CVS) Q1 2010 Earnings Report, Transcript and Summary

Good morning. My name is Regina, and I will be your conference operator today. At this time, I would like to welcome everyone to the CVS Caremark Corporation First Quarter 2010 Earnings Conference Call. [Operator Instructions] I would now like to turn the conference over to Nancy Christal, Senior Vice President of Investor Relations. Please go ahead.

Thanks, Regina. 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, who'll provide a business update; and Dave Denton, Executive Vice President and CFO, who will provide a financial review of the first quarter of 2010 and guidance for the second quarter and full year 2010. Larry Merlo, President of our Retail business; and Per Lofberg, President of our PBM business are also here with us today. And both of them will participate in the question-and-answer session that follows our prepared remark. During the Q&A session, we ask that you limit yourself to one to two questions, including follow-ups, so we can get to as many analysts and investors as possible. This morning, we'll discuss some non-GAAP financial measures in talking about our company's performance, namely free cash flow, EBITDA and adjusted EPS. In accordance with SEC regulations, you can find the definitions of the non-GAAP items I mentioned, as well as the reconciliations to comparable GAAP measures on the Investor Relations portion of our website at info.cvscaremark.com/investor. As always, today's call is being simulcast on our IR website. It will also be archived there for one month period following the call to make it easy for all investors to access it. Just a reminder, our 2010 Analyst Day will be held on the morning of Friday, October 8 in New York City. We'll provide more specific details soon, but please save the date. Please note that we expect to file our 10-Q by the end of day today, and it will be available on our website. Before we continue our attorneys have asked me to read the Safe Harbor statement. During this presentation, we'll make certain forward-looking statements that are subject to risks and uncertainties that could cause actual results to differ materially. Accordingly, for these forward-looking statements, we claim the protection of the Safe Harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995. We strongly recommend that you become familiar with the specific risks and uncertainties that are described in the Risk Factors section of our most recently filed annual report on Form 10-K and that you review the section entitled Cautionary Statement Concerning Forward-looking Statements in our most recently filed quarterly report on Form 10-Q. And now I'll turn this over to our CEO, Tom Ryan.

Thanks, Nancy, and good morning, everyone. I'm happy to report another solid quarter this morning, continued share gains in retail, the growth in our generic dispensing in mail and retail and better expense leverage enabled us to deliver unplanned operating margins in the quarter. And that's despite the weak flu season and the impact from severe weather in some of our key retail markets. Our adjusted earnings per share of $0.60 was slightly ahead of our plan, driven by lower-than-expected interest and the timing of our share repurchases. Now as we've said in the past, we plan to return value to our shareholders through a combination of dividends and share repurchases. We're very focused on the efficient allocation of capital. We will continue to invest in internal projects that meet our hurdle rates and use the rest of our free cash flow to increase value to shareholders. Before turning to the business update, I want to touch a little bit on healthcare reform legislation that was passed this year, and that's basically all that was passed. There's a lot of work that needs to be done and things will change as we go forward. But certainly, the new legislation addresses the access and coverage issues but there's still a lot of work to do on the cost side and the financing side. Pharmacy care is clearly recognized as a key to lowering healthcare costs over the long term. And while the legislation has many features, the largest benefit to our business is the anticipated addition of 32 million covered lives in 2014. As you know, increased coverage typically leads to increased utilization, just what we saw on the Med D plan. Other positive features include the promotion of healthcare IT, wellness and prevention and closing the doughnut hole. Now we received some questions on the possible impact from the repeal of the tax exclusion for the RDS beginning in 2013. As you know, the RDS reimburses employers 28% of their allowable prescription drug costs and is currently not counted as taxable income to the employer. As you know, this was established to provide an incentive to employers to keep offering drug coverage rather than shifting the retirees to Medicare Part D. With this new legislation, there will be some churn on these coverage lives. Some employers may choose to maintain the retirees' coverage and take the RDS despite this tax change. Others may move the employees to an EGWP [Employer Group Waiver Plans] plan. And we have already have many clients taking advantage of these, which will allow them to stay in the group product with less administrative burden and to continue to provide coverage to their retirees. Also EGWPs provide a certain degree of flexibility and plan design, member cost sharing and premium contributions. Now some employers may ultimately move their retirees to a Medicare Part D PDP program. And of course, Caremark and our healthcare clients are major players in this PDP space. The impact to our revenues and earnings is hard to predict. But overall, we believe we are well positioned to help our clients determine the right path and serve their needs, and therefore, capture new business in this area. Now let me turn to the business part. I'll talk first about our PBM. In the quarter, we had a 2.6 increase in net revenues, 110 basis point increase in our mail choice penetration to 24.8%, a 270 basis point increase in our generic dispensing rate to a record 70.4%. And 11% increase in our EBITDA for adjusted claim to $3.62. Now here's a brief update on last year's selling season. That's 2010, and this will be the last time we talk about 2010. Last quarter, I said we have $550 million remaining to be renewed in 2010. 2010 selling season is obviously nearly complete. And we have about 250 remaining. And most of those obviously are with fourth quarter renewal date. As for new business, again, last year, 2010, our net new business increased by $500 million since our last update. This included some Med D business, as well as some other new businesses that started to hit in '10. Let me touch on 2011 selling season. While it's still early, results to date are very encouraging. And we are optimistic. Our clinical strategies and value proposition are resonating with clients and consultants. As you know, we have a smaller-than-typical percentage of our books scheduled for renewal in 2011. We have made great progress on renewing existing accounts and have absolutely no significant terminations. Additionally, we see a fair amount of new prospects out for bid in 2011. And we've had some early successes. In 2011, the selling season so far, we are in a net positive position to date. Now when you think about 2011, I want to remind you that we serve as Health Net's PBM. And as many of you know, and as we've said in the past, 2009 Health Net sold its Northeast business to United Healthcare. We'll have to phase out of the Northeast business to United beginning this year. The impact was included in our revenue guidance for 2010. And we expect that to have approximately a negative impact on revenues of about $400 million in '11. We'll have more to say about 2011 selling season on our second and third conference calls. And we look forward to updating you then. As you know, we utilize a range of unique tools to drive down pharmacy costs and more importantly, overall healthcare costs to our clients. These include plan design to drive generics and 90-day pricing, as well as clinical programs that reduce wasteful spend and increase adherence to essential pharmacy care. I'd like to update you on some of the actions that our clients are taking. Since the last call, we signed up additional clients for Maintenance Choice, bringing our total to 494 plans, representing 5.6 million lives that have adopted Maintenance Choice. In 2009, 17% of our lives [ph] adopting Maintenance Choice came from voluntary mail plans. In 2010, it has more than doubled. Clients switching from voluntary mail plans to Maintenance Choice typically see a significant increase in 90-day utilization with substantial savings for clients and their members, as well as better adherence and better generic penetration. We are also seeing increased adoption of our high performance formulary step therapy plans that, once again, helped drive down costs. In addition to these plan design offerings, we continue to be focused on clinical programs that would drive generate utilization, remote compliance and lower overall healthcare costs to improve disease management. Now our clients are increasingly concerned about controlling their Specialty Pharmacy spend. While specialty therapies represent about 35% of the U.S. market in pharmacy and medical spend in '08, it's projected to be roughly 50% of that spend in 2013. And while three of the top 10 drugs in the U.S. were specialty drugs in '06, projected that seven of the top 10 will be specialty drugs in 2014. Our Specialty business has long been a clinical leader, providing programs that increase patient engagement and better manage cost and health. Our care team approach leverages the expertise of our clinical pharmacy staff that specializes in managing the needs of the specialty patients. Our Specialty Guideline Management program saves clients over $200 million annually. Currently, Specialty has a penetration of about 60% of our PBM book. So we really think there's an opportunity for additional PBM client pull through, as well as promoting our Specialty services to prospects outside our PBM book of business. We are well positioned in the marketplace. And we think this will be an important area of growth for us over the next five years. Clients are also beginning to take a look at genetic testing. We believe our investment in Generation Health positions us to take a leadership position in the utilization management of genomic testing. We are on schedule to pilot our enhanced codeveloped Genetic Benefit Management program on July 1. The pilot will feature retrospective interventions for six traditional PBM dispensed products. The program will also introduce Generation Health test lab network to facilitate genetic testing to help determine whether these target drugs will be effective or safe for certain members prior to the physician prescribing the drug therapy. So once again, this is appropriate utilization of drug therapy. The Comprehensive Genetic Benefit program will be made available to all of our clients beginning January 2011. We've seen a lot of early interest in this offering. And we are optimistic about the future opportunities. Now we've gotten some questions in regard to the timetable of our Consumer Engagement Engine program. I want to confirm that CEE is on track to be available across all our channels in mid-2010. The CEE will help us broaden our clinical capabilities across our entire asset base by providing an integrated data highlighting cost savings and health improvement opportunities to our pharmacist. Availability of CEE will allow us to broadly launch our Pharmacy Advisor program. This is an exciting and important step in our ability to improve pharmacy care on behalf of our clients. The program, which leverages our Consumer Engagement Engine technology will be available to clients in 2011. We've had successful pilots. And these results are extremely compelling. Pharmacists involved in the Pharmacy Advisory program are extremely enthusiastic about the positive exchanges they've had with patients. The ability of our pharmacists to have an impact on their patient's healthcare decisions has exceeded even their own expectations. Through face-to-face or phone interactions with a trusted pharmacist, who is armed with important and helpful information, we can improve adherence, improve gaps in care and most importantly, lower healthcare costs for clients and members. We'll have a lot more to say about CEE and the Pharmacy Advisor program in future quarters. Now let me move to the Retail side of our business. Our comps, as you know, were a bit below our expectations in the first quarter. And it was simply due to the weak flu season and severe weather in some regions, primarily in the mid-Atlantic region, where we have obviously significant share. Having said that, we continue to post industry-leading pharmacy comps. Excluding Longs, our Retail Pharmacy share grew 42 basis points nationally versus last year's first quarter, while our Retail Pharmacy share in the markets in which we operate grew 56 basis points. As expected, the inclusion of Longs in our comps had a slightly dilutive impact on our first quarter comp performance. And as we said before, we expect that to continue through the first half, turning positive in the second half with a slightly neutral to negative impact overall. Remember the Longs story, like that of Sav-On and Osco is more about driving improvement in margins and profitability rather than dramatic top line improvement. For the first quarter, total same store sales increased 2.3%, including a 36-basis-point negative impact from Longs. Now I thought it might be helpful here to take a look at our two-year stacked comps. On that basis, our total comps were 5.6%. Our pharmacy comps were 8.3%, and our front store comps were flat. So on a two-year stack basis, our pharmacy had total comps -- led the industry by over 500 basis points. And our front store comps led the industry by over 300 basis points, despite the negative impact from Longs. Pharmacy comp in the first quarter increased 3.7%. In addition to the impact of flu and weather, our pharmacy comps reflected a 290 point negative impact from new generics and a 20 basis point negative impact from Longs and 260 basis point positive impact from Maintenance Choice. Our generic dispensing rate rose more than 290 basis points to a record 72.1% in the quarter. Now like last quarter, our average front store transaction size grew slightly in the quarter, but comp traffic decreased slightly in the quarter. Once again, driven by the weather and we believe weak flu. However, while traffic was down in January and February, the good news is we saw a slight uptick in March. Front store comps decreased 0.7% in the quarter, which reflected a positive impact of Easter about 88 basis points and a negative impact from Longs of about 52%. Both customer accounts and average ring improved notably in Longs in the quarter versus the first quarter of 460 basis points and almost 60 basis points, respectively. So in Longs, we're making great progress. We're headed in the right direction. And the profitability continues to improve. Private Label as a percent of front store sales increased 130 basis points to 16.9%. We introduced 457 new Private Label items in the first quarter and plan to add 1,100 items throughout 2010. In the Longs mainland stores, we increased private label to nearly 15% of front store sales, up almost 900 basis points in the quarter. Our ExtraCare loyalty program currently has 64 million active members. And we continue to find new ways to reward members and make it easier. I'm sure many of you have seen our ExtraCare coupon centers that are now available nationwide, making it convenient for shoppers to scan their ExtraCare card and print off coupons that are appropriate to them. This is another example of how we're incorporating feedback from our customers. And it's a way to make it simple and easy for our customers to shop and save money. In the first quarter, we opened up 101 new or relocated stores and closed 10 others, resulting in a 38 net new-store impact for the quarter. For the full year, we're still on schedule to open up 250, 300 new stores, including about 100 relocations, once again, adding 2% to 3% retail square footage growth. I think it's worth noting that we're seeing less competition for some of the real estate sites, so the availability and the pricing is slightly better. We entered three new markets in 2010: St. Louis, Memphis and Puerto Rico. Our new markets are exceeding our expectations, especially Puerto Rico. I mean, we're really knocking the cover off the ball here. We've seen third-year run rates already in the first year. We've opened six stores in Puerto Rico during the first quarter and expect to have nine there by year end. We also completed 27 file buys in the first quarter. And as we said, we expect to complete about 200 in 2010. Let me talk a little bit about MinuteClinic. We've handled 7 million patients since its inception. We have a total of 570 clinics in 55 markets across the country. During the quarter, we continued to execute on the move of MinuteClinic from Minneapolis to our corporate headquarters, and we expect to complete that transition by the end of the summer. We expanded our third party coverage, adding close to another million lives in the network and now 81% of our visits are third-party paid. We continue to add new products and services. We recently launched health condition monitoring services for diabetes, hypertension, hyperlipidemia and asthma. The new monitoring serve an improved point-of-test lab tests called, Monitoring Made Easy are designed to support patients with ongoing healthcare conditions in between visits to their primary care provider. They can get immediate results at MinuteClinic regarding their cholesterol, their blood sugar, et cetera. MinuteClinic will send results to the primary care provider with patient permission. Monitoring Made Easy is available at MinuteClinic locations in CVS Pharmacy stores in 20 states and the District of Columbia. So we remain optimistic about the long-term prospects of MinuteClinic. We continue to expand our services and believe it will help us address the changing and the shortage of primary care physicians, as well as addressing the 32 million additional patients that will be covered by health insurance with the healthcare reform package. As we've said, we're investing $0.04 to $0.05 a share this year. And we expect about $0.01 per share related to the move of MinuteClinic back to -- including about $0.01 a share of the MinuteClinic moving back to Woonsocket. So we still expect MinuteClinic to break even by the end of 2011 on an all-in basis. So that's a general business overview. I'll turn it over to Dave Denton for our financials, and then we'll come back for some Q&A.

Thank you, Tom, and good morning. I'm happy to be here today to provide a detailed review of our first quarter financial results. I will also provide an update on our 2010 guidance for the full year and provide initial guidance for the second quarter. But before reviewing our operating results, I want to update you on our capital allocation practices. As I stated previously, we expect to use the majority of our free cash flow in the near term to enhance shareholder returns. And we did just that during the first quarter. Throughout the quarter, we continue to take advantage of our current authorization to repurchase $2 billion worth of our shares. We repurchased $887 million worth of our stock, and as a result, reduced our outstanding share base by approximately 26 million shares. As of the end of March, we had $613 million left on the authorization. And we're confident, we'll complete it during the second quarter. We delivered adjusted earnings per share of $0.60 for the quarter, an increase of 9% and $0.01 higher than the top end of our guidance. GAAP diluted EPS came in at $0.55 for the quarter. Results this quarter were slightly ahead of our expectations, due in part to lower interest expense and fewer weighted average shares. A more rapid pace of share repurchasing was responsible for the lower share count while lower-than-expected average borrowing and interest rates resulted at better-than-expected interest expense. Turning to revenues, our enterprise-wide net revenues increased in the first quarter by 2% to $23.8 billion. Breaking this down by segment, net revenues increased 3% in the PBM to $11.8 billion. Recall that on April 1 of last year, we changed the RxAmerica contracts from a net to gross revenue recognition method. That change added $560 million to the top line in the first quarter. The contract conversion was partially offset by the impact of new business and the termination of our few large client contracts, as well as the expected decrease of covered lives under our Medicare Part D program. Since Q1 was the final quarter to see the impact of our conversion of the RxAmerica network contracts to the Caremark contract structure, we may want to keep that in mind when modeling PBM revenue in the second quarter and the remainder of the year. PBM Pharmacy network revenues in the quarter rose 4% over 2009 levels to $7.7 billion, while Pharmacy network claims were down 10%. Total mail of choice revenues grew by 1% to $4.1 billion, while mail choice claims declined by 5%. The decline in claims was, of course, driven by the net impact of new business and terminations, as well as the decrease in Med D lives resulting from the 2010 bidding process. The network claims loss was impacted by the increase in mail choice penetration as claims continue to move from network to mail. Our overall mail choice penetration rate of 24.8% was up 110 basis points from the rate in the first quarter of '09. In our Retail business, we saw revenues increase 4% to $14 billion in the quarter. Tom spoke about this in detail, so I won't repeat that here. Turning to gross margin, compared to the first quarter of '09, we saw enterprise-wide margin contract by approximately 30 basis points to 20%, in line with our expectations. Within the PBM segment, gross margin was down about 30 basis points. This reflected the change in revenue recognition method for RxAmerica, as well as the elimination of retail differential within the Med D business that began on January 1. Partially offsetting those negative factors was a 270 basis point increase in the PBM's generic dispensing rate. Gross margin in the Retail segment declined by approximately 80 basis points in the first quarter to 28.5%. This largely reflects the impact of continued pressure on pharmacy reimbursement rate, especially those associated with state Medicaid program. The growth in Maintenance Choice, which compresses retail gross margin but helps the overall enterprise and the continued shift in the mix of our business towards pharmacy, these negative factors were partially offset by increased generic dispensing rate, the benefits we are starting to see from various front store initiatives and increased Private Label penetration. Our overall operating expenses as a percentage of revenues improved by approximately 35 basis points over last year's first quarter. The PBM segments rate improved by 20 basis points to 2.1%, primarily due to a decrease in litigation expenses. The Retail segment saw improvement in SG&A leverage of 95 basis points to 21.2%. Retail benefited from the absence of Longs integration expenses and the leverage we gained from the increase in net revenues. These benefits were offset somewhat by increased occupancy expenses. Within the Corporate segment, expenses were $135 million or less than 1% of consolidated revenues, with the percentage of consolidated revenues holding relatively flat to last year. So with improvements in SG&A as a percentage of sales slightly outpacing decline in gross margin, operating margin for the total enterprise improved as expected. It was up approximately 5 basis points to more than 5.9%. As expected, PBM profits were flat to last year, while Retail profits improved by 6%. Operating profit for the total enterprise was within the expected range for the quarter. Now going below the line on the consolidated income statement, we saw net interest expense in the quarter decline by $14 million to $128 million, while our expected income tax rate was 39.8%. And our weighted average share count was just under 1.4 billion shares. During the quarter, we generated approximately $660 million in free cash, which compares to approximately $310 million in last year's first quarter. This margin, increased year-over-year, was driven primarily by better management of our receivables, which we expect to persist throughout the year. Gross capital spending during the quarter was approximately $400 million. Given that we had no sale leaseback activity in the first quarter, this was also our net capital spending. Now let me turn to guidance for the full year 2010. We are narrowing the range and raising the low end of our estimate by $0.03. We now expect to deliver adjusted EPS from continuing operations in the range of $2.77 to $2.84, and GAAP diluted EPS of $2.58 to $2.65. As I said when I provided initial guidance, this includes our expectation that we will complete the remaining authorized share repurchases within the first half of this year, as well as our expectations that Longs will add $0.10 per share versus last year. It does not assume additional share repurchases beyond our current authorization. For the PBM segment, we continue to expect operating profit to decline by 10% to 12%. In the Retail segment, we now expect growth of 12% to 15%, just slightly lower than our prior expectation. This reflects the expected impact of the weaker flu and cough/cold season for the remainder of the year. For the PBM segment, we still expect revenues to decline by 4% to 6% for the year. For the Retail segment, we expect revenue to increase by 5% to 7% and the same-store sales to increase 3.5% to 5.5%, a slight reduction from our prior guidance for the reasons I just outlined. As a result for the total enterprise, we now expect revenue to be roughly flat to 2% down from 2009 levels. That is after inter-company eliminations, which are projected to equal 8.5% of combined segment revenues. For the total company, gross profit margins are expected to moderately improve relative to 2009 levels, with both the PBM and Retail segments modestly down. For the total company, operating expenses are expected to be between 14.5% and 14.7% of consolidated revenues, with the PBM modestly delevering and the Retail segment improving notably. And we expect operating expenses in the Corporate segment to be in the range of $555 million to $575 million, slightly delevering as a percent of consolidated revenues compared to 2009. We continue to expect operating margin for the total company to modestly improve over last year's levels. We currently forecast net interest of about $580 million to $600 million, a tax rate of 40% and approximately 1.38 billion weighted average shares for the year. We still expect total consolidated amortization for the 2010 to be roughly equivalent to last year's levels. Combined with estimated depreciation, we still project approximately $1.4 billion in D&A. Now as for capital spending, we are focusing on those capital projects that allow us to enhance efficiencies across our enterprise, while investing in future growth. We currently expect gross capital expenditures of between $2.4 billion and $2.6 billion, a slight reduction from our previous guidance as we have prioritized our capital investments in those projects yielding the best long term returns. Proceeds from sale leasebacks are still expected to total approximately $500 million to $600 million for the year. While we've had some nice improvements in receivables during the first quarter, we saw our cash cycle degrade slightly, specifically within inventory and accounts payable. As highlighted during our last call, improving working capital performance is one our top priorities. However, driving improvements in working capital does take some time. And even though we're beginning to launch several initiatives focused on improving our performance in this area, the results will not be instantaneous. So don't be surprised to see our cash cycle contract slightly before these improvements take hold and improve the trend. In the short term, the good news is that we are raising our free cash flow target. Given our renewed focus on working capital, better receivables management and a slight reduction in expected capital spend, we are now expected to generate between $2.5 billion and $2.75 billion in 2010, up from our previous guidance of $2 billion to $2.5 billion. And we still expect free cash flow to accelerate in 2011 and beyond. Turning to the second quarter, we expect total company revenues to be down 2% to 4%. In the Retail segment, we expect sales to increase 4.5% to 6.5% and total same-store sales to be up 3% to 5%. In the PBM segment, revenues will decrease by 8.5% to 10.5%, sequentially lower than first quarter levels as we lap the revenue accounting changes relating to RxAmerica. We expect adjusted EPS from continuing operations in the second quarter to be between $0.66 and $0.68 per diluted share compared to last year's $0.65 per share. GAAP EPS is expected to be in the range of $0.62 to $0.64 per diluted share. We expect the PBM segment operating profit to decline at a rate in the low to mid-teens, and we project that retail operating profit will grow at a rate in the high single to low double digits in the second quarter. As I said on the last call, Retail growth is expected to accelerate in the latter half of this year as the benefit from Longs increases and we begin to benefit from several of our current retail initiative. I hope that helps you with your model and provide a comprehensive picture of our financial forecast. And with that, I will turn it back to Tom.

Thanks, Dave. As Nancy said, the Presidents of our Retail and PBM businesses, Larry Merlo and Per Lofberg are with us today. So before opening it up for questions, I'd just like to ask Larry to take a minute or two to talk about why he's confident that the Retail business can achieve the growth that we projected, in spite of a softening economy and weaker-than-expected flu.

Well thanks, Tom, and good morning, everyone. There are several factors that are expected to help drive our retail performance. And let me just comment on some of the business specifics that I believe will positively impact our second half expectation. First is the growth from the Longs acquisition. And that is due in part to the absence of the one-time integration costs that we had last year, and the fact that we expect to see improved performance in the second half of this year. Now I think as you heard Tom mention earlier, these expectations are modeled after the Osco/Sav-On acquisition. And of course, the comparisons should also be easier as we'll be comping up against the disruption of last year's remodels. Our second is our adherence programs in the pharmacy. We should see the benefit of the Consumer Engagement Engine rollout for improved execution, as many of the processes that we have today are manual. And with CEE, we'll become automated into our pharmacy workflow. Additionally, initiatives to improve gross margins in the front end of our business are underway. And that should help drive our growth in the second half. We've been working with suppliers to improve margin performance on a category-by-category basis. We've also been working to refine and tailor our store merchandising programs, recognizing that not all stores are shopped the same. Some of you may recall at last year's Analyst Meeting, we talked about our efforts around tailoring and clustering. And we are in the process of rolling out our Urban Cluster program. The group of stores represents about 20% of our base. And we're improving the category assortment, hours of operation, the check-out experience. And at the same time, we're also doubling the consumable space in about half of our stores to take advantage of quick shopping trips. Now both of these tailoring programs are focused on increasing the number of trips to our stores. And the pilot results have been very encouraging. So we expect these two programs to benefit the second half as we begin to rollout these changes more broadly. Another factor driving the second half is the continued growth in Maintenance Choice. There's more Caremark clients adopt the program and their members take advantage of the flexibility the program affords. In addition, while we've talked about a weak seasonal flu period in Q1, we do expect the strong demand for flu shots as we go through the balance of the year. We're expecting to double flu shots this year with our pharmacists more broadly trained to administer vaccination. And finally, we expect to maintain and grow our retail share through continued focus on store level execution. Now certainly, we take nothing for granted. Like everyone else in the industry, we're battling a tough economic environment and the continued pressures around pharmacy reimbursement rates. And as a result, we know that we have to continue to earn our stripes everyday. That being said, the road map that I've just reviewed, I think, hit some of the highlights of our business that should allow us to achieve the growth targets that Dave laid out for you for the full year. So Tom, I'll turn it back to you.

Thanks, Larry. Now I'll open it up for questions.

[Operator Instructions] Our first question comes from the line of Tom Gallucci with Lazard Capital Markets.

Just wanted to focus in on the PBM side of the business. I was curious if you could just, a, give your perspectives, sort of on the competitive landscape and the pricing environment; and b, you said you think that your increasingly differentiating yourself can maybe, you or Per, point to specific things that seem to be jumping out of clients favorably relative to your sort of new pitch.

I'll just briefly make some comments and let Per jump in. But from a pricing standpoint, we think the market's similar to what it's been from the past five to 10 years. It's competitive, it's aggressive but at the end of the day, clients want the right service and they want the right clinical programs that are going to lower their overall healthcare costs. So it's a balance between pricing and service. I think pricing in the market is still rational and competitive. People have always gone, maybe aggressively after certain clients, and it's been the way for the last 10 to 15 years. And that's the way it'll continue to be. But overall, there's no dramatic changes. And I think we were open and honest when we said we lost some plans because of isolated service issues. And no one ever likes to talk about that. And the reason they say they always lose it is because of price. So overall, I think our pricing is pretty rational and consistent where it's been in the past. As part of the clinical programs, Larry, you want to mention anything about that as far as our offerings around the advisor...

Sure. The couple of flagship programs that are featured in almost every of our type negotiations today are the Maintenance Choice program and the so-called pharmacy advisor program, and I think into next year, the generic testing program that Tom alluded to in his introduction. I think all of those programs will be important, kind of value-added component in terms of both improving medical outcomes and driving down healthcare costs. And they're certainly being well-received as we present them across our existing customers and also introduce them into the new client negotiations that we're bidding onto accounts.

Our next question comes from the line of Scott Mushkin with Jeffries.

I just wondered if you guys could give us a little bit of update on how April is going. You had a bunch of clients come into the Maintenance Choice program that weren't part of a mandatory mail program. Have you seen the April comp accelerate? And how's satisfaction, how did it run in April? Any color you could give around that would be great.

Yes, Scott. We don't report the comps on a monthly basis. You also know you can see the transfer from the intercompany transfer side of the business that we're picking up share. So directionally, we're not going to report on April comps. We're extremely pleased with the client reception on Maintenance Choice.

Then I was wondering maybe you could give us a little tutorial on the consumer engagement engine. How do you expect it? What's the biggest driver to save payer's money? Do you expect it to save consumers' money? And do you think you prescribing in any way will negate some of the benefits of the CEE?

This is Per. So I'll try to comment on that. First of all, I think the innovation of that is sort of built into the consumer engagement engine is that it allows basically interaction with patients, both through the PBM platform and through our 7,000 retail stores based on patient-specific information that is presented to either the call center operator or the pharmacist in the call center or the retail stores. And that basically gives us the opportunity to address patient needs that we can identify based on the information we have available. I think what is unique about it is that because it involves both the Retail Pharmacy channel and the Call Center channels, it expands the reach of patients that we can actually connect with successfully. So in a typical benefit plan, we may have 25%, 30% of the patient base used in the call centers. And on average, probably an equal percentage used in the CVS stores. So in terms of the reach, we actually double the number of patients that we can potentially interact with through those two channels. In addition to that, which I think is very encouraging for us, is that the pilot programs that has been going on this past year, clearly show that consumers and physicians respond more readily when they are contacted by the retail pharmacies, either in a face-to-face interaction between the retail pharmacist and the patient or in a call by the local pharmacist to the treating physician. So the face-to-face interaction is more impactful in terms of changing consumer behavior than a call center interaction. So those two factors together are really a powerful leverage to address the medical needs in our member base. With respect to the e-prescribing, I can just say that I think we're sort of past the inflection point where e-prescribing now is growing rapidly. And that will have significant benefits to our business where we can avoid a tremendous amount of the manual intervention work, both in terms of prior authorization and therapeutic interchange calls and that sort of thing. It can basically replace that with a sort of electronic physician support, which should be a real benefit to the business. As you guys may know, just recently, controlled substances are now allowed to be transacted through e-prescribing, and I think that's going to also increase the adoption rates of that technology.

Do you have any solid numbers with these pilot programs of how much a payer Maintenance Choice would save with the consumer engagement engine? I don't know if you have that granularity.

Yes, we present those from time-to-time, both to specific clients and in our conferences. I can't put anything right off the top of my head here, but if you're interested, I'm sure we can share that kind of information with you at some data point.

And you can look at the numbers that Per has point that were showing the performance, basically in a typical mail environment in a call center environment with a standalone PBM we had Caremark previously. And then what it looks like with an integrated approach as far as adherence programs, generic dispensing compliance. We're seeing much better performance than e-mails. They've seen the numbers on the actual pilot. The other piece I would add, we'll move on, the ultimate goal here is to expand the clinical capability to others in the pharmacy retail network. At the end of the day, we're trying to figure it out in our own network and how we can do it easy and simple for the pharmacist and the patient. And we think we've got it. We know we have it now with this consumer engagement engine. And the question is how we move that on to others in the network and other pharmacies that we can pay for performance around what they do on the clinical side. So that's the ultimate goal.

Our next question comes from the line of Lisa Gill with JPMorgan.

Tom, when you talked about 2011, I know that we talked about a number in the past around renewals, maybe $7.5 billion. Is that the right number?

We're in that range. Here's the issue, we don't want to talk specifically about the renewal rates, but we'll say that we're in good shape right now. But directionally that's the number, that's right. Obviously less of our book of business than we usually have.

My question would be that my understanding is that you've renewed some larger pieces within that $7.5 billion. So I'm just curious as to why you want to want to update us around that at this point, first. And then secondly, as we look at the 2011 early wins that you had, can you maybe just talk about how many of those accounts have Maintenance Choice, some in the step therapy or a specialty so we can start thinking about the different programs we're able to sell into that new base of business?

I'd rather really wait, Lisa, on the -- we have had obviously some new accounts, you know, the ones that are out there publicly around the state of Tennessee, and the Mass GIC. Those are publicly stated accounts. We've had some others. But I don't want to get into the practice of naming each account. We are in good shape from a renewal standpoint. And then also from some new clients that we're taking in in 2011. As far as the breakdown of each of those, we're getting obviously an increased amount of reception on the Maintenance Choice side of the business. I can tell you I've met with a number of clients, I'm going to meet with two others at the end of this month. Initially we're hesitant on Maintenance Choice. But now, we looked at it as a way to save the payer money, save the plan money and save their employees' money by moving to the Maintenance Choice option. So we continue to get a lot of uptick on that, and the generic step therapy program. We continue to get uptick on that. So to my earlier comment, this is about lowering overall costs. You have to be price-competitive on the pharmacy side, you have to continue to lower and control pharmacy spend appropriately and pharmacy trend appropriately. But at the end of the day, it's about service and it's about lowering overall healthcare costs in the acceptance of the clinical programs. So people are seeing the clinical programs that we're offering out there and receptive to it. But I don't want to break it down by client.

And then just one last follow up just on specialty. I think you made a comment that only 60% of your PBM clients buy specialty from Caremark today. Can you maybe just talk about where you see that trend going over the next couple of years?

We're going to continue to work on growing that percentage. I do believe over time, it would be cost-effective for payors to basically single source the specialty program, just like over the past several decades, they're basically almost entirely gone to single source mail service contract. So I think the economics eventually will favor people going to single source arrangements there. And that's obviously a trend that we are promoting and eager to participate in.

Our next question comes from the line of Meredith Adler with Barclays Capital.

I maybe like to start by talking to Larry about some of the effort he has with vendors. Could you talk a little bit more about what some of those initiatives are to drive the gross margin? Is it just squeezing the vendor or is there more to it?

Meredith, it's really normal everyday business in terms of all of the various vehicles that we have to communicate with our customers. So if looking at ExtraCare programs, our promotional programs, as well as just everyday normal course of business in terms of how we present the category in the store, things like our supply chain, scorecard. So there's no one single element. It's probably five or six or seven things that, quite frankly, we've always done. And having just very good conversations in terms of how we can partner together to move the business forward.

Meredith, I would just add that we obviously have pretty good relationship with our suppliers. And the reason we have good relationship is because we can move share. If you look at our performance on the front end of our business, we led the industry for a number of years. When suppliers work with us, to Larry's point, on supply chain costs and productivity and policies, they see results. So to Larry's point, it's a constant just everyday business. It's not the project du jour.

But you do believe that it will drive profitability in the front end?

Sure. Better profitability, better productivity. We're looking to improve productivity and skew optimization and at the same time, balancing what's right for the customer. I use the old example years ago, people would come in and offer us an unbelievable price just to have one particular beverage and not carry any other beverages. Well, at the end of the day, that's shortsighted. You have to give the consumer what they want. So it's a balance between leveraging our size and scale and giving the consumer what they want. But just the answer to your question, we think it will be beneficial.

And Meredith, I guess the only other point I would add is that when you look at the power and the value of our ExtraCare program and the richness of that data for the last 10 years, suppliers are very willing to work together in terms of how we can partner to drive the market basket. And those are things that we're working on pretty excitably.

I have a question about AMP. Do you have a sense of the timing of when that might be introduced? And I have heard one company suggest that there's been so much pressure on Medicaid reimbursement already that may be some of what's happened is kind of absorbing what would happen with an introduction of AMP. Or do you think it will be incrementally worse?

We're certainly getting pressure, individual states with trying to balance the budgets. We've seen pressure from individual states, and they're looking at ways to save money as an industry and individually as a company. We go to states and talk about ways we can save the money through generics, through co-pays. But what I think will actually happen, and I may be off base, but I think the states are going to be more receptive to looking at plan designs that perhaps they weren't as receptive to before around step therapy, around co-pays, around limited formularies. So that's one of the options. As far as when the AMP is going to come in, we're not sure. We think we came out pretty good from a senate side on the way it's being calculated. But it's certainly a hit, but not as big as it could have been.

The testing that you've done of reaching out to patients to change their behavior, how does the local pharmacist reaching out but remotely, doing a phone call or something. How does that compare to the same action by a call center? Is it better when it's the local pharmacist?

Yes.

Much better. And that's really I think one of the great insights from this part of programs over the past couple of months. When the pharmacist has a one- to two-minute conversation with the patient to identify some need that the patient should think about, the likelihood those of patients actually responding favorably and agreeing to do something about it is much greater than when you have an interaction with the call center.

And Meredith, I think that really just comes down to the relationship and the trust that the customer patient has with their pharmacist.

It's what we're seeing. When you get a call from the pharmacist that you have a relationship with, you're certainly more inclined to do it. We see performance double and triple because they respect and trust the pharmacist. The flip side to that is our pharmacists love it. People say, "Well, how can a pharmacist do it?" They make time to do it and they like it because that's what they're trained to do. So there's a receptivity for our people.

Our next question comes from the line of Todd Duvick with Bank of America.

Had a quick question for you in the balance sheet. You've got about $2.4 billion of current debt maturities, and I'm wondering how you're thinking about those maturities with the financing conditions? And also if you can just talk a little bit about share buyback authorization beyond Q2, if you expect to come up with the new authorization?

Yes, this is Dave. Maybe I'll take that question. I guess, number one, we're fortunate in a sense that from a balance sheet perspective, our balance sheet is quite strong. We have very solid credit metrics and we're kind of well-positioned and well-financed from that perspective. And we do have, really this year about $2.1 billion of maturities coming due really within the next six months. The good news is we also generate significant free cash flow, and so a combination of the free cash flow and our access to the debt markets will allow us to accommodate those maturities without any issue. I can update you more broadly on that as time goes forward, but I think we're well-positioned and we have a lot of plans in place to contemplate the financing of the business throughout 2010. As it relates to share repurchases, clearly, one of our focus is about using our capital to enhance the value to shareholders over time. We currently have an authorization that takes us through $2 billion of which will have completed by the end of the first half of this year. At this point in time, we have no additional authorizations in place. And so we can update you again more broadly later in the year.

And that's a discussion that we'll have obviously with our Board. We continue to have it. And we certainly have bought shares back, and we'll continue to look at the opportunities on a go-forward basis.

Our next question comes from the line of Ed Kelly with Crédit Suisse.

I know you've been already asked a little bit about pricing on the PBM front, but I want to approach it from kind of a different angle. What are your thoughts on how you plan to balance the temptation to sacrifice some near-term margin to gain volume into a large generic lead? How do you think about that specifically and how do you think your competitors are thinking about it?

We're not pricing with that particular goal in mind. That's sort of, to kind of paraphrase it, to kind of bulk up in order to take advantage of the new generics. I should say, though, that the patent expirations on the horizon, they're well known to all of the majors, they're well known to the benefit consultants who are evaluating, or a C-Quos [ph], they're well known to the large customers. So in almost all of the major bids, there is some recognition that over the next several years, the generic dispensing rate is going to increase. And that gets built into the pricing over a span of a three-year contract, for example. So it is on the table, but it's a little different than I think what you were theorizing that we were sort of buying business to bulk up for an oncoming patent expiration.

Second question for you on Longs, could you just help us understand why Longs comps are negative now? It seems like it's probably down mid-single digits, I would think you'd be cycling some easy comparisons, but maybe you were closing product out before remodeling the stores? So just some color there would be helpful.

When you talk about the disruptive period that we're going up against, that really begins in the May timeframe. Because keep in mind that during the integration period, we started with the systems conversion. That was completed about this time a year ago, and then the remodel started after that and weren't completed until November.

And then also during that time, we had, obviously as you know, with all the acquisitions that we do, we have special programs to remove merchandise that we don't carry. So you get some artificial pop in those sales that you're competing against that also. You'll see, as we said, as we go throughout the year as those comparisons get better.

Our next question comes from the line of Ann Hynes with Caris & Company.

Just on health reform, Tom. You mentioned how Medicare Part D had a positive impact on utilization. But can you go into detail on what Massachusetts health reform had since you guys have a big exposure of Massachusetts? Can you describe some of your experiences with that, and also with payor mix, because I know Massachusetts was a big extension of Medicaid. So maybe how the reimbursement was for that?

We haven't -- Massachusetts, the experiment in Massachusetts obviously is still the experiment. And this is back to this issue of when we might agree with the healthcare policy, one might disagree with the physical policy on how it's going to be reimbursed. We haven't seen a large or significant increase in Massachusetts. Don't forget we have a pretty significant share in that state. So if it moves the needle, it didn't move it appreciably for us on the connect. But the bigger issue is that the country is going to learn from that and think about how we're going to pay for that, because you do get expanded coverage. And the question is how do you -- not only prescription coverage, but also medical coverage and how does one pay for it. To answer your question specifically, from our perspective we haven't seen a significant increase and I think it's mostly because of just this year's size and share we have.

Just a follow-up on your Specialty business, can you give us an update on how that business is doing and how gross margins are doing in that business?

Well, I'll ask Per to...

Well I think it's doing very nicely. It's a high-growth part of the drugs spend, and we are performing very nicely there. Margins continues to be strong in that business.

Once again, you're getting payers to, it's an important part, it's a growth. It's an important part of their spend. They're obviously working to pull it out of medical and see where we can actually impact it. And there's certain specialty drugs that shouldn't be prescribed, perhaps by primary care physicians. And so once again, it's not just about increasing utilization of pharmaceuticals. It's about the appropriate utilization of pharmaceuticals. And that $200 million annual savings that we had in Specialty, a part of that was because we took people off medications that they shouldn't have been on. I think you know that's what clients are looking for us. They're looking to us to provide solutions around that. And given our history, we believe, obviously, it will help us position us better for the future.

Our next question comes from the line of Deborah Weinswig with Citigroup.

So with regards to the retail front, can you talk a little bit about the promotional environment, and specifically with the ExtraCare card, how or utilizing that to drive traffic and offer value to consumers in this environment?

I'll ask Larry to jump in on that.

We are seeing pretty much the same from the consumer that she is continuing to look for value, and whether it's buying more products on sale or looking at store brand alternatives. As we've said before, we are not planning on promoting more. Deborah, as you just mentioned, we continue to leverage our ExtraCare program to drive more profitable sales. We're doing that in a variety of ways, and it kind of goes back to what we talked a little bit about earlier in terms of deleveraging the data that we have to anticipate purchases, to help the consumer identify value there. What Tom alluded to earlier in terms of the rollout of the ExtraCare kiosk, that was again listening to our customers in terms of how can we make a very good program better. And that's the feedback that they told us. Make the coupons there. We tested that in some markets with very favorable results, and we're chain right with it and you'll see the commercials as we speak. At the same time, we're continuing to look for other ideas that -- and we have a number of column bullets out there in terms of just trying things that haven't been done to see what sticks and to what we can learn from that and apply more broadly for the chain.

Just to add to that, 60-plus million ExtraCare cards, we got a 10-year head start on any of our competitors. We've always said we're a pharmacy that's convenient. We are not a convenience store. And people pushed away from loyalty cards, and we're glad we got the 10-year head start because that's another reason manufacturers want to work with us around the supply chain, because they can target their spend to the appropriate consumer. Our best customers are our most profitable customers, and those are the ones that we're driving. The manufacturer can target their spend. So therefore they're more inclined to give us better pricing and work with us more efficiently because we can target their spend. And I think that's a big, big edge for us in the front end of our business especially.

Our next question comes from the line of John Ransom with Raymond James.

Could you talk a little bit in your role as retailer and as you submit claims to other PBMs. Some of your peers are complaining pretty loudly about increased pressure, particularly, macking [ph], et cetera. Do you notice any of that? And how do you think about that kind of having one that's clearly in both camps?

Like pricing on the PBM side of our business, that's always been part of the industry. It's always a challenge as the PBMs are out negotiating and working on behalf of their clients. We're out looking what's in the best interest of our payer and ultimately, their employee was their member. So we're negotiating on the PBM side of our business in that way, and then we negotiate with the retail network. It's the same thing that's done with us by other PBMs. They were all looking for what's the best way to negotiate the best price and balance that with appropriate coverage, appropriate service. And that's always gone on. And that will continue go on.

You don't think it's any worse, there's nothing unusual this quarter? Because some of your peers seem to think so.

I don't know. I can't speak for my peers. I'm just saying that when we look at our business, third-party margins and third party pressure has always been in the industry. I can remember when people said what are you going to when third parties was 90% of your business, or margins, you just figure out a way to run the business. There's pressure from states, there's pressure from third party plans and there's pressure from payers and I don't think its an immersive effect in that it has been in the past. It's just something that we all have to deal it. We deal with it from a provider side and the payer side.

You're under some public pressure from the chains to when suite hearts [ph]. And some of the people are rattling the cuffs looking at the potential conflicts between your two roles. I just want to give you a kind of softball platform to talk about that and how investors should be thinking about that.

Yes, I think we've talked about that a fair amount in the past. And we've reported on it. There's some obviously some special interest groups that are we think are using some misinformation in the marketplace. We let the competitive marketplace and the consumer and the patient and the payer decide. And if we can have a plan in place, like Maintenance Choice, and extend our mail option, it's just some extension of mail. It's just that we have the ability to do it, maybe others don't, but it's the extension of mail. And I remember when mail came in, people said, "Well that was anti-competitive, and you can't have mandatory mail and people complain." I think it stands up to the light of day when it lowers price for the payer, it lowers price for the ultimate consumer, and it produces better outcomes. So I think some of the noise you're hearing in the marketplace is not necessarily targeted to better healthcare. It focused on better healthcare and better healthcare outcomes that have, maybe, a different agenda.

Our next question comes from the line of Helene Wolk with Sanford Bernstein.

My question is on the PBM, and I know you mentioned or expecting operating deleverage on the PBM side. Is there anything that we should know about in terms of investments in the PBM, or is that purely based on the revenue change?

The revenue change.

Yes, it's primarily. We are investing significantly in improving our internal processes and building technology to deal with new requirements in the marketplace. That, I don't think is going to affect the number you're looking at. That's primarily a revenue impact.

And can you update us on the IT platform changes that you're making and where it stands relative to timeline?

Its an ongoing process, and we are actively working on ways to sort of improve our infrastructure. We don't have any specific target dates or timelines that we are going public with it. But it's an important priority for us internally.

And on the retail front, you had mentioned around Longs expectations accelerating in the back half of the year based partly on the disruption through the remodels. Is there a similar sort of timing incidents here for the integration cost? Meaning, will we see that back-end loaded or is that likely more evenly distributed?

It's a little more evenly distributed across the second, third and fourth quarters.

Our final question comes from the line of Neil Currie with UBS.

Just a simple one about the ExtraCare coupon kiosks. I know you tested these kiosks in a couple of regions, I think out west. And I just wondered if you have the information you could share about. Did they move the needle when it came to comps in those stores that you tested them in?

We don't obviously want to share that information, but the fact that we're rolling it out, I think it kind of speaks for itself. And we're on Today's Show in Ellen DeGeneres and USA Today. And so we were pretty happy with the results there, Neil. Thanks a lot, and appreciate you taking the time. And as always, if you have any questions, you can call Nancy Christal at Investor Relations. Thanks a lot.

Ladies and gentlemen, this does conclude today's conference. Thank you for participating. You may now disconnect.