CVS Caremark Corporation — Q1 2012 Form 10-Q
Reporting period: Three months ended March 31, 2012; comparisons are with Q1 2011 unless otherwise noted. The filing is by CVS Caremark Corporation, the company’s name at the time, and describes its Pharmacy Services, Retail Pharmacy and Corporate segments. Financial statements are unaudited and were reviewed, not audited, by Ernst & Young.
Financial performance and liquidity
| Metric | Q1 2012 | Q1 2011 | Change / context |
|---|---|---|---|
| Net revenue | $30.798 billion | $25.695 billion | +19.9% |
| Gross profit | $5.113 billion | $4.742 billion | +7.8%; gross margin 16.6%, down about 185 basis points |
| Operating profit | $1.404 billion | $1.305 billion | +7.6% |
| Income from continuing operations | $776 million | $709 million | +9.4% |
| Net income attributable to CVS Caremark | $776 million | $713 million | +8.8% |
| Diluted EPS | $0.59 | $0.52 | Up $0.07 |
| Net cash from operations | $2.786 billion | $1.866 billion | Increase largely reflected timing of a CMS advance payment |
| Cash and cash equivalents | $2.211 billion | $1.413 billion at Dec. 31, 2011 | Quarter-end balance |
| Long-term debt | $9.206 billion | $9.208 billion at Dec. 31, 2011 | Short-term debt fell from $750 million to zero |
Operating expenses rose 8.0% to $3.709 billion, but declined to 12.0% of revenue from 13.4%. Net interest expense was $132 million, versus $134 million; the effective tax rate was 39.0%, versus 39.4%. Dividends declared were $0.1625 per share, versus $0.1250.
Investing activities used $443 million, including $376 million of capital expenditures. Financing activities used $1.545 billion, including $810 million for share repurchases, $211 million of dividends and repayment of $750 million in short-term debt. The company had no commercial paper or backup-credit-facility borrowings at quarter end. Its $4 billion repurchase authorization had approximately $2.2 billion remaining. Long-term debt had a carrying value of $9.2 billion and estimated fair value of $10.6 billion.
Segment results and changes versus prior year
- Pharmacy Services: Revenue increased 32.3% to $18.3 billion, but gross profit fell 2.3% to $616 million and operating profit fell to $349 million from $391 million. Gross margin declined to 3.4% from 4.6%. Claims growth reflected new client starts and the 2011 acquisition of Universal American’s Medicare prescription drug plan business. Management cited client pricing pressure and higher mail and Medicare Part D operating costs; higher generic dispensing partly offset these pressures.
- Retail Pharmacy: Revenue rose 9.9% to $16.024 billion; same-store sales increased 8.4%. Operating profit increased to $1.298 billion from $1.096 billion, and operating margin rose to 8.1% from 7.5%. Pharmacy same-store sales benefited from additional Express Scripts members after Walgreens left that network on January 1, 2012; CVS said it could not predict how long the impasse would continue. Pharmacy same-store sales were also negatively affected by generic drug introductions.
- Corporate: Operating expenses increased 13.9% to $168 million, primarily due to payroll and benefits, IT costs and depreciation.
Retail sales and gross profit also benefited from higher same-store sales and new stores. A change in prescription-inventory accounting contributed approximately $30 million to Retail Pharmacy gross profit in the quarter. The prior-year comparison excludes the TheraCom business, sold in November 2011 and presented as discontinued operations.
Outlook, risks and unusual items
- The filing gives no specific revenue or earnings guidance. Management planned approximately 225–250 new or relocated retail drugstores in 2012 and said operating cash flow, its commercial paper program, sale-leaseback activity and potential borrowing were expected to fund needs and long-term initiatives.
- Management expected PBM pricing and margin pressure to continue, including competitive client pricing, increased sharing of manufacturer rebates and discounts, and market or regulatory changes affecting retail-network pricing. Retail reimbursement pressure and generic-related effects were also identified as risks.
- Operating cash flow benefited from a CMS advance in March for April 2012 Medicare Part D premiums and claims; management identified this as a timing difference, so the quarterly increase may not represent a recurring improvement.
- Effective January 1, 2012, the company changed Retail Pharmacy prescription inventory valuation to weighted-average cost for inventory representing approximately 51% of consolidated inventories. The cumulative transition reduced inventory by $146 million, increased current deferred tax assets by $57 million and reduced retained earnings by $89 million. Without the change, Q1 continuing and attributable net income would have been $19 million lower and EPS $0.01 lower.
- Contingencies include government inquiries and litigation involving Medicaid claims, pharmacy practices, antitrust allegations and securities matters. A proposed FTC consent order contemplated $5 million in consumer redress, subject to final approval. The assistant-store-manager wage settlement received final court approval in April 2012, with reserves stated to cover settlement payments. Separately, a California environmental settlement approved April 16, 2012 required $13.75 million in penalties, projects and cost reimbursement, plus compliance measures. The company said it could not predict the timing or outcome of many legal matters.
- Other disclosed risks include reimbursement reductions, PBM client losses or failure to win new business, generic and brand-drug introduction trends, healthcare regulation, cybersecurity and IT-system risks, and litigation. Management stated that lease guarantees for approximately 76 former-subsidiary store leases could require payments if responsible parties defaulted, but did not expect their ultimate disposition to materially affect the company.
Key facts for investors to verify
- Whether Pharmacy Services can sustain revenue and claims growth while reversing or containing the decline in gross margin and operating profit.
- How much of Retail Pharmacy’s Q1 sales growth reflected the Walgreens–Express Scripts network impasse, leap-year timing and other temporary effects, and whether those benefits persist.
- The recurring cash-generation picture after accounting for the CMS payment timing, working-capital movements and capital spending.
- The earnings and comparability effects of the inventory accounting change, including its $30 million Q1 gross-profit benefit and $0.01 per-share effect.
- Final status and financial consequences of the FTC matter, government investigations, pending litigation and environmental obligations.
- Debt ratings, repurchase pace and remaining authorization: the company repurchased 18.1 million shares for about $810 million in the quarter, with approximately $2.2 billion authorized at March 31.