CVS Health Corporation — Q1 2015 Form 10-Q
Business context and reporting period
CVS Health reported results for the three months ended March 31, 2015, compared with the first quarter of 2014. Its businesses comprise Pharmacy Services (PBM, specialty pharmacy and related services), Retail Pharmacy and Corporate. The interim financial statements are unaudited; the independent accountant performed a review, not an audit.
Financial results and liquidity
| Metric | Q1 2015 | Q1 2014 |
|---|---|---|
| Net revenue | $36.332 billion | $32.689 billion |
| Gross profit | $6.164 billion | $5.942 billion |
| Operating profit | $2.132 billion | $2.024 billion |
| Net income | $1.221 billion | $1.129 billion |
| Diluted EPS | $1.07 | $0.95 |
| Operating cash flow | $1.984 billion | $2.172 billion |
- Revenue rose 11.1%; net income increased 8.1%. Gross profit grew 3.7%, while gross margin declined about 120 basis points to 17.0%. Operating expenses rose 2.9%, but fell as a share of revenue to 11.1% from 12.0%.
- Net interest expense fell to $134 million from $158 million. The effective tax rate was 38.9%, versus 39.5%.
- Cash and cash equivalents were $1.518 billion at quarter-end, down from $2.481 billion at December 31, 2014. Operating cash flow was lower by $188 million year over year, primarily due to working-capital changes. Capital expenditures were $419 million.
- Cash used in investing was $544 million, compared with $2.560 billion in Q1 2014, which included $2.1 billion paid for the Coram acquisition. Cash used in financing increased to $2.406 billion, primarily reflecting $2.0 billion of share repurchases, dividends and commercial-paper repayments.
- Short-term debt was $500 million, current long-term debt $573 million, and long-term debt $11.689 billion. Total reported debt across these categories was approximately $12.8 billion. The company also had $3.5 billion of undrawn backup credit facilities and reported $500 million of commercial paper outstanding. Debt ratings were investment grade with stable outlooks.
- Dividends declared were $0.35 per share, up from $0.275. CVS repurchased approximately 16.8 million shares for about $2.0 billion during the quarter.
Material changes and segment performance
- Pharmacy Services: Revenue increased 18.2% to $23.879 billion and operating profit rose to $734 million from $640 million. Operating margin eased to 3.1% from 3.2%. Growth was attributed to specialty pharmacy and higher network claims; claims processed increased to 251.1 million from 227.8 million.
- Retail Pharmacy: Revenue increased 2.9% to $16.951 billion, while operating profit declined to $1.727 billion from $1.750 billion; operating margin decreased to 10.2% from 10.6%. Pharmacy same-store sales rose 4.2%, but front-store same-store sales fell 6.1%, primarily following the decision to stop selling tobacco and amid softer customer traffic. Management said front-store same-store sales would have been about 8 percentage points higher excluding tobacco and associated basket sales from the prior-year comparison.
- Company-wide generic dispensing increased, supporting gross profit dollars but contributing to lower selling prices and reimbursement pressure. Pharmacy Services revenue grew faster than Retail Pharmacy revenue, shifting the business mix toward the lower-margin segment and weighing on consolidated gross margin.
Outlook, risks, contingencies and unusual items
- The filing provides no specific earnings or revenue guidance. Management expected generic dispensing rates to continue increasing, but at a slower pace, and cited favorable demand trends from an aging population and expanded health coverage. It also expected continued PBM pricing pressure, greater sharing of manufacturer rebates with clients, and retail pharmacy reimbursement pressure.
- Key risks include client retention and contract renewals, Medicare Part D competition, drug pricing and generic introductions, regulatory changes, government reimbursement, cybersecurity and privacy, and litigation or investigations. The filing says recorded legal accruals were not material, but outcomes and possible losses beyond accrued amounts generally could not be estimated.
- Notable proceedings include a putative Alabama class action seeking approximately $3.2 billion plus unspecified damages, pharmacy-network antitrust litigation, government inquiries concerning pharmacy and PBM practices, and DEA-related matters. CVS stated it could not predict outcomes of the described matters.
- Effective January 1, 2015, CVS changed the valuation method for front-store inventory representing about 36% of consolidated inventories to weighted average cost. The cumulative change reduced inventory by $7 million and retained earnings by $4 million. Without the change, Q1 net income would have been $4 million higher; basic and diluted EPS would have been unchanged.
- The $2.0 billion accelerated share repurchase was completed May 1, 2015, after quarter-end. CVS received a further 3.1 million shares, bringing total shares delivered to about 19.9 million at an average price of $100.64 per share.
Important facts for investors to verify
- Whether Pharmacy Services growth can continue while maintaining margins amid competitive pricing, rebate-sharing and reimbursement trends.
- Retail Pharmacy trends after tobacco removal, including front-store traffic and sales, pharmacy reimbursement, and the impact of Specialty Connect on reported segment revenue.
- Working-capital movements and the sustainability of operating cash flow relative to net income, capital spending, dividends and share repurchases.
- Debt, commercial-paper and credit-facility levels, and the company’s capacity to fund shareholder returns and strategic investments.
- Developments and potential financial or operational effects of the disclosed litigation, government investigations and regulatory matters.