01—Abstract
Summary
Summary of the 10-K filed February 26, 2010. Cited figures are marked; the original filing is the authoritative source.
CVS Caremark Corporation's FY2009 10-K shows a company that grew revenue and earnings through a combination of acquisitions and organic growth while returning cash to shareholders.
Net revenues rose 12.8% to $98.7 billiona (from $87.5 billion), driven largely by the October 2008 Longs Drug Stores acquisition, which added roughly $6.6 billion. Operating profit increased 6.5% to $6.4 billion, and diluted EPS rose 17% to $2.55 (from $2.18), helped by a one-time $167 million tax benefit from the expiration of statutes of limitation and settlements with tax authorities. Excluding that benefit, the effective tax rate would have been about 40.1% rather than 37.3%, so underlying earnings growth was more modest than headline figures suggest.
The Retail Pharmacy segment (about 56% of revenue) is the profit engine, with 7,025 stores and 13% revenue growth, while the Pharmacy Services (PBM) segment is margin-pressured: gross margin fell to 7.5% from 8.1%, reflecting client renewals at lower rates, rebate sharing, and the Medicare Part D 'differential' rule effective 2010. Management flagged that a small number of large PBM clients chose not to renew for 2010, and the top 10 clients are expected to represent about 29% of revenue, so client concentration and renewal risk are material going forward. Balance sheet and capital allocation: the company repurchased about $2.5 billionb of stock in 2009, completed the $2.0 billion 2008 program, and launched a new $2.0 billion program in November 2009.
Operating cash flow was $4.0 billionc against $2.5 billion of capex. Long-term debt is $8.8 billion (total debt about $11.2 billion) with ratings of Baa2/BBB+ (S&P outlook negative).
Significant legal exposure includes a Texas Medicaid qui tam case, an OIG subpoena and Texas AG civil investigative demands, FTC and DEA investigations, and a securities class action; management believes none will be material, but the outcomes are uncertain. Subsequent to year-end, the board approved a 15% dividend increase to $0.0875d per quarter.
02—Key points
Key Highlights
- Net revenues up 12.8% to $98.7B (2008: $87.5B), largely from the Longs Drug Stores acquisition (+$6.6B contribution)
- Operating profit up 6.5% to $6.4B; diluted EPS up 17% to $2.55, but including a one-time $167M tax benefit (ex-benefit effective tax rate ~40.1%)
- Retail Pharmacy segment operating profit rose 10.8% to $4.2B on 13% revenue growth; Pharmacy Services operating profit rose 4% to $2.9B despite gross margin compression to 7.5%
- PBM margin pressure: client renewals at lower rates, rebate sharing with clients, and CMS rule eliminating Part D 'spread' pricing from 2010 expected to reduce Medicare Part D profitability
- Client concentration risk: some large PBM clients did not renew for 2010; top 10 clients expected to be ~29% of 2010 revenue
- Strong cash generation ($4.0B operating cash flow) funded $2.5B of buybacks and $439M of dividends; new $2.0B repurchase program authorized November 2009
- Substantial legal and regulatory exposure: Texas Medicaid qui tam and state enforcement actions, OIG and FTC investigations, DEA pseudoephedrine matter, and securities class action; management expects no material impact but outcomes are uncertain
03—One dollar
Follow one dollar
Of each $1.00 of revenue in FY2009, CVS Health Corp kept $0.04.
- Revenue$98.22B100.0%
- Cost of revenue−$77.86B79.3%
- Gross profit$20.36B20.7%
- Operating costs−$13.93B14.2%
- Operating income$6.42B6.5%
- Interest, other & tax−$2.73B2.8%
- Net income$3.70B3.8%
Where FY2009 revenue went
$98.22B- Cost of revenue: $77.86B, 79% of revenue
- Operating costs: $13.93B, 14% of revenue
- Net income: $3.70B, 3.8% of revenue
- Interest, other & tax: $2.73B, 2.8% of revenue
Kept 3.8% as net incomeNet income $3.70B · 3.8%
Full revenue history →04—Financials
Financial Highlights
Figures from 10-KFY2009filed February 26, 2010Financial Statements
FY2009 against FY2008
| Line item | FY2009FY2008 | Change |
|---|---|---|
| Revenue | $98.22B$87.47B | +12.3% |
| Cost of Revenue | $77.86B$69.18B | +12.5% |
| Gross Profit | $20.36B$18.29B | +11.3% |
| Operating Expenses | $13.93B$12.24B | +13.8% |
| Operating Income | $6.42B$6.05B | +6.3% |
| Interest Expense | $530.00M$530.00M | 0.0% |
| Net Income | $3.70B$3.20B | +15.6% |
| EPS (Basic) | $2.58$2.23 | +15.7% |
| EPS (Diluted) | $2.55$2.18 | +17.0% |
| Shares Outstanding (Basic) | 1.43B1.43B | 0.0% |
| Shares Outstanding (Diluted) | 1.45B1.47B | −1.3% |
05—Questions
Frequently Asked Questions
How much of the 2009 revenue and earnings growth came from the Longs acquisition versus the underlying business?
The Longs Acquisition (completed October 2008) added about $6.6 billion to 2009 net revenues and $1.1 billion to gross profit, so most of the 12.8% revenue growth reflects the acquisition. Organic growth was partially offset by three fewer days in the 2009 fiscal year (roughly $671 million of revenue impact) and by the 2008 fiscal year having 368 days versus 365 in 2009. Investors should look at same-store sales (Retail Pharmacy total +5.0%, pharmacy +6.9%, front store +1.2%) for a cleaner view of the core business.
Did the tax benefit materially boost 2009 earnings?
Yes. The company recognized about $167 million of previously unrecognized tax benefits (including interest) from expired statutes of limitation and tax settlements. This lowered the effective tax rate to 37.3% from 39.6% in 2008. Excluding it, the 2009 effective rate would have been about 40.1%, and EPS would be roughly $0.12 lower on a diluted basis, so the reported EPS growth overstates the underlying operating improvement.
What are the main risks to the PBM (Pharmacy Services) business going forward?
Key risks include client loss and difficulty winning new business (about one-third of PBM contracts renew each year and a small number of large clients chose not to renew for 2010), continued margin pressure from clients demanding lower prices and a larger share of manufacturer rebates, and the CMS regulation eliminating Part D 'differential' or 'spread' pricing beginning in 2010, which management expects to reduce Medicare Part D profitability. Changes to AWP pricing benchmarks, which will reduce Medicaid reimbursement in 2010, add further pressure.
How is the company returning capital to shareholders and how strong is its balance sheet?
In 2009 the company repurchased about $2.5 billion of common stock, completing the $2.0 billion 2008 program and starting a new $2.0 billion program in November 2009 (about $500 million used in the fourth quarter). Dividends paid were $439 million, and the board approved a 15% increase to $0.0875 per quarter in January 2010. Total debt was about $11.2 billion, with long-term debt of $8.8 billion; the company's debt is rated Baa2 (Moody's, stable) and BBB+ (S&P, negative outlook). Shareholders' equity is $35.8 billion, and total assets are $61.6 billion, of which goodwill and intangibles make up about $36 billion.
What are the most significant pending legal matters?
The most significant matters include a qui tam lawsuit alleging Caremark underpaid government programs through its processing of Medicaid claims (on appeal to the Fifth Circuit, with a related Texas state enforcement action filed in 2009); an OIG subpoena and Texas Attorney General civil investigative demands regarding government claims processing; an FTC non-public investigation of business practices; a DEA matter regarding pseudoephedrine distribution that could result in civil or criminal penalties or DEA registration actions; and a securities class action and derivative suit filed in late 2009. Management states it does not believe any of these will have a material adverse effect, but it acknowledges that outcomes cannot be predicted with certainty.
06—Continue