Overview of Our Business

CVS Caremark Corporation ("we", "our", the "Company") is the largest provider of prescriptions in the United States. We fill or manage more than one billion prescriptions annually. As a fully integrated pharmacy services company, we believe we can drive value for our customers by effectively managing pharmaceutical costs and improving health care outcomes through our pharmacy benefit management, mail order and specialty pharmacy division, Caremark Pharmacy Services ®; our nearly 7,000 CVS/pharmacy ® and Longs Drug ® retail stores; our retail-based health clinic subsidiary, MinuteClinic ®; and our online pharmacy, CVS.com ®.

We strive to improve clinical outcomes to help employers and health plans control their health care costs. In that regard, we offer disease management, health assessment and wellness services to help plan participants manage and protect against potential health risks and avoid future health costs.

Today's health care delivery system is rapidly changing. Health care is becoming more consumer-centric as the U.S. health care system struggles to manage growing costs and employers are shifting more of the responsibility for managing those costs to employees. In addition, the aging population, increasing incidences of chronic diseases and increasing utilization of the Medicare drug benefit are fueling the demand for prescriptions and pharmacy services. Further, cost-effective generic drugs are becoming more widely available and new drug therapies are being introduced to treat unmet health care needs and reduce hospital stays. Consumers require medication management programs and better information to help them get the most out of their health care dollars. To assist our consumers with these requirements, we have introduced Proactive Pharmacy Care™, an earlier, easier, more effective approach to engaging plan participants in behaviors that can help lower costs, improve health, and save lives. Examples of Proactive Pharmacy Care programs include: Maintenance Choice™ (a flexible fulfillment option that affords eligible plan participants the convenient choice of picking up their 90-day supply of maintenance medications at any CVS/pharmacy store or obtaining them through mail order in either case at the cost of mail, which is typically lower, for both the plan participant and payor); Bridge Supply; and a new ExtraCare® Health Card program. As a fully integrated pharmacy services company, we believe we are well positioned to provide solutions to address these trends and improve the pharmacy services experience for consumers.

Our business includes two operating segments: Pharmacy Services and Retail Pharmacy.

Fiscal Year Change

On December 23, 2008, the Board of Directors of the Company approved a change in the Company's fiscal year end from the Saturday nearest December 31 of each year to December 31 of each year to better reflect the Company's position in the health care, rather than the retail, industry. The fiscal year change was effective beginning with the fourth quarter of fiscal 2008. The second quarter of 2009 and 2008 both include 91 days and the six months ended June 30, 2009 and June 28, 2008 include 181 days and 182 days, respectively.

Results of Operations

The following discussion explains the material changes in our results of operations for the quarters and six months ended June 30, 2009 and June 28, 2008 and the significant developments affecting our financial condition since December 31, 2008. We strongly recommend that you read our audited consolidated financial statements and footnotes and Management's Discussion and Analysis of Financial Condition and Results of Operations included as Exhibit 13 to our annual report on Form 10-K for the fiscal year ended December 31, 2008 (the "2008 Form 10-K") along with this report.

Management's Discussion and Analysis of Financial Condition and Results of Operations

Second Quarter and Six Months Ended June 30, 2009 and June 28, 2008

Summary of the Consolidated Financial Results:



                                                     Second Quarter                   Six Months Ended
                                                June 30,         June 28,         June 30,         June 28,
(In millions, except per share amounts)           2009             2008             2009             2008
Net revenues                                   $ 24,871.1       $ 21,140.3       $ 48,265.0       $ 42,466.3
Gross profit                                      5,052.2          4,373.2          9,800.2          8,666.2
Operating expenses                                3,452.4          2,895.1          6,823.2          5,818.0

Operating profit                                  1,599.8          1,478.1          2,977.0          2,848.2
Interest expense, net                               127.9            114.7            270.0            245.6

Earnings from continuing operations before
income tax provision                              1,471.9          1,363.4          2,707.0          2,602.6
Income tax provision                                582.8            539.9          1,074.4          1,030.6

Earnings from continuing operations                 889.1            823.5          1,632.6          1,572.0
Loss from discontinued operations, net of
income tax benefit                                   (2.6 )          (48.7 )           (7.7 )          (48.7 )

Net earnings                                        886.5            774.8          1,624.9          1,523.3

Diluted earnings per common share:
Earnings from continuing operations            $     0.60       $     0.56       $    1.110       $     1.07
Loss from discontinued operations                      -             (0.03 )         (0.005 )          (0.03 )

Diluted net earnings per common share          $     0.60       $     0.53       $    1.105       $     1.04

Net revenues increased $3.7 billion and $5.8 billion during the second quarter and six months ended June 30, 2009, respectively. As you review our performance in this area, we believe you should consider the following important information:

• Effective October 20, 2008, we acquired Longs Drug Stores Corporation, which included 529 retail drug stores (the "Longs Drug Stores"), RxAmerica, LLC ("RxAmerica"), which provides pharmacy benefit management services and Medicare Part D benefits, and other related assets (collectively, the "Longs Acquisition"). During the second quarter of 2009 and six months ended June 30, 2009, the Longs Acquisition, net of intersegment eliminations, accounted for approximately $1.9 billion and $3.2 billion, respectively, of net revenue.

• During the six months ended June 30, 2009, one less day in the reporting period decreased net revenues by approximately $382.0 million, compared to the six months ended June 28, 2008.

Please see the Segment Analysis later in this document for additional information about our net revenues.

Gross profit increased $679.0 million and $1.1 billion during the second quarter and six months ended June 30, 2009, respectively. As you review our performance in this area, we believe you should consider the following important information:

• During the second quarter of 2009 and the six months ended June 30, 2009, our gross profit dollars increased as a result of the Longs Acquisition; however our gross profit rate decreased slightly during the six months ended June 30, 2009 as a result of the Longs Acquisition.

Management's Discussion and Analysis of Financial Condition and Results of Operations

• Our gross profit continued to benefit from the increased utilization of generic drugs (which normally yield a higher gross profit rate than equivalent brand name drugs) in both the Pharmacy Services and Retail Pharmacy Segments.

• During the six months ended June 30, 2009, one less day in the reporting period decreased gross profit by approximately $92.8 million, compared to the six months ended June 28, 2008.

Please see the Segment Analysis later in this document for additional information about our gross profit.

Operating expenses increased $557.3 million and $1.0 billion during the second quarter and the six months ended June 30, 2009, respectively. As you review our performance in this area, we believe you should consider the following important information:

• During the second quarter of 2009 and the six months ended June 30, 2009, operating expenses increased as a result of the Longs Acquisition, including incremental costs associated with the integration of the Longs Drug Stores and RxAmerica.

• During the six months ended June 30, 2009, one less day in the reporting period decreased operating expenses by approximately $58.8 million, compared to the six months ended June 28, 2008.

Please see the Segment Analysis later in this document for additional information about our operating expenses.

Interest expense, net consisted of the following:

                                           Second Quarter Ended                             Six Months Ended
(In millions)                      June 30, 2009           June 28, 2008          June 30, 2009           June 28, 2008
Interest expense                  $         129.1         $         118.5        $          273.1        $         255.7
Interest income                              (1.2 )                  (3.8 )                  (3.1 )                (10.1 )

Interest expense, net             $         127.9         $         114.7        $          270.0        $         245.6

Net interest expense increased $13.2 million and $24.4 million during the second quarter and the six months ended June 30, 2009, respectively. This was primarily the result of an increase in our average debt balance due to increased borrowings to fund the Longs Acquisition.

Income tax provision ~ Our effective income tax rate was 39.6% and 39.7% for the second quarter and six months ended June 30, 2009, respectively, compared to 39.6% for the comparable 2008 periods.

Earnings from continuing operations for the second quarter ended June 30, 2009 increased $65.6 million, or 8.0%, to $889.1 million (or $0.60 per diluted share), compared to $823.5 million (or $0.56 per diluted share), in the comparable 2008 period. Earnings from continuing operations for the six months ended June 30, 2009 increased $60.6 million, or 3.9%, to $1.63 billion (or $1.11 per diluted share), compared to $1.57 billion (or $1.07 per diluted share) in the comparable 2008 period.

Loss from discontinued operations ~ In connection with certain business dispositions completed between 1991 and 1997, the Company continues to guarantee store lease obligations for a number of former subsidiaries, including Linens 'n Things. The Company's loss from discontinued operations for the second quarter and six months ended June 30, 2009 included $2.6 million ($4.3 million, net of a $1.7 million income tax benefit) and $7.7 million ($12.6 million, net of a $4.9 million income tax benefit) of lease-related costs (i.e., interest accretion

Management's Discussion and Analysis of Financial Condition and Results of Operations

and legal fees), respectively. This was compared to a loss from discontinued operations for the second quarter and six months ended June 28, 2008 of $48.7 million ($78.8 million, net of a $30.1 million income tax benefit) of lease-related costs. Please see Note 11 to the consolidated financial statements for additional information about our lease guarantees.

Net earnings for the second quarter ended June 30, 2009 increased $111.7 million or 14.4% to $886.5 million (or $0.60 per diluted share), compared to $774.8 million (or $0.53 per diluted share) in the comparable 2008 period. Net earnings for the six months ended June 30, 2009 increased $101.6 million or 6.7% to $1.62 billion (or $1.10 per diluted share), compared to $1.52 billion (or $1.04 per diluted share) in the comparable 2008 period.

Segment Analysis

We evaluate segment performance based on net revenues, gross profit and
operating profit before the effect of certain intersegment activities and
charges. Following is a reconciliation of the Company's business segments to the
consolidated financial statements:



                                Pharmacy Services       Retail Pharmacy        Intersegment            Consolidated
In millions                        Segment (1)              Segment           Eliminations(2)             Totals
Second Quarter Ended
June 30, 2009:
Net revenue                    $          13,007.9     $        13,797.2     $        (1,934.0 )      $     24,871.1
Gross profit                                 921.1               4,131.1                    -                5,052.2
Operating profit                             637.5                 962.3                    -                1,599.8
June 28, 2008:
Net revenue                    $          10,656.8     $        11,770.8     $        (1,287.3 )      $     21,140.3
Gross profit                                 849.9               3,523.3                    -                4,373.2
Operating profit                             614.1                 864.0                    -                1,478.1
Six Months Ended
June 30, 2009:
Net revenue                    $          24,542.7     $        27,294.1     $        (3,571.8 )      $     48,265.0
Gross profit                               1,712.9               8,087.3                    -                9,800.2
Operating profit                           1,123.3               1,853.7                    -                2,977.0
June 28, 2008:
Net revenue                    $          21,421.5     $        23,616.4     $        (2,571.6 )      $     42,466.3
Gross profit                               1,637.9               7,028.3                    -                8,666.2
Operating profit                           1,144.1               1,704.1                    -                2,848.2

(1) Net revenues of the Pharmacy Services Segment include approximately $1.77 billion and $1.54 billion of Retail Co-payments for the second quarters ended June 30, 2009 and June 28, 2008, respectively. Net revenues of the Pharmacy Services Segment include approximately $3.44 billion and $3.20 billion of Retail Co-payments for the six months ended June 30, 2009 and June 28, 2008, respectively.

(2) Intersegment eliminations relate to intersegment revenues that occur when a Pharmacy Services Segment customer uses a Retail Pharmacy Segment store to purchase covered products. When this occurs, both segments record the revenue on a standalone basis.

Management's Discussion and Analysis of Financial Condition and Results of Operations

Pharmacy Services Segment

The following table summarizes our Pharmacy Services Segment's performance for
the respective periods:



                                            Second Quarter Ended                Six Months Ended
                                          June 30,         June 28,         June 30,         June 28,
(In millions)                               2009             2008             2009             2008
Net revenues                             $ 13,007.9       $ 10,656.8       $ 24,542.7       $ 21,421.5
Gross profit                                  921.1            849.9          1,712.9          1,637.9
Gross profit % of net revenues                  7.1 %            8.0 %            7.0 %            7.6 %
Operating expenses                            283.6            235.8            589.6            493.8
Operating expense % of net revenues             2.2 %            2.2 %            2.4 %            2.3 %
Operating profit                              637.5            614.1          1,123.3          1,144.1
Operating profit % of net revenues              4.9 %            5.8 %            4.6 %            5.3 %

Net revenues:
Mail service                             $  4,072.7       $  3,620.8       $  8,027.7       $  7,267.9
Retail network                              8,844.9          6,942.9         16,343.1         13,966.7
Other                                          90.3             93.1            171.9            186.9
Pharmacy claims processed:
Total                                         164.1            151.3            327.5            308.1
Mail service                                   15.8             15.0             31.5             30.3
Retail network                                148.3            136.3            296.0            277.8
Generic dispensing rate:
Total                                          67.8 %           64.5 %           67.7 %           64.3 %
Mail service                                   56.3 %           54.5 %           55.9 %           53.6 %
Retail network                                 68.9 %           65.5 %           68.9 %           65.3 %
Mail order penetration rate(1)                 22.9 %           23.5 %           22.9 %           23.3 %

(1) Excluding the impact of RxAmerica and Maintenance Choice, the mail order penetration rate would have been 26.1% for the second quarter of 2009 and 25.5% for the six months ended June 30, 2009.

Net revenues ~ Net revenues increased $2.4 billion, or 22.1%, to $13.0 billion, and $3.1 billion, or 14.6%, to $24.5 billion in the second quarter and six months ended June 30, 2009, respectively, compared to $10.7 billion and $21.4 billion in the second quarter and six months ended June 28, 2008, respectively. As you review our Pharmacy Services Segment's revenue performance, we believe you should consider the following important information:

• The Pharmacy Services Segment recognizes revenues for its national retail pharmacy network transactions based on individual contract terms. In accordance with Emerging Issues Task Force Issue ("EITF") No. 99-19, "Reporting Revenue Gross as a Principal versus Net as an Agent," Caremark's contracts are predominantly accounted for using the gross method. Prior to April 2009, RxAmerica's contracts were accounted for using the net method. Effective April 1, 2009, we converted a number of the RxAmerica retail pharmacy network contracts to the Caremark contract structure, which resulted in those contracts being accounted for using the gross method which increased net revenues during the second quarter and six months ended June 30, 2009.

• During the second quarter and six months ended June 30, 2009, the inclusion of RxAmerica's results, increased net revenues by approximately $972.1 million and $1.2 billion, respectively, compared to the second quarter and six months ended June 28, 2008, respectively. These increases include the conversion of RxAmerica's retail pharmacy network contracts to the Caremark contract structure discussed above.

Management's Discussion and Analysis of Financial Condition and Results of Operations

• During the six months ended June 30, 2009, one less day in the reporting period decreased net revenues by approximately $158.9 million, compared to the six months ended June 28, 2008.

• Our mail service claims processed increased 5.3% and 4.0% to 15.8 million and 31.5 million claims in the second quarter and six months ended June 30, 2009, respectively, compared to 15.0 million and 30.3 million claims in the second quarter and six months ended June 28, 2008, respectively. This increase was primarily due to net new client starts offset by claims which were filled at a retail pharmacy under the Maintenance Choice program and are reported as retail claims. Maintenance Choice is a flexible fulfillment option that affords eligible plan participants the convenient choice of picking up their 90-day supply of maintenance medications at any CVS/pharmacy store or obtaining them through mail order, in either case, at the cost of mail (which is typically lower) for both the payer and the plan participant.

• During the second quarter and six months ended June 30, 2009, our average revenue per mail service claim increased by 7.0% and 6.1%, respectively, compared to the second quarter and six months ended June 28, 2008. Specialty mail service claims, which have significantly higher average net revenues per claim, were the primary driver of the increase. Average revenue per specialty mail service claim increased primarily due to drug cost inflation and claims mix. These increases were offset, in part, by an increase in the percentage of generic drugs dispensed and changes in client pricing.

• Our mail service generic dispensing rate increased to 56.3% and 55.9% in the second quarter and six months ended June 30, 2009, respectively, compared to 54.5% and 53.6% in the second quarter and six months ended June 28, 2008, respectively. This increase was primarily due to new generic drug introductions and our continued efforts to encourage plan participants to use generic drugs when they are available.

• Our retail network claims processed increased 8.8% and 6.6% to 148.3 million and 296.0 million in the second quarter and six months ended June 30, 2009, respectively, compared to 136.3 million and 277.8 million in the second quarter and six months ended June 28, 2008, respectively. This increase was primarily due to the addition of RxAmerica claims, new client starts and claims which were filled at retail pharmacies under the Maintenance Choice program, offset by a reduction in claims due to the termination of two large health plan clients effective January 1, 2009 and having one less day in the six months ended June 30, 2009, as discussed above.

• During the second quarter and six months ended June 30, 2009, our average revenue per retail network claim processed increased 17.1% and 9.8%, respectively, compared to the second quarter and six months ended June 28, 2008. Our average revenue per retail network claim processed is affected by (i) higher drug costs, which normally result in higher claim revenues,
(ii) customer pricing, (iii) changes in the percentage of generic drugs dispensed and (iv) claims mix. In addition, our average revenue per retail network claim was impacted by the inclusion of RxAmerica results, whose retail pharmacy network contracts were accounted for using the net revenue recognition method prior to April 1, 2009, as discussed above.

• Our retail network generic dispensing rate increased to 68.9% in the second quarter and six months ended June 30, 2009, compared to 65.5% and 65.3% in the second quarter and six months ended June 28, 2008, respectively. This increase was primarily due to the impact of new generic drug introductions, our continued efforts to encourage plan participants to use generic drugs when they are available and the impact of RxAmerica claims. RxAmerica retail network claims increased our generic dispensing rate by approximately 110 and 120 basis points during the second quarter and six months ended June 30, 2009 compared to the second quarter and six months ended June 28, 2008.

Management's Discussion and Analysis of Financial Condition and Results of Operations

Gross profit includes net revenues less cost of revenues. Cost of revenues includes (i) the cost of pharmaceuticals dispensed, either directly through our mail service and specialty retail pharmacies or indirectly through our national retail pharmacy network, (ii) shipping and handling costs and (iii) the operating costs of our mail service pharmacies, customer service operations and related information technology support. Gross profit as a percentage of revenues was 7.1% and 7.0% in the second quarter and six months ended June 30, 2009, respectively, compared to 8.0% and 7.6% in the second quarter and six months ended June 28, 2008, respectively.

As you review our Pharmacy Services Segment's performance in this area, we believe you should consider the following important information:

• Our total generic dispensing rate increased to 67.8% and 67.7% in the second quarter and six months ended June 30, 2009, respectively, compared to 64.5% and 64.3% in the second quarter and six months ended June 28, 2008, respectively. RxAmerica claims increased our total generic dispensing rate by approximately 110 and 120 basis points during the second quarter and six months ended June 30, 2009, respectively, compared to the second quarter and six months ended June 28, 2008.

• Our gross profit dollars and gross profit rates continued to be impacted by our efforts to (i) retain existing customers, (ii) obtain new business,
(iii) migrate customers and participants to our Maintenance Choice™ program and (iv) maintain or improve the purchase discounts we received from manufacturers, wholesalers and retail pharmacies. During the 2008 selling season, the Company renewed a number of existing clients and obtained new clients at lower rates, which resulted in gross profit compression in the second quarter and six months ended June 30, 2009.

• Our gross profit as a percentage of revenues was negatively impacted by the inclusion of RxAmerica results in the second quarter and six months ended June 30, 2009.

• In January 2009, the Centers for Medicare and Medicaid Services ("CMS") issued a regulation requiring that, beginning in 2010, any difference between the drug price charged to Medicare Part D plan sponsors by a PBM and the drug price paid by the PBM to the dispensing provider (commonly called "differential" or "spread") be reported as an administrative cost rather than a drug cost of the plan sponsor for purposes of calculating certain government subsidy payments and the drug price to be charged to enrollees. These changes impact our ability to offer Medicare Part D plan sponsors pricing for 2010 that includes the use of retail network "differential" or "spread," and we expect these changes to reduce the profitability of our Medicare Part D business beginning in 2010.

Total operating expenses, which include selling, general and administrative expenses (including integration and other merger-related expenses), depreciation and amortization related to selling, general and administrative activities and retail specialty pharmacy store and administrative payroll, employee benefits and occupancy costs increased $47.8 million to $283.6 million, or 2.2% of net revenues, and $95.8 million to $589.6 million, or 2.4% of net revenues, in the second quarter and six months ended June 30, 2009, respectively, compared to $235.8 million, or 2.2% of net revenues, and $493.8 million, or 2.3% of net revenues, in the second quarter and six months ended June 28, 2008, respectively.

Management's Discussion and Analysis of Financial Condition and Results of Operations

As you review our Pharmacy Services Segment's performance in this area, we believe you should consider the following important information:

• The dissolution of our joint venture with Universal American Corporation ("UAC") at the end of fiscal 2008, the income from which was historically an offset to operating expenses, and the inclusion of RxAmerica's total . . .