CVS Caremark Corporation — Q2 2013 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2013, compared with the corresponding 2012 periods. CVS Caremark operated pharmacy benefit management, retail pharmacy, and health clinic businesses. Amounts are in U.S. dollars; financial statement amounts are in millions unless noted.
Financial performance
| Metric | Q2 2013 | Q2 2012 | Six months 2013 | Six months 2012 |
|---|---|---|---|---|
| Net revenue | $31,248 | $30,714 | $62,011 | $61,512 |
| Gross profit | $5,836 | $5,449 | $11,418 | $10,562 |
| Gross margin | 18.7% | 17.7% | 18.4% | 17.2% |
| Operating profit | $1,968 | $1,708 | $3,667 | $3,111 |
| Net income attributable to CVS Caremark | $1,121 | $966 | $2,077 | $1,742 |
| Diluted EPS | $0.91 | $0.75 | $1.68 | $1.34 |
Q2 revenue grew 1.7%; six-month revenue grew 0.8%. Gross profit rose 7.1% in Q2 and 8.1% for the first half. Management attributed margin improvement mainly to higher generic dispensing, including improved pharmacy margins and, in Pharmacy Services, better rebates and lower streamlining costs. Interest expense, net, was $126 million in Q2 and $252 million for the first half, down from $132 million and $263 million, respectively.
Segments
- Pharmacy Services: Q2 revenue of $18.8 billion (+2.0%) and operating profit of $675 million versus $511 million. Six-month revenue was $37.1 billion (+1.1%) and operating profit $1.174 billion versus $860 million. Higher claims volume and generic dispensing supported profit; generic mix reduced revenue per pharmacy-network claim.
- Retail Pharmacy: Q2 revenue of $16.1 billion (+1.9%) and operating profit of $1.596 billion versus $1.469 billion. Six-month revenue was $32.2 billion (+1.0%) and operating profit $3.133 billion versus $2.766 billion. New stores and higher generic dispensing supported gross profit; same-store sales were subdued.
Cash flow, balance sheet, and capital allocation
- Cash from operations: $2.542 billion for the first six months, down from $4.017 billion. Management said the main driver was timing of a CMS payment: a July 2012 payment was received in June 2012, while the comparable 2013 payment arrived in July 2013; other working-capital timing also contributed.
- Investing cash flow: $1.093 billion used, including $804 million of property and equipment purchases and $300 million of acquisitions and other investments.
- Financing cash flow: $1.648 billion used, including $748 million of share repurchases and $553 million of dividends paid. The company repurchased 13.8 million shares in the first half; approximately $3.9 billion remained under its $6.0 billion authorization. Q2 dividends declared were $0.225 per share, versus $0.1625 a year earlier.
- Liquidity: Cash and cash equivalents were $1.174 billion at June 30, 2013, versus $1.375 billion at year-end 2012. No commercial paper or backup-facility borrowings were outstanding. The company maintained $3.5 billion of backup credit facilities.
- Debt: Short-term debt was zero, compared with $690 million at year-end; current long-term debt was $18 million and long-term debt was $9.358 billion, versus $9.133 billion at year-end. Long-term debt’s carrying value was $9.4 billion; estimated fair value was $10.3 billion. Ratings were Baa2/positive from Moody’s and BBB+/stable from S&P.
Changes, outlook, risks, and unusual items
- Generic dispensing rates increased across the businesses: Pharmacy Services total rate was 80.7% in Q2 versus 78.0%; Retail Pharmacy’s was 81.9% versus 79.1%. Generic conversions supported margins but typically reduced reported revenue and pharmacy sales growth. Management expected generic introductions to continue, though at a slower pace.
- Retail Pharmacy same-store sales increased 0.4% in Q2 but declined 0.4% for the first half. The filing cites generic conversions, reimbursement pressure, Easter timing, and the absence of a 2012 leap day as factors. Management also noted continued pressure from payors to reduce pharmacy reimbursement.
- Medicare Part D: CMS imposed enrollment and marketing sanctions on SilverScript effective January 15, 2013, following issues related to enrollment systems conversion and coverage determinations. A limited waiver allowed certain employer retiree enrollments through October 30, 2013. Management did not expect sanctions to be lifted before the 2014 enrollment period and could not estimate the duration, remediation costs, or financial impact. Current members could be retained, subject to attrition.
- Legal and regulatory matters: The company agreed in principle to a $20 million SEC civil penalty, fully reserved, subject to final documentation and required approvals; it said no financial statements would be restated. Other disclosed matters include government investigations, qui tam claims, securities litigation and pharmacy-network antitrust litigation. One Alabama class action seeks approximately $3.2 billion plus unspecified damages. The company said legal accruals were not material and it could not estimate losses beyond recorded accruals for the described matters.
- The company guaranteed approximately 74 former-subsidiary store leases, excluding Linens ’n Things; remaining terms extend through 2024. Management did not expect the guarantees’ ultimate disposition to materially harm consolidated results or cash flows.
- Management stated that operating cash flow, its commercial paper program, sale-leasebacks, and potential borrowings should fund near-term needs and long-term initiatives. The filing gives no specific full-year earnings or revenue guidance. A proposed lease-accounting standard was expected, as drafted, to materially affect financial position but not liquidity; the company said the impact could not yet be determined.
- The interim financial statements were unaudited and reviewed, not audited. Management reported disclosure controls as adequate and effective and no material change in internal control during the quarter.
Investor verification priorities
- Track CMS’s remediation review, sanction status, enrollment restrictions, member retention, and resulting costs or revenue effects for SilverScript.
- Reconcile operating cash flow and working-capital movements, especially the CMS payment timing and changes in receivables and accrued expenses.
- Monitor generic-drug mix, reimbursement and rebate trends, same-store sales, and whether margin gains persist as generic introductions slow.
- Confirm final approval and payment of the $20 million SEC settlement, and developments in the other disclosed legal and government matters.
- Assess debt, lease guarantees, capital spending, dividends, and buybacks against cash generation and the undrawn credit facilities.