CVS Caremark Corporation — Q2 2010 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2010; comparisons are with the corresponding 2009 periods. The company operated Pharmacy Services, Retail Pharmacy and Corporate segments. Financial statements are unaudited; the independent accountant performed an interim review, not an audit. Amounts below are in millions of dollars except per-share data.
Financial performance
| Metric | Q2 2010 | Q2 2009 | First half 2010 | First half 2009 |
|---|---|---|---|---|
| Net revenue | $24,007 | $24,871 | $47,767 | $48,265 |
| Gross profit | $5,020 | $5,052 | $9,766 | $9,800 |
| Operating profit | $1,501 | $1,600 | $2,911 | $2,977 |
| Income from continuing operations | $822 | $889 | $1,594 | $1,633 |
| Net income attributable to CVS Caremark | $821 | $886 | $1,592 | $1,625 |
| Diluted EPS | $0.60 | $0.60 | $1.15 | $1.11 |
| Net cash from operating activities | Not separately provided | Not separately provided | $1,712 | $1,323 |
- Consolidated gross margin was approximately 20.9% in Q2 versus 20.3% a year earlier; first-half margin was approximately 20.4% versus 20.3%. Operating margin was approximately 6.3% versus 6.4% in Q2 and 6.1% versus 6.2% for the first half.
- At June 30, cash and cash equivalents were $1,107; current assets were $17,270 and current liabilities $11,459. Short-term debt was $1,852, current long-term debt $655 and long-term debt $9,454. Total debt across those balance-sheet categories was approximately $11,961, compared with $11,175 at December 31, 2009.
- First-half investing cash outflow was $880, including $866 of capital expenditures; financing cash outflow was $811. Cash increased $21 to $1,107 over the six months.
Material changes and segment trends
- Q2 revenue declined 3.5% and first-half revenue declined 1.0%. Management attributed the reduction mainly to several large Pharmacy Services client contract terminations effective January 1, 2010, and fewer Medicare Part D covered lives.
- Pharmacy Services Q2 revenue fell 9.0% to $11,840 and operating profit fell to $591 from $697. First-half segment revenue was $23,677 versus $24,543 and operating profit $1,130 versus $1,234. Lower claims volumes drove pressure; higher generic dispensing rates provided some benefit. Prior-year revenue comparisons were also affected by changes from net to gross revenue recognition for certain contracts.
- Retail Pharmacy Q2 revenue rose 3.7% to $14,311 and operating profit rose to $1,096 from $1,056. First-half revenue increased 3.6% to $28,289 and operating profit to $2,125 from $2,028. Same-store sales grew 2.1% in Q2 and 2.2% in the first half; gross margin rate declined to 29.6% and 29.0%, respectively.
- Consolidated operating profit declined 6.2% in Q2 and 2.2% for the first half. Higher operating costs, including litigation-related expenses, store costs and consulting, outweighed some expense-control and lower integration costs.
- First-half operating cash flow increased by $389 year over year, which management linked primarily to improved working capital, cash collections and inventory management. The company repurchased $1.5 billion of shares in the first half and paid $241 in dividends.
Outlook, risks and unusual items
- No specific earnings or revenue guidance is provided in the supplied filing text. The company planned to open approximately 250–300 new or relocated retail drugstores in 2010; 98 new stores opened and 81 relocated in the first half.
- Management said the 2010 Medicare Part D regulatory change affecting treatment of pharmacy price differentials would continue to pressure that business’s profitability for the remainder of 2010. It also cited competitive pressure on PBM pricing, rebates and discounts, pharmacy reimbursement rates, generic conversions, and uncertain consumer demand.
- The company issued $1.0 billion of senior notes in May 2010: $550 million at 3.25% due 2015 and $450 million at 4.75% due 2020. Commercial paper outstanding at June 30 was $1.9 billion, at a weighted average rate of 0.5%; no backup credit-facility borrowings were outstanding. Ratings were Moody’s Baa2, stable, and S&P BBB+, negative.
- A new share repurchase authorization of up to $2.0 billion was approved in June, expiring at the end of 2011; no repurchases under that new authorization occurred in Q2. The prior $2.0 billion authorization was completed with $1.5 billion of repurchases in the first half of 2010.
- Significant legal and regulatory matters include government investigations involving PBM practices, Medicaid/Medicare claims and prescription-transfer promotions; a DEA inquiry concerning pseudoephedrine distribution; antitrust matters; and assistant-store-manager overtime litigation. A Florida court conditionally certified an FLSA collective action in May 2010. Management said outcomes were uncertain and could not be predicted; it did not expect the disclosed legal matters, individually, to materially adversely affect the company.
- Other contingencies include guarantees on approximately 70 former-subsidiary store leases, excluding Linens ’n Things; management did not expect their ultimate disposition to be material. The filing also identifies risks from health-care reform, regulation, client losses, reimbursement changes, litigation and economic conditions.
Investor verification priorities
- Check whether Pharmacy Services client losses and Medicare Part D enrollment declines persist, and how claim volumes and segment margins develop.
- Track retail pharmacy reimbursement rates, generic mix and the implementation effects of health-care reform and Medicare Part D rules.
- Review debt maturities, commercial paper reliance, ratings outlook and cash generation alongside continued dividends, store investment and repurchases.
- Monitor developments and potential exposure in the government investigations, DEA matter, antitrust proceedings and wage-and-hour cases; the filing provides no clear quantified aggregate reserve or exposure for these matters.
- Distinguish underlying volume and economics from reported PBM revenue changes caused by gross-versus-net revenue recognition.