CVS Caremark Corporation — Q1 2010 Form 10-Q
Reporting period: Three months ended March 31, 2010; comparisons are with Q1 2009 unless stated otherwise. Financial amounts are in U.S. dollars. CVS Caremark operated Pharmacy Services, Retail Pharmacy and Corporate segments. The interim statements are unaudited and were reviewed by Ernst & Young, not audited.
Financial performance
| Metric | Q1 2010 | Q1 2009 | Change |
|---|---|---|---|
| Net revenue | $23.760bn | $23.394bn | +1.6% |
| Gross profit | $4.746bn | $4.748bn | Essentially flat |
| Operating profit | $1.410bn | $1.377bn | +2.4% |
| Income from continuing operations | $772m | $743m | +3.9% |
| Net income attributable to CVS Caremark | $771m | $738m | +4.5% |
| Diluted EPS | $0.55 | $0.50 | +10.0% |
| Operating cash flow | $1.060bn | $771m | +$289m |
| Capital expenditures | $401m | $466m | -$65m |
Consolidated gross margin was approximately 20.0% versus 20.3%; operating margin was approximately 5.9% in both periods. Net interest expense declined $14m to $128m, primarily due to lower rates on floating-rate debt. The effective tax rate was 39.8% in both quarters. The diluted weighted-average share count declined to 1.396bn from 1.469bn, supporting EPS growth. Discontinued-operations losses were $2m versus $5m, primarily lease-related costs.
Segments and material year-over-year changes
- Pharmacy Services: Revenue was $11.836bn, up 2.6%; gross profit fell 2.0% to $782m and operating profit was nearly flat at $538m. Gross margin declined to 6.6% from 6.9%. Claims processed fell to 147.5m from 163.4m, reflecting large client contract terminations and fewer Medicare Part D covered lives after competitive bidding. Generic dispensing rose to 70.4% from 67.7%.
- Pharmacy Services revenue growth included a significant accounting-presentation effect: converting RxAmerica contracts from net to gross accounting added approximately $560m to year-over-year revenue. Management said the change also pressured reported gross margin. Client losses and Medicare Part D changes weighed on profit; competitive pricing and manufacturer rebate-sharing were additional pressures.
- Retail Pharmacy: Revenue increased 3.6% to $13.978bn; same-store sales rose 2.3%. Gross profit increased to $3.987bn, but gross margin declined to 28.5% from 29.3%. Operating profit rose 6.0% to $1.030bn, with operating margin improving to 7.4% from 7.2%. Pharmacy same-store sales increased 3.7%, while front-store same-store sales declined 0.7%. Generic dispensing rose to 72.1% from 69.2%.
- Retail results benefited from new stores, same-store growth, store-brand sales and higher generic dispensing. Margin pressures included lower third-party reimbursement, a higher share of insured pharmacy revenue and promotional activity. Weak flu demand, severe weather and softer sales at acquired Longs stores affected front-store results.
- Corporate: Operating expenses increased to $135m from $126m, primarily from higher outside legal and consulting costs and depreciation. Consolidated operating expenses declined $35m, mainly due to lower litigation-related and Longs integration costs.
Cash, debt and liquidity
- Cash and cash equivalents were $1.047bn at March 31, 2010, versus $1.086bn at December 31, 2009. Operating cash flow was $1.060bn; investing used $397m and financing used $702m, leaving a $39m net cash decrease.
- Management attributed the year-over-year operating cash flow increase primarily to timing of collections on third-party receivables. The filing does not establish that this increase represents a recurring improvement in cash generation.
- At March 31, current assets were $17.155bn and current liabilities $12.337bn, for a current ratio of approximately 1.39. Total debt, including short-term debt and current maturities, was approximately $11.373bn; long-term debt excluding current maturities was $8.454bn. Cash less total debt was approximately $10.326bn net debt.
- Commercial paper outstanding was $515m at a weighted average rate of 0.30%; there were no borrowings under backup credit facilities. A $675m facility was due to expire June 2, 2010, and the company intended to renew it. Long-term debt was rated Baa2/stable by Moody’s and BBB+/negative by S&P.
- The company repurchased approximately 25.7m shares for $887m during the quarter under its $2.0bn authorization; approximately $613m remained available at March 31. The quarterly dividend was raised 15% to $0.0875 per share, equivalent to $0.35 annually.
Outlook, risks and unusual items
- No specific earnings or revenue guidance was provided in the supplied filing text. The company planned approximately 250–300 new or relocated retail drugstores in 2010.
- Management expected pressure from reduced pharmacy reimbursement rates to continue. A CMS rule effective January 1, 2010 changed Medicare Part D treatment of pharmacy price differentials and was expected to reduce the profitability of that business during 2010.
- The company said the impact of the March 2010 health care reform law on Medicaid reimbursement could not yet be predicted. It also cited uncertainty related to generic and brand drug introductions, client retention and new business, industry competition, consumer utilization, rebates and pricing benchmarks.
- Material legal and regulatory matters included a federal Medicaid claims-processing qui tam case and related Texas action; FTC and multistate investigations into business practices; OIG inquiries involving government claims, dual-eligible customers and prescription-transfer incentives; and DEA/USAO inquiries concerning pseudoephedrine distribution. The company was cooperating and said outcomes could not be predicted. It stated management did not believe the disclosed legal matters would have a material adverse effect, while cautioning that adverse legal, regulatory or legislative developments could materially affect operations.
- The company also disclosed securities and shareholder derivative litigation, pharmacy network antitrust cases, wage-and-hour class actions, environmental compliance matters in California and Connecticut, and guarantees on certain former subsidiaries’ store leases. Management said the ultimate outcomes were uncertain; it believed remaining lease guarantees would not materially affect the company.
- SFAS 167 was adopted in Q1 2010 with no material impact. The company reported no outstanding derivatives and said market risk, principally interest-rate exposure, was not material. Disclosure controls were considered effective, with no material change in internal control over financial reporting reported for the quarter.
Important facts for investors to verify
- How much of Pharmacy Services’ reported revenue growth reflects the net-to-gross accounting conversion, rather than underlying volume or economics, and whether the decline in claims and client losses persists.
- Whether reimbursement pressure, Medicare Part D changes and competitive rebate-sharing continue to compress PBM and retail pharmacy margins.
- Whether higher operating cash flow is sustained, given management’s explanation that the improvement was primarily due to receivable-collection timing.
- Progress on renewing the $675m backup credit facility, debt ratings and remaining share-repurchase authorization; repurchases substantially exceeded quarterly dividends paid.
- Developments and potential financial or operational effects from the government investigations, litigation and environmental matters; the filing provides no clear estimate of potential exposure for these matters.