CVS Caremark Corporation — Q3 2012 Form 10-Q
Reporting period: Three and nine months ended September 30, 2012; comparison is with the corresponding 2011 periods. Financial statements are unaudited and were reviewed, not audited, by the independent accountant. Amounts below are in U.S. dollars; financial-statement amounts are in millions unless stated otherwise.
Business context
CVS Caremark operated Pharmacy Services (PBM, mail and specialty pharmacy, and Medicare Part D), Retail Pharmacy, and Corporate segments. At quarter-end, Retail Pharmacy included 7,423 drugstores and 609 MinuteClinic locations; Pharmacy Services operated mail and specialty pharmacy facilities and managed a network of approximately 67,000 retail pharmacies.
Financial performance
| Metric | Q3 2012 | Q3 2011 | Nine months 2012 | Nine months 2011 |
|---|---|---|---|---|
| Net revenues | $30,227 | $26,674 | $91,739 | $78,783 |
| Gross profit | $5,647 | $5,178 | $16,209 | $15,006 |
| Operating profit | $1,814 | $1,584 | $4,925 | $4,373 |
| Income from continuing operations | $1,011 | $867 | $2,753 | $2,389 |
| Net income attributable to CVS Caremark | $1,006 | $868 | $2,748 | $2,397 |
| Diluted EPS attributable to CVS Caremark | $0.79 | $0.65 | $2.13 | $1.77 |
- Revenue rose 13.3% in Q3 and 16.4% year to date. Management attributed growth to PBM client starts, drug-cost inflation, Medicare Part D growth, and retail same-store and new-store sales.
- Gross margin declined about 70 basis points to 18.7% in Q3 and 140 basis points to 17.7% year to date, reflecting the larger revenue mix from lower-margin Pharmacy Services. Operating expense ratios improved through expense leverage and cost controls.
- Pharmacy Services: Q3 revenue rose 22.2% to $18.1 billion; operating profit was $784 million. Gross margin was 6.0% versus 6.2%. Growth reflected client starts, higher claim volume, drug inflation, and Medicare Part D; margin pressure included client pricing, service costs, and business mix.
- Retail Pharmacy: Q3 revenue rose 5.5% to $15.5 billion; same-store sales increased 4.3%, and operating profit rose to $1.305 billion from $1.123 billion. Segment gross margin improved to 30.1% from 29.3%, helped by generic dispensing, partly offset by reimbursement pressure and weaker front-store margins.
- Q3 diluted EPS from continuing operations was $0.79, up from $0.65. Net income included a $5 million after-tax discontinued-operations loss, principally lease-guarantee costs related to Linens ’n Things.
Cash flow, debt, and liquidity
- Nine-month operating cash flow was $4.940 billion, compared with $5.035 billion in 2011. Capital expenditures were $1.314 billion; investing cash outflow was $1.183 billion, and financing cash outflow was $3.937 billion.
- Cash and equivalents were $1.233 billion at September 30, 2012, down from $1.413 billion at year-end 2011. Current assets were $18.879 billion and current liabilities $13.263 billion.
- Debt consisted of $825 million of short-term debt, $5 million current maturities, and $9.210 billion of long-term debt. Commercial paper outstanding was $825 million at a weighted-average rate of 0.35%; back-up credit facilities totaling $3.5 billion had no borrowings. Management stated operating cash flow, commercial paper, sale-leasebacks, and potential borrowings should be sufficient for expected cash needs.
- Long-term debt ratings were Moody’s Baa2 (positive outlook) and S&P BBB+ (stable outlook). Management cautioned that ratings are not assured and affect borrowing costs and capital access.
Material changes and notable items
- Effective January 1, 2012, Retail Pharmacy prescription inventories moved to weighted-average cost from prior FIFO-based methods. The transition reduced inventory by $146 million and retained earnings by $89 million, net of a $57 million deferred tax asset. The change reduced Q3 and nine-month 2012 income by approximately $6 million and $7 million, respectively; retrospective restatement was deemed impracticable.
- The company repurchased 74.8 million shares for approximately $4.0 billion in the first nine months and declared dividends of $0.4875 per share, up from $0.3750. A new $6.0 billion authorization was approved in September; approximately $5.0 billion remained available at quarter-end. A $1.2 billion accelerated repurchase was subject to final share settlement based on market prices.
- Goodwill and indefinite-lived trademarks passed annual impairment tests, with no impairment recorded. Total goodwill was $26.4 billion.
- The TheraCom sale closed in November 2011; its prior results are presented as discontinued operations. In October 2012, RxAmerica agreed to a $5.25 million OIG settlement, plus costs and fees, for historical Medicare Part D pricing submissions; the company said its quarter-end accrual covered the payment.
Outlook, risks, and contingencies
- No specific revenue or earnings guidance was provided in the supplied filing text. Management expected competitive PBM pricing and reimbursement pressures to continue, while generic use was expected to support margins, though at a slower pace.
- Retail pharmacy sales benefited from Walgreens’ temporary exit from the Express Scripts network. After the companies’ new agreement took effect September 15, 2012, CVS identified its ability to retain business gained during the impasse as a risk.
- Other cited risks include client losses or failure to win PBM business, drug-price and generic-introduction trends, Medicare Part D and Medicaid regulation, health-care reform, cyber and information-security risks, and litigation or government investigations.
- A long-running Alabama class action seeks approximately $3.2 billion plus unspecified damages; class certification was granted in part and appealed, with trial-court proceedings stayed pending appeal. The company stated its legal accruals were not material and that it could not estimate potential losses beyond recorded amounts for the described matters.
- CVS guaranteed approximately 77 former-subsidiary store leases, excluding Linens ’n Things guarantees. Management did not expect the remaining guarantees to materially affect financial condition, results, or cash flows, but payment could be required if responsible parties default.
Key facts for investors to verify
- Whether PBM client growth and higher claim volumes can offset continuing pricing and gross-margin pressure.
- How much pharmacy sales and earnings growth persists after the Express Scripts–Walgreens network agreement.
- Cash generation and debt levels after substantial repurchases, dividends, capital spending, and the remaining $5.0 billion repurchase authorization.
- Effects of the inventory accounting change and generic-drug trends on reported margins and comparability.
- Developments in the Alabama class action, government inquiries, and other legal or regulatory contingencies.