-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, FZz3W8NpY6cBG5i26Ad4XiDvM267wS7Mu6mpA0qWWHNq9oq3CO7hdbZwlhnQrook 1eQCvB7Frj9sp/TOv8D3mA== 0000912057-99-006590.txt : 19991118 0000912057-99-006590.hdr.sgml : 19991118 ACCESSION NUMBER: 0000912057-99-006590 CONFORMED SUBMISSION TYPE: 10-K/A PUBLIC DOCUMENT COUNT: 10 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19991117 FILER: COMPANY DATA: COMPANY CONFORMED NAME: CVS CORP CENTRAL INDEX KEY: 0000064803 STANDARD INDUSTRIAL CLASSIFICATION: RETAIL-DRUG STORES AND PROPRIETARY STORES [5912] IRS NUMBER: 050494040 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K/A SEC ACT: SEC FILE NUMBER: 001-01011 FILM NUMBER: 99759601 BUSINESS ADDRESS: STREET 1: ONE CVS DR. CITY: WOONSOCKET STATE: RI ZIP: 02895- BUSINESS PHONE: 4017651500 MAIL ADDRESS: STREET 1: ONE CVS DR. CITY: WOONSOCKET STATE: RI ZIP: 02895- FORMER COMPANY: FORMER CONFORMED NAME: MELVILLE CORP DATE OF NAME CHANGE: 19920703 FORMER COMPANY: FORMER CONFORMED NAME: MELVILLE SHOE CORP DATE OF NAME CHANGE: 19760630 10-K/A 1 FORM 10-K/A ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ----------------- FORM 10-K/A (AMENDMENT NO. 1) ----------------- ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998 COMMISSION FILE NUMBER 001-01011 CVS CORPORATION (Exact name of Registrant as specified in its charter) -------------------- DELAWARE 05-0494040 -------- ----------- (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) ONE CVS DRIVE 02895 WOONSOCKET, RHODE ISLAND ---------- - --------------------------------------- (Zip Code) (Address of principal executive offices) (401) 765-1500 -------------- (Registrant's telephone number, including area code) SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE EXCHANGE ACT: TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED ------------------- ----------------------------------------- Common Stock, par value $0.01 per share New York Stock Exchange SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE EXCHANGE ACT: NONE ------------------- 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] The aggregate market value of the registrant's voting stock* held by non-affiliates** of the registrant (without admitting that any person whose shares are not included in this calculation is an affiliate) on March 17, 1999 was approximately $19,895,631,210, based on the closing price on the New York Stock Exchange. As of March 17, 1999, the registrant had 390,601,264 shares of common stock outstanding. ------------------- * Does not include 5,224,367 outstanding shares of Series One ESOP Convertible Preference Stock. As of March 17, 1999, each share of ESOP Preference Stock was entitled to 2.3 votes per share on all matters submitted to a vote of the holders of common stock, voting with the common stock as a single class. ** Only voting stock held by directors and executive officers is excluded. ------------------- DOCUMENTS INCORPORATED BY REFERENCE The following documents (or specified parts thereof) are incorporated by reference into this Annual Report on Form 10-K/A as indicated: portions of CVS Corporation's 1998 Annual Report to Shareholders are incorporated by reference into Part II: Item 5 and portions of CVS Corporation's 1999 Proxy Statement are incorporated by reference into Part III: Items 10, 11, 12 and 13. ================================================================================ TABLE OF CONTENTS
PART I PAGE Explanatory Note: Purpose of this amendment on Form 10-K/A............................................... 2 Recent Developments...................................................................................... 2 Item 1: Business Overview of CVS' Business.................................................................. 3 Strategic Restructuring Program............................................................ 4 Merger with Revco D.S., Inc................................................................ 4 Merger with Arbor Drugs, Inc............................................................... 4 PharmaCare................................................................................. 5 Relationships with Managed Care Providers.................................................. 5 CVS Stores................................................................................. 5 Store Development.......................................................................... 6 Working Capital Practices.................................................................. 6 Information Systems........................................................................ 7 Relationships with Suppliers............................................................... 7 Customer Service........................................................................... 7 Government Regulation...................................................................... 8 Competition................................................................................ 8 Cautionary Statement Concerning Forward-Looking Statements................................. 8 Item 2: Properties.................................................................................... 9 Item 3: Legal Proceedings............................................................................. 10 Item 4: Submission of Matters to a Vote of Security Holders........................................... 11 Executive Officers of the Registrant .................................................................... 11 PART II Item 5: Market for Registrant's Common Equity and Related Stockholder Matters......................... 12 Item 6: Selected Financial Data....................................................................... 12 Item 7: Management's Discussion and Analysis of Financial Condition and Results of Operations......... 13 Item 7A: Quantitative and Qualitative Disclosures About Market Risk.................................... 20 Item 8: Financial Statements and Supplementary Data................................................... 20 Item 9: Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.......... 20 PART III Item 10: Directors and Executive Officers of the Registrant............................................ 20 Item 11: Executive Compensation........................................................................ 21 Item 12: Security Ownership of Certain Beneficial Owners and Management................................ 21 Item 13: Certain Relationships and Related Transactions................................................ 21 PART IV Item 14: Exhibits, Financial Statement Schedules, and Reports on Form 8-K.............................. 21 Where You Can Find More Information...................................................................... 24 Independent Auditors' Report............................................................................. 25 Schedule II - Valuation and Qualifying Accounts.......................................................... 26 Signatures .............................................................................................. 27
PART I EXPLANATORY NOTE: PURPOSE OF THIS AMENDMENT ON FORM 10-K/A The principal purpose of this Amendment is to reflect the restatement adjustments described under "Recent Developments" below. We are amending and restating only those items of our Form 10-K that are affected by the restatement adjustments. Our Form 10-K still speaks as of December 31, 1998 (except as otherwise expressly noted), and no attempt has been made in this Form 10-K/A to modify or update our disclosures, except as required to reflect the effects of the restatement adjustments to our financial statements. RECENT DEVELOPMENTS On May 11, 1999, CVS Corporation filed a Registration Statement on Form S-4 with the Securities and Exchange Commission related to an exchange offer for the $300 million of debt securities that CVS sold in a private placement on February 11, 1999. In connection with the SEC's review of that registration statement, CVS has restated its consolidated financial statements for 1997 and 1998. As a result of the restatement: - - Earnings from continuing operations increased by $11.9 million (or $0.03 per diluted common share) in 1997. - - Earnings from continuing operations decreased by $11.9 million (or $0.03 per diluted common share) in 1998. CVS notes that: - - The restatement adjustments simply shifted the nonrecurring costs discussed below between quarters in 1997 and 1998, and had no effect on the two years when viewed together. - - The restatement has no effect on 1999 or future years. - - The restatement has no effect on historical cash flows or future cash flow requirements. - - We believe the restatement should not affect the financial models of analysts and investors. The purpose of this Form 10-K/A is to restate CVS' consolidated financial statements for 1997 and 1998 to reflect the effect of the following: - - In connection with the merger of CVS and Revco D.S., Inc., CVS recorded a $39.6 million pre-tax ($23.4 million after-tax) charge in the second quarter of 1997, which represented the estimated nonrecurring costs that would be incurred in connection with eliminating the duplicate Revco information technology systems. As reflect in the table below, CVS agreed to restate 1997 to expense these nonrecurring costs in the fiscal quarters in which the costs were incurred. - - Also in connection with the merger of CVS and Revco, CVS recorded a $35.0 million pre-tax ($20.5 million after-tax) charge, which represented the estimated nonrecurring costs that would be incurred in connection with removing noncompatible merchandise fixtures from approximately 2,200 Revco stores. As reflected in the table below, CVS agreed to restate 1997 and 1998 to expense these nonrecurring costs in the fiscal quarters in which the costs were incurred. - - In connection with the merger of CVS and Arbor Drugs, Inc., CVS recorded an $11.0 million pre-tax ($6.5 million after-tax) charge in the second quarter of 1998, which represented the estimated nonrecurring costs that would be incurred by CVS in connection with eliminating the duplicate Arbor information technology systems. As reflected in the table below, CVS agreed to restate 1998 to expense these nonrecurring costs in the fiscal quarters in which the costs were incurred. 2 Following is a summary of the effect of the restatement adjustments discussed above on CVS' previously reported diluted earnings per common share from continuing operations for 1997 and 1998.
==================================================================================================================================== First Second Third Fourth Full Quarter Quarter Quarter Quarter Year - ------------------------------------------------------------------------------------------------------------------------------------ 1997: Diluted earnings per common share, as previously reported $ 0.23 $(0.60) $ 0.20 $ 0.31 $ 0.16 Restatement adjustments: Duplicate Revco information technology systems elimination costs -- 0.04 (0.01) (0.03) -- Noncompatible Revco store merchandise fixture removal costs -- 0.05 (0.01) (0.01) 0.03 - ------------------------------------------------------------------------------------------------------------------------------------ Diluted earnings per common share, as restated $ 0.23 $(0.51) $ 0.18 $ 0.27 $ 0.19 ==================================================================================================================================== 1998: Diluted earnings per common share, as previously reported $ 0.33 $ 0.03 $ 0.25 $ 0.36 $ 0.98 Restatement adjustments: Duplicate Arbor information technology systems elimination costs -- 0.01 (0.01) -- -- Noncompatible Revco store merchandise fixture removal costs (0.01) (0.01) (0.01) -- (0.03) - ------------------------------------------------------------------------------------------------------------------------------------ Diluted earnings per common share, as restated $ 0.32 $ 0.03 $ 0.23 $ 0.36 $ 0.95 ====================================================================================================================================
Please read Notes 15 and 16 to the consolidated financial statements for additional information about the restatement adjsutements. ITEM 1. BUSINESS OVERVIEW OF CVS' BUSINESS CVS Corporation is a leader in the chain drugstore industry in the United States, with revenues of $15.3 billion in 1998. As of December 31, 1998, we were the largest drugstore chain in the nation in terms of store count, operating 4,122 stores in 24 states in the Northeast, Mid-Atlantic, Midwest and Southeast regions and in the District of Columbia. Our stores are well positioned and operate in 66 of the top 100 drugstore markets in the country. We now hold the number one market share in six of the top ten drugstore markets. We are also among the industry leaders in terms of store productivity and operating profit margin. 3 PHARMACY OPERATIONS ~ A primary focus of our operations is our pharmacy business. In 1998, total pharmacy sales increased 17.0% to $8.8 billion, representing 58% of total sales for the year, compared to 55% of total sales in 1997. As of December 31, 1998, we were the largest drugstore chain in the nation in terms of prescriptions filled and pharmacy sales, dispensing over 251 million prescriptions (approximately 10.5% of the U.S. retail prescription market). We believe that our pharmacy operations will continue to represent a critical part of our business and strategy due to favorable trends. These trends include an aging American population, greater responsibility being borne by Americans for their healthcare, an increasing demand for retail formats that provide easy access and convenience, discovery of new and better drug therapies and the need for cost effective healthcare solutions. Our pharmacy business also benefits from an "independent file buy" program, in which we purchase prescription files from independent pharmacies. During 1998, we purchased approximately 350 prescription files, each containing an average weekly prescription count of nearly 560. We believe that independent file buys are productive investments. In many cases, the independent pharmacist will move to CVS, thereby providing continuity in the pharmacist-patient relationship. FRONT STORE OPERATIONS ~ In addition to prescription drugs and services, we offer a broad selection of general merchandise, presented in a well-organized fashion, in stores that are designed to be customer-friendly, inviting and easy to shop. Merchandise categories include: over-the-counter drugs, greeting cards, film and photofinishing services, beauty and cosmetics, seasonal merchandise and convenience foods. We also offer over 1,400 products under the CVS private label brand, which represented about 11 of our front store sales in 1998. In 1998, front store sales, which are generally higher margin than pharmacy sales, increased 3.9% to $6.5 billion, representing 42% of total sales for the year, compared to 45% of total sales in 1997. CVS Corporation is a Delaware corporation. Our principal executive offices are located at One CVS Drive, Woonsocket, Rhode Island 02895, telephone (401) 765-1500. As of December 31, 1998, CVS and its subsidiaries had about 97,000 employees. STRATEGIC RESTRUCTURING PROGRAM In November 1997, we completed the final phase of our comprehensive strategic restructuring program, first announced in October 1995 and subsequently refined in May 1996 and June 1997. The strategic restructuring program included: (i) the sale of Marshalls, Kay-Bee Toys, Wilsons, This End Up and Bob's Stores, (ii) the spin-off of Footstar, Inc., which included Meldisco, Footaction and Thom McAn, (iii) the initial and secondary public offerings of Linens 'n Things and (iv) the closing of our administrative office facility located in Rye, New York. For more information about our strategic restructuring program, see Note 4 of "Notes to Consolidated Financial Statements" of our 1998 Annual Report to Shareholders, which is set forth in Part IV: Item 14(A) of this Form 10-K/A. MERGER WITH REVCO D.S., INC. On May 29, 1997, we completed a merger with Revco D.S. Inc., pursuant to which 120.6 million shares of CVS common stock were exchanged for all the outstanding common stock of Revco. The aggregate value of this transaction, including the assumption of $900 million of existing Revco debt, was $3.8 billion. The merger of CVS and Revco was a tax-free reorganization that we treated as a pooling of interests for accounting purposes. Accordingly, we have restated our historical consolidated financial statements and footnotes to include Revco as if it had always been owned by CVS. The merger with Revco was a milestone event for our company in that it more than doubled our revenues and made us the nation's number one drugstore retailer in terms of store count. The merger brought us into high-growth, contiguous markets in the Mid-Atlantic, Southeast and Midwest regions of the United States. MERGER WITH ARBOR DRUGS, INC. On March 31, 1998, we completed a merger with Arbor Drugs, Inc., pursuant to which 37.8 million shares of CVS common stock were exchanged for all the outstanding common stock of Arbor. The aggregate value of this transaction, including the assumption of $17 million of existing Arbor debt, was $1.5 billion. The merger of CVS and Arbor was also a tax-free reorganization that we treated as a pooling of interests for accounting purposes. Accordingly, we have restated our historical consolidated financial statements and footnotes to include Arbor as if it had always been owned by CVS. 4 The merger with Arbor made us the market share leader in metropolitan Detroit, the nation's fourth largest retail drugstore market and strengthened our position as the nation's top drugstore retailer in terms of store count and retail prescriptions dispensed. PHARMACARE In order to provide patients with the best possible care at the lowest cost, we follow an integrated healthcare approach that brings together industry participants such as physicians, pharmaceutical companies, managed care providers and pharmacies. Our primary efforts in this area include the operation and expansion of PharmaCare, our prescription benefit management subsidiary, and the creation of strategic alliances with healthcare partners. PharmaCare provides a full range of prescription benefit management services to managed care and other organizations. These services include plan design and administration, formulary management, mail order pharmacy services, claims processing and generic substitution. In December 1997, PharmaCare strengthened its service network by merging with Revco's prescription benefit management subsidiary, Rx Connections, and assuming Revco's mail order pharmacy operations. At the end of 1998, PharmaCare managed healthcare services for about 6 million people through a preferred national pharmacy network of over 40,000 pharmacies. In addition, PharmaCare plays an increasing role in healthcare management through integrated partnerships with several large managed care providers. One feature that sets PharmaCare apart from other prescription benefit management providers is its proprietary Clinical Information Management System ("CIMS"). CIMS is a unique communication system designed to help PharmaCare's clients manage pharmaceutical utilization by facilitating clinical communications between the payer, patient, physician and pharmacist. The improved communication enables physicians to direct utilization to the more cost effective and/or clinically effective therapy. Since its introduction in 1994, the number of physicians using CIMS has grown to over 30,000. RELATIONSHIPS WITH MANAGED CARE PROVIDERS The growth in managed care has substantially increased the use of prescription drugs. Managed care providers have (i) made the cost of prescription drugs more affordable to a greater number of people and (ii) supported prescription drug therapy as an alternative to more expensive forms of treatment, such as surgery. Payments by third party providers under prescription drug plans represented 84% of total pharmacy sales in 1998, compared to 81% in 1997. In a typical third party payment plan, we contract with a third party payor (such as an insurance company, a prescription benefit management company, a governmental agency, a private employer, a health maintenance organization or other managed care provider) that agrees to pay for all or a portion of a customer's eligible prescription purchases in exchange for reduced prescription rates. Although third party payment plans provide a high volume of prescription drug sales, these sales typically generate lower gross margins than other sales due to the cost containment efforts of third party payors and the increasing competition among pharmacies for this business. The cost containment efforts and increased competition has also caused a continued decline of gross margins on third party sales. To address this trend, we have dropped a number of third party programs that fell below our minimum profitability standards. In the event this trend continues and we elect to drop additional programs and/or decide not to participate in future programs that fall below our minimum profitability standards, we may not be able to sustain our current rate of sales growth. CVS STORES We are the nation's largest chain drugstore company based on store count, operating 4,122 stores in 24 states and the District of Columbia as of December 31, 1998. The majority of our existing stores range in size from approximately 8,000 to 10,000 square feet, although most new stores are based on our 10,125 square foot freestanding prototype, which typically includes a drive-thru pharmacy. As of December 31, 1998, 23% of our stores were freestanding as opposed to being located in strip shopping center sites. Over 700 CVS stores were operated on an extended hour or 24-hour basis and 900 stores offered one-hour photo service. We also operated 360 stores with drive-thru pharmacies, and plan to add over 400 more in 1999. During 1998, we opened 382 new stores, including 198 relocations, and in 1999 we expect to open approximately 440 new stores, including about 300 relocations. Net selling space for our 4,122 stores was 30.6 million square feet at the end of 1998. 5 The following is a breakdown by state of the locations of CVS' stores at December 31, 1998: - ------------------------------------------------------------------------------------------ Alabama............................144 New Hampshire....................29 Connecticut........................122 New Jersey......................183 Delaware.............................3 New York........................363 District of Columbia................47 North Carolina..................296 Florida.............................22 Ohio............................414 Georgia............................304 Pennsylvania....................319 Illinois............................70 Rhode Island.....................52 Indiana............................291 South Carolina..................196 Kentucky............................71 Tennessee.......................146 Maine...............................20 Vermont...........................2 Maryland...........................170 Virginia........................253 Massachusetts......................321 West Virginia....................59 Michigan...........................225 - ------------------------------------------------------------------------------------------
STORE DEVELOPMENT The addition of new stores has played, and will continue to play, a major role in our continued growth. As we open new stores, we maintain our objective of securing a strong position in each market that our stores serve. Our strong market positions provide us with several important advantages, including (i) an ability to save on advertising and distribution costs and (ii) an ability to attract managed care providers, who want to provide their members with convenient access to pharmacy services. In addition, we are actively seeking to relocate many of our strip shopping center locations to freestanding sites. We expect that relocations of existing shopping center stores to freestanding locations will account for about two-thirds of store openings over the next several years. Because of their more convenient locations and larger size, relocated stores have typically realized significant improvements in customer count and revenues, driven largely by increased sales of higher margin front store merchandise. We believe our relocation program offers a significant opportunity for future growth, as approximately 23% of our existing stores are freestanding. We currently expect to have approximately 35% of our stores in freestanding locations by the end of 1999. Our long-term goal is to have 70-80% of our stores located in freestanding sites. We cannot, however, guarantee that future store relocations will achieve similar results as those historically achieved. See "Cautionary Statement Concerning Forward-Looking Statements" below. We also have an active remodeling and remerchandising program in place, which seeks to remodel 20% of our existing stores and remerchandise another 20% each year. To remerchandise a store, we review and update the store's merchandise planogram. The merchandise planogram specifies the items the store carries and where the items are placed in the store. We typically perform this review on the stores we acquire, in order to align the acquired store's merchandise product mix to our standard product mix, which varies based on store size and location. We also review our existing stores on a regular basis to address developing market trends. During 1998, we completed the process of converting all 1,900 retained Revco stores into the CVS store format, converted Arbor stores to CVS' accounting and store systems and closed Arbor's Troy, Michigan corporate headquarters facility. We believe that continuing to grow our store base and locating stores in desirable geographic markets are essential components to competing effectively in the current managed care environment. As a result, we believe that our store development program is an important part of our ability to maintain our leadership position in the chain drugstore industry. WORKING CAPITAL PRACTICES We generally finance our inventory and capital expenditure requirements with internally generated funds and our commercial paper program. We currently expect to continue to utilize our commercial paper program during 1999 to support our working capital needs. In addition, we may elect to use long-term borrowings in the future to support our continued growth. Due to the nature of the retail drugstore business, third party insurance programs currently pay for approximately 84% of our pharmacy sales. These claims are generally settled in less than 30 days. Our customer returns are not significant. 6 INFORMATION SYSTEMS We have invested significantly in information systems to enable us to deliver an exceptional level of customer service while lowering costs and increasing operating efficiency. Our client-server based systems permit rapid and flexible system development to meet changing business needs, while our scaleable technical architecture enables us to efficiently expand our network to accommodate new stores. PHARMACY SYSTEMS ~ The Rx2000 computer system enables our pharmacists to fill prescriptions more efficiently, giving the pharmacists more time to spend with customers. The system facilitates the management of third party healthcare plans and enables us to provide managed care providers with a level of information which we believe is unmatched by our competitors. By analyzing the data captured by the Rx2000 computer system, we and our managed care partners are able to evaluate treatment outcomes with an eye toward improving care and containing costs. We also continue to make significant progress on our next generation Rx2000 Pharmacy Delivery System, which will reengineer the way we fill prescriptions. The project includes integrated workflow improvements and automated pill-counting machines in high volume stores. During 1997, we implemented Rapid Rx Refill, which enables customers to order prescription refills 24 hours a day using a touch-tone telephone. In just over 18 months after its debut, Rapid Rx Refill now accounts for approximately 50% of refills. Overall, these initiatives are expected to continue to enhance pharmacy productivity, lower the costs to fill prescriptions and improve service by enabling our pharmacists to spend more time with customers. FRONT STORE SYSTEMS ~ Our point-of-sale scanning technology has enabled us to develop an advanced retail data warehouse of information. We use this information to quickly analyze data on a store-by-store basis to develop targeted marketing and merchandising strategies. We can also analyze the impact of pricing, promotion and mix on a category's sales and profitability, enabling us to develop tactical merchandising plans for each category by market. We believe that effective category management increases customer satisfaction and that our category management approach has been a primary factor in front store comparable sales gains and improved gross margins. We are also beginning the final phase of a multi-year supply chain initiative which will transform the way we receive, distribute and sell merchandise. Our supply chain initiatives will more effectively link our stores and distribution centers with suppliers to speed the delivery of merchandise to our stores in a manner that both reduces out-of-stock positions and lowers our investment in inventory. The first two phases focused on improving category management and maximizing gross profit through price elasticity and promotional allocations. The final phase will help us to more effectively tailor our product mix in specific markets. We have already begun to experience tangible benefits from our supply chain initiatives and we expect to continue to do so. RELATIONSHIPS WITH SUPPLIERS We centrally purchase most of our merchandise, including prescription drugs, directly from manufacturers. This purchasing strategy allows us to take advantage of the promotional and volume discount programs that certain manufacturers offer to retailers. During 1998, about 85% of the merchandise purchased by us was received by one of our distribution centers for redistribution to our stores. The balance of our store merchandise is shipped directly to our stores from manufacturers and distributors at prices negotiated at the corporate level. We believe that the loss of any one supplier or group of suppliers under common control would not materially affect our business. CUSTOMER SERVICE We strive to provide the highest levels of service to our customers and partners. As a result, we devote considerable time and attention to people, systems and service standards. We emphasize attracting and training friendly and helpful associates to work in our stores and throughout our organization. Each CVS store receives a formal customer service evaluation twice per year, based on a mystery shopper program, customer letters and calls, and market research. Our priority on customer service extends into the managed care portion of our business as well. In every market, a Managed Care Service Team ensures that managed care partners receive high levels of service. Our pharmacists consistently rank among the best in the industry on measurements of trust, relationship building and accessibility. This high level of service and expertise has played a key role in the growth of our pharmacy operations. 7 GOVERNMENT REGULATION Our pharmacies and pharmacists must be licensed by the appropriate state boards of pharmacy. Our pharmacies and distribution centers are also registered with the Federal Drug Enforcement Administration. Because of these licensing and registration requirements, we must comply with various statutes, rules and regulations, a violation of which could result in a suspension or revocation of these licenses or registrations. Under the Omnibus Budget Reconciliation Act of 1990, our pharmacists are required to offer counseling, without charge, to customers covered by Medicare about medication, dosage, delivery system, potential side effects and other information deemed significant by our pharmacists. Our pharmacists routinely offer such counseling to all customers. We also market products under various trademarks and tradenames which have been registered in the United States. Our rights in these trademarks endure for as long as they are used or registered. COMPETITION The retail drugstore business is highly competitive. We believe that we compete principally on the basis of: (i) store location and convenience, (ii) customer service and satisfaction, (iii) product selection and variety and (iv) price. We experience active competition not only from independent and other chain drugstores, but also from health maintenance organizations, hospitals, mail order organizations, supermarkets, discount drugstores and discount general merchandisers. The deep discount drug segment has grown significantly over the past several years as drug chains, and food, discount and specialty retailers have entered the business. Major retail companies now operate deep discount drugstores in the most competitive retailing markets. "Combo" stores, which consist of grocery, drugstore and several other operations under the same roof, have also grown significantly over the past several years as consumers have become more attracted to one-stop shopping. Retail mass merchandisers with prescription departments have also grown in popularity. CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING STATEMENTS In this report and in the documents incorporated by reference (as well as in other public filings, press releases and oral statements made by Company management), we make forward-looking statements about future events that have not yet happened. These statements are subject to risks and uncertainties. Forward-looking statements include information concerning: - - our future results of operations, cost savings and synergies following the Revco and Arbor mergers; - - our ability to elevate the performance level of Revco stores following the Revco merger; - - our ability to continue to achieve significant sales growth; - - our belief that we can continue to improve operating performance by relocating existing in-line stores to freestanding locations; - - our ability to continue to reduce selling, general and administrative expenses as a percentage of net sales; and - - the ability of the Company and our key vendors and suppliers to successfully manage issues presented by the Year 2000. In addition, statements that include the words "believes", "expects", "anticipates", "intends", "estimates" or similar expressions are forward-looking statements. For all of these statements, we claim the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995. You should understand that the following important factors, in addition to those discussed elsewhere in this report and in the documents which are incorporated by reference (and in our other public filings, press releases and oral statements made by Company management), could affect the future results of CVS and could cause those results to differ materially from those expressed in the forward-looking statements: WHAT FACTORS COULD AFFECT THE OUTCOME OF OUR FORWARD-LOOKING STATEMENTS? 8 INDUSTRY AND MARKET FACTORS - - changes in economic conditions generally or in the markets served by CVS; - - future federal and/or state regulatory and legislative actions affecting CVS and/or the chain drugstore industry; consumer preferences and spending patterns; - - competition from other drugstore chains, from alternative distribution channels such as supermarkets, membership clubs, mail order companies and internet companies (e-commerce) and from other third party plans; and - - the continued efforts of health maintenance organizations, managed care organizations, pharmacy benefit management companies and other third party payors to reduce prescription drug costs. OPERATING FACTORS - - our ability to combine the businesses of CVS, Revco and Arbor and maintain current operating performance levels during the integration period(s) and the challenges inherent in diverting the Company's management focus and resources from other strategic opportunities and from operational matters for an extended period of time during the integration process(es); - - our ability to implement new computer systems and technologies; - - our ability to continue to secure suitable new store locations on favorable lease terms as we seek to open new stores and relocate a portion of our existing store base to freestanding locations; - - the creditworthiness of the purchasers of former businesses whose store leases are guaranteed by CVS as described under Item 2. "Properties" below; - - our ability to continue to purchase inventory on favorable terms; - - our ability to attract, hire and retain suitable pharmacists and management personnel; - - our ability to establish effective promotional and pricing strategies in the different geographic markets in which we operate; and - - our relationships with suppliers. ITEM 2. PROPERTIES We lease most of our stores under long-term leases that vary as to rental amounts and payments, expiration dates, renewal options and other rental provisions. We do not think that any individual store lease is significant in relation to our overall business. For additional information on the amount of our rental obligations for retail store leases, see Note 6 of "Notes to Consolidated Financial Statements" of our 1998 Annual Report to Shareholders that is set forth in Part IV: Item 14(A) of this Form 10-K/A. Our stores are supported by 10 owned distribution centers, which are located in Rhode Island, New Jersey, Virginia, Indiana, Alabama, Pennsylvania, Tennessee, North Carolina, South Carolina and Michigan. These distribution centers contain an aggregate of approximately 5,400,000 square feet. In addition, we lease additional space near our distribution centers to handle certain distribution needs. We own our corporate headquarters, located in three buildings in Woonsocket, Rhode Island, which contain an aggregate of approximately 345,000 square feet. Additionally, a fourth headquarters building, expected to contain approximately 207,000 square feet, is currently under construction on a site adjacent to our existing corporate headquarters. We also lease approximately 352,000 square feet in seven office buildings in Rhode Island and Massachusetts. In addition, in connection with certain business dispositions completed between 1991 and 1997, we continue to guarantee lease obligations for approximately 1,600 former stores. We are indemnified for these guarantee obligations by the respective purchasers. These guarantees generally remain in effect for the initial lease term and any extension thereof pursuant to a renewal option provided for in the lease prior to the time of the disposition. Assuming that each respective purchaser became insolvent, an event which we believe to be highly unlikely, management estimates that it could settle these obligations for approximately $1.1 billion as of December 31, 1998. 9 ITEM 3. LEGAL PROCEEDINGS From time to time, the Company and its subsidiaries are involved in the assertion of claims and in litigation incidental to the normal course of business. In the opinion of management and our independent counsel, we do not believe that any existing claims or litigation will have a material adverse effect on our consolidated financial condition, results of operations or future cash flows. CVS is a party to two lawsuits that have been filed against various pharmaceutical manufacturers and wholesalers. The first lawsuit, IN RE BRAND NAME PRESCRIPTION DRUGS ANTITRUST LITIGATION, is a class action that was consolidated in 1994 in the U.S. District Court for the Northern District of Illinois, Eastern Division. The class plaintiffs of the suit, approximately 40,000 retail pharmacy operators, allege that approximately twenty defendant manufacturers and wholesalers conspired to fix and/or stabiliz the price of the prescription drugs sold to retail pharmacies in violation of the Sherman Antitrust Act. CVS is a member of the plaintiff class. The relief sought includes unspecified money damages and injunctive relief. With respect to this suit, approximately fifteen defendants have agreed to settlements totaling $720 million. The class plaintiffs were not able to reach settlements with the four remaining defendants, namely Forest Laboratories, G.D. Searle & Co., Johnson & Johnson and Novartis. As a result, a trial on the claims was commenced in September 1998. The trial resulted in a directed verdict in favor of the remaining four defendants, which was entered by the Court on November 30, 1998. With the exception of one claim, the U.S. Court of Appeals for the Seventh Circuit has affirmed the directed verdict. The exception was remanded back to the U.S. District Court for the Northern District of Illinois, Eastern Division for further proceedings, which have not yet been scheduled. The second lawsuit, RITE-AID CORPORATION, ET AL. VS. ABBOTT LABORATORIES, ET AL., was filed by individual chain pharmacies, including Revco D.S., Inc. The suit was filed in the U.S. District Court for the Middle District of Pennsylvania in October 1993. The suit alleges unlawful price discrimination by approximately 15 defendant drug manufacturers and wholesalers against approximately 17 retail pharmacy operators, in violation of the Robinson-Patman Act, and also asserts a conspiracy in violation of the Sherman Act. The relief sought includes unspecified money damages and injunctive relief. A few settlements have been reached to date and the case is expected to go to trial by no earlier than the latter part of 1999. 10 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of security holders during the fourth quarter of the year ended December 31, 1998. EXECUTIVE OFFICERS OF THE REGISTRANT The following is an unnumbered Item in Part I of this report.
- ------------------------------------------------------------------------------------------------------------------------- NAME AND CURRENT POSITION Five-Year Business History Age - ------------------------------------------------------------------------------------------------------------------------- CHARLES C. CONAWAY Executive Vice President and Chief Financial Officer of 38 Executive Vice President and Chief CVS Corporation since July 1996; Executive Vice President and Financial Officer, CVS Corporation and Chief Financial Officer of CVS Pharmacy, Inc. since February CVS Pharmacy, Inc. 1995; Senior Vice President - Pharmacy of CVS Pharmacy, Inc., September 1992 - February 1995 - ------------------------------------------------------------------------------------------------------------------------- STANLEY P. GOLDSTEIN Chairman of the Board of CVS Corporation since January 1987; 64 Chairman of the Board, CVS Corporation Chief Executive Officer of CVS Corporation, October 1996 - May 1998; President and Chief Executive Officer of Melville Corporation, January 1987 - October 1996 - ------------------------------------------------------------------------------------------------------------------------- ROSEMARY MEDE Vice President of CVS Corporation and Senior Vice President - 52 Vice President, CVS Corporation Human Resources of CVS Pharmacy, Inc. since October 1997; Vice Senior Vice President - Human Resources, President/General Manager of Business Services, Becton Dickinson CVS Pharmacy, Inc. & Co., December 1995 - September 1997; Various management positions in human resources, Becton Dickinson & Co., 1998 - November 1995 - ------------------------------------------------------------------------------------------------------------------------- LARRY J. MERLO Vice President of CVS Corporation since October 1996; Executive 43 Vice President, CVS Corporation Vice President - Stores of CVS Pharmacy, Inc. since March 1998; Executive Vice President - Stores, Senior Vice President - Stores of CVS Pharmacy, Inc., January 1994 CVS Pharmacy, Inc. - March 1998 - ------------------------------------------------------------------------------------------------------------------------- DANIEL C. NELSON Vice President of CVS Corporation since October 1996; Executive 49 Vice President, CVS Corporation Vice President - Marketing of CVS Pharmacy, Inc., since Executive Vice President - Marketing, September 1993 CVS Pharmacy, Inc. - -------------------------------------------------------------------------------------------------------------------------- THOMAS M. RYAN President and Chief Executive Officer of CVS Corporation since 46 President and Chief Executive May 1998; Vice Chairman and Chief Operating Officer of CVS Officer, CVS Corporation and Corporation, October 1996 - May 1998; President and Chief CVS Pharmacy, Inc. Executive Officer of CVS Pharmacy, Inc. since January 1994; Executive Vice President - Stores of CVS Pharmacy, Inc., January 1990 - January 1994 - -------------------------------------------------------------------------------------------------------------------------- DOUGLAS A. SGARRO Vice President of CVS Corporation and Senior Vice President - 39 Vice President, CVS Corporation Administrative and Chief Legal Officer of CVS Pharmacy, Inc. Senior Vice President - since September 1997; Partner in the New York City office of the Administration and Chief Legal law firm of Brown & Wood LLP, January 1993 - August 1997 Officer, CVS Pharmacy, Inc. - -------------------------------------------------------------------------------------------------------------------------- LARRY D. SOLBERG Vice President of CVS Corporation since October 1996; Senior 51 Vice President and Controller, Vice President - Finance and Controller of CVS Pharmacy, Inc. CVS Corporation since March 1996; Vice President and Controller of CVS Pharmacy, Senior Vice President - Inc., October 1994 - March 1996; Senior Vice President of PIMMS Finance and Controller, CVS Corp., September 1993 - October 1994 Pharmacy, Inc. - --------------------------------------------------------------------------------------------------------------------------
In each case, the individual's term of office extends to the date of the board of directors meeting following the next annual meeting of CVS stockholders. In addition to the office(s) which they hold in CVS Corporation and CVS Pharmacy, Inc. as shown above, each of the individuals listed holds various offices in certain CVS subsidiaries. 11 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The information required by this item is included in our 1998 Annual Report to Shareholders under the caption "Quarterly Financial Information," and is incorporated into this report by reference. Since October 16, 1996, the common stock of the Company has been listed on the New York Stock Exchange under the symbol "CVS." As of February 22, 1999, the record date for the 1999 Annual Meeting of Stockholders, there were 10,500 CVS stockholders of record. On May 13, 1998, the Company's stockholders approved an increase in the number of authorized common shares from 300 million to one billion. Also on that date, the Board of Directors authorized a two-for-one common stock split, which was effected by the issuance of one additional share of common stock for each share of common stock outstanding on May 25, 1998. All share and per share amounts were restated to reflect the effect of the stock split. ITEM 6. SELECTED FINANCIAL DATA
=================================================================================================================================== As Restated As Restated In millions, except per share amounts 1998(1) 1997(1) 1996 1995 1994 - ----------------------------------------------------------------------------------------------------------------------------------- STATEMENT OF OPERATIONS:(5) Net sales $15,273.6 $13,749.6 $11,831.6 $10,513.1 $ 9,469.1 Gross margin(2) 4,129.2 3,718.3 3,300.9 2,960.0 2,707.3 Selling, general & administrative 2,949.0 2,776.0 2,490.8 2,336.4 2,121.0 Depreciation and amortization 249.7 238.2 205.4 186.4 169.5 Merger, restructuring and other nonrecurring charges 178.6 422.4 12.8 165.5 -- - ----------------------------------------------------------------------------------------------------------------------------------- Operating profit(3) 751.9 281.7 591.9 271.7 416.8 Other expense (income), net 60.9 44.1 (51.5) 114.0 86.6 Income tax provision 306.5 149.2 271.0 74.3 144.3 - ----------------------------------------------------------------------------------------------------------------------------------- Earnings from continuing operations before extraordinary item(4) $ 384.5 $ 88.4 $ 372.4 $ 83.4 $ 185.9 =================================================================================================================================== PER COMMON SHARE DATA: Earnings from continuing operations before extraordinary item:(4) Basic $ 0.96 $ 0.20 $ 0.98 $ 0.18 $ 0.47 Diluted 0.95 0.19 0.95 0.18 0.47 Cash dividends per common share 0.2250 0.2200 0.2200 0.7600 0.7600 =================================================================================================================================== FINANCIAL POSITION AND OTHER DATA: Total assets $ 6,686.2 $ 5,920.5 $ 6,014.9 $ 6,614.4 $ 7,202.9 Total long-term debt 275.7 290.4 1,204.8 1,056.3 1,012.3 Total shareholders equity 3,110.6 2,626.5 2,413.8 2,567.4 3,341.4 Number of stores (at end of period) 4,122 4,094 4,204 3,715 3,617 ===================================================================================================================================
(1) The selected financial data as of December 31, 1997 and for the years ended December 31, 1998 and 1997 has been restated. Please read Notes 15 and 16 to the consolidated financial statements for additional information. (2) Gross margin includes the pre-tax effect of the following nonrecurring charges: (i) in 1998, $10.0 million ($5.9 million after-tax) related to the markdown of noncompatible Arbor merchandise and (ii) in 1997, $75.0 million ($49.9 million after-tax) related to the markdown of noncompatible Revco merchandise. (3) Operating profit includes the pre-tax effect of the charges discussed in Note (2) above and the following merger, restructuring and other nonrecurring charges: (i) in 1998, $147.3 million ($101.3 million after-tax) related to the merger of CVS and Arbor and $31.3 million ($18.4 million after-tax) of nonrecurring costs incurred in connection with eliminating Arbor's information technology systems and Revco's noncompatible store merchandise fixtures, (ii) in 1997, $337.1 million ($229.8 million after-tax) related to the merger of CVS and Revco, $54.3 million ($32.0 million after-tax) million of nonrecurring costs incurred in connection with eliminating Revco's information technology systems and noncompatible store merchandise fixtures and $31.0 million ($19.1 million after-tax) related to the restructuring of Big B, Inc., (iii) in 1996, $12.8 million ($6.5 million after-tax) related to the write-off of costs incurred in connection with the failed merger of Rite Aid Corporation and Revco and (iv) in 1995, $165.5 million ($97.7 million after-tax) related to the Company's strategic restructuring program and the early adoption of SFAS No. 121, and $49.5 million ($29.1 million after-tax) related to the Company changing its policy from capitalizing internally developed software costs to expensing the costs as incurred, outsourcing information technology functions and retaining former employees until their respective job functions were transitioned. 12 (4) Earnings from continuing operations before extraordinary item and earnings per common share from continuing operations before extraordinary item include the after-tax effect of the charges discussed in Notes (2) and (3) above and a $121.4 million ($72.1 million after-tax) gain realized during 1996 upon the sale of equity securities received from the sale of Marshalls. (5) Prior to the mergers, Arbor's fiscal year ended on July 31 and Revco's fiscal year ended on the Saturday closest to May 31. In recording the business combinations, Arbor's and Revco's historical stand-alone consolidated financial statements have been restated to a December 31 year-end, to conform to CVS' fiscal year-end. As permitted by the rules and regulations of the Securities and Exchange Commission, Arbor's fiscal year ended July 31, 1995 and Revco's fiscal year ended June 3, 1995 have been combined with CVS' fiscal year ended December 31, 1994. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS We strongly recommend that you read our accompanying audited consolidated financial statements and footnotes along with this important discussion and analysis. RECENT DEVELOPMENT On May 11, 1999, CVS filed a registration statement with the Securities and Exchange Commission related to an exchange offer for the $300 million of debt securities that CVS sold in a private placement on February 11, 1999. In connection with the SEC's review of that registration statement, CVS has restated its consolidated financial statements for 1997 and 1998 to reflect the effect of the adjustments discussed in Notes 15 and 16 to the consolidated financial statements. As a result of the restatement, earnings from continuing operations increased $11.9 million (or $0.03 per diluted common share) in 1997 and decreased $11.9 million (or $0.03 per diluted common share) in 1998. What should investors and analysts know about the restatement? - - The restatement simply shifted non-recurring costs that were related to the CVS/Arbor and CVS/Revco mergers between quarters in 1997 and 1998. The restatement had no effect on the two years when viewed together. - - The restatement has no effect on 1999 or future years. - - The restatement has no effect on historical cash flows or future cash flow requirements. - - The restatement has no effect on earnings from continuing operations before merger, restructuring and other nonrecurring charges. Accordingly, we believe the restatement should not affect the financial models of analysts and investors. The following discussion and analysis has been revised to reflect the effect of the restatement. Please read Notes 15 and 16 to the consolidated financial statements for additional information. INTRODUCTION 1998 was an excellent year for CVS. We are pleased to report that despite the significant challenges our company faced in integrating the operations of Arbor Drugs, Inc. and Revco D.S., Inc., we achieved another record year in terms of net sales, operating profit and diluted earnings per share, excluding the effect of the nonrecurring charges and gain. Our strong performance in 1998 translated into a 72.7% return to our shareholders. This compares to a total return of 18.1% for the Dow Jones Industrial Average and 28.6% for the S&P 500. While we are extremely proud of this accomplishment, we cannot guarantee that our future performance will result in similar returns to shareholders. Our total market capitalization grew to more than $21 billion at December 31, 1998. As a result of the significant increase in our stock price, on May 13, 1998, the Board of Directors approved a two-for-one common stock split, effective June 15, 1998. At that time, the Board also approved an increase in our annual post-split cash dividend to $0.23 per share, underscoring their continued optimism in our prospects for future growth. MERGERS As you review our consolidated financial statements and footnotes, you should carefully consider the impact of the following merger transactions and the nonrecurring charges that we recorded: CVS/ARBOR MERGER On March 31, 1998, we completed a merger with Arbor pursuant to which 37.8 million shares of CVS common stock were exchanged for all the outstanding common stock of Arbor. We also converted Arbor's stock options into options to purchase 5.3 million shares of our common stock. The merger of CVS and Arbor was a tax-free reorganization, which we treated as a pooling of interests under Accounting Principles Board Opinion No. 16, "Business Combinations." Accordingly, we have restated our historical consolidate financial statements and footnotes to include Arbor as if it had always been owned by CVS. The merger with Arbor made us the market share leader in metropolitan Detroit, the nation's fourth largest retail drugstore market, and strengthened our position as the nation's top drugstore retailer in terms of store count and retail prescriptions dispensed. We believe that we can achieve cost savings from the combined operations of approximately $30 million annually. This will come primarily from closing Arbor's corporate headquarters, achieving economies of scale in advertising, distribution and other operational areas, and spreading our investment in information technology over a larger store base. Please read the "Cautionary Statement Concerning Forward-Looking Statements" section below. CVS/REVCO MERGER On May 29, 1997, we completed a merger with Revco pursuant to which 120.6 million shares of CVS common stock were exchanged for all the outstanding common stock of Revco. We also converted Revco's stock options into options to purchase 6.6 million shares of our common stock. The merger of CVS and Revco was also a tax-free reorganization that we treated as a pooling of interests. Accordingly, we have restated our historical consolidated financial statements and footnotes to include Revco as if it had alway been owned by CVS. 13 The merger with Revco was a milestone event for our company in that it more than doubled our revenues and made us the nation's number one drugstore retailer in terms of store count. The merger brought us into high-growth, contiguous markets in the Mid-Atlantic, Southeast and Midwest regions of the United States. MERGER CHARGES During the second quarter of 1998, we recorded a $147.3 million charge to operating expenses for direct and other merger-related costs pertaining to the CVS/Arbor merger transaction and related restructuring activities. At that time, we also recorded a $10.0 million charge to cost of goods sold to reflect markdowns on noncompatible Arbor merchandise. During the second quarter of 1997, we recorded a $337.1 million charge to operating expenses for direct and other merger-related costs pertaining to the CVS/Revco merger transaction and related restructuring activities. At that time, we also recorded a $75.0 million charge to cost of goods sold to reflect markdowns on noncompatible Revco merchandise. INTEGRATION UPDATE We are pleased to report that the integration of Arbor is well underway. We have already converted Arbor to CVS' accounting and store systems and closed the Troy, Michigan corporate headquarters facility. With respect to merger synergies, we achieved approximately $20 million of cost savings in 1998 and we believe we are on track to realize at least $30 million of cost savings in 1999 from the Arbor merger. Please read the "Cautionary Statement Concerning Forward-Looking Statements" section below. We are further pleased to report that the integration of Revco is now complete and we have accomplished our goal of achieving at least $100 million of annual cost savings from the Revco merger. WHERE YOU CAN FIND MORE INFORMATION ABOUT THE MERGERS Please read the "Results of Operations" and "Cautionary Statement Concerning Forward-Looking Statements" sections below and Notes 2, 3, 15 and 16 to the consolidated financial statements for other important information about the mergers and the nonrecurring charges that we recorded. RESULTS OF OPERATIONS NET SALES increased 11.1% in 1998 to $15.3 billion. This compares to increases of 16.2% in 1997 and 12.5% in 1996. Same store sales, consisting of sales from stores that have been open for more than one year, rose 10.8% in 1998, 9.7% in 1997 and 8.9% in 1996. Pharmacy same store sales increased 16.5% in 1998, 16.5% in 1997 and 13.5% in 1996. Our pharmacy sales as a percentage of total sales were 58% in 1998, 55% in 1997 and 52% in 1996. Our third party prescription sales as a percentage of total pharmacy sales were 84% in 1998, 81% in 1997 and 80% in 1996. As you review our sales performance, we believe you should consider the following important information: - - Our pharmacy sales growth continued to benefit from our ability to attract and retain managed care customers, our ongoing program of purchasing prescription files from independent pharmacies and favorable industry trends. These trends include an aging American population; many "baby boomers" are now in their fifties and are consuming a greater number of prescription drugs. The increased use of pharmaceuticals as the first line of defense for healthcare and the introduction of a number of successful new prescription drugs also contributed to the growing demand for pharmacy services. - - Our front store sales growth was driven by solid performance in categories such as cosmetics, private label, seasonal, vitamins/nutrition, greeting cards, skin care, film and photofinishing, and convenience foods. - - The increase in net sales in 1998 was positively affected by our efforts to improve the performance of the Revco stores. To do this, we converted the retained Revco stores to the CVS store format and relocated certain stores. We are pleased to report that we are seeing improvements, especially in front store sales. However, the improved performance has been aided by temporary promotional events and the rate of progress has varied. We expect it to continue to vary, on a market-by-market basis. - - The increase in net sales in 1997 was positively affected by our acquisition of Big B, Inc., effective November 16, 1996. Excluding the positive impact of the Big B acquisition, net sales increased 11.3% in 1997 when compared to 1996. Please read Note 2 and Note 3 to the consolidated financial statements for other important information about the Big B acquisition. 14 - - We have an active program in place to relocate our existing shopping center stores to larger, more convenient, freestanding locations. Historically, we have achieved significant improvements in customer count and net sales when we do this. The resulting increase in net sales has typically been driven by an increase in front store sales, which normally have a higher gross margin. We believe that our relocation program offers a significant opportunity for future growth, as 23% of our existing stores are freestanding. We currently expect to have 35% of our stores in freestanding locations by the end of 1999. Our long-term goal is to have 70-80% of our stores located in freestanding sites. We cannot, however, guarantee that future store relocations will deliver the same results as those historically achieved. Please read the "Cautionary Statement Concerning Forward-Looking Statements" section below. GROSS MARGIN as a percentage of net sales was 27.0% in 1998. This compares to 27.0% in 1997 and 27.9% in 1996. Inventory shrinkage totaled $120 million or 0.79% of sales in 1998. This compares to 0.78% of sales in 1997 and 0.93% of sales in 1996. As you review our gross margin performance, please remember to consider the impact of the $10.0 million charge we recorded in 1998 to reflect markdowns on noncompatible Arbor merchandise and the $75.0 million charge we recorded in 1997 to reflect markdowns on noncompatible Revco merchandise. If you exclude the effect of these nonrecurring charges, our comparable gross margin as a percentage of net sales was 27.1% in 1998, 27.6% in 1997 and 27.9% in 1996. Why has our comparable gross margin rate been declining? - - Pharmacy sales are growing at a faster pace than front store sales. On average, our gross margin on pharmacy sales is lower than our gross margin on front store sales. - - Sales to customers covered by third party insurance programs have continued to increase and, thus, have become a larger part of our total pharmacy business. Our gross margin on third party sales has continued to decline largely due to the efforts of managed care organizations and other pharmacy benefit managers to reduce prescription drug costs. To address this trend, we have dropped a number of third party programs that fell below our minimum profitability standards. In the event this trend continues and we elect to drop additional programs and/or decide not to participate in future programs that fall below our minimum profitability standards, we may not be able to sustain our current rate of sales growth. TOTAL OPERATING EXPENSES were 22.1% of net sales in 1998. This compares to 25.0% in 1997 and 22.9% in 1996. As you review our performance in this area, please remember to consider the impact of the following nonrecurring charges: - - During 1998, we recorded the $147.3 million charge associated with the Arbor merger. In addition, we incurred $31.3 million of nonrecurring costs in connection with eliminating Arbor's information technology systems and Revco's noncompatible store merchandise fixtures. Please read Notes 3, 15 and 16 to the consolidated financial statements for other important information about these charges and costs. - - During 1997, we recorded the $337.1 million charge associated with the Revco merger. In addition, we incurred $54.3 million of nonrecurring costs in connection with eliminating Revco's information technology systems and removing Revco's noncompatible store merchandise fixtures. We also recorded a $31.0 million charge for certain costs associated with the restructuring of Big B. Please read Notes 3, 15 and 16 to the consolidated financial statements for other important information about these charges and costs. - - During 1996, Revco recorded a $12.8 million charge when Rite Aid Corporation announced that it had withdrawn its tender offer to acquire Revco. This event took place before we merged with Revco. If you exclude the effect of these nonrecurring charges, comparable total operating expenses as a percentage of net sales were 20.9% in 1998, 21.9% in 1997 and 22.8% in 1996. 15 What have we done to improve our comparable total operating expenses as a percentage of net sales? - - We eliminated most of Arbor's existing corporate overhead in 1998 and most of Revco's in 1997. - - Our strong sales performance has consistently allowed our net sales to grow at a faster pace than total operating expenses. - - Our information technology initiatives have led to greater productivity, which has resulted in lower operating costs and improved sales. Our major IT initiatives include: Supply Chain Management, Rx2000 Pharmacy Delivery Project, and Rapid Refill. As a result of combining the operations of CVS, Arbor and Revco, we were able to achieve substantial annual operating cost savings in 1998 and 1997. Although we are extremely proud of this accomplishment, we strongly advise you not to rely on the resulting operating expense improvement trend to predict our future performance. OPERATING PROFIT increased $470.2 million to $751.9 million in 1998. This compares to $281.7 million in 1997 and $591.9 million in 1996. If you exclude the effect of the nonrecurring charges we recorded in gross margin and total operating expenses, our comparable operating profit increased $161.4 million (or 20.7%) to $940.5 million in 1998. This compares to $779.1 million in 1997 and $604.7 million in 1996. Comparable operating profit as a percentage of net sales was 6.2% in 1998, 5.7% in 1997 and 5.1 in 1996. OTHER EXPENSE (INCOME), NET consisted of the following for the years ended December 31:
=================================================================================== In millions 1998 1997 1996 - ----------------------------------------------------------------------------------- Gain on sale of securities $ -- $ -- $(121.4) Dividend income -- -- (5.6) Interest expense 69.7 59.1 84.7 Interest income (8.8) (15.0) (9.2) Other expense (income), net $ 60.9 $ 44.1 $ (51.5) ===================================================================================
During 1998, our other expense (income), net increased $16.8 million due to higher interest expense and lower interest income. Our interest expense increased because we maintained higher average borrowing levels during 1998 to finance, in part, additional inventory. You should be aware that we purchased the additional inventory to support several initiatives. First we converted the Revco stores to the CVS merchandise mix. We also held promotional name change events in most Revco markets and realigned our stores and distribution centers. In order to properly support these important initiatives, we decided to temporarily increase our inventory levels during 1998. We believe that our inventory levels were back to "normal" at December 31, 1998. During 1997, our other expense (income), net increased $95.6 million to a net other expense of $44.1 million from a net other income of $51.5 million in 1996. As you review this change, you should consider the impact of the following information: - - During 1997, we recognized interest income on a note receivable that we received when we sold Kay-Bee Toys in 1996. This note was sold in 1997. We also had lower interest expense in 1997 because we retired most of the higher interest rate debt we absorbed as part of the CVS/Revco Merger. - - During 1996, we recognized a $121.4 million gain when we sold certain equity securities that we received when we sold Marshalls in 1995. INCOME TAX PROVISION - Our effective income tax rate was 44.4% in 1998. This compares to 62.8% in 1997 and 42.1% in 1996. Our effective income tax rates were higher in 1998 and 1997 because certain components of the charges we recorded in conjunction with the CVS/Arbor and CVS/Revco merger transactions were not deductible for income tax purposes. 16 EARNINGS FROM CONTINUING OPERATIONS BEFORE EXTRAORDINARY ITEM increased $296.1 million to $384.5 million (or $0.95 per diluted share) in 1998. This compares to $88.4 million (or $0.19 per diluted share) in 1997 and $372.4 million (or $0.95 per diluted share) in 1996. If you exclude the effect of the nonrecurring charges we recorded in cost of goods sold and total operating expenses and the gain on sale of securities included in other expense (income), net, our comparable earnings from continuing operations before extraordinary item increased 21.7% to $510.1 million (or $1.26 per diluted share) in 1998. This compares to $419.2 million (or $1.05 per diluted share) in 1997 and $306.8 million (or $0.78 per diluted share) in 1996. 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 Bob's 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. As part of completing this program, we recorded an after-tax charge of $20.7 million during the second quarter of 1997 and $148.1 million during the second quarter of 1996 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 the second quarter of 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 $384.5 million (or $0.95 per diluted share) in 1998. This compares to $88.8 million (or $0.19 per diluted share) in 1997 and $208.2 million (or $0.52 per diluted share) in 1996. LIQUIDITY & CAPITAL RESOURCES LIQUIDITY ~ The Company has three primary sources of liquidity: cash provided by operations, commercial paper and uncommitted lines of credit. Our commercial paper program is supported by a $670 million, five-year unsecured revolving credit facility that expires on May 30, 2002 and a $460 million, 364 day unsecured revolving credit facility that expires on June 26, 1999. Our credit facilities contain customary financial and operating covenants. We believe that the restrictions contained in these covenants do not materially affect our financial or operating flexibility. We can also obtain up to $35.0 million of short-term financing through various uncommitted lines of credit. As of December 31, 1998, we had $736.6 million of commercial paper outstanding at a weighted average interest rate of 5.8% and $34.5 million outstanding under our uncommitted lines of credit at a weighted average interest rate of 4.8%. During 1998, net cash provided by operations increased $326.8 million to $221.0 million. This compares to net cash used in operations of $105.8 million in 1997 and net cash provided by operations of $327.2 million in 1996. The improvement in 1998 was primarily the result of higher net earnings. During 1997, cash flow from operations was negatively impacted by an increase in inventory and by payments associated with the Revco merger. 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 Company's strategic restructuring program. As of December 31, 1998, the future cash payments associated with these programs totaled $152.9 million. These payments primarily include: (i) $19.1 million for employee severance, which extends through 2000, (ii) $11.3 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) $119.1 million for continuing lease obligations, which extend through 2020. CAPITAL RESOURCES ~ With a total debt to capitalization ratio of 25.4% at December 31, 1998, we are pleased to report that our financial condition remained strong at year-end. 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 1999. 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 twelve months. Please read the "Cautionary Statement Concerning Forward-Looking Statements" section below. 17 CAPITAL EXPENDITURES Our capital expenditures totaled $502.3 million in 1998. This compares to $341.6 million in 1997 and $328.9 million in 1996. During 1998, we opened 184 new stores, relocated 198 existing stores and closed 156 stores. During 1999, we expect that our capital expenditures will total approximately $450-$500 million. This currently includes a plan to open 140 new stores, relocate 300 existing stores and close 130 stores. As of December 31, 1998, we operated 4,122 stores in 24 states and the District of Columbia. This compares to 4,094 stores as of December 31, 1997. GOODWILL In connection with various acquisitions which were accounted for as purchase transactions, we recorded goodwill, which represented the excess of the purchase price we paid over the fair value of the net assets we acquired. The goodwill we recorded in these transactions is being amortized on a straight-line basis, generally over periods of 40 years. We evaluate goodwill for impairment whenever events or changes in circumstances suggest that the carrying amount may not be recoverable. Under these conditions, we would compare our estimated undiscounted future cash flows to our carrying amounts. If our carrying amounts exceeded our expected undiscounted future cash flows, we would consider the goodwill to be impaired and we would record an impairment loss. We do not currently believe that any of our goodwill is impaired. RECENT ACCOUNTING PRONOUNCEMENTS In March 1998, the American Institute of Certified Public Accountants issued Statement of Position 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use," effective for fiscal years beginning after December 15, 1998. This statement defines which costs incurred to develop or purchase internal-use software should be capitalized and which costs should be expensed. We are in the process of determining what impact, if any, this pronouncement will have on our consolidated financial statements. 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 requires companies to record derivative instruments on their balance sheet at fair value and establishes new accounting practices for hedge instruments. This statement is effective for years beginning after June 15, 1999. We are in the process of determining what impact, if any, this pronouncement will have on our consolidated financial statements. DISCRIMINATORY PRICING LITIGATION AGAINST DRUG MANUFACTURERS AND WHOLESALERS The Company is a party to two lawsuits which have been filed against various pharmaceutical manufacturers and wholesalers: - - The first lawsuit is a class action that alleges that manufacturers and wholesalers conspired to fix and/or stabilize the price of the prescription drugs sold to retail pharmacies in violation of the Sherman Antitrust Act. In this lawsuit, CVS is a member of the plaintiff class. - - The second lawsuit was filed by individual chain pharmacies, including Revco, as plaintiffs. This lawsuit alleges unlawful price discrimination against retail pharmacies by manufacturers and wholesalers in violation of the Robinson-Patman Act, and asserts a conspiracy in violation of the Sherman Act. CVS became a party to this lawsuit when it acquired Revco. With respect to the first lawsuit, fifteen defendants have agreed to settlements totaling $720 million. The class plaintiffs were not able to reach settlements with the four remaining defendants. As a result, a trial of the claims was commenced in September 1998. The trial resulted in a directed verdict in favor of the remaining defendents. The court has yet to approve a formula for distributing the settlement proceeds to class members. While we believe that our portion of the distribution could be significant, we cannot predict an exact dollar amount at this time. With respect to the second lawsuit, a few settlements have been reached to date and the case is expected to go to trial in the latter part of 1999. Our portion of any settlement or judgment in this lawsuit could also be significant, but we cannot predict an exact dollar amount at this time. 18 YEAR 2000 COMPLIANCE STATEMENT The "Year 2000 Issue" relates to the inability of certain computer hardware and software to properly recognize and process date-sensitive information for the Year 2000 and beyond. Without corrective measures, our computer applications could fail and/or produce erroneous results. To address this concern, we have a work plan in place to identify the potential issues that could affect our business. The following discussion will provide you with an update on where we stand on this important matter. INFORMATION TECHNOLOGY ("IT") SYSTEMS - We have completed the assessment phase for each of our critical information technology systems. Our IT business systems include point-of-sale, Rx2000 pharmacy, supply chain management, financial accounting and other corporate office systems. To date, we have modified or replaced approximately 85% of our critical IT business systems. We currently expect to modify or replace the remaining critical business systems by the end of the second quarter of 1999 and complete our systems testing by the end of the third quarter of 1999. NON-IT SYSTEMS - We are currently in the process of completing the assessment phase for each of our critical non-IT business systems, including those with embedded chip technology. Our non-IT business systems include distribution center logistics, HVAC, energy management, facility alarms and key entry systems. To date, we have modified or replaced approximately 30% of our critical non-IT business systems. We currently expect to modify or replace the remaining critical non-IT business systems and complete our systems testing by the end of the third quarter of 1999. BUSINESS PARTNERS - As part of our project work plan, we have been communicating with our key business partners, including our vendors, suppliers, financial institutions, managed care organizations, pharmacy benefit managers, third party insurance programs and governmental agencies to determine the status of their Year 2000 compliance programs. As part of our communication program, we required each of our key business partners to complete a Year 2000 readiness questionnaire. To date, approximately 90% of our business partners have responded, most of which have indicated that their ability to supply us will not be affected by the Year 2000 issue. We expect to complete our communications program during the third quarter of 1999. Should one or more of our critical business partners become unable to deliver the merchandise or services we require, we can often obtain similar merchandise or services from other sources. Because we are relying on information provided to us by outside parties, we cannot provide assurance that the information we receive is either complete or accurate. Therefore, we cannot provide assurance that we will not be adversely affected by the Year 2000 issues of our business partners. However, we believe that ongoing communication will continue to minimize our risk. POTENTIAL RISKS - The potential risks associated with failing to remediate our Year 2000 issues include: temporary disruptions in store operations; temporary disruptions in the ordering, receiving and shipping of merchandise and in the ordering and receiving of other goods and services; temporary disruptions in the billing and collecting of accounts receivable; temporary disruptions in services provided by banks and other financial institutions; temporary disruptions in communication services; and temporary disruptions in utility services. INCREMENTAL COST -We currently estimate that the incremental cost associated with completing our Year 2000 work plan will be approximately $10 million, about half of which had been incurred through December 31, 1998. This estimate could change as additional information becomes available. The cost to resolve our Year 2000 issues will be funded through our operating cash flows. CONTINGENCY PLAN - We are currently in the process of developing a contingency plan for each area in our organization that could be affected by the Year 2000 issue. We anticipate that our contingency plan will be completed during the third quarter of 1999. Although we currently anticipate minimal business disruption, the failure of either the Company or one or more of our major business partners to remediate critical Year 2000 issues could have a materially adverse impact on our business, operations and financial condition. Please read the "Cautionary Statement Concerning Forward Looking Statements" section below. 19 CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING STATEMENTS We have made forward-looking statements in this Annual Report that are subject to risks and uncertainties. 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 Part I: Item 1 of this Annual Report on Form 10-K/A. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We have not entered into any transactions using derivative financial instruments or derivative commodity instruments and we do not believe that there is any material market risk exposure with respect to other financial instruments (such as fixed and variable rate borrowings), which would require disclosure under this Item. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The information required by this item is set forth in Item 14(A) of this Form 10-K/A. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE No events have occurred which would require disclosure under this Item. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information required by this item, with the exception of the information relating to our executive officers, which is presented in Part I under "Executive Officers of the Registrant", appears in our 1999 Proxy Statement on pages 4 through 6 and page 27 under the captions Item 1: "Biographies of our Board Nominees" and Item 5: "Section 16(a) Beneficial Ownership Reporting Compliance" and is incorporated into this report by reference. ITEM 11. EXECUTIVE COMPENSATION The information required by this item appears in our 1999 Proxy Statement on pages 7, 8 and 10 through 21 under the captions Item 1: "Director Compensation", "Compensation Committee Interlocks and Insider Participation", "Compensation Committee Report on Executive Compensation", "Summary Compensation Table", "Stock Options", "Stock Performance Graph" and "Certain Executive Arrangements" and is incorporated into this report by reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by this item appears in our 1999 Proxy Statement on pages 8 through 10 under the captions Item 1: "Share Ownership of Directors and Certain Executive Officers" and "Share Ownership of Principal Stockholders" and is incorporated into this report by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by this item appears in our 1999 Proxy Statement on page 21 under the caption Item 1: "Transactions with Directors and Officers" and is incorporated into this report by reference. 20 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K A. FINANCIAL STATEMENTS, SCHEDULES AND EXHIBITS 1. FINANCIAL STATEMENTS (AS RESTATED) The consolidated balance sheets as of December 31, 1998 and 1997 and the related consolidated statements of operations, shareholders' equity and cash flows for the years ended December 31, 1998, 1997 and 1996 and the related notes to the consolidated financial statements and Independent Auditors' Report thereon are attached hereto commencing on page 28 of this Annual Report on Form 10-K/A. 2. SCHEDULES The following schedule appears on page 26 of this report: Schedule II -- Valuation and Qualifying Accounts We did not include other financial statement schedules because they are not applicable or the information is included in the financial statements or related notes. 3. EXHIBITS Exhibits marked with an asterisk (*) are hereby incorporated by reference to exhibits or appendices previously filed by the Registrant as indicated in brackets following the description of the exhibit.
EXHIBIT DESCRIPTION - ------- ----------- 3.1* Amended and Restated Certificate of Incorporation of the Registrant [incorporated by reference to Exhibit 3.1 of CVS Corporation's Annual Report on Form 10-K for the fiscal year ended December 31, 1996]. 3.1A* Certificate of Amendment to the Amended and Restated Certificate of Incorporation, effective May 13, 1998 [incorporated by reference to Exhibit 4.1A to Registrant's Registration Statement No. 333-52055 on Form S-3/A dated May 18, 1998]. 3.2 By-laws of the Registrant, as amended and restated, [incorporated by reference to Exhibit 3.2 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1998]. 4 Pursuant to Regulation S-K, Item 601(b)(4)(iii)(A), no instrument which defines the rights of holders of long-term debt of the Registrant and its subsidiaries is filed with this report. The Registrant hereby agrees to furnish a copy of any such instrument to the Securities and Exchange Commission upon request. 4.1* Specimen common stock certificate [incorporated by reference to Exhibit 4.1 to the Registration Statement of the Registrant on Form 8-B dated November 4, 1996]. 10.1* Stock Purchase Agreement dated as of October 14, 1995 between The TJX Companies, Inc. and Melville Corporation, as amended November 17, 1995 [incorporated by reference to Exhibits 2.1 and 2.2 to Melville's Current Report on Form 8-K dated December 4, 1995]. 10.2* Stock Purchase Agreement dated as of March 25, 1996 between Melville Corporation and Consolidated Stores Corporation, as amended May 3, 1996 [incorporated by reference to Exhibits 2.1 and 2.2 to Melville's Current Report on Form 8-K dated May 5, 1996]. 10.3* Distribution Agreement dated as of September 24, 1996 among Melville Corporation, Footstar, Inc. and Footstar Center, Inc. [incorporated by reference to Exhibit 99.1 to Melville's Current Report on Form 8-K dated October 28, 1996]. 21 EXHIBIT DESCRIPTION - ------- ----------- 10.4* Tax Disaffiliation Agreement dated as of September 24, 1996 among Melville Corporation, Footstar, Inc. and certain subsidiaries named therein [incorporated by reference to Exhibit 99.2 to Melville's Current Report on Form 8-K dated October 28, 1996]. 10.5* Agreement and Plan of Merger dated as of February 6, 1997, as amended as of March 19, 1997, among the Registrant, Revco D.S., Inc. and North Acquisition, Corp. [incorporated by reference to Annex A to the Registrant's Registration Statement No. 333-24163 on Form S-4 filed March 28, 1997]. 10.6* Agreement and Plan of Merger dated as of February 8, 1998, as amended as of March 2, 1998, among the Registrant, Arbor Drugs, Inc. and Red Acquisition, Inc. [incorporated by reference to Exhibit 2 to the Registrant's Registration Statement No. 333-47193 on Form S-4 filed March 2, 1998]. 10.7* Stockholder Agreement dated as of December 2, 1996 between the Registrant, Nashua Hollis CVS, Inc. and Linens 'n Things, Inc. [incorporated by reference to Exhibit 10(i)(6) to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1997]. 10.8* Tax Disaffiliation Agreement dated as of December 2, 1996 between the Registrant and Linens 'n Things, Inc. and certain of their respective affiliates [incorporated by reference to Exhibit 10(i)(7) to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1997]. 10.9* Five Year Credit Agreement dated as of May 23, 1997 by and among the Registrant, the Lenders party thereto, Fleet National Bank, as Documentation Agent, JP Morgan Securities, Inc., as Syndication Agent; and The Bank of New York, as Administrative Agent [incorporated by reference to Exhibit 10(i)(8) to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1997]. 10.10* Note Purchase Agreement dated June 7, 1989 by and among Melville Corporation and Subsidiaries Employee Stock Ownership Plan, as Issuer, Melville Corporation, as Guarantor, and the Purchasers listed therein [incorporated by reference to Exhibit 10(i)(9) to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1997]. 10.11 (i)* 1973 Stock Option Plan [incorporated by reference to Exhibit (10)(iii)(A)(i) to Melville Corporation's Annual Report on Form 10-K for the fiscal year ended December 31, 1987]. (ii)* 1987 Stock Option Plan [incorporated by reference to Exhibit (10)(iii)(A)(iii) to Melville Corporation's Annual Report on Form 10-K for the fiscal year ended December 31, 1987]. (iii)* 1989 Directors Stock Option Plan [incorporated by reference to Exhibit B to Melville Corporation's Annual Report on Form 10-K for the fiscal year ended December 31, 1988]. (iv)* Melville Corporation Omnibus Stock Incentive Plan [incorporated by reference to Exhibit B to Melville Corporation's Annual Report on Form 10-K for the fiscal year ended December 31, 1989 and Exhibit A to Melville's definitive Proxy Statement dated March 7, 1995]. (v)* Profit Incentive Plan of Melville Corporation [incorporated by reference to Exhibit A to Melville Corporation's definitive Proxy Statement dated March 14, 1994]. (vi)* Supplemental Retirement Plan for Select Senior Management of Melville Corporation I as amended through July 1995 [incorporated by reference to Exhibit 10(iii)(A)(vii) to Melville's Annual Report on Form 10-K for the fiscal year ended December 31, 1995]. (vii)* Supplemental Retirement Plan for Select Senior Management of Melville Corporation II as amended through July 1995 [incorporated by reference to Exhibit 10(iii)(A)(viii) to Melville's Annual Report on Form 10-K for the fiscal year ended December 31, 1995]. 22 EXHIBIT DESCRIPTION - ------- ----------- (viii)* Income Continuation Policy for Select Senior Executives of Melville Corporation as amended through May 12, 1988 [incorporated by reference to Exhibit 10 (viii) to Melville's Annual Report on Form 10-K for the fiscal year ended December 31, 1994]. (ix)* Melville Corporation 1996 Directors Stock Plan [incorporated by reference to Exhibit A to Melville's definitive Proxy Statement dated March 7, 1996]. (x)* Form of Employment Agreements between the Registrant and each of Messrs. Ryan, Conaway, Nelson and Merlo [incorporated by reference to the Registrant's Annual Report on Form 10-K/A for the fiscal year ended December 31, 1996]. (xi)* Deferred Stock Compensation Plan [incorporated by reference to Exhibit 10(iii)(A)(xi) to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1997]. (xii)* 1997 Incentive Compensation Plan [incorporated by reference to Annex F to Amendment No. 1 to the Registrant's Registration Statement No. 333-24163 on Form S-4/A filed April 17, 1997]. (xiii)* Deferred Compensation Plan [incorporated by reference to Exhibit 10.1 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended June 27, 1998]. (xiv)* Partnership Equity Program [incorporated by reference to Exhibit 10.2 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended June 27, 1998]. (xv)* Form of Collateral Assignment and Executive Life Insurance Agreement between Registrant and each of Messrs. Ryan, Conaway, Nelson and Merlo, [incorporated by reference to Exhibit 10.11(xv) to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1998]. (xvi)* Consulting Agreement between CVS Corporation and Eugene Applebaum [incorporated by reference to Exhibit 99(d) to Registrant's Registration Statement No. 333-47193 on Form S-4 filed March 2, 1998]. 21* Subsidiaries of the Registrant [incorporated by reference to Exhibit 21 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1998]. 23 Consent of KPMG LLP. 27.1 Restated Financial Data Schedule -- December 31, 1998 [Filed electronically with SEC only]. 27.2 Restated Financial Data Schedule -- September 26, 1998 [Filed electronically with SEC only]. 27.3 Restated Financial Data Schedule -- June 27, 1998 [Filed electronically with SEC only]. 27.4 Restated Financial Data Schedule -- March 28, 1998 [Filed electronically with SEC only]. 27.5 Restated Financial Data Schedule -- December 31, 1997 [Filed electronically with SEC only]. 27.6 Restated Financial Data Schedule -- September 27, 1997 [Filed electronically with SEC only]. 27.7 Restated Financial Data Schedule -- June 28, 1997 [Filed electronically with SEC only]. 27.8 Restated Financial Data Schedule -- March 29, 1997 [Filed electronically with SEC only].
23 B. REPORTS ON FORM 8-K On February 9, 1999, the Registrant filed a Current Report on Form 8-K in connection with CVS' announcement that it privately placed $300 million of 5.50% unsecured senior notes due 2004 as described in Item 7 above. On February 11, 1999, the Registrant filed a Current Report on Form 8-K in connection with CVS' announcement that effective April 14, 1999, Stanley P. Goldstein, Chairman of the Board of Directors, will retire as chairman although he will remain a Director. In connection with the retirement, Thomas M. Ryan, currently President and Chief Executive Officer, will be named Chairman of the Board of Directors and Chief Executive Officer and Charles C. Conaway, currently Executive Vice President and Chief Financial Officer, will be named President and Chief Operating Officer. WHERE YOU CAN FIND MORE INFORMATION CVS files annual, quarterly and special reports, proxy statements and other information with the Securities and Exchange Commission ("SEC"). You may read and copy any reports, statements or other information that we file at the SEC's public reference rooms in Washington, D.C., New York, New York and Chicago, Illinois. Please call the SEC at 1-800-SEC-0330 for further information on the public reference rooms. Our SEC filings are also available to the public from commercial document retrieval services and at the web site maintained by the SEC at "http://www.sec.gov." The SEC allows us to "incorporate by reference", which means that we can disclose important information to you by referring you to other documents that we file with the SEC. The information incorporated by reference is legally considered to be a part of this report. We incorporate by reference into Part II (Item 5) specified portions of our 1998 Annual Report to Shareholders. We also incorporate by reference into Part III (Items 10, 11, 12 and 13) specified portions of our Proxy Statement for the 1999 Annual Meeting of Shareholders, scheduled to be held on April 14, 1999. If you are a shareholder, we may have sent you some of the documents incorporated by reference, but you can obtain any of them through us or the SEC. Documents incorporated by reference are available from us without charge, excluding all exhibits unless we have specifically incorporated by reference an exhibit in this report. Shareholders may obtain documents incorporated by reference in this report by requesting them in writing or by telephone from: CVS Corporation Investor Relations 670 White Plains Road - Suite 210 Scarsdale, NY 10583 Telephone: (800) 201-0938 24 INDEPENDENT AUDITORS' REPORT Board of Directors and Shareholders CVS Corporation: Under date of January 27, 1999, except for Note 15, to which the date is November 12, 1999, we reported on the consolidated balance sheets of CVS Corporation and subsidiaries as of December 31, 1998 and 1997, and related consolidated statements of operations, shareholders' equity and cash flows for each of the years in the three-year period ended December 31, 1998, included in the December 31, 1998 annual report on Form 10-K/A of CVS Corporation. In connection with our audits of the aforementioned consolidated financial statements, we also audited the consolidated financial statement schedule as listed in the accompanying index. This financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion on this financial statement schedule based on our audits. In our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. The consolidated balance sheet as of December 31, 1997, and the related consolidated statements of operations, stockholders' equity and cash flows for the years ended December 31, 1998 and 1997, have been restated as discussed in Note 15. /s/ KPMG LLP - ------------ KPMG LLP Providence, Rhode Island January 27, 1999, except for Note 15, to which the date is November 12, 1999 25 CVS CORPORATION SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTs
- -------------------------------------------------------------------------------------------- BALANCE AT ADDITIONS DEDUCTIONS BALANCE BEGINNING OF CHARGED TO CHARGED TO AT END IN MILLIONS YEAR PROFIT & LOSS RESERVE(1) OF YEAR - -------------------------------------------------------------------------------------------- ACCOUNTS RECEIVABLE ALLOWANCE FOR DOUBTFUL ACCOUNTS: Year Ended December 31, 1998 $ 39.2 $ 6.3 $ 5.7 $ 39.8 - -------------------------------------------------------------------------------------------- Year Ended December 31, 1997 36.9 7.9 5.6 39.2 - -------------------------------------------------------------------------------------------- Year Ended December 31, 1996 59.3 11.6 34.0 36.9 - --------------------------------------------------------------------------------------------
(1) 1996 includes a deduction of $21.2 million that relates to the actual write-off of certain receivables of former operating businesses that were retained by the company subsequent to the sale of the related operating businesses. 26 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Annual Report on Form 10-K/A to be signed on its behalf by the undersigned, thereunto duly authorized. CVS CORPORATION Date: November 16, 1999 By: /s/ DAVID B. RICKARD --------------------------- David B. Rickard Executive Vice President and Chief Financial Officer 27 INDEPENDENT AUDITORS' REPORT KPMG LLP Board of Directors and Shareholders CVS Corporation: We have audited the accompanying consolidated balance sheets of CVS Corporation and subsidiaries as of December 31, 1998 and 1997, and the related consolidated statements of operations, shareholders' equity, and cash flows for each of the years in the three-year period ended December 31, 1998. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of CVS Corporation and subsidiaries as of December 31, 1998 and 1997, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1998, in conformity with generally accepted accounting principles. The consolidated balance sheet as of December 31, 1997, and the related consolidated statements of operations, stockholders' equity and cash flows for the years ended December 31, 1998 and 1997, have been restated as discussed in Note 15. /s/ KPMG LLP - ------------ KPMG LLP Providence, Rhode Island January 27, 1999, except for Note 15, to which the date is November 12, 1999 28 Consolidated Statements of Operations
========================================================================================================================== YEARS ENDED DECEMBER 31, AS RESTATED AS RESTATED IN MILLIONS, EXCEPT PER SHARE AMOUNTS 1998 1997 1996 - -------------------------------------------------------------------------------------------------------------------------- Net sales $ 15,273.6 $ 13,749.6 $ 11,831.6 Cost of goods sold, buying and warehousing costs 11,144.4 10,031.3 8,530.7 - -------------------------------------------------------------------------------------------------------------------------- Gross margin 4,129.2 3,718.3 3,300.9 Selling, general and administrative expenses 2,949.0 2,776.0 2,490.8 Depreciation and amortization 249.7 238.2 205.4 Merger, restructuring and other nonrecurring charges 178.6 422.4 12.8 - -------------------------------------------------------------------------------------------------------------------------- Total operating expenses 3,377.3 3,436.6 2,709.0 - -------------------------------------------------------------------------------------------------------------------------- Operating profit 751.9 281.7 591.9 Gain on sale of securities -- -- (121.4) Dividend income -- -- (5.6) Interest expense, net 60.9 44.1 75.5 - -------------------------------------------------------------------------------------------------------------------------- Other expense (income), net 60.9 44.1 (51.5) - -------------------------------------------------------------------------------------------------------------------------- Earnings from continuing operations before income taxes and extraordinary item 691.0 237.6 643.4 Income tax provision (306.5) (149.2) (271.0) - -------------------------------------------------------------------------------------------------------------------------- Earnings from continuing operations before extraordinary item 384.5 88.4 372.4 Discontinued operations: Loss from operations, net of tax benefit of $31.0 -- -- (54.8) Gain (loss) on disposal, net of tax (provision) benefit of $(12.4) and $56.2 in 1997 and 1996, respectively and minority interest of $22.2 in 1996 -- 17.5 (109.4) - -------------------------------------------------------------------------------------------------------------------------- Earnings (loss) from discontinued operations -- 17.5 (164.2) - -------------------------------------------------------------------------------------------------------------------------- Earnings before extraordinary item 384.5 105.9 208.2 Extraordinary item, loss related to early retirement of debt, net of income tax benefit of $11.4 -- (17.1) -- - -------------------------------------------------------------------------------------------------------------------------- Net earnings 384.5 88.8 $ 208.2 Preference dividends, net of income tax benefit (13.6) (13.7) (14.5) - -------------------------------------------------------------------------------------------------------------------------- Net earnings available to common shareholders $ 370.9 $ 75.1 $ 193.7 ========================================================================================================================== BASIC EARNINGS PER COMMON SHARE: Earnings from continuing operations before extraordinary item $ 0.96 $ 0.20 $ 0.98 Earnings (loss) from discontinued operations -- 0.05 (0.45) Extraordinary item, net of tax benefit -- (0.05) -- - -------------------------------------------------------------------------------------------------------------------------- Net earnings $ 0.96 $ 0.20 $ 0.53 - -------------------------------------------------------------------------------------------------------------------------- Weighted average common shares outstanding 387.1 377.2 366.9 ========================================================================================================================== DILUTED EARNINGS PER COMMON SHARE: Earnings from continuing operations before extraordinary item $ 0.95 $ 0.19 $ 0.95 Earnings (loss) from discontinued operations -- 0.05 (0.43) Extraordinary item, net of tax benefit -- (0.05) -- Net earnings $ 0.95 $ 0.19 $ 0.52 Weighted average common shares outstanding 405.2 385.1 383.6 ========================================================================================================================== DIVIDENDS DECLARED PER COMMON SHARE $ 0.225 $ 0.220 $ 0.220 ==========================================================================================================================
See accompanying notes to consolidated financial statements. 29 Consolidated Balance Sheets
================================================================================================================================= DECEMBER 31, AS RESTATED IN MILLIONS, EXCEPT PER SHARE AMOUNTS 1998 1997 - --------------------------------------------------------------------------------------------------------------------------------- ASSETS: Cash and cash equivalents $ 180.8 $ 192.5 Accounts receivable, net 650.3 452.4 Inventories 3,190.2 2,882.4 Other current assets 327.9 356.4 - --------------------------------------------------------------------------------------------------------------------------------- TOTAL CURRENT ASSETS 4,349.2 3,883.7 Property and equipment, net 1,351.2 1,072.3 Goodwill, net 724.6 711.5 Deferred charges and other assets 261.2 253.0 - --------------------------------------------------------------------------------------------------------------------------------- TOTAL ASSETS $ 6,686.2 $ 5,920.5 ================================================================================================================================= LIABILITIES: Accounts payable $ 1,286.3 $ 1,233.7 Accrued expenses 1,061.3 1,098.3 Short-term borrowings 771.1 466.4 Current maturities of long-term debt 14.6 41.9 - --------------------------------------------------------------------------------------------------------------------------------- TOTAL CURRENT LIABILITIES 3,133.3 2,840.3 Long-term debt 275.7 290.4 Other long-term liabilities 166.6 163.3 Commitments and contingencies (Note 13) SHAREHOLDERS' EQUITY: Preferred stock, $0.01 par value: authorized 120,619 shares, 0 shares issued and outstanding -- -- Preference stock, series one ESOP convertible, par value $1.00: Authorized 50,000,000 shares; issued and outstanding 5,239,000 shares at December 31, 1998 and 5,324,000 shares at December 31, 1997 280.0 284.6 Common stock, par value $0.01: authorized 1,000,000,000 shares; issued 401,380,000 shares at December 31, 1998 and 393,734,000 shares at December 31, 1997 4.0 3.9 Treasury stock, at cost: 11,169,000 shares at December 31, 1998 and 11,278,0000 shares at December 31, 1997 (260.2) (262.9) Guaranteed ESOP obligation (270.7) (292.2) Capital surplus 1,336.4 1,154.0 Retained earnings 2,021.1 1,739.1 - --------------------------------------------------------------------------------------------------------------------------------- TOTAL SHAREHOLDERS' EQUITY 3,110.6 2,626.5 - --------------------------------------------------------------------------------------------------------------------------------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 6,686.2 $ 5,920.5 =================================================================================================================================
See accompanying notes to consolidated financial statements. 30 Consolidated Statements of Shareholders' Equity
==================================================================================================================================== YEARS ENDED DECEMBER 31, Shares Dollars --------------------------------- ----------------------------------- IN MILLIONS 1998 1997 1996 1998 1997 1996 - ------------------------------------------------------------------------------------------------------------------------------------ PREFERENCE STOCK: Beginning of year 5.3 5.6 6.3 $ 284.6 $ 298.6 $ 334.9 Conversion to common stock (0.1) (0.3) (0.7) (4.6) (14.0) (36.3) - ------------------------------------------------------------------------------------------------------------------------------------ End of year 5.2 5.3 5.6 280.0 284.6 298.6 ==================================================================================================================================== COMMON STOCK: Beginning of year 393.7 369.3 357.5 3.9 3.7 357.5 Stock options exercised and awards under stock plans 7.5 10.9 4.1 0.1 0.1 4.1 Effect of change in par value -- -- -- -- -- (365.6) Other 0.2 13.5 7.7 -- 0.1 7.7 - ------------------------------------------------------------------------------------------------------------------------------------ End of year 401.4 393.7 369.3 4.0 3.9 3.7 ==================================================================================================================================== TREASURY STOCK: Beginning of year (11.3) (11.7) (13.1) (262.9) (273.1) (304.6) Conversion of preference stock 0.2 0.5 1.4 4.2 12.2 31.6 Other (0.1) (0.1) -- (1.5) (2.0) (0.1) - ------------------------------------------------------------------------------------------------------------------------------------ End of year (11.2) (11.3) (11.7) (260.2) (262.9) (273.1) ==================================================================================================================================== GUARANTEED ESOP OBLIGATION: Beginning of year (292.2) (292.2) (309.7) Reduction of guaranteed ESOP obligation 21.5 -- 17.5 - ------------------------------------------------------------------------------------------------------------------------------------ End of year (270.7) (292.2) (292.2) ==================================================================================================================================== CAPITAL SURPLUS: Beginning of year 1,154.0 941.2 532.4 Conversion of preference stock 0.3 1.8 4.7 Stock options exercised and awards under stock plans 176.2 195.9 56.7 Effect of change in par value -- -- 365.6 Other 5.9 15.1 (18.2) - ------------------------------------------------------------------------------------------------------------------------------------ End of year 1,336.4 1,154.0 941.2 ==================================================================================================================================== RETAINED EARNINGS: Beginning of year, as restated 1,739.1 1,737.9 1,956.7 Net earnings, as restated 384.5 88.8 208.2 Dividends: Preference stock, net of tax benefit (13.6) (13.7) (14.4) Redeemable preferred stock -- -- (0.1) Common stock (88.9) (73.9) (51.7) Footstar Distribution -- -- (360.8) - ------------------------------------------------------------------------------------------------------------------------------------ End of year, as restated 2,021.1 1,739.1 1,737.9 ==================================================================================================================================== OTHER: Beginning of year -- (2.4) 0.2 Cumulative translation adjustment -- -- (0.2) Unrealized holding gain (loss) on investments, net -- 2.4 (2.4) - ------------------------------------------------------------------------------------------------------------------------------------ End of year -- -- (2.4) ==================================================================================================================================== TOTAL SHAREHOLDERS' EQUITY, AS RESTATED $3,110.6 $2,626.5 $2,413.7 ====================================================================================================================================
See accompanying notes to consolidated financial statements. 31 Consolidated Statements of Cash Flows
======================================================================================================================= YEARS ENDED DECEMBER 31, AS RESTATED AS RESTATED IN MILLIONS 1998 1997 1996 - ----------------------------------------------------------------------------------------------------------------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net earnings $ 384.5 $ 88.8 $ 208.2 Adjustments required to reconcile net earnings to net cash provided by (used in) operating activities: Depreciation and amortization 249.7 242.6 262.8 Merger, restructuring and other nonrecurring charges 188.6 466.4 235.0 Deferred income taxes and other non-cash items 73.4 (210.1) 116.4 Net operating loss carryforwards utilized 7.2 69.4 15.3 Gain on sale of securities -- -- (121.4) Extraordinary item, loss on early retirement of debt, net of tax -- 17.1 -- Income (loss) from unconsolidated subsidiary -- 0.3 (4.5) Minority interest in net earnings -- -- 22.2 Change in assets and liabilities, excluding acquisitions and dispositions: (Increase) in accounts receivable, net (197.9) (82.5) (0.8) (Increase) in inventories (315.0) (566.1) (251.0) (Increase) in other current assets, deferred charges and other assets (82.7) (74.2) (99.1) Increase in accounts payable 52.6 174.7 176.5 (Decrease) in accrued expenses (280.4) (220.3) (215.5) Increase (decrease) in federal income taxes payable and other liabilities 141.0 (11.9) (16.9) - ----------------------------------------------------------------------------------------------------------------------- NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES 221.0 (105.8) 327.2 ======================================================================================================================= CASH FLOWS FROM INVESTING ACTIVITIES: Additions to property and equipment (502.3) (341.6) (328.9) Acquisitions, net of cash (62.2) -- (373.9) Proceeds from sale of businesses and other property and equipment 50.5 192.7 240.4 Proceeds from sale of investments -- 309.7 485.8 - ----------------------------------------------------------------------------------------------------------------------- NET CASH (USED IN) PROVIDED BY INVESTING ACTIVITIES (514.0) 160.8 23.4 ======================================================================================================================= CASH FLOWS FROM FINANCING ACTIVITIES: Additions to (reductions in) short-term borrowings 304.6 466.4 (52.0) Proceeds from exercise of stock options 121.1 169.1 62.1 (Reductions in) additions to long-term debt (41.9) (917.2) 128.5 Dividends paid (102.5) (87.6) (137.5) Other -- -- (25.8) - ----------------------------------------------------------------------------------------------------------------------- NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES 281.3 (369.3) (24.7) ======================================================================================================================= Net (decrease) increase in cash and cash equivalents (11.7) (314.3) 325.9 Cash and cash equivalents at beginning of year 192.5 506.8 180.9 - ----------------------------------------------------------------------------------------------------------------------- CASH AND CASH EQUIVALENTS AT END OF YEAR $ 180.8 $ 192.5 $ 506.8 =======================================================================================================================
See accompanying notes to consolidated financial statements. 32 1 SIGNIFICANT ACCOUNTING POLICIES DESCRIPTION OF BUSINESS ~ CVS Corporation ("CVS" or the "Company") is principally in the retail drugstore business. As of December 31, 1998, the Company operated 4,122 retail drugstores, located in 24 Northeast, Mid-Atlantic, Southeast and Midwest states and the District of Columbia. See Note 12 for further information about the Company's business segments. BASIS OF PRESENTATION AND RESTATEMENT ~ The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All material intercompany balances and transactions have been eliminated. As a result of the Company's strategic restructuring program, the results of operations of the former Footwear, Apparel, and Toys and Home Furnishings segments have been classified as discontinued operations in the accompanying consolidated statements of operations. See Note 4 for further information about the Company's strategic restructuring program and discontinued operations. On May 11, 1999, CVS filed a registration statement with the Securities and Exchange Commission related to an exchange offer for the $300 million of debt securities that CVS sold in a private placement on February 11, 1999. In connection with the SEC's review of that registration statement, CVS has restated its consolidated financial statements for 1998 and 1997 to reflect the effect of the restatement adjustments discussed in Notes 15 and 16. The accompanying consolidated financial statements as of December 31, 1997 and for the years ended December 31, 1998 and 1997 reflect the effect of the restatement adjustments. The restatement adjustments have no effect on 1999 or future years. STOCK SPLIT ~ On May 13, 1998, the Company's shareholders approved an increase in the number of authorized common shares from 300 million to one billion. Also on that date, the Board of Directors authorized a two-for-one common stock split, which was effected by the issuance of one additional share of common stock for each share of common stock outstanding. These shares were distributed on June 15, 1998 to shareholders of record as of May 25, 1998. All share and per share amounts presented herein have been restated to reflect the effect of the stock split. CASH AND CASH EQUIVALENTS ~ Cash and cash equivalents consist of cash and temporary investments with maturities of three months or less when purchased. ACCOUNTS RECEIVABLE ~ Accounts receivable are stated net of an allowance for uncollectible accounts of $39.8 million and $39.2 million as of December 31, 1998 and 1997, respectively. The balance primarily includes trade receivables due from managed care organizations, pharmacy benefit management companies, insurance companies, governmental agencies and vendors. INVENTORIES ~ Inventories are stated at the lower of cost or market using the first-in, first-out method. FINANCIAL INSTRUMENTS ~ The Company's financial instruments include cash and cash equivalents, accounts receivable, accounts payable, accrued expenses and short-term borrowings. Due to the short-term nature of these instruments, the Company's carrying value approximates fair value. The Company also utilizes letters of credit to guarantee certain foreign purchases. As of December 31, 1998 and 1997, approximately $62.4 million and $58.2 million, respectively, was outstanding under letters of credit. PROPERTY AND EQUIPMENT ~ Depreciation of property and equipment is computed on a straight-line basis, generally over the estimated useful lives of the asset or, when applicable, the term of the lease, whichever is shorter. Estimated useful lives generally range from 10 to 40 years for buildings and improvements, 3 to 10 years for fixtures and equipment, and 3 to 10 years for leasehold improvements. Maintenance and repair costs are charged directly to expense as incurred. Major renewals or replacements that substantially extend the useful life of an asset are capitalized and depreciated. IMPAIRMENT OF LONG-LIVED ASSETS ~ The Company primarily groups and evaluates fixed and intangible assets at an individual store level, which is the lowest level at which individual cash flows can be identified. Goodwill is allocated to individual stores based on historical store contribution, which approximates store cash flow. Other intangible assets (i.e., favorable lease interests and prescription files) are typically store specific and, therefore, are directly assigned to individual stores. When evaluating assets for potential impairment, the Company first compares the carrying amount of the asset to the asset's estimated future cash flows (undiscounted and without interest charges). If the estimated future cash flows used in this analysis are less than the carrying amount of the asset, an impairment loss calculation is prepared. The impairment loss calculation 33 compares the carrying value of the asset to the asset's estimated future cash flows (discounted and with interest charges). If the carrying amount exceeds the asset's estimated future cash flows, an impairment loss is recorded. DEFERRED CHARGES AND OTHER ASSETS ~ Deferred charges and other assets primarily include beneficial leasehold costs, which are amortized on a straight-line basis over the shorter of 15 years or the remaining life of the leasehold acquired, and reorganization goodwill, which is amortized on a straight-line basis over 20 years. The reorganization goodwill is the value of Revco D.S., Inc., in excess of identifiable assets, as determined during its 1992 reorganization under Chapter 11 of the United States Bankruptcy Code. See Note 11 for further information about reorganization goodwill. GOODWILL ~ Goodwill, which represents the excess of the purchase price over the fair value of net assets acquired, is amortized on a straight-line basis generally over periods of 40 years. Accumulated amortization was $85.6 million and $65.6 million at December 31, 1998 and 1997, respectively. The Company evaluates goodwill for impairment whenever events or circumstances indicate that the carrying amount may not be recoverable. If the carrying amount of the goodwill exceeds the expected undiscounted future cash flows, the Company records an impairment loss. STORE OPENING AND CLOSING COSTS ~ New store opening costs are charged directly to expense when incurred. When the Company closes a store, the estimated unrecoverable costs, including the remaining lease obligation, are charged to expense in the year of the closing. ADVERTISING COSTS ~ External costs incurred to produce media advertising are expensed when the advertising takes place. INCOME TAXES ~ Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the carrying amount of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes as well as for the deferred tax effects of tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. REVENUE RECOGNITION ~ The Company recognizes revenue from the sale of merchandise at the time the merchandise is sold. Service revenues from the Company's pharmacy benefit management segment are recognized at the time the service is provided. VENDOR ALLOWANCES ~ The total value of any up-front or other periodic payments received from vendors that are linked to purchase commitments are initially deferred. The deferred amounts are then amortized to reduce cost of goods sold over the life of the contract based upon periodic purchase volume. The total value of any up-front or other periodic payments received from vendors that are not linked to purchase commitments are also initially deferred. The deferred amounts are then amortized to reduce cost of goods sold on a straight-line basis over the life of the related contract. Funds that are directly linked to advertising commitments are recognized as a reduction of advertising expense when the related advertising commitment is satisfied. STOCK-BASED COMPENSATION ~ During 1996, the Company adopted Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based Compensation." Under SFAS No. 123, companies can elect to account for stock-based compensation using a fair value based method or continue to measure compensation expense using the intrinsic value method prescribed in Accounting Principles Board Opinion ("APB") No. 25, "Accounting for Stock Issued to Employees." The Company has elected to continue to account for its stock-based compensation plans under APB No. 25. See Note 7 for further information about the Company's stock incentive plans. INSURANCE ~ The Company is self-insured for general liability, workers compensation and automobile liability claims up to $500,000. Third party insurance coverage is maintained for claims that exceed this amount. The Company's self-insurance accruals are calculated using standard insurance industry actuarial assumptions and the Company's historical claims experience. USE OF ESTIMATES ~ The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates. 34 RECLASSIFICATIONS ~ Certain reclassifications have been made to the consolidated financial statements of prior years to conform to the current year presentation. EARNINGS PER COMMON SHARE ~ During the fourth quarter of 1997, the Company adopted SFAS No. 128, "Earnings Per Share" and restated previously reported earnings per common share. Basic earnings per common share is computed by dividing: (i) net earnings, after deducting the after-tax dividends on the ESOP Preference Stock, by (ii) the weighted average number of common shares outstanding during the year (the "Basic Shares"). When computing diluted earnings per common share, the Company normally assumes that the ESOP preference stock is converted into common stock and all dilutive stock options are exercised. After the assumed ESOP preference stock conversion, the ESOP trust would hold common stock rather than ESOP preference stock and would receive common stock dividends (currently $0.23 per share) rather than ESOP preference stock dividends (currently $3.90 per share). Since the ESOP Trust uses the dividends it receives to service its debt, the Company would have to increase its contribution to the ESOP trust to compensate it for the lower dividends. This additional contribution would reduce the Company's net earnings, which in turn, would reduce the amounts that would have to be accrued under the Company's incentive bonus and profit sharing plans. Diluted earnings per common share is computed by dividing: (i) net earnings, after accounting for the difference between the dividends on the ESOP Preference Stock and common stock and after making adjustments for the incentive bonuses and profit sharing plans by (ii) Basic Shares plus the additional shares that would be issued assuming that all dilutive stock options are exercised and the ESOP preference stock is converted into common stock. In 1997, the assumed conversion of the ESOP preference stock would have increased diluted earnings per common share and, therefore, was not considered. NEW ACCOUNTING PRONOUNCEMENTS ~ During 1998, the Company adopted: (i) SFAS No. 130, "Reporting Comprehensive Income," which established standards for the reporting and display of comprehensive income and its components, (ii) SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information," which requires companies to report financial information based on how management internally organizes data to make operating decisions and assess performance and (iii) SFAS No. 132, "Employers' Disclosures about Pensions and Other Postretirement Benefits," which revises the disclosure requirements for pensions and other postretirement benefit plans. Adoption of the above disclosure standards did not affect the Company's financial results. Comprehensive income does not differ from the consolidated net earnings presented in the accompanying consolidated statements of operations. 2 BUSINESS COMBINATIONS MERGER TRANSACTIONS On March 31, 1998, CVS completed a merger with Arbor Drugs, Inc. ("Arbor"), pursuant to which 37.8 million shares of CVS common stock were exchanged for all the outstanding common stock of Arbor (the "CVS/Arbor Merger"). Each outstanding share of Arbor common stock was exchanged for 0.6364 shares of CVS common stock. In addition, outstanding Arbor stock options were converted at the same exchange ratio into options to purchase 5.3 million shares of CVS common stock. On May 29, 1997, CVS completed a merger with Revco D.S., Inc. ("Revco"), pursuant to which 120.6 million shares of CVS common stock were exchanged for all the outstanding common stock of Revco (the "CVS/Revco Merger"). Each outstanding share of Revco common stock was exchanged for 1.7684 shares of CVS common stock. In addition, outstanding Revco stock options were converted at the same exchange ratio into options to purchase 6.6 million shares of CVS common stock. The CVS/Arbor Merger and CVS/Revco Merger (collectively, the "Mergers") constituted tax-free reorganizations and have been accounted for as pooling of interests under Accounting Principles Board Opinion No. 16, "Accounting for Business Combinations." Accordingly, all prior period financial statements presented have been restated to include the combined results of operations, financial position and cash flows of Arbor and Revco as if they had always been owned by CVS. Prior to the Mergers, Arbor's fiscal year ended on July 31 and Revco's fiscal year ended on the Saturday closest to May 31. These fiscal year-ends have been restated to a December 31 year-end to conform to CVS' fiscal year-end. Arbor's and Revco's cost of sales and inventories have been restated from the last-in, first-out method to the first-in, first-out method to conform to 35 CVS' accounting method for inventories. The impact of the restatement was to increase earnings from continuing operations by $0.5 million in 1998, $1.2 million in 1997 and $15.5 million in 1996. There were no material transactions between CVS, Arbor and Revco prior to the Mergers. Certain reclassifications have been made to Arbor's and Revco's historical stand-alone financial statements to conform to CVS' presentation. Following are the results of operations for the separate companies prior to the Mergers and the combined amounts presented in the consolidated financial statements:
============================================================================================== THREE MONTHS ENDED YEARS ENDED MARCH 28, MARCH 29, DECEMBER 31, IN MILLIONS 1998 1997 1997 1996 - ---------------------------------------------------------------------------------------------- Net sales: CVS $ 3,333.6 $ 1,515.0 $ 12,738.2 $ 5,528.1 Arbor 267.9 237.0 1,011.4 886.8 Revco -- 1,645.8 -- 5,416.7 - ---------------------------------------------------------------------------------------------- $ 3,601.5 $ 3,397.8 $ 13,749.6 $ 11,831.6 ============================================================================================== Earnings from continuing operations: CVS $ 118.3 $ 58.5 $ 49.2 $ 239.6 Arbor 10.7 9.4 39.2 31.6 Revco -- 24.2 -- 101.2 - ---------------------------------------------------------------------------------------------- $ 129.0 $ 92.1 $ 88.4 $ 372.4 ==============================================================================================
PURCHASE TRANSACTIONS On December 23, 1996, the Company completed the cash purchase of Big B, Inc. ("Big B") by acquiring all the outstanding shares of Big B common stock. The aggregate transaction value, including the assumption of $49.3 million of Big B debt, was $423.2 million. The Big B acquisition was accounted for as a purchase business combination. The resulting excess of purchase price over net assets acquired, $248.9 million, is being amortized on a straight-line basis over 40 years. For financial reporting purposes, Big B's results of operations have been included in the consolidated financial statements since November 16, 1996. The Company also acquired other retail drugstore businesses that were accounted for as purchase business combinations. These acquisitions did not have a material effect on the consolidated financial statements either individually or in the aggregate. The results of operations of these companies have been included in the consolidated financial statements since their respective dates of acquisition. 3 MERGER, RESTRUCTURING AND ASSET IMPAIRMENT CHARGES CVS/ARBOR CHARGE In accordance with Accounting Principles Board Opinion ("APB") No. 16, "Business Combinations", Emerging Issues Task Force ("EITF") Issue 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (Including Certain Costs Incurred in a Restructuring)" and SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of", CVS recorded a $147.3 million charge to operating expenses during the second quarter of 1998 for direct and other merger-related costs pertaining to the CVS/Arbor merger transaction and certain restructuring activities (the "CVS/Arbor Charge"). The Company also recorded a $10.0 million charge to cost of goods sold during the second quarter of 1998 to reflect markdowns on noncompatible Arbor merchandise. 36 Following is a summary of the significant components of the CVS/Arbor Charge:
======================================================= (IN MILLIONS) - ------------------------------------------------------- Merger transaction costs $ 15.0 Restructuring costs: Employee severance and benefits 27.1 Exit Costs: Noncancelable lease obligations 40.0 Duplicate facility 16.5 Asset write-offs 41.2 Contract cancellation costs 4.8 Other 2.7 - ------------------------------------------------------- Total $ 147.3 =======================================================
MERGER TRANSACTION COSTS included $12.0 million for estimated investment banker fees, $2.5 million for estimated professional fees, and $0.5 million for estimated filing fees, printing costs and other costs associated with furnishing information to shareholders. EMPLOYEE SEVERANCE AND BENEFITS included $15.0 million for estimated excess parachute payment excise taxes and related income tax gross-ups, $11.0 million for estimated employee severance and $1.1 million for estimated employee outplacement costs. The excess parachute payment excise taxes and related income tax gross-ups relate to employment agreements that Arbor had in place with 22 senior executives. Employee severance and benefits and employee outplacement costs relate to 236 employees that were locate in Arbor's Troy, Michigan corporate headquarters, including the 22 senior executives that were covered by employee agreements. EXIT COSTS - In conjunction with the merger transaction, management made the decision to close Arbor's Troy, Michigan corporate headquarters and 55 Arbor store locations. As a result, the following exit plan was executed: 1. Arbor's Troy, Michigan corporate headquarters would be closed as soon as possible after the merger. Management anticipated that this facility would be closed by no later than December 31, 1998. Since this location was a leased facility, management planned to return the premises to the landlord at the conclusion of the current lease term, which extends through 1999. This facility was closed in December 1998. 2. Arbor's Troy, Michigan corporate headquarters employees would be terminated as soon as possible after the merger. Management anticipated that these employees would be terminated by no later than December 31, 1998. However, significant headcount reductions were planned and occurred throughout the transition period. As of December 31, 1998, all of the employees had been terminated. 3. The 55 Arbor store locations discussed above would be closed as soon as practical after the merger. Management anticipated that these locations would be closed by no later than December 31, 1999. Estimated store closing dates could be affected by the timing of new store openings, the availability of real estate in the Arbor markets and the availability of store closing resources. Since these locations were leased facilities, management planned to either return the premises to the respective landlords at the conclusion of the current lease term or negotiate an early termination of the contractual obligations. As of December 31, 1998, 3 of these locations had been closed. The Company did not immediately initiate the Arbor store closing process because the Revco store closing process (discussed below) was continuing to consume its store closing resources. Management remains committed to closing the remaining locations. NONCANCELABLE LEASE OBLIGATIONS included $40.0 million for the estimated continuing lease obligations of the 55 Arbor store locations discussed above. As required by EITF Issue 88-10, "Costs Associated with Lease Modification or Termination", the estimated continuing lease obligations were reduced by estimated probable sublease rental income. 37 DUPLICATE FACILITY included the estimated costs associated with Arbor's Troy, Michigan corporate headquarters during the shutdown period. This facility was considered to be a duplicate facility that was not required by the combined company. Immediately after the merger transaction, the Company assumed all decision-making responsibility for Arbor and Arbor's corporate employees. The combined company did not retain these employees since they were incremental to their CVS counterparts. During the shutdown period, these employees primarily worked on shutdown activities. The $16.5 million charge included $1.8 million for the estimated cost of payroll and benefits that would be incurred in connection with complying with the Federal Worker Adjustment and Retraining Act (the "WARN Act"), $6.6 million for the estimated cost of payroll and benefits that would be incurred in connection with shutdown activities, $1.5 million for the estimated cost of temporary labor that would be incurred in connection with shutdow activities and $6.6 million for the estimated occupancy-related costs that would be incurred in connection with closing the duplicate corporate headquarters facility. ASSET WRITE-OFFS included $38.2 million for estimated fixed asset write-offs and $3.0 million for estimated intangible asset write-offs. The Company allocates goodwill to individual stores based on historical store contribution, which approximates store cash flow. Other intangibles (i.e., favorable lease interests and prescription files) are typically store specific and, therefore, are directly assigned to stores. The asset write-offs relate to the 55 store locations discussed above and the Troy, Michigan corporate headquarters. Management's decision to close the store locations was considered to be an event or change in circumstances as defined in SFAS No. 121. Since management intended to use these locations on a short-term basis during the shutdown period, impairment was measured using the "Assets to Be Held and Used" provisions of SFAS No. 121. The analysis was prepared at the individual store level, which is the lowest level at which individual cash flows can be identified. The analysis first compared the carrying amount of the store's assets to the store's estimated future cash flows (undiscounted and without interest charges) through the anticipated closing date. If the estimated future cash flows used in this analysis were less than the carrying amount of the store's assets, an impairment loss calculation was prepared. The impairment loss calculation compared the carrying value of the store's assets to the store's estimated future cash flows (discounted and with interest charges). Management's decision to close Arbor's Troy, Michigan corporate headquarters was also considered to be an event or change in circumstances as defined in SFAS No. 121. Since management intended to dispose of these assets, impairment was measured using the "Assets to Be Disposed Of" provisions of SFAS No. 121. Since management intended to discard the assets located in this facility, their entire net book value was considered to be impaired. CONTRACT CANCELLATION COSTS included $4.8 million for estimated termination fees and / or penalties associated with terminating various contracts that Arbor had in place prior to the merger, which would not be used by the combined company. OTHER COSTS included $1.3 million for the estimated write-off of Arbor's Point-of-Sale software and $1.4 million for travel and related expenses that would be incurred in connection with closing Arbor's corporate headquarters and store facilities. The above costs did not provide future benefit to the retained stores or corporate facilities. Following is a reconciliation of the beginning and ending liability balances at December 31, 1998:
==================================================================================================================================== Merger Employee Noncancel- Contract Transaction Severance & able Lease Duplicate Asset Cancellation In millions Costs Benefits(1) Obligations(2) Facility Write-Offs Costs Other Total - ------------------------------------------------------------------------------------------------------------------------------------ CVS/Arbor Charge $ 15.0 $ 27.1 $ 40.0 $ 16.5 $ 41.2 $ 4.8 $ 2.7 $ 147.3 Utilization - Cash (15.9) (13.8) -- (15.1) -- (1.2) (3.4) (49.4) Utilization - Non-cash -- -- -- -- (41.2) -- -- (41.2) Transfer(3) 0.9 -- -- (1.4) -- (0.2) 0.7 -- - ------------------------------------------------------------------------------------------------------------------------------- Balance at 12/31/98(4) $ -- $ 13.3 $ 40.0 $ -- $ -- $ 3.4 $ -- $ 56.7 ===============================================================================================================================
(1) Employee severance and benefits extend through 2000. (2) Noncancelable lease obligations extend through 2020. (3) The transfers between the components of the plan were recorded in the same period that the changes in estimates were determined. These amounts are considered to be immaterial. (4) The Company believes that the reserve balances at December 31, 1998 are adequate to cover the remaining liabilities associated with CVS/Arbor Charge. 38 CVS/REVCO CHARGE In accordance with APB No. 16, EITF Issue 94-3 and SFAS No. 121, CVS recorded a $337.1 million charge to operating expenses during the second quarter of 1997 for direct and other merger-related costs pertaining to the CVS/Revco merger transaction and certain restructuring activities (the "CVS/Revco Charge"). The Company also recorded a $75 million charge to cost of goods sold during the second quarter of 1997 to reflect markdowns on noncompatible Revco merchandise. Following is a summary of the significant components of the CVS/Revco Charge:
============================================================ (IN MILLIONS) - ------------------------------------------------------------ Merger transaction costs $ 35.0 Restructuring costs: Employee severance and benefits 89.8 Exit Costs: Noncancelable lease obligations 67.0 Duplicate facility 50.2 Asset write-offs 82.2 Contract cancellation costs 7.4 Other 5.5 - ------------------------------------------------------------ Total $ 337.1 ============================================================
MERGER TRANSACTION COSTS included $22.0 million for estimated investment banker fees, $10.0 million for estimated professional fees, and $3.0 million for estimated filing fees, printing costs and other costs associated with furnishing information to shareholders. EMPLOYEE SEVERANCE AND BENEFITS included $17.0 million for estimated excess parachute payment excise taxes and related income tax gross-ups, $53.7 million for estimated employee severance, $18.0 million for estimated incremental retirement benefits and $1.1 million for estimated employee outplacement costs. The excess parachute payment excise taxes and related income tax gross-ups relate to employment agreements that Revco had in place with 26 senior executives. Employee severance and benefits and employee outplacement costs relate to 1,195 employees that were located in Revco's Twinsburg, Ohio corporate headquarters, including the 26 senior executives that were covered by employee agreements. The incremental retirement benefits (i.e., enhanced SERP benefits) also resulted from the change in control. EXIT COSTS - In conjunction with the merger transaction, management made the decision to close Revco's Twinsburg, Ohio corporate headquarters and 223 Revco store locations. As a result, the following exit plan was executed: 1. Revco's Twinsburg, Ohio corporate headquarters would be closed as soon as possible after the merger. Management anticipated that this facility would be closed by no later than December 31, 1997. The corporate headquarters complex included both leased and owned facilities. Management planned to return the leased facilities to the respective landlords at the conclusion of the current lease term and/or negotiate an early termination of the contractual obligations. Management intended to sell the owned facility. These facilities were closed in March 1998. The related continuing lease obligations extend through 2007. The owned facility was sold on May 8, 1998. 2. Revco's Twinsburg, Ohio corporate headquarters employees would be terminated as soon as possible after the merger. Management anticipated that these employees would be terminated by no later than December 31, 1997. However, significant headcount reductions at Revco were planned and occurred throughout the transition period. As of December 31, 1998, all of the above employees had been terminated. 39 3. The 223 Revco store locations discussed above would be closed as soon as practical after the merger. Management anticipated that these stores would be closed by no later than December 31, 1998. Since these facilities were leased facilities, management planned to either return the premises to the respective landlords at the conclusion of the current lease term and/or negotiate an early termination of the contractual obligations. As of December 31, 1998, 218 of these locations had been closed. NONCANCELABLE LEASE OBLIGATIONS included $67.0 million for the estimated continuing lease obligations of the 223 Revco store locations discussed above. As required by EITF 88-10, the estimated continuing lease obligations were reduced by estimated probable sublease rental income. DUPLICATE FACILITY included the estimated costs associated with Revco's Twinsburg, Ohio corporate headquarters during the shutdown period. This facility was considered to be a duplicate facility that was not required by the combined company. Immediately after the merger transaction, the Company assumed all decision-making responsibility for Revco and Revco's corporate employees. The combined company did not retain these employees since they were incremental to their CVS counterparts. During the shutdown period, these employees primarily worked on shutdown activities. The $50.2 million charge included $10.4 million for the estimated cost of payroll and benefits that would be incurred in connection with complying with the WARN Act, $13.3 million for the estimated cost of payroll and benefits that would be incurred in connection with shutdown activities, $8.5 million for the estimated cost of temporary labor that would be incurred in connection shutdown activities and $18.0 million for the estimated occupancy-related costs that would be incurred in connection with closing the duplicate corporate headquarters facility. ASSET WRITE-OFFS included $40.3 million for estimated fixed asset write-offs and $41.9 million for estimated intangible asset write-offs. The Company allocates goodwill to individual stores based on historical store contribution, which approximates store cash flow. Other intangibles (i.e., favorable lease interests and prescription files) are typically store specific and, therefore, are directly assigned. The asset write-offs relate to the 223 store locations discussed above and the Twinsburg, Ohio corporate headquarters. Management's decision to close the store locations was considered to be an event or change in circumstances as defined in SFAS No. 121. Since management intended to use these locations on a short-term basis during the shutdown period, impairment was measured using the "Assets to Be Held and Used" provisions of SFAS No. 121. The analysis was prepared at the individual store level, which is the lowest level at which individual cash flows can be identified. The analysis first compared the carrying amount of the store's assets to the store's estimated future cash flows (undiscounted and without interest charges) through the anticipated closing date. If the estimated future cash flows used in this analysis were less than the carrying amount of the store's assets, an impairment loss calculation was prepared. The impairment loss calculation compared the carrying value of the store's assets to the store's estimated future cash flows (discounted and with interest charges). Management's decision to close Revco's corporate headquarters was also considered to be an event or change in circumstances as defined in SFAS No. 121. Since management intended to dispose of these assets, impairment was measured using the "Assets to Be Disposed Of" provisions of SFAS No. 121. The impairment loss of $3.9 million for the facility that Revco owned was calculated by subtracting the carrying value of the facility from the estimated fair value less cost to sell. Since management intended to discard the remaining assets located in these facilities, their entire net book value was considered to be impaired. CONTRACT CANCELLATION COSTS included $7.4 million for estimated termination fees and / or penalties associated with terminating various contracts that Revco had in place prior to the merger, which would not be used by the combined company. OTHER COSTS included $3.5 million for estimated travel and related expenses that would be incurred in connection with closing Revco's corporate headquarters and $2.0 million for other miscellaneous charges associated with closing Revco's corporate headquarters. The above costs did not provide future benefit to the retained stores or corporate facilities. 40 Following is a reconciliation of the beginning and ending liability balances at December 31, 1997 and 1998:
==================================================================================================================================== Merger Employee Noncancel- Contract Transaction Severance & able Lease Duplicate Asset Cancellation In millions Costs Benefits(1) Obligations(2) Facility Write-Offs Costs Other Total - ------------------------------------------------------------------------------------------------------------------------------------ CVS/Revco Charge $ 35.0 $ 89.8 $ 67.0 $ 50.2 $ 82.2 $ 7.4 $ 5.5 $ 337.1 Utilization - Cash (32.1) (37.4) (0.9) (37.6) -- (5.1) (5.5) (118.6) Utilization - Non-cash -- -- -- -- (82.2) -- -- (82.2) - ------------------------------------------------------------------------------------------------------------------------------------ Balance at 12/31/97 2.9 52.4 66.1 12.6 -- 2.3 -- 136.3 Utilization - Cash (0.3) (40.0) (17.0) (11.8) -- (2.3) (3.4) (74.8) Transfers(3) (2.6) -- -- (0.8) -- -- 3.4 -- - ------------------------------------------------------------------------------------------------------------------------------------ Balance at 12/31/98(4) $ -- $ 12.4 $ 49.1 $ -- $ -- $ -- $ -- $ 61.5 ====================================================================================================================================
(1) Employee severance extends through 1999. Employee benefits extend for a number of years to coincide with the payment of retirement benefits. (2) Noncancelable lease obligations extend through 2017. (3) The transfers between the components of the plan were recorded in the same period that the changes in estimates were determined. These amounts are considered to be immaterial. (4) The Company believes that the reserve balances at December 31, 1998 are adequate to cover the remaining liabilities associated with CVS/Arbor Charge. BIG B CHARGE In accordance with EITF Issue 94-3 and SFAS No. 121, the Company recorded a $31.0 million charge to operating expenses during the first quarter of 1997 for certain costs associated with the restructuring of Big B (the "Big B Charge"). This charge included accrued liabilities related to store closings and duplicate corporate facilities, such as the cancellation of lease agreements and the write-down of unutilized fixed assets. Asset write-offs included in this charge totaled $5.1 million. The balance of the charge, $25.9 million, will require cash outlays of which $8.9 million and $10.0 million had been incurred as of December 31, 1997 and 1998, respectively. The remaining cash outlays primarily include noncancelable lease commitments, which extend through 2012. These exit plans did not provide future benefit to the retained stores or corporate facilities. 4 STRATEGIC RESTRUCTURING PROGRAM & DISCONTINUED OPERATIONS In November 1997, the Company completed the final phase of its comprehensive strategic restructuring program, first announced in October 1995 and subsequently refined in May 1996 and June 1997. The strategic restructuring program included: (i) the sale of Marshalls, Kay-Bee Toys, Wilsons, This End Up and Bob's Stores, (ii) the spin-off of Footstar, Inc., which included Meldisco, Footaction and Thom McAn (the "Footstar Distribution"), (iii) the initial and secondary public offerings of Linens 'n Things and (iv) the closing of the administrative office facility located in Rye, New York. The strategic restructuring program was completed without significant changes to the Board approved plan. As part of completing this program, the Company recorded, as a component of discontinued operations, a pre-tax charge of $35.0 million ($20.7 million after-tax) during the second quarter of 1997 (the "1997 Charge") and $235.0 million ($148.1 million after-tax) during the second quarter of 1996 to finalize original liability estimates. The $35.0 million charge resulted from the Company's decision to retain and close seven Bob's Stores, which were affecting the overall marketability of the Bob's Stores business and the anticipated timing of the sale. As a result of this decision, the Company recorded a liability for the continuing lease obligations associated with these locations. At the time of adopting the plan of disposal, the Company expected to sell the entire Bob's Stores business and believed it was likely that the sale could be consummated within 12 months. The $235.0 million charge resulted from the Company's decision to separate Linens 'n Things and Bob's Stores from the Company and sell or close the remaining Thom McAn stores, and thereby exit the Thom McAn business by mid-1997. $151.0 million of this charge was related to the decision to separate Linens 'n Things and Bob's Stores, and $84.0 million was related to the decision to exit the Thom McAn business. Substantially all of this charge was related to asset write-offs, which will not require future cash outlays. As a result of adopting the plan to separate Linens 'n Things and Bob's Stores from the Company, the Apparel segment and Toys and Home Furnishings segment were discontinued in accordance with APB Opinion No. 30. 41 Following is a summary of the beginning and ending liability balances at December 31, 1998:
================================================================================================================================= Noncancelable Employee IN MILLIONS Loss on Disposal Lease Obligations(2) Severance(1) Other Total - --------------------------------------------------------------------------------------------------------------------------------- Balance at 12/31/96 $ 162.5 $ 55.5 $ 35.1 $ 4.8 $ 257.9 1997 Charge -- 35.0 -- -- 35.0 Utilization (192.9) (20.4) (22.0) (4.8) (240.1) - --------------------------------------------------------------------------------------------------------------------------------- Transfers(3) 38.8 (32.8) (6.0) -- -- - --------------------------------------------------------------------------------------------------------------------------------- Balance at 12/31/97 8.4 37.3 7.1 -- 52.8 Utilization (8.4) (7.3) (2.4) -- (18.1) - --------------------------------------------------------------------------------------------------------------------------------- Balance at 12/31/98(4) $ -- $ 30.0 $ 4.7 $ -- $ 34.7 =================================================================================================================================
(1) Employee severance extends through 2000. (2) Noncancelable lease obligations extend through 2016. (3) At the time the decision was made to separate Bob's Stores from CVS, an estimated loss on disposal was recorded in the consolidated statements of operations within discontinued operations. That loss included certain estimates. At the time of the sale, the total loss on disposal remained unchanged. However, the components of the loss differed. The transfers between the components of the plan were made to reflect the nature of the remaining reserve. In conjunction with the sale, the buyer assumed primary responsibility for the continuing lease obligations and retained certain employees that could have otherwise been terminated. (4) The Company believes that the reserve balances at December 31, 1998 are adequate to cover the remaining liabilities associated with this program. Following is a summary of discontinued operations by reporting segment for the years ended December 31:
================================================================================ IN MILLIONS 1997 1996 - ---------------------------------------------------------- ------------------ Net sales: Footwear $ -- $ 1,391.1 Apparel 348.3 526.4 Toys and Home Furnishings -- 900.3 - -------------------------------------------------------------------------------- $ 348.3 $ 2,817.8 ================================================================================ Operating (loss): Footwear $ -- $ (12.4) Apparel -- (171.3) Toys and Home Furnishings -- (49.7) - -------------------------------------------------------------------------------- $ -- $(233.4) ================================================================================
As of December 31, 1998 and 1997, there were no assets of the discontinued operations reflected in the accompanying consolidated balance sheets. As of December 31, 1998 and 1997, there were $34.7 million and $52.8 million of liabilities of the discontinued operations reflected in the accompanying consolidated balance sheets, respectively. 42 5 BORROWINGS AND CREDIT AGREEMENTS Following is a summary of the Company's borrowings at December 31:
================================================================================ IN MILLIONS 1998 1997 - -------------------------------------------------------------------------------- Commercial paper $ 736.6 $ 450.0 ESOP note payable(1) 270.7 292.1 Uncommitted lines of credit 34.5 16.4 9.125% senior notes -- 19.2 Mortgage notes payable 16.1 17.1 Capital lease obligations and other 3.5 3.9 - -------------------------------------------------------------------------------- 1,061.4 798.7 Less: Short-term borrowings (771.1) (466.4) Current portion of long-term debt (14.6) (41.9) - -------------------------------------------------------------------------------- $ 275.7 $ 290.4 ================================================================================
(1) See Note 9 for further information about the Company's ESOP Plan. The Company's commercial paper program is supported by a $670 million, five-year unsecured revolving credit facility, which expires on May 30, 2002 and a $460 million, 364 day unsecured revolving credit facility, which expires on June 26, 1999 (collectively, the "Credit Facilities"). The Credit Facilities require the Company to pay a quarterly facility fee of 0.07%, regardless of usage. The Company can also obtain up to $35.0 million of short-term financing through various uncommitted lines of credit. The weighted average interest rate for short-term borrowings was 5.7% as of December 31, 1998 and 1997. The Company was not obligated under any formal or informal compensating balance agreements. During the second quarter of 1997, the Company extinguished $865.7 million of the debt it absorbed as part of the CVS/Revco Merger using cash on hand and commercial paper borrowings. As a result, the Company recorded an extraordinary loss, net of income taxes, of $17.1 million, which consisted of early retirement premiums and the write-off of unamortized deferred financing costs. On January 15, 1998, the Company redeemed the remaining $19.2 million of 9.125% senior notes. At December 31, 1998, the aggregate long-term debt maturing during the next five years is as follows: $14.6 million in 1999, $17.3 million in 2000, $21.6 million in 2001, $26.5 million in 2002, $32.3 million in 2003, $178.0 million in 2004 and thereafter. Interest paid was approximately $70.7 million in 1998, $58.4 million in 1997 and $79.8 million in 1996. 6 LEASES The Company and its subsidiaries lease retail stores, warehouse facilities and office facilities under noncancelable operating leases over periods ranging from 5 to 20 years, and generally have options to renew such terms over periods ranging from 5 to 15 years. Following is a summary of the Company's net rental expense for operating leases for the years ended December 31:
========================================================================== IN MILLIONS 1998 1997 1996 - -------------------------------------------------------------------------- Minimum rentals $ 459.1 $ 409.6 $ 337.4 Contingent rentals 60.3 60.2 73.6 - -------------------------------------------------------------------------- 519.4 469.8 411.0 Less: sublease income (14.0) (9.5) (12.8) - -------------------------------------------------------------------------- $ 505.4 $ 460.3 $ 398.2 ==========================================================================
43 Following is a summary of the future minimum lease payments under capital and operating leases at December 31, 1998:
=================================================================================== IN MILLIONS CAPITAL LEASES OPERATING LEASES - --------------------------------------------------------------- ------------------- 1999 $ 0.4 $ 411.1 2000 0.4 388.1 2001 0.4 354.1 2002 0.2 328.0 2003 0.2 301.3 Thereafter 1.3 2,499.0 - --------------------------------------------------------------- ------------------- 2.9 $ 4,281.6 Less: imputed interest (1.4) - --------------------------------------------------------------- ------------------- Present value of capital lease obligations $ 1.5 ===================================================================================
7 STOCK INCENTIVE PLANS As of December 31, 1998, the Company had the following stock incentive plans (including the pre-merger plans of Arbor and Revco). Effective with the Mergers, outstanding Arbor and Revco stock options were exchanged for options to purchase CVS common stock. 1997 INCENTIVE COMPENSATION PLAN The 1997 Incentive Compensation Plan (the "1997 ICP"), superseded the 1990 Omnibus Stock Incentive Plan, the 1987 Stock Option Plan and the 1973 Stock Option Plan (collectively, the "Preexisting Plans"). Upon approval of the 1997 ICP, authority to make future grants under the Preexisting Plans was terminated, although previously granted awards remain outstanding in accordance with their terms and the terms of the Preexisting Plans. As of December 31, 1998, the 1997 ICP provided for the granting of up to 23,321,821 shares of common stock in the form of stock options, stock appreciation rights ("SARs"), restricted shares, deferred shares and performance-based awards to selected officers, employees and directors of the Company. All grants under the 1997 ICP are awarded at fair market value on the date of grant. The right to exercise or receive these awards generally commences between one and five years from the date of the grant and expires not more than ten years after the date of the grant, provided that the holder continues to be employed by the Company. As of December 31, 1998, there were 19,730,690 shares available for grant under the 1997 ICP. Restricted shares issued under the 1997 ICP may not exceed 3.6 million shares. In 1998, 1997 and 1996, 155,400, 44,610 and 633,100 shares of restricted stock were granted at a weighted average grant date fair value of $37.80, $23.02 and $13.14, respectively. Participants are entitled to vote and receive dividends on their restricted shares, although they are subject to certain transfer restrictions. Performance-based awards, which are subject to the achievement of certain business performance goals, totaled 56,346 at a weighted average grant date fair value of $36.70 in 1998. No awards were granted in 1997 and 1996. Compensation cost, which is based on the fair value at the date of grant, is recognized over the restricted or performance period. This cost totaled $3.1 million in 1998, $3.5 million in 1997 and $3.9 million in 1996. THE 1996 DIRECTORS STOCK PLAN The 1996 Directors Stock Plan (the "1996 DSP"), provides for the granting of up to 346,460 shares of common stock to the Company's nonemployee directors (the "Eligible Directors"). The 1996 DSP allows the Eligible Directors to elect to receive shares of common stock in lieu of cash compensation. Eligible Directors may also elect to defer compensation payable in common stock until their service as a director concludes. The 1996 DSP replaced the Company's 1989 Directors Stock Option Plan. As of December 31, 1998, there were 263,554 shares available for grant under the 1996 DSP. 44 Following is a summary of the fixed stock option activity under the 1997 ICP, the Preexisting Plans and the pre-merger plans of Arbor and Revco for the years ended December 31:
============================================================================================================================== 1998 1997 1996 ------------------------------ ------------------------------ ------------------------------ WEIGHTED AVERAGE WEIGHTED AVERAGE WEIGHTED AVERAGE SHARES EXERCISE PRICE SHARES EXERCISE PRICE SHARES EXERCISE PRICE - ------------------------------------------------------------------------------------------------------------------------------ Outstanding at beginning of year 16,070,146 $16.95 23,569,930 $13.96 25,782,040 $14.06 Granted 3,119,410 37.16 3,695,530 23.62 6,609,229 14.80 Exercised (7,137,027) 15.01 (10,756,726) 12.99 (3,534,729) 11.62 Canceled (70,407) 26.48 (438,588) 14.48 (5,286,610) 17.35 - ------------------------------------------------------------------------------------------------------------------------------ Outstanding at end of year 11,982,122 23.31 16,070,146 16.95 23,569,930 13.96 - ------------------------------------------------------------------------------------------------------------------------------ Exercisable at end of year 6,127,402 11,729,688 10,011,179 ==============================================================================================================================
Following is a summary of the fixed stock options outstanding and exercisable as of December 31, 1998:
================================================================================================================================ OPTIONS OUTSTANDING OPTIONS EXERCISABLE ---------------------------------------------------------- --------------------------------------- RANGE OF NUMBER WEIGHTED AVERAGE WEIGHTED AVERAGE NUMBER WEIGHTED AVERAGE EXERCISE PRICES OUTSTANDING REMAINING LIFE EXERCISE PRICE EXERCISABLE EXERCISE PRICE - --------------------------------------------------------------------------------------------------------------------------------- $ 5.00 to $20.00 6,024,451 5.5 $16.29 5,358,465 $16.24 20.01 to 35.00 2,857,611 7.1 23.10 697,787 22.20 35.01 to 46.50 3,100,060 9.1 37.16 71,150 37.45 $ 5.00 to $46.50 11,982,122 6.8 $23.31 6,127,402 $17.16 ================================================================================================================================
The Company applies APB Opinion No. 25 to account for its stock incentive plans. Accordingly, no compensation cost has been recognized for stock options granted. Had compensation cost been recognized based on the fair value of stock options granted consistent with SFAS No. 123, net earnings and net earnings per common share ("EPS") would approximate the pro forma amounts shown below for the years ended December 31.
============================================================================================ IN MILLIONS, EXCEPT PER SHARE AMOUNTS 1998 1997 1996 - -------------------------------------------------------------------------------------------- Net earnings: As reported $ 384.5 $ 88.8 $ 208.2 Pro forma 359.0 70.6 196.2 - -------------------------------------------------------------------------------------------- Basic EPS: As reported $ 0.96 $ 0.20 $ 0.53 Pro forma 0.89 0.15 0.50 - -------------------------------------------------------------------------------------------- Diluted EPS: As reported $ 0.95 $ 0.19 $ 0.52 Pro forma 0.88 0.15 0.49 ============================================================================================
Beginning with grants made on or after January 1, 1995, the fair value of each stock option grant was estimated using the Black-Scholes Option Pricing Model with the following assumptions:
========================================================================================= 1998 1997 1996 - ----------------------------------------------------------------------------------------- Dividend yield 0.40% 0.70% 1.07% Expected volatility 22.49% 22.77% 20.51% Risk-free interest rate 5.75% 5.50% 7.00% Expected life 7.0 5.5 5.0 - -----------------------------------------------------------------------------------------
8 PENSION PLANS AND OTHER POSTRETIREMENT BENEFITS The Company sponsors various retirement programs, including defined benefit, defined contribution and other plans that cover most full-time employees. 45 DEFINED BENEFIT PLANS The Company sponsors a noncontributory defined benefit pension plan that covers certain full-time employees of Revco who are not covered by collective bargaining agreements. On September 20, 1997, the Company suspended future benefit accruals under this plan. As a result of the plan's suspension, the Company realized a $6.0 million curtailment gain in 1997. Benefits paid to retirees are based upon age at retirement, years of credited service and average compensation during the five year period ending September 20, 1997. It is the Company's policy to fund this plan based on actuarial calculations and applicable federal regulations. Pursuant to various labor agreements, the Company is required to make contributions to certain union-administered pension plans that totaled $1.5 million in 1998, $1.6 million in 1997 and $1.2 million in 1996. The Company may be liable for its share of the plans' unfunded liabilities if the plans are terminated. The Company also has nonqualified supplemental executive retirement plans ("SERPs") in place for certain key employees for whom it has purchased cost recovery variable life insurance. DEFINED CONTRIBUTION PLANS The Company sponsors a Profit Sharing Plan and a 401(k) Savings Plan that cover substantially all employees who meet plan eligibility requirements. The Company also maintains a nonqualified, unfunded Deferred Compensation Plan for certain key employees. The Company's contributions under the above defined contribution plans totaled $26.4 million in 1998, $24.1 million in 1997 and $19.5 million in 1996. The Company also sponsors an Employee Stock Ownership Plan. See Note 9 for further information about this plan. OTHER POSTRETIREMENT BENEFITS The Company provides postretirement healthcare and life insurance benefits to retirees who meet eligibility requirements. The Company's funding policy is generally to pay covered expenses as they are incurred. Following is a reconciliation of the benefit obligation, fair value of plan assets and funded status of the Company's defined benefit and other postretirement benefit plans:
========================================================================================================================== DEFINED BENEFIT PLANS OTHER POSTRETIREMENT BENEFITS --------------------- ----------------------------- In millions 1998 1997 1998 1997 - -------------------------------------------------------------------------------------------------------------------------- CHANGE IN BENEFIT OBLIGATION: Benefit obligation at beginning of year $ 253.3 $ 255.1 $ 14.4 $ 15.5 Service cost 0.5 7.6 -- -- Interest cost 19.5 19.2 1.0 1.0 Actuarial loss (gain) 49.3 (10.4) 0.5 (0.7) Benefits paid (25.0) (18.2) (1.9) (1.4) - -------------------------------------------------------------------------------------------------------------------------- Benefit obligation at end of year $ 297.6 $ 253.3 $ 14.0 $ 14.4 ========================================================================================================================== CHANGE IN PLAN ASSETS: Fair value at beginning of year $ 201.5 $ 172.8 $ -- $ -- Actual return on plan assets 28.4 20.0 -- -- Company contributions 18.2 26.9 1.9 1.4 Benefits paid (25.0) (18.2) (1.9) (1.4) - -------------------------------------------------------------------------------------------------------------------------- Fair value at end of year(1) $ 223.1 $ 201.5 $ -- $ -- ========================================================================================================================== FUNDED STATUS: Funded status $ (74.5) $ (51.8) $ (14.0) $ (14.5) Unrecognized prior service cost 1.3 1.6 (1.0) (1.1) Unrecognized net loss (gain) 1.6 (8.4) (0.3) (1.0) - -------------------------------------------------------------------------------------------------------------------------- Accrued pension costs $ (71.6) $ (58.6) $ (15.3) $ (16.6) ========================================================================================================================== WEIGHTED AVERAGE ASSUMPTIONS: Discount rate 6.75% 7.25% 6.75% 7.25% Expected return on plan assets 9.00% 9.00% -- -- Rate of compensation increase 4.50% 4.50% -- -- ==========================================================================================================================
(1) Plan assets consist primarily of mutual funds, common stock and insurance contracts. 46 For measurement purposes, future healthcare costs are assumed to increase at an annual rate of 6.5% during 1999, decreasing to an annual growth rate of 5.0% in 2002 and thereafter. A one percent change in the assumed health care cost trend rate would change the accumulated postretirement benefit obligation by $1.0 million and the total service and interest costs by $0.1 million. Following is a summary of the net periodic pension cost for the defined benefit and other postretirement benefit plans:
======================================================================================================================== DEFINED BENEFIT PLANS OTHER POSTRETIREMENT BENEFITS In millions 1998 1997 1996 1998 1997 1996 - ------------------------------------------------------------------------------------------------------------------------ Service cost(1) $ 0.5 $ 7.6 $ 9.2 $ -- $ -- $ 0.4 Interest cost on benefit obligation 19.5 19.2 16.8 1.0 1.0 2.5 Expected return on plan assets (16.4) (14.9) (18.2) -- -- -- Amortization of net loss (gain) 1.2 0.3 6.1 (0.2) -- (1.1) Amortization of prior service cost 0.1 0.3 0.4 (0.1) (0.3) -- Curtailment gain -- (6.0) (1.3) -- -- -- - ------------------------------------------------------------------------------------------------------------------------ Net periodic pension cost $ 4.9 $ 6.5 $ 13.0 $ 0.7 $ 0.7 $ 1.8 ========================================================================================================================
(1) The decrease in total service cost is primarily due to the suspension of future benefit accruals under the Revco pension plan during 1997. 9 EMPLOYEE STOCK OWNERSHIP PLAN The Company sponsors a defined contribution Employee Stock Ownership Plan (the "ESOP") that covers full-time employees with at least one year of service. In 1989, the ESOP Trust borrowed $357.5 million through a 20-year note (the "ESOP Note"). The proceeds from the ESOP Note were used to purchase 6.7 million shares of Series One ESOP Convertible Preference Stock (the "ESOP Preference Stock") from the Company. Since the ESOP Note is guaranteed by the Company, the outstanding balance is reflected as long-term debt and a corresponding Guaranteed ESOP obligation is reflected in shareholders' equity in the accompanying consolidated balance sheets. Each share of ESOP Preference Stock has a guaranteed minimum liquidation value of $53.45, is convertible into 2.314 shares of common stock and is entitled to receive an annual dividend of $3.90 per share. The ESOP Trust uses the dividends received and contributions from the Company to repay the ESOP Note. As the ESOP Note is repaid, ESOP Preference Stock is allocated to participants based on: (i) the ratio of each year's debt service payment to total current and future debt service payments multiplied by (ii) the number of unallocated shares of ESOP Preference Stock in the plan. As of December 31, 1998, 5.2 million shares of ESOP Preference Stock were outstanding, of which 1.6 million shares were allocated to participants and the remaining 3.6 million shares were held in the ESOP Trust for future allocations. Annual ESOP expense recognized is equal to (i) the interest incurred on the ESOP Note plus (ii) the higher of (a) the principal repayments or (b) the cost of the shares allocated, less (iii) the dividends paid. Similarly, the Guaranteed ESOP obligation is reduced by the higher of (i) the principal payments or (ii) the cost of shares allocated. Following is a summary of the ESOP for the years ended December 31:
================================================================================ IN MILLIONS 1998 1997 1996 - ------------------------------------------------------------------------------- ESOP expense recognized $25.8 $13.8 $15.4 Dividends paid 20.5 20.8 21.8 Cash contributions 25.8 22.9 19.3 Interest costs incurred on ESOP loan 24.9 26.4 27.5 ESOP shares allocated 0.4 0.4 0.4 ================================================================================
47 10 SUPPLEMENTAL INFORMATION Following are the components of amounts included in the consolidated balance sheets as of December 31:
======================================================================================== IN MILLIONS 1998 1997 - ---------------------------------------------------------------------------------------- OTHER CURRENT ASSETS: Deferred income taxes $ 248.7 $ 295.8 Supplies 16.8 13.6 Other 62.4 47.0 - ---------------------------------------------------------------------------------------- $ 327.9 $ 356.4 ======================================================================================== PROPERTY AND EQUIPMENT: Land $ 91.0 $ 78.7 Buildings and improvements 290.2 231.5 Fixtures and equipment 1,178.4 938.9 Leasehold improvements 477.4 443.7 Capital leases 2.8 3.3 - ---------------------------------------------------------------------------------------- 2,039.8 1,696.1 Accumulated depreciation and amortization (688.6) (623.8) - ---------------------------------------------------------------------------------------- $ 1,351.2 $ 1,072.3 ======================================================================================== ACCRUED EXPENSES: Taxes other than federal income taxes $ 130.8 $ 127.5 Salaries and wages 111.5 131.1 Rent 92.2 84.8 Employee benefits 82.7 84.3 CVS/Revco reserve 61.5 136.3 CVS/Arbor reserve 56.7 -- Other 525.9 534.3 - ---------------------------------------------------------------------------------------- $ 1,061.3 $ 1,098.3 ========================================================================================
Following is a summary of the Company's non-cash financing activities for the years ended December 31:
============================================================================================== IN MILLIONS 1998 1997 1996 - ---------------------------------------------------------------------------------------------- Fair value of assets acquired $ 62.2 $ -- $ 423.2 Cash paid 62.2 -- 373.9 - ---------------------------------------------------------------------------------------------- Liabilities assumed $ -- $ -- $ 49.3 - ---------------------------------------------------------------------------------------------- Equity securities or notes received from sale of businesses $ -- $ 52.0 $ 172.4 ==============================================================================================
Interest expense was $69.7 million in 1998, $59.1 million in 1997 and $84.7 million in 1996. Interest income was $8.8 million in 1998, $15.0 million in 1997 and $9.2 million in 1996. 11 INCOME TAXES Deferred income taxes reflect the net tax effects of the temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. 48 The Company's income tax (provision) benefit for continuing operations for the years ended December 31 consisted of the following:
==================================================================================== IN MILLIONS Federal State Total - ------------------------------------------------------------------------------------ 1998: Current $ (197.3) $ (41.4) $ (238.7) Deferred (44.1) (23.7) (67.8) - ------------------------------------------------------------------------------------ $ (241.4) $ (65.1) $ (306.5) - ------------------------------------------------------------------------------------ 1997: Current $ (182.5) $ (68.5) $ (251.0) Deferred 75.0 26.8 101.8 - ------------------------------------------------------------------------------------ $ (107.5) $ (41.7) $ (149.2) - ------------------------------------------------------------------------------------ 1996: Current $ (195.6) $ (54.9) $ (250.5) Deferred (17.7) (2.8) (20.5) - ------------------------------------------------------------------------------------ $ (213.3) $ (57.7) $ (271.0) ====================================================================================
Following is a reconciliation of the statutory income tax rate to the Company's effective tax rate for the years ended December 31:
============================================================================================ 1998 1997 1996 - -------------------------------------------------------------------------------------------- Statutory income tax rate 35.0% 35.0% 35.0% State income taxes, net of federal tax benefit 5.8 6.6 5.5 Goodwill and other 1.2 1.4 1.6 - -------------------------------------------------------------------------------------------- Effective tax rate before merger-related costs 42.0 43.0 42.1 Merger-related costs (1) 2.4 19.8 -- - -------------------------------------------------------------------------------------------- Effective tax rate 44.4% 62.8% 42.1% ============================================================================================
(1) Includes state tax effect. Income taxes paid (refunded) were $102.6 million, $258.9 million and $(33.8) million during the years ended December 31, 1998, 1997 and 1996, respectively. Following is a summary of the significant components of the Company's deferred tax assets and liabilities as of December 31:
========================================================================== IN MILLIONS 1998 1997 - -------------------------------------------------------------------------- Deferred tax assets: Employee benefits $ 84.5 $ 119.0 Other assets 185.5 245.4 - -------------------------------------------------------------------------- Total deferred tax assets $ 270.0 $ 364.4 - -------------------------------------------------------------------------- Deferred tax liabilities: Property and equipment $ (44.0) $(27.0) Inventories (1.6) (29.9) Other liabilities -- (10.7) - -------------------------------------------------------------------------- Total deferred tax liabilities (45.6) (67.6) - -------------------------------------------------------------------------- Net deferred tax assets $ 224.4 $ 296.8 ==========================================================================
Based on historical pre-tax earnings, the Company believes it is more likely than not that the deferred tax assets will be realized. 49 As of December 31, 1998, the Company had federal net operating loss carryforwards ("NOLs") of $3.7 million that are attributable to Revco for periods prior to its emergence from Chapter 11. The benefits realized from these NOLs should reduce reorganization goodwill. Accordingly, the tax benefit of such NOLs utilized during the three years ended December 31, 1998, $7.2 million, $69.4 million and $15.3 million for 1998, 1997 and 1996, respectively, has not been included in the computation of the Company's income tax provision, but instead has been reflected as reductions of reorganization goodwill. On October 12, 1996, the Company completed the Footstar Distribution which is believed to be tax-free to the Company and its shareholders based on a legal opinion provided by outside counsel. However, since opinions of counsel are not binding on the Internal Revenue Service or the courts, it could ultimately be determined that the Footstar Distribution does not qualify as a tax-free distribution. If such occurred, the Company would be required to recognize a capital gain for tax purposes equal to the difference between the fair market value of the shares of Footstar stock distributed and the Company's basis in such shares. The Company, however, believes the likelihood of the Footstar Distribution not qualifying as a tax-free distribution to be remote. 12 BUSINESS SEGMENTS The Company currently operates a Retail segment and a Pharmacy Benefit Management ("PBM") segment. The Company's business segments are operating units that offer different products and services, and require distinct technology and marketing strategies. The Retail segment, which is described in Note 1, is the Company's only reportable segment. The PBM segment provides a full range of prescription benefit management services to managed care and other organizations. These services include plan design and administration, formulary management, mail order pharmacy services, claims processing and generic substitution. The accounting policies of the segments are substantially the same as those described in Note 1. The Company evaluates segment performance based on operating profit, before the effect of nonrecurring charges and gains and intersegment profits. Following is a reconciliation of the significant components of each segment's sales to consolidated net sales for the years ended December 31:
================================================================================ 1998 1997 1996 - -------------------------------------------------------------------------------- Pharmacy(1) 57.6% 54.7% 51.6% Front store 42.4 45.3 48.4 - -------------------------------------------------------------------------------- Consolidated net sales 100.0% 100.0% 100.0% ================================================================================
(1) Pharmacy sales includes the Retail segment's pharmacy sales, the PBM segment's total sales and the effect of the intersegment sales elimination discussed in the table below. 50 Following is a reconciliation of the Company's business segments to the consolidated financial statements:
================================================================================================================================== RETAIL PBM INTERSEGMENT OTHER CONSOLIDATED IN MILLIONS SEGMENT SEGMENT ELIMINATIONS(1) ADJUSTMENTS(2) TOTALS - ---------------------------------------------------------------------------------------------------------------------------------- 1998: Net sales $ 15,081.1 $ 488.4 $ (295.9) $ -- $ 15,273.6 Operating profit 927.8 12.7 -- (188.6) 751.9 Depreciation and amortization 248.6 1.1 -- -- 249.7 Total assets 6,602.1 119.6 (35.5) -- 6,686.2 Capital expenditures 498.0 4.3 -- -- 502.3 ================================================================================================================================== 1997: Net sales $ 13,649.4 $ 320.7 $ (220.5) $ -- $ 13,749.6 Operating profit 771.2 7.9 -- (497.4) 281.7 Depreciation and amortization 237.8 0.4 -- -- 238.2 Total assets 5,878.9 60.6 (19.0) -- 5,920.5 Capital expenditures 339.6 2.0 -- -- 341.6 ================================================================================================================================== 1996: Net sales $ 11,766.3 $ 208.9 $ (143.6) $ -- $ 11,831.6 Operating profit 602.5 2.2 -- (12.8) 591.9 Depreciation and amortization 205.2 0.2 -- -- 205.4 Total assets 6,003.5 32.8 (21.4) -- 6,014.9 Capital expenditures 326.9 2.0 -- -- 328.9 ==================================================================================================================================
(1) Intersegment eliminations relate to intersegment sales and accounts receivables that occur when a PBM segment customer uses a Retail segment store to purchase covered merchandise. When this occurs, both segments record the sale on a stand-alone basis. (2) Other adjustments relate to the merger, restructuring and other nonrecurring charges. These charges are not considered when management assesses the stand-alone performance of the Company's business segments. 13 COMMITMENTS & CONTINGENCIES In connection with certain business dispositions completed between 1991 and 1997, the Company continues to guarantee lease obligations for approximately 1,600 former stores. The Company is indemnified for these obligations by the respective purchasers. Assuming that each respective purchaser became insolvent, an event which the Company believes to be highly unlikely, management estimates that it could settle these obligations for approximately $1.1 billion as of December 31, 1998. In the opinion of management, the ultimate disposition of these guarantees will not have a material adverse effect on the Company's consolidated financial condition, results of operations or future cash flows. As of December 31, 1998, the Company has outstanding commitments to purchase $334.6 million of merchandise inventory for use in the normal course of business. The Company currently expects to satisfy these purchase commitments by 2002. The Company is also a defendant in various lawsuits arising in the ordinary course of business. In the opinion of management and the Company's outside counsel, the ultimate disposition of these lawsuits, exclusive of potential insurance recoveries, will not have a material adverse effect on the Company's consolidated financial condition, results of operations or future cash flows. 51 14 RECONCILIATION OF EARNINGS PER COMMON SHARE Following is a reconciliation of basic and diluted earnings per common share for the years ended December 31:
=============================================================================================================================== IN MILLIONS, EXCEPT PER SHARE AMOUNTS 1998 1997 1996 - ------------------------------------------------------------------------------------------------------------------------------- NUMERATOR FOR EARNINGS PER COMMON SHARE CALCULATION: Earnings from continuing operations before extraordinary item $ 384.5 $ 88.4 $ 372.4 Preference dividends, net of tax benefit (13.6) (13.7) (14.5) - ------------------------------------------------------------------------------------------------------------------------------- Earnings from continuing operations available to common shareholders, basic $ 370.9 $ 74.7 $ 357.9 - ------------------------------------------------------------------------------------------------------------------------------- Earnings (loss) from discontinued operations -- 17.5 (164.2) Extraordinary loss -- (17.1) -- - ------------------------------------------------------------------------------------------------------------------------------- Net earnings available to common shareholders, basic $ 370.9 $ 75.1 $ 193.7 =============================================================================================================================== Earnings from continuing operations before extraordinary item $ 384.5 $ 88.4 $ 372.4 Effect of dilutive securities: Preference dividends, net of tax benefit -- (13.7) -- Dilutive earnings adjustments (0.8) -- (7.5) - ------------------------------------------------------------------------------------------------------------------------------- Earnings from continuing operations available to common shareholders, diluted $ 383.7 $ 74.7 $ 364.9 - ------------------------------------------------------------------------------------------------------------------------------- Earnings (loss) from discontinued operations -- 17.5 (164.2) Extraordinary loss -- (17.1) -- - ------------------------------------------------------------------------------------------------------------------------------- Net earnings available to common shareholders, diluted $ 383.7 $ 75.1 $ 200.7 =============================================================================================================================== DENOMINATOR FOR EARNINGS PER COMMON SHARE CALCULATION: Weighted average common shares, basic 387.1 377.2 366.9 Effect of dilutive securities: Preference stock 10.5 -- 11.7 Stock options 7.6 7.9 5.0 - ------------------------------------------------------------------------------------------------------------------------------- Weighted average common shares, diluted 405.2 385.1 383.6 =============================================================================================================================== BASIC EARNINGS PER COMMON SHARE: Earnings from continuing operations before extraordinary item $ 0.96 $ 0.20 $ 0.98 Earnings (loss) from discontinued operations -- 0.05 (0.45) Extraordinary item, net of tax benefit -- (0.05) -- - ------------------------------------------------------------------------------------------------------------------------------- Net earnings $ 0.96 $ 0.20 $ 0.53 =============================================================================================================================== DILUTED EARNINGS PER COMMON SHARE: Earnings from continuing operations before extraordinary item $ 0.95 $ 0.19 $ 0.95 Earnings (loss) from discontinued operations -- 0.05 (0.43) Extraordinary item, net of tax benefit -- (0.05) -- - ------------------------------------------------------------------------------------------------------------------------------- Net earnings $ 0.95 $ 0.19 $ 0.52 ===============================================================================================================================
52 15 RESTATEMENT On May 11, 1999, CVS Corporation filed a Registration Statement on Form S-4 with the Securities and Exchange Commission related to an exchange offer for the $300 million of debt securities that CVS sold in a private placement on February 11, 1999. In connection with the SEC's review of that registration statement, CVS has restated its consolidated financial statements for 1998 and 1997 for the effect of the following: - - In connection with the merger of CVS and Arbor, CVS recorded an $11.0 million pre-tax ($6.5 million after-tax) charge in the second quarter of 1998, which represented the estimated nonrecurring costs that would be incurred in connection with eliminating the duplicate Arbor information technology systems. As reflected in the table below, CVS agreed to restate 1998 to expense these nonrecurring costs in the fiscal quarters in which the costs were incurred. - - In connection with the merger of CVS and Revco, CVS recorded a $39.6 million pre-tax ($23.4 million after-tax) charge in the second quarter of 1997, which represented the estimated nonrecurring costs that would be incurred in connection with eliminating the duplicate Revco information technology systems. As reflected in the table below, CVS agreed to restate 1997 to expense these nonrecurring costs in the fiscal quarters in which the costs were incurred. - - Also in connection with the merger of CVS and Revco, CVS recorded a $35.0 million pre-tax ($20.5 million after-tax) charge, which represented the estimated nonrecurring costs that would be incurred in connection with removing noncompatible merchandise fixtures from approximately 2,200 Revco stores. As reflected in the table below, CVS agreed to restate 1997 and 1998 to expense these nonrecurring costs in the fiscal quarters in which the costs were incurred. Following is a summary of the effect the above adjustments on CVS' consolidated statements of operations for the years ended December 31, 1998 and 1997:
================================================================================================================================= YEARS ENDED DECEMBER 31, 1998 1997 ------------------------------- ------------------------------- AS AS PREVIOUSLY AS AS PREVIOUSLY IN MILLIONS, EXCEPT PER SHARE AMOUNTS RESTATED REPORTED RESTATED REPORTED - --------------------------------------------------------------------------------------------------------------------------------- Net sales $ 15,273.6 $ 15,273.6 $ 13,749.6 $ 13,749.6 Cost of goods sold, buying and warehousing costs 11,144.4 11,144.4 10,031.3 10,031.3 - --------------------------------------------------------------------------------------------------------------------------------- Gross margin 4,129.2 4,129.2 3,718.3 3,718.3 Selling, general and administrative expenses 2,949.0 2,949.0 2,776.0 2,776.0 Depreciation and amortization 249.7 249.7 238.2 238.2 Merger, restructuring and other nonrecurring charges 178.6 158.3 422.4 442.7 - --------------------------------------------------------------------------------------------------------------------------------- Total operating expenses 3,377.3 3,357.0 3,436.6 3,456.9 - --------------------------------------------------------------------------------------------------------------------------------- Operating profit 751.9 772.2 281.7 261.4 Interest expense, net 60.9 60.9 44.1 44.1 - --------------------------------------------------------------------------------------------------------------------------------- Earnings from continuing operations before income taxes and extraordinary item 691.0 711.3 237.6 217.3 Income tax provision (306.5) (314.9) (149.2) (140.8) - --------------------------------------------------------------------------------------------------------------------------------- Earnings from continuing operations before extraordinary item 384.5 396.4 88.4 76.5 Discontinued operations, net of tax provision -- -- 17.5 17.5 - --------------------------------------------------------------------------------------------------------------------------------- Earning before extraordinary item -- -- 105.9 94.0 Extraordinary item, loss related to early retirement of debt, net of tax benefit of $11.4 -- -- (17.1) (17.1) - --------------------------------------------------------------------------------------------------------------------------------- Net earnings $ 384.5 $ 396.4 $ 88.8 $ 76.9 Preference dividends, net of income tax benefit (13.6) (13.6) (13.7) (13.7) - --------------------------------------------------------------------------------------------------------------------------------- Net earnings available to common shareholders $ 370.9 $ 382.8 $ 75.1 $ 63.2 ================================================================================================================================= BASIC EARNINGS PER COMMON SHARE: Earnings from continuing operations before extraordinary item $ 0.96 $ 0.99 $ 0.20 $ 0.17 Earnings from discontinued operations -- -- 0.05 0.05 Extraordinary loss, net of tax benefit -- -- (0.05) (0.05) - --------------------------------------------------------------------------------------------------------------------------------- Net earnings 0.96 0.99 0.20 0.17 - --------------------------------------------------------------------------------------------------------------------------------- Weighted average common shares outstanding 387.1 387.1 377.2 377.2 ================================================================================================================================= DILUTED EARNINGS PER COMMON SHARE: Earnings from continuing operations before extraordinary item $ 0.95 $ 0.98 $ 0.19 $ 0.16 Earnings from discontinued operations -- -- 0.05 0.05 Extraordinary loss, net of tax benefit -- -- (0.05) (0.05) - --------------------------------------------------------------------------------------------------------------------------------- Net earnings 0.95 0.98 0.19 0.16 - --------------------------------------------------------------------------------------------------------------------------------- Weighted average common shares outstanding 405.2 405.2 385.1 385.1 =================================================================================================================================
53 Following is a summary of the effect of the above adjustments on CVS' consolidated balance sheet as of December 31, 1997:
============================================================================================== DECEMBER 31, 1997 ----------------------------- AS AS PREVIOUSLY IN MILLIONS, EXCEPT PER SHARE AMOUNTS RESTATED REPORTED - --------------------------------------------------------------------------------------------- ASSETS: Cash and cash equivalents $ 192.5 $ 192.5 Accounts receivable, net 452.4 452.4 Inventories 2,882.4 2,882.4 Other current assets 356.4 364.8 - ---------------------------------------------------------------------------------------------- TOTAL CURRENT ASSETS 3,883.7 3,892.1 Property and equipment, net 1,072.3 1,072.3 Goodwill, net 711.5 711.5 Deferred charges and other assets 253.0 303.0 - ---------------------------------------------------------------------------------------------- TOTAL ASSETS $ 5,920.5 $ 5,978.9 ============================================================================================== LIABILITIES: Accounts payable $ 1,233.7 $ 1,233.7 Accrued expenses 1,098.3 1,168.6 Short-term borrowings 466.4 466.4 Current maturities of long-term debt 41.9 41.9 - ---------------------------------------------------------------------------------------------- TOTAL CURRENT LIABILITIES 2,840.3 2,910.6 Long-term debt 290.4 290.4 Other long-term liabilities 163.3 163.3 SHAREHOLDERS' EQUITY: Preference stock, series one ESOP convertible 284.6 284.6 Common stock, 3.9 3.9 Treasury stock, at cost: (262.9) (262.9) Guaranteed ESOP obligation (292.2) (292.2) Capital surplus 1,154.0 1,154.0 Retained earnings 1,739.1 1,727.2 - ---------------------------------------------------------------------------------------------- TOTAL SHAREHOLDERS' EQUITY 2,626.5 2,614.6 - ---------------------------------------------------------------------------------------------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 5,920.5 $ 5,978.9 ==============================================================================================
54 16 QUARTERLY FINANCIAL INFORMATION (UNAUDITED) Following is a summary of the effect of the restatement adjustments discussed in Note 15 on CVS' consolidated quarterly financial information:
=================================================================================================================================== 1998 FIRST QUARTER SECOND QUARTER THIRD QUARTER FOURTH QUARTER ---------------------- ----------------------- ---------------------- ----------------------- IN MILLIONS, AS AS PREVIOUSLY AS AS PREVIOUSLY AS AS PREVIOUSLY AS AS PREVIOUSLY EXCEPT PER SHARE AMOUNTS RESTATED REPORTED RESTATED REPORTED RESTATED REPORTED RESTATED REPORTED - ------------------------------------------------------------------------------------------------------------------------------------ Net sales $3,601.5 $3,601.5 $3,755.9 $3,755.9 $3,725.1 $3,725.1 $4,191.1 $4,191.1 Gross margin 1,006.9 1,006.9 1,020.5 1,020.5 $ 995.3 $ 995.3 $1,106.5 $1,106.5 Selling, general & administrative 704.2 704.2 726.4 726.4 742.9 742.9 775.5 775.5 Depreciation and amortization 63.8 63.8 61.2 61.2 60.7 60.7 64.0 64.0 Merger, restructuring and other nonrecurring charges 5.1 -- 161.0 158.3 10.6 -- 1.9 -- - ------------------------------------------------------------------------------------------------------------------------------------ Total operating expenses 773.1 768.0 948.6 945.9 814.2 803.6 841.4 839.5 - ------------------------------------------------------------------------------------------------------------------------------------ Operating profit 233.8 238.9 71.9 74.6 181.1 191.7 265.1 267.0 Interest expense, net 11.2 11.2 18.9 18.9 15.1 15.1 15.7 15.7 - ------------------------------------------------------------------------------------------------------------------------------------ Earnings before income taxes 222.6 227.7 53.0 55.7 166.0 176.6 249.4 251.3 Income tax provision 93.6 95.7 38.4 39.5 69.8 74.2 104.7 105.5 - ------------------------------------------------------------------------------------------------------------------------------------ Net earnings $ 129.0 $ 132.0 $ 14.6 $ 16.2 $ 96.2 $ 102.4 $ 144.7 $ 145.8 Preference dividends, net of income tax benefit (3.4) (3.4) (3.4) (3.4) (3.4) (3.4) (3.4) (3.4) - ------------------------------------------------------------------------------------------------------------------------------------ Net earnings available to common shareholders $ 125.6 $ 128.6 $ 11.2 $ 12.8 $ 92.8 $ 99.0 $ 141.3 $ 142.4 =================================================================================================================================== BASIC EARNINGS PER COMMON SHARE: Net earnings 0.33 0.34 0.03 0.03 0.24 0.25 0.36 0.37 - ----------------------------------------------------------------------------------------------------------------------------------- Weighted average common shares outstanding 382.9 382.9 385.8 385.8 389.5 389.5 390.1 390.1 =================================================================================================================================== DILUTED EARNINGS PER COMMON SHARE: Net earnings 0.32 0.33 0.03 0.03 0.23 0.25 0.36 0.36 - ----------------------------------------------------------------------------------------------------------------------------------- Weighted average common shares outstanding 400.9 400.9 394.6 394.6 396.1 396.1 407.5 407.5 =================================================================================================================================== DIVIDENDS DECLARED PER COMMON SHARE $ 0.0550 $ 0.0550 $ 0.0550 $ 0.0550 $ 0.0575 $ 0.0575 $ 0.0575 $ 0.0575 ===================================================================================================================================
55
=================================================================================================================================== 1997 FIRST QUARTER SECOND QUARTER THIRD QUARTER FOURTH QUARTER ---------------------- ----------------------- ---------------------- ----------------------- IN MILLIONS, AS AS PREVIOUSLY AS AS PREVIOUSLY AS AS PREVIOUSLY AS AS PREVIOUSLY EXCEPT PER SHARE AMOUNTS RESTATED REPORTED RESTATED REPORTED RESTATED REPORTED RESTATED REPORTED - ------------------------------------------------------------------------------------------------------------------------------------ Net sales $3,397.8 $3,397.8 $3,406.8 $3,406.8 $3,328.7 $3,328.7 $3,616.3 $3,616.3 Gross margin 967.9 967.9 873.0 873.0 $ 905.6 $ 905.6 $ 971.8 $ 971.8 Selling, general & administrative 703.3 703.3 693.7 693.7 688.6 688.6 690.4 690.4 Depreciation and amortization 57.7 57.7 58.7 58.7 63.5 63.5 58.3 58.3 Merger, restructuring and other nonrecurring charges 31.0 31.0 350.3 411.7 15.1 -- 26.0 -- - ----------------------------------------------------------------------------------------------------------------------------------- Total operating expenses 792.0 792.0 1,102.7 1,164.1 767.2 752.1 774.7 748.7 - ------------------------------------------------------------------------------------------------------------------------------------ Operating profit (loss) 175.9 175.9 (229.7) (291.1) 138.4 153.5 197.1 223.1 Interest expense, net 12.9 12.9 16.2 16.2 9.2 9.2 5.8 5.8 - ------------------------------------------------------------------------------------------------------------------------------------ Earnings (loss) from continuing operations before income taxes and extraordinary item 163.0 163.0 (245.9) (307.3) 129.2 144.3 191.3 217.3 Income tax provision (benefit) 70.9 70.9 (60.5) (85.9) 55.9 62.1 82.9 93.7 - ------------------------------------------------------------------------------------------------------------------------------------ Earnings (loss) from continuing operations before extraordinary item 92.1 92.1 (185.4) (221.4) 73.3 82.2 108.4 123.6 Discontinued operations, net of tax provision 0.1 0.1 17.4 17.4 -- -- -- -- - ------------------------------------------------------------------------------------------------------------------------------------ Earnings before extraordinary item 92.2 92.2 (168.0) (204.0) 73.3 82.2 108.4 123.6 Extraordinary loss, net of tax benefit -- -- (17.1) (17.1) -- -- -- -- - ------------------------------------------------------------------------------------------------------------------------------------ Net earnings (loss) $ 92.2 $ 92.2 $ (185.1) $(221.1) $ 73.3 $ 82.2 $ 108.4 $ 123.6 Preference dividends, net of income tax benefit (3.5) (3.5) (3.4) (3.4) (3.4) (3.4) (3.4) (3.4) - ------------------------------------------------------------------------------------------------------------------------------------ Net earnings (loss) available to common shareholders $ 88.7 $ 88.7 $ (188.5) $(224.5) $ 69.9 $ 78.8 $ 105.0 $ 120.2 =================================================================================================================================== BASIC EARNINGS PER COMMON SHARE: Earnings (loss) from continuing operations before extraordinary item $ 0.24 $ 0.24 $ (0.51) $(0.60) $ 0.18 $ 0.21 $ 0.27 $ 0.31 Earnings from discontinued operations -- -- 0.05 0.05 -- -- -- -- Extraordinary loss, net of tax benefit -- -- (0.05) (0.05) -- -- -- -- - ------------------------------------------------------------------------------------------------------------------------------------ Net earnings (loss) 0.24 0.24 (0.51) (0.60) 0.18 0.21 0.27 0.31 - ------------------------------------------------------------------------------------------------------------------------------------ Weighted average common shares outstanding 370.6 370.6 373.9 373.9 381.7 381.7 382.3 382.3 =================================================================================================================================== DILUTED EARNINGS PER COMMON SHARE: Earnings (loss) from continuing operations before extraordinary item $ 0.23 $ 0.23 $ (0.51) $(0.60) $ 0.18 $ 0.20 $ 0.27 $ 0.31 Earnings from discontinued operations -- -- 0.05 0.05 -- -- -- -- Extraordinary loss, net of tax benefit -- -- (0.05) (0.05) -- -- -- -- - ------------------------------------------------------------------------------------------------------------------------------------ Net earnings (loss) 0.23 0.23 (0.51) (0.60) 0.18 0.20 0.27 0.31 - ------------------------------------------------------------------------------------------------------------------------------------ Weighted average common shares outstanding 377.4 377.4 373.9 373.9 388.0 388.0 399.6 399.6 =================================================================================================================================== Dividends declared per common share $ 0.0550 $ 0.0550 $ 0.0550 $ 0.0550 $ 0.0550 $ 0.0550 $ 0.0550 $ 0.0550 ===================================================================================================================================
56 EX-23 2 EXHIBIT 23 EXHIBIT 23 CONSENT OF INDEPENDENT AUDITORS THE BOARD OF DIRECTORS AND SHAREHOLDERS OF CVS CORPORATION: We consent to incorporation by reference in the Registration Statements Numbers 333-49407, 33-40251, 333-34927, 333-28043, 33-17181, 2-97913, 2-77397 and 2-53766 on Form S-8 and 333-52055 on Form S-3 and 333-78253 on Form S-4 of CVS Corporation of our reports dated January 27, 1999, except for Note 15, to which the date is November 12, 1999, relating to the consolidated balance sheets of CVS Corporation and subsidiaries as of December 31, 1998 and 1997, and the related consolidated statement of operations, shareholders' equity and cash flows for each of the years in the three-year period ended December 31, 1998, and the related financial statement schedule, which reports appear in the December 31, 1998 annual report on Form 10-K/A of CVS Corporation. The consolidated balance sheet as of December 31, 1997, and the related consolidated statements of operations, stockholders' equity and cash flows for the years ended December 31, 1998 and 1997, have been restated as discussed in Note 15. KPMG LLP Providence, Rhode Island November 15, 1999 EX-27.1 3 EXHIBIT 27.1
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CONSOLIDATED CONDENSED BALANCE SHEET AND THE CONSOLIDATED CONDENSED STATEMENT OF OPERATIONS AS OF AND FOR THE YEAR ENDED DECEMBER 31, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 12-MOS DEC-31-1998 JAN-01-1998 DEC-31-1998 180,800 0 650,300 39,800 3,190,200 4,349,200 2,037,800 686,600 6,686,200 3,133,300 275,700 0 280,000 4,000 2,826,600 6,686,200 15,273,600 15,273,600 11,144,400 11,144,400 3,377,300 6,300 60,900 691,000 306,500 384,500 0 0 0 384,500 0.96 0.95
EX-27.2 4 EXHIBIT 27.2
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CONSOLIDATED CONDENSED BALANCE SHEET AND THE CONSOLIDATED CONDENSED STATEMENT OF OPERATIONS AS OF AND FOR THE NINE MONTHS ENDED SEPTEMBER 26, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 9-MOS DEC-31-1998 JAN-01-1998 SEP-28-1998 125,400 0 607,000 40,300 3,147,600 4,156,800 1,987,100 719,300 6,459,200 3,043,500 289,600 0 280,900 4,000 2,688,500 6,459,200 11,082,500 11,082,500 8,059,800 8,059,800 2,535,900 300 45,200 441,600 201,700 239,800 0 0 0 239,800 0.60 0.60
EX-27.3 5 EXHIBIT 27.3
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CONSOLIDATED CONDENSED BALANCE SHEET AND THE CONSOLIDATED CONDENSED STATEMENT OF OPERATIONS AS OF AND FOR THE SIX MONTHS ENDED JUNE 27, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 6-MOS DEC-31-1998 JAN-01-1998 JUN-27-1998 62,000 0 539,400 40,100 2,938,000 3,843,700 1,859,300 687,400 6,007,400 2,679,500 288,400 0 281,700 4,000 2,578,400 6,007,400 7,357,400 7,357,400 5,330,000 5,330,000 1,721,700 900 30,100 275,600 132,000 143,600 0 0 0 143,600 0.36 0.35
EX-27.4 6 EXHIBIT 27.4
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CONSOLIDATED CONDENSED BALANCE SHEET AND THE CONSOLIDATED CONDENSED STATEMENT OF OPERATIONS AS OF AND FOR THE THREE MONTHS ENDED MARCH 28, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 3-MOS DEC-31-1998 JAN-01-1998 MAR-28-1998 135,600 0 503,600 39,300 3,147,900 4,045,400 1,764,000 661,300 6,119,900 2,896,400 290,200 0 284,300 3,900 2,467,300 6,119,900 3,601,500 3,601,500 2,594,600 2,594,600 773,100 100 11,200 222,600 93,600 129,000 0 0 0 129,000 0.33 0.32
EX-27.5 7 EXHIBIT 27.5
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CONSOLIDATED CONDENSED BALANCE SHEET AND THE CONSOLIDATED CONDENSED STATEMENT OF OPERATIONS AS OF AND FOR THE YEAR ENDED DECEMBER 31, 1997 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 12-MOS DEC-31-1997 JAN-01-1997 DEC-31-1997 192,500 0 490,400 38,000 2,882,400 3,883,700 1,696,100 623,800 5,920,500 2,840,300 290,400 0 284,600 3,900 2,338,000 5,920,500 13,749,600 13,749,600 10,031,300 10,031,300 3,436,600 15,300 44,100 237,600 149,200 88,400 17,500 (17,100) 0 88,800 0.20 0.19
EX-27.6 8 EXHIBIT 27.6
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CONSOLIDATED CONDENSED BALANCE SHEET AND THE CONSOLIDATED CONDENSED STATEMENT OF OPERATIONS AS OF AND FOR THE NINE MONTHS ENDED SEPTEMBER 27, 1997 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 9-MOS DEC-31-1997 JAN-01-1997 SEP-27-1997 191,700 0 402,100 52,200 2,657,600 3,513,700 1,734,300 671,600 5,671,400 2,627,600 331,100 0 285,800 1,900 2,217,800 5,671,400 10,133,300 10,133,300 7,386,800 7,386,800 2,661,900 15,300 38,300 46,300 66,300 (20,000) 17,500 (17,100) 0 (19,600) (0.09) (0.10)
EX-27.7 9 EXHIBIT 27.7
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CONSOLIDATED CONDENSED BALANCE SHEET AND THE CONSOLIDATED CONDENSED STATEMENT OF OPERATIONS AS OF AND FOR THE SIX MONTHS ENDED JUNE 28, 1997 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 6-MOS DEC-31-1997 JAN-01-1997 JUN-28-1997 109,000 4,100 439,300 33,700 2,498,300 3,375,000 1,711,500 640,700 5,628,600 2,369,500 609,800 0 286,300 1,900 2,127,700 5,628,600 6,804,600 6,804,600 4,963,700 4,963,700 1,894,700 7,600 29,100 (82,900) (10,400) (93,300) 17,500 (17,100) 0 (92,900) (0.27) (0.27)
EX-27.8 10 EXHIBIT 27.8
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CONSOLIDATED CONDENSED BALANCE SHEET AND THE CONSOLIDATED CONDENSED STATEMENT OF OPERATIONS AS OF AND FOR THE THREE MONTHS ENDED MARCH 29, 1997 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 3-MOS DEC-31-1997 JAN-01-1997 MAR-29-1997 395,200 181,600 437,200 44,500 2,515,500 3,683,000 1,676,200 601,200 5,967,300 2,020,600 1,195,800 0 296,300 1,900 2,218,200 5,967,300 3,397,800 3,397,800 2,430,000 2,430,000 791,900 7,600 12,900 163,100 71,000 92,100 100 0 0 92,200 0.24 0.23
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