How did CVS perform in fiscal 2003 compared with 2002?

Net sales grew 10.0% to $26.6 billion and net earnings rose 18.2% to $847.3 million ($2.06 diluted EPS). Excluding the extra 53rd week, sales growth was 7.8%. The 2002 base was not affected by a restructuring charge, although 2001 included a $352.5 million pre-tax restructuring charge.

What are the main risks to CVS's growth outlook?

The company cites continued payor efforts to cut drug costs, shifts to mail order that force withdrawal from some benefit plans, reduced Medicaid and governmental reimbursement, generic drug conversion that lowers selling prices, and competition from supermarkets, discount retailers and internet pharmacies. Management said it may not be able to sustain its current sales growth rate if these trends continue.

How strong is CVS's balance sheet and liquidity?

Shareholders' equity rose to $6.02 billion and long-term debt fell to $753.1 million. The company had no commercial paper outstanding and maintained $1.25 billion in back-up credit facilities, of which $600 million expires in May 2004. Cash on hand was $843.2 million. Management believes cash flow and financing will cover its needs for at least several years.

Is CVS facing material legal or contingent liabilities?

A federal securities class action (filed 2001) is in discovery, and management calls it without merit. A Rhode Island state and federal investigation into business relationships with state officials is ongoing, and CVS is cooperating. Lease guarantees on roughly 706 former stores could total about $592 million if purchasers defaulted, but purchasers have indemnified CVS, and management does not expect a material adverse effect.

What is CVS's dividend and capital return policy?

The company paid $0.23 per share in 2003 and its board approved a 15% increase to $0.265 per share for 2004. No share repurchases were made in 2003, and the company has paid quarterly cash dividends since becoming a public company.

CVS 10-K FY2004 Annual Report — Revenue, Net Income, EPS

01—Abstract

Summary

Summary of the 10-K filed March 12, 2004. Cited figures are marked; the original filing is the authoritative source.

CVS Corporation's fiscal 2003 10-K (53 weeks ended January 3, 2004) shows a company growing profitably in a competitive retail pharmacy market.

Net sales rose 10.0% to $26.6 billion^a, aided by a 53rd week worth $530.8 million; on a comparable 52-week basis, sales grew 7.8%. Net earnings increased 18.2% to $847.3 million, or $2.06 per diluted share, versus $1.75 in 2002. Operating profit rose to $1.42 billion from $1.21 billion, and gross margin widened to 25.8% of sales from 25.1%, helped by generic drug mix, a stronger front-store mix, and an early flu season.

The 2002 comparison is also flattered by no restructuring charge, since the 2001 figures included a $352.5 million^b pre-tax restructuring charge. Investors should weigh several pressures alongside the growth. Pharmacy now makes up 68.8% of sales and carries lower margins than front-store merchandise, and third-party payors account for 93.2% of pharmacy sales.

Management warned that continued shifts to mail order, reimbursement cuts from payors and state Medicaid programs, and generic conversion could slow sales growth. Operating expenses rose to 20.5% of sales from 20.1%, and management expects the improvement in inventory losses to be smaller in 2004. Cash flow from operations fell to $968.9 million^c from $1.20 billion, mainly because of higher receivables, while capital spending reached $1.12 billion, which the company plans to keep above $1.1 billion in 2004.

The balance sheet remains conservative. Net debt fell to $233.1 million, long-term debt dropped to $753.1 million^d, and shareholders' equity rose to $6.02 billion. The company rates A2/A at Moody's and S&P, though both outlooks are negative.

Legal and contingent exposures include a consolidated securities class action that management calls without merit, an ongoing Rhode Island state investigation, and guarantees on about 706 former store leases with an estimated settlement exposure of $592 million. Management says the guarantees are indemnified by purchasers and are not expected to have a material adverse effect. The dividend is set to rise 15% to $0.265 per quarter in 2004.

02—Key points

Key Highlights

Net sales grew 10.0% to $26.6 billion in 2003 (7.8% on a comparable 52-week basis) and included a 53rd week contributing $530.8 million.
Net earnings rose 18.2% to $847.3 million, or $2.06 per diluted share, compared with $1.75 in 2002.
Operating profit increased to $1.42 billion from $1.21 billion, and gross margin improved to 25.8% of sales from 25.1%.
Pharmacy represents 68.8% of sales and third-party payors account for 93.2% of pharmacy sales, which pressures margins as payor reimbursement falls and mail order grows.
Operating cash flow declined to $968.9 million from $1.20 billion, and capital expenditures were $1.12 billion, with 2004 capex planned above $1.1 billion.
Net debt fell to $233.1 million, and the company holds A2/A credit ratings, though both outlooks are negative.
Contingent exposures include about 706 guaranteed former store leases (roughly $592 million if all purchasers defaulted, indemnified) and a securities class action that management considers without merit.

03—Questions

Frequently Asked Questions

How did CVS perform in fiscal 2003 compared with 2002?
Net sales grew 10.0% to $26.6 billion and net earnings rose 18.2% to $847.3 million ($2.06 diluted EPS). Excluding the extra 53rd week, sales growth was 7.8%. The 2002 base was not affected by a restructuring charge, although 2001 included a $352.5 million pre-tax restructuring charge.
What are the main risks to CVS's growth outlook?
The company cites continued payor efforts to cut drug costs, shifts to mail order that force withdrawal from some benefit plans, reduced Medicaid and governmental reimbursement, generic drug conversion that lowers selling prices, and competition from supermarkets, discount retailers and internet pharmacies. Management said it may not be able to sustain its current sales growth rate if these trends continue.
How strong is CVS's balance sheet and liquidity?
Shareholders' equity rose to $6.02 billion and long-term debt fell to $753.1 million. The company had no commercial paper outstanding and maintained $1.25 billion in back-up credit facilities, of which $600 million expires in May 2004. Cash on hand was $843.2 million. Management believes cash flow and financing will cover its needs for at least several years.
Is CVS facing material legal or contingent liabilities?
A federal securities class action (filed 2001) is in discovery, and management calls it without merit. A Rhode Island state and federal investigation into business relationships with state officials is ongoing, and CVS is cooperating. Lease guarantees on roughly 706 former stores could total about $592 million if purchasers defaulted, but purchasers have indemnified CVS, and management does not expect a material adverse effect.
What is CVS's dividend and capital return policy?
The company paid $0.23 per share in 2003 and its board approved a 15% increase to $0.265 per share for 2004. No share repurchases were made in 2003, and the company has paid quarterly cash dividends since becoming a public company.

04—Continue

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