CVS HEALTH Corp annual report, FY2018

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CVS Health Corporation — FY2018 Form 10-K

Reporting period: Fiscal year ended December 31, 2018. The filing incorporates the Annual Report’s financial statements and MD&A by reference, but the supplied text does not provide clear consolidated revenue, earnings, cash flow, margin, or year-end debt and liquidity figures.

Business context and reporting period

CVS Health operated Pharmacy Services, Retail/LTC, Health Care Benefits, and Corporate/Other segments. It reported more than 9,900 retail locations, approximately 1,100 walk-in clinics, about 92 million PBM plan members, and an estimated 38 million people served through health insurance products.

CVS completed its acquisition of Aetna on November 28, 2018, adding the Health Care Benefits segment. Aetna shareholders received $145 in cash and 0.8378 CVS shares per share; the transaction was valued at approximately $70 billion, or approximately $78 billion including assumed debt. Aetna’s results were included from the acquisition date; Aetna represented 3% of CVS’s FY2018 consolidated revenue and 21% of year-end assets.

Financial metrics and capital position

  • Acquisition financing: CVS issued approximately $45.0 billion of new debt to finance the cash portion and assumed Aetna debt with a fair value of approximately $8.1 billion. The company said post-acquisition indebtedness was substantially higher, increasing interest expense and reducing financial flexibility. The filing text does not provide a clear total debt, cash, or liquidity balance.
  • Impairment: CVS recorded $6.1 billion of goodwill impairment charges related to its LTC reporting unit in 2018. Goodwill and other intangible assets totaled $115.2 billion at year-end.
  • Dividends and repurchases: The quarterly dividend was $0.50 per share in 2018. No common shares were repurchased in Q4 2018; $13.9 billion remained under the 2016 repurchase authorization at year-end.
  • Other metrics: CVS reported approximately 1.9 billion prescriptions filled or managed by Pharmacy Services and 1.3 billion filled by Retail/LTC on a 30-day-equivalent basis. Retail/LTC held approximately 26% of the U.S. retail pharmacy market in December 2018.

Material changes versus the prior comparable period

  • The Aetna acquisition transformed CVS into a four-segment company and materially increased its scale, debt, integration requirements, and exposure to health insurance and government-funded programs.
  • To satisfy the DOJ consent decree, Aetna sold its standalone Medicare Part D plans to WellCare. The plans had approximately 2.3 million members at December 31, 2018; Aetna retained their financial results and provided administrative services through 2019.
  • CVS divested RxCrossroads on January 2, 2018.
  • The filing reports the $6.1 billion LTC goodwill impairment; the supplied text does not provide enough comparable-period income-statement data to quantify its effect on year-over-year earnings or margins.

Outlook, risks, contingencies, and unusual items

  • Management projected that Pharmacy Services and Retail/LTC operating income could be lower in 2019 than in 2018, partly because fewer new multi-source generics and lower brand-name drug price inflation were expected.
  • CVS projected Medicare Advantage benchmark rates would increase approximately 2.5% in 2019 versus 2018, excluding coding trend. At year-end, 79% of Medicare Advantage members were in plans rated at least four stars for 2019, which affects eligibility for quality bonuses in 2020.
  • Management emphasized integration execution, expected cost savings, technology and operational integration, retention of key employees, and the ability to manage substantially higher debt. It cautioned that anticipated acquisition benefits might be delayed or not achieved.
  • Key risks include changes to the ACA and government reimbursement, drug-pricing and PBM regulation, Medicare risk-adjustment audits, medical-cost forecasting, generic and brand drug economics, competitive pressures, data privacy and cybersecurity, and acquisition-related integration and leverage.
  • CMS proposed changes to Medicare Advantage risk-adjustment data validation audits that could increase recoveries and potentially apply retroactively; CVS said the impact could be material but was not yet clear. DOJ was investigating Aetna’s patient-chart review processes related to Medicare risk-adjustment submissions.
  • An arbitrator awarded certain hospitals approximately $150 million in October 2018 in a dispute concerning Aetna’s out-of-network benefit payment and administration practices. CVS also identified opioid and talc-related litigation. The supplied text does not provide a clear estimate of the ultimate exposure for these matters.
  • The ACA Health Insurer Fee was suspended for 2019; as then enacted, it was scheduled to apply again in 2020. CVS also noted proposed federal changes to treatment of manufacturer rebates in federally funded programs.

Important facts for investors to verify

  • Review the incorporated financial statements and MD&A for FY2018 revenue, net income, operating cash flow, segment margins, debt maturities, cash balances, and liquidity facilities; these values are not clear in the supplied filing text.
  • Assess the LTC goodwill impairment assumptions and the sensitivity of remaining goodwill and intangible assets to future impairment.
  • Track post-acquisition debt reduction, interest expense, credit ratings, integration costs, and realized Aetna synergies.
  • Monitor Medicare risk-adjustment audits, star ratings, reimbursement changes, and the financial transition of the divested Part D plans.
  • Review the status and potential financial exposure of the out-of-network arbitration, opioid and talc litigation, and other regulatory proceedings.