CAREMARK RX INC - 10-Q Quarterly Report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(MARK ONE)

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2004

¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission file number: 1-14200

CAREMARK RX, INC.

(Exact Name of Registrant as Specified in its Charter)


Delaware		63-1151076
(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization)		Identification No.)

211 Commerce Street, Suite 800

Nashville, Tennessee 37201

(Address and zip code of principal executive offices)

(615) 743-6600

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes x No ¨

As of April 30, 2004, the registrant had 463,626,679 shares (including 6,230,480 shares held in trust to be utilized in employee benefit plans) of common stock, par value $.001 per share, issued and outstanding.

FORWARD LOOKING STATEMENTS AND FACTORS THAT MAY AFFECT FUTURE RESULTS

In passing the Private Securities Litigation Reform Act of 1995 (the “Reform Act”), 15 U.S.C.A. Sections 77z-2 and 78u-5 (Supp. 1996), Congress encouraged public companies to make “forward looking statements” by creating a safe harbor to protect companies from securities law liability in connection with forward-looking statements. Caremark Rx, Inc. (“Caremark Rx”) intends to qualify both its written and oral forward-looking statements for protection under the Reform Act and any other similar safe harbor provisions. Unless the context indicates otherwise, the words “Company,” “we,” “our,” and “us,” whenever used in this Quarterly Report on Form 10-Q, refer collectively to Caremark Rx and its wholly-owned subsidiaries.

“Forward-looking statements” are defined by the Reform Act. Generally, forward-looking statements include expressed expectations of future events and the assumptions on which these expressed expectations are based. All forward-looking statements are inherently uncertain as they are based on various expectations and assumptions concerning future events, and they are subject to numerous known and unknown risks and uncertainties which could cause actual events or results to differ materially from those projected. Due to such risks and uncertainties, the investment community is urged not to place undue reliance on our written or oral forward-looking statements. We undertake no obligation to update or revise forward-looking statements to reflect changed assumptions, the occurrence of unanticipated events or changes to future operating results over time.

Forward-looking statements are contained in this document, primarily under the caption: “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” referred to as MD&A, and in the “Notes to Condensed Consolidated Financial Statements” appearing under Item 1. Moreover, through our senior management, we may from time to time make forward-looking statements about matters described herein or about other matters concerning us.

There are several factors which could adversely affect our operations and financial results, including, but not limited to, the following:

•

Risks relating to identification of, and competition for, growth and expansion opportunities;

•

Risks relating to declining reimbursement levels for, or increases in the costs of, products dispensed;

•

Risks relating to exposure to liabilities in excess of our insurance;

•

Risks relating to compliance with, or changes in, government regulation and legislation, including, but not limited to, pharmacy licensing requirements, the Health Insurance Portability and Accountability Act of 1996 (“HIPAA”) and healthcare reform legislation;

•

Risks relating to adverse developments in any investigation related to the pharmaceutical industry that may be conducted by governmental authorities;

•

Risks relating to adverse resolution of existing or future lawsuits;

•

Risks relating to successful integration of AdvancePCS;

•

Risks relating to our liquidity and capital requirements; and

•

Risks relating to our ability to successfully terminate leases and other contractual agreements related to our discontinued operations and the outcome of various legal disputes surrounding the closure or sale of our Physician Practice Management (“PPM”) business.

More detailed discussions of certain of these risk factors can be found under the captions: “Business,” “Legal Proceedings” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and in the “Notes to Consolidated Financial Statements” contained in our Annual Report on Form 10-K for the year ended December 31, 2003, which was filed with the Securities and Exchange Commission on March 9, 2004.

CAREMARK RX, INC. AND SUBSIDIARIES

QUARTERLY REPORT ON FORM 10-Q

INDEX


		Page

PART I—FINANCIAL INFORMATION

Item 1.	Financial Statements

	Condensed Consolidated Balance Sheets—March 31, 2004 (Unaudited) and December 31, 2003	2

	Condensed Consolidated Statements of Income (Unaudited)—Three Months Ended March 31, 2004 and 2003	3

	Condensed Consolidated Statements of Cash Flows (Unaudited)—Three Months Ended March 31, 2004 and 2003	4

	Notes to Condensed Consolidated Financial Statements (Unaudited)	5

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	17

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	24

Item 4.	Controls and Procedures	24

PART II—OTHER INFORMATION

Item 1.	Legal Proceedings	25

Item 4.	Submission of Matters to a Vote of Security Holders	28

Item 6.	Exhibits and Reports on Form 8-K	28

Signatures		30

CAREMARK RX, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except per share amounts)


	March 31, 2004			December 31, 2003
	(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents	$	357,111		$	815,328
Accounts receivable, less allowance for doubtful accounts of $43,657 in 2004 and $24,746 in 2003		2,143,726			669,680
Inventories		343,244			204,939
Income taxes receivable		40,210			—
Deferred tax asset, net		356,360			240,978
Prepaid expenses and other current assets		25,800			15,752

Total current assets		3,266,451			1,946,677
Property and equipment, net of accumulated depreciation of $176,733 in 2004 and $164,232 in 2003		300,759			159,769
Goodwill		6,899,210			49,171
Intangible assets, net of accumulated amortization of $13,248 in 2004 and $18,928 in 2003		955,880			9,273
Deferred tax asset, net		—			227,426
Other non-current assets		68,978			81,312

Total assets	$	11,491,278		$	2,473,628

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	536,254		$	385,362
Claims and discounts payable		2,503,892			509,713
Other accrued expenses and liabilities		255,904			158,666
Income taxes payable		—			7,820
Current portion of long-term debt		4,000			2,500

Total current liabilities		3,300,050			1,064,061
Long-term debt, net of current portion		600,000			693,125
Deferred tax liability		67,947			—
Other long-term liabilities		276,511			75,804

Total liabilities		4,244,508			1,832,990
Commitments and contingencies
Stockholders’ equity:
Common stock, $.001 par value per share; 700,000 shares authorized; issued—460,333 shares in 2004 and 268,578 shares in 2003		460			269
Additional paid-in capital		8,332,895			1,762,477
Unearned stock-based compensation		(49,088	)		—
Treasury stock—1,855 shares		(28,782	)		(28,782	)
Shares held in trust—6,236 shares in 2004 and 6,263 shares in 2003		(100,680	)		(101,103	)
Accumulated deficit		(897,045	)		(981,233	)
Accumulated other comprehensive loss		(10,990	)		(10,990	)

Total stockholders’ equity		7,246,770			640,638

Total liabilities and stockholders’ equity	$	11,491,278		$	2,473,628

The accompanying Notes to Condensed Consolidated Financial Statements

are an integral part of these balance sheets.

CAREMARK RX, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

(In thousands, except per share amounts)


	Three Months Ended March 31,
	2004		2003
Net revenue (1)	$	3,025,943	$	2,163,796

Operating expenses:
Cost of revenues (1)(2)		2,794,811		1,991,701
Selling, general and administrative expenses		55,911		46,103
Depreciation		12,789		9,859
Amortization of intangible assets		1,059		17
Interest expense, net		9,830		11,094
Stock option expense		819		—
Integration and other related expenses . . . . . . . .		10,410		—

Income before provision for income taxes		140,314		105,022
Provision for income taxes		56,126		42,009

Net income	$	84,188	$	63,013


Average number of common shares outstanding—basic		277,753		255,332
Common stock equivalents—stock options and warrants		8,159		6,449

Average number of common shares outstanding—diluted		285,912		261,781


Net income per common share—basic	$	0.30	$	0.25

Net income per common share—diluted	$	0.29	$	0.24

(1)	Includes $467,127 and $311,603 of retail copayments for the three months ended March 31, 2004 and 2003, respectively.

(2)	Excludes depreciation expense, which is presented separately.

The accompanying Notes to Condensed Consolidated Financial Statements

are an integral part of these statements.

CAREMARK RX, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(In thousands)


	Three Months Ended March 31,
	2004			2003
Cash flows from continuing operations:
Net income	$	84,188		$	63,013
Adjustments to reconcile net income to net cash provided by continuing operations:
Deferred income taxes		49,529			37,323
Depreciation and amortization		13,848			9,876
Non-cash interest expense		899			903
Writeoff of deferred financing costs		2,206			—
Stock option expense		819			—
Other non-cash expenses		129			397
Changes in operating assets and liabilities, net of effects of acquisitions and disposals of businesses		51,333			26,220

Net cash provided by continuing operations		202,951			137,732
Cash flows from investing activities:
Cash paid for AdvancePCS, net of cash acquired		(368,427	)		—
Capital expenditures, net		(12,943	)		(18,105	)
Partial liquidation of cost-method investment		10,382			—

Net cash used in investing activities		(370,988	)		(18,105	)
Cash flows from financing activities:
Repayments under credit facility		(245,625	)		(625	)
Borrowing under new term loan		150,000			—
Principal payment under AdvancePCS Senior Notes Tender Offer		(204,222	)		—
Proceeds from equity-based compensation plans		16,853			4,227
Purchase of treasury stock		—			(6,111	)
Deferred financing costs		(3,518	)		(100	)
Securities issuance costs		(1,892	)		—

Net cash used in financing activities		(288,404	)		(2,609	)
Cash used in discontinued operations		(1,776	)		(23,833	)

Net increase (decrease) in cash and cash equivalents		(458,217	)		93,185
Cash and cash equivalents—beginning of period		815,328			306,804

Cash and cash equivalents—end of period	$	357,111		$	399,989

Non-cash investing and financing activities related to the AdvancePCS Acquisition:
Fair value of non-cash net assets acquired (including approximately $6.85 billion of goodwill, based on the Company’s preliminary purchase price allocation)	$	6,891,347

Issuance of approximately 191 million shares of common stock		6,227,720
Issuance of replacement stock options for the purchase of approximately 14 million shares of common stock, net of approximately $49.9 million allocated to unearned compensation		271,909
Issuance of replacement warrants for the purchase of approximately 902,000 shares of common stock		15,000

Fair value of non-cash consideration	$	6,514,629

The accompanying Notes to Condensed Consolidated Financial Statements

are an integral part of these statements.

CAREMARK RX, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2004

(Unaudited)

Note 1. Business and Basis of Presentation

Caremark Rx, a Delaware corporation, is one of the largest pharmaceutical services companies in the United States. The Company’s operations are conducted primarily through Caremark Inc. (“Caremark”), a wholly-owned, indirect subsidiary of Caremark Rx, and CaremarkPCS (f/k/a AdvancePCS) (“CaremarkPCS” or “AdvancePCS”), a wholly-owned, direct subsidiary of Caremark Rx. Caremark Rx acquired AdvancePCS on March 24, 2004, as further described at Note 3, “Acquisition of AdvancePCS and Integration Plan,” below. The Company’s customers are primarily sponsors of health benefit plans (employers, insurance companies, unions, government employee groups, managed care organizations) and individuals located throughout the United States.

The accompanying unaudited condensed consolidated financial statements include the accounts of Caremark Rx and its wholly-owned subsidiaries and have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) for interim financial reporting and in accordance with Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and notes required by GAAP for complete financial statements.

In the opinion of management, the accompanying unaudited condensed consolidated financial statements contain all adjustments (consisting of normal recurring items) necessary for a fair presentation of results for the interim periods presented. The results of operations for any interim period are not necessarily indicative of results to be expected for a full year. The condensed consolidated balance sheet of the Company at December 31, 2003, has been derived from audited financial statements but does not include all disclosures required by GAAP. These financial statements and footnote disclosures should be read in conjunction with the Company’s audited consolidated financial statements and notes thereto for the year ended December 31, 2003, which appear in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 9, 2004.

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual amounts could differ from those estimates and assumptions.

Certain prior year amounts have been reclassified to conform to the current year’s presentation. Such reclassifications had no material effect on the Company’s previously reported consolidated financial position, results of operations or cash flows.

Note 2. Stock Options

The Company accounts for options to purchase its common stock under Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation (“FAS 123”). When the Company adopted FAS 123, it elected to continue using the intrinsic value method of expense recognition contained in Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (“APB 25”) and related interpretations, instead of the fair value method found in FAS 123, to account for employee stock options granted under its stock-based compensation plans.

The intrinsic value method requires the Company to recognize compensation expense based on the difference in the market price and the exercise price of options at their grant date. The exercise price of option grants under the Company’s stock-based compensation plans is equal to or greater than the market price of the underlying stock on the grant date; therefore, no compensation expense, other than compensation expense for the replacement stock options issued in connection with the AdvancePCS Acquisition as further discussed below has

CAREMARK RX, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

been recognized in the accompanying unaudited condensed consolidated financial statements.

The Company recognized approximately $819,000 of stock option expense in the three months ended March 31, 2004, related to the intrinsic value of unvested stock options issued to AdvancePCS optionees in exchange for their AdvancePCS options upon completion of the Company’s acquisition of AdvancePCS. The total intrinsic value of these unvested options at the acquisition date was approximately $49.9 million, and the Company expects to expense this amount over the remaining vesting period of the underlying stock options. The Company expects the expense for these options to total approximately $23 million for 2004.

FAS 123 requires companies which elected to continue applying the intrinsic value method to disclose pro forma information regarding net income and earnings per share as if the Company had recognized compensation expense for employee stock option grants using the fair value method described therein. The pro forma impact of applying this provision, using the Black-Scholes model (multiple-option method) to compute the fair value of stock option grants, on the Company’s net income to common stockholders and net income per common share is as follows (dollars in millions, except per share amounts):


	Three Months Ended March 31,
	2004		2003
As reported:
Net income	$	84.2	$	63.0