CVS Caremark Corporation — Q2 2012 Form 10-Q
Reporting period: Three and six months ended June 30, 2012. CVS Caremark operated Pharmacy Services, Retail Pharmacy and Corporate segments. Financial statements are unaudited; the independent accountant performed an interim review, not an audit.
Financial performance
| Metric | Q2 2012 | Q2 2011 | Six months 2012 | Six months 2011 |
|---|---|---|---|---|
| Net revenues | $30.714B | $26.414B | $61.512B | $52.109B |
| Operating profit | $1.708B | $1.484B | $3.111B | $2.789B |
| Net income attributable to CVS Caremark | $966M | $816M | $1.742B | $1.529B |
| Diluted EPS | $0.75 | $0.60 | $1.34 | $1.12 |
| Gross margin | 17.7% | 19.3% | 17.2% | 18.9% |
Q2 revenue rose 16.3% and attributable net income rose 18.4% year over year; first-half revenue rose 18.0% and attributable net income rose 13.9%. Higher revenue reflected Pharmacy Services growth, drug-cost inflation, new PBM clients, the acquired Universal American Medicare PDP business, and retail sales. Gross margin fell as the business mix shifted toward lower-margin Pharmacy Services. Operating-expense leverage helped offset that pressure.
Segments: Q2 Pharmacy Services revenue increased 28.2% to $18.423B, while operating profit rose to $511M from $448M; its operating margin declined to 2.8% from 3.1%, amid pricing pressure and higher operating costs. Retail Pharmacy revenue increased 6.9% to $15.846B, and operating profit rose to $1.469B from $1.240B; operating margin improved to 9.3% from 8.4%.
Cash flow, balance sheet and capital allocation
- Six-month operating cash flow was $4.017B, compared with $3.073B; management attributed much of the increase to a CMS advance received in June for July Medicare Part D premiums and claims, a timing effect.
- Investing cash outflow was $1.085B, versus $2.066B; the prior-year period included the $1.3B UAM Medicare PDP acquisition. Financing cash outflow was $2.522B, primarily reflecting $1.998B in share repurchases and $420M in dividends.
- At June 30, cash and equivalents were $1.823B; long-term debt was $9.208B, short-term debt $200M, and the current portion of long-term debt $5M. The company reported $19.299B of current assets and $13.136B of current liabilities.
- CVS repurchased 44.7M shares for approximately $2.0B in the first half, leaving about $1.0B authorized. Dividends declared were $0.1625 per share for Q2, versus $0.1250 a year earlier.
- The company reported no borrowings under its backup credit facilities and $200M of commercial paper outstanding. It said operating cash flows, its commercial paper program and potential future borrowings were expected to support liquidity needs and planned initiatives.
Material developments, outlook and risks
- Effective January 1, 2012, CVS changed the valuation method for retail prescription-drug inventories to weighted average cost. The opening adjustment reduced inventory by $146M and retained earnings by $89M, with a $57M increase in current deferred tax assets. The change reduced Q2 gross profit by about $31M; prior periods were not retrospectively adjusted.
- Retail pharmacy same-store sales rose 5.6% in Q2. Growth benefited from additional Express Scripts customers while Walgreens was outside that network. Express Scripts and Walgreens announced a new agreement effective September 15, 2012; CVS cautioned that retaining the business gained during the impasse was uncertain.
- Management cited continuing PBM pricing and rebate competition, reimbursement pressure, generic-drug impacts, customer retention, government-program regulation, health-care reform, information-security risks, and litigation or investigations. The filing gives no specific earnings or revenue guidance.
- The FTC investigation concluded in May 2012 under a consent order prohibiting misrepresentation of Medicare Part D drug prices or costs; CVS paid $5M in consumer redress. A multi-state investigation continued. Other disclosed matters included Medicaid-related claims, pharmacy-network antitrust litigation and a securities class-action dismissal under appeal. Management said legal accruals were not material, but outcomes of certain matters could not be predicted or reasonably estimated.
- CVS acquired the remaining 40% interest in Generation Health on June 29 for $31M. It also continued to carry guarantees for approximately 76 former-subsidiary store leases, with the longest remaining term through 2022; management did not expect these guarantees to materially affect consolidated results.
Important facts for investors to verify
- Whether CVS retained customers gained during the Express Scripts–Walgreens dispute after their new network agreement took effect.
- How much operating cash flow reflects recurring operations versus the CMS payment timing benefit.
- Whether Pharmacy Services can protect margins amid client pricing pressure, rebate sharing and reimbursement changes.
- The ongoing earnings and comparability effects of the retail inventory accounting change.
- Developments and potential exposure in the continuing government investigations, litigation and former-subsidiary lease guarantees.