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CVS Caremark Corporation (CVS - Free Report) reported third-quarter 2013 adjusted earnings per share (EPS) of $1.12, up a significant 16.7% year over year. The result also beat the Zacks Consensus Estimate by a penny.

This reflects the eighth consecutive quarter of positive earnings surprise for CVS. The quarterly result coincides with the upper end of the company’s EPS expectation of $1.09–$1.12.

However, excluding 17 cents of loss incurred in the year-ago quarter due toearly extinguishment of debt, the adjusted earnings increased 1.9% in the reported quarter. Without these adjustments, reported EPS in the fourth quarter surged 16.7% to $1.05.

Adjusting for certain one-time items (like intangible asset amortization, gain from a legal settlement and loss on early extinguishment of debt recognized in the fourth quarter of 2012), EPS for full year 2013 came in at $3.96, in line with the Zacks Consensus estimate and up 15.7% from the prior-year period. This adjusted EPS for the year also falls at the upper-end of the company provided guidance range of $3.94 – $3.97.

Per management, the EPS upside was led by higher profitability on the back of increased generic drugs dispensed and the growth of Maintenance Choice program in the Pharmacy Services and Retail Pharmacy segments.

Quarter Under Review

Net revenue improved 4.6% year over year to $32.83 billion in the fourth quarter, closely beating the Zacks Consensus Estimate of $32.68 billion. Full-year revenues increased 3.0% to $126.76 billion, marginally ahead of the Zacks Consensus Estimate of $126.66 billion.

The Pharmacy Services segment revenues increased 5.2% to $19.6 billion in the quarter. The segment gained from drug cost inflation, new products and new clients in specialty pharmacy business.

Pharmacy network claims that were processed during the quarter slipped 0.3% to 204.9 million. This was due to fewer Medicare Part D claims which resulted from lower membership as per sanctions placed on the company in 2013 by the Centers for Medicare and Medicaid Services.

The new client gains and ongoing adoption of the Maintenance Choice program increased the Mail Choice claims processed to 21.0 million, up 3.1% on a year-over-year basis.

Revenues from CVS’ Retail Pharmacy improved 5.6% year over year to $17.2 billion. Same-store sales increased 4.0% while front-end same store sales declined 1.9% year over year. Same store sales improved on account of higher same-store prescription volumes.

This positive impact was partly tempered by the introduction of generic drugs. Front-end same-store sales decline was attributed to softer traffic during the quarterwhich was partially offset by an increase in basket size.

Pharmacy same store sales were up 6.8% from the year-ago quarter. Despite the generic introductions that dragged sales by 230 bps, CVS posted pharmacy same-store sales growth.

Moreover, counting 90-day scripts as one script, pharmacy same-store prescription volumes inched up 0.8% from the year-ago quarter. When 90-day scripts were converted into 3 scripts, same-store prescription volumes grew 3.8% from the prior-year quarter.

The generic dispensing rate (the proportion of all generic prescriptions to total number of prescriptions dispensed) soared 110 bps each to 81.1% in the Pharmacy Services segment and 81.0% in the Retail Pharmacy segment.

With a nominal 0.7% increase in gross profit to $6.3 billion, gross margin contracted 74 bps to 19.3%. Gross margin for the Pharmacy Services business was $6.17%, registering a contraction of 98 bps year over year. The same for the Retail Pharmacy segment was 30.7%, down 60 bps from the year-ago quarter.

Operating expenses were up 3.2% on a year-over-year basis to roughly $4.1 billion in the quarter. However, operating margin contracted 57 bps to 6.8%. Operating margin for the Pharmacy Services segment contracted 100 bps to 4.6% while the same for the Retail Pharmacy franchise remained marginally in line at 9.7% in the quarter.

CVS exited the quarter with cash and cash equivalents and short-term investments of $4.17 bllion, down from $1.38 billion at the end of 2012. Net cash provided by operating activities for the year declined 13.3% to $5.8 billion. This resulted in free cash flow of $4.04 billion for the reported fiscal year.

During the fourth quarter, CVS opened 60 new retail drugstores and closed one retail drugstore. Further, the company relocated 17 retail drugstores, andclosed one retail drugstore, one onsite pharmacy, five specialty retail pharmacies and one specialty mail order pharmacy.

As of Dec 31, 2013, CVS operated 7,717 locations, which include 7,661 retail drugstores, 17 onsite pharmacies, 25 retail specialty pharmacy stores, 11 specialty mail order pharmacies and 4 mail service dispensing pharmacies in 46 states, as well as the District of Columbia and Puerto Rico.


Following the end of the fourth quarter and year 2013, CVS reconfirmed its adjusted EPS guidance for 2014 which was earlier provided during its annual analyst day on Dec 18, 2013. This guidance assumes $4.0 billion in share repurchase.

However, the company raised its 2014 free cash flow and cash flow from operations guidance to the range of $5.5 to $5.8 billion (from $5.1 to $5.4 billion) and $7.0 to $7.3 billion (from $6.6 to $6.9 billion). This change was due to shift in timing of certain cash receipts to early 2014 from late 2013.

For the first quarter of 2014, the company expects to report adjusted EPS in the range of $1.03 to $1.06. The current Zacks Consensus Estimate of 98 cents falls short of the guidance range.

Our Take

CVS continues to report strong quarterly results. We are encouraged by CVS’ fourth-quarter 2013 results which edged past the Zacks Consensus Estimate on both fronts. The company continues to benefit from the introduction of generics that pushed profits higher. It also witnessed robust double-digit growth in pharmacy benefit management (PBM) on the back of a strong selling season.

Furthermore, same-store sales and pharmacy store sales also improved. However, pressure on margin remains a major downside during the quarter.

Currently, the stock carries a Zacks Rank #3 (Hold). Some of the better-placed stocks in the broader medical sector includes Almost Family Inc. (AFAM - Free Report) , DaVita HealthCare Partners Inc. (DVA - Free Report) and Addus HomeCare Corporation (ADUS - Free Report) . While AFAM holds a Zacks Rank #1 (Strong Buy), ADUS and DVA carry a Zacks Rank #2 (Buy).

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