<PAGE>
================================================================================
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
July 1, 2000 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
------ ------
Common Stock, $0.01 par value, issued and outstanding at August 7, 2000:
390,666,755 shares
================================================================================
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================================================================================
INDEX
<TABLE>
<CAPTION>
PAGE
<S> <C> <C>
PART I
Item 1. Financial Statements
Consolidated Condensed Statements of Operations -
Thirteen and Twenty-Six Weeks Ended July 1, 2000 and June 26, 1999 3
Consolidated Condensed Balance Sheets -
As of July 1, 2000 and January 1, 2000 4
Consolidated Condensed Statements of Cash Flows -
Twenty-Six Weeks Ended July 1, 2000 and June 26, 1999 5
Notes to Consolidated Condensed Financial Statements 6
Independent Auditors' Review Report 10
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 11
Item 3. Quantitative and Qualitative Disclosures About Market Risk 16
PART II
Item 4. Submission of Matters to a Vote of Security Holders 17
Item 6. Exhibits and Reports on Form 8-K 18
Signature Page 18
</TABLE>
2
<PAGE>
PART I ITEM 1
================================================================================
CVS CORPORATION
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
13 WEEKS ENDED 26 WEEKS ENDED
JULY 1, June 26, JULY 1, June 26,
IN MILLIONS, EXCEPT PER SHARE AMOUNTS 2000 1999 2000 1999
----------------------------------------------------------- -------------- -------------- -------------- ---------------
<S> <C> <C> <C> <C>
Net sales $ 4,942.8 $ 4,362.4 $ 9,682.3 $ 8,602.9
Cost of goods sold, buying and warehousing costs 3,607.0 3,172.0 7,046.5 6,243.1
----------------------------------------------------------- -------------- -------------- -------------- ---------------
Gross margin 1,335.8 1,190.4 2,635.8 2,359.8
Selling, general and administrative expenses 928.5 831.5 1,821.8 1,639.7
Depreciation and amortization 73.4 68.7 145.2 136.7
----------------------------------------------------------- -------------- -------------- -------------- ---------------
Total operating expenses 1,001.9 900.2 1,967.0 1,776.4
----------------------------------------------------------- -------------- -------------- -------------- ---------------
Operating profit 333.9 290.2 668.8 583.4
Interest expense, net 23.0 14.5 39.1 28.8
----------------------------------------------------------- -------------- -------------- -------------- ---------------
Earnings before income tax provision 310.9 275.7 629.7 554.6
Income tax provision 124.4 113.1 251.9 227.4
----------------------------------------------------------- -------------- -------------- -------------- ---------------
Net earnings 186.5 162.6 377.8 327.2
Preference dividends, net of income tax benefit 3.7 3.6 7.5 7.2
----------------------------------------------------------- -------------- -------------- -------------- ---------------
Net earnings available to common shareholders $ 182.8 $ 159.0 $ 370.3 $ 320.0
=========================================================== ============== ============== ============== ===============
BASIC EARNINGS PER COMMON SHARE:
Net earnings $ 0.47 $ 0.41 $ 0.95 $ 0.82
----------------------------------------------------------- -------------- -------------- -------------- ---------------
Weighted average basic common shares outstanding 390.3 391.1 390.7 390.8
=========================================================== ============== ============== ============== ===============
DILUTED EARNINGS PER COMMON SHARE:
Net earnings $ 0.46 $ 0.40 $ 0.93 $ 0.80
----------------------------------------------------------- -------------- -------------- -------------- ---------------
Weighted average diluted common shares outstanding 408.0 408.7 407.2 408.8
=========================================================== ============== ============== ============== ===============
DIVIDENDS DECLARED PER COMMON SHARE $ 0.0575 $ 0.0575 $ 0.1150 $ 0.1150
=========================================================== ============== ============== ============== ===============
</TABLE>
See accompanying notes to consolidated condensed financial statements.
3
<PAGE>
PART I ITEM 1
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CVS CORPORATION
CONSOLIDATED CONDENSED BALANCE SHEETS
<TABLE>
<CAPTION>
(UNAUDITED)
JULY 1, January 1,
IN MILLIONS, EXCEPT SHARE AMOUNTS 2000 2000
--------------------------------------------------------------------------------------- -------------- --------------
<S> <C> <C>
ASSETS:
Cash and cash equivalents $ 182.5 $ 230.0
Accounts receivable, net 759.1 699.3
Inventories 3,500.1 3,445.5
Deferred income taxes 144.5 139.4
Other current assets 135.2 93.8
--------------------------------------------------------------------------------------- -------------- --------------
TOTAL CURRENT ASSETS 4,721.4 4,608.0
Property and equipment, net 1,778.3 1,601.0
Goodwill, net 741.3 706.9
Other assets 435.5 359.5
--------------------------------------------------------------------------------------- -------------- --------------
TOTAL ASSETS $ 7,676.5 $ 7,275.4
======================================================================================= ============== ==============
LIABILITIES:
Accounts payable $ 1,103.9 $ 1,454.2
Accrued expenses 956.2 967.4
Short-term borrowings 970.9 451.0
Current portion of long-term debt 17.3 17.3
--------------------------------------------------------------------------------------- -------------- --------------
TOTAL CURRENT LIABILITIES 3,048.3 2,889.9
Long-term debt 558.0 558.5
Deferred income taxes 27.2 27.2
Other long-term liabilities 110.4 120.1
SHAREHOLDERS' EQUITY:
Preference stock, series one ESOP convertible, par value $1.00:
authorized 50,000,000 shares; issued and outstanding 5,061,000 shares at
July 1, 2000 and 5,164,000 shares at January 1, 2000 270.5 276.0
Common stock, par value $0.01: authorized 1,000,000,000 shares; issued
405,787,000 shares at July 1, 2000 and 403,047,000 shares at January 1, 2000 4.1 4.0
Treasury stock, at cost: 15,120,000 shares at July 1, 2000 and 11,051,000
shares at January 1, 2000 (402.3) (258.5)
Guaranteed ESOP obligation (257.0) (257.0)
Capital surplus 1,441.2 1,371.7
Retained earnings 2,876.1 2,543.5
--------------------------------------------------------------------------------------- -------------- --------------
TOTAL SHAREHOLDERS' EQUITY 3,932.6 3,679.7
--------------------------------------------------------------------------------------- -------------- --------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 7,676.5 $ 7,275.4
======================================================================================= ============== ==============
</TABLE>
See accompanying notes to consolidated condensed financial statements.
4
<PAGE>
PART I ITEM 1
================================================================================
CVS CORPORATION
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
26 WEEKS ENDED
JULY 1, June 26,
IN MILLIONS 2000 1999
------------------------------------------------------------------------------ ------------------- -----------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings $ 377.8 $ 327.2
Adjustments required to reconcile net earnings to net cash
(used in) provided by operating activities:
Depreciation and amortization 145.2 136.7
Deferred income taxes and other non-cash items 3.7 4.2
Change in assets and liabilities, excluding acquisitions and dispositions:
(Increase) in accounts receivable, net (59.8) (76.7)
(Increase) decrease in inventories (54.6) 82.8
(Increase) decrease in other current assets (16.0) 1.5
(Increase) in other assets (59.9) (69.2)
(Decrease) in accounts payable (350.3) (246.7)
Increase (decrease) in accrued expenses 7.6 (11.8)
(Decrease) in other long-term liabilities (9.9) (31.4)
------------------------------------------------------------------------------ ------------------- -----------------
NET CASH (USED IN) PROVIDED BY OPERATING ACTIVITIES (16.2) 116.6
============================================================================== =================== =================
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to property and equipment (306.4) (276.3)
Acquisitions, net of cash (90.4) (16.7)
Proceeds from sale or disposal of assets 6.3 26.0
------------------------------------------------------------------------------ ------------------- -----------------
NET CASH USED IN INVESTING ACTIVITIES (390.5) (267.0)
============================================================================== =================== =================
CASH FLOWS FROM FINANCING ACTIVITIES:
Additions to (reductions in) short-term borrowings 520.0 (68.3)
Proceeds from exercise of stock options 34.2 15.3
(Reductions in) additions to long-term debt (0.5) 299.8
Dividends paid (45.0) (44.9)
Purchase of treasury shares (149.5) --
------------------------------------------------------------------------------ ------------------- -----------------
NET CASH PROVIDED BY FINANCING ACTIVITIES 359.2 201.9
============================================================================== =================== =================
Net (decrease) increase in cash and cash equivalents (47.5) 51.5
Cash and cash equivalents at beginning of period 230.0 180.8
------------------------------------------------------------------------------ ------------------- -----------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 182.5 $ 232.3
============================================================================== =================== =================
</TABLE>
See accompanying notes to consolidated condensed financial statements.
5
<PAGE>
PART I ITEM 1
================================================================================
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 January 1, 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 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 4,053 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 a mail order facility and 29
retail pharmacies located in 12 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
<PAGE>
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
twenty-six weeks ended July 1, 2000 and June 26, 1999:
<TABLE>
<CAPTION>
------------------------------- -------------------- --------------------- -------------------- --------------------
Retail Pharmacy All Other Intersegment Consolidated
IN MILLIONS Segment Segments Eliminations(1) Totals
------------------------------- -------------------- --------------------- -------------------- --------------------
<S> <C> <C> <C> <C>
13 WEEKS ENDED:
JULY 1, 2000:
Net sales $ 4,806.5 $ 192.0 $ (55.7) $ 4,942.8
Operating profit 329.9 4.0 -- 333.9
June 26, 1999:
Net sales $ 4,241.8 $ 222.6 $ (102.0) $ 4,362.4
Operating profit 284.3 5.9 -- 290.2
=============================== ==================== ===================== ==================== ====================
26 WEEKS ENDED:
JULY 1, 2000:
Net sales $ 9,392.4 $ 441.9 $ (152.0) $ 9,682.3
Operating profit 663.8 5.0 -- 668.8
June 26, 1999:
Net sales $ 8,390.2 $ 416.1 $ (203.4) $ 8,602.9
Operating profit 569.3 14.1 -- 583.4
=============================== ==================== ===================== ==================== ====================
Total assets:
JULY 1, 2000 $ 7,452.0 $ 240.3 $ (15.8) $ 7,676.5
January 1, 2000 7,146.1 173.4 (44.1) 7,275.4
=============================== ==================== ===================== ==================== ====================
</TABLE>
(1) Intersegment eliminations relate to intersegment sales and accounts
receivable that occur when a PBM segment customer uses a Retail segment
store to purchase covered merchandise. When this occurs, both segments
record the sale on a stand-alone basis.
NOTE 3
Following are the components of net interest expense:
<TABLE>
<CAPTION>
------------------------------- ----------------------------------------- -----------------------------------------
13 WEEKS ENDED 26 WEEKS ENDED
IN MILLIONS JULY 1, 2000 June 26, 1999 JULY 1, 2000 June 26, 1999
------------------------------- -------------------- -------------------- -------------------- --------------------
<S> <C> <C> <C> <C>
Interest expense $ 24.1 $ 16.4 $ 41.1 $ 32.5
Interest income (1.1) (1.9) (2.0) (3.7)
------------------------------- -------------------- -------------------- -------------------- --------------------
Interest expense, net $ 23.0 $ 14.5 $ 39.1 $ 28.8
=============================== ==================== ===================== ==================== ====================
</TABLE>
7
<PAGE>
PART I ITEM 1
================================================================================
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 normally 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 twenty-six weeks ended:
<TABLE>
<CAPTION>
--------------------------------------------------------------- ------------------------- --------------------------
13 WEEKS ENDED 26 WEEKS ENDED
JULY 1, June 26, JULY 1, June 26,
IN MILLIONS, EXCEPT PER SHARE AMOUNTS 2000 1999 2000 1999
--------------------------------------------------------------- ------------ ------------ ------------ -------------
<S> <C> <C> <C> <C>
NUMERATOR FOR EARNINGS PER COMMON SHARE CALCULATION:
Net earnings $ 186.5 $ 162.6 $ 377.8 $ 327.2
Preference dividends, net of income tax benefit (3.7) (3.6) (7.5) (7.2)
--------------------------------------------------------------- ------------ ------------ ------------ -------------
Net earnings available to common shareholders, basic $ 182.8 $ 159.0 $ 370.3 $ 320.0
--------------------------------------------------------------- ------------ ------------ ------------ -------------
Net earnings $ 186.5 $ 162.6 $ 377.8 $ 327.2
Effect of dilutive securities:
Dilutive earnings adjustments (0.1) 0.1 (0.2) 0.3
--------------------------------------------------------------- ------------ ------------ ------------ -------------
Net earnings available to common shareholders, diluted $ 186.4 $ 162.7 $ 377.6 $ 327.5
=============================================================== ============ ============ ============ =============
DENOMINATOR FOR EARNINGS PER COMMON SHARE CALCULATION:
Weighted average common shares, basic 390.3 391.1 390.7 390.8
Effect of dilutive securities:
ESOP preference stock 10.8 10.5 10.8 10.6
Stock options 6.9 7.1 5.7 7.4
--------------------------------------------------------------- ------------ ------------ ------------ -------------
Weighted average common shares, diluted 408.0 408.7 407.2 408.8
=============================================================== ============ ============ ============ =============
BASIC EARNINGS PER COMMON SHARE $ 0.47 $ 0.41 $ 0.95 $ 0.82
--------------------------------------------------------------- ------------ ------------ ------------ -------------
DILUTED EARNINGS PER COMMON SHARE $ 0.46 $ 0.40 $ 0.93 $ 0.80
=============================================================== ============ ============ ============ =============
</TABLE>
8
<PAGE>
PART I ITEM 1
================================================================================
CVS CORPORATION
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 5
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 common stock
primarily to fund certain employee benefit plans. During the second quarter of
2000, the Company repurchased 1.1 million shares of common stock at an aggregate
cost of $44.7 million. From the inception of the program through July 1, 2000,
the Company repurchased 4.3 million shares of common stock at an aggregate cost
of $149.5 million.
NOTE 6
In accordance with Accounting Principles Board Opinion No. 16, "Business
Combinations," Emerging Issues Task Force Issue No. 94-3, "Liability Recognition
for Certain Employee Termination Benefits and Other Costs to Exit an Activity
(Including Certain Costs Incurred in a Restructuring)" and Statement of
Financial Accounting Standards No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," the Company
recorded, during the second quarter of 1998, a $147.3 million charge to
operating expenses for direct and other merger-related costs pertaining to the
CVS/Arbor merger transaction and certain restructuring activities (the
"CVS/Arbor Charge"). The restructuring activities related to management's plan
to close Arbor's Troy, Michigan corporate headquarters, terminate Arbor's
corporate headquarters employees, and close certain store locations. Asset
write-offs included in this charge totaled $41.2 million. The balance of the
charge, $106.1 million, will require cash outlays of which $56.6 million had
been incurred as of July 1, 2000.
Following is a reconciliation of the beginning and ending liability balances
associated with the CVS/Arbor Charge as of July 1, 2000:
<TABLE>
<CAPTION>
-------------------------------------- ------------- ------------ -------------------------------------- ------------
Exit Costs
--------------------------------------
Merger Employee Noncancelable
Transaction Severance Lease Asset Other Exit
IN MILLIONS Costs & Benefits(1) Obligations(2) Write-offs Costs Total
-------------------------------------- ------------- ------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
CVS/Arbor Charge $ 15.0 $ 27.1 $ 40.0 $ 41.2 $ 24.0 $ 147.3
Utilization through 1/1/00 - cash (15.9) (16.8) (2.7) -- (19.7) (55.1)
Utilization through 1/1/00 - noncash -- -- -- (41.2) -- (41.2)
Transfer(3) 0.9 -- -- -- (0.9) --
-------------------------------------- ------------- ------------ ------------ ------------ ------------ ------------
Balance as of 1/1/00 $ -- $ 10.3 $ 37.3 $ -- $ 3.4 $ 51.0
Utilization through 7/1/00 - cash -- (0.6) (0.9) -- -- (1.5)
-------------------------------------- ------------- ------------ ------------ ------------ ------------ ------------
BALANCE AS OF 7/1/00(4) $ -- $ 9.7 $ 36.4 $ -- $ 3.4 $ 49.5
====================================== ============= ============ ============ ============ ============ ============
</TABLE>
(1) Employee severance extends through 2000. Employee benefits extend for a
number of years to coincide with the payment of excess parachute payment
excise taxes and related income tax gross-ups.
(2) Noncancelable lease obligations extend through 2020.
(3) The transfers between the components of the plan were recorded in the same
period that the changes in estimates were determined. These amounts are
considered to be immaterial.
(4) The Company believes that the reserve balances as of July 1, 2000 are
adequate to cover the remaining liabilities associated with the CVS/Arbor
Charge.
NOTE 7
On July 5, 2000 the Company signed a definitive agreement to acquire certain
assets of Stadtlander Pharmacy of Pittsburgh, Pa., a subsidiary of Bergen
Brunswig Corporation, for $124 million in cash plus the assumption of certain
liabilities. The transaction is subject to normal closing conditions and review
under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended.
Subject to satisfying these conditions, management expects to complete the
purchase during the third or fourth quarter of 2000.
9
<PAGE>
PART I INDEPENDENT AUDITORS' REVIEW REPORT
================================================================================
The Board of Directors and Shareholders of
CVS Corporation:
We have reviewed the consolidated condensed balance sheet of CVS Corporation as
of July 1, 2000, and the related consolidated condensed statements of operations
for the thirteen and twenty-six week periods ended July 1, 2000 and June 26,
1999, and the cash flows for the twenty-six weeks 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 generally accepted accounting principles.
We have previously audited, in accordance with generally accepted auditing
standards, the consolidated balance sheet of CVS Corporation as of January 1,
2000 and the related consolidated statements of operations, shareholders'
equity, and cash flows for the fifty-three week period ended January 1, 2000 and
the fifty-two week period ended December 26, 1998, (not presented herein); and
in our report dated February 7, 2000 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 January 1,
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
July 31, 2000
10
<PAGE>
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 twenty-six weeks ended July 1, 2000 and June 26,
1999 and the significant developments affecting our financial condition since
January 1, 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 January 1, 2000.
RESULTS OF OPERATIONS
SECOND QUARTER (Thirteen Weeks Ended July 1, 2000 versus June 26, 1999)
NET SALES for the second quarter of 2000 increased $580.4 million (or 13.3%) to
$4.9 billion, compared to $4.4 billion in the second quarter of 1999. Same store
sales, consisting of sales from stores that have been open for more than one
year, rose 12.2%, while pharmacy same store sales increased 18.6%. Pharmacy
sales were 62% of total sales in the second quarter of 2000, compared to 58% in
the second quarter of 1999. Third party prescription sales were 89% of pharmacy
sales during the second quarter of 2000, compared to 86% in the second quarter
of 1999.
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, our ongoing program of
purchasing prescription files from independent pharmacies 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 also
contributed to the growing demand for pharmacy services.
- Our front store sales growth was primarily driven by solid performance
in general merchandise, health and beauty, convenience foods and film
and photofinishing.
- Sales also benefited from our active 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. 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 36% of our existing stores are
freestanding at July 1, 2000. Our 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. Please read the "Cautionary Statement
Concerning Forward-Looking Statements" section below.
GROSS MARGIN for the second quarter of 2000 increased $145.4 million (or 12.2%)
to $1.3 billion, compared to $1.2 billion in the second quarter of 1999. Gross
margin as a percentage of net sales for the second quarter of 2000 was 27.0%,
compared to 27.3% of net sales in the second quarter of 1999.
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.
11
<PAGE>
PART I ITEM 2
================================================================================
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
- 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. Our gross margin on third party sales has
continued to decline largely due to the efforts of managed care
organizations and other pharmacy benefit managers to reduce
prescription drug costs. To address this trend, we have dropped a
number of third party programs that fell below our minimum
profitability standards. In the event this trend continues and we
elect to drop additional 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.
TOTAL OPERATING EXPENSES for the second quarter of 2000 were $1,001.9 million or
20.3% of net sales, compared to $900.2 million or 20.6% of net sales in the
second quarter of 1999.
What have we done to improve our total operating expenses as a percentage of net
sales?
- Our strong sales performance has consistently allowed net sales to
grow at a faster pace than total operating expenses.
- Our information technology initiatives have led to greater
productivity, which has resulted in lower operating costs,
particularly at the store level.
OPERATING PROFIT for the second quarter of 2000 increased $43.7 million (or
15.1%) to $333.9 million, compared to $290.2 million in the second quarter of
1999. Operating profit as a percentage of net sales was 6.8% in the second
quarter of 2000, compared to 6.7% in the second quarter of 1999.
INTEREST EXPENSE, NET for the second quarter of 2000 was $23.0 million, compared
to $14.5 million in the second quarter of 1999. Our interest expense totaled
$24.1 million in the second quarter of 2000, compared to $16.4 million in the
second quarter of 1999. Interest income was $1.1 million in the second quarter
of 2000 versus $1.9 million in the second quarter of 1999. Our interest expense
increased due to a combination of higher average interest rates and higher
average borrowing levels during the second quarter of 2000.
INCOME TAX PROVISION ~ Our effective income tax rate was 40.0% for the second
quarter of 2000, compared to 41.0% for the second quarter of 1999. The decrease
in our effective income tax rate was primarily due to lower state income taxes.
NET EARNINGS for the second quarter of 2000 increased $23.9 million (or 14.7%)
to $186.5 million, or $0.46 per diluted share, compared to $162.6 million, or
$0.40 per diluted share, in the second quarter of 1999.
SIX MONTHS (Twenty-Six Weeks Ended July 1, 2000 versus June 26, 1999)
NET SALES for the first six months of 2000 increased $1.1 billion (or 12.5%) to
$9.7 billion, compared to $8.6 billion in the first six months of 1999. Same
store sales, rose 10.5%, while pharmacy same store sales increased 16.9%.
Pharmacy sales were 62% of total sales in the first six months of 2000, compared
to 59% in the first six months of 1999. Third party prescription sales were 89%
of pharmacy sales during the first six months of 2000, compared to 86% in the
first six months of 1999. See "Second Quarter" above for further information
about the factors that affected our net sales.
GROSS MARGIN for the first six months of 2000 increased $276.0 million (or
11.7%) to $2.6 billion, compared to $2.4 billion in the first six months of
1999. Gross margin as a percentage of net sales for the first six months of 2000
was 27.2%, compared to 27.4% in the first six months of 1999. See "Second
Quarter" above for further information about the factors that affected our gross
margin as a percentage of net sales.
12
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PART I ITEM 2
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
TOTAL OPERATING EXPENSES for the first six months of 2000 were $2.0 billion or
20.3% of net sales, compared to $1.8 billion or 20.6% of net sales in the first
six months of 1999. See "Second Quarter" above for further information about the
factors that affected our operating expenses as a percentage of net sales.
OPERATING PROFIT for the first six months of 2000 increased $85.4 million (or
14.6%) to $668.8 million, compared to $583.4 million for the first six months of
1999. Operating profit as a percentage of net sales was 6.9% in the first six
months of 2000, compared to 6.8% in the first six months of 1999.
INTEREST EXPENSE, NET for the first six months of 2000 was $39.1 million,
compared to $28.8 million in the first six months of 1999. Our interest expense
totaled $41.1 million in the first six months of 2000, compared to $32.5 million
in the first six months of 1999. Interest income was $2.0 million in the first
six months of 2000, compared to $3.7 million in the first six months of 1999.
Our interest expense increased due to a combination of higher average interest
rates and higher average borrowing levels during the first six months of 2000.
INCOME TAX PROVISION ~ Our effective income tax rate was 40.0% for the first six
months of 2000, compared to 41.0% for the first six months of 1999. The decrease
in our effective income tax rate was primarily due to lower state income taxes.
NET EARNINGS in the first six months of 2000, increased $50.6 million (or 15.5%)
to $377.8 million, or $0.93 per diluted share, compared to $327.2 million, or
$0.80 per diluted share in the first six months of 1999.
LIQUIDITY AND CAPITAL RESOURCES
LIQUIDITY ~ The Company has three primary sources of liquidity: cash provided by
operations, commercial paper and uncommitted lines of credit. We generally
finance our working capital and capital expenditure requirements with internally
generated funds and our commercial paper program. In addition, we may elect to
use additional long-term borrowings in the future to support our continued
growth.
Our commercial paper program is supported by a $670 million, five-year unsecured
revolving credit facility which expires on May 30, 2002 and a $795 million,
364-day unsecured revolving credit facility which expires on May 25, 2001. We
can also obtain short-term financing through various uncommitted lines of
credit. As of July 1, 2000, we had $956.4 million of commercial paper
outstanding at a weighted average interest rate of 6.8% and $14.5 million
outstanding under the uncommitted lines of credit at a weighted average interest
rate of 7.1%.
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 common stock
primarily to fund certain employee benefit plans. During the second quarter of
2000, the Company repurchased 1.1 million shares of common stock at an aggregate
cost of $44.7 million. From the inception of the program through July 1, 2000,
the Company repurchased 4.3 million shares of common stock at an aggregate cost
of $149.5 million.
13
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PART I ITEM 2
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
NET CASH USED IN OPERATIONS ~ Net cash used in operations increased $132.8
million to $16.2 million during the first six months of 2000. This compares to
net cash provided by operations of $116.6 during the first six months of 1999.
The increase in net cash used in operations resulted primarily from additional
investments in inventory and a decrease in accounts payable. As of July 1, 2000,
the future cash payments associated with various restructuring programs totaled
$115.0 million. These payments primarily include: (i) $19.4 million for employee
severance, which extends through 2000 and retirement benefits and related excess
parachute payment excise taxes and income tax gross-ups, which extend for a
number of years to coincide with the payment of retirement benefits, and (ii)
$92.2 million for continuing lease obligations, which extend through 2020.
CAPITAL EXPENDITURES ~ Our additions to property and equipment totaled $306.4
million in the first six months of 2000, compared to $276.3 million in the first
six months of 1999. During the first six months of 2000, we opened 62 new
stores, relocated 113 stores and closed 78 stores. As of July 1, 2000, we
operated 4,082 retail and specialty pharmacy stores in 29 states and the
District of Columbia, compared to 4,096 stores as of June 26, 1999.
CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING STATEMENTS ~ Certain statements
in this Form 10-Q (as well as in other public filings, our 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 and cost savings and synergies following the Revco
and Arbor mergers;
- our planned store development, including store openings, number of
freestanding locations, new markets and capital expenditures;
- our belief that we have sufficient cash flows to support working
capital needs, capital expenditures and debt service requirements;
- our belief concerning the growth of our free cash flow;
- our belief that we can continue to improve operating performance by
relocating existing in-line stores to freestanding locations;
- our ability to continue to reduce selling, general and administrative
expenses as a percentage of net sales;
- our belief concerning the profitability of CVS.com;
- our belief concerning the growth and profitability of CVS ProCare; and
- our belief that we can continue to reduce inventory levels and improve
inventory turnover.
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.
14
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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 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 computer systems and
technologies;
- our ability to continue to secure suitable new store locations on
favorable lease terms;
- the creditworthiness of the purchasers of former businesses whose
store leases are guaranteed by CVS;
- our ability to continue to purchase inventory on favorable terms;
- our ability to attract, hire and retain suitable pharmacists and
management personnel; and
- our ability to establish effective advertising, marketing and
promotional programs (including pricing strategies) in the different
geographic markets in which we operate.
15
<PAGE>
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.
16
<PAGE>
PART II ITEM 4
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SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The following matters were submitted to a vote of security holders at our Annual
Meeting of Stockholders, which was held on Wednesday, April 19, 2000 in
Woonsocket, Rhode Island:
<TABLE>
<CAPTION>
------ --------------------------------------------------- -------------- -------------- ------------- --------------
BROKER
FOR AGAINST ABSTAINED NON-VOTES
------ --------------------------------------------------- -------------- -------------- ------------- --------------
<S> <C> <C> <C> <C>
1. The election, for one-year terms,
of all persons nominated for
directors, as set forth in the
Company's proxy statement dated
March 9, 2000, was approved by the
following votes:
Eugene Applebaum 331,825,465 2,433,656 -- --
W. Don Cornwell 331,849,193 2,409,928 -- --
Thomas P. Gerrity 331,775,875 2,483,246 -- --
Stanley P. Goldstein 331,798,872 2,460,249 -- --
Marian L. Heard 331,827,519 2,431,602 -- --
William H. Joyce 331,847,576 2,411,545 -- --
Terry R. Lautenbach 331,808,652 2,450,469 -- --
Terrence Murray 331,811,486 2,447,635 -- --
Sheli Z. Rosenberg 331,768,318 2,490,803 -- --
Thomas M. Ryan 331,848,791 2,410,330 -- --
Ivan G. Seidenberg 331,741,490 2,517,631 -- --
2. The appointment of KPMG LLP as the
Company's independent auditors for
the year ending December 30, 2000
was approved by the following vote: 333,127,497 213,934 917,690 --
=====================================================================================================================
</TABLE>
17
<PAGE>
PART II ITEM 6
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EXHIBITS AND REPORTS ON FORM 8-K
<TABLE>
Exhibits:
---------
<S> <C>
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).
10.1 Description of the Executive Retention Program.
10.2 364-day Credit Agreement dated as of May 26, 2000 by and among
the Registrant, the lenders party hereto, Fleet National Bank,
as Syndication Agent, Credit Suisse First Boston, as
Documentation Agent and The Bank of New York, as
Administrative Agent.
15.1 Letter re: Unaudited Interim Financial Information.
27.1 Financial Data Schedule - July 1, 2000.
</TABLE>
Reports on Form 8-K:
There were no Reports on Form 8-K filed during the second quarter of 2000.
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
and Chief Financial Officer
August 15, 2000
18
