CVS Caremark Corporation — 2011 Q2 Form 10-Q
Reporting period: Three and six months ended June 30, 2011; comparable periods are 2010. The filing is by CVS Caremark Corporation, then a diversified pharmacy services and retail pharmacy company.
Financial performance
Amounts are in millions of dollars, except per-share data and percentages.
| Metric | Q2 2011 | Q2 2010 | Six months 2011 | Six months 2010 |
|---|---|---|---|---|
| Net revenues | $26,629 | $24,007 | $52,509 | $47,767 |
| Gross profit | $5,095 | $5,020 | $9,846 | $9,766 |
| Operating profit | $1,490 | $1,501 | $2,801 | $2,911 |
| Net income attributable to CVS Caremark | $816 | $821 | $1,529 | $1,592 |
| Diluted EPS | $0.60 | $0.60 | $1.12 | $1.15 |
| Gross margin | 19.1% | 20.9% | 18.8% | 20.5% |
- Q2 revenue increased 10.9%, while gross profit rose 1.5% and operating profit declined 0.7%. For the first half, revenue rose 9.9%, gross profit 0.8%, while operating profit fell 3.8%.
- Q2 net interest expense was $148 million versus $135 million; first-half expense was $282 million versus $263 million. Effective tax rates were 39.2% for Q2 and 39.3% for the first half.
- Segments, Q2: Pharmacy Services revenue was $14.6 billion, up 23.2%, but operating profit fell to $454 million from $591 million. Retail Pharmacy revenue was $14.8 billion, up 3.6%, and operating profit rose to $1.24 billion from $1.10 billion.
- Pharmacy Services gross margin fell to 5.0% from 6.9% in Q2 and to 4.8% from 6.8% for the first half. Retail Pharmacy gross margin was broadly stable at 29.7% in Q2 and 29.1% for the first half.
Cash flow, balance sheet and capital
- First-half operating cash flow was $3.073 billion, compared with $1.712 billion in 2010. Investing cash use was $2.066 billion, including the acquisition; capital expenditures were $710 million. Financing cash use was $206 million. Cash increased by $801 million to $2.228 billion.
- At June 30, cash was $2.228 billion, current assets $19.065 billion, and current liabilities $11.752 billion. Long-term debt was $10.168 billion, with $916 million current; total debt shown on the balance sheet was about $11.084 billion. At year-end 2010, long-term debt was $8.652 billion, current long-term debt $1.105 billion, and short-term debt $300 million.
- The company issued $1.5 billion of senior notes in May: $550 million at 4.125% due 2021 and $950 million at 5.75% due 2041. No commercial paper or backup credit facility borrowings were outstanding at June 30. Debt ratings were Baa2 and BBB+, both with stable outlooks.
- First-half share repurchases totaled $971 million for 27.5 million shares; dividends paid were $341 million. The quarterly dividend declared was $0.125 per share, compared with $0.0875 a year earlier.
Material changes and management commentary
- Growth was driven by a large health-insurance-carrier PBM contract effective January 1, the April 29 acquisition of Universal American’s Medicare Part D business for approximately $1.3 billion, and retail sales growth. The acquired business brought CVS Caremark’s Medicare Part D beneficiaries to more than 3 million.
- Management attributed Pharmacy Services profit deterioration primarily to pricing compression, notably renewal of a large government-client contract, competitive pressures, and the profitability profile of the new carrier contract. Higher generic dispensing rates partly offset these pressures. Management expected competitive pricing and reimbursement trends to continue.
- Retail Pharmacy benefited from same-store sales and new stores. Q2 same-store sales increased 2.0%; prescriptions filled rose to 162.4 million from 157.5 million. Generic conversions and reimbursement pressure weighed on pharmacy revenue and margins, while private-label mix supported front-store margins.
- Management planned to open approximately 225–250 new or relocated retail drugstores in 2011. It said operating cash flow, available credit and potential borrowing were expected to support liquidity needs, investment and strategic initiatives. The filing provides no specific earnings or revenue guidance.
Risks, contingencies and unusual items
- Legal matters include government and state investigations concerning Medicaid claims processing, FTC and multistate antitrust inquiries, Medicare Part D inquiries, and securities-related litigation. A securities-related class action alleges approximately $3.2 billion in damages; the filing does not indicate that amount is a probable liability.
- Assistant store-manager overtime cases were under negotiated global-settlement terms, but no final agreement had been submitted for court approval. The company recorded legal reserves for estimated settlement payments; the amount is not stated here.
- CVS Caremark guaranteed approximately 84 leases of former subsidiaries, excluding Linens ’n Things; remaining terms extend through 2021. Management did not expect the guarantees to have a material adverse effect, but payment could be required if counterparties default.
- Other stated risks include PBM client retention and pricing, pharmacy reimbursement, generic and brand-drug trends, integration and expected benefits of the acquisition, healthcare regulation, litigation, competition, and access to financing. Management cautioned that actual results may differ materially from forward-looking statements.
- The interim financial statements were reviewed, not audited, by the independent registered public accounting firm. Management reported disclosure controls as adequate and effective and no material change in internal control during the quarter.
Investor verification priorities
- Track whether Pharmacy Services can stabilize margins amid contract pricing pressure, and whether the new carrier contract and Medicare Part D acquisition generate expected returns.
- Reconcile stronger operating cash flow with working-capital movements and the sustainability of cash generation after acquisition spending, capital expenditures, dividends and repurchases.
- Monitor debt growth, interest costs, credit ratings, and the use of proceeds from the 2011 notes.
- Review developments and reserve adequacy for the government investigations, antitrust matters, securities litigation and proposed overtime settlement.
- Confirm execution of the 2011 store-opening plan and assess reimbursement pressure, generic-drug effects and retail same-store sales trends.