--------------------------------------------------------------------------------
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 28, 2002 001-01011
CVS CORPORATION
---------------
(Exact name of registrant as specified in its charter)
Delaware 05-0494040
------------------------ ----------------------------------------
(State of Incorporation) (I.R.S. Employer Identification Number)
One CVS Drive, Woonsocket, Rhode Island 02895
---------------------------------------------
(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 7, 2002:
392,941,000 shares
--------------------------------------------------------------------------------
INDEX
Page
Part I
Item 1. Financial Statements
Consolidated Condensed Statements of Operations -
Thirteen and Thirty-nine Weeks Ended September 28, 2002 2
and September 29, 2001
Consolidated Condensed Balance Sheets -
As of September 28, 2002 and December 29, 2001 3
Consolidated Condensed Statements of Cash Flows -
Thirty-nine Weeks Ended September 28, 2002 and September 29, 2001 4
Notes to Consolidated Condensed Financial Statements 5
Independent Auditors' Review Report 11
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 12
Item 3. Quantitative and Qualitative Disclosures About Market Risk 20
Item 4 Controls and Procedures 21
Part II
Item 1. Legal Proceedings 22
Item 6. Exhibits and Reports on Form 8-K 23
Signature Page 23
Certifications 24
1
Part I Item 1
CVS Corporation
Consolidated Condensed Statements of Operations
(Unaudited)
----------------------------------------------------------------------------------------------------------------------
13 Weeks Ended 39 Weeks Ended
September 28, September 29, September 28, September 29,
In millions, except per share amounts 2002 2001 2002 2001
-----------------------------------------------------------------------------------------------------------------------
Net sales $ 5,876.4 $ 5,410.8 $ 17,836.7 $ 16,290.9
Cost of goods sold, buying and warehousing costs 4,395.1 4,039.0 13,380.6 12,007.2
-----------------------------------------------------------------------------------------------------------------------
Gross margin 1,481.3 1,371.8 4,456.1 4,283.7
Selling, general and administrative expenses 1,127.7 1,070.9 3,353.9 3,100.6
Depreciation and amortization 77.1 80.7 230.9 239.5
-----------------------------------------------------------------------------------------------------------------------
Total operating expenses 1,204.8 1,151.6 3,584.8 3,340.1
-----------------------------------------------------------------------------------------------------------------------
Operating profit 276.5 220.2 871.3 943.6
Interest expense, net 11.4 16.1 38.3 46.9
-----------------------------------------------------------------------------------------------------------------------
Earnings before income tax provision 265.1 204.1 833.0 896.7
Income tax provision 100.7 80.4 316.5 353.2
-----------------------------------------------------------------------------------------------------------------------
Net earnings 164.4 123.7 516.5 543.5
Preference dividends, net of income tax benefit 3.7 3.7 11.1 11.1
-----------------------------------------------------------------------------------------------------------------------
Net earnings available to common shareholders $ 160.7 $ 120.0 $ 505.4 $ 532.4
-----------------------------------------------------------------------------------------------------------------------
Basic earnings per common share:
Net earnings $ 0.41 $ 0.31 $ 1.29 $ 1.36
-----------------------------------------------------------------------------------------------------------------------
Weighted average basic common shares outstanding 392.7 391.5 392.1 392.6
-----------------------------------------------------------------------------------------------------------------------
Diluted earnings per common share:
Net earnings $ 0.40 $ 0.30 $ 1.26 $ 1.32
----------------------------------------------------------------------------------------------------------------------
Weighted average diluted common shares outstanding 405.4 406.0 405.4 409.7
----------------------------------------------------------------------------------------------------------------------
Dividends declared per common share $ 0.0575 $ 0.0575 $ 0.1725 $ 0.1725
----------------------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated condensed financial statements.
2
Part I Item 1
CVS Corporation
Consolidated Condensed Balance Sheets
-------------------------------------------------------------------------------------------------------------------
(Unaudited)
September 28, December 29,
In millions, except share and per share amounts 2002 2001
-------------------------------------------------------------------------------------------------------------------
Assets:
Cash and cash equivalents $ 217.3 $ 236.3
Accounts receivable, net 986.3 966.2
Inventories 3,983.0 3,918.6
Deferred income taxes 200.0 242.6
Other current assets 45.1 46.2
-------------------------------------------------------------------------------------------------------------------
Total current assets 5,431.7 5,409.9
Property and equipment, net 2,201.1 1,847.3
Goodwill, net 877.7 874.9
Intangible assets, net 342.3 318.0
Other assets 201.0 178.1
-------------------------------------------------------------------------------------------------------------------
Total assets $ 9,053.8 $ 8,628.2
-------------------------------------------------------------------------------------------------------------------
Liabilities:
Accounts payable $ 1,560.8 $ 1,535.8
Accrued expenses 1,270.1 1,267.9
Short-term borrowings 158.2 235.8
Current portion of long-term debt 26.3 26.4
-------------------------------------------------------------------------------------------------------------------
Total current liabilities 3,015.4 3,065.9
Long-term debt 807.7 810.4
Deferred income taxes 35.3 35.3
Other long-term liabilities 144.5 149.7
Shareholders' equity:
Preference stock, series one ESOP convertible, par value $1.00:
authorized 50,000,000 shares; issued and outstanding 4,716,000 shares
at September 28, 2002 and 4,887,000 shares at December 29, 2001 252.0 261.2
Common stock, par value $0.01: authorized 1,000,000,000 shares; issued
409,112,000 shares at September 28, 2002 and 408,532,000
shares at December 29, 2001 4.1 4.1
Treasury stock, at cost: 16,285,000 shares at September 28, 2002 and
17,645,000 shares at December 29, 2001 (471.6) (510.8)
Guaranteed ESOP obligation (219.9) (219.9)
Capital surplus 1,544.8 1,539.6
Retained earnings 3,941.5 3,492.7
-------------------------------------------------------------------------------------------------------------------
Total shareholders' equity 5,050.9 4,566.9
-------------------------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $ 9,053.8 $ 8,628.2
-------------------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated condensed financial statements.
3
Part I Item 1
CVS Corporation
Consolidated Condensed Statements of Cash Flows
(Unaudited)
-------------------------------------------------------------------------------------------------------------------
39 Weeks Ended
September 28, September 29,
In millions 2002 2001
-------------------------------------------------------------------------------------------------------------------
Cash flows from operating activities:
Net earnings $ 516.5 $ 543.5
Adjustments required to reconcile net earnings to net cash
provided by operating activities:
Depreciation and amortization 230.9 239.5
Deferred income taxes and other noncash items 54.9 11.5
Change in operating assets and liabilities, providing/(requiring) cash, net
of effects from acquisitions:
Accounts receivable, net (20.1) (132.0)
Inventories (64.4) (510.5)
Other current assets 1.8 (7.8)
Other assets (25.8) (2.7)
Accounts payable 24.9 199.2
Accrued expenses 9.4 58.9
Other long-term liabilities (5.2) 2.0
-------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 722.9 401.6
-------------------------------------------------------------------------------------------------------------------
Cash flows from investing activities:
Additions to property and equipment (804.7) (473.0)
Proceeds from sale-leaseback transactions 228.8 94.0
Acquisitions (net of cash acquired) and investments (68.5) (123.2)
Proceeds from sale or disposal of assets 17.6 11.6
-------------------------------------------------------------------------------------------------------------------
Net cash used in investing activities (626.8) (490.6)
-------------------------------------------------------------------------------------------------------------------
Cash flow from financing activities:
(Reductions in) additions to short-term borrowings (77.6) 13.8
Proceeds from exercise of stock options 32.9 45.1
(Reductions in) additions to long-term debt (2.8) 296.2
Purchase of treasury shares -- (129.0)
Dividends paid (67.6) (67.8)
-------------------------------------------------------------------------------------------------------------------
Net cash (used in) provided by financing activities (115.1) 158.3
-------------------------------------------------------------------------------------------------------------------
Net (decrease) increase in cash and cash equivalents (19.0) 69.3
Cash and cash equivalents at beginning of period 236.3 337.3
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Cash and cash equivalents at end of period $ 217.3 $ 406.6
-------------------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated condensed financial statements.
4
Part I Item 1
CVS Corporation
Notes to Consolidated Condensed Financial Statements
(Unaudited)
Note 1
The accompanying consolidated condensed financial statements of CVS Corporation
and subsidiaries ("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 29, 2001.
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 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 prior year's amounts to conform to
the current period presentation.
Note 2
The Company operates two business segments, Retail Pharmacy and Pharmacy Benefit
Management ("PBM"). The Company's business segments are operating units that
offer different products and services, and require distinct technology and
marketing strategies.
As of September 28, 2002, the Retail Pharmacy segment included 3,994 retail
drugstores and the Company's online retail website, CVS.com. The retail
drugstores are located in 27 states and the District of Columbia, operating
under the CVS or 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 and other organizations. These services include plan
design and administration, formulary management, mail order pharmacy services,
claims processing and generic substitution. The PBM segment also includes the
Company's specialty pharmacy business, which focuses on supporting individuals
that require complex and expensive drug therapies. The PBM segment operates
under the PharmaCare Management Services name, while the specialty pharmacy mail
order facilities and 33 retail pharmacies, located in 19 states and the District
of Columbia, operate under the CVS ProCare name.
5
Part I Item 1
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 as of and for the thirteen and
thirty-nine weeks ended September 28, 2002 and September 29, 2001:
----------------------------------------------------------------------------------------
Retail Pharmacy PBM Consolidated
In millions Segment Segment Totals
----------------------------------------------------------------------------------------
13 Weeks Ended:
September 28, 2002:
Net sales $ 5,605.4 $ 271.0 $ 5,876.4
Operating profit 258.2 18.3 276.5
September 29, 2001:
Net sales $ 5,193.0 $ 217.8 $ 5,410.8
Operating profit 210.5 9.7 220.2
----------------------------------------------------------------------------------------
39 Weeks Ended:
September 28, 2002:
Net sales $ 17,013.5 $ 823.2 $ 17,836.7
Operating profit 821.4 49.9 871.3
September 29, 2001:
Net sales $ 15,644.9 $ 646.0 $ 16,290.9
Operating profit 916.1 27.5 943.6
----------------------------------------------------------------------------------------
Total assets:
September 28, 2002 $ 8,564.8 $ 489.0 $ 9,053.8
December 29, 2001 8,123.7 504.5 8,628.2
----------------------------------------------------------------------------------------
Note 3
During the fourth quarter of 2001, management approved an Action Plan, which
resulted from a comprehensive business review designed to streamline operations
and enhance operating efficiencies.
Following is a summary of the specific initiatives contained in the Action Plan:
1. 229 CVS/pharmacy and CVS ProCare store locations (the "Stores") would
be closed by no later than March 2002. Since these locations were
leased facilities, management planned to either return the premises to
the respective landlords at the conclusion of the current lease term
or negotiate an early termination of the contractual obligations. As
of March 31, 2002, all of the Stores were closed.
2. The Henderson, North Carolina distribution center (the "D.C.") would
be closed and its operations would be transferred to the Company's
remaining distribution centers by no later than May 2002. Since this
location was owned, management planned to sell the property upon
closure. The D.C. was closed in April 2002 and was sold in May 2002.
3. The Columbus, Ohio mail order facility (the "Mail Facility") would be
closed and its operations would be transferred to the Company's
Pittsburgh, Pennsylvania mail order facility by no later than April
2002. Since this location was a leased facility, management planned to
either return the premises to the landlord at the conclusion of the
lease or negotiate an early termination of the contractual obligation.
The Mail Facility was closed in March 2002.
6
Part I Item 1
CVS Corporation
Notes to Consolidated Condensed Financial Statements
(Unaudited)
4. Two satellite office facilities (the "Satellite Facilities") would be
closed and their operations would be consolidated into the Company's
Woonsocket, Rhode Island corporate headquarters by no later than
December 2001. Since these locations were leased facilities,
management planned to either return the premises to the landlords at
the conclusion of the lease terms or negotiate an early termination of
the contractual obligations. The Satellite Facilities were closed in
December 2001.
5. Approximately 1,500 managerial, administrative and store employees in
the Company's Woonsocket, Rhode Island corporate headquarters;
Columbus Mail Facility; Henderson D.C. and the Stores would be
terminated. As of April 30, 2002, all of these employees had been
terminated.
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
recorded a $346.8 million pre-tax charge ($226.9 million after-tax) to operating
expenses during the fourth quarter of 2001 for restructuring and asset
impairment costs associated with the Action Plan. In accordance with Accounting
Research Bulletin No. 43, "Restatement and Revision of Accounting Research
Bulletins," the Company also recorded a $5.7 million pre-tax charge ($3.6
million after-tax) to cost of goods sold during the fourth quarter of 2001 to
reflect the markdown of certain inventory contained in the Stores to its net
realizable value. In total, the restructuring and asset impairment charge was
$352.5 million pre-tax, or $230.5 million after-tax (the "Restructuring
Charge"). The aggregate impact of the 229 stores on the Company's consolidated
financial statements for the year ended December 29, 2001, totaled $585.3
million in net sales and $13.7 million in operating losses, which included
depreciation and amortization of $12.4 million, incremental markdowns incurred
in connection with liquidating inventory and incremental payroll and other
store-related costs incurred in connection with closing and/or preparing the 229
stores for closing. Whenever possible, the Company attempts to transfer the
customer base of its closed stores to adjacent CVS store locations. The
Company's success in retaining customers and the related impact on the above
revenue and operating income or loss, however, cannot be precisely calculated.
Following is a reconciliation of the beginning and ending liability balances
associated with the Restructuring Charge as of the respective balance sheet
dates:
----------------------------------------------------------------------------------------------------------
Noncancelable Lease Employee
In millions Obligations/(1)/ Asset Write-Offs Severance & Benefits Total
----------------------------------------------------------------------------------------------------------
Restructuring Charge $ 227.4 $ 105.6 $ 19.5 $ 352.5
Utilized - Cash -- -- (2.1) (2.1)
Utilized - Noncash -- (105.6) -- (105.6)
----------------------------------------------------------------------------------------------------------
Balance at 12/29/01 $ 227.4 $ -- $ 17.4 $ 244.8
Utilized - Cash (29.8) -- (12.7) (42.5)
----------------------------------------------------------------------------------------------------------
Balance at 09/28/02/(2)/ $ 197.6 $ -- $ 4.7 $ 202.3
----------------------------------------------------------------------------------------------------------
(1) Noncancelable lease obligations extend through 2024.
(2) The Company believes that the reserve balances as of September 28, 2002 are
adequate to cover the remaining liabilities associated with the Action
Plan.
7
Part I Item 1
CVS Corporation
Notes to Consolidated Condensed Financial Statements
(Unaudited)
Note 4
Effective at the beginning of fiscal 2002, the Company adopted SFAS No. 142,
"Goodwill and Other Intangible Assets." As a result of the adoption, goodwill
and other indefinite-lived intangible assets are no longer being amortized, but
are subject to annual impairment reviews, or more frequent reviews if events or
circumstances indicate there may be an impairment. Upon adoption, the Company
performed the required implementation impairment review which resulted in no
impairment to goodwill. During the third quarter of 2002, the Company performed
its required annual goodwill impairment test. The annual review concluded there
was no impairment of goodwill.
The following details the impact, on a pro-forma basis, of discontinuing the
amortization of goodwill on net earnings and earnings per common share ("EPS")
for the referenced historical periods:
-------------------------------------------------------------------------------------------------------------------------
13 Weeks Ended 39 Weeks Ended 52 Weeks Ended 52 Weeks Ended 52 Weeks Ended
September 29, September 29, December 29, December 30, January 1,
In millions 2001 2001 2001 2000 2000
-------------------------------------------------------------------------------------------------------------------------
Net Earnings: As reported $ 123.7 $ 543.5 $ 413.2 $ 746.0 $ 635.1
Goodwill amortization/(1)/ 8.0 22.0 28.2 31.9 38.1
As adjusted 131.7 565.5 441.4 777.9 673.2
-------------------------------------------------------------------------------------------------------------------------
Basic EPS: As reported $ 0.31 $ 1.36 $ 1.02 $ 1.87 $ 1.59
Goodwill amortization/(1)/ 0.02 0.05 0.07 0.08 0.09
As adjusted 0.33 1.41 1.09 1.95 1.68
-------------------------------------------------------------------------------------------------------------------------
Diluted EPS: As reported $ 0.30 $ 1.32 $ 1.00 $ 1.83 $ 1.55
Goodwill amortization/(1)/ 0.02 0.05 0.07 0.08 0.10
As adjusted 0.32 1.37 1.07 1.91 1.65
-------------------------------------------------------------------------------------------------------------------------
(1) Represents the after-tax impact of goodwill amortization.
The carrying amount of goodwill as of September 28, 2002 was $877.7 million. For
the thirty-nine weeks ended September 28, 2002, gross goodwill increased $2.8
million, primarily due to store acquisitions. There has been no impairment of
goodwill during the thirty-nine weeks ended September 28, 2002.
Intangible assets other than goodwill are required to be separated into two
categories: finite-lived and indefinite-lived. Intangible assets with finite
useful lives are amortized over their estimated useful life, while intangible
assets with indefinite useful lives are not amortized. The Company currently has
no intangible assets with indefinite lives. Following is a summary of the
Company's amortizable intangible assets as of the respective balance sheet
dates:
--------------------------------------------------------------------------------------------------------
As of September 28, 2002 As of December 29, 2001
------------------------------------------------------------------------
Gross Accumulated Gross Accumulated
In millions Carrying Amount Amortization Carrying Amount Amortization
--------------------------------------------------------------------------------------------------------
Customer lists and
Covenants not to compete $ 458.6 $ (184.0) $ 379.7 $ (135.1)
Favorable leases and Other/(1)/ 135.4 (67.7) 134.4 (61.0)
--------------------------------------------------------------------------------------------------------
$ 594.0 $ (251.7) $ 514.1 $ (196.1)
--------------------------------------------------------------------------------------------------------
(1) The gross carrying amount and accumulated amortization for favorable leases
and other as of December 29, 2001 have been reclassified to conform to
current period presentation.
8
Part I Item 1
CVS Corporation
Notes to Consolidated Condensed Financial Statements
(Unaudited)
The increase in the gross carrying amount of customer lists and covenants not to
compete during the thirty-nine weeks ended September 28, 2002 was primarily due
to the acquisition of customer lists. The amortization expense for these
intangible assets for the thirteen and thirty-nine week periods ended September
28, 2002 was $13.6 million and $38.3 million, respectively. The anticipated
annual amortization expense for these intangible assets is $54.8 million, $54.2
million, $46.6 million, $40.7 million, $38.6 million and $36.4 million in 2002,
2003, 2004, 2005, 2006 and 2007, respectively.
Note 5
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:
---------------------------------------------------------------------------------------------------------------------------
13 Weeks Ended 39 Weeks Ended
September 28, September 29, September 28, September 29,
In millions, except per share amounts 2002 2001 2002 2001
---------------------------------------------------------------------------------------------------------------------------
Numerator for earnings per common share calculation:
Net earnings $ 164.4 $ 123.7 $ 516.5 $ 543.5
Preference dividends, net of income tax benefit (3.7) (3.7) (11.1) (11.1)
---------------------------------------------------------------------------------------------------------------------------
Net earnings available to common shareholders, basic $ 160.7 $ 120.0 $ 505.4 $ 532.4
---------------------------------------------------------------------------------------------------------------------------
Net earnings $ 164.4 $ 123.7 $ 516.5 $ 543.5
Dilutive earnings adjustments (1.7) (1.9) (5.1) (2.9)
---------------------------------------------------------------------------------------------------------------------------
Net earnings available to common shareholders, diluted $ 162.7 $ 121.8 $ 511.4 $ 540.6
---------------------------------------------------------------------------------------------------------------------------
Denominator for earnings per common share calculation:
Weighted average common shares, basic 392.7 391.5 392.1 392.6
Effect of dilutive securities:
ESOP preference stock 10.7 10.7 10.8 10.7
Stock options 2.0 3.8 2.5 6.4
---------------------------------------------------------------------------------------------------------------------------
Weighted average common shares, diluted 405.4 406.0 405.4 409.7
---------------------------------------------------------------------------------------------------------------------------
Basic earnings per common share $ 0.41 $ 0.31 $ 1.29 $ 1.36
---------------------------------------------------------------------------------------------------------------------------
Diluted earnings per common share $ 0.40 $ 0.30 $ 1.26 $ 1.32
---------------------------------------------------------------------------------------------------------------------------
9
Part I Item 1
CVS Corporation
Notes to Consolidated Condensed Financial Statements
(Unaudited)
Note 6
Following are the components of net interest expense:
---------------------------------------------------------------------------------------------------
13 Weeks Ended 39 Weeks Ended
September 28, September 29, September 28, September 29,
In millions 2002 2001 2002 2001
---------------------------------------------------------------------------------------------------
Interest expense $ 12.1 $ 17.0 $ 41.3 $ 50.1
Interest income (0.7) (0.9) (3.0) (3.2)
---------------------------------------------------------------------------------------------------
Interest expense, net $ 11.4 $ 16.1 $ 38.3 $ 46.9
---------------------------------------------------------------------------------------------------
10
Part I Independent Auditors' Review Report
The Board of Directors and Shareholders
CVS Corporation:
We have reviewed the consolidated condensed balance sheet of CVS Corporation and
subsidiaries as of September 28, 2002, and the related consolidated condensed
statements of operations and cash flows for the thirteen and thirty-nine week
periods ended September 28, 2002 and September 29, 2001. 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 auditing standards generally accepted in the United States of America, 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 and subsidiaries as of December 29, 2001 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, 2002 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 29, 2001, 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 25, 2002
11
Part I Item 2
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 28, 2002 and
the significant developments affecting our financial condition since December
29, 2001. 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 29, 2001.
Results of Operations
Thirteen and Thirty-Nine Weeks Ended September 28, 2002 versus September 29,
2001
Net sales - The following table summarizes our sales performance for the
respective periods:
-----------------------------------------------------------------------------------------------------------------
13 Weeks Ended 39 Weeks Ended
September 28, September 29, September 28, September 29,
2002 2001 2002 2001
-----------------------------------------------------------------------------------------------------------------
Net sales (in billions) $ 5.9 $ 5.4 $ 17.8 $ 16.3
Net sales increase:
Total 8.6% 10.1% 9.5% 11.6%
Pharmacy 11.5% 13.9% 11.7% 16.3%
Front Store 2.8% 2.9% 5.0% 3.2%
Same store sales increase:
Total 8.4% 7.6% 9.0% 9.0%
Pharmacy 12.0% 11.8% 12.0% 14.1%
Front Store 1.3% 0.3% 3.4% 0.4%
Pharmacy percentage of total sales 68.4% 66.6% 67.9% 66.5%
Third party percentage of pharmacy sales 92.1% 90.6% 92.1% 90.6%
-----------------------------------------------------------------------------------------------------------------
As you review our sales performance, we believe you should consider the
following important information:
. Our pharmacy sales growth continued to benefit 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 also contributed to the growing demand
for pharmacy services.
. Pharmacy sales were negatively impacted by recent generic drug
introductions, which are being substituted for higher priced brand name
drugs. Excluding the recent generic drug introductions, we estimate that
total same store sales growth for the third quarter of 2002 would have
been approximately 130 basis points higher, while pharmacy same store
sales growth would have been approximately 190 basis points higher. For
the first nine months of 2002, we estimate that total and pharmacy same
store sales growth would have been approximately 70 basis points and 110
basis points higher, respectively.
. Front store sales continued to benefit from an increase in promotional
programs that were designed to respond to competitive and economic
conditions. During the third quarter of 2002, we reduced our promotional
programs compared to the first six months of 2002, although they still
remain at an elevated level when compared to historical levels. We will
continue to monitor the competitive and economic environment and we will
modify our future promotional programs, if necessary. We cannot,
however, guarantee that our current and/or future promotional programs
will produce the desired lift in front store sales due to a number of
uncertainties that include, but are not limited to, the general economic
environment, consumer confidence, and stock market volatility.
12
Part I Item 2
Management's Discussion and Analysis of Financial Condition and
Results of Operations
. Total sales were negatively impacted by the 229 stores closed during the
first quarter of 2002 as part of the 2001 strategic restructuring. We
estimate that the impact of the 229 store closings, net of sales which
we believe transferred to our remaining stores, lowered total sales by
approximately $72 million, (a reduction of approximately 140 basis
points on total sales growth) for the third quarter of 2002 and
approximately $181 million, (a reduction of approximately 120 basis
points on total sales growth) for the first nine months of 2002.
However, we believe the sales which transferred to our remaining stores
benefited total same store sales growth by approximately 60 basis points
for the third quarter of 2002 and approximately 60 basis points for the
first nine months of 2002.
. Total sales also continued to benefit from our relocation program, which
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. Although the number of annual relocations has decreased, our
relocation strategy remains an important component of our overall growth
strategy, as only 46% of our existing stores were freestanding as of
September 28, 2002. Our current long-term expectation is to have 70 to
80% of our stores located in freestanding locations. We cannot, however,
guarantee that we will achieve this expectation or that future store
relocations will deliver the same positive results as those historically
achieved. Please read the "Cautionary Statement Concerning
Forward-Looking Statements" section below.
Gross margin, which includes net sales less the cost of merchandise sold during
the reporting period and the related purchasing costs, warehousing costs,
delivery costs and actual and estimated inventory losses, increased $109.5
million (or 8.0%) to $1.5 billion, or 25.2% of net sales for the third quarter
of 2002, compared to $1.4 billion, or 25.4% of net sales in the third quarter of
2001. Inventory losses for the third quarter of 2002 were 1.25% of net sales,
compared to 1.63% of net sales in the third quarter of 2001 and 1.22% of net
sales in the first nine months of 2002, compared to 1.27% of net sales in the
first nine months of 2001. Gross margin for the first nine months of 2002
increased $172.4 million (or 4.0%) to $4.5 billion, or 25.0% of net sales,
compared to $4.3 billion, or 26.3% of net sales in the first nine months of
2001.
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 as a percentage of total
sales for the third quarter and first nine months of 2002 were 68.4% and
67.9%, respectively, compared to 66.6% and 66.5% in the third quarter
and first nine months of 2001, respectively.
. 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 for the third quarter and first nine months of 2002
were 92.1% of pharmacy sales, versus 90.6% in the third quarter and
first nine months of 2001.
. In recent years, our third party gross margin rates have been adversely
affected by the efforts of managed care organizations, pharmacy benefit
managers, governmental and other third party payors to reduce
prescription drug costs. To address this trend, we have dropped and/or
renegotiated a number of third party programs that fell below our
minimum profitability standards. These efforts have helped to stabilize
third party reimbursement rates. However, in recent months, as a result
of increasing budget shortfalls, numerous state legislatures have
proposed or are reported to be considering reductions in pharmacy
reimbursement rates for Medicaid and other governmental programs. In the
event this trend continues and we elect to withdraw from third party
programs and/or decide not to participate in future programs that fall
below our minimum profitability standards, we may not be able to sustain
our current rate of sales growth and gross margin dollars could be
adversely affected.
13
Part I Item 2
Management's Discussion and Analysis of Financial Condition and
Results of Operations
. Also contributing to the gross margin rate decline during 2002 was an
increase in markdowns associated with the increased promotional activity
(discussed above), offset, in part, by the increase in generic drug
sales (also discussed above), which normally yield a higher gross margin
rate than brand name drug sales.
Total operating expenses, which include store and administrative payroll,
employee benefits, store and administrative occupancy costs, selling expenses,
advertising expenses, administrative expenses and depreciation and amortization
expense, increased $53.2 million (or 4.6%) to $1,204.8 million, or 20.5% of net
sales, for the third quarter of 2002, compared to $1,151.6 million, or 21.3% of
net sales in the third quarter of 2001. Total operating expenses for the first
nine months of 2002 increased $244.7 million (or 7.3%) to $3,584.8 million, or
20.1% of net sales, compared to $3,340.1 million, or 20.5% of net sales in the
first nine months of 2001.
As you review our performance in this area, please remember to consider the
impact of the following items:
. During the third quarter of 2002, we received settlement proceeds in
connection with two lawsuits (in which the Company was a co-plaintiff)
relating to alleged antitrust law violations by certain pharmaceutical
manufacturers, as well as a class action lawsuit related to alleged
antitrust law violations by certain vitamin ingredient manufacturers. We
also recorded a litigation accrual as a result of entering into
settlement agreements for certain nonrecurring litigation matters
including a collective action lawsuit filed against CVS (see Part II,
Item I "Legal Proceedings" for further information). The net effect of
these nonrecurring litigation items was a $7.0 million pre-tax ($4.4
million after-tax) nonrecurring gain, or $0.01 per diluted share for the
third quarter of 2002. For the first nine months of 2002, the net effect
of these nonrecurring litigation items, including a litigation accrual
recorded during the first quarter of 2002 related to the above
collective action lawsuit, was a nonrecurring net loss of $3.2 million
pre-tax ($2.0 million after-tax), or less than a $0.01 impact per
diluted share.
What factors have contributed to the improvement in our total operating expenses
as a percentage of net sales?
. The initiatives completed as part of the 2001 strategic restructuring
and other technology enhancements (such as Assisted Inventory Management
"A.I.M.", and Excellence in Pharmacy Innovation and Care "E.P.I.C.")
have lead to a more streamlined operating structure, which lowered
operating costs, particularly at the store level.
. As a result of adopting SFAS No. 142 at the beginning of fiscal 2002, we
no longer amortize goodwill and other indefinite-lived intangible
assets. Goodwill amortization totaled $8.8 million pre-tax ($8.0 million
after-tax, or $0.02 per diluted share) during the third quarter of 2001
and $24.4 million pre-tax ($22.0 million after-tax, or $0.05 per diluted
share) for the first nine months of 2001. For further information on the
impact of adopting SFAS No. 142, see Note 4 to the consolidated
condensed financial statements.
. Our strong sales performance has consistently allowed net sales to grow
at a faster pace than total operating expenses.
Operating profit for the third quarter of 2002 increased $56.3 million (or
25.6%) to $276.5 million, or 4.7% of net sales, compared to $220.2 million or
4.1% of net sales in the third quarter of 2001. For the first nine months of
2002, operating profit decreased $72.3 million (or 7.7%) to $871.3 million, or
4.9% of net sales, compared to $943.6 million, or 5.8% of net sales in the first
nine months of 2001. Excluding the nonrecurring litigation items recorded during
2002, operating profit for the third quarter of 2002 increased $49.3 million (or
22.4%) to $269.5 million, or 4.6% of net sales, while for the first nine months
of 2002, operating profit decreased $69.1 million (or 7.3%) to $874.5 million.
The increase in operating profit as a percentage of net sales during the third
quarter of 2002 was primarily due to the improvement in total operating expenses
as a percentage of net sales as discussed above. The decrease in operating
profit as a percentage of net sales during the first nine months of 2002 was
primarily due to incremental expenses incurred during the first quarter of 2002
related to the execution of the 2001 strategic restructuring that were not part
of the resulting restructuring charge and increased markdowns associated with
the increased promotional activity as discussed above.
14
Part I Item 2
Management's Discussion and Analysis of Financial Condition and
Results of Operations
Interest expense, net consisted of the following:
-------------------------------------------------------------------------------------------------------------
13 Weeks Ended 39 Weeks Ended
September 28, September 29, September 28, September 29,
In millions 2002 2001 2002 2001
-------------------------------------------------------------------------------------------------------------
Interest expense $ 12.1 $ 17.0 $ 41.3 $ 50.1
Interest income (0.7) (0.9) (3.0) (3.2)
-------------------------------------------------------------------------------------------------------------
Interest expense, net $ 11.4 $ 16.1 $ 38.3 $ 46.9
-------------------------------------------------------------------------------------------------------------
The decrease in interest expense for the thirteen and thirty-nine weeks ended
September 28, 2002 was driven by a combination of lower interest rates and lower
average debt balances during 2002 compared to 2001.
Income tax provision ~ Our effective income tax rate was 38.0% for the third
quarter and first nine months of 2002, compared to 39.4% for the comparable
periods of 2001. The decrease in our effective income tax rate was primarily due
to the elimination of goodwill amortization that was not deductible for income
tax purposes and lower state income taxes.
Net earnings for the third quarter of 2002 increased $40.7 million (or 32.9%) to
$164.4 million, or $0.40 per diluted share, compared to $123.7 million, or $0.30
per diluted share, in the third quarter of 2001. For the first nine months of
2002, net earnings decreased $27.0 million (or 5.0%) to $516.5 million, or $1.26
per diluted share, compared to $543.5 million, or $1.32 per diluted share,
during the first nine months of 2001. Excluding the nonrecurring litigation
items recorded during 2002, net earnings for the third quarter of 2002 increased
$36.3 million (or 29.4%) to $160.0 million, or $0.39 per diluted share, while
for or the first nine months of 2002, net earnings decreased $24.9 million (or
4.6%) to $518.5 million, or $1.27 per diluted share.
Liquidity and Capital Resources
We fund the growth of our business through a combination of cash flow from
operations, commercial paper and long-term borrowings. Our liquidity is not
currently dependent on the use of off-balance sheet transactions other than
normal operating leases.
We had $158.2 million of commercial paper outstanding at a weighted average
interest rate of 1.9% as of September 28, 2002. In connection with our
commercial paper program, we maintain a $650 million, five-year unsecured
back-up credit facility, which expires on May 21, 2006 and a $650 million,
364-day unsecured back-up credit facility, which expires on May 19, 2003. As of
September 28, 2002, we had not borrowed against the credit facilities.
Our credit facilities and unsecured senior notes contain customary restrictive
financial and operating covenants. These covenants do not include a requirement
for the acceleration of our debt maturities in the event of a downgrade in our
credit rating. We do not believe that the restrictions contained in these
covenants materially affect our financial or operating flexibility, nor do we
currently foresee any reasonable circumstances under which we would lose our
investment-grade debt ratings. However, if this were to occur, it could
adversely impact, among other things, our future borrowing costs, access to
capital markets and new store operating lease costs.
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 and the foreseeable
future.
Given the current favorable interest rate environment, on October 30, 2002, we
elected to privately place $300 million of 3.875% unsecured senior notes due
November 1, 2007, to reduce our future exposure to fluctuations in short-term
interest rates. We may redeem these notes at any time, in whole or in part, at a
defined redemption price plus accrued interest. Proceeds from the notes will be
used to repay outstanding commercial paper.
15
Part I Item 2
Management's Discussion and Analysis of Financial Condition and
Results of Operations
Net cash provided by operating activities increased to $722.9 million in the
first nine months of 2002, compared to $401.6 million during the first nine
months of 2001. The improvement in net cash provided by operations was primarily
the result of improved working capital management. Cash provided by operating
activities will be negatively impacted by future payments associated with the
strategic restructuring. The timing of future cash payments related to the
strategic restructuring depends on when, and if, early lease terminations can be
reached. As of September 28, 2002, the remaining payments, which primarily
consist of noncancelable lease obligations extending through 2024, totaled
$202.3 million.
Net cash (used in) investing activities increased to $626.8 million during the
first nine months of 2002. This compares to $490.6 million during the first nine
months of 2001. The increase in net cash used in investing activities was
primarily due to higher additions to property and equipment. Additions to
property and equipment totaled $804.7 million in the first nine months of 2002,
compared to $473.0 million in the first nine months of 2001. The majority of our
capital spending in both periods supported our real estate development program.
During the third quarter of 2002, we opened 34 new stores, relocated 16 stores
and closed 9 stores. For the first nine months of 2002, we opened 108 new
stores, relocated 71 stores and closed 272 stores. During the remainder of
fiscal 2002, we plan to open approximately 60 to 70 new stores and relocate
approximately 20 stores. For the year, approximately 70-75 of our new stores are
expected to be in new markets, including Chicago, Illinois; Las Vegas, Nevada;
Phoenix, Arizona; and several markets in Florida and Texas. We finance a portion
of our new store development program through sale-leaseback transactions.
Proceeds from sale-leaseback transactions totaled $228.8 million for the first
nine months of 2002, compared to $94.0 million for the first nine months of
2001. All of the properties were sold at net book value and the resulting leases
qualify and are accounted for as operating leases. As of September 28, 2002, we
operated 4,027 retail and specialty pharmacy stores in 32 states and the
District of Columbia, compared to 4,135 stores as of September 29, 2001.
Net cash (used in) provided by financing activities increased to a net use of
$115.1 million during the first nine months of 2002. This compares to net cash
provided by financing activities of $158.3 million during the first nine months
of 2001. The increase in net cash used in financing activities was primarily due
to the proceeds from the issuance of the $300 million of 5.625% unsecured senior
notes during the first quarter of 2001, offset, in part, by the repurchase of
3.4 million shares of the Company's common stock at an aggregate cost of $129.0
million during the first nine months of 2001.
Critical Accounting Policies
We prepare our consolidated financial statements in conformity with generally
accepted accounting principles, which requires management to make certain
estimates and apply judgment. We base our estimates and judgments on historical
experience, current trends and other factors that management believes to be
important at the time the consolidated financial statements are prepared. On a
regular basis, management reviews our accounting policies and how they are
applied and disclosed in our consolidated financial statements. While management
believes that the historical experience, current trends and other factors
considered support the preparation of our consolidated financial statements in
conformity with generally accepted accounting principles, actual results could
differ from our estimates, and such differences could be material.
Our significant accounting policies are discussed in Note 1 to our consolidated
financial statements for the fiscal year ended December 29, 2001. Management
believes that the following accounting policies include a higher degree of
judgment and/or complexity and, thus, are considered to be critical accounting
policies. The critical accounting policies discussed below are applicable to
both of our business segments. Management has discussed the development and
selection of our critical accounting policies with the Audit Committee of our
Board of Directors and the Audit Committee has reviewed the Company's
disclosures relating to them.
16
Part I Item 2
Management's Discussion and Analysis of Financial Condition and
Results of Operations
Impairment of Long-Lived Assets
We evaluate the recoverability of long-lived assets, including intangible assets
with finite lives, but excluding goodwill, which is tested for impairment using
a separate test, annually or whenever events or changes in circumstances
indicate that the carrying value of an asset may not be recoverable. We group
and evaluate long-lived assets for impairment at the individual store level,
which is the lowest level at which individual cash flows can be identified. When
evaluating long-lived assets for potential impairment, we first compare the
carrying amount of the asset to the individual store's estimated future cash
flows (undiscounted and without interest charges). If the estimated future cash
flows are less than the carrying amount of the asset, an impairment loss
calculation is prepared. The impairment loss calculation compares the carrying
amount of the asset to the individual store's estimated future cash flows
(discounted and with interest charges). If required, an impairment loss is
recorded for the portion of the asset's carrying value that exceeds the asset's
estimated future cash flow (discounted and with interest charges).
Our impairment loss calculation contains uncertainty since management must use
judgment to estimate each store's future sales, profitability and cash flows.
When preparing these estimates, management considers each store's historical
results and current operating trends and our consolidated sales, profitability
and cash flow results and forecasts. These estimates can be affected by a number
of factors including, but not limited to, general economic conditions, the cost
of real estate, the continued efforts of third party organizations to reduce
prescription drug costs, the continued efforts of competitors to gain market
share and consumer spending patterns. Effective fiscal 2002, we adopted SFAS No.
144 "Accounting for Impairment or Disposal of Long-Lived Assets." The adoption
did not have a material impact on our impairment loss methodology, nor have we
made any other material changes to our impairment loss methodology during the
past three years.
Closed Store Lease Liabilities
We account for closed store lease termination costs in accordance with Emerging
Issue Task Force No. 88-10, "Costs Associated with Lease Modification or
Termination." As such, when a leased store is closed, we record a liability for
the estimated remaining obligation under the non-cancelable lease, which
includes future real estate taxes and common area maintenance charges, if
applicable. The liability is reduced by estimated future sublease income, if
applicable.
The calculation of our closed store lease liability contains uncertainty since
management must use judgment to estimate the timing and duration of future
vacancy periods, the amount and timing of future lump sum settlement payments
and the amount and timing of potential future sublease income. When estimating
these potential termination costs and their related timing, we consider a number
of factors, which include, but are not limited to historical settlement
experience, the owner of the property, the location and condition of the
property, the terms of the underlying lease, the specific marketplace demand and
general economic conditions. We have not made any material changes in the
reserve methodology used to record closed store lease reserves during the past
three years.
Self-Insurance Liabilities
We are self insured for certain losses related to general liability, worker's
compensation and auto liability, although we maintain stop loss coverage with
third party insurers to limit our total liability exposure.
The estimate of our self-insurance liability contains uncertainty since
management must use judgment to estimate the ultimate cost that will be incurred
to settle reported claims and unreported claims for incidents incurred but not
reported as of the balance sheet date. When estimating our self-insurance
liability, we consider a number of factors, which include, but are not limited
to, historical claim experience, demographic factors, severity factors and
valuations provided by independent third-party actuaries. On a quarterly basis,
management reviews its assumptions with its independent third party actuaries to
determine that our self-insurance liability is adequate. We have not made any
material changes in the accounting methodology used to establish our
self-insurance liability during the past three years.
17
Part I Item 2
Management's Discussion and Analysis of Financial Condition and
Results of Operations
Inventory
Our inventory is valued at the lower of cost or market on a first-in, first-out
basis using the retail method for inventory in our stores and the cost method
for inventory in our distribution centers. Under the retail method, inventory is
stated at cost, which is determined by applying a cost-to-retail ratio to the
ending retail value of our inventory. Since the retail value of our inventory is
adjusted on a regular basis to reflect current market conditions, our carrying
value should approximate the lower of cost or market. In addition, we reduce the
value of our ending inventory for estimated inventory losses that have occurred
during the interim period between physical inventory counts. Physical inventory
counts are taken on a regular basis in each location to ensure that the amounts
reflected in the consolidated financial statements are properly stated.
The accounting for inventory contains uncertainty since management must use
judgment to estimate the inventory losses that have occurred during the interim
period between physical inventory counts. When estimating these losses, we
consider a number of factors, which include but are not limited to, historical
physical inventory results on a location-by-location basis and current inventory
loss trends. We have not made any material changes in the accounting methodology
used to establish our inventory loss reserves during the past three years.
Although management believes that the estimates discussed above are reasonable
and the related calculations conform to generally accepted accounting
principles, actual results could differ from our estimates, and such differences
could be material.
Recent Accounting Pronouncement
In April 2002, the Financial Accounting Standards Board ("FASB") issued
Statement No. 145, "Rescission of FASB Statements No. 4, 44 and 64, Amendment of
FASB Statement No. 13, and Technical Corrections". This Statement (i) eliminates
extraordinary accounting treatment for a gain or loss reported on the
extinguishment of debt, (ii) eliminates inconsistencies in the accounting
required for sale-leaseback transactions and certain lease modifications with
similar economic effects, and (iii) amends other existing authoritative
pronouncements to make technical corrections, clarify meanings, or describe
their applicability under changed conditions. The provisions of this Statement
are effective for fiscal years beginning after May 15, 2002. We do not expect
that the adoption of this Statement will have a material impact on our
consolidated results of operations or financial position.
In June 2002, the FASB issued Statement No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities". This Statement nullifies existing
guidance related to the accounting and reporting for costs associated with exit
or disposal activities and requires that the fair value of a liability
associated with an exit or disposal activity be recognized when the liability is
incurred. Under previous guidance, certain exit costs were permitted to be
accrued upon management's commitment to an exit plan, which is generally before
an actual liability has been incurred. The provisions of this Statement are
required to be adopted for all exit or disposal activities initiated after
December 31, 2002. The Statement will not impact any liabilities recorded prior
to adoption. We are in the process of evaluating the effect of adopting this
Statement on our consolidated results of operations or financial position.
Cautionary Statement Concerning Forward-Looking Statements ~ The Private
Securities Litigation Reform Act of 1995 (the "Reform Act") provides a safe
harbor for forward-looking statements made by or on behalf of CVS Corporation.
The Company and its representatives may, from time to time, make written or
verbal forward-looking statements, including statements contained in the
Company's filings with the Securities and Exchange Commission and in its reports
to stockholders. Generally, the inclusion of the words "believe," "expect,"
"intend," "estimate," "anticipate," "will," and similar expressions identify
statements that constitute forward-looking statements. All statements addressing
operating performance of CVS Corporation or any subsidiary, events, or
developments that the Company expects or anticipates will occur in the future,
including statements relating to sales growth, earnings or earnings per common
share growth, free cash flow, inventory levels and turn rates, store
development, relocations and new market entries, as well as statements
expressing optimism or pessimism about future operating results or events, are
forward-looking statements within the meaning of the Reform Act. The
forward-looking
18
Part I Item 2
Management's Discussion and Analysis of Financial Condition and
Results of Operations
statements are and will be based upon management's then-current views and
assumptions regarding future events and operating performance, and are
applicable only as of the dates of such statements. The Company undertakes no
obligation to update or revise any forward-looking statements, whether as a
result of new information, future events, or otherwise. By their nature, all
forward-looking statements involve risks and uncertainties. Actual results may
differ materially from those contemplated by the forward-looking statements for
a number of reasons, including but not limited to:
.. The strength of the economy in general or in the markets served by CVS,
including changes in consumer purchasing power and/or spending patterns;
.. Increased competition from other drugstore chains, from alternative
distribution channels such as supermarkets, membership clubs, mail order
companies, discount retailers and internet companies (e-commerce) and from
other third party plans;
.. Changes in consumer preferences or loyalties;
.. Price reductions taken by the Company in response to competitive pressures,
as well as price reductions taken to drive demand that may not result in
anticipated sales levels;
.. Our ability to achieve projected levels of efficiencies, cost reduction
measures and other benefits from the Action Plan announced during the fourth
quarter of fiscal 2001 and other initiatives;
.. The effects of litigation and the creditworthiness of the purchasers of
former businesses whose store leases are guaranteed by CVS;
.. Our ability to generate sufficient cash flows to support capital expansion,
and general operating activities, and our ability to obtain necessary
financing at favorable interest rates;
.. Changes in laws and regulations, including changes in accounting standards,
taxation requirements, including tax rate changes, new tax laws and revised
tax law interpretations;
.. Interest rate fluctuations and other capital market conditions;
.. The continued introduction of successful new prescription drugs;
.. The continued efforts of health maintenance organizations, managed care
organizations, pharmacy benefit management companies and other third party
payers to reduce prescription drug costs;
.. Our ability to continue to successfully implement new computer systems and
technologies;
.. Our ability to continue to secure suitable new store locations at acceptable
lease terms;
.. Our ability to continue to purchase inventory on favorable terms;
.. 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
.. Other risks and uncertainties detailed from time to time in our filings with
the Securities and Exchange Commission.
The foregoing list is not exhaustive. There can be no assurance that the Company
has correctly identified and appropriately assessed all factors affecting its
business. Additional risks and uncertainties not presently known to the Company
or that it currently believes to be immaterial also may adversely impact the
Company. Should any risks and uncertainties develop into actual events, these
developments could have material adverse effects on the Company's business,
financial condition, and results of operations. For these reasons, you are
cautioned not to place undue reliance on the Company's forward-looking
statements.
19
Part I Item 3
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.
20
Part I Item 4
Controls and Procedures
(a) Evaluation of disclosure controls and procedures: The Company's Chief
Executive Officer and Chief Financial Officer, after evaluating the
effectiveness of the design and operation of the Company's disclosure controls
and procedures (as defined in Exchange Act Rules 13a-14(c) and 15d-14(c)) as of
a date within ninety days of the filing date of this quarterly report, have
concluded that as of such date the Company's disclosure controls and procedures
were adequate and effective and designed to ensure that material information
relating to the Company and its subsidiaries would be made known to such
officers on a timely basis.
(b) Changes in internal controls: There have been no significant changes
(including corrective actions with regard to significant deficiencies or
material weaknesses) in our internal controls or other factors that could
significantly affect these controls subsequent to the date of the evaluation
referenced in paragraph (a) above.
21
Part II Item 1
Legal Proceedings
During the third quarter of 2002, the Company agreed to settle Hill v. CVS
Rx Services, Inc. (Civil Action No. CV OO-HGD-3355-S), a collective action
filed against CVS in the Federal District Court of Alabama by certain
current and former CVS pharmacists alleging violations of the Fair Labor
Standards Act (the "FLSA Lawsuit").
22
Part II Item 6
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.
99.1 Certification of Chief Executive Officer pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
99.2 Certification of Chief Financial Officer pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
Reports on Form 8-K:
On July 31, 2002, we filed a Current Report on Form 8-K in connection with our
announcement that our Chief Executive Officer and Chief Financial Officer both
intended to certify the company's periodic reports on a timely basis in
accordance with the administrative order of the Securities Exchange Commission.
On August 9, 2002 we filed a Current Report on Form 8-K in connection with the
announcement that our Chief Executive Officer and Chief Financial Officer both
certified the company's periodic reports in accordance with the administrative
order of the Securities Exchange Commission requiring the filing of sworn
statements pursuant to Section 21(a)(1) of the Securities and Exchange Act of
1934.
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 12, 2002
23
Certification
I, Thomas M. Ryan, Chairman of the Board, President and Chief Executive Officer
of CVS Corporation, certify that:
1. I have reviewed this quarterly report on Form 10-Q of CVS Corporation;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary in
order to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period covered
by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
term in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we
have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this quarterly report is being
prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee
of the registrant's board of directors :
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have identified
for the registrant's auditors any material weaknesses in internal
controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
Date: November 12, 2002 By: /s/ Thomas M. Ryan
------------------
Thomas M. Ryan
Chairman of the Board, President
and Chief Executive Officer
24
Certification
I, David B. Rickard, Executive Vice President, Chief Financial Officer and Chief
Administrative Officer of CVS Corporation, certify that:
1. I have reviewed this quarterly report on Form 10-Q of CVS Corporation;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary in
order to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period covered
by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
term in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we
have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this quarterly report is being
prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee
of the registrant's board of directors :
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have identified
for the registrant's auditors any material weaknesses in internal
controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
Date: November 12, 2002 By: /s/ David B. Rickard
--------------------
David B. Rickard
Executive Vice President,
Chief Financial Officer and
Chief Administrative Officer
25