CVS Health Corporation — Q1 2017 Form 10-Q
Business context and reporting period. The filing covers the three months ended March 31, 2017, for CVS Health’s Pharmacy Services, Retail/LTC, and Corporate segments. Interim financial statements are unaudited; the independent accountant performed a review, not an audit.
Financial performance
| Metric | Q1 2017 | Q1 2016 | Change |
|---|---|---|---|
| Net revenue | $44.514 billion | $43.215 billion | +3.0% |
| Gross profit | $6.580 billion | $6.744 billion | −2.4% |
| Gross margin | 14.8% | 15.6% | −0.8 percentage points |
| Operating profit | $1.793 billion | $2.185 billion | −17.9% |
| Net income attributable to CVS Health | $952 million | $1.146 billion | −16.9% |
| Diluted EPS | $0.92 | $1.04 | −11.5% |
| Operating cash flow | $3.533 billion | $2.439 billion | +$1.094 billion |
- Segments: Pharmacy Services revenue rose 8.5% to $31.223 billion, while operating profit was unchanged at $784 million. Retail/LTC revenue fell 3.8% to $19.341 billion and operating profit declined to $1.411 billion from $1.784 billion. Retail/LTC included a $199 million store-closure charge in 2017.
- Cash and liquidity: Cash and cash equivalents were $2.217 billion at quarter-end, down from $3.371 billion at December 31, 2016. Current assets were $29.457 billion and current liabilities $27.288 billion.
- Debt: Short-term debt was $1.768 billion, current long-term debt $43 million, and long-term debt $25.622 billion—approximately $27.4 billion in total debt. The company reported $1.8 billion of commercial paper outstanding at a 1.16% weighted-average rate, no borrowings under its backup or revolving credit facilities, and compliance with debt covenants. Long-term debt ratings were Baa1 and BBB+, both with stable outlooks.
- Capital returns and investment: CVS repurchased approximately 36.1 million shares for $3.6 billion and paid $516 million in dividends. Capital expenditures were $457 million. Financing activities used $4.133 billion, and cash declined by $1.154 billion.
Material changes and management commentary
- Revenue growth was driven by Pharmacy Services claim growth, new business, brand inflation, and specialty pharmacy. Pharmacy Services claims processed increased 9.6% overall; the generic dispensing rate rose to 87.0% from 85.6%. Price compression and higher generic use weighed on revenue per network claim and segment margin.
- Retail/LTC results faced restricted pharmacy-network participation, reimbursement pressure, generic drug conversions, and softer front-store traffic. Same-store sales fell 4.7%; same-store prescription volume declined 1.4%. Management said network restrictions are expected to weigh on prescription growth for several more quarters.
- Operating cash flow improved mainly because of the timing of Medicare Part D payments; management cautioned that interim results may not indicate full-year performance. No specific earnings or revenue guidance is provided in the supplied filing text.
- The company closed 60 stores in Q1 as part of an initiative targeting about 70 underperforming-store closures in 2017. It expects approximately $20 million of additional related charges during the rest of 2017. The closure charge primarily reflects the present value of noncancelable lease obligations, some extending through 2039.
- Discontinued operations recorded a $9 million after-tax loss, including a $15 million pre-tax charge related to Bob’s Stores lease guarantees. Bob’s Stores’ successor filed for bankruptcy in February 2017; CVS said it was monitoring the proceedings and could not yet determine which leases would be assumed.
- The effective tax rate declined to 37.3% from 39.4%, including a $19 million discrete tax benefit from adoption of share-based payment accounting guidance. Interest expense, net, fell $31 million, primarily reflecting 2016 debt refinancing and tender activity.
Risks, contingencies, and other notable items
- CVS disclosed a broad range of ongoing litigation, government investigations, subpoenas, and audits involving, among other matters, Medicaid pricing, PBM practices, controlled substances, temperature-sensitive pharmaceuticals, and insulin pricing. The company stated it generally could not estimate potential losses beyond amounts accrued; it also reported a tentative $23 million resolution of one matter and agreements in principle or financial terms for certain other matters, all subject to approvals and final agreements.
- In March 2017, CVS was named in four West Virginia county opioid-related lawsuits. The company is defending the actions.
- Competitive pressures, client demands for lower prices, reimbursement reductions, restricted pharmacy networks, regulatory change, generic-drug trends, and potential loss of PBM, LTC, or Medicare Part D business are identified as significant risks.
- CVS expects the new lease accounting standard to materially affect its consolidated balance sheet; it was still evaluating the effects. The company did not expect the new revenue recognition standard to materially affect results, cash flows, or financial position, but expected expanded disclosures.
- Disclosure controls were assessed as adequate and effective, with no material changes in internal control over financial reporting reported for the quarter.
Investor verification priorities
- Track whether Pharmacy Services growth converts into stronger gross profit and operating profit amid price compression and rebate-sharing pressure.
- Verify the duration and financial impact of Retail/LTC network exclusions, reimbursement pressure, and same-store sales declines.
- Assess cash generation quality, particularly the effect of Medicare Part D payment timing, against buybacks, dividends, capital spending, and debt levels.
- Monitor store-closure costs, lease obligations, and developments in the Bob’s Stores bankruptcy and other lease guarantees.
- Review updates on material legal and regulatory matters, especially Medicaid pricing, PBM investigations, opioid litigation, and insulin-related claims.
- Confirm the pace and balance-sheet impact of lease-standard adoption and any changes to management’s outlook in subsequent filings.