01—Abstract
Summary
Summary of the 10-K filed February 27, 2008. Cited figures are marked; the original filing is the authoritative source.
CVS Caremark's fiscal 2007 10-K, filed February 27, 2008, reflects a transformative year driven by the March 22, 2007 merger with Caremark Rx, Inc. The combined company reported net revenues of $76.3 billiona, up 74% from $43.8 billion in 2006, and net earnings of $2.64 billion, or $1.92 per diluted share, up from $1.60.
Operating profit rose to $4.79 billionb from $2.44 billion. Gross profit benefited from roughly $400 million in purchasing and operating synergies realized in 2007, with management expecting purchasing synergies to grow substantially in 2008 as the full-year merger benefit takes hold. Much of the revenue jump is attributable to the Pharmacy Services segment, which added about $26.5 billion of revenue from Caremark, though the lower-margin gross accounting for certain PBM retail network contracts compressed that segment's gross margin to 8.6% from 12.4%.
The balance sheet expanded sharply, with total assets rising to $54.7 billionc from $20.6 billion. Goodwill increased to $23.9 billion and intangible assets to $10.4 billion, and long-term debt grew to $8.3 billion from $2.9 billion, financed largely by $4.5 billion in new notes and ECAPS issued in 2007 and the special cash dividend paid to Caremark shareholders. Equity swelled to $31.3 billion as share issuance for the merger offset the $5.4 billion of share repurchases completed through a $5.0 billion program, which management states has been substantially completed pending final settlement of the November accelerated share repurchase.
Operating cash flow nearly doubled to $3.2 billiond. Investors should weigh the significant risk profile disclosed. Key concerns include the company's dependence on PBM client renewals (about one-third of the PBM base renews annually), margin pressure from generic drug pricing and rising client demands, uncertainty around Medicare Part D economics as risk corridors change in 2008, and the AWP pricing benchmark litigation.
The filing also details extensive legal exposure, including a Medicaid-related qui tam suit, ERISA fiduciary claims, a $3.2 billion-claim Alabama class action, antitrust suits over pharmacy networks, and a Rhode Island corruption-related investigation. The company describes its debt ratings as Baa2 and BBB+, investment grade, with management expecting to maintain that status.
02—Key points
Key Highlights
- Net revenues rose 74% to $76.3 billion in 2007 from $43.8 billion in 2006, driven primarily by the March 2007 Caremark Merger, which added about $26.5 billion to Pharmacy Services revenue.
- Diluted EPS increased to $1.92 from $1.60 (up 20%), with net earnings of $2.64 billion, up 93% year over year, though share count expansion from the merger dampened per-share growth.
- Approximately $400 million in purchasing and operating synergies were realized in 2007, with management expecting purchasing synergies to increase substantially in 2008 on a full-year basis.
- Total assets nearly tripled to $54.7 billion, with goodwill of $23.9 billion and intangibles of $10.4 billion, reflecting the merger's purchase accounting; no goodwill or intangible impairment was recorded.
- The company returned substantial capital to shareholders, repurchasing about $5.4 billion of stock under a $5.0 billion program and paying a $7.50 per share special cash dividend to Caremark holders, with long-term debt rising to $8.3 billion.
- Pharmacy Services gross margin fell to 8.6% from 12.4% largely due to gross revenue recognition of Caremark's retail network contracts, though gross profit dollars were not affected by this presentation change.
- Material risks include PBM client renewal exposure (top 10 clients ~33.2% of 2008 revenue), Medicare Part D risk-corridor changes in 2008, AWP pricing benchmark uncertainty, and multiple pending antitrust, ERISA, and qui tam lawsuits.
03—One dollar
Follow one dollar
Of each $1.00 of revenue in FY2007, CVS Health Corp kept $0.03.
- Revenue$76.33B100.0%
- Cost of revenue−$60.22B78.9%
- Gross profit$16.11B21.1%
- Operating costs−$11.31B14.8%
- Operating income$4.79B6.3%
- Interest, other & tax−$2.16B2.8%
- Net income$2.64B3.5%
Where FY2007 revenue went
$76.33B- Cost of revenue: $60.22B, 79% of revenue
- Operating costs: $11.31B, 15% of revenue
- Net income: $2.64B, 3.5% of revenue
- Interest, other & tax: $2.16B, 2.8% of revenue
Kept 3.5% as net incomeNet income $2.64B · 3.5%
Full revenue history →04—Financials
Financial Highlights
Figures from 10-KFY2007filed February 27, 2008Financial Statements
| Revenue | $76.33B |
| Cost of Revenue | $60.22B |
| Gross Profit | $16.11B |
| Operating Expenses | $11.31B |
| Operating Income | $4.79B |
| Net Income | $2.64B |
| EPS (Basic) | $1.97 |
| EPS (Diluted) | $1.92 |
| Shares Outstanding (Basic) | 1.33B |
| Shares Outstanding (Diluted) | 1.37B |
05—Questions
Frequently Asked Questions
How much of the 2007 revenue growth came from the Caremark Merger versus organic growth?
The vast majority came from the merger. Management attributes a $26.5 billion increase in Pharmacy Services revenue to the Caremark Merger, while Retail Pharmacy revenue grew $2.2 billion, largely from a full year of the Standalone Drug Business acquired from Albertson's in June 2006. Comparable-basis Pharmacy Services revenue, which assumes the merger occurred at the start of each period, grew about 7% to $43.3 billion, indicating underlying growth was modest relative to the headline figure.
Why did net earnings nearly double while EPS only rose about 20%?
The share count increased substantially because roughly 712.7 million shares were issued to Caremark shareholders in the merger, and the weighted average diluted share count rose to 1,371.8 million from 853.2 million. Net earnings grew 93%, but the much larger share base limited per-share gains. Note that 2006 diluted EPS also included a one-time benefit and SAB 108 adjustment, which management excluded for comparability, as well as a tax reserve reversal.
How is the company's balance sheet positioned after the merger and share repurchases?
Leverage increased significantly, with long-term debt of $8.3 billion and $2.1 billion of commercial paper outstanding, versus $2.9 billion of long-term debt at the end of 2006. Cash and equivalents rose to $1.06 billion. Management states that cash flow from operations, commercial paper, and long-term borrowings will fund growth, and that current debt ratings of Baa2 and BBB+ are expected to remain investment grade. Equity rose to $31.3 billion, though it was boosted by the merger's stock issuance and offset by treasury stock of $5.6 billion.
What are the main legal and regulatory risks investors should monitor?
Several matters stand out. A Texas qui tam suit alleging improper processing of Medicaid claims is pending, with DOJ and several states intervening, and the OIG subpoenaed information on related claims in December 2007. An Alabama class action (Lauriello) seeks approximately $3.2 billion in damages over insurance coverage for prior securities settlements. Multidistrict antitrust litigation challenges PBM retail network practices, and the AWP pricing benchmark is under court scrutiny after the FDB and Medi-Span settlements were not approved as proposed in January 2008. The company also disclosed a $44 million-scale consumer protection settlement from February 2008 totaling roughly $41 million in payments, and is under investigation related to Rhode Island business relationships involving former legislators. Management does not expect most individual matters to be material but acknowledges outcomes could be adverse.
What is the outlook for 2008 and key growth drivers?
Management expects to open 300 to 325 new or relocated stores in 2008 and plans gross capital expenditures above $2.0 billion. It anticipates continued purchasing synergies from the merger and expects generic dispensing rates to rise, which supports gross profit dollars even as it pressures revenue. New revenue programs tied to the merger, such as prescription compliance initiatives, expanded MinuteClinic use by plan members, and in-store pickup options, are expected to begin in 2008, though management cautioned that timing and incremental revenue amounts cannot be assured. Headwinds include Medicare Part D risk-sharing changes in 2008 and the scheduled Medicaid generic reimbursement changes, which are currently delayed by court injunction.
06—Continue