01—Abstract
Summary
Summary of the 10-K filed February 18, 2011. Cited figures are marked; the original filing is the authoritative source.
CVS Caremark's FY2010 10-K shows a company that remains the largest U.S. pharmacy health care provider, with 2010 net revenues of $96.4 billiona, down 2.3% from $98.7 billion in 2009, while net income attributable to CVS Caremark fell 7.3% to $3.4 billion ($2.49 diluted EPS vs. $2.55).
The revenue decline was driven by the Pharmacy Services segment (down 6.4%), which lost several large client contracts effective January 1, 2010 and saw Medicare Part D covered lives shrink after the competitive bidding process; the Retail Pharmacy segment grew 3.6%, with same-store sales up 2.1%. Gross margin held roughly flat at 21.0% of revenue, but Pharmacy Services gross profit fell 12.6%, reflecting loss of the retail "differential" or "spread" under a new CMS rule, pricing compression on a large client renewal, and the shift to lower-margin generics. Note that 2009 and 2010 earnings were both helped by previously unrecognized tax benefits ($47 millionb in 2010 and $167 million in 2009), so underlying growth is weaker than the headline figures suggest.
Cash generation was solid, with operating cash flow of $4.8 billionc, up from $4.0 billion, and capital expenditures of $2.0 billion. Management returned capital through $1.5 billion of share repurchases (completing the 2009 program) and dividends that were raised 15% in January 2010 and then 43% in January 2011 to $0.125 quarterly. A new $2.0 billion repurchase authorization was in place but unused at year-end.
Long-term debt was $8.7 billiond, with the balance sheet carrying $25.7 billion of goodwill and $9.8 billion of intangibles, and debt ratings of Baa2 (stable) and BBB+ (negative outlook). Forward-looking items include the pending $1.25 billion acquisition of Universal American's Medicare Part D business, expected to close by Q2 2011; a CEO transition from Thomas Ryan to Larry Merlo effective March 1, 2011; and an industry-wide shift away from AWP pricing benchmarks, with FDB discontinuing AWP in September 2011. Litigation and regulatory exposure is a notable investor focus.
Matters include a qui tam False Claims Act suit over Medicaid claims processing (with the Texas AG also pursuing related claims), a putative class action seeking roughly $3.2 billion in damages over insurance coverage misrepresentation, multidistrict PBM antitrust litigation, a multistate FTC-led antitrust investigation involving 24 states, and a $75 million civil penalty plus forfeiture related to pseudoephedrine sales. Consistent with the filing, the company describes its exposure as not expected to have a material adverse effect, though it acknowledges that outcomes cannot be predicted with certainty.
02—Key points
Key Highlights
- Revenue declined 2.3% to $96.4B in 2010, driven by a 6.4% drop in Pharmacy Services offset by 3.6% growth in Retail Pharmacy.
- Net income attributable to CVS Caremark fell 7.3% to $3.4B; diluted EPS was $2.49 versus $2.55 in 2009, with results aided by $47M of tax benefits.
- Pharmacy Services gross profit fell 12.6% to $3.4B, with gross margin compressing from 7.5% to 7.0% on loss of retail 'spread' under new CMS rules.
- Operating cash flow rose to $4.8B from $4.0B, funding $2.0B of capex and $1.5B of share repurchases.
- Quarterly dividend raised to $0.125 in January 2011 (43% increase), reflecting confidence in cash flow; a new $2.0B buyback authorization remained unused at year-end.
- Pending $1.25B acquisition of Universal American's Medicare Part D business, expected to close by end of Q2 2011.
- Material litigation and regulatory exposure, including a qui tam FCA case, a $3.2B-claim class action, PBM antitrust litigation, and a multistate investigation.
03—One dollar
Follow one dollar
Of each $1.00 of revenue in FY2010, CVS Health Corp kept $0.04.
- Revenue$95.78B100.0%
- Cost of revenue−$75.56B78.9%
- Gross profit$20.22B21.1%
- Operating costs−$14.08B14.7%
- Operating income$6.14B6.4%
- Interest, other & tax−$2.71B2.8%
- Net income$3.42B3.6%
Where FY2010 revenue went
$95.78B- Cost of revenue: $75.56B, 79% of revenue
- Operating costs: $14.08B, 15% of revenue
- Net income: $3.42B, 3.6% of revenue
- Interest, other & tax: $2.71B, 2.8% of revenue
Kept 3.6% as net incomeNet income $3.42B · 3.6%
Full revenue history →04—Financials
Financial Highlights
Figures from 10-KFY2010filed February 18, 2011Financial Statements
FY2010 against FY2009
| Line item | FY2010FY2009 | Change |
|---|---|---|
| Revenue | $95.78B$98.22B | −2.5% |
| Cost of Revenue | $75.56B$77.86B | −3.0% |
| Gross Profit | $20.22B$20.36B | −0.7% |
| Operating Expenses | $14.08B$13.93B | +1.1% |
| Operating Income | $6.14B$6.42B | −4.5% |
| Interest Expense | $539.00M$530.00M | +1.7% |
| Net Income | $3.42B$3.70B | −7.4% |
| EPS (Basic) | $2.51$2.58 | −2.7% |
| EPS (Diluted) | $2.49$2.55 | −2.4% |
| Shares Outstanding (Basic) | 1.37B1.43B | −4.7% |
| Shares Outstanding (Diluted) | 1.38B1.45B | −5.0% |
05—Questions
Frequently Asked Questions
Why did revenue and profit decline in 2010 despite a growing retail business?
The Pharmacy Services segment drove the decline. Revenue there fell 6.4% after several large client contracts terminated on January 1, 2010, and Medicare Part D covered lives shrank following the 2010 competitive bidding process. Gross profit in that segment dropped 12.6% because CMS now treats retail 'differential' or 'spread' as an administrative cost, which removed a profit source. Retail Pharmacy revenue rose 3.6%, but its gross margin slipped from 30.0% to 29.7%.
Is the dividend increase sustainable, and how much cash does the company return to shareholders?
The dividend rose from $0.0875 to $0.125 per quarter in January 2011, an annual rate of $0.50. Total 2010 dividends paid were $479 million, and share repurchases were $1.5 billion. With operating cash flow of $4.8B against capex of $2.0B, free cash flow of roughly $2.8B covers dividends comfortably. The payout is still modest against earnings of about $3.4B, but the balance sheet carries $8.7B of long-term debt.
How significant are the pending legal and regulatory matters?
Several matters carry headline exposure. The qui tam suit over Medicaid claims processing, the Texas AG's related action, and the OIG subpoenas are ongoing, and the Lauriello class action seeks about $3.2B in damages. Management says none is expected to have a material adverse effect, but it also states that outcomes cannot be predicted with certainty. The company already paid $75M in civil penalties and $2.6M in forfeiture in the pseudoephedrine matter. Investors should monitor the multistate FTC-led antitrust investigation, which could affect the PBM business model.
What does the Universal American acquisition mean for the business?
The $1.25B purchase would add Universal American's Medicare Part D business, which is intended to rebuild Pharmacy Services scale after the 2010 Part D enrollment decline. Closing depends on regulatory approvals and UAC shareholder approval. Management expects closing by the end of Q2 2011, and the filing warns that delay or altered terms could prevent realization of the expected benefits.
What are the biggest risks to future earnings?
Key risks include continued margin compression in the PBM industry as clients demand larger rebate shares, the shift toward generics that lowers pharmacy margins, and the loss of retail 'spread' under Medicare Part D rules. Health care reform under PPACA creates uncertainty for plan designs and MLR requirements. The move away from AWP pricing benchmarks could alter Medicaid and commercial reimbursement. Lastly, the 10-K flags that 2010 and 2009 earnings were supported by one-time tax benefits, so normalized profit growth may be weaker than reported.
06—Continue