Overview of Our Business
CVS Caremark Corporation ("CVS Caremark", the "Company", "we" or "us"), together
with its subsidiaries is the largest pharmacy health care provider in the United
States. We are uniquely positioned to deliver significant benefits to health
plan sponsors through effective cost management solutions and innovative
programs that engage plan members and promote healthier and more cost-effective
behaviors. Our integrated pharmacy services model enhances our ability to offer
plan members and consumers expanded choice, greater access and more personalized
services to help them on their path to better health. We effectively manage
pharmaceutical costs and improve health care outcomes through our pharmacy
benefit management, mail order and specialty pharmacy division, CVS
Caremark® Pharmacy Services ("Caremark"); our approximately 7,400
CVS/pharmacy® retail stores; our retail-based health clinic subsidiary,
MinuteClinic®; and our online retail pharmacy, CVS.com®.
We currently have three segments: Pharmacy Services, Retail Pharmacy and
Corporate.
Pharmacy Services Segment
Our Pharmacy Services business provides a full range of PBM services, including
mail order and specialty pharmacy services, plan design and administration,
formulary management, discounted drug purchase arrangements, Medicare Part D
services, retail pharmacy network management services, prescription management
systems, clinical services, disease management services and pharmacogenomics.
Our clients are primarily employers, insurance companies, unions, government
employee groups, managed care organizations and other sponsors of health benefit
plans and individuals throughout the United States. As a pharmacy benefits
manager, we manage the dispensing of pharmaceuticals through our mail order
pharmacies and national network of approximately 67,000 retail pharmacies (which
include our CVS/pharmacy stores) to eligible members in the benefit plans
maintained by our clients and utilize our information systems to perform, among
other things, safety checks, drug interaction screenings and brand to generic
substitutions.
Our specialty pharmacies support individuals that require complex and expensive
drug therapies. Our specialty pharmacy business includes mail order and retail
specialty pharmacies that operate under the CVS Caremark® and CarePlus
CVS/pharmacy® names. We also provide health management programs, which include
integrated disease management for 29 conditions, through our strategic alliance
with Alere, L.L.C. and our Accordant® health management offering. In addition,
through our SilverScript Insurance Company and Pennsylvania Life Insurance
Company subsidiaries, we are a national provider of drug benefits to eligible
beneficiaries under the Federal Government's Medicare Part D program. The
Pharmacy Services Segment operates under the CVS Caremark® Pharmacy Services,
Caremark®, CVS Caremark®, CarePlus CVS/pharmacy®, CarePlus™, RxAmerica® and
Accordant® names. As of June 30, 2012, the Pharmacy Services Segment operated 31
retail specialty pharmacy stores, 12 specialty mail order pharmacies and five
mail service pharmacies located in 22 states, Puerto Rico and the District of
Columbia.
Retail Pharmacy Segment
Our Retail Pharmacy Segment sells prescription drugs and a wide assortment of
general merchandise, including over-the-counter drugs, beauty products and
cosmetics, photo finishing, seasonal merchandise, greeting cards and convenience
foods through our CVS/pharmacy and Longs Drugs® retail stores and online through
CVS.com. Our Retail Pharmacy Segment derives the majority of its revenues
through the sale of prescription drugs, which are dispensed by our more than
22,000 retail pharmacists. Our Retail Pharmacy Segment also provides health care
services through our MinuteClinic health care clinics. MinuteClinics are staffed
by nurse practitioners and physician assistants who utilize nationally
recognized protocols to diagnose and treat minor health conditions, perform
health screenings, monitor chronic conditions, and deliver vaccinations. As of
June 30, 2012, our Retail Pharmacy Segment included 7,381 retail drugstores (of
which 7,323 operated a pharmacy) located in 41 states, the District of Columbia,
and Puerto Rico operating primarily under the CVS/pharmacy® or Longs
Drugs® names, 28 onsite pharmacies and 584 retail health care clinics operating
under the MinuteClinic® name (of which 577 were located in CVS/pharmacy stores),
and our online retail website, CVS.com.
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Corporate Segment
The Corporate Segment provides management and administrative services to support
the Company. The Corporate Segment consists of certain aspects of our executive
management, corporate relations, legal, compliance, human resources, corporate
information technology and finance departments.
Results of Operations
The following discussion explains the material changes in our results of
operations for the three and six months ended June 30, 2012 and 2011, and the
significant developments affecting our financial condition since December 31,
2011. We strongly recommend that you read our audited consolidated financial
statements and notes thereto and Management's Discussion and Analysis of
Financial Condition and Results of Operations included as Exhibit 13 to our
Annual Report on Form 10-K for the year ended December 31, 2011 (the "2011
Form 10-K") along with this report.
Summary of the Condensed Consolidated Financial Results:
Three Months Ended Six Months Ended
June 30, June 30,
In millions 2012 2011 2012 2011
Net revenues $ 30,714 $ 26,414 $ 61,512 $ 52,109
Cost of revenues 25,265 21,328 50,950 42,281
Gross profit 5,449 5,086 10,562 9,828
Operating expenses 3,741 3,602 7,451 7,039
Operating profit 1,708 1,484 3,111 2,789
Interest expense, net 132 148 263 282
Income before income tax
provision 1,576 1,336 2,848 2,507
Income tax provision 610 523 1,106 985
Income from continuing
operations 966 813 1,742 1,522
Income (loss) from discontinued
operations, net of tax (1) 2 (2) 5
Net income 965 815 1,740 1,527
Net loss attributable to
noncontrolling interest 1 1 2 2
Net income attributable to CVS
Caremark $ 966 $ 816 $ 1,742 $ 1,529
Net Revenues
Net revenues increased $4.3 billion, or 16.3% and $9.4 billion, or 18.0% in the
three and six months ended June 30, 2012, respectively, as compared to the prior
year periods. Net revenues in the periods were positively impacted from the
Pharmacy Services Segment by new PBM client starts, drug cost inflation and our
acquisition of the Medicare prescription drug plan of Universal American Corp.
("UAM Medicare PDP Business") on April 29, 2011, as well as positive same store
and new store sales in our Retail Pharmacy Segment.
Please see the section entitled "Segment Analysis" below for additional
information regarding net revenues.
Gross Profit
Gross profit dollars increased $363 million and $734 million in the three and
six months ended June 30, 2012, respectively, as compared to the prior year
periods. Gross profit as a percentage of net revenues decreased approximately
150 basis points to 17.7% and 170 basis points to 17.2% in the three and six
months ended June 30, 2012, respectively, as compared to the prior year periods.
The decline in gross profit as a percent of net revenues was driven by the
increased weighting toward Pharmacy Services whose gross profit margin tends to
be lower than that of the Retail Pharmacy Segment.
Please see the section entitled "Segment Analysis" below for additional
information regarding gross profit.
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Operating Expenses
Operating expenses increased $139 million, or 3.9% and $412 million, or 5.9% in
the three and six months ended June 30, 2012, respectively, as compared to the
prior year periods. Operating expenses as a percent of net revenues decreased
approximately 145 basis points to 12.2% and 140 basis points to 12.1% in the
three and six months ended June 30, 2012 as compared to 13.6% and 13.5% in the
prior year periods, respectively. Operating expenses as a percentage of net
revenues decreased due to expense leverage from same store sales growth and
expense control initiatives. The increase in operating expense dollars in the
three and six months ended June 30, 2012 was primarily due to incremental store
operating costs associated with the increase in sales volume in our stores and a
higher store count, as well as operating expenses associated with the UAM
Medicare PDP Business we acquired on April 29, 2011.
Please see the section entitled "Segment Analysis" below for additional
information regarding operating expenses.
Interest Expense, net
Interest expense, net decreased $16 million and $19 million in the three and six
months ended June 30, 2012, respectively, as compared to the prior year periods.
This decrease resulted from lower average borrowings during the three and six
months ended June 30, 2012.
For additional information on our financing activities, please see the
"Liquidity and Capital Resources" section later in Management's Discussion and
Analysis of Financial Condition and Results of Operations.
Income Tax Provision
Our effective income tax rate improved to 38.7% and 38.8% for the three and six
months ended June 30, 2012, respectively, compared to 39.2% and 39.3% for the
three and six months ended June 30, 2011, respectively. The fluctuation in the
effective income tax rate is primarily due to changes in our state effective
income tax rate and permanent items.
Income (Loss) from Discontinued Operations
The loss from discontinued operations for the three months ended June 30, 2012
consisted of $1 million ($2 million, net of a $1 million income tax benefit) of
lease-related costs associated with guarantees of store lease obligations of
Linens 'n Things, a former subsidiary of the Company that became insolvent
subsequent to its disposition. Income from discontinued operations for the three
months ended June 30, 2011 consisted of $3 million ($6 million, net of a $3
million income tax expense) of income related to the operations of our TheraCom
subsidiary, partially offset by $1 million ($2 million, net of a $1 million
income tax benefit) of lease-related costs related to Linens 'n Things lease
guarantees.
The loss from discontinued operations for the six months ended June 30, 2012
consisted of $2 million ($3 million, net of a $1 million income tax benefit) of
lease-related costs, compared to income of $7 million ($12 million, net of a $5
million income tax expense) related to the operations of our TheraCom
subsidiary, partially offset by $2 million ($4 million, net of a $2 million
income tax benefit) of lease-related costs in the prior year period. The
decrease in the income from discontinued operations is primarily related to the
sale of our TheraCom subsidiary in November 2011.
See Notes 6 and 9 to the condensed consolidated financial statements for
additional information about our lease guarantees.
Net Loss Attributable to Noncontrolling Interest
Net loss attributable to noncontrolling interest represents the minority
shareholders' portion of the net loss from our majority owned subsidiary,
Generation Health, Inc. The net loss attributable to noncontrolling interest for
the three and six months ended June 30, 2012 and 2011 was approximately $1
million and $2 million, respectively. The Company purchased the remaining
interest in Generation Health, Inc. on June 29, 2012.
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Segment Analysis
We evaluate the performance of our Pharmacy Services and Retail Pharmacy
segments based on net revenue, gross profit and operating profit before the
effect of nonrecurring charges and gains and certain intersegment activities. We
evaluate the performance of our Corporate Segment based on operating expenses
before the effect of nonrecurring charges and gains and certain intersegment
activities. The following is a reconciliation of our segments to the condensed
consolidated financial statements:
Pharmacy Retail
Services Pharmacy Corporate Intersegment Consolidated
In millions Segment(1)(3) Segment Segment Eliminations(2) Totals
Three Months Ended
June 30, 2012:
Net revenues $ 18,423 $ 15,846 $ † $ (3,555) $ 30,714
Gross profit 777 4,769 † (97) 5,449
Operating profit (loss) 511 1,469 (175) (97) 1,708
June 30, 2011:
Net revenues 14,374 14,826 † (2,786) 26,414
Gross profit 720 4,408 † (42) 5,086
Operating profit (loss) 448 1,240 (162) (42) 1,484
Six Months Ended
June 30, 2012:
Net revenues 36,722 31,869 † (7,079) 61,512
Gross profit 1,393 9,341 † (172) 10,562
Operating profit (loss) 860 2,766 (343) (172) 3,111
June 30, 2011:
Net revenues 28,203 29,413 † (5,507) 52,109
Gross profit 1,350 8,555 † (77) 9,828
Operating profit (loss) 839 2,336 (309) (77) 2,789
(1) Net revenues of the Pharmacy Services Segment includes approximately
$2.1 billion and $1.9 billion of retail co-payments for the three months ended
June 30, 2012 and 2011, respectively, as well as $4.4 billion and $4.1 billion
of retail co-payments for the six months ended June 30, 2012 and 2011,
respectively.
(2) Intersegment eliminations relate to two types of transactions:
(i) Intersegment revenues that occur when Pharmacy Services Segment customers
use Retail Pharmacy Segment stores to purchase covered products. When this
occurs, both the Pharmacy Services and Retail Pharmacy segments record the
revenue on a standalone basis, and (ii) Intersegment revenues, gross profit and
operating profit that occur when Pharmacy Services Segment customers, through
the Company's intersegment activities (such as the Maintenance Choice program),
elect to pick-up their maintenance prescriptions at Retail Pharmacy Segment
stores instead of receiving them through the mail. When this occurs, both the
Pharmacy Services and Retail Pharmacy segments record the revenue, gross profit
and operating profit on a standalone basis. Beginning in the fourth quarter of
2011, the Maintenance Choice eliminations reflect all discounts available for
the purchase of mail order prescription drugs. The following amounts are
eliminated in consolidation in connection with the item (ii) intersegment
activity: net revenues of $840 million and $626 million for the three months
ended June 30, 2012 and 2011, respectively, and $1.6 billion and $1.2 billion
for the six months ended June 30, 2012 and 2011, respectively; gross profit and
operating profit of $97 million and $42 million for the three months ended
June 30, 2012 and 2011, respectively, and $172 million and $77 million for the
six months ended June 30, 2012 and 2011, respectively.
(3) The results of the Pharmacy Services Segment for the three and six
months ended June 30, 2011 have been revised to reflect the results of TheraCom
as discontinued operations. See Note 6 to the condensed consolidated financial
statements.
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Pharmacy Services Segment
The following table summarizes our Pharmacy Services Segment's performance for
the respective periods:
Three Months Ended Six Months Ended
June 30, June 30,
In millions 2012 2011(4) 2012 2011(4)
Net revenues $18,423 $ 14,374 $ 36,722 $ 28,203
Gross profit 777 720 1,393 1,350
Gross profit % of net revenues 4.2% 5.0% 3.8% 4.8%
Operating expenses 266 272 533
511
Operating expense % of net revenues 1.4% 1.9% 1.5%
1.8%
Operating profit 511 448 860
839
Operating profit % of net revenues 2.8% 3.1% 2.3%
3.0%
Net revenues(1):
Mail choice(2) $ 5,744 $ 4,582 $ 11,410 $ 8,975
Pharmacy network(3) 12,625 9,737 25,209 19,114
Other 54 55 103 114
Pharmacy claims processed(1):
Total 218.3 191.8 437.2 367.0
Mail choice(2) 20.5 17.8 40.9 35.3
Pharmacy network(3) 197.8 174.0 396.3 331.7
Generic dispensing rate(1):
Total 78.0% 74.1% 77.3% 73.9%
Mail choice(2) 71.2% 64.6% 70.1% 64.2%
Pharmacy network(3) 78.6% 75.0% 78.0% 74.9%
Mail choice penetration rate 22.9% 22.6% 22.9% 23.3%
(1) Pharmacy network net revenues, claims processed and generic dispensing
rates do not include Maintenance Choice, which are included within the mail
choice category.
(2) Mail choice is defined as claims filled at a Pharmacy Services' mail
facility, which includes specialty mail claims, as well as 90-day claims filled
at retail under the Maintenance Choice program.
(3) Pharmacy network is defined as claims filled at retail pharmacies,
including our retail drugstores.
(4) The results of the Pharmacy Services Segment for the three and six
months ended June 30, 2011 have been revised to reflect the results of TheraCom
as discontinued operations. See Note 6 to the condensed consolidated financial
statements.
Net Revenues
Net revenues increased $4.0 billion, or 28.2%, to $18.4 billion in the three
months ended June 30, 2012, as compared to the prior year period. As you review
our Pharmacy Services Segment's performance in this area, we believe you should
consider the following important information that impacted the three month
period ended June 30, 2012:
† Our mail choice claims processed increased 15.5% to 20.5 million
claims in the three months ended June 30, 2012, compared to 17.8 million claims
in the prior year period. The increase in mail choice claim volume was primarily
due to a significant number of new client starts, as well as increased claims
associated with the continuing client adoption of our Maintenance Choice
program.
† Our average revenue per mail choice claim increased by 8.6%, compared
to the prior year period. This increase was primarily due to drug cost inflation
particularly in our specialty business.
† Our mail choice generic dispensing rate increased to 71.2% in the
three months ended June 30, 2012, compared to 64.6% in the prior year period.
This increase was primarily due to new generic prescription drug introductions,
as well as our continuous effort to encourage plan members to use clinically
appropriate generic prescription drugs when they are available.
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† Our pharmacy network claims processed increased 13.7% to 197.8
million claims in the three months ended June 30, 2012, compared to 174.0
million claims in the prior year period. The increase in the pharmacy network
claim volume was primarily due to a large number of new client starts, as well
as higher claims activity associated with our Medicare Part D program related to
the April 29, 2011 purchase of the UAM Medicare PDP Business.
† Our average revenue per pharmacy network claim processed increased
14.1%, as compared to the prior year period. This increase was primarily due to
drug cost inflation partially offset by increases in the generic dispensing
rate.
† Our pharmacy network generic dispensing rate increased to 78.6% in
the three months ended June 30, 2012, compared to 75.0% in the prior year
period. This increase was primarily due to new generic prescription drug
introductions, as well as our continuous effort to encourage plan members to use
clinically appropriate generic prescription drugs when they are available.
Net revenues increased $8.5 billion, or 30.2%, to $36.7 billion in the six
months ended June 30, 2012, as compared to the prior year period. The increase
in net revenues was primarily due to new activity resulting from our acquisition
of the UAM Medicare PDP Business. As you review our Pharmacy Services Segment's
performance in this area, we believe you should consider the following important
information that impacted the six month period ended June 30, 2012:
† Our mail choice claims processed increased 16.0% to 40.9 million
claims in the six months ended June 30, 2012, compared to 35.3 million claims in
the prior year period. The increase in mail choice claim volume was primarily
due to a significant number of new client starts, as well as increased claims
associated with the continuing client adoption of our Maintenance Choice
program.
† Our average revenue per mail choice claim increased by 9.6%, compared
to the prior year period. This increase was primarily due to drug cost
inflation, partially offset by increases in the percentage of generic
prescription drugs dispensed and changes in client pricing.
† Our mail choice generic dispensing rate increased to 70.1% in the six
months ended June 30, 2012, compared to 64.2% in the prior year period. This
increase was primarily due to new generic prescription drug introductions and
our continuous effort to encourage plan members to use clinically appropriate
generic prescription drugs when they are available.
† Our pharmacy network claims processed increased 19.5% to 396.3
million claims in the six months ended June 30, 2012, compared to 331.7 million
claims in the prior year period. The increase in the pharmacy network claim
volume was primarily due to new client starts and higher claims activity
associated with our Medicare Part D program as a result of our acquisition of
the UAM Medicare PDP Business completed at the end of April 2011 and increases
in covered lives under our legacy Medicare Part D program.
† Our average revenue per pharmacy network claim processed increased
10.4% as compared to the prior year period. This increase was primarily due to
drug cost inflation partially offset by increases in the generic dispensing
rate.
† Our pharmacy network generic dispensing rate increased to 78.0% in the
six months ended June 30, 2012, compared to 74.9% in the prior year period. This
increase was primarily due to new generic prescription drug introductions and
our continuous effort to encourage plan members to use clinically appropriate
generic prescription drugs when they are available.
Gross Profit
Gross profit in our Pharmacy Services Segment includes net revenues less cost of
revenues. Cost of revenues includes (i) the cost of pharmaceuticals dispensed,
either directly through our mail service and specialty retail pharmacies or
indirectly through our national pharmacy network, (ii) shipping and handling
costs and (iii) the operating costs of our mail service pharmacies, customer
service operations and related information technology support.
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Gross profit increased $57 million, or 8.1%, to $777 million in the three months
ended June 30, 2012, as compared to the prior year period. Gross profit as a
percentage of net revenues was 4.2% in the three months ended June 30, 2012,
compared to 5.0% in the prior year period. Gross profit increased $43 million,
or 3.2%, to $1.4 billion in the six months ended June 30, 2012, as compared to
the prior year period. Gross profit as a percentage of net revenues was 3.8% in
the six months ended June 30, 2012, compared to 4.8% in the prior year period.
The increase in gross profit dollars was primarily due to a significant number
of new client starts, an increase in generic dispensing and drug cost inflation.
The decrease in gross profit as a percentage of revenue was driven primarily by
client pricing compression, increased payroll and other expenses associated with
our mail operations and expanding Medicare Part D operations. The increase in
expenses associated with our mail operations was the result of the significant
number of new client starts.
As you review our Pharmacy Services Segment's performance in this area, we
believe you should consider the following important information that impacted
the three and six month periods ended June 30, 2012:
† Our gross profit dollars and gross profit as a percentage of net
revenues continued to be impacted by our efforts to (i) retain existing clients,
(ii) obtain new business and (iii) maintain or improve the purchase discounts we
received from manufacturers, wholesalers and retail pharmacies. In particular,
competitive pressures in the PBM industry have caused us and other PBMs to
continue to share a larger portion of rebates and/or discounts received from
pharmaceutical manufacturers. In addition, market dynamics and regulatory
changes have impacted our ability to offer plan sponsors pricing that includes
retail network "differential" or "spread". We expect these trends to continue.
† Our gross profit as a percentage of revenues benefited from the
increase in our total generic dispensing rate, which increased to 78.0% and
77.3% in the three and six months ended June 30, 2012, respectively, compared to
our generic dispensing rate of 74.1% and 73.9% in the prior year periods,
respectively. This increase was primarily due to new generic drug introductions
and our continued efforts to encourage plan members to use clinically
appropriate generic drugs when they are available.
Operating Expenses
Operating expenses in our Pharmacy Services Segment include selling, general and
administrative expenses, depreciation and amortization related to selling,
general and administrative activities and specialty pharmacy store and
administrative payroll, employee benefits and occupancy costs.
Operating expenses decreased $6 million to $266 million, or 1.4% as a percentage
of net revenues in the three months ended June 30, 2012, compared to $272
million, or 1.9% as a percentage of net revenues in the prior year period. The
decrease in operating expenses is primarily related to disciplined expense
management and a decrease in integration expense related to the acquisition of
the UAM Medicare PDP Business.
Operating expenses increased $22 million to $533 million, or 1.5% as a
percentage of net revenues in the six months ended June 30, 2012, compared to
$511 million, or 1.8% as a percentage of net revenues in the prior year period.
The increase in operating expenses is primarily related to costs associated with
changes designed to streamline our business and two full quarters of expenses
associated with the UAM Medicare PDP Business which was acquired at the end of
April 2011, partially offset by disciplined expense controls.
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Retail Pharmacy Segment
The following table summarizes our Retail Pharmacy Segment's performance for the
respective periods:
Three Months Ended Six Months Ended
June 30, June 30,
In millions 2012 2011 2012 2011
Net revenues $15,846 $14,826 $31,869 $29,413
Gross profit 4,769 4,408 9,341 8,555
Gross profit % of net revenues 30.1% 29.7% 29.3%
29.1%
Operating expenses 3,300 3,168 6,575
6,219
Operating expense % of net revenues 20.8% 21.4% 20.6% 21.1%
Operating profit
1,469 1,240 2,766
2,336
Operating profit % of net revenues 9.3% 8.4% 8.7% 7.9%
Net revenue increase:
Total 6.9% 3.6% 8.4% 4.0%
Pharmacy 8.3% 3.9% 9.7% 4.5%
Front store 3.9% 3.0% 5.5% 2.9%
Same store sales increase:
Total 5.6% 2.0% 7.0% 2.3%
Pharmacy 7.2% 2.6% 8.5% 3.1%
Front store 2.3% 0.8% 3.7% 0.6%
Generic dispensing rate 79.1% 75.6% 78.6% 75.4%
Pharmacy % of total revenues 68.8% 67.9% 69.4% 68.5%
Third party % of pharmacy revenue 97.6% 97.7% 97.9% 97.6%
Retail prescriptions filled
176.4 162.4 355.9 328.0
As of June 30, 2012, we operated 7,381 retail drugstores, compared to 7,266
retail drugstores on June 30, 2011.
Net Revenues
Net revenues increased $1 billion, or 6.9%, to $15.8 billion in the three months
ended June 30, 2012, as compared to the prior year period. This increase was
primarily driven by the same store sales increase of 5.6% and net revenues from
new stores, which accounted for approximately 110 basis points of our total net
revenue percentage increase in the three months ended June 30, 2012. Net
revenues increased $2.5 billion, or 8.4%, to $31.9 billion in the six months
ended June 30, 2012, as compared to the prior year period. This increase was
primarily driven by the same store sales increase of 7.0% and net revenues from
new stores, which accounted for approximately 115 basis points of our total net
revenue percentage increase in the six months ended June 30, 2012.
As you review our Retail Pharmacy Segment's performance in this area, we believe
you should consider the following important information that impacted the three
and six month periods ended June 30, 2012:
† Front store same store sales for the period rose by 2.3% and 3.7% for
the three and six month periods ended June 30, 2012, respectively, compared to
the prior year periods. Front store same store sales for the three months ended
June 30, 2012 were negatively impacted by the early onset of the allergy season
which shifted sales into the first quarter. Front store same store sales for the
six month period ended June 30, 2012 were positively impacted by approximately
65 basis points due to an additional day in 2012 related to the leap year.
† Pharmacy same store sales rose 7.2% and 8.5% for the three and six
month periods ended June 30, 2012, respectively, as compared to the prior year
periods. One of the largest drivers of the increase was the contractual impasse
between Express Scripts and Walgreens, our principal PBM and retail pharmacy
competitors, respectively, which resulted in Walgreens' exit from the Express
Scripts network as of January 1, 2012 and a significant amount of additional
Express Scripts members filling their prescriptions in our retail pharmacy
stores during the first half of the year. On July 19, 2012, Express Scripts and
Walgreens announced that they entered into a new pharmacy network agreement that
takes effect on September 15, 2012. As a result of the new agreement, the
Company's future results will be impacted by its ability to retain the
additional business gained from the contractual impasse. Please see the
"Cautionary Statement Concerning Forward-Looking Statements" section later in
Management's Discussion and Analysis of Financial Condition and Results of
Operations. Pharmacy same store sales for the six month period ended June 30,
2012 also benefited by 35 basis points from the extra day as a result of 2012
being a leap year.
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† Pharmacy revenues continue to be negatively impacted by the
conversion of brand named drugs to equivalent generic drugs, which typically
have a lower selling price. Pharmacy same store sales were negatively impacted
by approximately 500 and 400 basis points for the three and six month periods
ended June 30, 2012, respectively, due to recent generic introductions. In
addition, our pharmacy growth has also been adversely affected by the lack of
significant new brand name drug introductions and higher consumer co-payments
and co-insurance arrangements.
† Pharmacy revenue growth continued to benefit from the Medicare Part D
prescription drug program, our ability to attract and retain managed care
customers and favorable industry trends. These trends include an aging American
population; many "baby boomers" are now in their fifties and sixties and are
consuming a greater number of prescription drugs. In addition, the increased use
of pharmaceuticals as the first line of defense for individual health care also
contributed to the growing demand for pharmacy services. We believe these
favorable industry trends will continue.
Gross Profit
Gross profit in our Retail Pharmacy Segment includes net revenues less the cost
of merchandise sold in the period and the related purchasing costs, warehousing
costs, delivery costs and actual and estimated inventory losses.
Gross profit increased $361 million, or 8.2%, to $4.8 billion in the three
months ended June 30, 2012, as compared to the prior year period. Gross profit
as a percentage of net revenues increased to 30.1% in the three months ended
June 30, 2012, compared to 29.7% in the prior year period. The increase in gross
profit dollars was primarily driven by same store sales increases. The increase
in gross profit as a percentage of revenue was primarily driven by increased
pharmacy margins due to the positive impact of increased generic drugs
dispensed, partially offset by continued reimbursement pressure, lower front
store margins and the accounting change discussed below. Front store revenues as
a percentage of total revenues for the three months ended June 30, 2012 were
31.2%, as compared to 32.1% in the prior year period. Pharmacy revenues as a
percentage of total revenues for the three months ended June 30, 2012 were
68.8%, compared to 67.9% in the prior year period.
Gross profit increased $786 million, or 9.2%, to $9.3 billion in the six months
ended June 30, 2012, as compared to the prior year period. Gross profit as a
percentage of net revenues increased to 29.3% in the six months ended June 30,
2012, compared to 29.1% in the prior year period. The increase in gross profit
dollars was primarily driven by same store sales increases. The slight increase
in gross profit as a percentage of revenue was primarily driven by increased
pharmacy margins due to the positive impact of increased generic drugs dispensed
partially offset by continued reimbursement pressure and lower front store
margins. Front store revenues as a percentage of total revenues for the six
months ended June 30, 2012 were 30.6%, as compared to 31.5% in the prior year
period. Pharmacy revenues as a percentage of revenues for the six months ended
June 30, 2012 were 69.4%, compared to 68.5% in the prior year period.
As you review our Retail Pharmacy Segment's performance in this area, we believe
you should consider the following important information that impacted the three
and six month periods ended June 30, 2012:
† Gross profit was negatively impacted by approximately $31 million and
$1 million for the three and six month periods ended June 30, 2012,
respectively, as a result of the change in inventory accounting methods
described in Note 2 to our condensed consolidated financial statements. The
impact of this change on gross profit as a percentage of net revenues for the
three months ended June 30, 2012 was approximately 20 basis points.
† Sales to customers covered by third party insurance programs are a
significant component of our retail pharmacy business. On average, our gross
profit on third party pharmacy revenues is lower than our gross profit on cash
pharmacy revenues. Third party revenues were 97.6% and 97.9% in the three and
six months ended June 30, 2012, respectively, compared to 97.7% and 97.6% in the
three and six months ended June 30, 2011.
† Our pharmacy gross profit rates have been adversely affected by the
efforts of managed care organizations, pharmacy benefit managers and
governmental and other third-party payors to reduce their prescription drug
costs. In the event this trend continues, we may not be able to sustain our
current rate of revenue growth and gross profit dollars could be adversely
impacted.
† The increased use of generic drugs has positively impacted our gross
profit margins but in recent years has resulted in third party payors augmenting
their efforts to reduce reimbursement payments to retail pharmacies
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for prescriptions. This trend, which we expect to continue, reduces the benefit
we realize from brand to generic product conversions.
Operating Expenses
Operating expenses in our Retail Pharmacy Segment include store payroll, store
employee benefits, occupancy costs, selling expenses, advertising expenses,
depreciation and amortization expense and certain administrative expenses.
Operating expenses increased $132 million to $3.3 billion, or 20.8% as a
percentage of net revenues, in the three months ended June 30, 2012, as compared
to $3.2 billion, or 21.4% as a percentage of net revenues, in the prior year
period. Operating expenses increased $356 million to $6.6 billion, or 20.6% as a
percentage of net revenues, in the six months ended June 30, 2012, as compared
to $6.2 billion, or 21.1% as a percentage of net revenues, in the prior year
period. The improvement in operating expenses as a percentage of net revenues
for the three and six months ended June 30, 2012 was primarily due to expense
leverage from our same store sales growth and expense control initiatives.
Corporate Segment
Operating Expenses
Operating expenses in our Corporate Segment include executive management,
corporate relations, legal, compliance, human resources, corporate information
technology and finance departments. Operating expenses increased $13 million, or
8.0%, to $175 million and $34 million, or 11.0%, to $343 million in the three
and six months ended June 30, 2012, respectively, as compared to the prior year
period. The increase in operating expenses was primarily related to higher
payroll, insurance and depreciation.
Liquidity and Capital Resources
We maintain a level of liquidity sufficient to allow us to cover our cash needs
in the short-term. Over the long-term, we manage our cash and capital structure
to maximize shareholder return, strengthen our financial position and maintain
flexibility for future strategic initiatives. We continuously assess our working
capital needs, debt and leverage levels, capital expenditure requirements,
dividend payouts, potential share repurchases and future investments or
acquisitions. We believe our operating cash flows, commercial paper program,
sale-leaseback program, as well as any potential future borrowings, will be
sufficient to fund these future payments and long-term initiatives.
Net cash provided by operating activities was $4.0 billion in the six months
ended June 30, 2012, compared to $3.1 billion in the six months ended June 30,
2011. The $0.9 billion increase in cash provided by operating activities is
primarily due to a timing difference associated with an advance payment received
in June 2012 from the Centers for Medicare and Medicaid Services ("CMS") for
July 2012Medicare Part D premiums and claims. With the exception of the first
month of the year, the monthly payment we receive from CMS is paid on the first
day of each month, unless the first day of the month falls on a weekend, in
which case the payment is made on the last business day of the previous month.
Net cash used in investing activities was $1.1 billion in the six months ended
June 30, 2012, compared to $2.1 billion in the six months ended June 30, 2011.
The $1.0 billion decrease in cash used in investing activities was primarily due
to the $1.3 billion acquisition of the UAM Medicare PDP Business which occurred
in April 2011.
Net cash used in financing activities was $2.5 billion in the six months ended
June 30, 2012, compared to net cash used in financing activities of $0.2 billion
in the six months ended June 30, 2011. The $2.3 billion increase in cash used in
financing activities was primarily due to a $1.0 billion increase in share
repurchases, a $1.5 billion debt issuance in 2011 and no debt issuances in 2012,
partially offset by an increase in proceeds from stock option exercises of
approximately $0.2 billion.
On August 23, 2011, our Board of Directors authorized a share repurchase program
for up to $4.0 billion of outstanding common stock (the "2011 Repurchase
Program"). The 2011 Repurchase Program, which was effective immediately, permits
us to effect repurchases from time to time through a combination of open market
repurchases, privately negotiated transactions, accelerated share repurchase
transactions, and/or other derivative transactions. The
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2011 Repurchase Program may be modified or terminated by the Board of Directors
at any time. During the six months ended June 30, 2012, the Company repurchased
an aggregate of 44.7 million shares of common stock for approximately $2.0
billion pursuant to the 2011 Repurchase Program.
We had $200 million of commercial paper outstanding at a weighted average
interest rate of 0.34% as of June 30, 2012. In connection with our commercial
paper program, we maintain a $1.0 billion, three-year unsecured back-up credit
facility, which expires on May 27, 2013, a $1.25 billion, four-year unsecured
back-up credit facility which expires on May 12, 2015 and a $1.25 billion,
five-year unsecured back-up credit facility, which expires on February 17, 2017.
The credit facilities allow for borrowings at various rates depending on the
Company's public debt ratings and require the Company to pay a weighted average
quarterly facility fee of 0.05%, regardless of usage. As of June 30, 2012, the
Company had no outstanding borrowings against the back-up credit facilities.
Our back-up credit facilities, unsecured senior notes and enhanced capital
advantaged preferred securities contain customary restrictive financial and
operating covenants. These covenants do not include a requirement for the
acceleration of our debt maturities in the event of a downgrade in our credit
rating. We do not believe the restrictions contained in these covenants
materially affect our financial or operating flexibility.
As of June 30, 2012, our long-term debt was rated "Baa2" by Moody's with a
positive outlook and "BBB+" by Standard & Poor's with a stable outlook and our
commercial paper program was rated "P-2" by Moody's and "A-2" by Standard &
Poor's. In assessing our credit strength, we believe that both Moody's and
Standard & Poor's considered, among other things, our capital structure and
financial policies as well as our consolidated balance sheet, our historical
acquisition activity and other financial information. Although we currently
believe our long-term debt ratings will remain investment grade, we cannot
guarantee the future actions of Moody's and/or Standard & Poor's. Our debt
ratings have a direct impact on our future borrowing costs, access to capital
markets and new store operating lease costs.
Off-Balance Sheet Arrangements
In connection with executing operating leases, we provide a guarantee of the
lease payments. We also finance a portion of our new store development through
sale-leaseback transactions, which involve selling stores to unrelated parties
and then leasing the stores back under leases that qualify and are accounted for
as operating leases. We do not have any retained or contingent interests in the
stores, and we do not provide any guarantees, other than a guarantee of the
lease payments, in connection with the transactions. In accordance with
accounting principles generally accepted in the United States of America
("GAAP"), such operating leases are not reflected in our condensed consolidated
balance sheet. See Note 9 to our condensed consolidated financial statements for
a detailed discussion of these guarantees.
Critical Accounting Policies
We prepare our consolidated financial statements in conformity with GAAP, which
requires management to make certain estimates and apply judgments. We base our
estimates and judgments on historical experience, current trends and other
factors that management believes to be important at the time the condensed
consolidated financial statements are prepared. On a regular basis, we review
our accounting policies and how they are applied and disclosed in our condensed
consolidated financial statements.
While we believe that the historical experience, current trends and other
factors considered support the preparation of our condensed consolidated
financial statements in conformity with GAAP, actual results could differ from
our estimates and such differences could be material.
As discussed in Note 2 to the condensed consolidated financial statements,
effective January 1, 2012, the Company changed its methods of accounting for
prescription drug inventories in the Retail Pharmacy Segment. Prior to 2012, the
Company valued prescription drug inventories at the lower of cost or market on a
first-in, first-out ("FIFO") basis in retail pharmacies using the retail
inventory method and in distribution centers using the FIFO cost method.
Effective January 1, 2012, all prescription drug inventories in the Retail
Pharmacy Segment have been valued at the lower of cost or market using the
weighted average cost method. The Company recorded the cumulative effect of
these changes in accounting principle as of January 1, 2012. The Company
determined that retrospective application for periods prior to 2012 is
impracticable, as the period-specific information necessary to value
prescription drug inventories in the Retail Pharmacy Segment under the weighted
average cost method is unavailable. The Company implemented a new pharmacy cost
accounting system to value prescription drug inventory as of January 1, 2012 and
calculate the cumulative impact.
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For a full description of our other critical accounting policies, please refer
to Item 7, "Management's Discussion and Analysis of Financial Condition and
Results of Operations" in our 2011 Annual Report on Form 10-K.
Cautionary Statement Concerning Forward-Looking Statements
The Private Securities Litigation Reform Act of 1995 (the "Reform Act") provides
a safe harbor for forward-looking statements made by or on behalf of CVS
Caremark Corporation. The Company and its representatives may, from time to
time, make written or verbal forward-looking statements, including statements
contained in the Company's filings with the Securities and Exchange Commission
("SEC") and in its reports to stockholders. Generally, the inclusion of the
words "believe," "expect," "intend," "estimate," "project," "anticipate,"
"will," "should" and similar expressions identify statements that constitute
forward-looking statements. All statements addressing operating performance of
CVS Caremark Corporation or any subsidiary, events or developments that the
Company expects or anticipates will occur in the future, including statements
relating to revenue growth, earnings or earnings per common share growth,
adjusted earnings or adjusted earnings per common share growth, free cash flow,
debt ratings, inventory levels, inventory turn and loss rates, store
development, relocations and new market entries, PBM business and sales trends,
the Company's ability to attract or retain customers, Medicare Part D
competitive bidding and enrollment, new product development and the impact of
industry developments, as well as statements expressing optimism or pessimism
about future operating results or events, are forward-looking statements within
the meaning of the Reform Act.
The forward-looking statements are and will be based upon management's
then-current views and assumptions regarding future events and operating
performance, and are applicable only as of the dates of such statements. The
Company undertakes no obligation to update or revise any forward-looking
statements, whether as a result of new information, future events, or otherwise.
By their nature, all forward-looking statements involve risks and uncertainties.
Actual results may differ materially from those contemplated by the
forward-looking statements for a number of reasons, including, but not limited
to:
† Risks relating to the health of the economy in general and in the markets
we serve, which could impact consumer purchasing power, preferences and/or
spending patterns, drug utilization trends, the financial health of our PBM
clients or other payors doing business with the Company and our ability to
secure necessary financing, suitable store locations and sale-leaseback
transactions on acceptable terms.
† Efforts to reduce reimbursement levels and alter health care financing
practices, including pressure to reduce reimbursement levels for generic drugs.
† The possibility of PBM client loss and/or the failure to win new PBM
business.
† Risks related to the frequency and rate of the introduction of generic
drugs and brand name prescription products.
† Risks of declining gross margins in the PBM industry attributable to
increased competitive pressures, increased client demand for lower prices,
enhanced service offerings and/or higher service levels and market dynamics and
regulatory changes that impact our ability to offer plan sponsors pricing that
includes the use of retail "differential" or "spread."
† Regulatory and business changes relating to our participation in federal
and state government-funded programs, such as Medicare Part D and Medicaid.
† Possible changes in industry pricing benchmarks.
† An extremely competitive business environment, including the uncertain
impact of increased consolidation in the PBM industry and the willingness of
some PBM clients to consider adopting narrow or more restricted retail pharmacy
networks.
† Uncertainty related to our ability to retain customers gained as a result
of the Express Scripts and Walgreens contractual impasse, including uncertainty
regarding the marketing and other expenses we may need to incur in our efforts
to retain these customers.
† Uncertainty regarding the impact of the new pharmacy network agreement
entered into by Express Scripts and Walgreens, including uncertainty relating to
the effect on our net revenues, gross profit and cash flows over time if we are
unable to retain the business we have gained as a result of the Express Scripts
and Walgreens contractual impasse.
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† Reform of the U.S. health care system, including the impact of the recent
United States Supreme Court ruling on the Patient Protection and Affordable Care
Act.
† Risks relating to our failure to properly maintain our information
technology systems, our information security systems and our infrastructure to
support our business and to protect the privacy and security of sensitive
customer and business information.
† Risks related to compliance with a broad and complex regulatory framework,
including compliance with new and existing federal, state and local laws and
regulations relating to health care, accounting standards, corporate securities,
tax, environmental and other laws and regulations affecting our business.
† Risks related to litigation, government investigations and other legal
proceedings as they relate to our business, the pharmacy services, retail
pharmacy or retail clinic industries or to the health care industry generally.
† Other risks and uncertainties detailed from time to time in our filings
with the SEC.
The foregoing list is not exhaustive. There can be no assurance that the Company
has correctly identified and appropriately assessed all factors affecting its
business. Additional risks and uncertainties not presently known to the Company
or that it currently believes to be immaterial also may adversely impact the
Company. Should any risks and uncertainties develop into actual events, these
developments could have a material adverse effect on the Company's business,
financial condition and results of operations. For these reasons, you are
cautioned not to place undue reliance on the Company's forward-looking
statements.
