CVS Caremark Corporation — Q3 2010 Form 10-Q
Business context and reporting period. The filing covers the quarter and nine months ended September 30, 2010. CVS Caremark operated Pharmacy Services (PBM, mail and specialty pharmacy), Retail Pharmacy, and Corporate segments. Financial statements are unaudited; the independent accountant performed an interim review, not an audit.
Financial performance
Amounts are in millions except per-share data. Year-over-year comparisons are against the corresponding 2009 period.
| Metric | Q3 2010 | Q3 2009 | Nine months 2010 | Nine months 2009 |
|---|---|---|---|---|
| Net revenues | $23,875 | $24,642 | $71,641 | $72,907 |
| Gross profit | $5,024 | $5,012 | $14,790 | $14,812 |
| Operating profit | $1,484 | $1,566 | $4,394 | $4,543 |
| Income from continuing operations | $819 | $1,023 | $2,413 | $2,656 |
| Net income attributable to CVS Caremark | $809 | $1,021 | $2,401 | $2,646 |
| Diluted EPS | $0.59 | $0.71 | $1.74 | $1.81 |
| Net cash from operating activities | Not provided for quarter | Not provided for quarter | $3,004 | $2,230 |
- Q3 revenue fell 3.1%; gross profit was nearly flat, while operating profit declined 5.2% and attributable net income declined about 20.8%. Diluted EPS fell 16.9%.
- Consolidated gross margin rose to 21.0% in Q3 and 20.6% for the nine months, up approximately 70 and 30 basis points, respectively.
- Q3 net interest expense was $137, up from $123; the nine-month amount was $399 versus $393. Q3 effective tax rate was 39.2%; the prior-year quarter’s 29.1% rate benefited from approximately $156 of tax benefits. Excluding that benefit, the prior-year rate was approximately 39.8%.
Segment results
- Pharmacy Services: Q3 revenue declined 8.5% to $11,926; gross profit fell 14.5% to $882 and operating profit fell to $652 from $799. Nine-month revenue declined 5.2% to $35,603 and operating profit fell to $1,781 from $2,033. Contract terminations and lower Medicare Part D covered lives reduced claims and profit; CMS rules restricting use of PBM drug-price spread and pricing pressure also weighed on margins. Generic dispensing rates increased.
- Retail Pharmacy: Q3 revenue increased 4.1% to $14,159 and operating profit rose to $1,039 from $910. Nine-month revenue increased 3.8% to $42,448 and operating profit reached $3,164 versus $2,938. Same-store sales grew 2.5% in Q3 and 2.3% year to date. Nine-month gross margin declined to 29.2% from 29.5%, reflecting mix and third-party reimbursement pressures.
Cash, debt and liquidity
- Nine-month operating cash flow was $3,004, up from $2,230. Investing used $1,388 and financing used $1,723; cash declined $107 to $979.
- At September 30, current assets were $17,339 and current liabilities $11,674 (current ratio approximately 1.49). Short-term debt was $1,384, current long-term debt $1,104, and long-term debt $8,653. Total reported debt was approximately $11.1 billion.
- The company reported $1.4 billion of commercial paper outstanding at a weighted-average rate of 0.45%; no borrowings were outstanding under its backup credit facilities. It issued $1.0 billion of senior notes in May and repaid $2.1 billion of long-term debt during the nine months.
- Nine-month capital expenditures were $1,379, versus $1,752 a year earlier. The company repurchased approximately $1.5 billion of shares under its prior authorization, paid $360 in dividends, and had not repurchased shares under the new $2.0 billion program by quarter-end. The quarterly dividend was raised 15% to $0.0875 per share.
Material changes, outlook and risks
- Management attributed weaker consolidated sales primarily to terminated large PBM contracts and reduced Medicare Part D covered lives, partly offset by retail same-store growth and new stores. It planned approximately 250–300 new or relocated retail stores in 2010.
- Management stated that operating cash flow, commercial paper, sale-leasebacks and potential future borrowings were expected to fund cash needs and long-term initiatives. No specific earnings or revenue guidance is provided in the supplied filing text.
- Retail performance faced economic weakness, lower-priced and promotional purchasing, generic substitution, higher consumer cost sharing, and reimbursement pressure from commercial and government payors. The company noted uncertainty about the effects of ACA Medicaid pharmacy reimbursement changes expected to be implemented in 2011.
- On October 13, 2010, CVS resolved the pseudoephedrine matter for $75 in civil penalties and $2.6 in criminal forfeiture; it said its recorded legal reserves were sufficient. The agreement also imposes ongoing compliance requirements.
- Other material legal and regulatory exposures include government inquiries into Medicaid and Medicare claims and business practices, PBM antitrust matters, wage-and-hour class or collective actions, and a securities class action and derivative suit. Management could not predict outcomes and stated it did not expect the disclosed matters to have a material adverse effect, while acknowledging that adverse legal, regulatory or industry developments could materially affect results.
- The company guaranteed approximately 70 former-subsidiary store leases, excluding Linens ’n Things; management did not expect the guarantees’ ultimate disposition to have a material adverse effect. Linens ’n Things lease-related discontinued-operation costs increased amid a weak commercial real estate market.
- A proposed lease-accounting standard could materially affect reported financial position and results, though management expected no material liquidity effect. The annual impairment tests found no goodwill or indefinite-lived trademark impairment. Long-term debt carried Moody’s Baa2 stable and S&P BBB+ negative ratings.
Most important facts for investors to verify
- Whether Pharmacy Services client retention, Medicare Part D enrollment and PBM margins stabilize, including the ongoing effect of CMS spread rules and contract pricing.
- Whether retail same-store growth and operating leverage offset reimbursement, generic-drug mix and consumer-spending pressures.
- Cash generation, working-capital movements, commercial-paper reliance, debt maturities, credit ratings and continued share repurchases or dividends.
- Developments and potential financial exposure from the government investigations, litigation, pseudoephedrine settlement compliance and lease guarantees.
- The eventual implementation and financial-statement effects of ACA reimbursement provisions and proposed lease-accounting changes.