Pharmacy News EU

Overview of Our Business
CVS Caremark Corporation ("CVS Caremark", the "Company", "we" or "us") is thelargest pharmacy health care provider in the United States. As a fullyintegrated pharmacy services company, we believe we can drive value for ourcustomers by effectively managing pharmaceutical costs and improving health careoutcomes through our pharmacy benefit management, mail order and specialtypharmacy division, Caremark Pharmacy Services; our more than 7,100CVS/pharmacy retail drugstores; our retail-based health clinic subsidiary,MinuteClinic; and our online pharmacy, CVS.com.We currently have three segments: Pharmacy Services, Retail Pharmacy andCorporate.
Our Pharmacy Services segment provides a full range of pharmacy benefitmanagement ("PBM") services including mail order pharmacy services, specialtypharmacy services, plan design and administration, formulary management andclaims processing. Our clients are primarily employers, insurance companies,unions, government employee groups, managed care organizations and othersponsors of health benefit plans and individuals throughout the United States.In addition, through the Company’s SilverScript and Accendo subsidiaries, theCompany is a national provider of drug benefits to eligible beneficiaries underthe Federal Government’s Medicare Part D program.Our Retail Pharmacy segment sells prescription drugs and a wide assortment ofgeneral merchandise, including over-the-counter drugs, beauty products andcosmetics, photo finishing, seasonal merchandise, greeting cards and conveniencefoods through our CVS/pharmacy and Longs Drug retail stores and online throughCVS.com. Our Retail Pharmacy segment also provides health care services throughour MinuteClinic health care clinics. MinuteClinics are staffed by nursepractitioners and physician assistants who utilize nationally recognizedprotocols to diagnose and treat minor health conditions, perform healthscreenings, monitor chronic health conditions and deliver vaccinations. Webelieve our clinics provide quality services that are quick, high quality,affordable and convenient.The Corporate segment provides management and administrative services to supportthe Company. The Corporate segment consists of certain aspects of our executivemanagement, corporate relations, legal, compliance, human resources, corporateinformation technology and finance departments.Results of Operations
The following discussion explains the material changes in our results ofoperations for the three and six months ended June 30, 2010 and 2009 and thesignificant developments affecting our financial condition since December 31,2009. We strongly recommend that you read our audited consolidated financialstatements and footnotes and Management’s Discussion and Analysis of FinancialCondition and Results of Operations included as Exhibit 13 to our Annual Reporton Form 10-K for the year ended December 31, 2009 (the "2009 Form 10-K") alongwith this report. 18
Table of Contents Part I Item 2 Management’s Discussion and Analysis of Financial Condition and Results of
OperationsThree and Six Months Ended June 30, 2010 and 2009
Summary of the Condensed Consolidated Financial Results:
Three Months Ended Six Months Ended June 30, June 30,In millions, except per share amounts 2010 2009 2010 2009Net revenues $ 24,007 $ 24,871 $ 47,767 $ 48,265Cost of revenues 18,987 19,819 38,001 38,465Gross profit 5,020 5,052 9,766 9,800Operating expenses 3,519 3,452 6,855 6,823Operating profit 1,501 1,600 2,911 2,977Interest expense, net 135 128 263 270Income before income tax provision 1,366 1,472 2,648 2,707Income tax provision 544 583 1,054 1,074
Income from continuing operations 822 889 1,594 1,633Loss from discontinued operations, net of tax (1 ) (3 ) (3 ) (8 )Net income 821 886 1,591 1,625Net loss attributable to noncontrolling interest – – 1 -Net income attributable to CVS Caremark $ 821 $ 886 $ 1,592 $ 1,625Net RevenuesNet revenues decreased $864 million, or 3.5% and $498 million, or 1.0% in thethree and six months ended June 30, 2010, respectively, as compared to the prioryear periods. Net revenues in both periods were negatively impacted by thetermination of a few large client contracts effective January 1, 2010 and thedecrease of covered lives under our Medicare Part D program in our PharmacyServices segment. This was partially offset by same store sales growth and salesfrom new retail stores in our Retail Pharmacy segment.Please see the Segment Analysis later in this document for additionalinformation about our net revenues.
Gross Profit
Gross profit decreased $32 million, or 0.6% and $34 million, or 0.3% in thethree and six months ended June 30, 2010, respectively, as compared to the prioryear periods. Pharmacy Services segment gross profit in both periods declined asa result of the termination of a few large client contracts effective January 1,2010, the decrease of covered lives under our Medicare Part D program, as wellas regulatory changes, effective January 1, 2010, which impacted pricingassociated with our Medicare Part D program.Please see the Segment Analysis later in this document for additionalinformation about our gross profit.
Operating Expenses
Operating expenses increased $67 million, or 1.9% in the three months endedJune 30, 2010 and $32 million, or 0.5% in the six months ended June 30, 2010, ascompared to the prior year periods. This increase was primarily related tohigher litigation-related expenses, store operating costs and increasedconsulting costs. This was partially offset by lower integration-relatedexpenses and company-wide expense control initiatives.
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Table of Contents Part I Item 2 Management’s Discussion and Analysis of Financial Condition and Results of
OperationsPlease see the Segment Analysis later in this document for additionalinformation about our operating expenses.
Interest Expense, net
Interest expense, net increased $7 million in the three months ended June 30,2010, as compared to the prior year period. This increase was primarily due toan increase in our average debt balance in the current period.Interest expense, net decreased $7 million in the six months ended June 30,2010, as compared to the prior year period. This decrease was primarily due tolower interest rates, partially offset by an increase in our average debtbalance.
For additional information on our financing activities, please see the"Liquidity and Capital Resources" section later in Management’s Discussion andAnalysis of Financial Condition and Results of Operations.
Income Tax Provision
Our effective income tax rate was 39.8% for both the three and six months endedJune 30, 2010 and 39.6% and 39.7% for the three and six months ended June 30,2009, respectively.Loss from Discontinued Operations
Loss from discontinued operations for the three months ended June 30, 2010included $1 million ($2 million, net of a $1 million income tax benefit) oflease-related costs, compared to $3 million ($4 million, net of a $1 millionincome tax benefit) of lease-related costs in the prior year period.
Loss from discontinued operations for the six months ended June 30, 2010included $3 million ($5 million, net of a $2 million income tax benefit) oflease-related costs, compared to $8 million ($13 million, net of a $5 millionincome tax benefit) of lease-related costs in the prior year period.
See Note 10 to the condensed consolidated financial statements for additionalinformation about our lease guarantees.
Net Loss Attributable to Noncontrolling Interest
Net loss attributable to noncontrolling interest represents the minorityshareholders’ portion of the net loss from our majority owned subsidiary,Generation Health, Inc., which we acquired in the fourth quarter of 2009. Thenet loss attributable to noncontrolling interest for the three and six monthsended June 30, 2010 was de minimis. 20
Table of Contents Part I Item 2 Management’s Discussion and Analysis of Financial Condition and Results of
OperationsSegment AnalysisWe evaluate the performance of our Pharmacy Services and Retail Pharmacysegments based on net revenue, gross profit and operating profit before theeffect of nonrecurring charges and gains and certain intersegment activities. Weevaluate the performance of our Corporate segment based on operating expensesbefore the effect of nonrecurring charges and gains and certain intersegmentactivities. The following is a reconciliation of our segments to the condensedconsolidated financial statements: Pharmacy Services Retail Pharmacy Corporate Intersegment ConsolidatedIn millions Segment(1) Segment Segment Eliminations(2) TotalsThree Months EndedJune 30, 2010:Net revenues $ 11,840 $ 14,311 $ – $ (2,144 ) $ 24,007Gross profit 821 4,229 – (30 ) 5,020Operating profit (loss) 591 1,096 (156 ) (30 ) 1,501June 30, 2009(3):Net revenues $ 13,008 $ 13,797 $ – $ (1,934 ) $ 24,871Gross profit 931 4,131 – (10 ) 5,052Operating profit (loss) 697 1,056 (143 ) (10 ) 1,600Six Months EndedJune 30, 2010:Net revenues $ 23,677 $ 28,289 $ – $ (4,199 ) $ 47,767Gross profit 1,603 8,216 – (53 ) 9,766Operating profit (loss) 1,130 2,125 (291 ) (53 ) 2,911June 30, 2009(3):Net revenues $ 24,543 $ 27,294 $ – $ (3,572 ) $ 48,265Gross profit 1,729 8,087 – (16 ) 9,800Operating profit (loss) 1,234 2,028 (269 ) (16 ) 2,977(1) Net revenues of the Pharmacy Services segment include approximately $1.6
billon and $1.8 billion of retail co-payments for the three months ended
June 30, 2010 and 2009, respectively, and $3.4 billion of retail co-payments
for the six months ended June 30, 2010 and 2009.(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. As a
result, both the Pharmacy Services and the Retail Pharmacy segments include
the following results associated with this activity: net revenues of $430
million and $156 million for the three months ended June 30, 2010 and 2009,
respectively, and $770 million and $254 million for the six months ended
June 30, 2010 and 2009, respectively; gross profit of $30 million and $10
million for the three months ended June 30, 2010 and 2009, respectively, and
$53 million and $16 million for the six months ended June 30, 2010 and 2009,
respectively; and operating profit of $30 million and $10 million for the
three months ended June 30, 2010 and 2009, respectively, and $53 million and
$16 million for the six months ended June 30, 2010 and 2009, respectively.
(3) The results for the three and six months ended June 30, 2009 have been
revised to conform to the 2010 presentation. 21
Table of Contents Part I Item 2 Management’s Discussion and Analysis of Financial Condition and Results of
OperationsPharmacy Services SegmentThe following table summarizes our Pharmacy Services segment’s performance forthe respective periods: Three Months Ended Six Months Ended June 30, June 30, In millions 2010 2009(1) 2010 2009(1) Net revenues $ 11,840 $ 13,008 $ 23,677 $ 24,543 Gross profit 821 931 1,603 1,729 Gross profit % of net revenues 6.9 % 7.2 % 6.8 % 7.0 %
Operating expenses 230 234 473 495 Operating expense % of net revenues 1.9 % 1.8 % 2.0 % 2.0 %
Operating profit 591 697 1,130 1,234
Operating profit % of net revenues 5.0 % 5.4 % 4.8 % 5.0 % Net revenues(2) : Mail choice(3) $ 4,111 $ 4,229 $ 8,189 $ 8,282 Pharmacy network(4) 7,630 8,689 15,300 16,089 Other 99 90 188 172 Pharmacy claims processed(2) :
Total 144.3 164.1 291.7 327.5 Mail choice(3) 16.0 16.6 31.5 32.9 Pharmacy network(4) 128.3 147.5 260.2 294.6 Generic dispensing rate(2):
Total 71.0 % 67.8 % 70.7 % 67.7 % Mail choice(3) 61.0 % 56.3 % 59.9 % 55.9 % Pharmacy network(4) 72.2 % 68.9 % 71.9 % 68.9 % Mail choice penetration rate 25.9 % 24.0 % 25.4 % 23.8 %(1) The results for the three and six months ended June 30, 2009 have been
revised to conform to the 2010 presentation of the Pharmacy Services segment.
(2) Pharmacy network net revenues, claims processed and generic dispensing rates
do not include Maintenance Choice, which are included within the mail choice
category.(3) 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.(4) Pharmacy network is defined as claims filled at retail pharmacies, including
our retail drugstores.Net RevenuesNet revenues decreased $1.2 billion, or 9.0%, to $11.8 billion in the threemonths ended June 30, 2010, as compared to the prior year period.
? Our mail choice claims processed decreased 4.0% to 16.0 million claims in
the three months ended June 30, 2010, compared to 16.6 million claims in
the prior year period. The decrease in mail choice claim volume was
related to the termination of a few large client contracts effective
January 1, 2010, partially offset by new client starts on January 1, 2010.
? Our average revenue per mail choice claim increased by 1.3%, compared to
the prior year period. This increase was primarily due to drug cost
inflation and claims mix, partially offset by increases in the percentage
of generic prescription drugs dispensed and changes in client pricing.
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Table of Contents Part I Item 2 Management’s Discussion and Analysis of Financial Condition and Results of Operations ? Our mail choice generic dispensing rate increased to 61.0% in the three months ended June 30, 2010, compared to 56.3% 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
generic prescription drugs when they are available. ? Our pharmacy network claims processed decreased 13.0% to 128.3 million claims in the three months ended June 30, 2010, compared to 147.5 million
claims in the prior year period. The decrease in the pharmacy network
claim volume was primarily the result of the termination of a few large
client contracts effective January 1, 2010 and the decrease of covered
lives under our Medicare Part D program as a result of the 2010 Medicare
Part D competitive bidding process, partially offset by new client starts on January 1, 2010. ? Our average revenue per pharmacy network claim processed increased 0.9%,
as compared to the prior year period. This increase was primarily due to drug cost inflation and claims mix, partially offset by increases in the percentage of generic prescription drugs dispensed and changes in client pricing. ? Our pharmacy network generic dispensing rate increased to 72.2% in the
three months ended June 30, 2010, compared to 68.9% 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 generic prescription drugs when they are available.Net revenues decreased $866 million, or 3.5%, to $23.7 billion in the six monthsended June 30, 2010, as compared to the prior year period.
? Our mail choice claims processed decreased 4.4% to 31.5 million claims in
the six months ended June 30, 2010, compared to 32.9 million claims in the
prior year period. The decrease in mail choice claim volume was related to
the termination of a few large client contracts effective January 1, 2010,
partially offset by new client starts on January 1, 2010. ? Our average revenue per mail choice claim increased by 3.4%, as compared to the prior year period. This increase was primarily due to drug cost inflation and claims mix, partially offset by an increase in the percentage of generic prescription drugs dispensed and changes in client pricing. ? Our mail choice generic dispensing rate increased to 59.9% in the six
months ended June 30, 2010, compared to 55.9% 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
generic prescription drugs when they are available. ? Our pharmacy network claims processed decreased 11.6% to 260.2 million claims in the six months ended June 30, 2010, compared to 294.6 million in
the prior year period. The decrease in the pharmacy network claim volume
was primarily the result of the termination of a few large client
contracts effective January 1, 2010 and the decrease of covered lives
under our Medicare Part D program as a result of the 2010 Medicare Part D
competitive bidding process. ? Our average revenue per pharmacy network claim processed increased 7.6%,
as compared to the prior year period. The increase was primarily due to
the conversion of RxAmerica’s pharmacy network contracts from net to gross
on April 1, 2009 and a change in the revenue recognition method from net
to gross for a large health plan on March 1, 2009, partially offset by an
increase in our pharmacy network generic dispensing rate and changes in
client pricing. ? Our pharmacy network generic dispensing rate increased to 71.9% in the six
months ended June 30, 2010, compared to 68.9% 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 generic prescription drugs when they are available. 23
Table of Contents Part I Item 2 Management’s Discussion and Analysis of Financial Condition and Results of Operations ? The Pharmacy Services segment recognizes revenues for its national pharmacy network transactions based on individual contract terms. In accordance with ASC 605, Revenue Recognition (formerly Emerging Issues Task Force ("EITF") EITF No. 99-19, "Reporting Revenue Gross as a Principal versus Net as an Agent"), Caremark’s contracts are predominantly
accounted for using the gross method. Prior to April 2009, RxAmerica’s
contracts were accounted for using the net method. Effective April 1,
2009, we converted a number of the RxAmerica pharmacy network contracts to
the Caremark contract structure, which resulted in those contracts being
accounted for using the gross method and changed the revenue recognition
method from net to gross for a large health plan on March 1, 2009. These two items increased net revenues $1.5 billion in the six months ended June 30, 2010 as compared to the prior year period.Gross Profit
Gross profit in our Pharmacy Services segment includes net revenues less cost ofrevenues. Cost of revenues includes (i) the cost of pharmaceuticals dispensed,either directly through our mail service and specialty retail pharmacies orindirectly through our national pharmacy network, (ii) shipping and handlingcosts and (iii) the operating costs of our mail service pharmacies, customerservice operations and related information technology support.Gross profit decreased $110 million, or 11.8%, to $821 million in the threemonths ended June 30, 2010, as compared to the prior year period. Gross profitas a percentage of net revenues was 6.9% in the three months ended June 30,2010, compared to 7.2% in the prior year period.
Gross profit decreased $126 million, or 7.3%, to $1.6 billion in the six monthsended June 30, 2010, as compared to the prior year period. Gross profit aspercentage of net revenues was 6.8% in the six months ended June 30, 2010,compared to 7.0% in the prior year period. The decrease in our gross profit as apercentage of net revenues was primarily attributed to the change in the revenuerecognition method from net to gross associated with the RxAmerica pharmacynetwork contracts on April 1, 2009 and a large health plan on March 1, 2009.As you review our Pharmacy Services segment’s performance in this area, webelieve you should consider the following important information that impactedboth the three and six month periods ended June 30, 2010:
? Our gross profit dollars declined as a result of the termination of a few
large client contracts effective January 1, 2010 and the decrease of covered lives under our Medicare Part D program as a result of the 2010 Medicare Part D competitive bidding process. ? Our gross profit as a percentage of net revenues benefited from the
increase in our total generic dispensing rate, which increased to 71.0%
and 70.7% in the three and six months ended June 30, 2010, respectively,
compared to 67.8% and 67.7% in the prior year periods, respectively. This
increase was due to new generic prescription drug introductions and our
continuous effort to encourage plan members to use generic prescription
drugs when they are available. ? 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 has
caused us and other PBMs to continue to share a larger portion of rebates
and/or discounts received from pharmaceutical manufacturers. ? Effective January 1, 2010, the Centers for Medicare and Medicaid Services ("CMS") issued a regulation requiring that any difference between the drug
price charged to Medicare Part D plan sponsors by a PBM and the drug paid
by the PBM to the dispensing provider (commonly called 24
Table of Contents Part I Item 2 Management’s Discussion and Analysis of Financial Condition and Results of
Operations "differential" or "spread") be reported as an administrative cost rather
than a drug cost of the plan sponsor for purposes of calculating certain
government subsidy payments and the drug price to be charged to enrollees.
These changes have impacted our ability to offer Medicare Part D plan
sponsors pricing that includes the use of retail network "differential" or
"spread." This change impacted our gross profit as a percentage of net revenues in both the three and six months ended June 30, 2010 and will continue to impact the profitability of our Medicare Part D business for the remainder of 2010. ? In conjunction with a class action settlement with two entities that
publish the Average Wholesale Price ("AWP") of pharmaceuticals (a pricing
benchmark widely used in the pharmacy industry), the AWP for many
brand-name and some generic prescription drugs were reduced effective
September 26, 2009. We have reached understandings with most of our
commercial third-party payors where we participate as pharmacy providers
to adjust reimbursements to account for this change in methodology, but
most state Medicaid programs that utilize AWP as a pricing reference have
not taken action to make similar adjustments.
Operating Expenses
Operating expenses in our Pharmacy Services segment include selling, general andadministrative expenses, depreciation and amortization related to selling,general and administrative activities and specialty pharmacy store andadministrative payroll, employee benefits and occupancy costs.
Operating expenses decreased $4 million to $230 million, or 1.9% as a percentageof net revenues in the three months ended June 30, 2010, compared to the prioryear period primarily associated with lower operating costs associated with ourMedicare Part D program.Operating expenses decreased $22 million to $473 million, or 2.0% as apercentage of net revenues in the six months ended June 30, 2010, compared tothe prior year period. The decrease in operating expenses is primarily relatedto lower litigation-related charges and lower operating costs associated withour Medicare Part D program. 25
Table of Contents Part I Item 2 Management’s Discussion and Analysis of Financial Condition and Results of
OperationsRetail Pharmacy SegmentThe following table summarizes our Retail Pharmacy segment’s performance for therespective periods: Three Months Ended Six Months Ended June 30, June 30,In millions 2010 2009(1) 2010 2009(1)Net revenues $ 14,311 $ 13,797 $ 28,289 $ 27,294Gross profit 4,229 4,131 8,216 8,087Gross profit % of net revenues 29.6 % 29.9 % 29.0 % 29.6 %Operating expenses 3,133 3,075 6,091 6,059Operating expense % of netrevenues 21.9 % 22.3 % 21.5 % 22.2 %Operating profit 1,096 1,056 2,125 2,028Operating profit % of net revenues 7.7 % 7.7 % 7.5 % 7.4 %Net revenue increase(2) :Total 3.7 % 17.2 % 3.6 % 15.6 %Pharmacy 4.2 % 16.3 % 4.4 % 14.7 %Front store 2.8 % 19.1 % 2.0 % 17.4 %Same store sales increase(decrease)(3) :Total 2.1 % 6.1 % 2.2 % 4.7 %Pharmacy 2.9 % 7.5 % 3.3 % 6.0 %Front store 0.4 % 3.0 % (0.2 )% 1.9 %Generic dispensing rate 72.7 % 69.6 % 72.4 % 69.4 %Pharmacy % of total revenues 67.6 % 67.3 % 68.0 % 67.5 %Third party % of pharmacy revenue 97.2 % 96.9 % 97.2 % 96.8 %Retail prescriptions filled 157.5 153.2 314.8 305.7(1) The results for the three and six months ended June 30, 2009 have been
revised to conform to the 2010 presentation of the Retail Pharmacy segment.
(2) The net revenue increase for the three and six months ended June 30, 2009
include the results associated with stores acquired from Longs Drug Stores
Corporation in October 2008.(3) Beginning in November 2009, same store sales increase includes the stores
acquired from Longs Drug Stores Corporation in October 2008.
As of June 30, 2010, we operated 7,109 retail drugstores compared to 6,949retail drugstores on June 30, 2009.
Net Revenues
Net revenues increased $514 million, or 3.7%, to $14.3 billion in the threemonths ended June 30, 2010, as compared to the prior year period. This increasewas primarily driven by same store sales increase of 2.1% and net revenues fromnew stores, which accounted for approximately 150 basis points of our total netrevenue percentage increase in the three months ended June 30, 2010. Netrevenues increased $1.0 billion, or 3.6%, to $28.3 billion in the six monthsended June 30, 2010, as compared to the prior year period. This increase wasprimarily driven by a same store sales increase of 2.2% and net revenues fromnew stores, which accounted for approximately 140 basis points of our total netrevenue percentage increase in the six months ended June 30, 2010. 26
Table of Contents Part I Item 2 Management’s Discussion and Analysis of Financial Condition and Results of
OperationsAs you review our Retail Pharmacy segment’s performance in this area, we believeyou should consider the following important information that impacted both thethree and six month periods ended June 30, 2010: ? Total net revenues were negatively impacted by the H1N1 influenza
outbreak, which benefited both prior year periods. ? Front store revenues were positively impacted by strong sales of general merchandise and beauty products. ? Front store revenues were negatively impacted by lower sales in stores acquired from Longs Drug Stores Corporation. ? Front store revenues were negatively impacted due to the weakness in the
overall economic environment and its impact on consumer shopping behavior. ? Front store revenues were positively impacted by the increase in the federal excise tax associated with tobacco products (which took effect on
April 1, 2009). ? Pharmacy revenues were positively impacted by a stronger allergy season and negatively impacted by a weaker flu season and higher generic dispensing rates. ? Pharmacy revenues continued to benefit from incremental prescription
volume associated with our Maintenance Choice program. ? 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. In addition, our pharmacy growth has also been adversely affected by a decline in utilization trend as a result of a sluggish economy, a decline in the number of significant new brand named drug introductions, higher consumer co-payments and co-insurance arrangements and by an increase in the number of over-the-counter remedies
that were historically only available by prescription. ? Pharmacy revenue growth continued to benefit from expansions into new markets, increased penetration in existing markets, the ability to attract
and retain managed care customers and favorable industry trends. These
favorable industry 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 healthcare
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 costof merchandise sold in the period and the related purchasing costs, warehousingcosts, delivery costs and actual and estimated inventory losses.Gross profit increased $98 million, or 2.4%, to $4.2 billion in the three monthsended June 30, 2010, as compared to the prior year period. Gross profit as apercentage of net revenues decreased approximately 40 basis points to 29.6% inthe three months ended June 30, 2010, compared to 29.9% in the prior yearperiod. ? Our average gross profit on front store revenues is higher than our
average gross profit on pharmacy revenues. Front store revenues as a
percentage of total revenues for the three months ended June 30, 2010 was
32.4%, as compared to 32.7% in the prior year period. Pharmacy revenues as a percentage of 27
Table of Contents Part I Item 2 Management’s Discussion and Analysis of Financial Condition and Results of Operations total revenues for the three months ended June 30, 2010 were 67.6%, compared to 67.3% in the prior year period. The decrease in the contribution percentage of front store revenues as a percentage of total revenue had a negative effect on our overall gross profit in the three months ended June 30, 2010. ? Sales to customers covered by third party insurance programs area 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 97.2% in the three months ended June 30, 2010, compared to 96.9% in the prior year period. We expect this trend to continue.Gross profit increased $129 million, or 1.6%, to $8.2 billion in the six monthsended June 30, 2010, as compared to the prior year period. Gross profit aspercentage of net revenues decreased approximately 60 basis points to 29.0% inthe six months ended June 30, 2010, compared to 29.6% in the prior year period. ? Our average gross profit on front store revenues is higher than our average gross profit on pharmacy revenues. Front store revenues as a
percentage of total revenues for the six months ended June 30, 2010 was
32.0%, compared to 32.5% in the prior year period. Pharmacy revenues as a
percentage of total revenues for the six months ended June 30, 2010 were
68.0%, compared to 67.5% in the prior year period. The decrease in the contribution percentage of front store revenues as a percentage of total revenue had a negative effect on our overall gross profit in the six months ended June 30, 2010. ? 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 97.2% in the
six months ended June 30, 2010, compared to 96.8% in the prior year period. The increase in third party revenues had a negative effect on gross profit and we expect this trend to continue.As you review our Retail Pharmacy segment’s performance in this area, we believeyou should consider the following important information that impacted both thethree and six month periods ended June 30, 2010: ? Our front store gross profit as a percentage of net revenues was
positively impacted by increased sales of our more profitable store brand
products and negatively impacted by increased consumer demand for promotional sales items. ? Our pharmacy gross profit as a percentage of net revenues have been
adversely affected by the efforts of managed care organizations, pharmacy
benefit managers, governmental (especially State Medicaid entities) 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 our gross profit could be adversely impacted.
? Our pharmacy gross profit as a percentage of net revenues were negatively
impacted by a reduction in third party reimbursement rates that were not
fully offset by the increase in our generic dispensing rate. We expect this trend to continue. ? The Federal Government’s Medicare Part D benefit is increasing prescription utilization. However, it is also decreasing our pharmacy
gross profit rates as our higher gross profit business (e.g., cash customers) continues to migrate to Medicare Part D. ? On March 23, 2010, the Patient Protection and Affordable Care Act ("PPACA") was signed into law by President Obama. The PPACA modified the
manner in which retail pharmacies are reimbursed for multiple source
(i.e., generic) prescription drugs dispensed to Medicaid beneficiaries.
Specifically, the PPACA revised the definition of "multiple source" prescription drugs and redefined Average 28
Table of Contents Part I Item 2 Management’s Discussion and Analysis of Financial Condition and Results of Operations Manufacturer Price ("AMP"), the reimbursement benchmark applicable to Medicaid paid prescriptions. While these changes are effective October 1,
2010, as a practical matter they are not expected to be implemented until 2011. In recent years, retail pharmacies have experienced a decrease in reimbursement rates for Medicaid paid prescriptions and it is difficult to
predict the effect of changes made by the PPACA on this trend. ? In conjunction with a class action settlement with two entities that publish the AWP of pharmaceuticals, the AWP for many brand-name and some
generic prescription drugs were reduced effective September 26, 2009. We
have reached understandings with most of our commercial third-party payors
where we participate as pharmacy providers to adjust reimbursements to
account for this change in methodology, but most state Medicaid programs
that utilize AWP as a pricing reference have not taken action to make similar adjustments.Operating Expenses
Operating expenses in our Retail Pharmacy segment include store payroll, storeemployee benefits, occupancy costs, selling expenses, advertising expenses,depreciation and amortization expense and certain administrative expenses.
Operating expenses increased $58 million to $3.1 billion, or 21.9% as apercentage of net revenues in the three months ended June 30, 2010, as comparedto $3.1 billion, or 22.3% as a percentage of net revenues in the prior yearperiod. Operating expenses increased $32 million to $6.1 billion, or 21.5% as apercentage of net revenues in the six months ended June 30, 2010, as compared to$6.1 billion, or 22.2% as a percentage of net revenues in the prior year period.The increases in operating expenses in both the three and six months endedJune 30, 2010 was primarily due to higher store operating costs and accruals foranticipated legal settlements, partially offset by lower integration-relatedcosts.Corporate SegmentOperating ExpensesOperating expenses in our Corporate segment include executive management,corporate relations, legal, compliance, human resources, corporate informationtechnology and finance-related costs.
Operating expenses increased $13 million, or 9.0% to $156 million in the threemonths ended June 30, 2010, as compared to the prior year period. The increasein operating expenses was related to higher professional fees, primarily legalfees.Operating expenses increased $22 million, or 8.1% to $291 million in the sixmonths ended June 30, 2010, as compared to the prior year period. The increasein operating expenses was related to higher professional fees, primarily legalfees as well as depreciation expense associated with corporate-related assets.Liquidity and Capital Resources
We maintain a level of liquidity sufficient to allow us to cover our cash needsin the short-term. Over the long-term, we manage our cash and capital structureto maximize shareholder return, strengthen our financial position and maintainflexibility for future strategic initiatives. We continuously assess our workingcapital needs, debt and leverage levels, capital expenditure requirements,dividend payouts, potential share repurchases and future investments oracquisitions. We believe our operating cash flows, commercial paper program,sale-leaseback program, as well as any potential future borrowings, will besufficient to fund these future payments and long-term initiatives.Net cash provided by operating activities was $1.7 billion in the six monthsended June 30, 2010, compared to $1.3 billion in the six months ended June 30,2009. This increase was related to an overall improvement in 29
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Operationsworking capital, which was primarily due to increased cash collections of thirdparty receivables and improved inventory management. This was partially offsetby a decrease in claims payable due to prompt payment provisions of the MedicareImprovements for Patients and Providers Act of 2008, which took effect onJanuary 1, 2010.Net cash used in investing activities was $880 million in the six months endedJune 30, 2010, compared to $608 million in the six months ended June 30, 2009.The $272 million increase in cash used in investing activities was primarily dueto $503 million of sale-leaseback proceeds in 2009 versus none in 2010,partially offset by a $225 million decrease in capital expenditures in 2010.Gross capital expenditures totaled $866 million in the six months ended June 30,2010, compared to $1.1 billion in the six months ended March 31, 2009. In thesix months ended June 30, 2010, we opened 98 new retail drugstores and closed 14retail drugstores and four specialty pharmacy stores. In addition, the Companyrelocated 81 retail drugstores. In 2010, we plan to open approximately 250 to300 new or relocated retail drugstores.Net cash used in financing activities was $811 million in the six months endedJune 30, 2010, compared to net cash used in financing activities of $842 millionin the six months ended June 30, 2009. Net cash used in financing activities wasprimarily due to the repayment of $1.8 billion in long-term debt and repurchasesof common stock, offset in part by an increase in short-term debt and theissuance of $1.0 billion in long-term debt.In January 2010, our Board of Directors authorized a 15% increase in ourquarterly common stock dividend to $0.0875 per share on the Company’s commonstock. This increase equates to an annual dividend rate of $0.35 per share.
On November 4, 2009, our Board of Directors authorized a share repurchaseprogram for up to $2.0 billion of our outstanding common stock (the "2009Repurchase Program"). In 2009, we repurchased 16.1 million shares of commonstock for approximately $500 million pursuant to the 2009 Repurchase Program. Inthe three and six months ended June 30, 2010, we repurchased approximately16.7 million shares of common stock for approximately $613 million, and42.4 million shares of common stock for approximately $1.5 billion,respectively, completing the 2009 Repurchase Program.
On June 14, 2010, our Board of Directors authorized a new share repurchaseprogram for up to $2.0 billion of our outstanding common stock. The sharerepurchase authorization, which was effective immediately and expires at the endof 2011, permits us to effect repurchases from time to time through acombination of open market repurchases, privately negotiated transactions,accelerated share repurchase transactions, and/or other derivative transactions.The share repurchase program may be modified, extended or terminated by theBoard of Directors at any time. The Company did not make any share repurchasesunder the 2010 Repurchase Program during the three months ended June 30, 2010.We had $1.9 billion of commercial paper outstanding at a weighted averageinterest rate of 0.5% as of June 30, 2010. In connection with our commercialpaper program, we maintain a $1.4 billion, five-year unsecured back-up creditfacility, which expires on May 12, 2011, a $1.3 billion, five-year unsecuredback-up credit facility, which expires on March 12, 2012, and a $1.0 billion,three-year unsecured back-up credit facility, which expires on May 27, 2013. Thecredit facilities allow for borrowings at various rates that are dependent, inpart, on our public debt rating. There were no borrowings outstanding under theback-up credit facilities.On May 13, 2010, we issued $550 million of 3.25% unsecured senior notes dueMay 18, 2015 and issued $450 million of 4.75% unsecured senior notes due May 18,2020 (collectively, the "2010 Notes"). The 2010
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Table of Contents Part I Item 2 Management’s Discussion and Analysis of Financial Condition and Results of
OperationsNotes pay interest semi-annually and may be redeemed, in whole at any time, orin part from time to time, at our option at a defined redemption price plusaccrued and unpaid interest to the redemption date. The net proceeds of the 2010Notes were used to repay a portion of our outstanding commercial paperborrowings, certain other corporate debt and for general corporate purposes.Our back-up credit facilities, unsecured senior notes and enhanced capitaladvantaged preferred securities contain customary restrictive financial andoperating covenants. These covenants do not include a requirement for theacceleration of our debt maturities in the event of a downgrade in our creditrating. We do not believe the restrictions contained in these covenantsmaterially affect our financial or operating flexibility.
As of June 30, 2010, our long-term debt was rated "Baa2" by Moody’s with astable outlook and "BBB+" by Standard & Poor’s with a negative outlook, and ourcommercial 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 andStandard & Poor’s considered, among other things, our capital structure andfinancial policies as well as our consolidated balance sheet, our historicalacquisition activity and other financial information. Although we currentlybelieve our long-term debt ratings will remain investment grade, we cannotguarantee the future actions of Moody’s and/or Standard & Poor’s. Our debtratings have a direct impact on our future borrowing costs, access to capitalmarkets and new store operating lease costs.Off-Balance Sheet Arrangements
In connection with executing operating leases, we provide a guarantee of thelease payments. We also finance a portion of our new store development throughsale-leaseback transactions, which involve selling stores to unrelated partiesand then leasing the stores back under leases that qualify and are accounted foras operating leases. We do not have any retained or contingent interests in thestores, and we do not provide any guarantees, other than a guarantee of thelease payments, in connection with the transactions. In accordance withgenerally accepted accounting principles, such operating leases are notreflected in our condensed consolidated balance sheet. We refer you to the"Notes to Consolidated Financial Statements" on page 65 of our Annual Report toStockholders included as Exhibit 13 to our 2009 Form 10-K for a detaileddiscussion of these guarantees.Critical Accounting Policies
We prepare our consolidated financial statements in conformity with accountingprinciples generally accepted in the United States of America ("GAAP"), whichrequires management to make certain estimates and apply judgments. We base ourestimates and judgments on historical experience, current trends and otherfactors that management believes to be important at the time the condensedconsolidated financial statements are prepared. On a regular basis, we reviewour accounting policies and how they are applied and disclosed in our condensedconsolidated financial statements.While we believe that the historical experience, current trends and otherfactors considered support the preparation of our condensed consolidatedfinancial statements in conformity with GAAP, actual results could differ fromour estimates and such differences could be material. Our critical accountingpolicies are discussed in Item 7, "Management’s Discussion and Analysis ofFinancial Condition and Results of Operations" in our 2009 Form 10-K. There havebeen no material changes to the critical accounting policies previouslydisclosed in that report. 31
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OperationsRecently Adopted Accounting Pronouncements
In June 2009, the Financial Accounting Standards Board ("FASB") issued guidancethat amends Accounting Standards Codification ("ASC") 810 Consolidations(formerly Statement of Financial Accounting Standard ("SFAS") No. 167,"Amendments to FASB Interpretation No. 46(R)"). The amendment requires a companyto analyze whether its interest in a variable interest entity ("VIE") gives it acontrolling financial interest. The determination of whether a company isrequired to consolidate another entity is based on, among other things, theother entity’s purpose and design and a company’s ability to direct theactivities of the other entity that most significantly impact the other entity’seconomic performance. Additional disclosures are required to identify acompany’s involvement with the VIE and any significant changes in risk exposuredue to such involvement. The amendment is effective for all new and existingVIEs as of the beginning of the first fiscal year that begins after November 15,2009. The adoption of this standard did not have a material impact on ourconsolidated results of operations, financial position or cash flows.In January 2010, the FASB issued guidance which expanded the requireddisclosures about fair value measurements. In particular, this guidance requires(i) separate disclosure of the amounts of significant transfers in and out ofLevel 1 and Level 2 fair value measurements along with the reasons for suchtransfers, (ii) information about purchases, sales, issuances and settlements tobe presented separately in the reconciliation for Level 3 fair valuemeasurements, (iii) expanded fair value measurement disclosures for each classof assets and liabilities and (iv) disclosures about the valuation techniquesand inputs used to measure fair value for both recurring and nonrecurring fairvalue measurements that fall in either Level 2 or Level 3. This guidance iseffective for annual reporting periods beginning after December 15, 2009 exceptfor (ii) above which is effective for fiscal years beginning after December 15,2010. The adoption of this standard did not have a material impact on ourconsolidated results of operations, financial position or cash flows.Cautionary Statement Concerning Forward-Looking Statements
The Private Securities Litigation Reform Act of 1995 (the "Reform Act") providesa safe harbor for forward-looking statements made by or on behalf of CVSCaremark Corporation. The Company and its representatives may, from time totime, make written or verbal forward-looking statements, including statementscontained in the Company’s filings with the Securities and Exchange Commissionand 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 constituteforward-looking statements. All statements addressing operating performance ofCVS Caremark Corporation or any subsidiary, events or developments that theCompany expects or anticipates will occur in the future, including statementsrelating to revenue growth, earnings or earnings per common share growth, freecash flow, debt ratings, inventory levels, inventory turn and loss rates, storedevelopment, relocations, new market entries and PBM client contracting, as wellas statements expressing optimism or permission about future operating resultsor events, are forward-looking statements within the meaning of the Reform Act.The forward-looking statements are and will be based upon management’sthen-current views and assumptions regarding future events and operatingperformance, and are applicable only as of the dates of such statements. TheCompany undertakes no obligation to update or revise any forward-lookingstatements, whether as a result of new information, future events or otherwise.
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OperationsBy their nature, all forward-looking statements involve risks and uncertainties.Actual results may differ materially from those contemplated by theforward-looking statements for a number of reasons, including, but not limitedto: ? Our business is