CVS Caremark Corporation — Q3 2009 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2009; comparable periods ended September 27, 2008. The 2009 quarter included one additional day. Financial statements are unaudited; the independent accountant performed an interim review, not an audit.
Business context and financial performance
CVS Caremark operated Pharmacy Services, Retail Pharmacy and Corporate segments. At September 30, 2009, it had 7,008 retail drugstores and 569 MinuteClinic locations. The Longs Drug Stores acquisition closed in October 2008 and materially affected year-over-year comparisons.
| Metric | Q3 2009 | Q3 2008 | Nine months 2009 | Nine months 2008 |
|---|---|---|---|---|
| Net revenues | $24.64B | $20.86B | $72.91B | $63.33B |
| Gross profit | $5.01B | $4.40B | $14.81B | $13.07B |
| Operating profit | $1.57B | $1.47B | $4.54B | $4.31B |
| Income from continuing operations | $1.02B | $818.8M | $2.66B | $2.39B |
| Net income | $1.02B | $736.0M | $2.65B | $2.26B |
| Diluted EPS | $0.71 | $0.50 | $1.81 | $1.54 |
Revenue rose 18.1% in Q3 and 15.1% year to date. Approximate consolidated gross margin was 20.3% in Q3 versus 21.1%; operating margin was 6.4% versus 7.0%. For the nine months, gross margin was approximately 20.3% versus 20.6%, and operating margin was 6.2% versus 6.8%.
- Q3 diluted EPS from continuing operations was $0.71, up from $0.56; nine-month EPS was $1.82, up from $1.63.
- Pharmacy Services Q3 revenue increased 23.4% to $13.03B, while its gross margin declined to 7.9% from 8.4% and operating margin to 6.1% from 6.7%.
- Retail Pharmacy Q3 revenue increased 17.9% to $13.61B; same-store sales rose 5.7%. Gross margin fell to 29.4% from 30.4%, and operating margin to 6.7% from 7.5%.
Cash flow, debt and liquidity
- Nine-month operating cash flow was $2.23B, compared with $2.18B. Capital expenditures were $1.75B; investing cash outflow was $1.05B.
- Financing cash outflow was $1.41B, including $1.54B in share repurchases, $330.8M in dividends and net reduction in short-term debt; $2.80B of long-term debt issuance partly offset outflows.
- Cash and cash equivalents were $1.13B, down from $1.35B at December 31, 2008. Current assets were $17.40B and current liabilities $12.70B.
- Total reported short- and long-term debt was approximately $11.96B, versus $11.75B at year-end 2008. Long-term debt carrying value was $8.3B; estimated fair value was $8.6B.
- Commercial paper outstanding was $1.1B at a 0.7% weighted average rate; there were no borrowings under $3.375B of committed backup credit facilities. Long-term debt ratings were Baa2 (Moody’s) and BBB+ (S&P).
Material changes, outlook and risks
- Longs contributed approximately $1.9B of Q3 and $5.1B of nine-month revenue. Q3’s extra day contributed an estimated $303.2M revenue and $61.3M gross profit.
- Management attributed margin pressure to promotional sales, lower third-party reimbursement, PBM client pricing and integration costs. Increased generic dispensing supported profitability; generic dispensing rates rose in both segments.
- A $155.7M tax benefit, or approximately $0.11 per diluted share, from previously unrecognized tax benefits reduced Q3 tax expense. Without it, the 2009 effective tax rate would have been approximately 39.8%. This is a significant contributor to reported earnings growth.
- The company expected new Medicare Part D rules effective in 2010 to reduce PBM profitability, and anticipated lower 2010 Medicaid reimbursement for certain specialty and other products following changes to AWP benchmarks. The filing provides no specific earnings or revenue guidance.
- Management planned approximately 50 new or relocated retail pharmacy openings for the remainder of 2009. The board authorized a new share repurchase program of up to $2.0B on November 4, 2009, expiring at the end of 2011.
- Contingencies include DEA and U.S. Attorney discussions regarding alleged pseudoephedrine distribution issues, an FTC investigation, government inquiries and Medicaid-related litigation, and lease guarantees for former subsidiaries. Outcomes and potential financial effects were uncertain; management stated it could not assure that legal or regulatory developments would not materially affect the business.
Important facts for investors to verify
- How much of reported earnings growth reflects the $155.7M tax benefit, acquisition effects and the extra reporting day, versus underlying operating growth.
- Whether Retail Pharmacy and Pharmacy Services margin declines continue, especially amid reimbursement pressure, client pricing and 2010 policy changes.
- Integration progress and realized benefits from the Longs acquisition, including its contribution to comparable revenue and operating profit.
- Developments and any financial exposure from the DEA, FTC, Medicaid-related investigations and litigation, and legacy lease guarantees.
- Debt maturities, refinancing requirements, cash generation after capital spending and repurchases, and the impact of sale-leaseback activity.