CVS Caremark Corporation (CVS)

During the first quarter of 2007, net PBM revenues benefited from the Caremark Merger. Caremark operations accounted for a PBM Segment revenue increase of approximately $1.0 billion or 118% during the first quarter of fiscal 2007.

As a result of the Caremark Merger, PBM revenues benefited by increased mail volume of 22.2% during the quarter. This was partially offset by a decrease in average script price due to the conversion of brand named drugs to equivalent generic drugs, which typically have a lower selling price.

The PBM Segment recognizes revenues for its national retail pharmacy network transactions based on an individual contract basis. In accordance with Emerging Issues Task Force Issue No. 99-19, “Reporting Revenue Gross as a Principal versus Net as an Agent”, (“EITF 99-19”), Caremark contracts are predominately accounted for on a gross basis whereas PharmaCare’s contracts are accounted for on a net basis. During 2007, we expect a number of PharmaCare’s contracts to be converted to Caremark’s contract structure, which will result in those contracts being accounted for under the gross method. Please see Note 2 to the consolidated condensed financials included herein for further information regarding our revenue recognition policies.

PBM revenues continued to benefit from certain risk-based or reinsurance arrangements in connection with providing pharmacy plan management services to prescription drug plans qualifying under Medicare Part D.

Our pharmacy gross profit rate continued to benefit from an increase in generic drug revenues, which normally yield a higher gross profit rate than equivalent brand name drug revenues. However, increased utilization of generic products has resulted in increased scrutiny of generic reimbursement payments to pharmacies, causing a reduction in the generic profit rate. We expect this trend to continue.

Sales to customers covered by third party insurance programs have continued to increase and, thus, have become a larger component of our total pharmacy business. On average, our gross profit on third party pharmacy revenues is lower than our gross profit on cash pharmacy revenues. Retail pharmacy third party revenues were 94.4% of pharmacy revenues during the first quarter of 2007, compared to 93.9% of pharmacy revenues during the first quarter of 2006. We expect this trend to continue.

As a result of the introduction of the new Medicare Part D benefit during 2007, utilization has increased and pharmacy gross profit rates have decreased as higher profit business (such as cash and state Medicaid customers) continue to migrate to Part D coverage.

On February 8, 2006, the President signed into law the Deficit Reduction Act of 2005 (the “Act”). The Act seeks to reduce federal spending by altering Medicaid reimbursement formula for multi-source (i.e., generic) drugs. According to the Congressional Budget Office, retail pharmacies are expected to negotiate with individual states for higher dispensing fees to mitigate the adverse effect of these changes. These changes are currently scheduled to take effect during the second quarter of 2007 and are expected to result in reduced Medicaid reimbursement rates for retail pharmacies.

Our pharmacy gross profit rates have been adversely affected by the efforts of managed care organizations, pharmacy benefit managers, governmental and other third party payors to reduce their prescription costs. In the event this trend continues, we may not be able to sustain our current rate of revenue growth and gross profit dollars for the retail pharmacy segment could be adversely impacted.

Our gross margin rates have been impacted by the Caremark Merger. As discussed above, retail network contracts are reviewed on an individual basis to determine under applicable accounting rules whether contractual revenues should be accounted for under the gross or net method. Under these rules the majority of Caremark’s network contracts are accounted for using the gross method, resulting in increased revenues and increased cost of revenues.

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