As you review our total operating expenses, we believe you should consider the following important information:
Income tax provision ~ Our effective income tax rate was 39.4% for the second quarter of 2001, compared to 40.0% for the second quarter of 2000. The decrease in our effective income tax rate was primarily due to lower state income taxes and a decrease in the amount of goodwill amortization that is not deductible for income tax purposes.
Net earnings for the second quarter of 2001 increased $11.5 million (or 6.2%) to $198.0 million, or $0.48 per diluted share, compared to $186.5 million, or $0.46 per diluted share, in the second quarter of 2000.
Six Months (Twenty-Six Weeks Ended June 30, 2001 versus July 1, 2000)
Net sales for the first six months of 2001 increased $1.2 billion (or 12.4%) to $10.9 billion, compared to $9.7 billion in the first six months of 2000. Same store sales, consisting of sales from stores that have been open for more than one year, rose 9.8%, while pharmacy same store sales increased 15.3%. Pharmacy sales were 67% of total sales in the first six months of 2001, compared to 62% in the first six months of 2000. Third party prescription sales were 91% of pharmacy sales during the first six months of 2001, compared to 89% in the first six months of 2000. See “Second Quarter” above for further information about the factors that affected our net sales.
Gross margin for the first six months of 2001 increased $276.0 million (or 10.5%) to $2.9 billion, compared to $2.6 billion in the first six months of 2000. Gross margin as a percentage of net sales for the first six months of 2001 was 26.8%, compared to 27.2% of net sales in the first six months of 2000. See “Second Quarter” above for further information about the factors that affected our gross margin as a percentage of net sales.
Total operating expenses for the first six months of 2001 were 20.1% of net sales, compared to 20.3% of net sales in the first six months of 2000. During the first six months of 2001, we received $46.8 million of settlement proceeds from lawsuits alleging antitrust law violations by certain manufacturers of brand name prescription drugs. We elected to contribute the entire $46.8 million in settlement proceeds to the CVS Charitable Trust, Inc. to fund future charitable giving. As a result, the net effect of these two nonrecurring items had no impact on our net earnings for the first six months of 2001. See “Second Quarter” above for further information about the factors that affected our total operating expenses.
Operating profit for the first six months of 2001 increased $54.6 million (or 8.2%) to $723.4 million, compared to $668.8 million in the first six months of 2000. Operating profit as a percentage of net sales was 6.6% in the first six months of 2001, compared to 6.9% in the first six months of 2000.
Interest expense, net for the first six months of 2001was $30.8 million, compared to $39.1 million in the first six months of 2000. Our interest expense totaled $33.1 million in the first six months of 2001, compared to $41.1 million in the first six months of 2000. Interest income was $2.3 million in the first six months of 2001 versus $2.0 million in the first six months of 2000. Our interest expense decreased due to a combination of lower average interest rates and lower average borrowing levels during the first six months of 2001.
Income tax provision ~ Our effective income tax rate was 39.4% for the first six months of 2001, compared to 40.0% for the first six months of 2000. The decrease in our effective income tax rate was primarily due to lower state income taxes and a decrease in the amount of goodwill amortization that is not deductible for income tax purposes.
Net earnings for the first six months of 2001 increased $41.9 million (or 11.1%) to $419.7 million, or $1.02 per diluted share, compared to $377.8 million, or $0.93 per diluted share, in the first six months of 2000.
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Liquidity and Capital Resources
Liquidity ~ Our primary sources of liquidity are cash provided by operations, commercial paper and long-term borrowings. We may also elect to use other financing sources in the future to support our continued growth.
Our commercial paper program is supported by a $650 million, five-year unsecured revolving credit facility which expires on May 30, 2006 and a $650 million, 364-day unsecured revolving credit facility, which expires on May 30, 2002. As of June 30, 2001, we had $479.5 million of commercial paper outstanding at a weighted average interest rate of 3.9%.
Our credit facilities and unsecured senior notes contain customary restrictive financial and operating covenants. We do not believe that the restrictions contained in these covenants materially affect our financial or operating flexibility.
We believe that our cash on hand and cash provided by operations, together with our ability to obtain additional short-term and long-term financing, will be sufficient to cover our working capital needs, capital expenditures and debt service requirements for at least the next twelve months.
On March 6, 2000, the Board of Directors approved a common stock repurchase program, which allows the Company to acquire up to $1 billion of its common stock, in part, to fund employee benefit plans. The Company had no repurchase activity during the first or second quarter of 2001. Following the end of the second quarter of 2001, the Company repurchased 2.6 million shares of common stock at an aggregate cost of $99.8 million. From the inception of the program through August 7, 2001, the Company repurchased 7.3 million shares of common stock at an aggregate cost of $263.0 million.
Net Cash Used in Operations ~ Net cash provided by operations increased $143.2 million to $127.0 million in the first six months of 2001. This compares to net cash used in operations of $16.2 in the first six months of 2000. The improvement in net cash provided by operations was primarily the result of higher net earnings and improved working capital management.
Capital Expenditures ~ Our additions to property and equipment totaled $275.8 million during the first six months of 2001, compared to $306.4 million during the first six months of 2000. During the second quarter, we opened 16 new stores, relocated 24 stores and closed 13 stores. Year-to-date, we opened 30 new stores, relocated 48 and closed 33. During the remainder of fiscal 2001, we plan to open approximately 180 new or relocated stores. As of June 30, 2001, we operated 4,130 retail and specialty pharmacy stores in 31 states and the District of Columbia, compared to 4,082 stores as of July 1, 2000.
The Company currently intends to continue to finance a portion of its new store development program through sale-leaseback transactions. Although the Company has previously confined its sale-leaseback activity to new store development projects, management is currently considering a sale-leaseback transaction involving certain of its distribution centers. Proceeds from the transaction would be used to fund additional new store construction. The Company anticipates the transaction could be finalized during the third quarter. The Company cannot, however, guarantee that the transaction will be completed on terms and in a time frame satisfactory to the Company.
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Recent Accounting Pronouncements ~ In June 2001, the Financial Accounting Standard Board issued two new pronouncements; Statement of Financial Accounting Standards (“SFAS”) No. 141, “Business Combinations” and SFAS No. 142, “Goodwill and Other Intangible Assets.” SFAS No. 141, which is effective for acquisitions initiated after June 30, 2001, prohibits the use of the pooling-of-interest method for business combinations and establishes the accounting and financial reporting requirements for business combinations accounted for by the purchase method. SFAS No. 142, addresses financial accounting and reporting for acquired goodwill and other intangible assets. Except for goodwill and intangible assets acquired after June 30, 2001, which are subject immediately to the provisions of SFAS No. 142, this statement is effective for fiscal years beginning after December 15, 2001.
We are currently in the process of determining the impact these pronouncements will have on our consolidated financial statements.
Cautionary Statement Concerning Forward-Looking Statements ~ Certain statements in this Form 10-Q (as well as in our other public filings, web site, press releases and oral statements made by Company management and/or representatives), constitute forward-looking statements, which are subject to risks and uncertainties. Forward-looking statements include information concerning:
| • | our future results of operations, including sales and earnings per common share growth; |
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| • | our ability to continue to reduce selling, general and administrative expenses as a percentage of net sales; |
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| • | our belief concerning the growth and profitability of CVS ProCare; |
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| • | our belief concerning the growth and profitability of CVS.com; |
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| • | our belief concerning our ability to increase our free cash flow; |
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| • | our belief that we will have sufficient cash flows to support our future working capital needs, capital expenditures and debt service requirements; |
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| • | our belief that we can continue to reduce inventory levels and improve inventory turnover; |
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| • | our planned store development program, including store openings, number of freestanding locations, new markets and capital expenditures; |
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| • | our ability to continue to fund our new store development through sale-leaseback transaction on terms satisfactory to the Company; and |
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| • | our belief that we can continue to improve operating performance by relocating existing in-line stores to freestanding locations. |
In addition, statements that include the words “believes”, “expects”, “anticipates”, “intends”, “estimates” or similar expressions are forward-looking statements. For all of these statements, we claim the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995.
You should understand that the following important factors, in addition to those discussed elsewhere in this report and in the documents which are incorporated by reference (and in our other public filings, press releases and oral statements made by Company management and/or representatives), could cause actual results to differ materially from those expressed in the forward-looking statements.
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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; |
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| • | future federal and/or state regulatory and legislative actions affecting CVS and/or the chain drugstore industry; |
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| • | consumer preferences and spending patterns; |
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| • | 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; |
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| • | the continued introduction of successful new prescription drugs; |
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| • | 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 |
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| • | changes in accounting policies and practices, including taxation requirements. |
Operating Factors
| • | our ability to continue to implement new information systems and technologies; |
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| • | our ability to successfully attract customers through our customer reactivation program; |
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| • | our ability to continue to secure suitable new store locations at favorable lease terms; |
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| • | our ability to continue to purchase inventory on favorable terms; |
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| • | adverse determinations with respect to litigation or other claims; |
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| • | our ability to attract, hire and retain suitable pharmacists and management personnel; |
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| • | our ability to establish effective advertising, marketing and promotional programs (including pricing strategies) in the different geographic markets in which we operate; and |
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| • | the creditworthiness of the purchasers of former businesses whose store leases are guaranteed by CVS. |
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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.
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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 18, 2001 in Woonsocket, Rhode Island:
| | | | | For | | Against | | Abstained | | Broker
Non-Votes |
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| 1. | The election, for one-year terms, of all persons nominated for directors, as set forth in the Company’s proxy statement dated March 14, 2001, was approved by the following votes: | | | | | | | | |
| | | Eugene Applebaum | | 301,507,662 | | 4,176,705 | | — | | — |
| | | W. Don Cornwell | | 303,381,476 | | 2,302,891 | | — | | — |
| | | Thomas P. Gerrity | | 303,353,448 | | 2,330,919 | | — | | — |
| | | Stanley P. Goldstein | | 303,366,562 | | 2,317,805 | | — | | — |
| | | Marian L. Heard | | 303,360,375 | | 2,323,992 | | — | | — |
| | | William H. Joyce | | 303,381,270 | | 2,303,097 | | — | | — |
| | | Terry R. Lautenbach | | 303,393,195 | | 2,291,172 | | — | | — |
| | | Terrence Murray | | 302,392,806 | | 3,291,561 | | — | | — |
| | | Sheli Z. Rosenberg | | 303,332,277 | | 2,352,090 | | — | | — |
| | | Thomas M. Ryan | | 303,218,918 | | 2,465,449 | | — | | — |
| | | Ivan G. Seidenberg | | 303,361,368 | | 2,322,999 | | — | | — |
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| 2. | The amendment to the Company’s 1997 Incentive Compensation Plan increasing the number of shares authorized for issuance under the Plan by 19.5 million was approved by the following vote: | | 289,845,420 | | 13,917,510 | | 1,921,437 | | — |
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| 3. | Ratification of the appointment of KPMG LLP as the Company’s independent auditors for the year ending December 29, 2001 was approved by the following vote: | | 302,998,899 | | 1,550,354 | | 1,135,114 | | — |
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Exhibits and Reports on Form 8-K
Exhibits:
| | 3.1 | Amended and Restated Certificate of Incorporation of the Registrant (incorporated by reference to Exhibit 3.1 to CVS Corporation’s Annual Report on Form 10-K for the fiscal year ended December 31, 1996). |
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| | 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). |
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| | 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). |
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| | 10.1 | 364-day Credit Agreement dated as of May 21, 2001 by and among the Registrant, the lenders party hereto, Credit Suisse First Boston and First Union National Bank, as Co-Documentation Agents, Fleet National Bank, as Administrative Agent and BNY Capital Markets, Inc. and Fleet Securities, Inc., as Syndication Agent. |
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| | 10.2 | Five-year Credit Agreement dated as of May 21, 2001 by and among the Registrant, the lenders party hereto, Credit Suisse First Boston and First Union National Bank, as Co-Documentation Agents, The Bank of New York, as Administrative Agent and .BNY Capital Markets, Inc. and Fleet Securities, Inc., as Syndication Agent. |
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| | 15.1 | Letter re: Unaudited Interim Financial Information. |
Reports on Form 8-K:
There were no Reports on Form 8-K filed during the second quarter of 2001.
Signatures:
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Quarterly Report on Form 10-Q to be signed on its behalf by the undersigned thereunto duly authorized.
CVS Corporation
(Registrant)
David B. Rickard
Executive Vice President
and Chief Financial Officer
August 14, 2001
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