CVS Caremark Corporation — Q1 2011 Form 10-Q
Reporting period: Three months ended March 31, 2011; comparisons are with Q1 2010 unless noted. The filing is for CVS Caremark Corporation (now CVS Health), and its interim financial statements are unaudited. The independent accountant performed a review, not an audit.
Financial results
| Metric | Q1 2011 | Q1 2010 | Change |
|---|---|---|---|
| Net revenue | $25.880 billion | $23.760 billion | Up 8.9% |
| Gross profit | $4.751 billion | $4.746 billion | Essentially flat |
| Gross margin | 18.4% | 20.0% | Down about 160 bps |
| Operating profit | $1.311 billion | $1.410 billion | Down $99 million |
| Income from continuing operations | $713 million | $772 million | Down 7.6% |
| Net income attributable to CVS Caremark | $713 million | $771 million | Down 7.5% |
| Diluted EPS | $0.52 | $0.55 | Down $0.03 |
| Operating cash flow | $1.866 billion | $1.060 billion | Up $806 million |
Margins and operating drivers: Operating expenses rose 3.1% to $3.440 billion, but declined to 13.3% of revenue from 14.0%. Net interest expense was $134 million versus $128 million; the effective tax rate was 39.4% versus 39.8%. Dividends declared were $0.125 per share, compared with $0.0875.
Segments: Pharmacy Services revenue increased 18.4% to $14.014 billion, while operating profit fell to $397 million from $538 million; its gross margin declined to 4.6% from 6.6%, chiefly reflecting client pricing compression and the pricing of a new large health-insurer contract. Claims volume rose, partly due to that contract, and generic dispensing increased. Retail Pharmacy revenue increased 4.4% to $14.587 billion; operating profit rose to $1.096 billion from $1.030 billion. Same-store sales increased 2.6%, while gross margin edged down to 28.4% from 28.5%.
Balance sheet, cash flow and capital
At March 31, 2011, cash and cash equivalents were $2.162 billion, up from $1.427 billion at year-end 2010. Current assets were $18.380 billion and current liabilities $11.465 billion. Short-term debt was $300 million; current long-term debt was $806 million; long-term debt was $8.669 billion. Total debt was approximately $9.8 billion, calculated from these reported balances. The filing reported long-term debt carrying value of $9.5 billion and estimated fair value of $10.1 billion. Cash balances include amounts in transit and funds held by insurance subsidiaries for claims.
Q1 investing cash outflow was $299 million, including $309 million of property and equipment purchases. Financing cash outflow was $832 million, including $301 million of long-term debt repayments, $171 million of dividends paid and $467 million of share repurchases. The company repurchased 14.2 million shares under its $2.0 billion authorization. Operating cash flow improved, with management citing inventory management, supplier-payment timing and higher claims payables, partly offset by increased receivables.
The company had $300 million of commercial paper outstanding at a 0.41% weighted-average rate and no borrowings under its backup credit facilities. A $1.4 billion facility was due to expire May 12, 2011; CVS Caremark said it intended to renew it. Long-term debt ratings were Moody’s Baa2 (stable) and S&P BBB+ (negative).
Material developments, outlook and risks
- Revenue growth was supported by a large PBM contract effective January 1, 2011, retail sales and new stores. Management reported ongoing PBM pricing pressure, particularly from contract renewals and competition, and expected these trends to continue.
- On April 29, 2011, after quarter-end, the company acquired Universal American’s Medicare Part D business for cash consideration of $1.25 billion plus $185 million of excess capital, less $110 million of assumed trust preferred securities. Management said the addition would bring Medicare benefit coverage to over 3 million beneficiaries.
- Management planned to open approximately 225–250 new or relocated retail drugstores in full-year 2011. The filing provides no specific full-year revenue or earnings guidance.
- Key stated risks include PBM client losses and pricing demands, reduced pharmacy reimbursement and manufacturer discounts, generic-drug mix and pricing changes, competition, health-care legislation and regulation, and litigation or government investigations. Management cautioned that actual results could differ materially from forward-looking statements.
- In April 2011, the company settled a Medicare/Medicaid claims investigation for $17.5 million and an amendment to its Corporate Integrity Agreement; the quarter-end legal reserve was stated to be sufficient. Other disclosed matters include PBM-related government investigations, antitrust claims, wage-and-hour class or collective actions, securities litigation and an SEC subpoena. Management could not predict the outcomes of several matters.
- The company disclosed guarantees on approximately 83 former-subsidiary store leases, excluding Linens ’n Things, with remaining terms extending through 2019. Management did not expect their ultimate disposition to materially adversely affect consolidated results or financial condition.
Most important facts for investors to verify
- Whether Pharmacy Services pricing compression continues and how the new large-client contract contributes to profit, not just revenue and claims volume.
- Whether operating cash flow remains strong after considering working-capital timing, and the company’s cash and debt position following the April 2011 acquisition.
- The acquired Medicare Part D business’s purchase accounting, integration, performance and effect on leverage and cash needs.
- Progress on renewing the expiring backup credit facility and any change in debt ratings or borrowing costs.
- Developments in the government investigations, litigation and compliance obligations, including any additional financial or operating consequences.