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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
Quarterly Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the Quarterly Period Ended Commission File Number
September 29, 2001 001-01011
CVS CORPORATION
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(Exact name of registrant as specified in its charter)
Delaware 05-0494040
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(State of Incorporation) (I.R.S. Employer Identification Number)
One CVS Drive, Woonsocket, Rhode Island 02895
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(Address of principal executive offices)
Telephone: (401) 765-1500
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No ____
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Common Stock, $0.01 par value, issued and outstanding at November 6, 2001:
390,784,079 shares
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INDEX
Page
Part I
Item 1. Financial Statements
Consolidated Condensed Statements of Operations -
Thirteen and Thirty-nine Weeks Ended September 29, 2001 3
and September 30, 2000
Consolidated Condensed Balance Sheets -
As of September 29, 2001 and December 30, 2000 4
Consolidated Condensed Statements of Cash Flows -
Thirty-nine Weeks Ended September 29, 2001 and September 30, 2000 5
Notes to Consolidated Condensed Financial Statements 6
Independent Auditors' Review Report 9
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 10
Item 3. Quantitative and Qualitative Disclosures About Market Risk 17
Part II
Item 1. Legal Proceedings 18
Item 6. Exhibits and Reports on Form 8-K 19
Signature Page 19
2
Part I Item 1
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CVS Corporation
Consolidated Condensed Statements of Operations
(Unaudited)
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13 Weeks Ended 39 Weeks Ended
September 29, September 30, September 29, September 30,
In millions, except per share amounts 2001 2000 2001 2000
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Net sales $5,410.8 $4,916.4 $16,290.9 $14,598.7
Cost of goods sold, buying and warehousing costs 4,039.0 3,619.0 12,007.2 10,665.5
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Gross margin 1,371.8 1,297.4 4,283.7 3,933.2
Selling, general and administrative expenses 1,070.9 937.7 3,100.6 2,759.5
Depreciation and amortization 80.7 75.0 239.5 220.2
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Total operating expenses 1,151.6 1,012.7 3,340.1 2,979.7
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Operating profit 220.2 284.7 943.6 953.5
Interest expense, net 16.1 20.1 46.9 59.2
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Earnings before income tax provision 204.1 264.6 896.7 894.3
Income tax provision 80.4 105.9 353.2 357.8
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Net earnings 123.7 158.7 543.5 536.5
Preference dividends, net of income tax benefit 3.7 3.8 11.1 11.3
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Net earnings available to common shareholders $ 120.0 $ 154.9 $ 532.4 $ 525.2
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Basic earnings per common share:
Net earnings $ 0.31 $ 0.40 $ 1.36 $ 1.34
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Weighted average basic common shares
outstanding 391.5 391.0 392.6 390.8
==========================================================================================================================
Diluted earnings per common share:
Net earnings $ 0.30 $ 0.39 $ 1.32 $ 1.32
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Weighted average diluted common shares
outstanding 406.0 407.5 409.7 407.3
==========================================================================================================================
Dividends declared per common share $ 0.0575 $ 0.0575 $ 0.1725 $ 0.1725
==========================================================================================================================
See accompanying notes to consolidated condensed financial statements.
3
Part I Item 1
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CVS Corporation
Consolidated Condensed Balance Sheets
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(Unaudited)
September 29, December 30,
In millions, except share and per share amounts 2001 2000
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Assets:
Cash and cash equivalents $ 406.6 $ 337.3
Accounts receivable, net 956.5 824.5
Inventories 4,068.1 3,557.6
Deferred income taxes 132.5 124.9
Other current assets 100.8 92.3
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Total current assets 5,664.5 4,936.6
Property and equipment, net 1,952.5 1,742.1
Goodwill, net 850.7 818.5
Other assets 477.8 452.3
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Total assets $8,945.5 $7,949.5
====================================================================================================================
Liabilities:
Accounts payable $1,550.7 $1,351.5
Accrued expenses 1,074.6 1,001.4
Short-term borrowings 603.4 589.6
Current portion of long-term debt 21.6 21.6
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Total current liabilities 3,250.3 2,964.1
Long-term debt 836.2 536.8
Deferred income taxes 28.0 28.0
Other long-term liabilities 118.0 116.0
Shareholders' equity:
Preference stock, series one ESOP convertible, par value $1.00:
authorized 50,000,000 shares; issued and outstanding
4,917,000 shares at September 29, 2001 and 5,006,000 shares
at December 30, 2000 262.8 267.5
Common stock, par value $0.01: authorized 1,000,000,000 shares;
issued 408,404,000 shares at September 29, 2001 and 407,395,000
shares at December 30, 2000 4.1 4.1
Treasury stock, at cost: 17,629,000 shares at September 29, 2001 and
15,073,000 shares at December 30, 2000 (510.7) (404.9)
Guaranteed ESOP obligation (240.6) (240.6)
Capital surplus 1,537.0 1,493.8
Retained earnings 3,660.4 3,184.7
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Total shareholders' equity 4,713.0 4,304.6
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Total liabilities and shareholders' equity $8,945.5 $7,949.5
====================================================================================================================
See accompanying notes to consolidated condensed financial statements.
4
Part I Item 1
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CVS Corporation
Consolidated Condensed Statements of Cash Flows
(Unaudited)
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39 Weeks Ended
September 29, September 30,
In millions 2001 2000
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Cash flows from operating activities:
Net earnings $ 543.5 $ 536.5
Adjustments required to reconcile net earnings to net cash
provided by operating activities:
Depreciation and amortization 239.5 220.2
Deferred income taxes and other noncash items 11.5 11.6
Change in operating assets and liabilities, providing/(requiring)
cash, net of effects from acquisitions:
Accounts receivable, net (132.0) (56.0)
Inventories (510.5) (318.5)
Other current assets (7.8) (20.6)
Other assets (2.7) (55.5)
Accounts payable 199.2 (34.7)
Accrued expenses 58.9 35.0
Other long-term liabilities 2.0 (15.8)
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Net cash provided by operating activities 401.6 302.2
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Cash flows from investing activities:
Additions to property and equipment (473.0) (496.6)
Proceeds from sale-leaseback transactions 94.0 140.9
Acquisitions (net of cash acquired) and investments (123.2) (244.9)
Proceeds from sale or disposal of assets 11.6 9.2
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Net cash used in investing activities (490.6) (591.4)
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Cash flow from financing activities:
Additions to (reductions in) long-term debt 296.2 (0.7)
Proceeds from exercise of stock options 45.1 54.1
Additions to short-term borrowings 13.8 451.4
Purchase of treasury shares (129.0) (163.2)
Dividends paid (67.8) (67.5)
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Net cash provided by financing activities 158.3 274.1
===================================================================================================================
Net increase (decrease) in cash and cash equivalents 69.3 (15.1)
Cash and cash equivalents at beginning of period 337.3 230.0
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Cash and cash equivalents at end of period $ 406.6 $ 214.9
===================================================================================================================
See accompanying notes to consolidated condensed financial statements.
5
Part I Item 1
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CVS Corporation
Notes to Consolidated Condensed Financial Statements
(Unaudited)
Note 1
The accompanying consolidated condensed financial statements of CVS Corporation
("CVS" or the "Company") have been prepared without audit, in accordance with
the rules and regulations of the Securities and Exchange Commission. In
accordance with such rules and regulations, certain information and footnote
disclosures normally included in financial statements prepared in accordance
with generally accepted accounting principles have been condensed or omitted,
although the Company believes that the disclosures included herein are adequate
to make the information presented not misleading. These consolidated condensed
financial statements should be read in conjunction with the consolidated
financial statements and notes thereto included in the Company's Annual Report
on Form 10-K for the fiscal year ended December 30, 2000.
In the opinion of management, the accompanying consolidated condensed financial
statements include all adjustments (consisting only of normal recurring
adjustments) which are necessary to present a fair statement of the Company's
results of operations for the interim periods presented. Because of the
influence of various factors on the Company's operations, including certain
holidays and other seasonal influences, net earnings for any interim period may
not be comparable to the same interim period in previous years or necessarily
indicative of earnings for the full fiscal year.
Certain reclassifications have been made to the consolidated condensed financial
statements of prior periods to conform to the current period presentation.
Note 2
The Company currently operates four business segments: Retail Pharmacy, Pharmacy
Benefit Management ("PBM"), Specialty Pharmacy and Internet Pharmacy. The
Company's business segments are operating units that offer different products
and services, and require distinct technology and marketing strategies.
The Retail Pharmacy segment, which includes 4,086 retail drugstores located in
24 states and the District of Columbia, operates under the CVS/pharmacy name.
The Retail Pharmacy segment is the Company's only reportable segment.
The PBM segment provides a full range of prescription benefit management
services to managed care providers and other organizations. These services
include plan design and administration, formulary management, mail order
pharmacy services, claims processing and generic substitution. The PBM segment
operates under the PharmaCare Management Services name.
The Specialty Pharmacy segment, which includes mail order facilities and 49
retail pharmacies located in 20 states and the District of Columbia, operates
under the CVS ProCare name. The Specialty Pharmacy segment focuses on supporting
individuals that require complex and expensive drug therapies.
The Internet Pharmacy segment, which includes a mail order facility and a
complete online retail pharmacy, operates under the CVS.com name.
The Company evaluates segment performance based on operating profit before
intersegment profits.
6
Part I Item 1
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CVS Corporation
Notes to Consolidated Condensed Financial Statements
(Unaudited)
Following is a reconciliation of the Company's business segments to the
consolidated condensed financial statements for the thirteen and thirty-nine
weeks ended September 29, 2001 and September 30, 2000 and total assets as of
September 29, 2001 and December 30, 2000:
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Retail Pharmacy All Other Consolidated
In millions Segment Segments Totals
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13 weeks ended:
September 29, 2001:
Net sales $ 5,188.7 $222.1 $ 5,410.8
Operating profit 215.9 4.3 220.2
September 30, 2000:
Net sales $ 4,764.6 $151.8 $ 4,916.4
Operating profit 284.1 0.6 284.7
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39 weeks ended:
September 29, 2001:
Net sales $15,633.2 $657.7 $16,290.9
Operating profit 934.7 8.9 943.6
September 30, 2000:
Net sales $14,157.0 $441.7 $14,598.7
Operating profit 947.9 5.6 953.5
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Total assets:
September 29, 2001 $ 8,418.2 $527.3 $ 8,945.5
December 30, 2000 7,498.8 450.7 7,949.5
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Note 3
Following are the components of net interest expense for the thirteen and
thirty-nine week periods listed below:
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13 Weeks Ended 39 Weeks Ended
September 29, September 30, September 29, September 30,
In millions 2001 2000 2001 2000
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Interest expense $17.0 $21.3 $50.1 $62.4
Interest income (0.9) (1.2) (3.2) (3.2)
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Interest expense, net $16.1 $20.1 $46.9 $59.2
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7
Part I Item 1
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CVS Corporation
Notes to Consolidated Condensed Financial Statements
(Unaudited)
Note 4
Basic earnings per common share is computed by dividing: (i) net earnings, after
deducting the after-tax dividends on the ESOP preference stock, by (ii) the
weighted average number of common shares outstanding during the period (the
"Basic Shares").
When computing diluted earnings per common share, the Company assumes that the
ESOP preference stock is converted into common stock and all dilutive stock
options are exercised. After the assumed ESOP preference stock conversion, the
ESOP Trust would hold common stock rather than ESOP preference stock and would
receive common stock dividends (currently $0.23 per share) rather than ESOP
preference stock dividends (currently $3.90 per share). Since the ESOP Trust
uses the dividends it receives to service its debt, the Company would have to
increase its contribution to the ESOP Trust to compensate it for the lower
dividends. This additional contribution would reduce the Company's net earnings,
which in turn, would reduce the amounts that would have to be accrued under the
Company's incentive compensation plans. Diluted earnings per common share is
computed by dividing: (i) net earnings, after accounting for the difference
between the dividends on the ESOP preference stock and common stock and after
making adjustments for the incentive compensation plans by (ii) Basic Shares
plus the additional shares that would be issued assuming that all dilutive stock
options are exercised and the ESOP preference stock is converted into common
stock.
Following is a reconciliation of basic and diluted earnings per common share for
the thirteen and thirty-nine week periods listed below:
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13 weeks ended 39 weeks ended
September 29, September 30, September 29, September 30,
In millions, except per share amounts 2001 2000 2001 2000
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Numerator for earnings per common share calculation:
Net earnings $123.7 $158.7 $543.5 $536.5
Preference dividends, net of income tax benefit (3.7) (3.8) (11.1) (11.3)
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Net earnings available to common shareholders, basic $120.0 $154.9 $532.4 $525.2
===================================================++=============================================================================
Net earnings $123.7 $158.7 $543.5 $536.5
Effect of dilutive securities:
Dilutive earnings adjustments (1.9) (0.1) (2.9) (0.4)
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Net earnings available to common shareholders, diluted $121.8 $158.6 $540.6 $536.1
=====================================================++===========================================================================
Denominator for earnings per common share calculation:
Weighted average common shares, basic 391.5 391.0 392.6 390.8
Effect of dilutive securities:
ESOP preference stock 10.7 10.8 10.7 10.8
Stock options 3.8 5.7 6.4 5.7
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Weighted average common shares, diluted 406.0 407.5 409.7 407.3
==================================================================================================================================
Basic earnings per common share $ 0.31 $ 0.40 $ 1.36 $ 1.34
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Diluted earnings per common share $ 0.30 $ 0.39 $ 1.32 $ 1.32
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8
Part I Independent Auditors' Review Report
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The Board of Directors and Shareholders of
CVS Corporation:
We have reviewed the consolidated condensed balance sheet of CVS Corporation as
of September 29, 2001, and the related consolidated condensed statements of
operations for the thirteen and thirty-nine week periods ended September 29,
2001 and September 30, 2000, and cash flows for the thirty-nine week periods
then ended. These consolidated condensed financial statements are the
responsibility of the Company's management.
We conducted our review in accordance with standards established by the American
Institute of Certified Public Accountants. A review of interim financial
information consists principally of applying analytical procedures to financial
data and making inquiries of persons responsible for financial and accounting
matters. It is substantially less in scope than an audit conducted in accordance
with generally accepted auditing standards, the objective of which is the
expression of an opinion regarding the financial statements taken as a whole.
Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that should
be made to the consolidated condensed financial statements referred to above for
them to be in conformity with accounting principles generally accepted in the
United States of America.
We have previously audited, in accordance with auditing standards generally
accepted in the United States of America, the consolidated balance sheet of CVS
Corporation as of December 30, 2000 and the related consolidated statements of
operations, shareholders' equity, and cash flows for the fifty-two week period
then ended (not presented herein); and in our report dated February 1, 2001 we
expressed an unqualified opinion on those consolidated financial statements. In
our opinion, the information set forth in the accompanying consolidated
condensed balance sheet as of December 30, 2000, is fairly presented, in all
material respects, in relation to the consolidated balance sheet from which it
has been derived.
/s/ KPMG LLP
------------
KPMG LLP
Providence, Rhode Island
October 29, 2001
9
Part I Item 2
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Management's Discussion and Analysis of Financial Condition and Results of
Operations
Introduction
The following discussion explains the material changes in our results of
operations for the thirteen and thirty-nine weeks ended September 29, 2001 and
September 30, 2000 and the significant developments affecting our financial
condition since December 30, 2000. We strongly recommend that you read our
audited consolidated financial statements and footnotes and Management's
Discussion and Analysis of Financial Condition and Results of Operations
included in our Annual Report on Form 10-K for the fiscal year ended December
30, 2000.
The following discussion contains forward-looking statements which are subject
to risks and uncertainties which could cause actual results to differ
materially. Please read the "Cautionary Statement Concerning Forward-Looking
Statements" section below.
Results of Operations
Third Quarter (Thirteen Weeks Ended September 29, 2001 versus September 30,
2000)
Net sales for the third quarter of 2001 increased $494.4 million (or 10.1%) to
$5.4 billion, compared to $4.9 billion in the third quarter of 2000. Same store
sales, consisting of sales from stores that have been open for more than one
year, rose 7.6%. Pharmacy same store sales increased 11.8%, while front-end
same store sales increased 0.3%.
As you review our sales performance, we believe you should consider the
following important information:
. Our pharmacy sales growth has benefited from 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 are consuming a greater number of prescription
drugs. The increased use of pharmaceuticals as the first line of defense
for healthcare and the introduction of a number of successful new
prescription drugs has also contributed to the growing demand for
pharmacy services. However, the introduction of new prescription drugs
has had less of an impact on sales in fiscal 2001, compared to recent
years, due to the lack of significant "blockbuster" drug introductions
during 2001.
. Sales also benefited from our active relocation program that seeks to
move our existing shopping center stores to larger, more convenient,
freestanding locations. Historically, we have achieved significant
improvements in customer count and net sales when we do this. The
resulting increase in net sales has typically been driven by an increase
in front store sales, which normally have a higher gross margin. We
believe that our relocation program offers a significant opportunity for
future growth, as only 41% of our existing stores were freestanding as
of September 29, 2001. Our current long-term goal is to have 70-80% of
our stores located in freestanding sites. We cannot, however, guarantee
that future store relocations will deliver the same results as those
historically achieved.
. Sales were negatively impacted by operational problems combined with the
weakening economy and increasingly competitive environment. We believe
the operational issues, which included: a pharmacist shortage resulting
in reduced pharmacy hours and closed pharmacy departments; out-of-stock
merchandise and increased customer wait times; combined with the
weakening economy and an increasingly competitive environment,
ultimately resulted in lower customer counts and lost sales during the
third quarter. To address these issues, we intensified our pharmacist
recruiting and retention efforts. These efforts significantly improved
staffing levels and reduced turnover in our stores. We also continued
our customer reactivation program, which involves direct mailings and
targeted incentives to former CVS customers. Further, we increased our
promotional activity in response to the increasingly competitive
environment.
10
Part I Item 2
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Management's Discussion and Analysis of Financial Condition and Results of
Operations
. Sales were also negatively impacted during the third quarter by fewer
prescription file buys versus last year and our declining to participate
in certain third party insurance plans, which did not meet our minimum
profitability standards.
. In the event that the negative trends described above continue and/or
our sales initiatives do not perform as planned, we may not be able to
meet our sales and net earnings targets.
Gross margin for the third quarter of 2001 increased $74.4 million (or 5.7%) to
$1.4 billion, compared to $1.3 billion in the third quarter of 2000. Gross
margin as a percentage of net sales for the third quarter of 2001 was 25.4%,
compared to 26.4% of net sales in the third quarter of 2000.
Why has our gross margin rate been declining?
. Pharmacy sales are growing at a faster pace than front store sales. On
average, our gross margin on pharmacy sales is lower than our gross
margin on front store sales. Pharmacy sales were 67% of total sales in
the third quarter of 2001, compared to 63% in the third quarter of 2000.
. Sales to customers covered by third party insurance programs have
continued to increase and, thus, have become a larger part of our total
pharmacy business. On average, our gross margin on third party pharmacy
sales is lower than our gross margin on cash pharmacy sales. Third party
prescription sales were 91% of pharmacy sales in the third quarter of
2001, compared to 89% in the third quarter of 2000.
. Also contributing to the decline was an increase in markdowns associated
with our increased promotional activity and elevated shrink expense. We
expect these trends to continue in the fourth quarter of 2001.
Total operating expenses for the third quarter of 2001 were 21.3% of net sales
compared to 20.6% of net sales in the third quarter of 2000. During the third
quarter of 2000, we recognized a $19.2 million pre-tax ($11.5 million after-tax)
nonrecurring gain in total operating expenses representing partial payment of
our share of the settlement proceeds from a class action lawsuit. If you
exclude the effect of this nonrecurring gain, comparable total operating
expenses for the third quarter of 2001 were 21.3% of net sales compared to 21.0%
of net sales in the third quarter of 2000.
As you review our comparable total operating expenses, we believe you should
consider the following important information:
. Historically, our sales performance has allowed net sales to grow at a
faster pace than total operating expenses.
. During the third quarter of 2001, we incurred higher store pharmacy
payroll and benefits expense as a percentage of net sales to address the
shortage of pharmacists discussed above. We also incurred higher
advertising expenses as we continued our customer reactivation program
aimed at attracting lost customers and in response to the increasingly
competitive environment.
Operating profit for the third quarter of 2001 decreased $64.5 million (or
22.7%) to $220.2 million, compared to $284.7 million in the third quarter of
2000. If you exclude the effect of the nonrecurring gain we recognized during
the third quarter of 2000, our comparable operating profit decreased $45.3
million (or 17.1%) to $220.2 million compared to $265.5 million in the third
quarter of 2000. Comparable operating profit as a percentage of net sales was
4.1% in the third quarter of 2001, compared to 5.4% in the third quarter of
2000.
11
Part I Item 2
--------------------------------------------------------------------------------
Management's Discussion and Analysis of Financial Condition and Results of
Operations
Interest expense, net for the third quarter of 2001 was $16.1 million, compared
to $20.1 million in the third quarter of 2000. Our interest expense totaled
$17.0 million in the third quarter of 2001, compared to $21.3 million in the
third quarter of 2000. Interest income was $0.9 million in the third quarter of
2001 versus $1.2 million in the third quarter of 2000. Interest expense
decreased due to a combination of lower average interest rates and lower average
borrowing levels during the third quarter of 2001.
Income tax provision ~ Our effective income tax rate was 39.4% for the third
quarter of 2001, compared to 40.0% for the third quarter of 2000. The decrease
in our effective income tax rate was primarily due to lower state income taxes
and a decrease in the amount of goodwill amortization that is not deductible for
income tax purposes.
Net earnings for the third quarter of 2001 decreased $35.0 million (or 22.1%) to
$123.7 million, or $0.30 per diluted share, compared to $158.7 million, or $0.39
per diluted share, in the third quarter of 2000. If you exclude the effect of
the nonrecurring gain we recognized in the third quarter of 2000, our comparable
net earnings decreased $23.5 million (or 16.0%) to $123.7 million, or $0.30 per
diluted share, compared to $147.2 million, or $0.36 per diluted share in the
third quarter of 2000.
Nine Months (Thirty-nine Weeks Ended September 29, 2001 versus September 30,
2000)
Net sales for the first nine months of 2001 increased $1.7 billion (or 11.6%) to
$16.3 billion, compared to $14.6 billion in the first nine months of 2000. Same
store sales, consisting of sales from stores that have been open for more than
one year, rose 9.0%. Pharmacy same store sales increased 14.1%, while front-
end same store sales increased 0.4%. Pharmacy sales were 67% of total sales in
the first nine months of 2001, compared to 62% in the first nine months of 2000.
Third party prescription sales were 91% of pharmacy sales during the first nine
months of 2001, compared to 89% in the first nine months of 2000. See "Third
Quarter" above for further information about the factors that affected our net
sales.
Gross margin for the first nine months of 2001 increased $350.5 million (or
8.9%) to $4.3 billion, compared to $3.9 billion in the first nine months of
2000. Gross margin as a percentage of net sales for the first nine months of
2001 was 26.3%, compared to 26.9% of net sales in the first nine months of 2000.
See "Third Quarter" above for further information about the factors that
affected our gross margin as a percentage of net sales.
Total operating expenses for the first nine months of 2001 were 20.5% of net
sales, compared to 20.4% of net sales in the first nine months of 2000. If you
exclude the effect of the nonrecurring gain we recognized in the third quarter
of 2000, comparable total operating expenses were 20.5% of net sales in the
first nine months of 2001 compared to 20.5% of net sales in the first nine
months of 2000. During the first nine months of 2001, we received $46.8 million
of settlement proceeds from lawsuits alleging antitrust law violations by
certain manufacturers of brand name prescription drugs. We elected to contribute
the entire $46.8 million in settlement proceeds to the CVS Charitable Trust,
Inc. to fund future charitable giving. As a result, the net effect of these two
nonrecurring items had no impact on our net earnings for the first nine months
of 2001. See "Third Quarter" above for further information about the factors
that affected our total operating expenses.
Operating profit for the first nine months of 2001 decreased $9.9 million (or
1.0%) to $943.6 million, compared to $953.5 million in the first nine months of
2000. If you exclude the effect of the nonrecurring gain we recognized in the
third quarter of 2000, our comparable operating profit increased $9.3 million
(or 1.0%) to $943.6 million compared to $934.3 million in the first nine months
of 2000. Comparable operating profit as a percentage of net sales was 5.8% in
the first nine months of 2001, compared to 6.4% in the first nine months of
2000.
12
Part I Item 2
--------------------------------------------------------------------------------
Management's Discussion and Analysis of Financial Condition and Results of
Operations
Interest expense, net for the first nine months of 2001 was $46.9 million,
compared to $59.2 million in the first nine months of 2000. Our interest expense
totaled $50.1 million in the first nine months of 2001, compared to $62.4
million in the first nine months of 2000. Interest income was $3.2 million in
the first nine months of both 2001 and 2000. Interest expense decreased due to a
combination of lower average interest rates and lower average borrowing levels
during the first nine months of 2001.
Income tax provision ~ Our effective income tax rate was 39.4% for the first
nine months of 2001, compared to 40.0% for the first nine months of 2000. The
decrease in our effective income tax rate was primarily due to lower state
income taxes and a decrease in the amount of goodwill amortization that is not
deductible for income tax purposes.
Net earnings for the first nine months of 2001 increased $7.0 million (or 1.3%)
to $543.5 million, or $1.32 per diluted share, compared to $536.5 million, or
$1.32 per diluted share, in the first nine months of 2000. If you exclude the
effect of the nonrecurring gain we recognized in the third quarter of 2000, our
comparable net earnings increased $18.5 million (or 3.5%) to $543.5 million, or
$1.32 per diluted share, compared to $525.0 million, or $1.29 per diluted share
in the first nine months of 2000.
Liquidity and Capital Resources
Liquidity ~ Our primary sources of liquidity are cash provided by operations,
commercial paper and long-term borrowings. We may also elect to use other
financing sources in the future to support our continued growth.
Our commercial paper program is supported by a $650 million, five-year unsecured
revolving credit facility which expires on May 30, 2006 and a $650 million, 364-
day unsecured revolving credit facility, which expires on May 30, 2002. As of
September 29, 2001, we had $603.4 million of commercial paper outstanding at a
weighted average interest rate of 2.9%.
Our credit facilities and unsecured senior notes contain customary restrictive
financial and operating covenants. We do not believe that the restrictions
contained in these covenants materially affect our financial or operating
flexibility.
We believe that our cash on hand and cash provided by operations, together with
our ability to obtain additional short-term and long-term financing, will be
sufficient to cover our working capital needs, capital expenditures and debt
service requirements for at least the next twelve months.
On March 6, 2000, the Board of Directors approved a common stock repurchase
program, which allows the Company to acquire up to $1 billion of its common
stock, in part, to fund employee benefit plans. During the third quarter of
2001, the Company repurchased 3.4 million shares of common stock at an aggregate
cost of $129.0 million. From the inception of the program through September 29,
2001, the Company repurchased 8.1 million shares of common stock at an aggregate
cost of $292.2 million.
Net Cash Used in Operations ~ Net cash provided by operations increased $99.4
million to $401.6 million in the first nine months of 2001 compared to $302.2
million in the first nine months of 2000. The improvement in net cash provided
by operations was primarily the result of improved working capital management.
Capital Expenditures ~ Our additions to property and equipment totaled $473.0
million during the first nine months of 2001, compared to $496.6 million during
the first nine months of 2000. During the third quarter, we opened 29 new
stores, relocated 34 stores and closed 24 stores. Year-to-date, we opened 59 new
stores, relocated 82 and closed 57. During the remainder of fiscal 2001, we plan
to open approximately 100 new or relocated stores. As of September 29, 2001, we
operated 4,135 retail and specialty pharmacy stores in 32 states and the
District of Columbia, compared to 4,106 stores as of September 30, 2000.
13
Part I Item 2
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Management's Discussion and Analysis of Financial Condition and Results of
Operations
We finance a portion of our new store development program through sale-leaseback
transactions. During the third quarter of 2001, we completed a sale-leaseback
transaction involving five of our distribution centers. The distribution centers
were sold at fair market value resulting in net proceeds of $94.0 million. The
gain on the transaction was deferred and is being amortized over the life of the
new operating lease.
Recent Developments
Restructuring and Asset Impairment Charge
As part of a comprehensive business review designed to streamline operations and
enhance operating efficiencies, the Company announced on October 30, 2001, its
intention to implement an Action Plan during the fourth quarter of 2001 that
primarily includes the following:
. Closing approximately 200 stores as part of a store consolidation
program;
. Closing one of its ten distribution facilities;
. Closing one of ProCare's two mail order facilities; and
. Staff reductions related to the above closings and other streamlining
initiatives.
While the above Action Plan is not yet finalized, the Company expects to record
a pre-tax restructuring and asset impairment charge of approximately $350
million, or $0.56 per diluted share, during the fourth quarter of 2001, in
accordance with, Emerging Issues Task Force Issue 94-3, "Liability Recognition
for Certain Employee Termination Benefits and Other Costs to Exit an Activity
(Including Certain Costs Incurred in a Restructuring)," Statement of Financial
Accounting Standards ("SFAS") No. 121, "Accounting for the Impairment of Long-
Lived Assets and for Long-Lived Assets to Be Disposed Of" and Staff Accounting
Bulletin No. 100, "Restructuring and Impairment Charges."
The Company also announced it would integrate its specialty pharmacy business
segment, ProCare, and its PBM segment, PharmaCare.
Recent Accounting Pronouncements
In June 2001, the Financial Accounting Standards Board issued two new
pronouncements; Statement of Financial Accounting Standards ("SFAS") No. 141,
"Business Combinations" and SFAS No. 142, "Goodwill and Other Intangible
Assets." SFAS No. 141, which is effective for acquisitions initiated after June
30, 2001, prohibits the use of the pooling-of-interest method for business
combinations and establishes the accounting and financial reporting requirements
for business combinations accounted for by the purchase method. SFAS No. 142,
addresses financial accounting and reporting for acquired goodwill and other
intangible assets. Among other things, SFAS No. 142 requires that goodwill no
longer be amortized, but instead be tested for impairment in accordance with the
provisions of SFAS No. 142. Amortization expense related to goodwill was $33.7
million in 2000 and is $24.4 million for the first nine months of 2001. Except
for goodwill and intangible assets acquired after June 30, 2001, which are
subject immediately to the provisions of SFAS No. 142, this statement is
effective for fiscal years beginning after December 15, 2001.
Also in June 2001, SFAS No. 143, "Accounting for Asset Retirement Obligations"
was issued. This statement requires companies to record the fair value of a
liability for an asset retirement obligation in the period in which it is
incurred and to capitalize the associated asset retirement costs as part of the
carrying amount of the long-lived asset. The provisions of SFAS No. 143 are
effective for fiscal years beginning after June 15, 2002.
14
Part I Item 2
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Management's Discussion and Analysis of Financial Condition and Results of
Operations
In August 2001, SFAS No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets" was issued. Although this statement, which supersedes SFAS
No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of", retains many of the recognition and measurement
provision of SFAS No. 121, it significantly changes the criteria for classifying
an asset as held-for-sale. The provisions of SFAS No. 144 are effective for
fiscal years beginning after December 15, 2001.
We are currently in the process of determining the impact these pronouncements
will have on our consolidated financial statements.
Cautionary Statement Concerning Forward-Looking Statements
Certain statements in this Form 10-Q (as well as in our other public filings,
web site, press releases and oral statements made by Company management and/or
representatives), constitute forward-looking statements, which are subject to
risks and uncertainties. Forward-looking statements include information
concerning:
. our future results of operations, including sales and earnings per common
share growth;
. our ability to continue to reduce selling, general and administrative
expenses as a percentage of net sales;
. our belief concerning the growth and profitability of CVS ProCare and the
benefits associated with the integration of CVS ProCare and PharmaCare;
. our belief concerning the growth and profitability of CVS.com;
. our belief concerning our ability to continue to increase our free cash
flow;
. our belief that we will have sufficient cash flows to support our future
working capital needs, capital expenditures and debt service requirements;
. our belief that we can continue to reduce inventory levels and improve
inventory turnover;
. our planned store development program, including store openings, number of
freestanding locations, new markets and capital expenditures;
. our ability to continue to fund our new store development through sale-
leaseback transaction on terms satisfactory to the Company; and
. our belief that we can continue to improve operating performance by
relocating existing in-line stores to freestanding locations.
In addition, statements that include the words "believes", "expects",
"anticipates", "intends", "estimates" or similar expressions are forward-looking
statements. For all of these statements, we claim the protection of the safe
harbor for forward-looking statements contained in the Private Securities
Litigation Reform Act of 1995.
You should understand that the following important factors, in addition to those
discussed elsewhere in this report and in the documents which are incorporated
by reference (and in our other public filings, press releases and oral
statements made by Company management and/or representatives), could cause
actual results to differ materially from those expressed in the forward-looking
statements.
15
Part I Item 2
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Management's Discussion and Analysis of Financial Condition and Results of
Operations
What Factors Could Affect the Outcome of Our Forward-Looking Statements?
Industry and Market Factors
. changes in economic conditions generally or in the markets served by CVS;
. future federal and/or state regulatory and legislative actions affecting
CVS and/or the chain drugstore industry;
. consumer preferences and spending patterns;
. competition from other drugstore chains, from alternative distribution
channels such as supermarkets, membership clubs, mail order companies and
internet companies (e-commerce) and from other third party plans;
. the continued introduction of successful new prescription drugs;
. the continued efforts of health maintenance organizations, managed care
organizations, pharmacy benefit management companies, governmental agencies
and other third party payers to reduce prescription drug costs; and
. changes in accounting policies and practices, including taxation
requirements.
Operating Factors
. our ability to continue to implement new information systems and
technologies;
. our ability to successfully attract customers through our customer
reactivation program;
. our ability to obtain the benefits expected from the Action Plan;
. our ability to continue to secure suitable new store locations at favorable
lease terms;
. our ability to continue to purchase inventory on favorable terms;
. adverse determinations with respect to litigation or other claims;
. our ability to attract, hire and retain suitable pharmacists and management
personnel;
. our ability to establish effective advertising, marketing and promotional
programs (including pricing strategies) in the different geographic markets
in which we operate; and
. the creditworthiness of the purchasers of former businesses whose store
leases are guaranteed by CVS.
16
Part I Item 3
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Quantitative and Qualitative Disclosures About Market Risk
The Company has not entered into any transactions using derivative financial
instruments or derivative commodity instruments and believes that its exposure
to market risk associated with other financial instruments, principally interest
rate risk inherent in its debt portfolio, is not material.
17
Part II Item 1
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Legal Proceedings
As of November 9, 2001, six actions have been filed in the United States
District Court for the District of Massachusetts asserting claims under the
federal securities laws on behalf of a purported class of the Company's
shareholders. The actions are styled Turberg v. CVS Corp., et al., No. 01-CV-
----------------------------
11464; Shapiro v. CVS Corp., et al., No. 01-CV-11490; Taylor v. CVS Corp., et
---------------------------- -----------------------
al., No. 01-CV-11507; Knisley v. CVS Corp., et al., No. 01-CV-11613; Fink v. CVS
--- ---------------------------- -----------
Corp., et al., No. 01-CV-11637; and Potash v. CVS Corp., et al., No. 01-CV-
------------- ---------------------------
11732. The complaints in the actions, which are substantially identical, allege
that several public statements by the Company between February and May 2001
failed to disclose that, as later reported by the Company in a June 27, 2001
press release, the Company's earnings per share for the second quarter and for
the full year would be lower than previously anticipated. According to the
complaints, following the June 27, 2001 announcement, the price of the Company's
common stock fell from $44.10 to $36.51 per share. Plaintiffs assert claims
against the Company and Thomas M. Ryan, the Chairman of the Board of Directors,
President and Chief Executive Officer of the Company, for alleged securities
fraud under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and
Rule 10b-5 promulgated thereunder. The actions are in their earliest stages.
The Company and Mr. Ryan believe that the claims asserted in the actions are
without merit and intend to defend against them vigorously.
18
Part II Item 6
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Exhibits and Reports on Form 8-K
Exhibits:
---------
3.1 Amended and Restated Certificate of Incorporation of the Registrant
(incorporated by reference to Exhibit 3.1 to CVS Corporation's Annual
Report on Form 10-K for the fiscal year ended December 31, 1996).
3.1A Certificate of Amendment to the Amended and Restated Certificate of
Incorporation, effective May 13, 1998 (incorporated by reference to
Exhibit 4.1A to Registrant's Registration Statement No. 333-52055 on
Form S-3/A dated May 18, 1998).
3.2 By-laws of the Registrant, as amended and restated (incorporated by
reference to Exhibit 3.2 to CVS Corporation's Annual Report on Form
10-K for the fiscal year ended December 31, 1998).
15.1 Letter re: Unaudited Interim Financial Information.
Reports on Form 8-K:
--------------------
There were no Reports on Form 8-K filed during the third quarter of 2001.
Signatures:
-----------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this Quarterly Report on Form 10-Q to be signed on
its behalf by the undersigned thereunto duly authorized.
CVS Corporation
(Registrant)
/s/ David B. Rickard
--------------------
David B. Rickard
Executive Vice President, Chief Financial Officer
and Chief Administrative Officer
November 9, 2001
19