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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
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ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED JANUARY 1, 2000
COMMISSION FILE NUMBER 001-01011
CVS CORPORATION
(Exact name of Registrant as specified in its charter)
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DELAWARE 05-0494040
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(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
ONE CVS DRIVE 02895
WOONSOCKET, RHODE ISLAND ----------
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(Address of principal executive offices)
(401) 765-1500
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(Registrant's telephone number, including area code)
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE EXCHANGE ACT:
COMMON STOCK, PAR VALUE $0.01 PER SHARE NEW YORK STOCK EXCHANGE
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Title of each class Name of each exchange on which registered
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE EXCHANGE ACT: NONE
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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 common stock held by
non-affiliates of the registrant was approximately $14,163,727,852 as of March
21, 2000, based on the closing price of the common stock on the New York Stock
Exchange. For purposes of this calculation, only executive officers and
directors are deemed to be the affiliates of the registrant. This amount
excludes the value of 5,150,187 shares of Series One ESOP Convertible Preference
Stock.
As of March 21, 2000, the registrant had 389,023,886 shares of common stock
outstanding.
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DOCUMENTS INCORPORATED BY REFERENCE
The information required by Part III of this Annual Report on Form 10-K, to the
extent not set forth herein, is incorporated by reference from specified
portions of our definitive Proxy Statement for the 2000 Annual Meeting of
Stockholders.
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TABLE OF CONTENTS
PART I PAGE
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Item 1: Business................................................................................... 2
Item 2: Properties................................................................................. 8
Item 3: Legal Proceedings.......................................................................... 8
Item 4: Submission of Matters to a Vote of Security Holders........................................ 8
Executive Officers of the Registrant ................................................................ 9
PART II
Item 5: Market for Registrant's Common Equity and Related Stockholder Matters...................... 10
Item 6: Selected Financial Data.................................................................... 10
Item 7: Management's Discussion and Analysis of Financial Condition and Results of Operations...... 11
Item 7A: Quantitative and Qualitative Disclosures About Market Risk................................. 15
Item 8: Financial Statements and Supplementary Data................................................ 15
Item 9: Changes in and Disagreements with Accountants on Accounting and Financial Disclosure....... 40
PART III
Item 10: Directors and Executive Officers of the Registrant......................................... 41
Item 11: Executive Compensation..................................................................... 41
Item 12: Security Ownership of Certain Beneficial Owners and Management............................. 41
Item 13: Certain Relationships and Related Transactions............................................. 41
PART IV
Item 14: Exhibits, Financial Statement Schedules, and Reports on Form 8-K........................... 41
Independent Auditors' Report......................................................................... 45
Schedule II - Valuation and Qualifying Accounts...................................................... 46
Signatures .......................................................................................... 47
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PART I
ITEM 1. -- BUSINESS
OVERVIEW ~ CVS Corporation is a leader in the retail drugstore industry in the
United States with net sales of $18.1 billion in fiscal 1999. We are the largest
retail drugstore chain in the nation based on store count and hold the number
one market share in 30 of the top 100 U.S. drugstore markets, more than any
other retail drugstore chain. We also filled more prescriptions than any other
retailer in America during fiscal 1999. Our current operations are grouped into
four businesses: Retail Pharmacy, Pharmacy Benefit Management ("PBM"), Specialty
Pharmacy and Internet Pharmacy.
Retail Pharmacy ~ As of January 1, 2000, the Retail Pharmacy business
includes 4,086 retail drugstores, located in 24 states and the District of
Columbia, operating under the CVS/pharmacy name. CVS/pharmacy stores sell
prescription drugs and a wide assortment of general merchandise, including
over-the-counter drugs, greeting cards, film and photofinishing services,
beauty products and cosmetics, seasonal merchandise and convenience foods.
Existing stores generally range in size from approximately 8,000 to 12,000
square feet, although most new stores are based on one of our standard
10,125 or 10,880 square foot freestanding buildings, which typically
include a drive-thru pharmacy. The Retail Pharmacy is our only reportable
segment as it represented approximately 97% of consolidated net sales and
operating profit in fiscal 1999.
Pharmacy Benefit Management ~ The PBM business 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 PBM business operates under the PharmaCare
Management Services name. 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 clinically effective therapy.
Since its introduction in 1995, the number of physicians using CIMS has
grown to over 50,000. PharmaCare now ranks as one of the top ten PBMs in
the nation.
Specialty Pharmacy ~ As of January 1, 2000, the Specialty Pharmacy business
includes a mail order facility and 20 retail pharmacies, opened or under
construction, located in nine states and the District of Columbia,
operating under the CVS ProCare name. CVS ProCare primarily sells
prescription drugs to individuals requiring complex and expensive drug
therapies, including treatments for HIV/AIDS, organ transplants,
infertility, and conditions such as multiple sclerosis and growth hormone
deficiency. Stores are typically 1,500 square feet and include a limited
general merchandise offering targeted to this specific patient population.
Internet Pharmacy ~ The Internet Pharmacy business includes a mail order
facility and a complete online retail pharmacy, operating under the CVS.com
name. CVS.com enables customers to order prescriptions for in-store pickup
or mail delivery, buy general merchandise, receive the latest health news
and general health information and ask questions to our pharmacists.
CVS Corporation is a Delaware corporation. Our Store Support Center (corporate
office) is located at One CVS Drive, Woonsocket, Rhode Island 02895, telephone
(401) 765-1500.
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 purpose of the
restructuring plan was, among other things, to enhance stockholder value by
transforming Melville Corporation from a diversified retailer with a wide range
of specialty retail businesses into an industry-focused retail healthcare
company operating under the CVS Corporation name. 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.
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As part of this program, on October 16, 1996, we changed our common stock
trading symbol on the New York Stock Exchange to "CVS" from "MES." On November
20, 1996, following shareholder approval, we officially changed our name to CVS
Corporation from Melville Corporation.
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 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 restated our historical consolidated 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 at the time, and
strengthened our position as the nation's top drugstore retailer in terms of
store count and retail prescriptions dispensed.
CVS/PHARMACY STORES
OPERATING STRATEGY ~ Our operating strategy is to provide a broad assortment of
high-quality merchandise at competitive prices using a retail format that
emphasizes exceptional service and convenience. One of the keys to our strategy
is technology, which allows us to constantly improve service and explore ways to
provide more personalized product offerings and services. We believe our
continuing to be the first to market with new products and services, using
innovative marketing, introducing more products which are unique to CVS and
adjusting our mix of merchandise to match customer needs and preferences is very
important in our ability to maintain customer satisfaction.
CUSTOMERS ~ During fiscal 1999 we served an average of 2.5 million customers per
day. Since our sales are to numerous customers, including managed care
organizations, the loss of any one customer would not have a material effect on
the business. No single customer, including managed care organizations, accounts
for more than ten percent of our total sales.
PRODUCTS ~ A typical CVS/pharmacy store sells prescription drugs and a wide
assortment of high-quality, nationally advertised brand name and private label
merchandise. General merchandise categories include over-the-counter drugs,
greeting cards, film and photofinishing services, beauty products and cosmetics,
seasonal merchandise and convenience foods.
We centrally purchase most of our merchandise, including prescription drugs,
directly from numerous manufacturers and distributors. This purchasing strategy
allows us to take advantage of the promotional and volume discount programs that
certain manufacturers and distributors offer to retailers. During fiscal 1999,
approximately 90% of the merchandise we purchased was received by one of our
distribution centers for redistribution to our stores, while the balance was
shipped directly to the stores. We believe that competitive sources are readily
available for substantially all of the products we carry and the loss of any one
supplier would not have a material effect on the business.
To complement the national brand name products we offer, we also carry a full
range of high-quality private label products that are only available through
CVS. As of January 1, 2000, we carried approximately 1,500 CVS brand products,
which accounted for approximately 11% of our front store sales in fiscal 1999.
Due to the success of our private label program, we will continue to assess
opportunities to expand our range of private label product offerings.
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OPERATIONS ~ As of January 1, 2000, we operated 4,086 CVS/pharmacy stores, of
which over 750 were operated on an extended hour or 24-hour basis. Store
operations are divided into two areas, pharmacy and front store:
Pharmacy ~ Pharmacy sales increased 24.4% to $10.6 billion, representing
59% of total sales in fiscal 1999, compared to 58% in fiscal 1998 and 55%
in fiscal 1997. During fiscal 1999, we filled 281 million prescriptions, or
almost 11% of the U.S. retail market, which was more than any other
retailer. We believe that our pharmacy operations will continue to
represent a critical part of our business and strategy due to our ability
to attract and retain managed care customers, favorable industry trends and
our on-going program of purchasing prescription files from independent
pharmacies.
The growth in managed care has substantially increased the use of
prescription drugs. Managed care providers have made the cost of
prescription drugs more affordable to a greater number of people and
supported prescription drug therapy as an alternative to more expensive
forms of treatment, such as surgery. Payments by third party managed care
providers under prescription drug plans represented 87% of our total
pharmacy sales in fiscal 1999, compared to 84% in fiscal 1998 and 81% in
fiscal 1997.
In a typical third party payment plan, we contract with a third party payer
(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 payers and the increasing competition among pharmacies for this
business. To address this trend, we have dropped and/or renegotiated 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.
Pharmacy sales should also continue to benefit from favorable industry
trends. These trends include an aging American population consuming a
greater number of prescription drugs, pharmaceuticals being used more often
as the first line of defense for managing illness and the introduction and
aggressive marketing of several successful new drugs. Each of these trends
is contributing to a strong prescription drug industry, which we believe
will continue to fuel the future growth of our pharmacy sales.
Our pharmacy business also benefits from a program, in which we purchase
prescription files from independent pharmacies. During fiscal 1999, we
purchased 327 prescription files. We believe that purchasing these
prescription files are productive investments. In many cases, the
independent pharmacist will join CVS, thereby providing continuity in the
pharmacist-patient relationship.
Front Store ~ Front store sales, which are generally higher margin than
pharmacy sales, increased 9.3% to $7.1 billion, representing 41% of total
sales in fiscal 1999, compared to 42% in fiscal 1998 and 45% in fiscal
1997. We believe that our effective management of the mix of merchandise in
our stores has been a primary factor in our front store comparable sales
gains and improved gross margins and will continue to fuel front store
sales growth and increase customer satisfaction. We intend to continue our
front store growth by continuing to be the first to market with new
products and services, using innovative marketing, introducing more
products which are unique to CVS and adjusting our mix of merchandise to
match customer needs and preferences.
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STORE DEVELOPMENT ~ The addition of new stores has played, and will continue to
play, a major role in our continued growth. In fiscal 1999, we opened 445 new
stores, which included 12 CVS ProCare stores and 299 relocations. We expect to
open approximately 400 to 450 new stores during fiscal 2000, including
approximately 250 relocations. During fiscal 2000, we plan to enter Tampa,
Florida, the 13th largest U.S. drugstore market, and Grand Rapids, Michigan, the
73rd largest U.S. drugstore market. Going forward, we expect to enter two to
three new markets each year. As we open new stores, we maintain our objective of
securing a strong position in each market that our stores serve. In fiscal 1999,
we held the number one or number two market position in approximately 83% of the
top 100 U.S. drugstore markets we served. Our strong market positions provide us
with several important advantages, including an ability to save on advertising
and distribution costs and an ability to attract managed care providers, who
want to provide their members with convenient access to pharmacy services.
A key part of our store development program is our relocation effort. Our
relocation program actively seeks to relocate many of our strip shopping center
locations to freestanding sites. 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 only 33% of our existing stores
were freestanding as of January 1, 2000. We currently expect to have
approximately 40% of our stores in freestanding locations by the end of fiscal
2000. Our long-term goal is to have approximately 80% of our stores located in
freestanding sites. We cannot, however, guarantee that future store relocations
will achieve similar results as those historically achieved.
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 integral part of our ability to maintain our
leadership position in the retail drugstore industry.
The following is a breakdown by state of our 4,098 store locations as of January
1, 2000*:
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Alabama 140 Kentucky 71 Pennsylvania 327
California 1 Maine 19 Rhode Island 53
Connecticut 123 Maryland 169 South Carolina 183
Delaware 3 Massachusetts 325 Texas 1
District of Columbia 48 Michigan 242 Tennessee 142
Florida 21 New Hampshire 28 Vermont 2
Georgia 288 New Jersey 196 Virginia 247
Illinois 69 North Carolina 279 West Virginia 58
Indiana 280 Ohio 396
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* Includes 12 CVS ProCare store located in California, Florida, Georgia,
Maryland, Massachusetts, New York, Pennsylvania, Rhode Island, Texas and
the District of Columbia.
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 fiscal 2000 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, the majority of our
non-pharmacy sales are in cash, while third party insurance programs, which
typically settle in less than 30 days, paid for 87% of our pharmacy sales in
fiscal 1999. Our customer returns are not significant.
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.
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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 Excellence in Pharmacy Innovation and Care
("EPIC") program. EPIC is a multiyear project that will reengineer the way
our pharmacies communicate and fill prescriptions. The project includes
integrated workflow improvements and automated pill-counting machines in
high volume stores. During fiscal 1997, we implemented Rapid Rx Refill,
which enables customers to order prescription refills 24 hours a day using
a touch-tone telephone. Rapid Rx Refill now accounts for approximately 50%
of refills. Together, these initiatives are expected to continue to enhance
pharmacy productivity, increase capacity, lower costs and improve service
by lowering customer wait times and enabling pharmacists to spend more time
with customers.
Front Store Systems ~ Our point-of-sale scanning technology has enabled us
to develop an advanced retail database 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. We are also working
on 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. We have already begun to experience tangible
benefits from our supply chain initiatives and we expect to continue to do
so.
ASSOCIATE DEVELOPMENT ~ As of January 1, 2000, we employed approximately 100,000
associates. To deliver the highest levels of service to our customers and
partners, we devote considerable time and attention to our people and service
standards. We emphasize attracting and training friendly and helpful associates
to work in our stores and throughout our organization. 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 company.
INTELLECTUAL PROPERTY AND LICENSES ~ We have registered or applied for
registration of a variety of trade names, service marks and trademarks for use
in our business. We regard our intellectual property as having significant value
and as being an important factor in the marketing of the Company and our stores.
We are not aware of any facts that could negatively impact our continuing use of
any of our intellectual property.
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.
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. In each of the markets we serve, there are a number of independent
and other retail drugstore chains, supermarkets, convenience stores and discount
merchandisers. With respect to some products, we also compete with mail order
providers and internet pharmacies.
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CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING STATEMENTS ~ Certain statements
in this Annual Report (as well as in other public filings, our web site, press
releases and oral statements made by Company management and/or representatives),
constitute forward-looking statements, which are subject to risks and
uncertainties.
Forward-looking statements include information concerning:
- our future results of operations, including sales and earnings per
common share growth and cost savings and synergies following the Revco
and Arbor mergers;
- our planned store development, including store openings, new markets
and capital expenditures;
- our belief that we have sufficient cash flows to support working
capital needs, capital expenditures and debt service requirements;
- our belief concerning the growth of our free cash flow;
- 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;
- our belief concerning the profitability of CVS.com;
- our belief concerning the growth of CVS ProCare sales and store
locations; and
- our belief that we can continue to reduce inventory levels and improve
inventory turnover.
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 and/or representatives), could cause
actual results to differ materially from those expressed in the forward-looking
statements:
WHAT FACTORS COULD AFFECT THE OUTCOME OF OUR FORWARD-LOOKING STATEMENTS?
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;
- the continued efforts of health maintenance organizations, managed
care organizations, pharmacy benefit management companies and other
third party payers to reduce prescription drug costs; and
- changes in accounting policies and practices, including taxation
requirements.
OPERATING FACTORS
- our ability to implement new computer systems and technologies;
- our ability to continue to secure suitable new store locations on
favorable lease terms;
- the creditworthiness of the purchasers of former businesses whose
store leases are guaranteed by CVS;
- our ability to continue to purchase inventory on favorable terms;
- our ability to attract, hire and retain suitable pharmacists and
management personnel; and
- our ability to establish effective advertising, marketing and
promotional programs (including pricing strategies) in the different
geographic markets in which we operate.
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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" on page 31 of this Annual Report.
As of January 1, 2000, we owned approximately two percent of our 4,098 retail
and specialty pharmacy drugstores. Net selling space for our retail and
specialty pharmacy drugstores totaled 30.3 million square feet as of January 1,
2000. Approximately 26% of our stores included drive-thru pharmacies as of
January 1, 2000.
Our stores are supported by ten company-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 also lease approximately 141,000 square feet in
three mail order service facilities located in Ohio.
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 eight office buildings in Rhode Island, Massachusetts and Washington.
In addition, in connection with certain business dispositions completed between
1991 and 1997, we continue to guarantee lease obligations for approximately
1,400 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 that we believe to be
highly unlikely, management estimates that it could settle these obligations for
approximately $1.0 billion as of January 1, 2000.
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.
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 January 1, 2000.
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EXECUTIVE OFFICERS OF THE REGISTRANT
The following sets forth the name, age and biographical information for each of
our executive officers as of January 1, 2000:
CHARLES C. CONAWAY, age 39, President and Chief Operating Officer of CVS
Corporation since April 1999; Executive Vice President and Chief Financial
Officer of CVS Corporation from July 1996 to April 1999; Executive Vice
President and Chief Financial Officer of CVS Pharmacy, Inc. from February 1995
to April 1999; Senior Vice President -- Pharmacy of CVS Pharmacy, Inc. from
September 1992 to February 1995; Chairman of the Board of PharmaCare Management
Services, Inc. and director of Linens 'n Things, Inc.
ROSEMARY MEDE, age 53, Senior Vice President -- Human Resources of CVS Pharmacy,
Inc. since October 1997; Vice President of CVS Corporation since October 1997;
Vice President/General Manager of Business Services of Becton Dickinson & Co.
from December 1995 to September 1997; held various management positions in human
resources at Becton Dickinson from 1988 to November 1995.
LARRY J. MERLO, age 44, Executive Vice President -- Stores of CVS Pharmacy, Inc.
since March 1998; Vice President of CVS Corporation since October 1996; Senior
Vice President -- Stores of CVS Pharmacy, Inc. from January 1994 to March 1998.
DANIEL C. NELSON, age 50, Executive Vice President -- Marketing of CVS Pharmacy,
Inc. since September 1993; Vice President of CVS Corporation since October 1996.
Mr. Nelson resigned from his position with the Company in February 2000.
DAVID B. RICKARD, age 53, Executive Vice President and Chief Financial Officer
of CVS Corporation and CVS Pharmacy, Inc. since September 1999; Senior Vice
President and Chief Financial Officer of RJR Nabisco Holdings Corporation from
March 1997 through August 1999; Executive Vice President, International
Distillers and Vintners Americas, November 1996 through March 1997; Finance
Director, International Distillers and Vintners, August 1995 to November 1996;
Group Controller, Grand Metropolitan PLC, 1994 to August 1995.
THOMAS M. RYAN, age 47, Chairman of the Board of CVS Corporation since April
1999 and Chief Executive Officer of CVS Corporation since May 1998; President of
CVS Corporation from May 1998 to April 1999; Vice Chairman and Chief Operating
Officer of CVS Corporation from October 1996 to May 1998; President and Chief
Executive Officer of CVS Pharmacy, Inc. from January 1994 to April 1999;
director of FleetBoston Financial Corporation and Reebok International Ltd.
DOUGLAS A. SGARRO, age 40, Senior Vice President -- Administration and Chief
Legal Officer of CVS Pharmacy, Inc. since September 1997; President of CVS
Realty Co., the real estate development, construction and property management
division of CVS Pharmacy, Inc., since October 1999; Vice President of CVS
Corporation since September 1997; partner in the New York City office of the law
firm of Brown & Wood LLP from January 1993 to August 1997.
LARRY D. SOLBERG, age 52, Senior Vice President -- Finance and Controller of CVS
Pharmacy, Inc. since March 1996; Vice President of CVS Corporation since October
1996; Vice President and Controller of CVS Pharmacy, Inc. from October 1994 to
March 1996.
LARRY J. ZIGERELLI, age 41, Executive Vice President -- Corporate Development of
CVS Pharmacy, Inc. since February 1999; Vice President of CVS Corporation since
February 1999; Vice President and General Manager, Food and Beverage -- Latin
America, The Procter & Gamble Company from June 1998 to January 1999; Vice
President and General Manager, Puerto Rico and the Caribbean, The Procter &
Gamble Company from October 1994 to May 1998. Effective with the resignation of
Mr. Nelson in February 2000, Mr. Zigerelli assumed the title of Executive Vice
President -- Marketing of CVS Corporation.
9
11
PART II
ITEM 5. -- MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Since October 16, 1996, our common stock has been listed on the New York Stock
Exchange under the symbol "CVS." Information regarding the market prices of our
common stock and dividends declared may be found in Note 15 of the Notes to
Consolidated Financial Statements included in "Item 8 -- Financial Statements
and Supplementary Data."
On June 15, 1998, there was a two-for-one stock split on all shares of common
stock owned by shareholders as of May 25, 1998.
ITEM 6. -- SELECTED FINANCIAL DATA
The following selected financial data should be read in conjunction with "Item 8
- -- Financial Statements and Supplementary Data" and "Item 7 -- Management's
Discussion and Analysis of Financial Condition and Results of Operations."
- -----------------------------------------------------------------------------------------------------------------------
Fiscal Year
1999 1998 1997 1996 1995
In millions, except per share amounts (53 WEEKS) (52 weeks) (52 weeks) (52 weeks) (52 weeks)
- -----------------------------------------------------------------------------------------------------------------------
STATEMENT OF OPERATIONS DATA:
Net sales $ 18,098.3 $ 15,273.6 $ 13,749.6 $ 11,831.6 $ 10,513.1
Gross margin(1) 4,861.4 4,129.2 3,718.3 3,300.9 2,960.0
Selling, general & administrative 3,448.0 2,949.0 2,776.0 2,490.8 2,336.4
Depreciation and amortization 277.9 249.7 238.2 205.4 186.4
Merger, restructuring and other
nonrecurring charges -- 178.6 422.4 12.8 165.5
- -----------------------------------------------------------------------------------------------------------------------
Operating profit(2) 1,135.5 751.9 281.7 591.9 271.7
Other expense (income), net 59.1 60.9 44.1 (51.5) 114.0
Income tax provision 441.3 306.5 149.2 271.0 74.3
- -----------------------------------------------------------------------------------------------------------------------
Earnings from continuing operations
before extraordinary item(3) $ 635.1 $ 384.5 $ 88.4 $ 372.4 $ 83.4
- -----------------------------------------------------------------------------------------------------------------------
PER COMMON SHARE DATA:
Earnings from continuing operations
before extraordinary item (3)
Basic $ 1.59 $ 0.96 $ 0.20 $ 0.98 $ 0.18
Diluted 1.55 0.95 0.19 0.95 0.18
Cash dividends per common share 0.230 0.225 0.220 0.220 0.760
- -----------------------------------------------------------------------------------------------------------------------
BALANCE SHEET AND OTHER DATA:
Total assets $ 7,275.4 $ 6,686.2 $ 5,920.5 $ 6,014.9 $ 6,614.4
Long-term debt 558.5 275.7 290.4 1,204.8 1,056.3
Total shareholders' equity 3,679.7 3,110.6 2,626.5 2,413.8 2,567.4
Number of stores (at end of period) 4,098 4,122 4,094 4,204 3,715
- -----------------------------------------------------------------------------------------------------------------------
(1) 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.
(2) Operating profit includes the pre-tax effect of the charges discussed in
Note (1) 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) 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.
(3) 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 (1) and (2)
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.
10
12
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.
RESULTS OF OPERATIONS
Fiscal 1999, which ended on January 1, 2000, included 53 weeks, while fiscal
1998 and 1997, which ended on December 26, 1998 and December 27, 1997,
respectively, included 52 weeks.
NET SALES increased 18.5% in 1999 to $18.1 billion. This compares to increases
of 11.1% in 1998 and 16.2% in 1997. Same store sales, consisting of sales from
stores that have been open for more than one year, rose 12.5% in 1999, 10.8% in
1998 and 9.7% in 1997. Pharmacy same-store sales increased 19.4% in 1999 and
16.5% in 1998 and 1997. Our pharmacy sales as a percentage of total net sales
were 59% in 1999, 58% in 1998 and 55% in 1997. Our third party prescription
sales as a percentage of total pharmacy sales were 87% in 1999, 84% in 1998 and
81% in 1997.
As you review our sales performance, we believe you should consider the
following important information:
- - 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 strong performance in the health
and beauty, photo, seasonal, and general merchandise categories.
- - The increase in net sales in 1999 was positively affected by the 53rd week.
Excluding the positive impact of the 53rd week, net sales increased 16.0%
in 1999 when compared to 1998.
- - 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.
Our performance during the conversion period was positively affected by
temporary promotional events.
- - 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 3 to the consolidated financial
statements for other important information about the Big B acquisition.
- - We continued 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 only 33% of our existing stores are freestanding. We
currently expect to have approximately 40% of our stores in freestanding
locations by the end of 2000. Our long-term goal is to have 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 26.9% in 1999. This compares to
27.0% in 1998 and 1997. Inventory shrinkage was 0.9% of net sales in 1999,
compared to 0.8% of net sales in 1998 and 1997. As you review our gross margin
performance, please remember to consider the impact of the following
nonrecurring charges:
- - During 1998, we recorded a $10.0 million charge to cost of goods sold to
reflect markdowns on noncompatible Arbor merchandise, which resulted from
the CVS/Arbor merger transaction. Please read Notes 2 and 3 to the
consolidated financial statements for other important information about the
CVS/Arbor merger.
11
13
- - During 1997, we recorded a $75.0 million charge to cost of goods sold to
reflect markdowns on noncompatible Revco merchandise, which resulted from
the CVS/Revco merger transaction. Please read Notes 2 and 3 to the
consolidated financial statements for other important information about the
CVS/Revco merger.
If you exclude the effect of these nonrecurring charges, our comparable gross
margin as a percentage of net sales was 26.9% in 1999, 27.1% in 1998 and 27.6%
in 1997.
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 and/or renegotiated 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 20.6% of net sales in 1999. This compares to 22.1%
in 1998 and 25.0% in 1997. As you review our performance in this area, please
remember to consider the impact of the following nonrecurring charges:
- - During 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. 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 2 and 3 to the consolidated financial
statements for other important information about the CVS/Arbor merger.
- - During 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. 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, Inc. Please read Notes 2
and 3 to the consolidated financial statements for other important
information about the CVS/Revco merger and Big B acquisition.
If you exclude the effect of the nonrecurring charges we incurred in 1998 and
1997, comparable operating expenses as a percentage of net sales were 20.6% in
1999, 20.9% in 1998 and 21.9% in 1997.
What have we done to improve our comparable total operating expenses as a
percentage of net sales?
- - 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.
- - We eliminated most of Arbor's existing corporate overhead in 1998 and most
of Revco's in 1997.
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.
12
14
OPERATING PROFIT increased $383.6 million to $1.1 billion in 1999. This compares
to $751.9 million in 1998 and $281.7 million in 1997. If you exclude the effect
of the nonrecurring charges we recorded in gross margin and in total operating
expenses, our comparable operating profit increased $195.0 million (or 20.7%) to
$1.1 billion in 1999. This compares to $940.5 million in 1998 and $779.1 million
in 1997. Comparable operating profit as a percentage of net sales was 6.3% in
1999, 6.2% in 1998 and 5.7% in 1997.
INTEREST EXPENSE, NET consisted of the following:
- ----------------------------------------------------------------------------------------------------------------------
Fiscal Year
In millions 1999 1998 1997
- ----------------------------------------------------------------------------------------------------------------------
Interest expense $ 66.1 $ 69.7 $ 59.1
Interest income (7.0) (8.8) (15.0)
- ----------------------------------------------------------------------------------------------------------------------
Interest expense, net $ 59.1 $ 60.9 $ 44.1
- ----------------------------------------------------------------------------------------------------------------------
The decrease in interest expense in 1999 was primarily due to the fact that we
replaced $300 million of our commercial paper borrowings with unsecured senior
notes that bear a lower interest rate than our commercial paper. The increase in
interest expense in 1998 was primarily due to higher average borrowing levels
when compared to 1997. The decrease in interest income in 1998 was primarily due
to interest income recognized during 1997 on a note receivable that we received
when we sold Kay-Bee Toys in 1996. This note was sold in 1997.
INCOME TAX PROVISION ~ Our effective income tax rate was 41.0% in 1999 compared
to 44.4% in 1998 and 62.8% in 1997. Our effective income tax rates were higher
in 1998 and 1997 because certain components of the nonrecurring charges we
recorded in conjunction with the CVS/Arbor and CVS/Revco merger transactions
were not deductible for income tax purposes.
EARNINGS FROM CONTINUING OPERATIONS BEFORE EXTRAORDINARY ITEM increased $250.6
million to $635.1 million (or $1.55 per diluted share) in 1999. This compares to
$384.5 million (or $0.95 per diluted share) in 1998 and $88.4 million (or $0.19
per diluted share) in 1997. If you exclude the effect of the nonrecurring
charges we recorded in cost of goods sold and in total operating expenses, our
comparable earnings from continuing operations before extraordinary item
increased 24.5% to $635.1 million (or $1.55 per diluted share) in 1999. This
compares to $510.1 million (or $1.26 per diluted share) in 1998 and $419.2
million (or $1.05 per diluted share) in 1997.
DISCONTINUED OPERATIONS ~ In November 1997, we completed the final phase of a
comprehensive strategic restructuring program, under which we sold Marshalls,
Kay-Bee Toys, Wilsons, This End Up and 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. During
1997, we sold our remaining investment in Linens `n Things and recorded, as a
component of discontinued operations, an after-tax gain of $38.2 million. In
connection with recording this gain, we also recorded, as a component of
discontinued operations, an after-tax charge of $20.7 million during 1997 to
finalize our original liability estimates. Please read Note 4 to the
consolidated financial statements for other important information about this
program.
EXTRAORDINARY ITEM ~ During 1997, we retired $865.7 million of the debt we
absorbed when we acquired Revco. As a result, we recorded a charge for an
extraordinary item, net of income taxes, of $17.1 million. The extraordinary
item included the early retirement premiums we paid and the balance of our
deferred financing costs.
NET EARNINGS were $635.1 million (or $1.55 per diluted share) in 1999. This
compares to $384.5 million (or $0.95 per diluted share) in 1998 and $88.8
million (or $0.19 per diluted share) in 1997.
LIQUIDITY & CAPITAL RESOURCES
LIQUIDITY ~ The Company has three primary sources of liquidity: cash provided by
operations, commercial paper and uncommitted lines of credit. We generally
finance our inventory and capital expenditure requirements with internally
generated funds and commercial paper. We currently expect to continue to utilize
our commercial paper program to support our working capital needs. In addition,
we may elect to use long-term borrowings in the future to support our continued
growth.
13
15
Our commercial paper program is supported by a $670 million, five-year unsecured
revolving credit facility that expires on May 30, 2002, and a $530 million,
364-day unsecured revolving credit facility that expires on June 21, 2000. We
can also obtain up to $35.0 million of short-term financing through various
uncommitted lines of credit. As of January 1, 2000, we had $451.0 million of
commercial paper outstanding at a weighted average interest rate of 6.2%. There
were no borrowings outstanding under the uncommitted lines of credit as of
January 1, 2000.
On February 11, 1999, we issued $300 million of 5.5% unsecured senior notes due
February 15, 2004. The proceeds from the issuance were used to repay outstanding
commercial paper borrowings.
Our credit facilities and unsecured senior notes contain customary restrictive
financial and operating covenants. We do not believe that the restrictions
contained in these covenants materially affect our financial or operating
flexibility.
CAPITAL RESOURCES ~ Although there can be no assurance and assuming market
interest rates remain favorable, we currently believe that we will continue to
have access to capital at attractive interest rates in 2000. We further believe
that our cash on hand and cash provided by operations, together with our ability
to obtain additional short-term and long-term financing, will be sufficient to
cover our future working capital needs, capital expenditures and debt service
requirements for at least the next 12 months.
NET CASH PROVIDED BY OPERATIONS ~ Net cash provided by operations was $658.8
million in 1999. This compares to net cash provided by operations of $221.0
million in 1998 and net cash used in operations of $105.8 million in 1997. The
improvement in net cash provided by operations was primarily the result of
higher net earnings, improved working capital management and a reduction in cash
payments associated with the Arbor and Revco mergers. You should be aware that
cash flow from operations will continue to be negatively impacted by future
payments associated with the Arbor and Revco mergers and the Company's strategic
restructuring program. As of January 1, 2000, the future cash payments
associated with these programs totaled $123.0 million. These payments primarily
include: (i) $12.1 million for employee severance, which extends through 2000,
(ii) $9.0 million for retirement benefits and related excess parachute payment
excise taxes, which extend for a number of years to coincide with the future
payment of retirement benefits, and (iii) $98.5 million for continuing lease
obligations, which extend through 2020.
CAPITAL EXPENDITURES ~ Our capital expenditures totaled $493.5 million in 1999.
This compared to $502.3 million in 1998 and $341.6 million in 1997. During 1999,
we opened 146 new stores, relocated 299 existing stores and closed 170 stores.
During 2000, we currently expect to open 425 stores, including 250 relocations.
As of January 1, 2000, we operated 4,098 retail drugstores in 26 states and the
District of Columbia.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities." This statement, which establishes the accounting and
financial reporting requirements for derivative instruments, requires companies
to recognize derivatives as either assets or liabilities on the balance sheet
and measure those instruments at fair value. In May 1999, the Financial
Accounting Standards Board delayed the implementation date for this statement by
one year. We expect to adopt SFAS No. 133 in 2001. We currently are in the
process of determining what impact, if any, this pronouncement will have on our
consolidated financial statements.
CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING STATEMENTS
We have made forward-looking statements in this Annual Report that are subject
to risks and uncertainties that could cause actual results to differ materially.
For these statements, we claim the protection of the safe harbor for
forward-looking statements contained in the Private Securities Litigation Reform
Act of 1995. We strongly recommend that you become familiar with the specific
risks and uncertainties that we have outlined for you under "Item 1 -- Business
- -- Cautionary Statement Concerning Forward-Looking Statements."
14
16
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 believe that our exposure to market
risk associated with other financial instruments (such as fixed and variable
rate borrowings), are not material.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Financial Statements:
Management's Responsibility for Financial Reporting.................................................................. 16
Independent Auditor's Report......................................................................................... 17
Consolidated Statements of Operations for the fiscal years ended January
1, 2000, December 26, 1998 and December 27, 1997.................................................................. 18
Consolidated Balance Sheets as of January 1, 2000 and December 26, 1998.............................................. 19
Consolidated Statements of Shareholders' Equity for the fiscal years
ended January 1, 2000, December 26, 1998 and December 27, 1997.................................................... 20
Consolidated Statements of Cash Flows for the fiscal years ended January 1, 2000,
December 26, 1998 and December 27, 1997........................................................................... 21
Notes to Consolidated Financial Statements...........................................................................22-40
Financial Statement Schedule:
Schedule II -- Valuation and Qualifying Accounts..................................................................... 46
All other schedules are omitted because they are not applicable.
15
17
MANAGEMENT'S RESPONSIBILITY FOR FINANCIAL REPORTING
The integrity and objectivity of the financial statements and related financial
information in this Annual Report are the responsibility of the management of
the Company. The financial statements have been prepared in conformity with
generally accepted accounting principles and include, when necessary, the best
estimates and judgments of management.
The Company maintains a system of internal controls designed to provide
reasonable assurance, at appropriate cost, that assets are safeguarded,
transactions are executed in accordance with management's authorization, and the
accounting records provide a reliable basis for the preparation of the financial
statements. The system of internal accounting controls is continually reviewed
by management and improved and modified as necessary in response to changing
business conditions and the recommendations of the Company's internal auditors
and independent auditors.
KPMG LLP, independent auditors, are engaged to render an opinion regarding the
fair presentation of the consolidated financial statements of the Company. Their
accompanying report is based upon an audit conducted in accordance with
generally accepted auditing standards and included a review of the system of
internal controls to the extent they considered necessary to support their
opinion.
The Audit Committee of the Board of Directors, consisting solely of outside
directors, meets periodically with management, internal auditors and the
independent auditors to review matters relating to the Company's financial
reporting, the adequacy of internal accounting controls and the scope and
results of audit work. The internal auditors and independent auditors have free
access to the Audit Committee.
/s/ THOMAS M. RYAN
- ------------------
Thomas M. Ryan
Chairman of the Board and Chief Executive Officer
/s/ DAVID B. RICKARD
- --------------------
David B. Rickard
Executive Vice President and Chief Financial Officer
February 7, 2000
16
18
INDEPENDENT AUDITORS' REPORT
Board of Directors and Shareholders
CVS Corporation:
We have audited the accompanying consolidated balance sheets of CVS Corporation
and subsidiaries as of January 1, 2000 and December 26, 1998, and the related
consolidated statements of operations, shareholders' equity, and cash flows for
the fifty-three week period ended January 1, 2000 and the fifty-two week periods
ended December 26, 1998 and December 27, 1997. 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 January 1, 2000 and December 26, 1998, and the results of
their operations and their cash flows for the fifty-three week period ended
January 1, 2000 and the fifty-two week periods ended December 26, 1998 and
December 27, 1997, in conformity with generally accepted accounting principles.
/s/ KPMG LLP
- ------------
KPMG LLP
Providence, Rhode Island
February 7, 2000
17
19
CVS CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
- ----------------------------------------------------------------------------------------------------------------------
Fiscal Year Ended
JANUARY 1, December 26, December 27,
2000 1998 1997
In millions, except per share amounts (53 WEEKS) (52 weeks) (52 weeks)
- ----------------------------------------------------------------------------------------------------------------------
Net sales $ 18,098.3 $ 15,273.6 $ 13,749.6
Cost of goods sold, buying and warehousing costs 13,236.9 11,144.4 10,031.3
- ----------------------------------------------------------------------------------------------------------------------
Gross margin 4,861.4 4,129.2 3,718.3
Selling, general and administrative expenses 3,448.0 2,949.0 2,776.0
Depreciation and amortization 277.9 249.7 238.2
Merger, restructuring and other nonrecurring charges -- 178.6 422.4
- ----------------------------------------------------------------------------------------------------------------------
Total operating expenses 3,725.9 3,377.3 3,436.6
- ----------------------------------------------------------------------------------------------------------------------
Operating profit 1,135.5 751.9 281.7
Interest expense, net 59.1 60.9 44.1
- ----------------------------------------------------------------------------------------------------------------------
Earnings from continuing operations before income tax provision
and extraordinary item 1,076.4 691.0 237.6
Income tax provision 441.3 306.5 149.2
- ----------------------------------------------------------------------------------------------------------------------
Earnings from continuing operations before extraordinary item 635.1 384.5 88.4
Discontinued operations:
Gain on disposal, net of income tax provision of $12.4 -- -- 17.5
- ----------------------------------------------------------------------------------------------------------------------
Earnings from discontinued operations -- -- 17.5
- ----------------------------------------------------------------------------------------------------------------------
Earnings before extraordinary item 635.1 384.5 105.9
Extraordinary item, loss related to early retirement of
debt, net of income tax benefit of $11.4 -- -- (17.1)
- ----------------------------------------------------------------------------------------------------------------------
Net earnings 635.1 384.5 88.8
Preference dividends, net of income tax benefit (14.7) (13.6) (13.7)
- ----------------------------------------------------------------------------------------------------------------------
Net earnings available to common shareholders $ 620.4 $ 370.9 $ 75.1
- ----------------------------------------------------------------------------------------------------------------------
BASIC EARNINGS PER COMMON SHARE:
Earnings from continuing operations before extraordinary item $ 1.59 $ 0.96 $ 0.20
Earnings from discontinued operations -- -- 0.05
Extraordinary item, net of income tax benefit -- -- (0.05)
- ----------------------------------------------------------------------------------------------------------------------
Net earnings $ 1.59 $ 0.96 $ 0.20
- ----------------------------------------------------------------------------------------------------------------------
Weighted average common shares outstanding 391.3 387.1 377.2
- ----------------------------------------------------------------------------------------------------------------------
DILUTED EARNINGS PER COMMON SHARE:
Earnings from continuing operations before extraordinary item $ 1.55 $ 0.95 $ 0.19
Earnings from discontinued operations -- -- 0.05
Extraordinary item, net of income tax benefit -- -- (0.05)
- ----------------------------------------------------------------------------------------------------------------------
Net earnings $ 1.55 $ 0.95 $ 0.19
- ----------------------------------------------------------------------------------------------------------------------
Weighted average common shares outstanding 408.9 405.2 385.1
- ----------------------------------------------------------------------------------------------------------------------
DIVIDENDS DECLARED PER COMMON SHARE $ 0.230 $ 0.225 $ 0.220
- ----------------------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
18
20
CVS CORPORATION
CONSOLIDATED BALANCE SHEETS
- ----------------------------------------------------------------------------------------------------------------------
JANUARY 1, December 26,
In millions, except shares and per share amounts 2000 1998
- ----------------------------------------------------------------------------------------------------------------------
ASSETS:
Cash and cash equivalents $ 230.0 $ 180.8
Accounts receivable, net 699.3 650.3
Inventories 3,445.5 3,190.2
Deferred income taxes 139.4 248.7
Other current assets 93.8 79.2
- ----------------------------------------------------------------------------------------------------------------------
TOTAL CURRENT ASSETS 4,608.0 4,349.2
Property and equipment, net 1,601.0 1,351.2
Goodwill, net 706.9 724.6
Other assets 359.5 261.2
- ----------------------------------------------------------------------------------------------------------------------
TOTAL ASSETS $ 7,275.4 $ 6,686.2
- ----------------------------------------------------------------------------------------------------------------------
LIABILITIES:
Accounts payable $ 1,454.2 $ 1,286.3
Accrued expenses 967.4 1,061.3
Short-term borrowings 451.0 771.1
Current portion of long-term debt 17.3 14.6
- ----------------------------------------------------------------------------------------------------------------------
TOTAL CURRENT LIABILITIES 2,889.9 3,133.3
Long-term debt 558.5 275.7
Deferred income taxes 27.2 24.3
Other long-term liabilities 120.1 142.3
Commitments and contingencies (Note 12)
SHAREHOLDERS' EQUITY:
Preferred stock, $0.01 par value: authorized 120,619 shares; no shares issued
or outstanding -- --
Preference stock, series one ESOP convertible, par value $1.00:
authorized 50,000,000 shares; issued and outstanding 5,164,000 shares at
January 1, 2000, and 5,239,000 shares at December 26, 1998 276.0 280.0
Common stock, par value $0.01: authorized 1,000,000,000 shares; issued
403,047,000 shares at January 1, 2000 and 401,380,000 shares at
December 26, 1998 4.0 4.0
Treasury stock, at cost: 11,051,000 shares at January 1, 2000, and 11,169,000
shares at December 26, 1998 (258.5) (260.2)
Guaranteed ESOP obligation (257.0) (270.7)
Capital surplus 1,371.7 1,336.4
Retained earnings 2,543.5 2,021.1
- ----------------------------------------------------------------------------------------------------------------------
TOTAL SHAREHOLDERS' EQUITY 3,679.7 3,110.6
- ----------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 7,275.4 $ 6,686.2
- ----------------------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
19
21
CVS CORPORATION
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
- -----------------------------------------------------------------------------------------------------------------------
Fiscal Year Ended
Shares Dollars
------------------------------------ ---------------------------------------
JANUARY 1, December 26, December 27, JANUARY 1, December 26, December 27,
In millions 2000 1998 1997 2000 1998 1997
- -----------------------------------------------------------------------------------------------------------------------
PREFERENCE STOCK:
Beginning of year 5.2 5.3 5.6 $ 280.0 $ 284.6 $ 298.6
Conversion to common stock -- (0.1) (0.3) (4.0) (4.6) (14.0)
- -----------------------------------------------------------------------------------------------------------------------
End of year 5.2 5.2 5.3 276.0 280.0 284.6
- -----------------------------------------------------------------------------------------------------------------------
COMMON STOCK:
Beginning of year 401.4 393.7 369.3 4.0 3.9 3.7
Stock options exercised and awards
under stock plans 1.0 7.5 10.9 -- 0.1 0.1
Other 0.6 0.2 13.5 -- -- 0.1
- -----------------------------------------------------------------------------------------------------------------------
End of year 403.0 401.4 393.7 4.0 4.0 3.9
- -----------------------------------------------------------------------------------------------------------------------
TREASURY STOCK:
Beginning of year (11.2) (11.3) (11.7) (260.2) (262.9) (273.1)
Conversion of preference stock 0.2 0.2 0.5 4.0 4.2 12.2
Other (0.1) (0.1) (0.1) (2.3) (1.5) (2.0)
- -----------------------------------------------------------------------------------------------------------------------
End of year (11.1) (11.2) (11.3) (258.5) (260.2) (262.9)
- -----------------------------------------------------------------------------------------------------------------------
GUARANTEED ESOP OBLIGATION:
Beginning of year (270.7) (292.2) (292.2)
Reduction of guaranteed ESOP
obligation 13.7 21.5 --
- -----------------------------------------------------------------------------------------------------------------------
End of year (257.0) (270.7) (292.2)
- -----------------------------------------------------------------------------------------------------------------------
CAPITAL SURPLUS:
Beginning of year 1,336.4 1,154.0 941.2
Conversion of preference stock 0.1 0.3 1.8
Stock options exercised and awards
under stock plans 31.3 176.2 195.9
Other 3.9 5.9 15.1
- -----------------------------------------------------------------------------------------------------------------------
End of year 1,371.7 1,336.4 1,154.0
- -----------------------------------------------------------------------------------------------------------------------
RETAINED EARNINGS:
Beginning of year 2,021.1 1,739.1 1,737.9
Net earnings 635.1 384.5 88.8
Dividends:
Preference stock, net of income
tax benefit (14.7) (13.6) (13.7)
Common stock (90.0) (88.9) (73.9)
Immaterial pooling of interests (8.0) -- --
- -----------------------------------------------------------------------------------------------------------------------
End of year 2,543.5 2,021.1 1,739.1
- -----------------------------------------------------------------------------------------------------------------------
OTHER:
Beginning of year -- -- (2.4)
Unrealized holding gain on
investments, net -- -- 2.4
- -----------------------------------------------------------------------------------------------------------------------
End of year -- -- --
- -----------------------------------------------------------------------------------------------------------------------
TOTAL SHAREHOLDERS' EQUITY $ 3,679.7 $ 3,110.6 $ 2,626.5
- -----------------------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
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22
CVS CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
- ----------------------------------------------------------------------------------------------------------------------
Fiscal Year Ended
JANUARY 1, December 26, December 27,
2000 1998 1997
In millions (53 WEEKS) (52 weeks) (52 weeks)
- ----------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings $ 635.1 $ 384.5 $ 88.8
Adjustments required to reconcile net earnings to net cash
provided by (used in) operating activities:
Depreciation and amortization 277.9 249.7 242.6
Merger, restructuring and other nonrecurring charges -- 188.6 466.4
Deferred income taxes and other noncash items 124.8 80.6 (140.4)
Extraordinary item, net of income tax benefit -- -- 17.1
Change in assets and liabilities, excluding acquisitions:
Increase in accounts receivable, net (48.9) (197.9) (82.5)
Increase in inventories (255.0) (315.0) (566.1)
Increase in other current assets (16.7) (18.5) (18.3)
Increase in accounts payable 166.8 52.6 174.7
Decrease in accrued expenses (37.7) (134.5) (232.3)
Decrease in other assets and other long-term liabilities (187.5) (69.1) (55.8)
- ----------------------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES 658.8 221.0 (105.8)
- ----------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to property and equipment (493.5) (502.3) (341.6)
Acquisitions, net of cash (33.6) (62.2) --
Proceeds from sale of businesses and other property and equipment 28.2 50.5 192.7
Proceeds from sale of investments -- -- 309.7
- ----------------------------------------------------------------------------------------------------------------------
NET CASH (USED IN) PROVIDED BY INVESTING ACTIVITIES (498.9) (514.0) 160.8
- ----------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
(Reductions in) additions to short-term borrowings (324.5) 304.6 466.4
Proceeds from exercise of stock options 20.4 121.1 169.1
Additions to (reductions in) long-term debt 298.1 (41.9) (917.2)
Dividends paid (104.7) (102.5) (87.6)
- ----------------------------------------------------------------------------------------------------------------------
NET CASH (USED IN) PROVIDED BY FINANCING ACTIVITIES (110.7) 281.3 (369.3)
- ----------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents 49.2 (11.7) (314.3)
Cash and cash equivalents at beginning of year 180.8 192.5 506.8
- ----------------------------------------------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 230.0 $ 180.8 $ 192.5
- ----------------------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
21
23
NOTE 1 -- SIGNIFICANT ACCOUNTING POLICIES
DESCRIPTION OF BUSINESS ~ CVS Corporation ("CVS" or the "Company") is
principally in the retail drugstore business. As of January 1, 2000, the Company
operated 4,098 retail drugstores and three mail order facilities located in 26
states and the District of Columbia. See Note 13 for further information about
the Company's business segments.
BASIS OF PRESENTATION ~ The consolidated financial statements include the
accounts of the Company and its wholly-owned subsidiaries. All material
intercompany balances and transactions have been eliminated. Fiscal 1999, which
ended on January 1, 2000, included 53 weeks, while fiscal 1998 and 1997, which
ended on December 26, 1998 and December 27, 1997, respectively, included 52
weeks.
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.
RECLASSIFICATIONS ~ Certain reclassifications have been made to the consolidated
financial statements of prior years to conform to the current year presentation.
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 $41.1 million and $39.8 million as of January 1, 2000
and December 26, 1998, respectively. The balance primarily includes amounts due
from third party providers (e.g., pharmacy benefit managers, insurance
companies, governmental agencies and vendors).
FINANCIAL INSTRUMENTS ~ 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.
INVENTORIES ~ Inventories are stated at the lower of cost or market using the
first-in, first-out method.
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 compares the carrying amount 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 (discounted and
with interest charges), an impairment loss is recorded.
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 $105.0 million
and $85.6 million as of January 1, 2000 and December 26, 1998, 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.
22
24
OTHER ASSETS ~ Other assets primarily include favorable leases, which are
amortized on a straight-line basis over the life of the lease, 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 2 for further
information about the Company's merger with Revco D.S. Inc.
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 is 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 is 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.
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.
STOCK-BASED COMPENSATION ~ The Company has 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 ("APB") Opinion No. 25, "Accounting for Stock Issued to
Employees." The Company has elected to continue to account for its stock-based
compensation plans under APB Opinion No. 25. See Note 7 for further information
about the Company's stock incentive plans.
ADVERTISING COSTS ~ External costs incurred to produce media advertising are
charged to expense when the advertising takes place.
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.
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 the
enacted tax rates expected to apply to taxable income in the years in which
those temporary differences are expected to be recovered or settled.
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 be accrued under the
Company's incentive compensation plans.
23
25
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
compensation 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 fiscal 1999, the Company adopted American
Institute of Certified Public Accountants Statement of Position 98-1,
"Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use." This statement defines which costs incurred to develop or
purchase internal-use software should be capitalized and which costs should be
expensed. The adoption of this statement did not have a material effect on the
Company's consolidated financial statements.
NOTE 2 -- BUSINESS COMBINATIONS
CVS/ARBOR MERGER
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.
CVS/REVCO MERGER
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 constituted tax-free reorganizations
and have been accounted for as pooling of interests under APB Opinion No. 16,
"Business Combinations". Accordingly, all prior period financial statements were
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.
The Company also acquired other businesses that were accounted for as purchase
business combinations and immaterial pooling of interests. These acquisitions
did not have a material effect on the Company's consolidated financial
statements either individually or in the aggregate. The results of operations of
these businesses have been included in the consolidated financial statements
since their respective dates of acquisition.
NOTE 3 -- MERGER, RESTRUCTURING & ASSET IMPAIRMENT CHARGES
CVS/ARBOR CHARGE
In accordance with APB Opinion No. 16, 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.
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26
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 located in Arbor's Troy, Michigan
corporate headquarters, including the 22 senior executives that were covered by
employment 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 returned the premises to the landlord at the
conclusion of the current lease term, which extended 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. At the time the exit plan was executed,
management anticipated that these locations would be closed by no later
than December 31, 1999. 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. 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. To date, 41 of these locations have been closed or are in the
process of being closed. 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.
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.
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
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27
$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 shutdown 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 as
of the respective balance sheet dates:
- ----------------------------------------------------------------------------------------------------------------------------
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 12/26/98 -- 13.3 40.0 -- -- 3.4 -- 56.7
Utilization - Cash -- (3.0) (2.7) -- -- -- -- (5.7)
- ----------------------------------------------------------------------------------------------------------------------------
Balance at 01/1/00(4) $ -- $ 10.3 $ 37.3 $ -- $ -- $ 3.4 $ -- $ 51.0
- ----------------------------------------------------------------------------------------------------------------------------
(1) Employee severance extends through 2000. Employee benefits extend for a
number of years to coincide with the payment of excess parachute payment
excise taxes and related income tax gross-ups.
(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 as of January 1, 2000 are
adequate to cover the remaining liabilities associated with the CVS/Arbor
Charge.
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CVS/REVCO CHARGE
In accordance with APB Opinion 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 employment
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.
3. The 223 Revco store locations discussed above would be closed as soon as
practical after the merger. At the time the exit plan was executed,
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,
all of these locations have been closed.
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29
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 with 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 to stores. 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.
28
30
Following is a reconciliation of the beginning and ending liability balances as
of the respective balance sheet dates:
- ----------------------------------------------------------------------------------------------------------------------------
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 12/27/97 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 12/26/98 -- 12.4 49.1 -- -- -- -- 61.5
Utilization - Cash -- (3.4) (9.9) -- -- -- -- (13.3)
- ----------------------------------------------------------------------------------------------------------------------------
Balance at 01/1/00(4) $ -- $ 9.0 $ 39.2 $ -- $ -- $ -- $ -- $ 48.2
- ----------------------------------------------------------------------------------------------------------------------------
(1) Employee severance extended through 1999. Employee benefits extend for a
number of years to coincide with the payment of retirement benefits and
excess parachute payment excise taxes and related income tax gross-ups.
(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 as of January 1, 2000 are
adequate to cover the remaining liabilities associated with the CVS/Revco
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, Inc. (the "Big B
Charge"), which the Company acquired in 1996. 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 $15.9
million and $10.0 million had been incurred as of January 1, 2000 and December
26, 1998, respectively. The remaining cash outlays primarily include
noncancelable lease commitments, which extend through 2012. The above costs did
not provide future benefit to the retained stores or corporate facilities.
NOTE 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, (iii) the initial and secondary public offerings of
Linens `n Things and (iv) the closing of the Company's administrative office
facility located in Rye, New York.
The strategic restructuring program was completed without significant changes to
the Board approved plan.
During the second quarter of 1997, the Company sold its remaining investment in
Linens `n Things and recorded, as a component of discontinued operations, a
pre-tax gain of $65.0 million ($38.2 million after-tax). In connection with
recording this gain, the Company also 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"). The 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.
29
31
Following is a summary of the beginning and ending liability balances as of the
respective balance sheet dates:
- -------------------------------------------------------------------------------------------------------------------
Noncancelable Lease Employee
In millions Loss on Disposal Obligations(1) Severance(2) Other Total(3)
- -------------------------------------------------------------------------------------------------------------------
Balance at 12/28/96 $ 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(4) 38.8 (32.8) (6.0) -- --
- -------------------------------------------------------------------------------------------------------------------
Balance at 12/27/97 8.4 37.3 7.1 -- 52.8
Utilization (8.4) (7.3) (2.4) -- (18.1)
- -------------------------------------------------------------------------------------------------------------------
Balance at 12/26/98 -- 30.0 4.7 -- 34.7
Utilization -- (8.0) (2.9) -- (10.9)
- -------------------------------------------------------------------------------------------------------------------
Balance at 01/01/00(5) $ -- $ 22.0 $ 1.8 $ -- $ 23.8
- -------------------------------------------------------------------------------------------------------------------
(1) Noncancelable lease obligations extend through 2016.
(2) Employee severance extends through 2000.
(3) As of January 1, 2000 and December 26, 1998, there were no assets and $23.8
million and $34.7 million of liabilities, respectively, of the discontinued
operations reflected in the accompanying consolidated balance sheets.
(4) 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.
(5) The Company believes that the reserve balances as of January 1, 2000 are
adequate to cover the remaining liabilities associated with this program.
NOTE 5 -- BORROWINGS AND CREDIT AGREEMENTS
Following is a summary of the Company's borrowings as of the respective balance
sheet dates:
- ---------------------------------------------------------------------------------------------------------------------
JANUARY 1, December 26,
In millions 2000 1998
- ---------------------------------------------------------------------------------------------------------------------
Commercial paper $ 451.0 $ 736.6
ESOP note payable(1) 257.0 270.7
Uncommitted lines of credit -- 34.5
5.5% unsecured senior notes 300.0 --
Mortgage notes payable 17.3 16.1
Capital lease obligations 1.5 3.5
- ---------------------------------------------------------------------------------------------------------------------
1,026.8 1,061.4
Less:
Short-term borrowings (451.0) (771.1)
Current portion of long-term debt (17.3) (14.6)
- ---------------------------------------------------------------------------------------------------------------------
$ 558.5 $ 275.7
- ---------------------------------------------------------------------------------------------------------------------
(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 $530
million, 364-day unsecured revolving credit facility, which expires on June 21,
2000 (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 6.2% as of January 1, 2000 and 5.7% as of December 26,
1998.
In February 1999, the Company issued $300 million of 5.5% unsecured senior notes
due February 15, 2004. The proceeds from the issuance were used to repay
outstanding commercial paper borrowings.
The Credit Facilities and unsecured senior notes contain customary restrictive
financial and operating covenants. The covenants do not materially effect the
Company's financial or operating flexibility.
30
32
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.
At January 1, 2000, the aggregate long-term debt maturing during the next five
years is as follows: $17.3 million in 2000, $21.6 million in 2001, $26.5 million
in 2002, $32.3 million in 2003, $323.5 million in 2004, $154.6 million in 2005
and thereafter.
NOTE 6 -- LEASES
The Company and its subsidiaries lease retail stores, warehouse facilities,
office facilities and equipment under noncancelable operating leases typically
over periods ranging from 5 to 20 years, along with options to renew over
periods ranging from 5 to 15 years.
Following is a summary of the Company's net rental expense for operating leases
for the respective fiscal years:
- ---------------------------------------------------------------------------------------------------------------------
Fiscal Year
In millions 1999 1998 1997
- ---------------------------------------------------------------------------------------------------------------------
Minimum rentals $ 572.4 $ 459.1 $ 409.6
Contingent rentals 64.8 60.3 60.2
- ---------------------------------------------------------------------------------------------------------------------
637.2 519.4 469.8
Less: sublease income (13.2) (14.0) (9.5)
- ---------------------------------------------------------------------------------------------------------------------
$ 624.0 $ 505.4 $ 460.3
- ---------------------------------------------------------------------------------------------------------------------
Following is a summary of the future minimum lease payments under capital and
operating leases as of January 1, 2000:
- -----------------------------------------------------------------------------------------------------------------------
In millions Capital Leases Operating Leases
- -----------------------------------------------------------------------------------------------------------------------
2000 $ 0.4 $ 474.1
2001 0.4 441.8
2002 0.4 406.0
2003 0.4 377.4
2004 0.4 347.5
Thereafter 1.6 3,159.1
- -----------------------------------------------------------------------------------------------------------------------
3.6 $ 5,205.9
Less: imputed interest (2.1)
- -----------------------------------------------------------------------------------------------------------------------
Present value of capital lease obligations $ 1.5
- -----------------------------------------------------------------------------------------------------------------------
During fiscal 1999, the Company entered into sale-leaseback transactions
totaling $229 million as a means of financing a portion of its store development
program. The properties were sold at net book value and were typically leased
back over periods of 20 years. The resulting leases are being accounted for as
operating leases and are included in the above tables.
NOTE 7 -- STOCK INCENTIVE PLANS
As of January 1, 2000, the Company had the following stock incentive plans,
which include the pre-merger plans of Arbor and Revco. Effective with the
mergers, all 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"), superceded 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.
31
33
As of January 1, 2000, the 1997 ICP provided for the granting of up to
23,382,245 shares of common stock in the form of stock options, stock
appreciation rights, 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 January 1, 2000, there were 17,915,519 shares available for
future grants under the 1997 ICP.
Restricted shares issued under the 1997 ICP may not exceed 3.6 million shares.
In fiscal 1999, 1998 and 1997, 14,402, 155,400 and 44,610 shares of restricted
stock were granted at a weighted average grant date fair value of $50.88, $37.80
and $23.02, respectively. Participants are entitled to vote and receive
dividends on their restricted shares, although they are subject to certain
transfer restrictions. Compensation costs, which are recognized over the
restricted period, totaled $2.3 million in 1999, $3.1 million in 1998 and $3.5
million in 1997.
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 January 1, 2000, there were 247,071 shares available
for future grant under the 1996 DSP.
Following is a summary of the fixed stock option activity for the respective
fiscal years:
- ------------------------------------------------------------------------------------------------------------------------
1999 1998 1997
----------------------- ------------------------- -------------------------
WEIGHTED Weighted Weighted
AVERAGE Average Average
SHARES EXERCISE PRICE Shares Exercise Price Shares Exercise Price
- ------------------------------------------------------------------------------------------------------------------------
Outstanding at beginning of year 11,982,122 $ 23.31 16,070,146 $ 16.95 23,569,930 $ 13.96
Granted 2,175,342 48.02 3,119,410 37.16 3,695,530 23.62
Exercised (927,080) 18.87 (7,137,027) 15.01 (10,756,726) 12.99
Canceled (265,784) 37.65 (70,407) 26.48 (438,588) 14.48
- ------------------------------------------------------------------------------------------------------------------------
Outstanding at end of year 12,964,600 27.38 11,982,122 23.31 16,070,146 16.95
- ------------------------------------------------------------------------------------------------------------------------
Exercisable at end of year 6,065,351 $ 17.92 6,127,402 $ 17.16 11,729,688 $ 16.11
- ------------------------------------------------------------------------------------------------------------------------
Following is a summary of the fixed stock options outstanding and exercisable as
of January 1, 2000:
- ------------------------------------------------------------------------------------------------------------------------
Options Outstanding Options Exercisable
----------------------------------------------------- ----------------------------------
Range of Number Weighted Average Weighted Average Number Weighted Average
Exercise Prices Outstanding Remaining Life Exercise Price Exercisable Exercise Price
- ------------------------------------------------------------------------------------------------------------------------
Under $15 516,927 5.3 $ 11.43 496,038 $ 11.83
$15.01 to $20.00 4,934,909 4.9 16.72 4,607,689 16.72
20.01 to 25.00 2,357,420 6.4 22.81 652,241 22.27
25.01 to 40.00 3,110,464 8.0 36.71 297,019 36.24
40.01 to 51.38 2,044,880 9.3 48.19 12,364 42.65
- ------------------------------------------------------------------------------------------------------------------------
Total 12,964,600 6.6 $ 27.38 6,065,351 $ 17.92
- ------------------------------------------------------------------------------------------------------------------------
32
34
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:
- ------------------------------------------------------------------------------------------------------------------------
Fiscal Year
In millions, except per share amounts 1999 1998 1997
- ------------------------------------------------------------------------------------------------------------------------
Net earnings:
As reported $ 635.1 $ 384.5 $ 88.8
Pro forma 614.7 359.0 70.6
- ------------------------------------------------------------------------------------------------------------------------
Basic EPS:
As reported $ 1.59 $ 0.96 $ 0.20
Pro forma 1.53 0.89 0.15
- ------------------------------------------------------------------------------------------------------------------------
Diluted EPS:
As reported $ 1.55 $ 0.95 $ 0.19
Pro forma 1.50 0.88 0.15
- ------------------------------------------------------------------------------------------------------------------------
The fair value of each stock option grant was estimated using the Black-Scholes
Option Pricing Model with the following assumptions:
- ----------------------------------------------------------------------------------------------------------------------
Fiscal Year
1999 1998 1997
- ----------------------------------------------------------------------------------------------------------------------
Dividend yield 0.58% 0.40% 0.70%
Expected volatility 25.86% 22.49% 22.77%
Risk-free interest rate 6.50% 5.75% 5.50%
Expected life 6.0 7.0 5.5
- ----------------------------------------------------------------------------------------------------------------------
1999 EMPLOYEE STOCK PURCHASE PLAN
The 1999 Employee Stock Purchase Plan provides for the granting of up to
7,400,000 shares of common stock. The plan, which covers substantially all
employees, gives employees the option to purchase common stock at the end of
each six month offering period, at a purchase price equal to 85% of the lower of
the fair market value on the first day or the last day of the offering period.
Employees pay for the shares ratably over each offering period through payroll
deductions. During 1999, options for 210,833 shares were exercised at an average
price of $33.42.
NOTE 8 -- PENSION PLANS AND OTHER POSTRETIREMENT BENEFITS
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. The plan is
funded based on actuarial calculations and applicable federal regulations.
Pursuant to various labor agreements, the Company is also required to make
contributions to certain union-administered pension and health and welfare plans
that totaled $8.4 million, $7.5 million and $7.6 million in fiscal 1999, 1998
and 1997, respectively. 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 in place for certain key
employees for whom it has purchased cost recovery variable life insurance.
33
35
DEFINED CONTRIBUTION PLANS
The Company sponsors a Profit Sharing Plan and a voluntary 401(k) Savings Plan
that covers substantially all employees who meet plan eligibility requirements.
The Company makes matching contributions consistent with the provisions of the
plan. The Company also maintains a non-qualified, unfunded Deferred Compensation
Plan for certain key employees. This plan provides participants the opportunity
to defer portions of their compensation and receive matching contributions that
they would have otherwise received under the 401(k) Savings Plan if not for
certain restrictions and limitations under the Internal Revenue Code. The
Company's contributions under the above defined contribution plans totaled $17.0
million, $26.4 million and $24.1 million in fiscal 1999, 1998 and 1997,
respectively. 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 as of the respective balance sheet dates:
- -----------------------------------------------------------------------------------------------------------------------
Defined Benefit Plans Other Postretirement Benefits
Fiscal Year Fiscal Year
In millions 1999 1998 1999 1998
- -----------------------------------------------------------------------------------------------------------------------
CHANGE IN BENEFIT OBLIGATION:
Benefit obligation at beginning of year $ 297.6 $ 253.3 $ 14.0 $ 14.4
Service cost 0.7 0.5 -- --
Interest cost 19.8 19.5 0.9 1.0
Actuarial (gain) loss (40.3) 49.3 1.1 0.5
Benefits paid (23.0) (25.0) (2.0) (1.9)
- -----------------------------------------------------------------------------------------------------------------------
Benefit obligation at end of year $ 254.8 $ 297.6 $ 14.0 $ 14.0
- -----------------------------------------------------------------------------------------------------------------------
CHANGE IN PLAN ASSETS:
Fair value at beginning of year $ 223.1 $ 201.5 $ -- $ --
Actual return on plan assets 37.3 28.4 -- --
Company contributions 11.4 18.2 2.0 1.9
Benefits paid (23.0) (25.0) (2.0) (1.9)
- -----------------------------------------------------------------------------------------------------------------------
Fair value at end of year(1) $ 248.8 $ 223.1 $ -- $ --
- -----------------------------------------------------------------------------------------------------------------------
FUNDED STATUS:
Funded status $ (6.0) $ (74.5) $ (14.0) $ (14.0)
Unrecognized prior service cost 1.1 1.3 (0.9) (1.0)
Unrecognized net (gain) loss (60.6) 1.6 0.8 (0.3)
- -----------------------------------------------------------------------------------------------------------------------
Accrued pension costs $ (65.5) $ (71.6) $ (14.1) $ (15.3)
- -----------------------------------------------------------------------------------------------------------------------
(1) Plan assets consist primarily of mutual funds, common stock and insurance
contracts.
Following is a summary of the net periodic pension cost for the defined benefit
and other postretirement benefit plans for the respective fiscal years:
- -----------------------------------------------------------------------------------------------------------------------
Defined Benefit Plans Other Postretirement Benefits
In millions 1999 1998 1997 1999 1998 1997
- -----------------------------------------------------------------------------------------------------------------------
Service cost(1) $ 0.7 $ 0.5 $ 7.6 $ -- $ -- $ --
Interest cost on benefit obligation 19.8 19.5 19.2 0.9 1.0 1.0
Expected return on plan assets (16.6) (16.4) (14.9) -- -- --
Amortization of net loss (gain) 1.3 1.2 0.3 -- (0.2) --
Amortization of prior service cost 0.1 0.1 0.3 (0.1) (0.1) (0.3)
Curtailment gain -- -- (6.0) -- -- --
- -----------------------------------------------------------------------------------------------------------------------
Net periodic pension cost $ 5.3 $ 4.9 $ 6.5 $ 0.8 $ 0.7 $ 0.7
- -----------------------------------------------------------------------------------------------------------------------
WEIGHTED AVERAGE ASSUMPTIONS:
Discount rate 8.00% 6.75% 7.25% 7.75% 6.75% 7.25%
Expected return on plan assets 9.00% 9.00% 9.00% -- -- --
Rate of compensation increase 4.00% 4.50% 4.50% -- -- --
- -----------------------------------------------------------------------------------------------------------------------
(1) The decrease in total service cost is primarily due to the suspension of
future benefit accruals under the Revco pension plan during 1997.
34
36
For measurement purposes, future healthcare costs are assumed to increase at an
annual rate of 9.0%, decreasing to an annual growth rate of 5.0% in 2004 and
thereafter. A one percent change in the assumed health care cost trend rate
would change the accumulated postretirement benefit obligation by $0.9 million
and the total service and interest costs by $0.1 million.
NOTE 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 January 1, 2000, 5.2 million shares of ESOP
Preference Stock were outstanding, of which 1.9 million shares were allocated to
participants and the remaining 3.3 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 activity as of the respective fiscal years:
- ----------------------------------------------------------------------------------------------------------------------
Fiscal Year
In millions 1999 1998 1997
- ----------------------------------------------------------------------------------------------------------------------
ESOP expense recognized $ 16.6 $ 25.8 $ 13.8
Dividends paid 20.1 20.5 20.8
Cash contributions 16.6 25.8 22.9
Interest payments 23.1 24.9 26.4
ESOP shares allocated 0.3 0.4 0.4
- ----------------------------------------------------------------------------------------------------------------------
NOTE 10 -- INCOME TAXES
The provision for income taxes consisted of the following for the respective
fiscal years:
- ----------------------------------------------------------------------------------------------------------------------
Fiscal Year
In millions 1999 1998 1997
- ----------------------------------------------------------------------------------------------------------------------
Current: Federal $ 289.6 $ 197.3 $ 182.5
State 68.4 41.4 68.5
- ----------------------------------------------------------------------------------------------------------------------
358.0 238.7 251.0
- ----------------------------------------------------------------------------------------------------------------------
Deferred: Federal 72.6 44.1 (75.0)
State 10.7 23.7 (26.8)
- ----------------------------------------------------------------------------------------------------------------------
83.3 67.8 (101.8)
- ----------------------------------------------------------------------------------------------------------------------
Total $ 441.3 $ 306.5 $ 149.2
- ----------------------------------------------------------------------------------------------------------------------
35
37
Following is a reconciliation of the statutory income tax rate to the Company's
effective tax rate for the respective fiscal years:
- ----------------------------------------------------------------------------------------------------------------------
Fiscal Year
1999 1998 1997
- ----------------------------------------------------------------------------------------------------------------------
Statutory income tax rate 35.0% 35.0% 35.0%
State income taxes, net of federal tax benefit 4.8 5.8 6.6
Goodwill and other 1.2 1.2 1.4
- ----------------------------------------------------------------------------------------------------------------------
Effective tax rate before merger-related costs 41.0 42.0 43.0
Merger-related costs (1) -- 2.4 19.8
- ----------------------------------------------------------------------------------------------------------------------
Effective tax rate 41.0% 44.4% 62.8%
- ----------------------------------------------------------------------------------------------------------------------
(1) Includes state tax effect.
Following is a summary of the significant components of the Company's deferred
tax assets and liabilities as of the respective balance sheet dates:
- ----------------------------------------------------------------------------------------------------------------------
JANUARY 1, December 26,
In millions 2000 1998
- ----------------------------------------------------------------------------------------------------------------------
Deferred tax assets:
Employee benefits $ 56.7 $ 84.5
Other 135.1 185.5
- ----------------------------------------------------------------------------------------------------------------------
Total deferred tax assets 191.8 270.0
- ----------------------------------------------------------------------------------------------------------------------
Deferred tax liabilities:
Accelerated depreciation (68.9) (44.0)
Inventory (10.7) (1.6)
- ----------------------------------------------------------------------------------------------------------------------
Total deferred tax liabilities (79.6) (45.6)
- ----------------------------------------------------------------------------------------------------------------------
Net deferred tax assets $ 112.2 $ 224.4
- ----------------------------------------------------------------------------------------------------------------------
Income taxes paid were $354.5 million, $102.6 million and $258.9 million for
fiscal 1999, 1998 and 1997, respectively.
Based on historical pre-tax earnings, the Company believes it is more likely
than not that the deferred tax assets will be realized.
NOTE 11 -- SUPPLEMENTAL INFORMATION
Following are the components of property and equipment included in the
consolidated balance sheets as of the respective balance sheet dates:
- ---------------------------------------------------------------------------------------------------------------------
JANUARY 1, December 26,
In millions 2000 1998
- ---------------------------------------------------------------------------------------------------------------------
Land $ 89.6 $ 91.0
Buildings and improvements 467.8 296.8
Fixtures and equipment 1,326.5 1,171.8
Leasehold improvements 518.5 477.4
Capital leases 2.2 2.8
- ---------------------------------------------------------------------------------------------------------------------
2,404.6 2,039.8
Accumulated depreciation and amortization (803.6) (688.6)
- ---------------------------------------------------------------------------------------------------------------------
$ 1,601.0 $ 1,351.2
- ---------------------------------------------------------------------------------------------------------------------
36
38
Following is a summary of the Company's noncash financing activities for the
respective fiscal years:
- ---------------------------------------------------------------------------------------------------------------------
In millions 1999 1998 1997
- ---------------------------------------------------------------------------------------------------------------------
Fair value of assets acquired $ -- $ 62.2 $ --
Cash paid -- 62.2 --
- ---------------------------------------------------------------------------------------------------------------------
Liabilities assumed $ -- $ -- $ --
- ---------------------------------------------------------------------------------------------------------------------
Equity securities or notes received from sale of business $ -- $ -- $ 52.0
- ---------------------------------------------------------------------------------------------------------------------
Interest expense was $66.1 million, $69.7 million and $59.1 million and interest
income was $7.0 million, $8.8 million and $15.0 million in fiscal 1999, 1998 and
1997, respectively. Interest paid totaled $69.0 million, $70.7 million and $58.4
million in fiscal 1999, 1998 and 1997, respectively.
NOTE 12 -- COMMITMENTS & CONTINGENCIES
In connection with certain business dispositions completed between 1991 and
1997, the Company continues to guarantee lease obligations for approximately
1,400 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 $1.0 billion as of
January 1, 2000.
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 January 1, 2000, the Company had outstanding commitments to purchase
$283.8 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.
NOTE 13 -- BUSINESS SEGMENTS
The Company currently operates four business segments: Retail Pharmacy, Pharmacy
Benefit Management ("PBM"), Specialty Pharmacy and Internet Pharmacy. The
Company's business segments are operating units that offer different products
and services, and require distinct technology and marketing strategies.
The Retail Pharmacy segment, which includes 4,086 retail drugstores located in
24 states and the District of Columbia, operates under the CVS/pharmacy name.
The Retail Pharmacy segment 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 PBM segment operates under the
PharmaCare Management Services name.
The Specialty Pharmacy segment, which includes a mail order facility and 12
retail pharmacies located in 9 states and the District of Columbia, operates
under the CVS ProCare name. The Specialty Pharmacy segment focuses on supporting
individuals that require complex and expensive drug therapies.
The Internet Pharmacy segment, which includes a mail order facility and a
complete online retail pharmacy, operates under the CVS.com name.
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.
37
39
Following is a reconciliation of the significant components of the Retail
Pharmacy segment's net sales for the respective fiscal years.
- ---------------------------------------------------------------------------------------------------------------------
1999 1998 1997
- ---------------------------------------------------------------------------------------------------------------------
Pharmacy 58.7% 57.6% 54.7%
Front store 41.3 42.4 45.3
- ---------------------------------------------------------------------------------------------------------------------
Total net sales 100.0% 100.0% 100.0%
- ---------------------------------------------------------------------------------------------------------------------
Following is a reconciliation of the Company's business segments to the
consolidated financial statements:
- -----------------------------------------------------------------------------------------------------------------------
Retail Pharmacy All Other Intersegment Other Consolidated
In millions Segment Segments Eliminations(1) Adjustments(2) Totals
- -----------------------------------------------------------------------------------------------------------------------
1999:
Net sales $17,625.7 $888.4 $(415.8) $ -- $18,098.3
Operating profit 1,120.4 15.1 -- -- 1,135.5
Depreciation and amortization 274.6 3.3 -- -- 277.9
Total assets 7,146.1 173.4 (44.1) -- 7,275.4
Capital expenditures 477.1 16.4 -- -- 493.5
- -----------------------------------------------------------------------------------------------------------------------
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
- -----------------------------------------------------------------------------------------------------------------------
(1) Intersegment eliminations relate to intersegment sales and accounts
receivables that occur when a Pharmacy Benefit Management segment customer
uses a Retail Pharmacy 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.
38
40
NOTE 14 -- RECONCILIATION OF EARNINGS PER COMMON SHARE
Following is a reconciliation of basic and diluted earnings per common share for
the respective fiscal years:
- ----------------------------------------------------------------------------------------------------------------------
Fiscal Year
In millions, except per share amounts 1999 1998 1997
- ----------------------------------------------------------------------------------------------------------------------
NUMERATOR FOR EARNINGS PER COMMON SHARE CALCULATION:
Earnings from continuing operations before extraordinary item $ 635.1 $ 384.5 $ 88.4
Preference dividends, net of tax benefit (14.7) (13.6) (13.7)
- ----------------------------------------------------------------------------------------------------------------------
Earnings from continuing operations available to common
shareholders, basic $ 620.4 $ 370.9 $ 74.7
- ----------------------------------------------------------------------------------------------------------------------
Earnings from discontinued operations -- -- 17.5
Extraordinary loss -- -- (17.1)
- ----------------------------------------------------------------------------------------------------------------------
Net earnings available to common shareholders, basic $ 620.4 $ 370.9 $ 75.1
- ----------------------------------------------------------------------------------------------------------------------
Earnings from continuing operations before extraordinary item $ 635.1 $ 384.5 $ 88.4
Effect of dilutive securities:
Preference dividends, net of tax benefit -- -- (13.7)
Dilutive earnings adjustments -- (0.8) --
- ----------------------------------------------------------------------------------------------------------------------
Earnings from continuing operations available to common
shareholders, diluted $ 635.1 $ 383.7 $ 74.7
- ----------------------------------------------------------------------------------------------------------------------
Earnings from discontinued operations -- -- 17.5
Extraordinary loss -- -- (17.1)
- ----------------------------------------------------------------------------------------------------------------------
Net earnings available to common shareholders, diluted $ 635.1 $ 383.7 $ 75.1
- ----------------------------------------------------------------------------------------------------------------------
DENOMINATOR FOR EARNINGS PER COMMON SHARE CALCULATION:
Weighted average common shares, basic 391.3 387.1 377.2
Effect of dilutive securities:
Preference stock 10.7 10.5 --
Stock options 6.9 7.6 7.9
- ----------------------------------------------------------------------------------------------------------------------
Weighted average common shares, diluted 408.9 405.2 385.1
- ----------------------------------------------------------------------------------------------------------------------
BASIC EARNINGS PER COMMON SHARE:
Earnings from continuing operations before extraordinary item $ 1.59 $ 0.96 $ 0.20
Earnings from discontinued operations -- -- 0.05
Extraordinary item, net of tax benefit -- -- (0.05)
- ----------------------------------------------------------------------------------------------------------------------
Net earnings $ 1.59 $ 0.96 $ 0.20
- ----------------------------------------------------------------------------------------------------------------------
DILUTED EARNINGS PER COMMON SHARE:
Earnings from continuing operations before extraordinary item $ 1.55 $ 0.95 $ 0.19
Earnings from discontinued operations -- -- 0.05
Extraordinary item, net of tax benefit -- -- (0.05)
- ----------------------------------------------------------------------------------------------------------------------
Net earnings $ 1.55 $ 0.95 $ 0.19
- ----------------------------------------------------------------------------------------------------------------------
39
41
NOTE 15 -- QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
Following is a summary of the unaudited quarterly results of operations and
common stock prices for the respective fiscal quarters:
- ------------------------------------------------------------------------------------------------------------------------------
Dollars in millions, except per share amounts First Quarter Second Quarter Third Quarter Fourth Quarter Fiscal Year
- ------------------------------------------------------------------------------------------------------------------------------
FISCAL 1999:
Net sales $ 4,240.5 $ 4,362.4 $ 4,311.8 $ 5,183.6 $18,098.3
Gross margin 1,169.4 1,190.4 1,141.1 1,360.5 4,861.4
Operating profit 293.2 290.2 219.7 332.4 1,135.5
Net earnings 164.6 162.6 121.6 186.3 635.1
- ------------------------------------------------------------------------------------------------------------------------------
Net earnings per common share, basic 0.41 0.41 0.30 0.47 1.59
Net earnings per common share, diluted 0.40 0.40 0.30 0.46 1.55
- ------------------------------------------------------------------------------------------------------------------------------
Dividends per common share 0.0575 0.0575 0.0575 0.0575 0.2300
- ------------------------------------------------------------------------------------------------------------------------------
Stock price: (New York Stock Exchange)
High 56.44 52.06 53.00 45.75 56.44
Low 45.50 40.50 37.75 30.31 30.31
- ------------------------------------------------------------------------------------------------------------------------------
Registered shareholders at year-end 11,200
- ------------------------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------------------
Fiscal 1998:
Net sales $ 3,601.5 $ 3,755.9 $ 3,725.1 4,191.1 $15,273.6
Gross margin 1,006.9 1,020.5 995.3 1,106.5 4,129.2
Operating profit 233.8 71.9 181.1 265.1 751.9
Net earnings 129.0 14.6 96.2 144.7 384.5
- ------------------------------------------------------------------------------------------------------------------------------
Net earnings per common share, basic 0.33 0.03 0.24 0.36 0.96
Net earnings per common share, diluted 0.32 0.03 0.23 0.36 0.95
- ------------------------------------------------------------------------------------------------------------------------------
Dividends per common share 0.0550 0.0550 0.0575 0.0575 0.2250
- ------------------------------------------------------------------------------------------------------------------------------
Stock price: (New York Stock Exchange)
High 37.44 39.63 46.50 55.69 55.69
Low 31.06 33.38 36.38 42.06 31.06
- ------------------------------------------------------------------------------------------------------------------------------
Registered shareholders at year-end 10,500
- ------------------------------------------------------------------------------------------------------------------------------
ITEM 9. -- CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
No events have occurred which would require disclosure under this Item.
40
42
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 of this report
under "Executive Officers of the Registrant," appears in our Proxy Statement for
the 2000 Annual Meeting of Stockholders on pages 4 through 6 and page 23 under
the captions Item 1: "Biographies of our Board Nominees," "Committees of the
Board of CVS," and "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 Proxy Statement for the
2000 Annual Meeting of Stockholders on pages 7, 8 and 10 through 20 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 Proxy Statement for the
2000 Annual Meeting of Stockholders on pages 8 and 9 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 Proxy Statement for the
2000 Annual Meeting of Stockholders on page 21 and 22 under the caption Item 1:
"Transactions with Directors and Officers" and is incorporated into this report
by reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
A. DOCUMENTS FILED AS PART OF THIS REPORT:
1. FINANCIAL STATEMENTS:
The following financial statements are filled as a part of this Annual
Report under "Item 8 -- Financial Statements and Supplementary Data":
Management's Responsibility for Financial Reporting............................................................. 16
Independent Auditor's Report.................................................................................... 17
Consolidated Statements of Operations for the fiscal years ended January 1, 2000, December 26, 1998 and
December 27, 1997............................................................................................ 18
Consolidated Balance Sheets as of January 1, 2000 and December 26, 1998......................................... 19
Consolidated Statements of Shareholders' Equity for the fiscal years ended January 1, 2000,
December 26, 1998 and December 27, 1997...................................................................... 20
Consolidated Statements of Cash Flows for the fiscal years ended January 1, 2000,
December 26, 1998 and December 27, 1997...................................................................... 21
Notes to Consolidated Financial Statements...................................................................... 22-40
2. FINANCIAL STATEMENT SCHEDULES
The following financial statement schedule is filed on page 46 of this
report: Schedule II -- Valuation and Qualifying Accounts. All other
financial statement schedules are omitted because they are not applicable
or the information is included in the financial statements or related
notes.
41
43
B. REPORTS ON FORM 8-K
On March 14, 2000, we filed a Current Report on Form 8-K correcting our issued
and outstanding common share balance included in the Proxy Statement for the
2000 Annual Meeting of Stockholders
On March 8, 2000, we filed a Current Report on Form 8-K announcing the
authorization by the Board of Directors of a common stock repurchase program.
On November 15, 1999, we filed a Current Report on Form 8-K relating to the
status of the exchange offer for our 5 1/2% unsecured senior notes and the
adjustment of the timing of certain merger-related charges.
C. 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].
4.2* Indenture, dated as of February 11, 1999, between CVS Corporation and The Bank of New York
[incorporated by reference to Exhibit 4.1 to Registrant's Registration Statement No. 333-78253
on Form S-4 dated May 11, 1999].
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].
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].
42
44
EXHIBIT DESCRIPTION
- ------- -----------
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* 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].
10.12* 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].
10.13* 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].
10.14* 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].
10.15* Profit Incentive Plan of Melville Corporation [incorporated by reference to Exhibit A to
Melville Corporation's definitive Proxy Statement dated March 14, 1994].
10.16* 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].
10.17* 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].
10.18* 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].
43
45
EXHIBIT DESCRIPTION
- ------- -----------
10.19 CVS Corporation 1996 Directors Stock Plan, as amended and restated.
10.20* Form of Employment Agreements between the Registrant and the Registrant's executive officers
[incorporated by reference to the Registrant's Annual Report on Form 10-K/A for the fiscal year
ended December 31, 1996].
10.21* 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].
10.22* 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].
10.23* 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].
10.24* 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].
10.25* Form of Collateral Assignment and Executive Life Insurance Agreement between Registrant and the
Registrant's executive officers [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].
10.26* 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].
10.27 Description of the Long-Term Performance Share Plan
21 Subsidiaries of the Registrant
23 Consent of KPMG LLP
27 Financial Data Schedule -- January 1, 2000 [Filed electronically with SEC only].
44
46
INDEPENDENT AUDITORS' REPORT
Board of Directors and Shareholders
CVS Corporation:
Under date of February 7, 2000, we reported on the consolidated balance sheets
of CVS Corporation and subsidiaries as of January 1, 2000 and December 26, 1998,
and the related consolidated statements of operations, shareholders' equity and
cash flows for each of the years in the fifty-three week period ended January 1,
2000 and the fifty-two week periods ended December 26, 1998 and December 27,
1997. These consolidated financial statements and our report thereon are
included in the January 1, 2000 annual report on Form 10-K 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.
/s/ KPMG LLP
- ------------
KPMG LLP
Providence, Rhode Island
February 7, 2000
45
47
CVS CORPORATION
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
- --------------------------------------------------------------------------------------------------------------------------
BALANCE AT ADDITIONS WRITE-OFFS BALANCE
BEGINNING OF CHARGED TO BAD CHARGED TO AT
In millions YEAR DEBT EXPENSE ALLOWANCE END OF YEAR
- --------------------------------------------------------------------------------------------------------------------------
ACCOUNTS RECEIVABLE -- ALLOWANCE FOR DOUBTFUL ACCOUNTS:
Fiscal Year Ended January 1, 2000 $ 39.8 $ 22.8 $ 21.5 $ 41.1
- --------------------------------------------------------------------------------------------------------------------------
Fiscal Year Ended December 26, 1998 39.2 22.4 21.8 39.8
- --------------------------------------------------------------------------------------------------------------------------
Fiscal Year Ended December 27, 1997 36.9 22.1 19.8 39.2
- --------------------------------------------------------------------------------------------------------------------------
46
48
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 to
be signed on its behalf by the undersigned, thereunto duly authorized.
CVS CORPORATION
Date: March 30, 2000 By: /s/ DAVID B. RICKARD
----------------------
David B. Rickard
Executive Vice President and
Chief Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
Signature Title(s) Date
--------- -------- ----
/s/ EUGENE APPLEBAUM Director March 30, 2000
--------------------
Eugene Applebaum
/s/ ALLAN J. BLOOSTEIN Director March 30, 2000
----------------------
Allan J. Bloostein
/s/ W. DON CORNWELL Director March 30, 2000
-------------------
W. Don Cornwell
/s/ THOMAS P. GERRITY Director March 30, 2000
---------------------
Thomas P. Gerrity
/s/ STANLEY P. GOLDSTEIN Director March 30, 2000
------------------------
Stanley P. Goldstein
/s/ MARIAN L. HEARD Director March 30, 2000
-------------------
Marian L. Heard
/s/ WILLIAM H. JOYCE Director March 30, 2000
--------------------
William H. Joyce
/s/ TERRY R. LAUTENBACH Director March 30, 2000
-----------------------
Terry R. Lautenbach
/s/ TERRENCE MURRAY Director March 30, 2000
-------------------
Terrence Murray
/s/ DAVID B. RICKARD Executive Vice President and Chief Financial Officer March 30, 2000
-------------------- (Principal Financial Officer)
David B. Rickard
/s/ SHELI Z. ROSENBERG Director March 30, 2000
----------------------
Sheli Z. Rosenberg
/s/ THOMAS M. RYAN Chairman of the Board and Chief Executive Officer March 30, 2000
------------------ (Principal Executive Officer)
Thomas M. Ryan
/s/ IVAN G. SEIDENBERG Director March 30, 2000
----------------------
Ivan G. Seidenberg
/s/ LARRY D. SOLBERG Vice President and Controller March 30, 2000
-------------------- (Principal Accounting Officer)
Larry D. Solberg
47