CVS Caremark Corporation — Q1 2013 Form 10-Q
Reporting period: Three months ended March 31, 2013; comparisons are with Q1 2012 unless noted. The filing is by CVS Caremark Corporation (identified in the request as CVS Health). Interim financial statements were reviewed, not audited.
Financial performance and position
| Metric | Q1 2013 | Q1 2012 | Change |
|---|---|---|---|
| Net revenues | $30.763 billion | $30.798 billion | Down 0.1% |
| Gross profit | $5.582 billion | $5.113 billion | Up 9.2% |
| Operating profit | $1.699 billion | $1.404 billion | Up 21.0% |
| Net income attributable to CVS Caremark | $956 million | $776 million | Up 23.2% |
| Diluted EPS | $0.77 | $0.59 | Up 30.5% |
| Operating cash flow | $1.640 billion | $2.786 billion | Down $1.146 billion |
- Gross margin rose to 18.1% from 16.6%; operating margin increased to 5.5% from 4.6%. The filing attributes gross-margin improvement chiefly to higher generic dispensing.
- Operating expenses increased 4.7% to $3.883 billion, including higher retail store costs and corporate legal costs. Net interest expense declined to $126 million from $132 million. The effective tax rate was 39.2%, versus 39.0%.
- Cash and cash equivalents were $1.551 billion at March 31, compared with $1.375 billion at year-end 2012. Current assets were $19.727 billion and current liabilities $13.195 billion.
- Total debt, including short-term debt and current maturities, was approximately $9.664 billion at quarter-end, versus $9.828 billion at December 31, 2012. Long-term debt’s carrying value was $9.4 billion; estimated fair value was $10.7 billion.
- Investing activities used $567 million, including $318 million of property and equipment purchases and $254 million for acquisitions and other investments. Financing activities used $897 million, including $393 million of share repurchases and $277 million of dividends. Cash capital spending less property-sale proceeds was $313 million.
Material changes and segment performance
- Pharmacy Services: Revenue was nearly flat at $18.311 billion. Gross profit increased 24.6% to $768 million and operating profit rose to $499 million from $349 million. Claims processed increased; generic dispensing reached 80.5%, up from 76.5%. Management cited generics, rebate improvement and streamlining benefits. Competitive pressure, client discount-sharing and reduced retail network spread remain margin risks.
- Retail Pharmacy: Revenue increased 0.2% to $16.051 billion; gross profit rose 8.3% to $4.952 billion and operating profit increased to $1.537 billion from $1.298 billion. Same-store sales declined 1.2% overall: pharmacy sales fell 2.3%, while front-store sales rose 1.4%. Generic dispensing increased to 81.2%. Generic conversions reduced pharmacy sales, while flu-related demand and the Easter calendar shift provided offsets.
- Consolidated revenue was essentially unchanged as generic drugs lowered selling prices, partly offset by higher volumes, specialty drug inflation and retail front-store sales. Diluted weighted-average shares declined to 1.241 billion from 1.309 billion, supporting per-share growth.
- Operating cash flow fell year over year primarily because a CMS payment for April 2012 Medicare Part D premiums and claims had been received in March 2012; the comparable 2013 payment arrived in April 2013. Management described the difference as timing-related.
Outlook, risks and unusual items
- The filing provides no specific numerical earnings or revenue guidance. Management expected generic-drug trends to continue, though at a slower pace, and anticipated continued reimbursement pressure on retail pharmacy margins and competition in PBM pricing.
- CMS imposed intermediate sanctions on the SilverScript Medicare Part D plan effective January 15, 2013, suspending new enrollment and marketing. Existing members were not affected; a limited waiver allowed certain employer-related enrollment through July 30, 2013. CVS Caremark was working with CMS on corrective actions and could not predict the sanctions’ duration or required remediation.
- In March 2013, the company settled all matters related to its processing of Texas Medicaid claims; settlement terms and amount are not specified in the filing text.
- Legal matters include a putative Alabama class action seeking approximately $3.2 billion plus unspecified damages, PBM antitrust litigation, government inquiries involving pharmacy programs and an SEC investigation concerning 2009 disclosures, securities transactions and Longs acquisition accounting. The company generally could not estimate possible losses beyond accrued amounts. It stated that accrued legal matters were not material individually or in aggregate.
- The company guaranteed approximately 71 former-subsidiary store leases, excluding Linens ’n Things; management did not expect the ultimate disposition to materially harm financial condition, results or cash flows.
- Commercial paper outstanding was $300 million at a weighted average rate of 0.28%. The company had no borrowings under its backup credit facilities and intended to renew the facility expiring May 27, 2013. Debt ratings were investment grade at quarter-end.
- Management cited risks including reimbursement reductions, PBM client retention and pricing competition, Medicare Part D rules and sanctions, regulation, litigation, generic and brand-drug trends, and information security. The board-authorized $6 billion repurchase program had approximately $4.3 billion remaining; 7.4 million shares were repurchased for $393 million during the quarter.
Key facts for investors to verify
- Progress, scope and duration of CMS’s SilverScript sanctions and corrective-action process, including the status of the limited waiver.
- Financial and operational effects of the Texas Medicaid settlement and any material developments in other legal or regulatory matters.
- Whether gross-margin gains from generic dispensing, rebates and efficiency initiatives persist as reimbursement and PBM pricing pressure continues.
- Underlying operating cash generation after accounting for CMS payment timing, working-capital movements and acquisition spending.
- Capital allocation and leverage implications of continuing dividends and share repurchases, alongside debt maturities and renewal of the backup credit facility.