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We strongly recommend that you read our accompanying audited consolidated financial
statements and footnotes along with this important discussion
and analysis.
Fiscal 1999, which ended on January 1, 2000, included 53 weeks, while fiscal 1998
and 1997, which ended on December 26, 1998 and December 27, 1997, respectively,
included 52 weeks.
Net sales increased 18.5% in 1999 to $18.1 billion. This compares to increases
of 11.1% in 1998 and 16.2% in 1997. Same-store sales, consisting of sales from stores
that have been open for more than one year, rose 12.5% in 1999, 10.8% in 1998 and 9.7%
in 1997. Pharmacy same-store sales increased 19.4% in 1999 and 16.5% in 1998 and 1997.
Our pharmacy sales as a percentage of total net sales were 59% in 1999, 58% in 1998
and 55% in 1997. Our third party prescription sales as a percentage of total pharmacy
sales were 87% in 1999, 84% in 1998 and 81% in 1997.
As you review our sales performance, we believe you should consider the following
important information:
Why has our comparable gross margin rate been declining?
Total operating expenses were 20.6% of net sales in 1999. This compares to 22.1% in
1998 and 25.0% in 1997. As you review our performance in this area, please remember
to consider the impact of the following nonrecurring charges:
What have we done to improve our comparable total operating expenses as a percentage
of net sales?
Operating profit increased $383.6 million to $1.1 billion in 1999.
This compares to $751.9 million in 1998 and $281.7 million in 1997. If you
exclude the effect of the nonrecurring charges we recorded in gross
margin and in total operating expenses, our comparable operating profit
increased $195.0 million (or 20.7%) to $1.1 billion in 1999. This
compares to $940.5 million in 1998 and $779.1 million in 1997. Comparable
operating profit as a percentage of net sales was 6.3% in 1999, 6.2% in
1998 and 5.7% in 1997.
Interest expense, net consisted of the following:
The decrease in interest expense in 1999 was primarily due to the fact that we
replaced $300 million of our commercial paper borrowings with unsecured senior
notes that bear a lower interest rate than our commercial paper. The increase
in interest expense in 1998 was primarily due to higher average borrowing
levels when compared to 1997. The decrease in interest income in 1998 was
primarily due to interest income recognized during 1997 on a note receivable
that we received when we sold Kay-Bee Toys in 1996. This note was sold in 1997.
Income tax provision ~ Our effective income tax rate was 41.0% in 1999
compared to 44.4% in 1998 and 62.8% in 1997. Our effective income tax rates
were higher in 1998 and 1997 because certain components of the nonrecurring
charges we recorded in conjunction with the CVS/Arbor and CVS/Revco merger
transactions were not deductible for income tax purposes.
Earnings from continuing operations before extraordinary item
increased $250.6 million to $635.1 million (or $1.55 per diluted share)
in 1999. This compares to $384.5 million (or $0.95 per diluted share) in
1998 and $88.4 million (or $0.19 per diluted share) in 1997. If you
exclude the effect of the nonrecurring charges we recorded in cost of goods
sold and in total operating expenses, our comparable earnings from continuing
operations before extraordinary item increased 24.5% to $635.1 million
(or $1.55 per diluted share) in 1999. This compares to $510.1 million
(or $1.26 per diluted share) in 1998 and $419.2 million (or $1.05 per
diluted share) in 1997.
Discontinued Operations ~ In November 1997, we completed the final
phase of a comprehensive strategic restructuring program, under which we
sold Marshalls, Kay-Bee Toys, Wilsons, This End Up and Bobs Stores. As
part of this program, we also completed the spin-off of Footstar, Inc.,
which included Meldisco, Footaction and Thom McAn, completed the initial
and secondary public offerings of Linens n Things and eliminated certain
corporate overhead costs. During 1997, we sold our remaining investment in
Linens n Things and recorded, as a component of discontinued operations,
an after-tax gain of $38.2 million. In connection with recording this gain,
we also recorded, as a component of discontinued operations, an after-tax
charge of $20.7 million during 1997 to finalize our original liability
estimates. Please read Note 4 to the consolidated financial statements for
other important information about this program.
Extraordinary item ~ During 1997, we retired $865.7 million of the
debt we absorbed when we acquired Revco. As a result, we recorded a charge
for an extraordinary item, net of income taxes, of $17.1 million. The
extraordinary item included the early retirement premiums we paid and the
balance of our deferred financing costs.
Net earnings were $635.1 million (or $1.55 per diluted share) in 1999.
This compares to $384.5 million (or $0.95 per diluted share) in 1998
and $88.8 million (or $0.19 per diluted share) in 1997.
Liquidity ~ The Company has three primary sources of liquidity:
cash provided by operations, commercial paper and uncommitted lines of
credit. We generally finance our inventory and capital expenditure
requirements with internally generated funds and commercial paper.
We currently expect to continue to utilize our commercial paper
program to support our working capital needs. In addition, we may
elect to use long-term borrowings in the future to support our
continued growth.
Our commercial paper program is supported by a $670 million, five-year
unsecured revolving credit facility that expires on May 30, 2002,
and a $530 million, 364-day unsecured revolving credit facility
that expires on June 21, 2000. We can also obtain up to $35.0 million
of short-term financing through various uncommitted lines of credit.
As of January 1, 2000, we had $451.0 million of commercial paper
outstanding at a weighted average interest rate of 6.2%. There were
no borrowings outstanding under the uncommitted lines of credit as
of January 1, 2000.
On February 11, 1999, we issued $300 million of 5.5% unsecured
senior notes due February 15, 2004. The proceeds from the issuance
were used to repay outstanding commercial paper borrowings.
Our credit facilities and unsecured senior notes contain customary
restrictive financial and operating covenants. We do not believe that
the restrictions contained in these covenants materially affect our
financial or operating flexibility.
Capital Resources ~ Although there can be no assurance and assuming
market interest rates remain favorable, we currently believe that we will
continue to have access to capital at attractive interest rates in 2000.
We further believe that our cash on hand and cash provided by operations,
together with our ability to obtain additional short-term and long-term
financing, will be sufficient to cover our future working capital needs,
capital expenditures and debt service requirements for at least the next 12 months.
Net Cash Provided by Operations ~ Net cash provided by operations
was $658.8 million in 1999. This compares to net cash provided by
operations of $221.0 million in 1998 and net cash used in operations
of $105.8 million in 1997. The improvement in net cash provided by operations
was primarily the result of higher net earnings, improved working capital
management and a reduction in cash payments associated with the Arbor and
Revco mergers. You should be aware that cash flow from operations will
continue to be negatively impacted by future payments associated with the
Arbor and Revco mergers and the Companys strategic restructuring program.
As of January 1, 2000, the future cash payments associated with these
programs totaled $123.0 million. These payments primarily include: (i) $12.1
million for employee severance, which extends through 2000, (ii) $9.0 million
for retirement benefits and related excess parachute payment excise taxes,
which extend for a number of years to coincide with the future payment of
retirement benefits, and (iii) $98.5 million for continuing lease obligations,
which extend through 2020.
Capital Expenditures ~ Our capital expenditures totaled $493.5 million
in 1999. This compared to $502.3 million in 1998 and $341.6 million in 1997.
During 1999, we opened 146 new stores, relocated 299 existing stores and
closed 170 stores. During 2000, we currently expect to open 425 stores,
including 250 relocations. As of January 1, 2000, we operated 4,098 retail
drugstores in 26 states and the District of Columbia.
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities." This statement, which establishes
the accounting and financial reporting requirements for derivitave
instruments, requires companies to recognize derivatives as either assets
or liabilities on the balance sheet and measure those instruments at fair
value. In May 1999, the Financial Accounting Standards Board delayed the
implementation date for this statement by one year. We expect to adopt
SFAS No. 133 in 2001. We currently are in the process of determining
what impact, if any, this pronouncement will have on our consolidated
financial statements.
We have made forward-looking statements in this Annual Report that are
subject to risks and uncertainties that could cause actual results to
differ materially. For these statements, we claim the protection of the
safe harbor for forward-looking statements contained in the Private
Securities Litigation Reform Act of 1995. We strongly recommend that
you become familiar with the specific risks and uncertainties that we
have outlined for you under the caption "Cautionary Statement Concerning
Forward-Looking Statements" in our Annual Report on Form 10-K for the
fiscal year ended January 1, 2000.
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©1999 CVS/pharmacy, Inc.
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