01—Abstract
Summary
Summary of the 10-K filed February 27, 2009. Cited figures are marked; the original filing is the authoritative source.
CVS Caremark's 2008 Form 10-K reports a year of strong earnings growth, driven by the 2007 Caremark Merger and the October 2008 Longs Drug Stores acquisition.
Net revenues rose 14.6% to $87.5 billiona, operating profit increased 26.1% to $6.0 billion, and diluted EPS reached $2.18 (or $2.27 from continuing operations), compared with $1.92 in 2007. Note that fiscal 2008 contained 368 days because of a change in fiscal year-end to December 31, so year-over-year comparisons are modestly flattered. The Retail Pharmacy segment (about 56% of revenue) improved operating margin to 7.1% from 6.0%, helped by generic mix, front-store gains, and purchasing synergies.
The Pharmacy Services segment is structurally lower-margin, with gross margin compressing to 8.1% from 8.6% as clients took larger shares of rebates, mail penetration fell to 22.9%, and new or renewed client contracts were priced at lower rates, which management expects to pressure 2009 gross profit. Cash generation was solid, with operating cash flow of $3.9 billionb, but investing outflows of $4.6 billion reflected the Longs deal and capital spending. Long-term debt is $8.1 billion, and the company rated Baa2/BBB+.
Key risks for investors include declining drug utilization during the 2008-2009 recession, Medicare Part D margin dilution, AWP pricing benchmark changes, pending PBM antitrust and qui tam litigation (including a claim seeking about $3.2 billionc in the Lauriello case), and integration risk from Longs. The company also disclosed a 15% dividend-related signal through a 10.5% increase to the quarterly dividend, and a $2.0 billion share repurchase program that is delayed until the second half of 2009.
02—Key points
Key Highlights
- Net revenues grew 14.6% to $87.5B (2008) from $76.3B (2007), with the Caremark Merger adding about $6.9B and the Longs Acquisition adding about $1.1B.
- Operating profit rose 26.1% to $6.05B; operating margin expanded to 6.9% from 6.3%, with Retail Pharmacy operating margin up to 7.1% from 6.0%.
- Diluted EPS of $2.18 net ($2.27 from continuing operations), up from $1.92 in 2007; includes a $0.09 per share loss from Linens 'n Things lease guarantees.
- Pharmacy Services gross margin fell to 8.1% from 8.6% due to client rebate sharing, lower mail penetration (22.9% vs. 28.2%), and lower-priced renewals; management expects further gross profit compression in 2009.
- Operating cash flow of $3.9B vs. $3.2B in 2007; net cash used in investing of $4.6B mainly reflects the $2.6B Longs acquisition and $2.2B capex.
- Balance sheet: total assets $61.0B, goodwill and intangibles of $35.9B (about 59% of assets), long-term debt $8.1B, and shareholders' equity $34.6B.
- Dividend raised 10.5% to $0.07625 per quarter in January 2009; $2.0B buyback authorized but delayed until 2H 2009 because of the Longs deal.
03—One dollar
Follow one dollar
Of each $1.00 of revenue in FY2008, CVS Health Corp kept $0.04.
- Revenue$87.47B100.0%
- Cost of revenue−$69.18B79.1%
- Gross profit$18.29B20.9%
- Operating costs−$12.24B14.0%
- Operating income$6.05B6.9%
- Interest, other & tax−$2.85B3.3%
- Net income$3.20B3.7%
Where FY2008 revenue went
$87.47B- Cost of revenue: $69.18B, 79% of revenue
- Operating costs: $12.24B, 14% of revenue
- Net income: $3.20B, 3.7% of revenue
- Interest, other & tax: $2.85B, 3.3% of revenue
Kept 3.7% as net incomeNet income $3.20B · 3.7%
Full revenue history →04—Financials
Financial Highlights
Figures from 10-KFY2008filed February 27, 2009Financial Statements
FY2008 against FY2007
| Line item | FY2008FY2007 | Change |
|---|---|---|
| Revenue | $87.47B$76.33B | +14.6% |
| Cost of Revenue | $69.18B$60.22B | +14.9% |
| Gross Profit | $18.29B$16.11B | +13.5% |
| Operating Expenses | $12.24B$11.31B | +8.2% |
| Operating Income | $6.05B$4.79B | +26.1% |
| Interest Expense | $530.00M— | — |
| Net Income | $3.20B$2.64B | +21.3% |
| EPS (Basic) | $2.23$1.97 | +13.2% |
| EPS (Diluted) | $2.18$1.92 | +13.5% |
| Shares Outstanding (Basic) | 1.43B1.33B | +8.0% |
| Shares Outstanding (Diluted) | 1.47B1.37B | +7.1% |
05—Questions
Frequently Asked Questions
Why does 2008 look better than it might on a normalized basis?
Fiscal 2008 included 368 days versus 364 in prior years, which management estimates added about $1.1B to revenue and about $238M to gross profit. The results also include a full year of Caremark (versus about nine months in 2007) and only about two months of Longs, so organic growth is lower than headline growth.
What are the biggest threats to the Pharmacy Services business?
Clients are renewing at lower prices, and PBMs are sharing more manufacturer rebates with clients, which compresses gross margin. Mail penetration has also declined, and the company warns that the generic-drug margin benefit is shrinking as third-party payors cut reimbursement. Medicare Part D has pushed cash customers into lower-margin coverage, and the company may lose clients who drop drug benefits for Medicare-eligible members.
How exposed is the company to litigation?
Material exposure exists in several areas. The Lauriello class action seeks about $3.2B in compensatory damages, although the company has not recorded a reserve for it. A qui tam Medicaid claims-processing case (partially favorable to Caremark after August 2008 summary judgment rulings) and a federal OIG subpoena remain open, and the In re PBM Antitrust Litigation consolidates pharmacy network claims. Management believes none are individually expected to be material, but the filing acknowledges adverse outcomes could affect operations.
Is the dividend and capital return policy safe?
The dividend has been paid every quarter since the company went public and was raised 10.5% in January 2009, which signals confidence in cash flow. The $2.0B repurchase program was delayed due to the Longs acquisition and is planned for the second half of 2009, though the timing depends on market conditions. With $1.35B of cash and $3.0B of short-term debt, liquidity relies heavily on commercial paper access, which is backed by $5.5B in committed bank facilities.
What is the Longs Acquisition's contribution and what are the integration risks?
The Longs acquisition, closed October 20, 2008 for about $2.6B, added 529 drugstores and RxAmerica (a PBM and Part D provider). It contributed about $1.1B to revenue, $314M to gross profit, and $260M to operating expenses in 2008. Longs' inventory accounting still uses the cost method and will be converted to the retail method in 2009, and integration and system conversions (such as Rx Connect) present execution risk for synergy targets.
06—Continue