This excerpt taken from the CVS 10-K filed Feb 27, 2007.
Gross profit, which includes net revenues less the cost of merchandise sold during the reporting period and the related purchasing costs, warehousing costs, delivery costs and actual and estimated inventory losses, as a percentage of net revenues was 27.3% in 2006. This compares to 26.8% in 2005 and 26.3% in 2004.
As you review our performance in this area, we believe you should consider the following important information:
· Front store revenues increased as a percentage of total revenues during 2006. On average our gross profit on front store revenues is higher than our gross profit on pharmacy revenues. Pharmacy revenues as a percentage of total revenues during 2006 were 69.6%, compared to 70.2% in 2005 and 70.0% in 2004.
· Our pharmacy gross profit rate continued to benefit from an increase in generic drug revenues in 2006, which normally yield a higher gross profit rate than equivalent brand name drug revenues. However, increased utilization of generic products has resulted in pressure to decrease reimbursement payments to pharmacies for generic drugs, causing a reduction in the generic profit rate. We expect this trend to continue.
· Sales to customers covered by third party insurance programs have continued to increase and, thus, have become a larger component of our total pharmacy business. On average, our gross profit on third party pharmacy revenues is lower than our gross profit on cash pharmacy revenues. Third party pharmacy revenues were 94.7% of pharmacy revenues in 2006, compared to 94.1% of pharmacy revenues in 2005 and 2004. We expect this trend to continue.
· The introduction of the new Medicare Part D benefit is resulting in increased utilization and decreased pharmacy gross profit rates as higher profit business (such as cash and state Medicaid customers) continued to migrate to Part D coverage during 2006.
· On February 8, 2006, the President signed into law the Deficit Reduction Act of 2005 (the DRA). The DRA seeks to reduce federal spending by altering Medicaid reimbursement formula for multi-source (i.e., generic) drugs. According to the Congressional Budget Office, retail pharmacies are expected to negotiate with individual states for higher dispensing fees to mitigate the adverse effect of these changes. These changes are currently scheduled to take effect late in the first quarter of 2007 and are expected to result in reduced Medicaid reimbursement rates for retail pharmacies. The extent of these reductions cannot be determined at this time.
· Our pharmacy gross profit rates have been adversely affected by the efforts of managed care organizations, pharmacy benefit managers, governmental and other third party payors to reduce their prescription costs. In the event this trend continues, we may not be able to sustain our current rate of revenue growth and gross profit dollars could be adversely impacted.