CVS Caremark Corporation — Q1 2014 Form 10-Q
Reporting period: Three months ended March 31, 2014; comparative period is Q1 2013. The interim financial statements are unaudited and were reviewed by the independent accountant. The filing describes CVS Caremark’s Pharmacy Services, Retail Pharmacy and Corporate segments.
Financial performance
| Metric | Q1 2014 | Q1 2013 | Change |
|---|---|---|---|
| Net revenue | $32.689 billion | $30.751 billion | +6.3% |
| Gross profit | $5.942 billion | $5.577 billion | +$365 million |
| Operating profit | $2.024 billion | $1.694 billion | +$330 million |
| Net income | $1.129 billion | $954 million | +$175 million |
| Diluted EPS | $0.95 | $0.77 | +23% |
| Operating cash flow | $2.172 billion | $1.640 billion | +$532 million |
- Gross margin was 18.2%, up approximately 5 basis points; operating margin was approximately 6.2%, versus 5.5%. Operating expenses rose 0.9%, slower than revenue growth, and fell to 12.0% of revenue from 12.6%.
- Pharmacy Services revenue rose 10.3% to $20.2 billion; operating profit increased to $640 million from $499 million. Segment gross margin improved to 4.6% from 4.2%.
- Retail Pharmacy revenue rose 2.7% to $16.5 billion; operating profit increased to $1.75 billion from $1.53 billion. Same-store pharmacy sales grew 3.8%, while front-store same-store sales declined 3.8%.
- Cash used in investing was $2.560 billion, including the Coram acquisition; capital expenditures were $388 million. Operating cash flow less capital expenditures was approximately $1.784 billion, versus $1.322 billion in Q1 2013.
Financial position and liquidity
- Cash and cash equivalents were $2.766 billion at March 31, down from $4.089 billion at year-end, primarily reflecting acquisition spending, share repurchases and dividends. Net cash decreased $1.323 billion during the quarter.
- Total debt was approximately $13.410 billion, including $565 million current and $12.845 billion long-term. Long-term debt carrying value was $13.4 billion; estimated fair value was $14.5 billion.
- Current assets were $24.460 billion and current liabilities $16.213 billion. No commercial paper or backup credit-facility borrowings were outstanding. The company reported $3.5 billion of backup credit facilities available.
- Management stated that operating cash flows, its commercial paper and sale-leaseback programs, and potential future borrowing were expected to support liquidity needs. Debt ratings were investment grade with stable outlooks at Moody’s and S&P.
Material changes and management commentary
- CVS acquired Coram, a specialty infusion and enteral nutrition business, on January 16 for approximately $2.1 billion cash plus approximately $0.1 billion contingent consideration. The preliminary purchase accounting included $1.6 billion goodwill, which is nondeductible for tax purposes; valuation and tax matters remained open. Coram results were included in Pharmacy Services from the acquisition date.
- Growth reflected specialty pharmacy, Coram, drug-cost inflation, new clients and products, pharmacy same-store growth and new stores. Higher generic dispensing supported margins, while generic drugs generally reduce selling prices and revenue.
- Pharmacy Services processed 227.8 million claims, approximately flat year over year; its generic dispensing rate rose to 82.4% from 80.5%. Retail prescription volume increased 2.7%, and its generic dispensing rate rose to 82.9% from 81.2%.
- Retail results faced a milder flu season, severe weather and Easter’s shift into April, which weighed on front-store sales and pharmacy activity. Higher generic dispensing and mix supported gross profit, but reimbursement pressure continued.
- The company repurchased 11.0 million shares for approximately $801 million and paid $325 million in dividends. Approximately $5.9 billion remained available under the active repurchase authorization.
- Interest expense increased $32 million, primarily because of the $4 billion debt issuance in December 2013. The effective tax rate was 39.5%, compared with 39.1%.
Outlook, risks and contingencies
- The filing provides no specific full-year revenue, earnings or EPS guidance. Management expected generic introductions to continue at a slower pace and identified continued PBM pricing, rebate-sharing and retail reimbursement pressure.
- Management cited risks including client retention and contract renewals, Medicare Part D competition and regulation, government reimbursement changes, generic and brand-drug trends, supplier access, health-care reform, cybersecurity, Coram integration and legal or regulatory proceedings.
- CMS sanctions on the SilverScript Medicare Part D plan were removed in December 2013 after corrective actions. New enrollment resumed, and low-income subsidy enrollment began again for effective dates from May 1, 2014.
- In April 2014, the company concluded an SEC settlement concerning alleged 2009 violations, on a no-admit-or-deny basis. It paid a $20 million civil penalty, fully reserved at March 31; no financial-statement restatement was required.
- Other matters included government inquiries into Medicare Part D manufacturer fees and rebates, controlled-substance compliance and other pharmacy practices, plus pending litigation. Management said it could not reliably estimate potential losses beyond recorded accruals for the described matters. It also noted approximately 72 legacy store-lease guarantees, with remaining terms extending through 2026.
- A proposed lease-accounting update was expected, as drafted, to materially affect the balance sheet, though management did not expect a material liquidity impact; the standard was not final.
Important facts for investors to verify
- Whether Coram’s preliminary purchase accounting, tax attributes, contingent consideration and integration results change materially.
- Whether operating cash flow and margin gains persist after the acquisition-related cash outlay and share repurchases.
- How PBM rebate sharing, spread-pricing pressure and retail pharmacy reimbursement affect segment margins.
- Developments and potential financial consequences of government investigations, litigation and controlled-substance matters.
- Actual utilization of the remaining repurchase authorization and the company’s debt, cash and liquidity position in subsequent periods.