01—Abstract
Summary
Summary of the 10-K filed March 18, 2003. Cited figures are marked; the original filing is the authoritative source.
CVS Corporation's 2002 Form 10-K (fiscal year ended December 28, 2002, filed March 18, 2003) reports a year of strong profit recovery following the 2001 strategic restructuring.
Net sales rose 8.7% to $24.2 billiona, driven by an 11.2% increase in pharmacy sales, while front store sales grew 3.8%. Operating profit nearly doubled from the restructuring-depressed 2001 level to $1.21 billion (5.0% of sales), and diluted EPS rose to $1.75 from $1.00. Excluding nonrecurring items in 2001, operating profit grew about 8% and net earnings grew roughly 12% per diluted share, indicating that underlying growth was real but more modest than the headline comparison suggests.
The balance sheet and cash flow picture improved meaningfully. Operating cash flow rose to $1.20 billionb from $681 million, funding $1.11 billion in capital expenditures, mostly for new stores and remodels, and the company ended the year with $700 million in cash. Net debt fell to $413 million from $836 million.
Management plans over $1 billionc in 2003 capital spending, including 150-175 new stores, and a new Texas distribution center. Gross margin continued to compress, falling to 25.1% from 25.6%, as lower-margin pharmacy sales and third-party reimbursement pressure outpaced front store growth. Management also flagged risks from state Medicaid reimbursement cuts, generic substitution, and a continuing inventory-loss problem.
The filing also discloses a pending securities class action alleging fraud between February and October 2001, which management calls without merit. Investors should weigh the company's market-leading store footprint, loyalty program, and improving returns against margin pressure from the PBM and third-party payer mix, and the reliance on continued store expansion to drive growth.
02—Key points
Key Highlights
- Net sales grew 8.7% to $24.2 billion in 2002, with pharmacy sales up 11.2% and front store sales up 3.8%, and pharmacy reached 67.6% of total sales.
- Operating profit rose to $1.21 billion (5.0% of sales) from $771 million in 2001, which was depressed by the $352.5 million restructuring charge; excluding nonrecurring items, operating profit grew about 8%.
- Diluted EPS was $1.75 versus $1.00 in 2001 and $1.83 in 2000; the 2001 figure included restructuring charges and the 2000 figure included nonrecurring litigation gains.
- Gross margin declined to 25.1% from 25.6% as pharmacy mix shifted toward lower-margin third-party business (92.3% of pharmacy sales) and generic substitution reduced sales dollars.
- Operating cash flow more than doubled to $1.20 billion, and net debt fell to $413 million from $836 million, with year-end cash of $700 million.
- Capital expenditures reached $1.11 billion in 2002, and 2003 plans exceed $1 billion, including 150-175 new stores and a new Texas distribution center.
- A consolidated federal securities class action (alleging fraud for purchases from February to October 2001) survived a motion to dismiss in December 2002; management says it is without merit.
03—Questions
Frequently Asked Questions
How did CVS perform financially in 2002 compared with 2001?
Net sales increased 8.7% to $24.2 billion, and net earnings rose to $716.6 million ($1.75 per diluted share) from $413.2 million ($1.00) in 2001. The 2001 comparison is distorted by the $352.5 million restructuring charge, so the underlying improvement is more modest: excluding nonrecurring items, net earnings per diluted share rose from about $1.56 to $1.75.
Why is gross margin declining, and is it a concern?
Gross margin fell to 25.1% from 25.6% in 2001 and 26.7% in 2000. The main drivers are faster growth in pharmacy sales, which carry lower margins than front store items, and a rising share of third-party insurance business, where reimbursement rates are under pressure. Inventory losses, though declining to 1.19% of sales from 1.52%, also weighed on margins. Continued compression would be a concern because it limits the profit benefit of sales growth.
What is the company's debt and liquidity position?
Long-term debt rose to $1.08 billion from $810 million after a $300 million 3.875% note issuance in October 2002, which was used to repay commercial paper. Net debt fell to $413 million, and the company rates A2 by Moody's and A by S&P. It had no borrowings under its $1.3 billion in back-up credit facilities at year-end, though the $650 million 364-day facility expires in May 2003 and was under evaluation for renewal.
What are the main risks disclosed in the filing?
Key risks include state Medicaid and governmental pharmacy reimbursement cuts (Medicaid was about 8% of sales), pressure from PBMs and managed care payers, competition from mail order, internet, and discount retailers, generic drug substitution, and the potential for the company to withdraw from unprofitable third-party programs. The pending securities class action and the approximately $660 million potential exposure on lease guarantees for about 875 former stores, which management considers highly unlikely to be triggered, are also disclosed.
What is the outlook for 2003 growth?
Management plans to open 150-175 new stores (including 80-100 in new markets), relocate about 100 stores, and close about 50, with capital spending of over $1 billion. The company expects continued pharmacy-driven growth from an aging population and loyalty-program benefits from its 33 million ExtraCare members, while noting that the lack of major new drug introductions and generic substitution may weigh on same-store sales. The filing does not provide explicit earnings guidance.
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