01—Abstract
Summary
Summary of the 10-K filed February 27, 2007. Cited figures are marked; the original filing is the authoritative source.
CVS Corporation's fiscal 2006 10-K (fiscal year ended December 30, 2006) shows a company that grew substantially, with net revenues of $43.8 billiona (up 18.4% from $37.0 billion) and net earnings of $1.37 billion, or $1.60 per diluted share (up from $1.45).
Growth was driven largely by the June 2006 acquisition of roughly 700 standalone drugstores from Albertsons for $4.0 billionb, though the company reported that excluding the acquired business, revenues still rose about 10.4%. Same-store sales increased 8.2% overall, with pharmacy same-store sales up 9.1%. Gross margin expanded to 27.3% from 26.8%, while operating expenses rose to 21.7% of revenue, partly due to SFAS 123(R) stock compensation and integration costs.
Interest expense nearly doubled to $215.8 millionc, reflecting the debt used to finance the acquisition, and long-term debt rose to $2.87 billion. The dominant strategic event is the proposed merger with Caremark Rx, a pharmacy benefit manager, structured as a merger of equals in which Caremark shareholders receive 1.670 CVS shares per Caremark share. The filing discloses a competing unsolicited offer from Express Scripts, which Caremark's board rejected, a $6 per share special dividend to Caremark holders, and a planned 150 million share accelerated buyback after closing.
The closing was expected in Q1 2007 but was subject to shareholder votes that had been delayed by Delaware litigation, and the filing notes a $675 milliond termination fee payable to Caremark under certain circumstances. Investors should weigh the transformative upside against integration risk, purchase-accounting charges, and the uncertainty surrounding Medicare Part D, generic reimbursement pressure, and pending regulatory and legal matters, including an SEC inquiry into a 2000 transaction and a Rhode Island investigation.
The balance sheet remains sound, with shareholders' equity of $9.9 billion, operating cash flow of $1.74 billion, and investment-grade credit ratings (Baa2/BBB+), although the company's leverage increased materially. The dividend was raised 26% to an annualized $0.195 per share for 2007, signaling management's confidence in cash generation.
02—Key points
Key Highlights
- Net revenues grew 18.4% to $43.8 billion, with approximately 10.4% organic growth excluding the Albertsons Standalone Drug Business acquired for $4.0 billion in June 2006.
- Net earnings rose 11.8% to $1.37 billion; diluted EPS reached $1.60 versus $1.45 in 2005, though results include a $42.7 million SFAS 123(R) charge and a $24.7 million SAB 108 benefit.
- Pending merger with Caremark Rx (1.670 CVS shares per Caremark share) faces a competing Express Scripts bid, shareholder vote delays from Delaware litigation, and a $675 million termination fee exposure.
- Caremark holders are to receive a $6 per share special cash dividend, and 150 million shares are to be retired via an accelerated share repurchase after the merger closes.
- Interest expense, net, nearly doubled to $215.8 million, and long-term debt increased to $2.87 billion from $1.59 billion, reflecting acquisition financing; ratings were Baa2/BBB+ with positive outlook as of year-end.
- Operating cash flow was $1.74 billion, and capital expenditures were $1.77 billion, with 2007 capex guidance above $1.7 billion for 250-275 new or relocated stores.
- Regulatory and legal overhang includes an SEC inquiry into a 2000 barter transaction, a DOJ/state Medicaid generic dosage-form investigation, a Rhode Island corruption probe, and the AWP pricing benchmark settlement affecting PBM economics.
03—Questions
Frequently Asked Questions
Why did CVS's revenue growth accelerate in 2006?
Most of the 18.4% increase came from the June 2006 Albertsons Standalone Drug Business acquisition, which added roughly 700 stores for $4.0 billion. Excluding that business, revenues grew about 10.4%, driven by same-store sales growth of 8.2%, new store openings, and pharmacy growth tied to the Medicare Part D benefit and an aging population.
What are the key terms and risks of the proposed Caremark merger?
Caremark shareholders would receive 1.670 CVS shares for each Caremark share in a merger of equals, with the deal expected to close in Q1 2007 subject to both shareholder votes and regulatory review. Risks include a competing Express Scripts offer, Delaware and Tennessee shareholder litigation that delayed the votes, integration and purchase-accounting charges, and a $675 million termination fee payable to Caremark under certain conditions. The filing says the merger is expected to be accretive in the first full year after closing, but this is based on preliminary estimates.
How healthy is CVS's balance sheet after the acquisition and planned merger?
Shareholders' equity grew to $9.9 billion, and total assets reached $20.6 billion. Debt rose significantly, with short-term debt of $1.84 billion and long-term debt of $2.87 billion, and the company had $530.7 million in cash. Credit ratings were investment grade (Baa2/BBB+), though the filing notes that the planned Caremark financing, including a $5.0 billion bridge facility, will add further leverage.
Is the dividend sustainable, and what did management signal about future payouts?
The 2006 dividend totaled $0.155 per share, and in January 2007 the board raised the quarterly dividend 26% to $0.04875, or $0.195 annualized. Operating cash flow of $1.74 billion covered dividends of $140.9 million comfortably, although a larger combined company with higher debt service could change that calculus.
What regulatory or legal issues could materially affect CVS beyond the merger?
The filing discloses an SEC enforcement inquiry into a 2000 transaction involving plush toy inventory and $42.5 million in barter credits, which led to the resignation of the Controller and Treasurer, though management does not expect a material impact. Other matters include a DOJ and state attorney general investigation into generic drug dispensing practices in Medicaid, a Rhode Island investigation in which two CVS employees were indicted, and pending changes to AWP drug pricing benchmarks following the FDB settlement.
04—Continue