CVS Health Corporation — Q3 2019 Form 10-Q
Reporting period: Three and nine months ended September 30, 2019. Financial statements are unaudited; Ernst & Young performed an interim review. CVS acquired Aetna on November 28, 2018, so 2019 includes Aetna for the full period while 2018 comparisons largely do not. Segment comparisons were recast for a 2019 realignment.
Financial results
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Total revenue | $64.810B | $47.490B | $189.887B | $140.155B |
| Operating income | $2.928B | $2.574B | $8.950B | $3.197B |
| Net income attributable to CVS Health | $1.530B | $1.390B | $4.887B | $(0.175)B |
| Diluted EPS | $1.17 | $1.36 | $3.75 | $(0.17) |
| Operating cash flow | Not provided separately | Not provided separately | $10.214B | $6.386B |
Q3 revenue rose 36.5% and nine-month revenue rose 35.5%, primarily from Aetna; pharmacy revenue growth and investment income also contributed. Q3 GAAP operating margin was approximately 4.5%, versus 5.4% a year earlier; nine-month margin was approximately 4.7%, versus 2.3%. These comparisons reflect the acquisition and differing unusual items. Nine-month 2018 results included a $3.921B goodwill impairment; excluding specified items, adjusted operating income was $11.573B for 2019 versus $7.542B for 2018. Adjusted operating income is a non-GAAP measure.
Q3 adjusted operating income was $3.947B versus $2.650B. Pharmacy Services Q3 adjusted operating income increased 5.7% to $1.439B, while Retail/LTC declined 6.5% to $1.516B; Health Care Benefits reported $1.423B. Retail/LTC faced reimbursement pressure. Pharmacy Services benefited from claims growth and purchasing economics, partly offset by price compression. Health Care Benefits results include Aetna and are not directly comparable with 2018.
Health Care Benefits’ medical benefit ratio was 83.3% for Q3 and 83.7% for the nine months; 2018 comparisons are not meaningful because the segment then consisted primarily of SilverScript PDP.
Cash, debt and liquidity
- Cash and cash equivalents were $5.193B at September 30, 2019, up from $4.059B at year-end 2018; approximately $1.2B was held by the parent or unrestricted subsidiaries.
- Nine-month operating cash flow was $10.214B. Investing used $2.630B, including $1.890B of capital expenditures; financing used $6.410B. Operating cash flow less capital expenditures was approximately $8.324B, an arithmetic measure rather than company-defined free cash flow.
- Debt principal was $69.848B, including $1.070B of commercial paper; reported short-term debt and current and long-term debt carrying amounts totaled $69.054B. Operating lease liabilities were an additional $20.624B.
- CVS issued $3.5B of senior notes and used proceeds to repay debt, tendered for $4.0B of notes, and completed repayment of its $3.0B three-year acquisition term loan. The tenders resulted in a $79M loss on early extinguishment.
- Six billion dollars of revolving credit facilities were undrawn. CVS reported compliance with debt covenants and investment-grade ratings of Baa2 from Moody’s and BBB from S&P.
Material changes, outlook and risks
- Integration and outlook: Management said CVS was on track for approximately $800M of Aetna synergies in 2020. It cautioned that Q4 Health Care Benefits income is generally seasonally lowest and that 2019–2020 EPS comparisons are affected by acquisition-related dilution and interest expense.
- Health insurer fee: The ACA fee was suspended for 2019 but, as enacted, was expected to be $15.5B industry-wide in 2020. CVS expected its 2020 effective tax rate to increase because the fee is not federally deductible and said recovering its share through premiums could be challenging.
- Unusual items: CVS recorded a $205M pre-tax loss on the July sale of Brazilian subsidiary Onofre and $231M of 2019 store rationalization charges, including $96M in Q3. It planned to close 22 additional underperforming stores in Q1 2020; 46 stores had been identified for closure earlier in 2019.
- Accounting and impairment: Lease accounting adoption added $20.757B of operating lease right-of-use assets and $20.624B of operating lease liabilities at September 30; management said the change did not materially affect operating results or cash flows. Annual goodwill tests found no impairment, but the Commercial Business and LTC reporting units’ fair values exceeded carrying values by only approximately 4% and 9%, respectively. LTC goodwill was approximately $431M, and further impairment was identified as reasonably possible if forecasts are missed.
- Contingencies: Litigation and regulatory matters include opioid-related claims, PBM and drug-pricing investigations, usual-and-customary pricing claims, Medicare risk-adjustment audits, and other claims. CVS said it could not estimate possible losses beyond accrued amounts for many matters; adverse outcomes could be material. The Texas Medicaid pricing case had reached a settlement in principle. The Aetna DOJ consent-decree process was concluded without conditions in September 2019.
- Other operating pressures: Management cited retail pharmacy reimbursement pressure, PBM price compression and competition, LTC customer and skilled-nursing-facility challenges, health-care cost and reserve estimation risk, regulatory and policy changes, and Aetna integration and elevated debt.
Most important facts for investors to verify
- Separate underlying performance from acquisition-driven revenue and earnings growth; review the non-GAAP adjustments and segment recast against GAAP results.
- Track Aetna integration, delivery of the approximately $800M 2020 synergy target, and debt reduction, including interest costs and upcoming maturities.
- Monitor Retail/LTC reimbursement trends and LTC customer retention, occupancy, and impairment assumptions.
- Assess Health Care Benefits medical costs, reserve development, Medicare star ratings and risk-adjustment audit exposure, as well as the 2020 health insurer fee’s effect on pricing and taxes.
- Review developments in material litigation and regulatory investigations and the sensitivity of goodwill valuations, particularly for Commercial Business and LTC.