CVS Health Corporation — Q1 2016 Form 10-Q
Reporting period: Three months ended March 31, 2016; unaudited. CVS Health operates Pharmacy Services, Retail/LTC and Corporate businesses. Results include Omnicare, acquired in August 2015, and Target pharmacies and clinics, acquired in December 2015, which were not included in the full prior-year comparison.
Financial performance
| Metric | Q1 2016 | Q1 2015 | Change |
|---|---|---|---|
| Net revenues | $43.215B | $36.332B | +18.9% |
| Gross profit | $6.744B | $6.164B | +9.4% |
| Gross margin | 15.6% | 17.0% | Down about 135 bps |
| Operating profit | $2.176B | $2.132B | +2.1% |
| Net income attributable to CVS Health | $1.146B | $1.221B | Down 6.1% |
| Diluted EPS | $1.04 | $1.07 | Down 2.8% |
| Operating cash flow | $2.412B | $1.984B | +21.6% |
- Operating expenses were $4.568B, up 13.3%; operating margin was approximately 5.0%, versus 5.9% a year earlier. Net interest expense more than doubled to $283M from $134M, primarily reflecting acquisition-related borrowing.
- Pharmacy Services revenue rose 20.5% to $28.765B; operating profit was $782M versus $734M. Segment gross margin fell to 3.8% from 4.3%, amid mix changes and price compression.
- Retail/LTC revenue rose 18.6% to $20.112B; operating profit was $1.777B versus $1.727B. Segment gross margin fell to 29.0% from 31.2%, primarily due to pharmacy reimbursement pressure and a higher pharmacy-sales mix. Its results included $57M of acquisition integration costs in operating expenses.
- Cash and equivalents were $1.779B at March 31, down from $2.459B at year-end. Current assets were $29.413B and current liabilities $24.537B.
- Debt comprised $1.202B current and $26.267B long-term, or $27.469B total; long-term debt was unchanged from year-end. The company reported no commercial-paper or backup-credit-facility borrowings. Its debt was rated Baa1 by Moody’s and BBB+ by S&P, both with stable outlooks.
- Investing cash outflow was $633M, including $598M of property and equipment purchases. Financing cash outflow was $2.460B, including $2.066B of share repurchases and $470M of dividends. The quarterly dividend declared was $0.425 per share, versus $0.350.
Material changes and management commentary
Revenue growth reflected increased Pharmacy Services claims and specialty-pharmacy activity, Omnicare, Target locations and higher Retail/LTC same-store pharmacy sales. Growth did not translate proportionately into profit: management cited pricing and reimbursement pressure, price compression and a less favorable business mix. Consolidated gross margin contracted despite higher gross profit dollars.
Pharmacy Services processed 304.8M claims, up from 251.1M; its total generic dispensing rate rose to 85.2% from 83.5%. Retail/LTC same-store sales increased 4.2%, including pharmacy sales growth of 5.5%; same-store prescription volume rose 5.9%. The company noted that leap-year timing and Easter timing benefited certain first-quarter comparisons, while softer front-store traffic, generic introductions and a weaker, later flu season were headwinds.
Operating cash flow improved by $428M, which management attributed primarily to working-capital changes. CVS repurchased approximately 22.4M shares for $2.1B; $5.6B remained under its $10B repurchase authorization at quarter-end. Management stated that operating cash flow, its commercial-paper program and potential borrowings were expected to support short- and long-term needs.
Outlook, risks and contingencies
- The filing provides no specific numerical earnings or revenue guidance. Management expected generic dispensing to continue increasing, though more slowly, and expected reimbursement, competitive and PBM pricing pressures to continue. It described aging demographics, Medicare Part D utilization and expanded coverage as supportive industry trends.
- Key risks include reimbursement reductions, client retention and contract renewals, Medicare Part D competition, generic and brand-drug trends, regulatory changes, government program reimbursement, acquisition integration and realization of expected benefits, and litigation or investigations.
- Legal matters include an agreement in principle to contribute $80M to resolve the Lauriello litigation, subject to final terms and court approval; the company said reserves fully covered the contribution. A separate Bellevue pharmacy antitrust settlement was also agreed in principle, with confidential terms and a reserve recorded. CVS denied wrongdoing in these matters.
- CVS paid an $8M fine in Q1 under a settlement concerning alleged Controlled Substances Act violations; the amount had been fully reserved. The filing also describes multiple ongoing government inquiries and legal proceedings, including pharmacy billing, reimbursement, pricing, controlled-substance and False Claims Act matters. For many, the company could not estimate a possible loss beyond amounts accrued.
- Approximately 70 legacy store-lease guarantees remained, with terms extending through 2026; management did not expect their ultimate disposition to have a material adverse effect. Operating leases are not reflected on the balance sheet under the accounting then in effect. CVS said the new lease standard would materially affect its balance sheet but not liquidity.
- The interim financial statements received an independent accountant’s review, not an audit. Management reported disclosure controls were adequate and effective; integration of acquired businesses’ controls was ongoing.
Most important facts for investors to verify
- Whether acquisition-driven revenue and claim growth can offset margin pressure, higher interest costs and integration costs.
- Trends in PBM and retail pharmacy reimbursement, price compression, client renewals and generic-drug economics.
- Omnicare and Target integration progress, associated costs and realization of anticipated benefits.
- Cash allocation among buybacks, dividends, capital investment and debt management, and the effect of acquisition-related debt on future interest expense and credit ratings.
- Developments and potential financial exposure from the disclosed settlements, government inquiries and other legal proceedings.