Annual Reports

 
Quarterly Reports

  • 10-Q (Nov 6, 2017)
  • 10-Q (Aug 8, 2017)
  • 10-Q (May 2, 2017)
  • 10-Q (Nov 8, 2016)
  • 10-Q (Aug 2, 2016)
  • 10-Q (May 3, 2016)

 
8-K

 
Other

CVS HEALTH Corp 10-Q 2014

Documents found in this filing:

  1. 10-Q
  2. Ex-15.1
  3. Ex-31.1
  4. Ex-31.2
  5. Ex-32.1
  6. Ex-32.2
  7. Ex-32.2
CVS 2014.09.30-10Q


 
UNITED STATES
 
SECURITIES AND EXCHANGE COMMISSION
 
Washington, D.C.  20549
 
FORM 10-Q

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended September 30, 2014
 
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from __________ to _________.

Commission File Number 001-01011
  
CVS HEALTH 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)
 
Registrant's telephone number, including area code:  (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 [   ]
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes [X] No [   ]
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company.  See the definitions of “large accelerated filer," "accelerated filer” and "smaller reporting company" in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer [X]
 
Accelerated filer [   ]
Non-accelerated filer [   ] (Do not check if a smaller reporting company)
 
Smaller reporting company [   ]
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [  ] No [X]
 
Common Stock, $0.01 par value, issued and outstanding at October 30, 2014:
 
1,146,383,477 shares
 




INDEX
 
 
Page
 
 
 
Item 1.
Financial Statements
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 





Part I
 
Item 1

 
CVS Health Corporation
(formerly CVS Caremark Corporation)
Condensed Consolidated Statements of Income
(Unaudited)
 
 
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
In millions, except per share amounts
2014
 
2013
 
2014
 
2013
 
 
 
 
 
 
 
 
Net revenues
$
35,021

 
$
31,932

 
$
102,312

 
$
93,931

Cost of revenues
28,553

 
25,905

 
83,578

 
76,487

Gross profit
6,468

 
6,027

 
18,734

 
17,444

Operating expenses
4,222

 
3,873

 
12,256

 
11,624

Operating profit
2,246

 
2,154

 
6,478

 
5,820

Interest expense, net
153

 
122

 
469

 
374

Loss on early extinguishment of debt
521

 

 
521

 

Income before income tax provision
1,572

 
2,032

 
5,488

 
5,446

Income tax provision
624

 
777

 
2,165

 
2,112

Income from continuing operations
948

 
1,255

 
3,323

 
3,334

Loss from discontinued operations, net of tax

 
(6
)
 

 
(7
)
Net income
$
948

 
$
1,249

 
$
3,323

 
$
3,327

 
 
 
 
 
 
 
 
Basic earnings per share:
 

 
 

 
 

 
 

Income from continuing operations
$
0.82

 
$
1.03

 
$
2.84

 
$
2.72

Loss from discontinued operations
$

 
$

 
$

 
$
(0.01
)
Net income
$
0.82

 
$
1.03

 
$
2.84

 
$
2.71

Weighted average basic shares outstanding
1,157

 
1,218

 
1,167

 
1,226

 
 
 
 
 
 
 
 
Diluted earnings per share:
 
 
 
 
 
 
 
Income from continuing operations
$
0.81

 
$
1.02

 
$
2.82

 
$
2.70

Loss from discontinued operations
$

 
$

 
$

 
$
(0.01
)
Net income
$
0.81

 
$
1.02

 
$
2.82

 
$
2.70

Weighted average diluted shares outstanding
1,164

 
1,226

 
1,175

 
1,234

 
 
 
 
 
 
 
 
Dividends declared per share
$
0.275

 
$
0.225

 
$
0.825

 
$
0.675

  
See accompanying notes to condensed consolidated financial statements.


3



CVS Health Corporation
(formerly CVS Caremark Corporation)
Condensed Consolidated Statements of Comprehensive Income
(Unaudited)
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
In millions
2014
 
2013
 
2014
 
2013
 
 
 
 
 
 
 
 
Net income
$
948

 
$
1,249

 
$
3,323

 
$
3,327

Other comprehensive income (loss):
 

 
 

 
 

 
 

Foreign currency translation adjustments, net of tax
(29
)
 
3

 
(14
)
 
(15
)
Cash flow hedges, net of tax
1

 
1

 
3

 
2

Total other comprehensive income (loss)
(28
)
 
4

 
(11
)
 
(13
)
Comprehensive income
$
920

 
$
1,253

 
$
3,312

 
$
3,314

 
 
See accompanying notes to condensed consolidated financial statements.


4



CVS Health Corporation
(formerly CVS Caremark Corporation)
Condensed Consolidated Balance Sheets
(Unaudited)
 
In millions, except per share amounts
September 30,
2014
 
December 31,
2013
 
 
 
 
Assets:
 
 
 
Cash and cash equivalents
$
1,132

 
$
4,089

Short-term investments
78

 
88

Accounts receivable, net
10,828

 
8,729

Inventories
11,613

 
11,045

Deferred income taxes
1,042

 
902

Other current assets
644

 
472

Total current assets
25,337

 
25,325

Property and equipment, net
8,694

 
8,615

Goodwill
28,151

 
26,542

Intangible assets, net
9,854

 
9,529

Other assets
1,540

 
1,515

Total assets
$
73,576

 
$
71,526

 
 
 
 
Liabilities:
 

 
 

Accounts payable
$
6,033

 
$
5,548

Claims and discounts payable
5,400

 
4,548

Accrued expenses
5,433

 
4,768

Short-term debt
775

 

Current portion of long-term debt
572

 
561

Total current liabilities
18,213

 
15,425

Long-term debt
11,709

 
12,841

Deferred income taxes
4,051

 
3,901

Other long-term liabilities
1,494

 
1,421

Commitments and contingencies (Note 12)

 

 
 
 
 
Shareholders’ equity:
 

 
 

CVS Health shareholders' equity:
 
 
 
Preferred stock, par value $0.01: 0.1 share authorized; none issued or outstanding

 

Common stock, par value $0.01: 3,200 shares authorized; 1,690 shares issued and 1,153
 
 
 
shares outstanding at September 30, 2014 and 1,680 shares issued and 1,180 shares
 
 
 
outstanding at December 31, 2013
17

 
17

Treasury stock, at cost: 536 shares at September 30, 2014 and 500 shares at December 31,
 
 
 
2013
(22,877
)
 
(20,169
)
Shares held in trust: 1 share at September 30, 2014 and December 31, 2013
(31
)
 
(31
)
Capital surplus
30,310

 
29,777

Retained earnings
30,845

 
28,493

Accumulated other comprehensive income (loss)
(160
)
 
(149
)
Total CVS Health shareholders' equity
38,104

 
37,938

Noncontrolling interest
5

 

Total shareholders’ equity
38,109

 
37,938

Total liabilities and shareholders’ equity
$
73,576

 
$
71,526

 
See accompanying notes to condensed consolidated financial statements.


5



CVS Health Corporation
(formerly CVS Caremark Corporation)
Condensed Consolidated Statements of Cash Flows
(Unaudited)
 
Nine Months Ended September 30,
In millions
2014
 
2013
Cash flows from operating activities:
 
 
 
Cash receipts from customers
$
95,816

 
$
85,408

Cash paid for inventory and prescriptions dispensed by retail network pharmacies
(77,067
)
 
(67,826
)
Cash paid to other suppliers and employees
(11,267
)
 
(10,760
)
Interest received
11

 
5

Interest paid
(458
)
 
(369
)
Income taxes paid
(2,321
)
 
(2,213
)
Net cash provided by operating activities
4,714

 
4,245

 
 
 
 
Cash flows from investing activities:
 

 
 

Purchases of property and equipment
(1,436
)
 
(1,330
)
Proceeds from sale-leaseback transactions
328

 
156

Proceeds from sale of property and equipment
8

 
13

Acquisitions (net of cash acquired) and other investments
(2,392
)
 
(354
)
Purchase of available-for-sale investments
(161
)
 
(107
)
Sales/maturities of available-for-sale investments
119

 

Net cash used in investing activities
(3,534
)
 
(1,622
)
 
 
 
 
Cash flows from financing activities:
 

 
 

Increase in short-term debt
775

 
124

Proceeds from issuance of long-term debt
1,483

 

Repayments of long-term debt
(3,086
)
 

Dividends paid
(971
)
 
(829
)
Proceeds from exercise of stock options
378

 
431

Excess tax benefits from stock-based compensation
89

 
48

Repurchase of common stock
(2,801
)
 
(2,272
)
Net cash used in financing activities
(4,133
)
 
(2,498
)
Effect of exchange rate changes on cash and cash equivalents
(4
)
 
5

Net increase (decrease) in cash and cash equivalents
(2,957
)
 
130

Cash and cash equivalents at beginning of period
4,089

 
1,375

Cash and cash equivalents at end of period
$
1,132

 
$
1,505

 
 
 
 
Reconciliation of net income to net cash provided by operating activities:
 

 
 

Net income
$
3,323

 
$
3,327

Adjustments to reconcile net income to net cash provided by operating activities:
 

 
 

Depreciation and amortization
1,442

 
1,412

Stock-based compensation
121

 
101

Loss on early extinguishment of debt
521

 

Deferred income taxes and other noncash items
(64
)
 
129

Change in operating assets and liabilities, net of effects from acquisitions:
 

 
 

Accounts receivable, net
(1,872
)
 
(1,518
)
Inventories
(449
)
 
(79
)
Other current assets
(160
)
 
176

Other assets
(19
)
 
(125
)
Accounts payable and claims and discounts payable
1,222

 
697

Accrued expenses
676

 
76

Other long-term liabilities
(27
)
 
49

Net cash provided by operating activities
$
4,714

 
$
4,245

 
See accompanying notes to condensed consolidated financial statements.

6



CVS Health Corporation
(formerly CVS Caremark Corporation)
Notes to Condensed Consolidated Financial Statements
(Unaudited)
 
Note 1 – Accounting Policies
 
Basis of Presentation
 
The accompanying unaudited condensed consolidated financial statements of CVS Health Corporation (formerly CVS Caremark Corporation) (“CVS Health” or the “Company”) have been prepared in accordance with the rules and regulations of the U.S. Securities and Exchange Commission (“SEC”) regarding interim financial reporting. In accordance with such rules and regulations, certain information and accompanying note disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) have been condensed or omitted, although the Company believes the disclosures included herein are adequate to make the information presented not misleading. These condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto, which are included in Exhibit 13 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2013.
 
In the opinion of management, the accompanying unaudited condensed consolidated financial statements include all adjustments consisting only of normal recurring adjustments, necessary for a fair presentation of the results for the interim periods presented. Because of the influence of various factors on the Company’s operations, including business combinations, certain holidays and other seasonal influences, net income for any interim period may not be comparable to the same interim period in previous years or necessarily indicative of income for the full year.
 
Principles of Consolidation
 
The condensed consolidated financial statements include the accounts of the Company and its majority-owned subsidiaries and variable interest entities for which the Company is the primary beneficiary. All material intercompany balances and transactions have been eliminated.

The Company continually evaluates its investments to determine if they represent variable interests in a variable interest entity (“VIE”). If the Company determines that it has a variable interest in a VIE, the Company then evaluates if it is the primary beneficiary of the VIE. The evaluation is a qualitative assessment as to whether the Company has the ability to direct the activities of a VIE that most significantly impact the entity’s economic performance. The Company consolidates a VIE if it is considered to be the primary beneficiary.

Assets and liabilities of VIEs for which the Company is the primary beneficiary were not significant to the Company’s consolidated financial statements. VIE creditors do not have recourse against the general credit of the Company.
 
Fair Value of Financial Instruments
 
The Company utilizes the three-level valuation hierarchy for the recognition and disclosure of fair value measurements. The categorization of assets and liabilities within this hierarchy is based upon the lowest level of input that is significant to the measurement of fair value. The three levels of the hierarchy consist of the following:
 
Level 1 – Inputs to the valuation methodology are unadjusted quoted prices in active markets for identical assets or liabilities that the Company has the ability to access at the measurement date.
 
Level 2 – Inputs to the valuation methodology are quoted prices for similar assets and liabilities in active markets, quoted prices in markets that are not active or inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the instrument.

Level 3 – Inputs to the valuation methodology are unobservable inputs based upon management’s best estimate of inputs market participants could use in pricing the asset or liability at the measurement date, including assumptions about risk.
 

7



As of September 30, 2014, the carrying value of cash and cash equivalents, short-term and long-term investments, accounts receivable and accounts payable approximated their fair value due to the nature of these financial instruments. The Company invests in money market funds, commercial paper and time deposits that are classified as cash and cash equivalents within the accompanying condensed consolidated balance sheets, as these funds are highly liquid and readily convertible to known amounts of cash. These investments are classified within Level 1 of the fair value hierarchy because they are valued using quoted market prices. The Company’s short-term investments consist of certificates of deposit with initial maturities of greater than three months when purchased that mature in less than one year from the balance sheet date. The Company's long-term investments, which are classified as noncurrent other assets within the accompanying condensed consolidated balance sheet, consist of certificates of deposit and money market funds. These investments, which are classified within Level 1 of the fair value hierarchy, are carried at fair value, which approximated historical cost at September 30, 2014. The carrying amount and estimated fair value of the Company’s total long-term debt was $12.3 billion and $13.1 billion, respectively, as of September 30, 2014. The fair value of the Company’s long-term debt was estimated based on quoted prices currently offered in active markets for the Company’s debt, which is considered Level 1 of the fair value hierarchy.

Generic Sourcing Venture

In July 2014, the Company and Cardinal Health, Inc. (“Cardinal”) established Red Oak Sourcing, LLC (“Red Oak”), a generic pharmaceutical sourcing entity in which the Company and Cardinal each own 50%. The Red Oak arrangement has an initial term of ten years. Under this arrangement, the Company and Cardinal contributed their sourcing and supply chain expertise to Red Oak and agreed to source and negotiate generic pharmaceutical supply contracts for both companies through Red Oak; however, Red Oak does not own or hold inventory on behalf of either company. No physical assets (e.g., property and equipment) were contributed to Red Oak by either company and minimal funding was provided to capitalize Red Oak.

Red Oak is a variable interest entity. The Company has determined that it is the primary beneficiary of this variable interest entity because it has the ability to direct the activities of Red Oak. Consequently, the Company consolidates Red Oak in its condensed consolidated financial statements within its Retail Pharmacy Segment. Revenues associated with Red Oak expenses reimbursed by Cardinal for the three months ended September 30, 2014 and amounts due to Cardinal from Red Oak at September 30, 2014 were immaterial.

Cardinal is required to pay the Company 39 quarterly payments of $25.6 million commencing in October 2014 and, if certain milestones are achieved, it will pay additional predetermined quarterly amounts to the Company beginning in the third quarter of 2015. The payments will reduce the Company’s carrying cost of inventory and will be recognized in cost of revenues when the related inventory is sold.

Related Party Transactions

The Company has an equity method investment in SureScripts, LLC ("SureScripts"), which operates a clinical health information network. The Pharmacy Services and Retail Pharmacy segments utilize this clinical health information network in providing services to client plan members and retail customers. The Company expensed fees of approximately $7 million and $12 million in the three months ended September 30, 2014 and 2013, respectively, and $34 million and $35 million in the nine months ended September 30, 2014 and 2013, respectively, for the use of this network.

The Company's investment in and equity in earnings in SureScripts for all periods presented is immaterial.

In September 2014, the Company made a charitable contribution of $25 million to the CVS Foundation (formerly CVS Caremark Charitable Trust, Inc.) (the "Foundation") to fund future giving. The Foundation is a non-profit entity that focuses on health, education and community involvement programs. The charitable contribution was recorded as an operating expense in the condensed consolidated statements of income for the three and nine months ended September 30, 2014.

New Accounting Pronouncement

In May 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standard Update ("ASU") No. 2014-09, Revenue from Contracts with Customers (Topic 606). ASU No. 2014-09 outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. This new guidance is effective for annual reporting periods (including interim reporting periods within those periods) beginning after December 15, 2016; early adoption is not permitted. Companies have the option of using either a full retrospective or a modified retrospective approach to adopt the guidance. This update could impact the

8



timing and amounts of revenue recognized. The Company is currently evaluating the effect that implementation of this update will have on its consolidated financial position and results of operations upon adoption. 

Note 2 – Coram Acquisition

On January 16, 2014, the Company acquired 100 percent of the voting interests of Coram LLC ("Coram"), the specialty infusion services and enteral nutrition business unit of Apria Healthcare Group Inc. ("Apria"), for cash consideration of approximately $2.1 billion, plus contingent consideration of approximately $0.1 billion. The purchase price was also subject to a working capital adjustment, which was finalized in the three months ended September 30, 2014 resulting in the Company receiving $9 million from Apria. Coram is one of the nation's largest providers of comprehensive infusion services, caring for approximately 165,000 patients annually. Coram has approximately 4,600 employees, including approximately 600 nurses and 250 dietitians, operating primarily through 84 branch locations and six centers of excellence for patient intake.

The contingent consideration is based on the Company’s future realization of Coram’s tax net operating loss carryforwards (“NOLs”) as of the date of the acquisition. The Company will pay the seller the first $60 million in tax savings realized from the future utilization of the Coram NOLs, plus 50% of any additional future tax savings from the remaining NOLs. The estimated fair value of the approximately $0.1 billion contingent consideration liability associated with the future realization of the Coram NOLs was estimated by discounting, to present value, the contingent payments expected to be made based on the Company’s estimate of the amount and timing of Coram NOLs that will ultimately be realized. The change in fair value of the contingent consideration liability recognized in earnings for the three and nine months ended September 30, 2014 was immaterial.

The fair value of assets acquired and liabilities assumed were approximately $2.5 billion and $0.3 billion, respectively, which included accounts receivable of approximately $0.2 billion, identifiable finite-lived intangible assets of approximately $0.5 billion and goodwill of approximately $1.6 billion which is nondeductible for income tax purposes. The goodwill represents future economic benefits expected to arise from the Company's expanded presence in the specialty pharmaceuticals market, the assembled workforce acquired, and the expected synergies from combining operations with Coram. The assessment of fair value is preliminary and is based on information that was available to management at the time the condensed consolidated financial statements were prepared. Accordingly, such amounts may change. The most significant open items include the accounting for deferred income taxes including the acquired NOLs and tax credit carryforwards and the accounting for the related contingent consideration liability. The Company has requested additional information from the seller with respect to certain acquired tax attributes and uncertain tax positions and is awaiting the completion of a third party study to quantify the Company's annual NOL usage limitation.

Coram’s results of operations are included in the Company’s Pharmacy Services Segment beginning on January 16, 2014. Pro forma information for this acquisition is not presented as Coram’s results are immaterial to the Company’s condensed consolidated financial statements. During the nine months ended September 30, 2014, acquisition costs of $14 million were expensed as incurred within operating expenses.

Note 3 – Goodwill and Intangible Assets

Goodwill and indefinitely-lived trademarks are not amortized, but are subject to annual impairment reviews, or more frequent reviews if events or circumstances indicate there may be impairment. During the three months ended September 30, 2014, the Company performed its required annual impairment tests and concluded there was no impairment of goodwill or trademarks. Intangible assets with finite useful lives are amortized over their estimated useful life.













9



Below is a summary of the changes in the carrying amount of goodwill by segment for the nine months ended September 30, 2014:
In millions
Pharmacy Services
 
Retail Pharmacy
 
Total
Balance, December 31, 2013
$
19,658

 
$
6,884

 
$
26,542

Acquisitions
1,577

 
38

 
1,615

Foreign currency translation adjustments

 
(5
)
 
(5
)
Other (1)
(1
)
 

 
(1
)
Balance, September 30, 2014
$
21,234

 
$
6,917

 
$
28,151


(1) "Other" represents immaterial purchase accounting adjustments for acquisitions.

The increase in goodwill for the nine months ended September 30, 2014 relates to the Coram acquisition and other immaterial acquisitions.

The following is a summary of the Company's intangible assets as of September 30, 2014 and December 31, 2013:
 
September 30, 2014
 
December 31, 2013
In millions
Gross
Carrying Amount
 
Accumulated Amortization
 
Net Carrying Amount
 
Gross
Carrying Amount
 
Accumulated Amortization
 
Net Carrying Amount
Trademarks (indefinitely-lived)
$
6,398

 
$

 
$
6,398

 
$
6,398

 
$

 
$
6,398

Customer contracts and
  relationships and covenants not
  to compete
6,465

 
(3,434
)
 
3,031

 
5,840

 
(3,083
)
 
2,757

Favorable leases and other
888

 
(463
)
 
425

 
800

 
(426
)
 
374

 
$
13,751

 
$
(3,897
)
 
$
9,854

 
$
13,038

 
$
(3,509
)
 
$
9,529


The amortization expense related to finite-lived intangible assets for the three and nine months ended September 30, 2014 was $126 million and $391 million, respectively. The amortization expense related to finite-lived intangible assets for the three and nine months ended September 30, 2013 was $124 million and $370 million, respectively.

Note 4 – Borrowings

On August 7, 2014, the Company issued $850 million of 2.25% unsecured senior notes due August 12, 2019 and $650 million of 3.375% unsecured senior notes due August 12, 2024 (collectively, the "2014 Notes") for total proceeds of approximately $1.5 billion, net of discounts and underwriting fees. The 2014 Notes pay interest semi-annually and may be redeemed, in whole at any time, or in part from time to time, at the Company's option at a defined redemption price plus accrued and unpaid interest to the redemption date. The net proceeds of the 2014 Notes were used for general corporate purposes and to repay certain corporate debt.

On August 7, 2014, the Company announced tender offers for any and all of the 6.25% Senior Notes due 2027, and up to a maximum amount of the 6.125% Senior Notes due 2039, the 5.75% Senior Notes due 2041 and the 5.75% Senior Notes due 2017, for up to an aggregate principal amount of $1.5 billion. On August 21, 2014, the Company increased the aggregate principal amount of the tender offers to $2.0 billion and completed the repurchase for the maximum amount on September 4, 2014. The Company paid a premium of $490 million in excess of the debt principal in connection with the tender offers, wrote off $26 million of unamortized deferred financing costs and incurred $5 million in fees, for a total loss on early extinguishment of debt of $521 million. The loss on early extinguishment of debt was recorded in income from continuing operations in the condensed consolidated statements of income for the three and nine months ended September 30, 2014.

Note 5 – Share Repurchase Program
 
On December 17, 2013, the Company's Board of Directors authorized a new share repurchase program for up to $6.0 billion of outstanding common stock (the "2013 Repurchase Program"). On September 19, 2012, the Company’s Board of Directors authorized a share repurchase program for up to $6.0 billion of outstanding common stock (the “2012 Repurchase Program”). The share repurchase authorizations, each of which was effective immediately, permitted the Company to effect repurchases

10



from time to time through a combination of open market repurchases, privately negotiated transactions, accelerated share repurchase transactions, and/or other derivative transactions.

During the three months ended September 30, 2014, the Company repurchased an aggregate of approximately 10.2 million shares of common stock for approximately $0.8 billion pursuant to the 2013 Repurchase Program. During the nine months ended September 30, 2014, the Company repurchased an aggregate of approximately 37.2 million shares of common stock for approximately $2.8 billion pursuant to the 2013 and 2012 Repurchase Programs. As of September 30, 2014, approximately $3.9 billion remained available for future repurchases under the 2013 Repurchase Program and the 2012 Repurchase Program was complete. The 2013 Repurchase Program may be modified or terminated by the Board of Directors at any time.

Note 6 – Accumulated Other Comprehensive Income

Accumulated other comprehensive income (loss) consists of foreign currency translation adjustments, unrealized losses on cash flow hedges executed in previous years associated with the issuance of long-term debt, and changes in the net actuarial gains and losses associated with pension and other postretirement benefit plans. The following table summarizes the activity within the components of accumulated other comprehensive income (loss).

Changes in accumulated other comprehensive income (loss) by component are shown below(1):

 
Three Months Ended September 30, 2014
In millions
Foreign Currency
 
Losses on Cash Flow Hedges
 
Pension and Other Postretirement Benefits
 
Total
Balance, June 30, 2014
$
(15
)
 
$
(11
)
 
$
(106
)
 
$
(132
)
     Other comprehensive income before
       reclassifications
(29
)
 

 

 
(29
)
     Amounts reclassified from accumulated
       other comprehensive income (2)

 
1

 

 
1

Other comprehensive income (loss)
(29
)
 
1

 

 
(28
)
Balance, September 30, 2014
$
(44
)
 
$
(10
)
 
$
(106
)
 
$
(160
)
 
 
 
 
 
 
 
 
 
Three Months Ended September 30, 2013
 
Foreign Currency
 
Losses on Cash Flow Hedges
 
Pension and Other Postretirement Benefits
 
Total
Balance, June 30, 2013
$
(18
)
 
$
(15
)
 
$
(165
)
 
$
(198
)
     Other comprehensive income (loss) before
       reclassifications
3

 

 

 
3

     Amounts reclassified from accumulated
       other comprehensive income (2)

 
1

 

 
1

Other comprehensive income
3

 
1

 

 
4

Balance, September 30, 2013
$
(15
)
 
$
(14
)
 
$
(165
)
 
$
(194
)
 
 
 
 
 
 
 
 

11



 
Nine Months Ended September 30, 2014
 
Foreign Currency
 
Losses on Cash Flow Hedges
 
Pension and Other Postretirement Benefits
 
Total
Balance, December 31, 2013
$
(30
)
 
$
(13
)
 
$
(106
)
 
$
(149
)
     Other comprehensive income before
       reclassifications
(14
)
 

 

 
(14
)
     Amounts reclassified from accumulated
       other comprehensive income (2)

 
3

 

 
3

Other comprehensive income (loss)
(14
)
 
3

 

 
(11
)
Balance, September 30, 2014
$
(44
)
 
$
(10
)
 
$
(106
)
 
$
(160
)
 
 
 
 
 
 
 
 
 
Nine Months Ended September 30, 2013
 
Foreign Currency
 
Losses on Cash Flow Hedges
 
Pension and Other Postretirement Benefits
 
Total
Balance, December 31, 2012
$

 
$
(16
)
 
$
(165
)
 
$
(181
)
     Other comprehensive income (loss) before
       reclassifications
(15
)
 

 

 
(15
)
     Amounts reclassified from accumulated
       other comprehensive income (2)

 
2

 

 
2

Other comprehensive income (loss)
(15
)
 
2

 

 
(13
)
Balance, September 30, 2013
$
(15
)
 
$
(14
)
 
$
(165
)
 
$
(194
)

(1) All amounts are net of tax.
(2) The amounts reclassified from accumulated other comprehensive income for losses on cash flow hedges are recorded within interest expense, net on the condensed consolidated statement of income. The amounts reclassified from accumulated other comprehensive income for pension and other postretirement benefits are included in operating expenses on the condensed consolidated statement of income.

Note 7 – Stock-Based Compensation

Compensation expense related to stock options for the three and nine months ended September 30, 2014 totaled $26 million and $76 million, respectively, compared to $25 million and $73 million for the three and nine months ended September 30, 2013, respectively. Compensation expense related to restricted stock awards for the three and nine months ended September 30, 2014 totaled $18 million and $45 million, respectively, compared to $10 million and $28 million for the three and nine months ended September 30, 2013, respectively. The Company had 29 million stock options outstanding as of September 30, 2014 with a weighted average exercise price of $47.16 and a weighted average contractual term of 4.33 years.

Note 8 – Sale-Leaseback Transactions

The Company finances a portion of its store development program through sale-leaseback transactions. The properties are generally sold at net book value, which approximates fair value, and the resulting leases typically qualify and are accounted for as operating leases. The Company does not have any retained or contingent interests in the stores and does not provide any guarantees, other than a guarantee of lease payments, in connection with the sale-leaseback transactions. Proceeds from sale-leaseback transactions totaled $328 million and $156 million for the nine months ended September 30, 2014 and 2013, respectively.


12



Note 9 – Interest Expense
 
The following are the components of net interest expense:
 
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
In millions
2014
 
2013
 
2014
 
2013
Interest expense
$
158

 
$
125

 
$
480

 
$
379

Interest income
(5
)
 
(3
)
 
(11
)
 
(5
)
Interest expense, net
$
153

 
$
122

 
$
469

 
$
374


Note 10 – Earnings Per Share
 
Earnings per share is computed using the two-class method. Options to purchase approximately 4.1 million and 2.8 million shares of common stock were outstanding, but were not included in the calculation of diluted earnings per share for the three and nine months ended September 30, 2014, respectively, because the options’ exercise prices were greater than the average market price of the common shares and, therefore, the effect would be antidilutive. For the same reason, options to purchase approximately 8.2 million and 5.7 million shares of common stock were outstanding, but were not included in the calculation of diluted earnings per share for the three and nine months ended September 30, 2013, respectively.

The following is a reconciliation of basic and diluted earnings per share from continuing operations for the respective periods:
 
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
In millions, except per share amounts
2014
 
2013
 
2014
 
2013
Numerator for earnings per share calculations:
 
 
 
 
 
 
 
Income from continuing operations attributable to common
     stockholders(1)
$
944

 
$
1,255

 
$
3,310

 
$
3,334

 
 
 
 
 
 
 
 
Denominators for earnings per share calculations:
 

 
 

 
 

 
 

Weighted average shares, basic
1,157

 
1,218

 
1,167

 
1,226

Effect of dilutive securities
7

 
8

 
8

 
8

Weighted average shares, diluted
1,164

 
1,226

 
1,175

 
1,234

 
 
 
 
 
 
 
 
Earnings per share from continuing operations:
 

 
 

 
 

 
 

Basic
$
0.82

 
$
1.03

 
$
2.84

 
$
2.72

Diluted
$
0.81

 
$
1.02

 
$
2.82

 
$
2.70


(1)
Comprised of income from continuing operations less amounts allocable to participating securities of $4 million and $13 million for the three and nine months ended September 30, 2014.


13



Note 11 – Segment Reporting
 
The Company has three reportable segments: Pharmacy Services, Retail Pharmacy and Corporate. The Company’s segments maintain separate financial information for which operating results are evaluated on a regular basis by the Company’s chief operating decision maker in deciding how to allocate resources and in assessing performance. The Company evaluates its Pharmacy Services and Retail Pharmacy segments’ performance based on net revenue, gross profit and operating profit before the effect of nonrecurring charges and gains and certain intersegment activities. The Company evaluates the performance of its Corporate Segment based on operating expenses before the effect of nonrecurring charges and gains and certain intersegment activities.
 
The Pharmacy Services Segment provides a full range of pharmacy benefit management (“PBM”) services including mail service dispensing pharmacies, specialty pharmacy and infusion services, plan design and administration, formulary management, discounted drug purchase arrangements, Medicare Part D services, retail pharmacy network management services, prescription management systems, clinical services, disease management services and medical pharmacy management services. The Company’s customers are primarily employers, insurance companies, unions, government employee groups, managed care organizations and other sponsors of health benefit plans and individuals throughout the United States. Through the Company’s SilverScript Insurance Company subsidiary, the Company is a national provider of drug benefits to eligible beneficiaries under the Federal Government’s Medicare Part D program. The Pharmacy Services business operates under the Caremark®, CarePlus CVS/pharmacy®, CVS/caremarkTM, CVS/specialtyTM, RxAmerica®, Accordant®, SilverScript®, Novologix® and Coram® names. As of September 30, 2014, the Pharmacy Services Segment operated 26 retail specialty pharmacy stores, 11 specialty mail order pharmacies, four mail service dispensing pharmacies, and 84 branches and six centers of excellence for infusion and enteral services located in 40 states, Puerto Rico and the District of Columbia.
 
The Retail Pharmacy Segment sells prescription drugs and a wide assortment of general merchandise, including over-the-counter drugs, beauty products and cosmetics, photo finishing, seasonal merchandise, greeting cards and convenience foods through the Company’s CVS/pharmacy®, CVS®, Longs Drugs®, Navarro Discount Pharmacy® and Drogaria Onofre® retail stores and online through CVS.com®, Navarro.com and Onofre.com.br. As of September 30, 2014, the Retail Pharmacy Segment included 7,779 retail drugstores (of which 7,714 operated a pharmacy), 17 onsite pharmacies, 936 retail medical clinics, and the online retail websites, CVS.com, Navarro.com and Onofre.com.br. The retail drugstores are located in 44 states, the District of Columbia, Puerto Rico and Brazil. The retail medical clinics operate under the MinuteClinic® name, and 928 are located within CVS/pharmacy stores. MinuteClinics utilize nationally-recognized medical protocols to diagnose and treat minor health conditions, perform health screenings, monitor chronic conditions and deliver vaccinations. The clinics are staffed by board-certified nurse practitioners and physician assistants who provide access to affordable care without appointment.
 
The Corporate Segment provides management and administrative services to support the Company. The Corporate Segment consists of certain aspects of executive management, corporate relations, legal, compliance, human resources, corporate information technology and finance departments.

14



In millions
Pharmacy
Services
Segment(1)
 
Retail
Pharmacy
Segment
 
Corporate
Segment
 
Intersegment
Eliminations(2)
 
Consolidated
Totals
Three Months Ended
 
 
 
 
 
 
 
 
 
September 30, 2014:
 
 
 
 
 
 
 
 
 
Net revenues
$
22,534

 
$
16,749

 
$

 
$
(4,262
)
 
$
35,021

Gross profit
1,403

 
5,237

 

 
(172
)
 
6,468

Operating profit (loss)
1,087

 
1,527

 
(196
)
 
(172
)
 
2,246

September 30, 2013:
 

 
 

 
 

 
 

 
 

Net revenues
19,483

 
16,248

 

 
(3,799
)
 
31,932

Gross profit
1,294

 
4,876

 

 
(143
)
 
6,027

Operating profit (loss)(3)
1,012

 
1,464

 
(179
)
 
(143
)
 
2,154

Nine Months Ended
 

 
 

 
 

 
 

 
 

September 30, 2014:
 

 
 

 
 

 
 

 
 

Net revenues
64,566

 
50,100

 

 
(12,354
)
 
102,312

Gross profit
3,533

 
15,719

 

 
(518
)
 
18,734

Operating profit (loss)
2,605

 
4,982

 
(591
)
 
(518
)
 
6,478

September 30, 2013:
 

 
 

 
 

 
 

 
 

Net revenues
56,593

 
48,426

 

 
(11,088
)
 
93,931

Gross profit
3,025

 
14,828

 

 
(409
)
 
17,444

Operating profit (loss)(3)
2,186

 
4,596

 
(553
)
 
(409
)
 
5,820

Total assets:
 

 
 

 
 

 
 

 
 

September 30, 2014
42,527

 
31,197

 
1,344

 
(1,492
)
 
73,576

December 31, 2013
38,343

 
30,191

 
4,420

 
(1,428
)
 
71,526

Goodwill:
 

 
 

 
 

 
 

 
 

September 30, 2014
21,234

 
6,917

 

 

 
28,151

December 31, 2013
19,658

 
6,884

 

 

 
26,542


(1)          Net revenues of the Pharmacy Services Segment include approximately $1.9 billion of retail co-payments for both the three months ended September 30, 2014 and 2013, as well as $6.1 billion of retail co-payments for both the nine months ended September 30, 2014 and 2013.
(2)        Intersegment eliminations relate to two types of transactions: (i) Intersegment revenues that occur when Pharmacy Services Segment customers use Retail Pharmacy Segment stores to purchase covered products. When this occurs, both the Pharmacy Services and Retail Pharmacy segments record the revenue on a stand-alone basis, and (ii) Intersegment revenues, gross profit and operating profit that occur when Pharmacy Services Segment customers, through the Company’s intersegment activities (such as the Maintenance Choice® program), elect to pick-up their maintenance prescriptions at Retail Pharmacy Segment stores instead of receiving them through the mail. When this occurs, both the Pharmacy Services and Retail Pharmacy segments record the revenue, gross profit and operating profit on a standalone basis. The following amounts are eliminated in consolidation in connection with the intersegment activity described in item (ii) above: net revenues of $1.2 billion and $1.1 billion for the three months ended September 30, 2014 and 2013, respectively, and $3.6 billion and $3.1 billion for the nine months ended September 30, 2014 and 2013, respectively; and gross profit and operating profit of $172 million and $143 million for the three months ended September 30, 2014 and 2013, respectively, and $518 million and $409 million for the nine months ended September 30, 2014 and 2013, respectively.
(3)
Consolidated operating profit for the three and nine months ended September 30, 2013 includes a $72 million gain on a legal settlement, of which, $11 million is included in the Pharmacy Services Segment and $61 million is included in the Retail Pharmacy Segment.
 
Note 12 – Commitments and Contingencies
 
Lease Guarantees
 
Between 1991 and 1997, the Company sold or spun off a number of subsidiaries, including Bob’s Stores, Linens ‘n Things and Marshalls. In many cases, when a former subsidiary leased a store, the Company provided a guarantee of the store’s lease obligations. When the subsidiaries were disposed of, the Company’s guarantees remained in place, although each initial purchaser has indemnified the Company for any lease obligations the Company was required to satisfy. If any of the purchasers or any of the former subsidiaries were to become insolvent and failed to make the required payments under a store lease, the Company could be required to satisfy these obligations.


15



As of September 30, 2014, the Company guaranteed approximately 72 such store leases (excluding the lease guarantees related to Linens ‘n Things, which have been recorded as a liability on the condensed consolidated balance sheet), with the maximum remaining lease term extending through 2026. Management believes the ultimate disposition of any of the remaining guarantees will not have a material adverse effect on the Company’s consolidated financial condition, results of operations or future cash flows.

Legal Matters
 
The Company is a party to legal proceedings, investigations and claims in the ordinary course of its business, including the matters described below. The Company records accruals for outstanding legal matters when it believes it is probable that a loss will be incurred and the amount can be reasonably estimated. The Company evaluates, on a quarterly basis, developments in legal matters that could affect the amount of any accrual and developments that would make a loss contingency both probable and reasonably estimable. If a loss contingency is not both probable and estimable, the Company does not establish an accrued liability. None of the Company’s accruals for outstanding legal matters are material individually or in the aggregate to the Company’s financial position.
 
The Company’s contingencies are subject to significant uncertainties, including, among other factors: (i) the procedural status of pending matters; (ii) whether class action status is sought and certified; (iii) whether asserted claims or allegations will survive dispositive motion practice; (iv) the extent of potential damages, fines or penalties, which are often unspecified or indeterminate; (v) the impact of discovery on the legal process; (vi) whether novel or unsettled legal theories are at issue; (vii) the settlement posture of the parties, and/or (viii) in the case of certain government agency investigations, whether a sealed qui tam lawsuit (“whistleblower” action) has been filed and whether the government agency makes a decision to intervene in the lawsuit following investigation.
 
Except as otherwise noted, the Company cannot predict with certainty the timing or outcome of the legal matters described below, and is unable to reasonably estimate a possible loss or range of possible loss in excess of amounts already accrued for these matters.
 
In December 2007, the Company received a document subpoena from the Office of Inspector General (“OIG”) within the U.S. Department of Health and Human Services (“HHS”), requesting information relating to the processing of Medicaid and certain other government agency claims on behalf of its clients (which allegedly resulted in underpayments from our pharmacy benefit management clients to the applicable government agencies) on one of the Company's adjudication platforms. In September 2014, the Company settled the underlying lawsuit with the United States Department of Justice (“DOJ”), the OIG and the private plaintiff without any admission of liability and is in discussions with the OIG concerning other claim processing issues.

Caremark (the term “Caremark” being used herein to generally refer to any one or more pharmacy benefit management subsidiaries of the Company, as applicable) was named in a putative class action lawsuit filed in October 2003 in Alabama state court by John Lauriello, purportedly on behalf of participants in the 1999 settlement of various securities class action and derivative lawsuits against Caremark and others. Other defendants include insurance companies that provided coverage to Caremark with respect to the settled lawsuits. The Lauriello lawsuit seeks approximately $3.2 billion in compensatory damages plus other non-specified damages based on allegations that the amount of insurance coverage available for the settled lawsuits was misrepresented and suppressed. A similar lawsuit was filed in November 2003 by Frank McArthur, also in Alabama state court, naming as defendants Caremark, several insurance companies, attorneys and law firms involved in the 1999 settlement. This lawsuit was stayed as a later-filed class action, but McArthur was subsequently allowed to intervene in the Lauriello action. Following the close of class discovery, the trial court entered an Order on August 15, 2012 that granted the plaintiffs’ motion to certify a class pursuant to Alabama Rules of Civil Procedure 23(b)(3) but denied their request that the class also be certified pursuant to Rule 23(b)(1). In addition, the August 15, 2012 Order appointed class representatives and class counsel. On September 12, 2014, the Alabama Supreme Court affirmed the trial court's August 15, 2012 Order. The Defendants timely filed an Application for Rehearing with the Alabama Supreme Court seeking to clarify or modify its September 12, 2014 decision. The proceedings in the trial court remain stayed pending resolution of the rehearing application.

Various lawsuits have been filed alleging that Caremark has violated applicable antitrust laws in establishing and maintaining retail pharmacy networks for client health plans. In August 2003, Bellevue Drug Co., Robert Schreiber, Inc. d/b/a Burns Pharmacy and Rehn-Huerbinger Drug Co. d/b/a Parkway Drugs #4, together with Pharmacy Freedom Fund and the National Community Pharmacists Association filed a putative class action against Caremark in Pennsylvania federal court, seeking treble damages and injunctive relief. This case was initially sent to

16



arbitration based on the contract terms between the pharmacies and Caremark. In October 2003, two independent pharmacies, North Jackson Pharmacy, Inc. and C&C, Inc. d/b/a Big C Discount Drugs, Inc., filed a putative class action complaint in Alabama federal court against Caremark and two PBM competitors, seeking treble damages and injunctive relief. The North Jackson Pharmacy case against two of the Caremark entities named as defendants was transferred to Illinois federal court, and the case against a separate Caremark entity was sent to arbitration based on contract terms between the pharmacies and Caremark. The Bellevue arbitration was then stayed by the parties pending developments in the North Jackson Pharmacy court case.

In August 2006, the Bellevue case and the North Jackson Pharmacy case were both transferred to Pennsylvania federal court by the Judicial Panel on Multidistrict Litigation for coordinated and consolidated proceedings with other cases before the panel, including cases against other PBMs. Caremark appealed the decision which vacated an order compelling arbitration and staying the proceedings in the Bellevue case and, following the appeal, the Court of Appeals reinstated the order compelling arbitration of the Bellevue case. Following remand, plaintiffs in the Bellevue case sought dismissal of their complaint to permit an immediate appeal of the reinstated order compelling arbitration and pursued an appeal to the Third Circuit Court of Appeals. In November 2012, the Third Circuit Court reversed the district court ruling and directed the parties to proceed in federal court. Motions for class certification in the coordinated cases within the multidistrict litigation, including the North Jackson Pharmacy case, remain pending, and the court has permitted certain additional class discovery and briefing. The consolidated action is now known as the In Re Pharmacy Benefit Managers Antitrust Litigation.

In November 2009, a securities class action lawsuit was filed in the United States District Court for the District of Rhode Island purportedly on behalf of purchasers of the Company's stock between May 5, 2009 and November 4, 2009. Plaintiffs subsequently amended the lawsuit to allege a class period beginning October 30, 2008. The lawsuit names the Company and certain officers as defendants and includes allegations of securities fraud relating to public disclosures made by the Company concerning the PBM business and allegations of insider trading. In addition, a shareholder derivative lawsuit was filed in December 2009 in the same court against the directors and certain officers of the Company. This lawsuit, which was stayed pending developments in the related securities class action, includes allegations of, among other things, securities fraud, insider trading and breach of fiduciary duties and further alleges that the Company was damaged by the purchase of stock at allegedly inflated prices under its share repurchase program. In January 2011, both lawsuits were transferred to the United States District Court for the District of New Hampshire. In June 2012, the court granted the Company’s motion to dismiss the securities class action. The plaintiffs subsequently appealed the court’s ruling on the motion to dismiss. In May 2013, the First Circuit Court of Appeals vacated the prior ruling and remanded the case to the district court for further proceedings. In December 2013, the district court denied the Company’s renewed motion to dismiss the lawsuit. The derivative lawsuit is presently stayed pending further developments in the class action.

In March 2010, the Company learned that various State Attorneys General offices and certain other government agencies were conducting a multi-state investigation of certain of the Company’s business practices similar to those being investigated at that time by the U.S. Federal Trade Commission (“FTC”). Twenty-eight states, the District of Columbia and the County of Los Angeles are known to be participating in this investigation. The prior FTC investigation, which commenced in August 2009, was officially concluded in May 2012 when the consent order entered into between the FTC and the Company became final. The Company has cooperated in the multi-state investigation.

In March 2010, the Company received a subpoena from the OIG requesting information about programs under which the Company has offered customers remuneration conditioned upon the transfer of prescriptions for drugs or medications to the Company’s pharmacies in the form of gift cards, cash, non-prescription merchandise or discounts or coupons for non-prescription merchandise. The subpoena relates to an investigation of possible false or otherwise improper claims for payment under the Medicare and Medicaid programs. The Company has provided documents and other information in response to this request for information.

In January 2012, the United States District Court for the Eastern District of Pennsylvania unsealed a first amended qui tam complaint filed in August 2011 by an individual relator, who is described in the complaint as having once been employed by a firm providing pharmacy prescription benefit audit and recovery services. The complaint seeks monetary damages and alleges that Caremark's processing of Medicare claims on behalf of one of its clients violated the federal false claims act. The United States, acting through the U.S. Attorney's Office in Philadelphia, Pennsylvania, declined to intervene in the lawsuit. Caremark filed a motion to dismiss the amended complaint and the DOJ filed a

17



Statement of Interest with regard to Caremark's motion to dismiss. In December 2012, the court denied Caremark's motion to dismiss the amended complaint. Discovery is proceeding in the matter.

In January 2012, the Company received a subpoena from the OIG requesting information about its Health Savings Pass program, a prescription drug discount program for uninsured or underinsured individuals, in connection with an investigation of possible false or otherwise improper claims for payment involving HHS programs. In February 2012, the Company also received a civil investigative demand from the Office of the Attorney General of the State of Texas requesting a copy of information produced under this OIG subpoena and other information related to prescription drug claims submitted by the Company's pharmacies to Texas Medicaid for reimbursement. In May 2014, the Company received a second set of civil investigative demands from the Attorney General of the State of Texas, requesting that the Company produce further information related to prescription drug claims submitted by the Company's pharmacies to Texas Medicaid for reimbursement. The Company is providing documents and other information in response to these requests for information.

A purported shareholder derivative action was filed on behalf of nominal defendant CVS Health Corporation against certain of the Company’s officers and members of its Board of Directors. The action, which alleged a single claim for breach of fiduciary duty relating to the Company's alleged failure to properly implement internal regulatory controls to comply with the Controlled Substances Act and the Combat Methamphetamine Epidemic Act, was originally filed in June 2012. In addition, an amended complaint was filed in November 2012 and a Supplemental Complaint was filed in April 2013. In October 2013, the court granted the Company's motion to dismiss and entered judgment dismissing the action, without prejudice. Following dismissal of the action, the same purported shareholder sent a letter to the Company's Board of Directors demanding that the Board investigate her allegations and pursue legal action against certain directors and officers of the Company. After conducting a thorough review, an independent committee of the Board of Directors rejected the demand.

On October 12, 2012, the Drug Enforcement Agency (“DEA”) Administrator published its Final Decision and Order revoking the DEA license registrations for dispensing controlled substances at two of the Company's retail pharmacy stores in Sanford, Florida. The license revocations for the two stores formally became effective on November 13, 2012. The pharmacies had voluntarily suspended dispensing controlled substances since April 2012, and have continued operating in that manner in compliance with the DEA Order. The Company has entered into discussions with the U.S. Attorney’s Office for the Middle District of Florida concerning civil penalties for violations of the Controlled Substances Act arising from the circumstances underlying the action taken against the two Sanford, Florida stores. The Company is also undergoing audits by the DEA and is in discussions with the DEA and the U.S. Attorney’s Office in several locations. Whether agreements can be reached and on what terms is uncertain.

In November 2012, the Company received a subpoena from the OIG requesting information concerning automatic refill programs used by pharmacies to refill prescriptions for customers. The Company has been cooperating and providing documents and other information in response to this request for information.

In March 2014, the Company received a subpoena from the United States Attorney’s Office for the District of Rhode Island, requesting documents and information concerning bona fide service fees and rebates received from certain pharmaceutical manufacturers in connection with certain drugs utilized under Part D of the Medicare Program. The Company has been cooperating with the government and producing documents in response to the subpoena.

The Company is also a party to other legal proceedings, government investigations, inquiries and audits arising in the normal course of its business, none of which is expected to be material to the Company. The Company can give no assurance, however, that its business, financial condition and results of operations will not be materially adversely affected, or that the Company will not be required to materially change its business practices, based on: (i) future enactment of new health care or other laws or regulations; (ii) the interpretation or application of existing laws or regulations as they may relate to the Company's business, the pharmacy services, retail pharmacy or retail clinic industries or to the health care industry generally; (iii) pending or future federal or state governmental investigations of the Company’s business or the pharmacy services, retail pharmacy or retail clinic industry or of the health care industry generally; (iv) pending or future government enforcement actions against the Company; (v) adverse developments in any pending qui tam lawsuit against the Company, whether sealed or unsealed, or in any future qui tam lawsuit that may be filed against the Company; or (vi) adverse developments in pending or future legal proceedings against the Company or affecting the pharmacy services, retail pharmacy or retail clinic industry or the health care industry generally.

18



Report of Independent Registered Public Accounting Firm
 
The Board of Directors and Shareholders
CVS Health Corporation
 
We have reviewed the condensed consolidated balance sheet of CVS Health Corporation (the Company) as of September 30, 2014, and the related condensed consolidated statements of income and comprehensive income for the three-month and nine-month periods ended September 30, 2014 and 2013, and the condensed consolidated statements of cash flows for the nine-month periods ended September 30, 2014 and 2013. These financial statements are the responsibility of the Company's management.

We conducted our review in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board (United States), 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 condensed consolidated financial statements referred to above for them to be in conformity with U.S. generally accepted accounting principles.

We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of CVS Health Corporation as of December 31, 2013, and the related consolidated statements of income, comprehensive income, shareholders' equity, and cash flows for the year then ended not presented herein and we expressed an unqualified audit opinion on those consolidated financial statements and included an explanatory paragraph for the Company's election to change its methods of accounting for prescription drug inventories in the Retail Pharmacy Segment effective January 1, 2012 in our report dated February 10, 2014. In our opinion, the accompanying condensed consolidated balance sheet of CVS Health Corporation as of December 31, 2013, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.
 
 
 
/s/ Ernst & Young LLP
 
 
November 4, 2014
 
Boston, Massachusetts
 


19



Part I
 
Item 2
 
Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
Overview of Our Business
 
CVS Health Corporation (formerly CVS Caremark Corporation), together with its subsidiaries (collectively referred to in this document as “CVS Health,” the “Company,” “we,” "our" or “us”), is a pharmacy innovation company with integrated offerings across the entire spectrum of pharmacy care. We are uniquely positioned to deliver significant benefits to health plan sponsors through effective cost management solutions and innovative programs that engage plan members and promote healthier and more cost-effective behaviors. Our integrated pharmacy services model enhances our ability to offer plan members and consumers expanded choice, greater access and more personalized services to help them on their path to better health. We effectively manage pharmaceutical costs and improve health care outcomes through our wide array of pharmacy care services, including our pharmacy benefit management ("PBM"), mail service pharmacies and SilverScript Insurance Company ("SilverScript"), CVS/caremarkTM; our specialty benefit management and specialty pharmacies, CVS/specialtyTM; our online retail pharmacies (CVS.com®, Navarro.com and Onofre.com.br) and our more than 7,700 retail stores (including Longs Drugs®, Drogaria Onofre® and Navarro Discount Pharmacy® ), CVS/pharmacy®; and our retail medical clinics, CVS/minuteclinicTM 
 
We currently have three reportable segments: Pharmacy Services, Retail Pharmacy and Corporate.
 
Pharmacy Services Segment
 
Our Pharmacy Services Segment provides a full range of PBM services, including mail service dispensing pharmacy, specialty pharmacy and infusion services, plan design and administration, formulary management, discounted drug purchase arrangements, Medicare Part D services, retail pharmacy network management services, prescription management systems, clinical services, disease management services and medical pharmacy management services. Our clients are primarily employers, insurance companies, unions, government employee groups, managed care organizations and other sponsors of health benefit plans and individuals throughout the United States. As a pharmacy benefits manager, we manage the dispensing of pharmaceuticals through our mail service dispensing pharmacies and national network of more than 68,000 retail pharmacies, consisting of over 41,000 chain pharmacies (which includes our CVS/pharmacy stores) and approximately 27,000 independent pharmacies, to eligible members in the benefit plans maintained by our clients and utilize our information systems to perform, among other things, safety checks, drug interaction screenings and brand to generic substitutions.
 
Our specialty pharmacies support individuals that require complex and expensive drug therapies. Our specialty pharmacy business includes mail order and retail specialty pharmacies that operate under the CVS Caremark®, CarePlus CVS/pharmacy® and CVS/specialtyTM names. The Pharmacy Services Segment also provides health management programs, which include integrated condition management program for 17 rare conditions, through our Accordant® rare disease management offering. In addition, through our SilverScript Insurance Company subsidiary, we are a national provider of drug benefits to eligible beneficiaries under the Federal Government’s Medicare Part D program. The Pharmacy Services Segment operates under the Caremark®, CarePlus CVS/pharmacy®, CVS/caremarkTM, CVS/specialtyTM, Navarro Specialty Services®, Navarro Health Services®, RxAmerica®, Accordant®, SilverScript®, Novologix® and Coram® names. As of September 30, 2014, the Pharmacy Services Segment operated 26 retail specialty pharmacy stores, 11 specialty mail order pharmacies, four mail service dispensing pharmacies, and 84 branches and six centers of excellence for infusion and enteral services located in 40 states, Puerto Rico and the District of Columbia.
 
Retail Pharmacy Segment
 
Our Retail Pharmacy Segment sells prescription drugs and a wide assortment of general merchandise, including over-the-counter drugs, beauty products and cosmetics, photo finishing, seasonal merchandise, greeting cards and convenience foods through our CVS/pharmacy, CVS®, Longs Drugs, Navarro and Drogaria Onofre retail stores and online through CVS.com, Navarro.com and Onofre.com.br. Our Retail Pharmacy Segment derives the majority of its revenues through the sale of prescription drugs, which are dispensed by our more than 24,000 retail pharmacists. Our Retail Pharmacy Segment also provides health care services through our CVS/minuteclinic medical clinics. CVS/minuteclinics are staffed by nurse practitioners and physician assistants who utilize nationally recognized protocols to diagnose and treat minor health conditions, perform health screenings, monitor chronic conditions, and deliver vaccinations. As of September 30, 2014, our Retail Pharmacy Segment included 7,779 retail drugstores (of which 7,714 operated a pharmacy) located in 44 states, the District of Columbia, Puerto Rico and Brazil operating primarily under the CVS/pharmacy®, CVS®, Longs Drugs®, Navarro Discount Pharmacy® or Drogaria Onofre® names, 17 onsite pharmacies, 936 retail health care clinics operating under the

20



MinuteClinic® name (of which 928 were located in CVS/pharmacy stores), and our online retail websites, CVS.com, Navarro.com and Onofre.com.br.

Corporate Segment
 
The Corporate Segment provides management and administrative services to support the Company. The Corporate Segment consists of certain aspects of our executive management, corporate relations, legal, compliance, human resources, corporate information technology and finance departments.

Generic Sourcing Venture

In July 2014, the Company and Cardinal Health, Inc. (“Cardinal”) established Red Oak Sourcing, LLC (“Red Oak”), a generic pharmaceutical sourcing entity in which the Company and Cardinal each own 50%. The Red Oak arrangement has an initial term of ten years. Under this arrangement, the Company and Cardinal contributed their sourcing and supply chain expertise to Red Oak and agreed to source and negotiate generic pharmaceutical supply contracts for both companies through Red Oak; however, Red Oak does not own or hold inventory on behalf of either company. No physical assets (e.g., property and equipment) were contributed to Red Oak by either company and minimal funding was provided to capitalize Red Oak.

Red Oak is a variable interest entity. The Company has determined that it is the primary beneficiary of this variable interest entity because it has the ability to direct the activities of Red Oak. Consequently, the Company consolidates Red Oak in its condensed consolidated financial statements within its Retail Pharmacy Segment. Revenues associated with Red Oak expenses reimbursed by Cardinal for the three months ended September 30, 2014 and amounts due to Cardinal from Red Oak at September 30, 2014 were immaterial.

Cardinal is required to pay the Company 39 quarterly payments of $25.6 million commencing in October 2014 and, if certain milestones are achieved, it will pay additional predetermined quarterly amounts to the Company beginning in the third quarter of 2015. The payments will reduce the Company’s carrying cost of inventory and will be recognized in cost of revenues when the related inventory is sold.

Results of Operations
 
The following discussion explains the material changes in our results of operations for the three and nine months ended September 30, 2014 and 2013, and the significant developments affecting our financial condition since December 31, 2013. We strongly recommend that you read our audited consolidated financial statements and notes thereto and Management’s Discussion and Analysis of Financial Condition and Results of Operations included as Exhibit 13 to our Annual Report on Form 10-K for the year ended December 31, 2013 (the “2013 Form 10-K”) along with this report.


21



Summary of the Condensed Consolidated Financial Results:
 
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
In millions
2014
 
2013
 
2014
 
2013
 
 
 
 
 
 
 
 
Net revenues
$
35,021

 
$
31,932

 
$
102,312

 
$
93,931

Cost of revenues
28,553

 
25,905

 
83,578

 
76,487

Gross profit
6,468

 
6,027

 
18,734

 
17,444

Operating expenses
4,222

 
3,873

 
12,256

 
11,624

Operating profit
2,246

 
2,154

 
6,478

 
5,820

Interest expense, net
153

 
122

 
469

 
374

Loss on early extinguishment of debt
521

 

 
521

 

Income before income tax provision
1,572

 
2,032

 
5,488

 
5,446

Income tax provision
624

 
777

 
2,165

 
2,112

Income from continuing operations
948

 
1,255

 
3,323

 
3,334

Loss from discontinued operations, net of tax

 
(6
)
 

 
(7
)
Net income
$
948

 
$
1,249

 
$
3,323

 
$
3,327

 
Net Revenues
 
Net revenues increased approximately $3.1 billion, or 9.7%, and $8.4 billion, or 8.9%, in the three and nine months ended September 30, 2014, respectively, as compared to the prior year. The increase in the Pharmacy Services Segment was primarily driven by growth in specialty pharmacy, including the acquisition of Coram and the impact of Specialty Connect®, and increased volume in pharmacy network claims. The increase in the Retail Pharmacy Segment was primarily due to an increase in pharmacy same store sales and revenue from new stores. Net revenues in both periods were negatively impacted by increased generic dispensing rates for both the Pharmacy Services and Retail Pharmacy segments. However, the impact in the three and nine months ended September 30, 2014 was lower than in the prior year due to a slow down in significant generic drug introductions. Generic prescription drugs typically have a lower selling price than brand name prescription drugs.
 
Please see the section entitled “Segment Analysis” below for additional information regarding net revenues.
 
Gross Profit
 
Gross profit dollars increased $441 million and $1.3 billion in the three and nine months ended September 30, 2014, respectively, as compared to the prior year. Gross profit as a percentage of net revenues decreased approximately 40 basis points and 30 basis points to 18.5% and 18.3% in the three and nine months ended September 30, 2014, respectively, as compared to the prior year. The decrease was primarily due to lower Pharmacy Services Segment margins and a change in the mix of business, as the lower margin Pharmacy Services Segment grew faster than the Retail Pharmacy Segment. Gross profit dollars for both the three and nine months ended September 30, 2014, were positively impacted by an increase in generic dispensing rates compared to the prior year. In addition, during the nine months ended September 30, 2014, gross profit was positively impacted by $69 million from the State of California's final decision to exclude certain drugs from previously proposed retroactive reimbursement rate adjustments for the state administered Medicaid program. Of the $69 million, $53 million was attributed to the Retail Pharmacy Segment and $16 million was attributed to the Pharmacy Services Segment. The reimbursement rate adjustment was recorded as an increase in net revenues in the condensed consolidated statements of income for the nine months ended September 30, 2014.
 
Please see the section entitled “Segment Analysis” below for additional information regarding gross profit.

Operating Expenses
 
Operating expenses increased $349 million, or 9.0%, and $632 million, or 5.4%, in the three and nine months ended September 30, 2014, respectively, as compared to the prior year. Operating expenses as a percentage of net revenues remained flat at 12.1% for the three months ended September 30, 2014 and decreased approximately 40 basis points to 12.0% in the nine months ended September 30, 2014, as compared to 12.1% and 12.4% in the prior year, respectively. Operating expenses as a percentage of net revenues decreased for the nine months ended September 30, 2014 due to expense leverage from sales growth

22



in both operating segments. The increase in operating expense dollars in the three months ended September 30, 2014, was primarily due to incremental store operating costs associated with operating more stores in our Retail Pharmacy Segment and increased costs associated with infusion services in our Pharmacy Services Segment due to the acquisition of Coram. The increase in operating expense dollars in the nine months ended September 30, 2014, was primarily due to incremental weather-related costs and store operating costs associated with operating more stores in our Retail Pharmacy Segment and increased costs associated with infusion services in our Pharmacy Services Segment due to the acquisition of Coram.

Operating expenses for the three and nine months ended September 30, 2013 included a legal settlement with a drug manufacturer of $72 million, of which approximately $61 million was attributed to the Retail Pharmacy Segment and approximately $11 million was attributed to the Pharmacy Services Segment. The gain on the legal settlement was recorded as a reduction of operating expenses in the condensed consolidated statements of income for the three and nine months ended September 30, 2013.
 
Please see the section entitled “Segment Analysis” below for additional information regarding operating expenses.
 
Interest Expense, net
 
Interest expense, net, increased $31 million and $95 million in the three and nine months ended September 30, 2014, as compared to the prior year. This increase is primarily due to the increase in long-term debt outstanding as a result of the $4 billion debt issuance that occurred in December 2013 and the $1.5 billion debt issuance that occurred in August 2014.
 
For additional information on our financing activities, please see the “Liquidity and Capital Resources” section later in Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Loss on Early Extinguishment of Debt

During the three months ended September 30, 2014, the Company completed a $2.0 billion tender offer and repurchase of certain Senior Notes (see Note 4 to the condensed consolidated financial statements). The Company paid a premium of $490 million in excess of the debt principal in connection with the repurchase of the Senior Notes, wrote off $26 million of unamortized deferred financing costs and incurred $5 million in fees, for a total loss on the early extinguishment of debt of $521 million.
 
Income Tax Provision
 
Our effective income tax rate was 39.7% and 39.4% for the three and nine months ended September 30, 2014, respectively, compared to 38.2% and 38.8% for the three and nine months ended September 30, 2013. The difference in the effective income tax rate for the three and nine months ended September 30, 2014, was primarily due to certain permanent items.
 

23



Segment Analysis
 
We evaluate the performance of our Pharmacy Services and Retail Pharmacy segments based on net revenue, gross profit and operating profit before the effect of nonrecurring charges and gains and certain intersegment activities. We evaluate the performance of our Corporate Segment based on operating expenses before the effect of nonrecurring charges and gains and certain intersegment activities. The following is a reconciliation of our segments to the condensed consolidated financial statements:
In millions
Pharmacy
Services
Segment(1)
 
Retail
Pharmacy
Segment
 
Corporate
Segment
 
Intersegment
Eliminations (2)
 
Consolidated
Totals
Three Months Ended
 
 
 
 
 
 
 
 
 
September 30, 2014:
 
 
 
 
 
 
 
 
 
Net revenues
$
22,534

 
$
16,749

 
$

 
$
(4,262
)
 
$
35,021

Gross profit
1,403

 
5,237

 

 
(172
)
 
6,468

Operating profit (loss)
1,087

 
1,527

 
(196
)
 
(172
)
 
2,246

September 30, 2013:
 

 
 

 
 

 
 

 
 

Net revenues
19,483

 
16,248

 

 
(3,799
)
 
31,932

Gross profit
1,294

 
4,876

 

 
(143
)
 
6,027

Operating profit (loss)(3)
1,012

 
1,464

 
(179
)
 
(143
)
 
2,154

Nine Months Ended
 

 
 

 
 

 
 

 
 

September 30, 2014:
 

 
 

 
 

 
 

 
 

Net revenues
64,566

 
50,100

 

 
(12,354
)
 
102,312

Gross profit
3,533

 
15,719

 

 
(518
)
 
18,734

Operating profit (loss)
2,605

 
4,982

 
(591
)
 
(518
)
 
6,478

September 30, 2013:
 

 
 

 
 

 
 

 
 

Net revenues
56,593

 
48,426

 

 
(11,088
)
 
93,931

Gross profit
3,025

 
14,828

 

 
(409
)
 
17,444

Operating profit (loss)(3)
2,186

 
4,596

 
(553
)
 
(409
)
 
5,820

 
(1) 
Net revenues of the Pharmacy Services Segment include approximately $1.9 billion of retail co-payments for both the three months ended September 30, 2014 and 2013, as well as $6.1 billion of retail co-payments for both the nine months ended September 30, 2014 and 2013.
(2)
Intersegment eliminations relate to two types of transaction: (i) Intersegment revenues that occur when Pharmacy Services Segment customers use Retail Pharmacy Segment stores to purchase covered products. When this occurs, both the Pharmacy Services and Retail Pharmacy segments record the revenue on a stand-alone basis, and (ii) Intersegment revenues, gross profit and operating profit that occur when Pharmacy Services Segment customers, through the Company's intersegment activities (such as the Maintenance Choice® program), elect to pick-up their maintenance prescriptions at Retail Pharmacy Segment stores instead of receiving them through the mail. When this occurs, both the Pharmacy Services and Retail Pharmacy segments record the revenue, gross profit and operating profit on a standalone basis. The following amounts are eliminated in consolidation in connection with the intersegment activity described in item (ii) above: net revenues of $1.2 billion and $1.1 billion for the three months ended September 30, 2014 and 2013, respectively, and $3.6 billion and $3.1 billion for the nine months ended September 30, 2014 and 2013, respectively; and gross profit and operating profit of $172 million and $143 million for the three months ended September 30, 2014 and 2013, respectively, and $518 million and $409 million for the nine months ended September 30, 2014 and 2013, respectively.
 (3)
Consolidated operating profit for the three and nine months ended September 30, 2013 includes a $72 million gain on a legal settlement, of which, $11 million is included in the Pharmacy Services Segment and $61 million is included in the Retail Pharmacy Segment.


24



Pharmacy Services Segment
 
The following table summarizes our Pharmacy Services Segment’s performance for the respective periods:
 
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
In millions
2014
 
2013
 
2014
 
2013
 
 
 
 
 
 
 
 
Net revenues
$
22,534

 
$
19,483

 
$
64,566

 
$
56,593

Gross profit
1,403

 
1,294

 
3,533

 
3,025

Gross profit % of net revenues
6.2
%
 
6.6
%
 
5.5
%
 
5.4
%
Operating expenses(5)
316

 
282

 
928

 
839

Operating expense % of net revenues
1.4
%
 
1.4
%
 
1.4
%
 
1.5
%
Operating profit
1,087

 
1,012

 
2,605

 
2,186

Operating profit % of net revenues
4.8
%
 
5.2
%
 
4.0
%
 
3.9
%
Net revenues(1)(4):
 

 
 

 
 

 
 

Mail choice(2)
$
8,054

 
$
6,369

 
$
22,641

 
$
18,274

Pharmacy network(3)
14,420

 
13,063

 
41,748

 
38,163

Other
60

 
51

 
177

 
156

Pharmacy claims processed(1):
 

 
 

 


 
 

Total
230.3

 
221.9

 
689.1

 
676.2

Mail choice(2)
20.7

 
21.0

 
61.1

 
62.3

Pharmacy network(3)
209.6

 
200.9

 
628.0

 
613.9

Generic dispensing rate(1):
 
 
 

 
 

 
 

Total
82.5
%
 
80.7
%
 
82.3
%
 
80.4
%
Mail choice(2)
75.0
%
 
72.8
%
 
74.5
%
 
72.4
%
Pharmacy network(3)
83.2
%
 
81.5
%
 
83.1
%
 
81.2
%
Mail choice penetration rate
21.7
%
 
23.0
%
 
21.5
%
 
22.5
%
 
(1)          Pharmacy network net revenues, claims processed and generic dispensing rates do not include Maintenance Choice, which are included within the mail choice category.
(2)          Mail choice is defined as claims filled at a Pharmacy Services mail facility, which includes specialty claims, as well as 90-day claims filled at retail pharmacies under the Maintenance Choice program. The mail choice generic dispensing rate is lower than the pharmacy network generic dispensing rate as there are fewer generic substitutions available for maintenance medications (e.g. therapies for chronic conditions) dispensed from mail service pharmacies.
(3)          Pharmacy network is defined as claims filled at retail pharmacies, including our retail drugstores, but excluding Maintenance Choice activity.
(4)
In May 2014, the Company implemented Specialty Connect, which integrates the Company's mail and retail capabilities, providing members with the choice to bring their specialty prescriptions to any CVS/pharmacy location. Whether submitted through our mail order pharmacy or at CVS/pharmacy, all prescriptions are filled through the Company’s specialty mail order pharmacies, so all revenue from this specialty prescription services program is recorded within the Pharmacy Services Segment. Members then can choose to pick up their medication at their local CVS/pharmacy or have it sent to their home through the mail.
(5)
Operating expenses for the three and nine months ended September 30, 2013 includes a $11 million gain on a legal settlement.

Net Revenues
 
Net revenues increased $3.1 billion, or 15.7%, to $22.5 billion in the three months ended September 30, 2014, as compared to the prior year. The increase is primarily due to an increase in specialty pharmacy and pharmacy network claims. As you review our Pharmacy Services Segment’s performance in this area, we believe you should consider the following important information that impacted the three months ended September 30, 2014:
 
Our mail choice claims processed decreased 1.3% to 20.7 million claims in the three months ended September 30, 2014, compared to 21.0 million claims in the prior year. The decrease in mail choice claims was driven by a decline in traditional mail volumes, which was partially offset by growth in our Maintenance Choice program and specialty pharmacy.
 
Our average revenue per mail choice claim increased by 28.2%, compared to the prior year. This increase was primarily due to growth in specialty pharmacy, drug inflation and product mix.

25