01—Abstract
Summary
Summary of the 10-K filed February 17, 2012. Cited figures are marked; the original filing is the authoritative source.
CVS Caremark's FY2011 10-K (filed February 17, 2012) shows a company that grew revenue strongly but saw profit growth stall and margins compress.
Net revenues rose 11.8% to $107.1 billiona, driven largely by the new Aetna PBM contract and the April 2011 acquisition of Universal American's Medicare Part D business for about $1.3 billion. Gross profit grew only 1.7% to $20.6 billion, and gross margin fell to 19.2% from 21.1%, reflecting the mix shift toward the lower-margin Pharmacy Services segment, whose gross margin dropped to 5.6% from 7.0%. Net income attributable to CVS Caremark rose about 1% to $3.46 billion, or $2.57 per diluted share, and was flattered in prior years by tax benefits.
Operating profit grew 3.1% to $6.33 billionb. Retail Pharmacy remains the profit engine, with segment operating profit up 8.2% to $4.9 billion and same-store sales up 2.3%, while Pharmacy Services operating profit fell about 6% to $2.2 billion. Cash generation was strong, with operating cash flow of $5.9 billion, up from $4.8 billion, and free cash flow after $1.9 billion of capex of roughly $4.0 billion.
The company returned substantial capital: $3.0 billionc of buybacks, including the $1.0 billion Barclays ASR, and dividends were raised to $0.1625 quarterly, an annualized $0.65. Long-term debt rose to $9.2 billion, and the company remains rated Baa2/BBB+. Investors should weigh several risks disclosed in the filing: pressure on PBM gross margins from client demands and the reduced ability to earn retail "differential" or "spread" under CMS rules; proposed Medicaid reimbursement changes (FUL at 175% of AMP) whose impact is not yet quantifiable; the pending Express Scripts–Medco merger, which could reshape the competitive landscape; the phase-out of the retiree drug subsidy tax deductibility in 2013; and a material legal docket, including the Texas qui tam case, the PBM antitrust litigation, securities class actions, and government investigations, though management does not expect these to be material.
02—Key points
Key Highlights
- Net revenues grew 11.8% to $107.1 billion, led by the Aetna contract and the UAM Medicare Part D acquisition, while Pharmacy Services revenue rose 24.9% to $58.9 billion.
- Gross margin contracted to 19.2% from 21.1% as the mix shifted toward lower-margin PBM business; Pharmacy Services gross margin fell to 5.6% from 7.0%.
- Net income attributable to CVS Caremark was $3.46 billion ($2.57 diluted EPS), up only about 1% year over year; 2010 and 2009 had tax benefits that flattered results.
- Retail Pharmacy was the profit driver, with segment operating profit up 8.2% to $4.9 billion on 2.3% same-store sales growth and 75.6% generic dispensing.
- Operating cash flow rose to $5.9 billion from $4.8 billion, while capital expenditures fell to $1.9 billion.
- Shareholder returns were significant: $3.0 billion in buybacks (including a $1.0 billion ASR) and a 30% dividend increase to $0.1625 per quarter.
- Key risks include PBM margin compression, the loss of retail 'spread' under CMS rules, proposed Medicaid FUL changes, the Express Scripts–Medco merger, and the 2013 end of retiree drug subsidy tax deductibility.
03—One dollar
Follow one dollar
Of each $1.00 of revenue in FY2011, CVS Health Corp kept $0.03.
- Revenue$107.08B100.0%
- Cost of revenue−$86.52B80.8%
- Gross profit$20.56B19.2%
- Operating costs−$14.23B13.3%
- Operating income$6.33B5.9%
- Interest, other & tax−$2.87B2.7%
- Net income$3.46B3.2%
Where FY2011 revenue went
$107.08B- Cost of revenue: $86.52B, 81% of revenue
- Operating costs: $14.23B, 13% of revenue
- Net income: $3.46B, 3.2% of revenue
- Interest, other & tax: $2.87B, 2.7% of revenue
Kept 3.2% as net incomeNet income $3.46B · 3.2%
Full revenue history →04—Financials
Financial Highlights
Figures from 10-KFY2011filed February 17, 2012Financial Statements
FY2011 against FY2010
| Line item | FY2011FY2010 | Change |
|---|---|---|
| Revenue | $107.08B$95.78B | +11.8% |
| Cost of Revenue | $86.52B$75.56B | +14.5% |
| Gross Profit | $20.56B$20.22B | +1.7% |
| Operating Expenses | $14.23B$14.08B | +1.1% |
| Operating Income | $6.33B$6.14B | +3.2% |
| Interest Expense | $588.00M$539.00M | +9.1% |
| Net Income | $3.46B$3.42B | +1.0% |
| EPS (Basic) | $2.59$2.51 | +3.2% |
| EPS (Diluted) | $2.57$2.49 | +3.2% |
| Shares Outstanding (Basic) | 1.34B1.37B | −2.1% |
| Shares Outstanding (Diluted) | 1.35B1.38B | −2.2% |
05—Questions
Frequently Asked Questions
How did CVS Caremark's profitability trend in 2011?
Revenue grew faster than profit. Net revenues rose 11.8% to $107.1 billion, but gross profit grew only 1.7% and operating profit rose 3.1% to $6.33 billion. Net income attributable to the company was up about 1% to $3.46 billion. Margins compressed because growth came disproportionately from the lower-margin Pharmacy Services segment.
What drove the growth in the Pharmacy Services segment, and what is the concern?
Growth came from the new long-term Aetna contract effective January 1, 2011, and the April 2011 acquisition of the UAM Medicare Part D business for about $1.3 billion. However, client pricing pressure and contract renewals reduced gross margin to 5.6% from 7.0%, and segment operating profit fell about 6% to $2.2 billion.
Is the company's balance sheet and capital allocation sound?
Long-term debt increased to $9.2 billion, and the company is rated Baa2 by Moody's and BBB+ by S&P, both with stable outlooks. Operating cash flow of $5.9 billion comfortably covers capex, dividends of about $674 million, and buybacks of $3.0 billion. Goodwill and intangibles total about $36 billion, which is a large share of total assets of $64.5 billion.
What are the most significant legal and regulatory risks?
The most significant items include a Texas federal qui tam lawsuit over Medicaid claims processing, a Texas state enforcement action, In re Pharmacy Benefit Managers Antitrust Litigation, securities class actions tied to 2009 disclosures, and ongoing OIG and SEC subpoenas. Management says none is expected to be material, but the outcomes are uncertain. Regulatory risks include the proposed Medicaid FUL rule, changes to Part D, and the eventual Express Scripts–Medco merger's effect on competition.
06—Continue