01—Abstract
Summary
Summary of the 10-K filed March 16, 2005. Cited figures are marked; the original filing is the authoritative source.
CVS Corporation's fiscal 2004 10-K (fiscal year ended January 1, 2005) shows a company that grew sharply through the July 31, 2004 acquisition of 1,268 Eckerd drugstores and Eckerd Health Services from J.C.
Penney for a purchase price of $2.15 billiona. Net sales rose 15.1% to $30.6 billion, operating profit rose 2.2% to $1.45 billion, and net earnings increased 8.4% to $918.8 million, or $2.20 per diluted share. Comparable internal figures excluding a $65.9 million non-cash lease accounting adjustment and a $60.0 million tax reserve reversal were $899.3 million, or $2.15 per diluted share, which indicates underlying earnings growth of roughly 6%.
Operating margins were pressured by integration costs and lower sales per store at the acquired stores, which management says had declined significantly in the year before the deal. The balance sheet and cash flow picture weakened. Net debt rose to $2.45 billionb from $233 million, long-term debt increased to $1.93 billion, and operating cash flow fell to $914 million from $969 million, driven by inventory build for the acquired stores.
Capital expenditures reached $1.35 billionc, and management plans more than $1.4 billion in 2005 spending, including 275 to 300 new or relocated stores. Management also raised the quarterly dividend 9% to $0.0725 per share. Investors should weigh the growth from the Eckerd deal against integration risk, rising leverage, and several legal matters.
These include a securities class action scheduled for trial on May 9, 2005, an ERISA suit, a shareholder derivative suit, state and federal investigations, and contingent lease guarantees of about $517 milliond tied to former subsidiaries. The company also noted growing pressure from mail order channels and third-party payors on pharmacy margins.
02—Key points
Key Highlights
- Net sales increased 15.1% to $30.6 billion in 2004, driven by pharmacy sales growth of 17.1% and the Eckerd acquisition, which contributed roughly 970 basis points of growth.
- Net earnings rose 8.4% to $918.8 million ($2.20 diluted EPS), but excluding a $65.9M lease accounting adjustment and a $60.0M tax reserve reversal, comparable earnings were $899.3M ($2.15 diluted EPS).
- Acquired 1,268 Eckerd stores and Eckerd Health Services from J.C. Penney for $2.15 billion, adding stores and PBM scale; CVS now operates 5,375 stores in 36 states and D.C.
- Total debt rose sharply: long-term debt increased to $1.93 billion from $753 million, short-term commercial paper was $885.6 million, and net debt reached $2.45 billion, versus $233 million a year earlier.
- Operating cash flow declined to $914.2 million from $968.9 million, largely due to inventory investment in the acquired stores; capital expenditures rose to $1.35 billion.
- Pharmacy represented 70.0% of sales, with 94.1% of pharmacy sales from third-party payors, and management warned of continued margin pressure from generics, mail order, and payor cost-cutting.
- Dividend increased 9% to $0.0725 per quarter ($0.29 annualized), and the company plans over $1.4 billion in 2005 capital spending for 275 to 300 new or relocated stores.
03—Questions
Frequently Asked Questions
How did the Eckerd acquisition affect CVS's 2004 results?
The July 31, 2004 acquisition of 1,268 Eckerd stores and Eckerd Health Services added about 970 basis points to the 15.1% sales growth. It also lifted total assets to $14.5 billion and goodwill to $1.9 billion, while adding integration and operating costs that pushed operating expenses to 21.5% of sales. Management said the acquired stores had sales declines in the year before the deal and that results will depend on successful turnaround initiatives.
What one-time items affected reported 2004 earnings?
Reported net earnings of $918.8 million included a $65.9 million pre-tax ($40.5 million after-tax) non-cash charge to conform lease accounting to SEC guidance, which reduced earnings, and a $60.0 million reversal of previously recorded tax reserves, which increased earnings. Excluding both items, comparable net earnings were $899.3 million, or $2.15 per diluted share.
How much debt does CVS carry and how did it change?
Long-term debt rose to $1,925.9 million from $753.1 million, and the company had $885.6 million in commercial paper outstanding at a 1.8% weighted average rate. The company issued $650 million of 4.0% notes due 2009 and $550 million of 4.875% notes due 2014 in September 2004. Net debt increased to $2.45 billion, and ratings were A3 (Moody's) and A- (S&P), both stable.
What legal risks does the filing disclose?
A securities fraud class action covering purchases between February 2001 and October 2001 survived summary judgment and is set for trial on May 9, 2005. Additional suits include an ERISA class action and a shareholder derivative suit, both based on similar allegations. Government investigations involve Rhode Island business relationships and generic drug reimbursement practices. The company calls the securities and private suits without merit, and no contingency is expected to be individually material beyond these disclosures.
What is the outlook for 2005 and what risks are highlighted?
Management plans over $1.4 billion in gross capital expenditures and 275 to 300 new or relocated stores in 2005, and expects integration-related expense pressure to ease. Key risks include third-party payor pressure to reduce drug costs, growth of mail order pharmacy, the ability to integrate and improve the Eckerd stores, the 2006 Medicare Part D benefit start, and possible loss of business if CVS withdraws from unfavorable third-party programs. The company also has about $517 million in potential exposure from lease guarantees on roughly 525 stores of former subsidiaries, though it indemnified by purchasers and believes the ultimate impact will not be material.
04—Continue