CVS Health Corporation — Form 10-Q Summary
Reporting period: Three and nine months ended September 30, 2016. CVS Health operates Pharmacy Services, Retail/LTC and Corporate segments. The comparisons below are with the corresponding 2015 periods; amounts are in U.S. dollars.
Financial performance
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Net revenue | $44.615 billion | $38.644 billion | $131.555 billion | $112.144 billion |
| Gross profit | $7.492 billion | $6.661 billion | $21.251 billion | $19.227 billion |
| Operating profit | $2.817 billion | $2.331 billion | $7.343 billion | $6.725 billion |
| Net income attributable to CVS Health | $1.540 billion | $1.246 billion | $3.610 billion | $3.739 billion |
| Diluted EPS | $1.43 | $1.11 | $3.32 | $3.29 |
- Revenue grew 15.5% in Q3 and 17.3% year to date. Acquisitions of Omnicare and Target pharmacies and clinics contributed, alongside Pharmacy Services claim growth, specialty pharmacy growth and higher retail pharmacy sales.
- Gross margin was 16.8% in Q3 and 16.2% year to date, down approximately 45 and 100 basis points, respectively. Management cited business mix, PBM price compression and retail reimbursement pressure.
- Operating profit increased 20.8% in Q3 and 9.2% year to date. Operating expenses rose in dollars but declined as a share of revenue, reflecting expense leverage.
- Q3 net income and EPS increased year over year. Nine-month net income declined despite higher operating profit, primarily reflecting a $643 million loss on early debt extinguishments in 2016. Nine-month diluted EPS increased, also benefiting from fewer weighted-average shares.
- Dividends declared were $0.425 per share in Q3 and $1.275 year to date, versus $0.350 and $1.050 in 2015, respectively.
Segments and operating trends
- Pharmacy Services: Q3 revenue was $30.429 billion, up 19.2%; operating profit was $1.458 billion, up from $1.162 billion. Q3 gross margin improved to 5.9% from 5.8%; year-to-date gross margin declined to 4.8% from 5.1%, with management citing mix and price compression. Growth reflected increased network claims, specialty pharmacy and new business.
- Retail/LTC: Q3 revenue was $20.143 billion, up 12.5%; operating profit was $1.773 billion, up from $1.643 billion. Gross margin declined to 29.3% from 30.0%, reflecting pharmacy reimbursement pressure and acquisition mix. Pharmacy same-store sales rose 3.4%, while front-store same-store sales fell 1.0%.
- CVS reported 9,694 retail stores and 1,136 MinuteClinics at quarter-end. It noted that recently announced restricted-network relationships excluding CVS were expected to weigh on prescription growth over the next several quarters.
Cash flow, balance sheet and capital
- For the first nine months, operating cash flow was $7.948 billion, versus $4.841 billion in 2015. Management attributed much of the increase to timing of Medicare Part D payments.
- Investing cash outflow was $1.652 billion, versus $11.000 billion, as the prior-year period included $9.6 billion of Omnicare acquisition consideration. Financing cash outflow was $6.568 billion, versus $6.576 billion of inflow in 2015.
- Capital expenditures were $1.607 billion. CVS repurchased approximately 41.4 million shares for $4.0 billion and paid $1.384 billion in dividends during the nine months.
- At September 30, cash and cash equivalents were $2.189 billion; current assets were $30.939 billion and current liabilities $26.741 billion. Total assets were $94.156 billion and shareholders’ equity $35.954 billion.
- Debt included $340 million of short-term debt, $783 million of current long-term debt and $25.610 billion of long-term debt. CVS issued $3.5 billion of notes in May and repaid or redeemed notes, recording $643 million of early-extinguishment losses. It reported $340 million of commercial paper outstanding and no borrowings under its $3.5 billion backup credit facilities.
- Management said operating cash flow, commercial paper, sale-leasebacks and potential future borrowings were expected to provide sufficient funding for needs and strategic initiatives. Debt ratings were Baa1/BBB+ with stable outlooks.
Outlook, risks and notable items
- No specific earnings or revenue guidance is provided in the supplied filing text. Management expected generic dispensing rates to continue rising, though more slowly, and cited ongoing price and reimbursement pressure.
- Key stated risks include PBM and LTC client retention and contract renewals, restricted pharmacy networks, reimbursement and pricing pressure, Medicare Part D competition, regulation, litigation and integration of acquisitions. CVS also warned that continued reimbursement pressure could constrain revenue growth and harm gross profit.
- Annual impairment testing found no goodwill or trade-name impairment. However, LTC and RxCrossroads reporting-unit fair values exceeded carrying values by only 7% and 12%, respectively, making assumptions and operating performance relevant to future impairment risk.
- Legal matters include multiple government inquiries and lawsuits. The filing describes settlements or proposed settlements involving Omnicare and other matters, including a five-year corporate integrity agreement effective October 11, 2016. CVS said it could not estimate potential losses beyond accrued amounts for many matters.
- On November 2, 2016, after quarter-end, the board authorized a new share repurchase program of up to $15 billion. CVS stated that the Bob’s Stores lease assignment arrangement remained subject to bankruptcy-court approval.
Most important facts for investors to verify
- How much reported revenue and cash generation reflects acquired businesses and timing of Medicare Part D payments versus sustainable underlying growth.
- Whether PBM price compression, retail reimbursement pressure and restricted networks continue to reduce margins or prescription volumes.
- The effect of debt refinancing and the $643 million extinguishment loss on recurring earnings, leverage and future interest costs.
- Integration performance and impairment sensitivity for Omnicare, Target-related operations, LTC and RxCrossroads.
- Developments, accruals and potential financial or compliance effects from the disclosed legal proceedings and government investigations.
- Actual pace and financing of the newly authorized $15 billion repurchase program relative to dividends, debt reduction and investment needs.