01—Abstract
Summary
Summary of the 10-K filed March 14, 2006. Cited figures are marked; the original filing is the authoritative source.
CVS Corporation's fiscal 2005 10-K shows a retail drugstore and pharmacy benefit management (PBM) company that grew sharply, driven largely by the July 2004 Eckerd acquisition.
Net sales rose 21.0% to $37.0 billiona, and net earnings increased 33.3% to $1.22 billion ($1.45 per diluted share). Operating profit grew to $2.02 billion from $1.45 billion, though the 2005 results include a $52.6 million tax reserve reversal, which management excludes from its comparable figures (comparable 2005 diluted EPS of about $1.39). Excluding the Eckerd acquisition, total sales grew roughly 8.4%.
Same-store sales rose 6.5%, with pharmacy same-store sales up 7.0% and front-store up 5.5%. The company's balance sheet strengthened, with shareholders' equity rising to $8.33 billion and long-term debt falling to $1.59 billionb from $1.93 billion. Operating cash flow increased to $1.61 billion from $914 million.
The main forward-looking items are the pending $2.93 billionc purchase of roughly 700 Sav-on and Osco stores from Albertson's, plus a $1.0 billion real estate purchase, expected to close in mid-2006 and to be funded partly through sale-leasebacks. Standard & Poor's placed CVS's long-term debt on negative outlook, and Moody's placed its ratings under review for possible downgrade. Management expects the ratings to remain investment grade.
Investors should weigh several risks. Medicare Part D (effective January 2006) is expected to reduce pharmacy gross margin rates, and the Deficit Reduction Act will cut Medicaid reimbursement for generic drugs starting in 2007. The company also disclosed an SEC informal inquiry into a 2000 barter transaction involving plush toy inventory, which led to the resignation of the Controller and Treasurer.
The CFO is serving as interim Principal Accounting Officer. Management does not expect these matters to be material.
02—Key points
Key Highlights
- Net sales increased 21.0% to $37.0 billion in 2005, and same-store sales rose 6.5%, with pharmacy at 7.0% and front store at 5.5%.
- Net earnings rose 33.3% to $1.22 billion ($1.45 diluted EPS). Excluding a $52.6 million tax reserve reversal, comparable diluted EPS was about $1.39.
- Operating profit increased to $2.02 billion from $1.45 billion, and operating margin improved to about 5.5% from 4.8%.
- Operating cash flow reached $1.61 billion, up from $914 million in 2004, and long-term debt fell to $1.59 billion.
- A pending $2.93 billion acquisition of about 700 Albertson's stores plus $1.0 billion in real estate, expected to close in mid-2006, prompted negative outlook from S&P and a review for downgrade from Moody's.
- The SEC's informal inquiry into a 2000 barter transaction led to the resignation of the Controller and Treasurer. Management does not expect a material impact.
- Medicare Part D and Medicaid reimbursement cuts under the Deficit Reduction Act are expected to pressure pharmacy gross margins going forward.
03—Questions
Frequently Asked Questions
How much of the 2005 growth came from the Eckerd acquisition versus the existing business?
The July 2004 Eckerd acquisition significantly boosted reported results. Excluding the acquired businesses, total sales grew about 8.4% in 2005 (versus 5.2% in 2004). Reported growth of 21.0% therefore includes a substantial acquisition contribution, so investors should focus on organic growth when judging underlying trends.
Is the 2005 earnings increase sustainable given the one-time items?
Reported 2005 net earnings include a $52.6 million tax reserve reversal, which management excludes from its comparable figures. Comparable diluted EPS is about $1.39, compared with the reported $1.45. Gross margin improved to 26.8% from 26.3%, supported by generic drug mix and lower inventory losses. Management noted that the inventory-loss benefit will be less significant in the future, and that Medicare Part D may pressure pharmacy margins.
What are the main risks from the pending Albertson's acquisition?
The $2.93 billion purchase of about 700 stores plus $1.0 billion in real estate is conditioned on regulatory review under Hart-Scott-Rodino and on the Albertson's–Supervalu merger closing. Financing will combine cash, debt, and sale-leaseback proceeds. S&P placed CVS's long-term debt on negative outlook and Moody's placed ratings under review for possible downgrade, although management expects investment-grade ratings to remain.
What does the SEC inquiry mean for investors?
The SEC enforcement staff opened an informal inquiry into a 2000 transaction in which CVS recorded plush toy inventory conveyed to a third party, received $42.5 million in barter credits, and made a $12.5 million cash payment. An internal audit committee review found that various aspects of the accounting were incorrect, though no restatement of these financial statements was required. The Controller and Treasurer resigned. The company does not expect a material effect on results or financial condition, but the outcome and timing remain uncertain.
How will the new Medicare Part D program and Medicaid changes affect profitability?
Management expects Medicare Part D, effective January 1, 2006, to increase prescription utilization while reducing pharmacy gross margin rates, as higher-margin cash and state Medicaid customers migrate to Part D coverage. The Deficit Reduction Act, effective January 2007, will reduce Medicaid reimbursement for generic drugs, with states expected to offset some of the impact through higher dispensing fees. The total financial impact cannot yet be determined.
04—Continue