CVS Caremark Corporation — Q2 2009 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2009, compared with periods ended June 28, 2008. CVS Caremark operates Pharmacy Services and Retail Pharmacy businesses. The quarter was 91 days in both years; the 2009 six-month period had one fewer day. Interim financial statements are unaudited and were reviewed, not audited, by the independent accountant.
Financial performance
- Second quarter revenue: $24.87 billion, up 17.6%; gross profit was $5.05 billion, up 15.5%; operating profit was $1.60 billion, up 8.2%.
- Second quarter earnings: Continuing-operations earnings were $889 million, up 8.0%; net earnings were $887 million, up 14.4%. Diluted EPS was $0.60 versus $0.53.
- Margins: Consolidated gross margin was approximately 20.3% versus 20.7%; operating margin was 6.4% versus 7.0%. The filing reports segment operating margins of 4.9% for Pharmacy Services (5.8% prior year) and 7.0% for Retail Pharmacy (7.3%).
- First six months: Revenue was $48.27 billion, up 13.7%; operating profit was $2.98 billion, up 4.5%; net earnings were $1.62 billion, up 6.7%. Diluted EPS was reported as $1.105 versus $1.04.
- Cash flow: Six-month operating cash flow was $1.32 billion, down from $1.39 billion. Capital expenditures were $1.09 billion; sale-leaseback proceeds were $503 million. Cash declined $127 million to $1.23 billion.
- Liquidity and debt: Current assets were $16.77 billion and current liabilities $12.76 billion. Short-term debt was $1.33 billion, current maturities of long-term debt $2.40 billion, and long-term debt $7.31 billion. Total reported debt was approximately $11.04 billion, versus $11.75 billion at year-end 2008. Commercial paper outstanding was $1.3 billion at a 0.9% weighted-average rate; no borrowings were outstanding on $3.375 billion of committed backup facilities.
- Dividends: Quarterly dividend increased 10.5% to $0.07625 per share. Share repurchases resumed July 1, 2009.
Material changes and drivers
- The Longs Drug Stores acquisition, completed October 20, 2008, contributed approximately $1.9 billion of Q2 revenue and $3.2 billion for the six-month period, net of intersegment eliminations. Acquisition-related integration expenses also increased costs.
- Pharmacy Services revenue grew 22.1% in Q2, while operating profit rose 3.8%; its gross margin declined to 7.1% from 8.0%. Growth reflected RxAmerica, higher claims and revenue per claim, but RxAmerica contract accounting changes also increased reported revenue.
- Retail Pharmacy revenue grew 17.2% in Q2; same-store sales increased 6.1% (pharmacy 7.5%, front store 3.0%). Segment operating profit grew 11.4%, but operating margin declined to 7.0% from 7.3% as expenses grew faster than sales.
- Generic dispensing increased in both segments. Management cited generic growth as a gross-margin benefit, but noted reimbursement pressure and lower selling prices can limit that benefit. Pharmacy Services also faced margin compression from client renewals and new business priced at lower rates.
- Higher taxes paid contributed to lower operating cash flow. Net interest expense increased, primarily reflecting higher average debt associated with the Longs acquisition.
Outlook, risks and unusual items
- Management expected cash from operations, supplemented by commercial paper and long-term borrowing, to fund growth. It planned 125–150 new or relocated retail stores during the remainder of 2009.
- Management expected a 2010 CMS rule on Medicare Part D pricing “spread” reporting to reduce profitability of the Medicare Part D business.
- Key risks include economic weakness affecting utilization and clients, reimbursement and pricing pressure, competition, client retention and new-business wins, acquisition integration and synergies, regulation and healthcare reform, and drug-product mix and rebate levels.
- Contingencies include legacy store-lease guarantees, including Linens ’n Things-related costs, and pending government claims-processing and pharmacy network antitrust matters. The federal qui tam court rulings were favorable to Caremark, but the United States sought an appeal; Texas also brought a related enforcement action. The filing does not provide a clear quantified exposure for these matters.
- The company reported approximately $167 million of unrecognized tax benefits related to business combinations; some could be recognized during 2009 and affect the effective tax rate. No material subsequent events through August 4, 2009 were reported.
- Sale-leaseback proceeds rose substantially year over year. The resulting leases are operating leases and are not reflected as debt on the balance sheet.
Investor verification priorities
- Separate acquisition growth and RxAmerica gross-versus-net revenue accounting changes from underlying volume and profitability trends.
- Assess the sustainability of segment margins amid generic reimbursement pressure, lower-priced client contracts and integration costs.
- Review debt maturities, commercial-paper dependence, lease obligations and the effect of sale-leasebacks on future commitments.
- Track 2010 Medicare Part D rule impacts and developments in the Medicaid claims, Texas enforcement and pharmacy-network litigation.
- Confirm whether planned store openings, share repurchases and the expected recognition of tax benefits occurred as described.