CVS Caremark Corporation — Q2 2014 Form 10-Q
Business context and reporting period. The filing covers the quarter and six months ended June 30, 2014. CVS Caremark operated Pharmacy Services, Retail Pharmacy and Corporate segments, combining pharmacy benefit management, specialty and infusion services, retail pharmacies and health clinics. The interim statements are unaudited; the independent accountant performed a review, not an audit.
Financial performance and liquidity
| Metric | Q2 2014 | Q2 2013 | First half 2014 | First half 2013 |
|---|---|---|---|---|
| Net revenue | $34.6B | $31.2B | $67.3B | $62.0B |
| Gross profit | $6.3B | $5.8B | $12.3B | $11.4B |
| Operating profit | $2.2B | $2.0B | $4.2B | $3.7B |
| Net income | $1.25B | $1.12B | $2.38B | $2.08B |
| Diluted EPS | $1.06 | $0.91 | $2.01 | $1.68 |
| Operating cash flow | Not stated for quarter | Not stated for quarter | $3.07B | $2.54B |
- Q2 revenue rose 10.7% and first-half revenue 8.5%; net income increased about 11% and 14%, respectively. Revenue growth reflected new PBM business, specialty pharmacy, drug inflation and product mix, as well as retail pharmacy growth.
- Consolidated gross margin was approximately 18.3% in Q2 and 18.2% for the first half, down about 40 and 20 basis points, respectively, from the prior year, chiefly because the lower-margin Pharmacy Services segment grew faster. Operating expense leverage supported operating profit growth.
- At June 30, cash and cash equivalents were $1.61B; current assets were $24.14B and current liabilities $16.63B. Total debt was approximately $13.37B, comprising $1.12B current and $12.25B long-term. Long-term debt’s estimated fair value was $14.7B versus $13.4B carrying value.
- First-half investing cash outflow was $3.19B, including the Coram acquisition; financing cash outflow was $2.36B, including $2.00B of share repurchases and $647M of dividends. Cash declined $2.48B from year-end. The company reported no commercial paper or backup-facility borrowings and had $3.5B in committed backup credit facilities available.
Material changes versus prior period
- Pharmacy Services revenue increased 16.2% in Q2 and 13.3% in the first half; segment operating profit rose to $878M and $1.52B, respectively. Coram, acquired in January for about $2.1B cash plus contingent consideration, contributed to specialty and infusion growth. The segment also benefited from higher generic dispensing and favorable purchasing economics.
- Retail Pharmacy revenue increased 4.5% in Q2 and 3.6% in the first half; segment operating profit increased to $1.71B and $3.46B. Pharmacy same-store sales grew, while front-store same-store sales declined 0.4% in Q2 and 2.1% in the first half. Retail prescription volume growth slowed versus the prior-year comparison.
- Interest expense increased $32M in Q2 and $64M in the first half, mainly reflecting the $4B debt issuance in December 2013. The company repurchased 27M shares for $2.0B in the first half; basic weighted-average shares fell to 1.172B from 1.230B.
Outlook, commentary, risks and unusual items
- The filing provides no specific numerical earnings or revenue guidance. Management said it expects generic introductions to continue, though at a slower pace, and expects favorable demographic and coverage trends to support pharmacy demand. It also expects competitive PBM pricing, client rebate demands and pharmacy reimbursement pressure to persist.
- Q2 and first-half gross profit included a $69M favorable California Medicaid reimbursement decision ($53M Retail Pharmacy; $16M Pharmacy Services). Coram acquisition costs of $14M were expensed in the first half. Coram purchase accounting remained preliminary, including open items related to working capital, deferred taxes, acquired tax attributes and contingent consideration.
- Risks highlighted include PBM contract retention and pricing competition, Medicare Part D bidding and regulation, lower reimbursement, generic/brand drug mix, health-care law changes, Coram integration, and litigation and government investigations. Multiple legal and regulatory matters remain pending; the company said it could not estimate possible losses beyond recorded accruals, which were not material in aggregate. It also disclosed guarantees on about 72 former-subsidiary store leases and stated it did not expect them to have a material adverse effect.
- Management considered operating cash flows, its commercial paper program and potential borrowings sufficient for expected needs. Moody’s rated long-term debt Baa1 and S&P rated it BBB+, both with stable outlooks at June 30, 2014. A proposed lease-accounting standard was expected potentially to materially affect reported financial position, though the impact was not yet determinable.
Most important facts for investors to verify
- How much reported growth and margin improvement is sustainable after the Coram acquisition and the $69M California reimbursement benefit.
- Whether Pharmacy Services can sustain segment growth amid declining traditional mail claims, lower PBM pricing and increased client sharing of manufacturer rebates.
- Retail Pharmacy trends in front-store sales, prescription volumes, reimbursement rates and generic drug conversions.
- Coram’s final purchase-price allocation, integration progress, tax-attribute value and future contribution to cash flow and earnings.
- Cash use from repurchases and dividends, debt maturities and borrowing costs, and the potential financial outcomes of the disclosed legal and government matters.