CVS Health Corporation — Q1 2019 Form 10-Q
Reporting period: Three months ended March 31, 2019. Unaudited interim financial statements were reviewed by Ernst & Young. CVS acquired Aetna on November 28, 2018, so Q1 2019 includes Aetna while Q1 2018 largely does not; year-over-year comparisons are therefore not fully comparable. The company also realigned segments and retrospectively adjusted 2018 segment data.
Financial performance
| Metric | Q1 2019 | Q1 2018 | Change / context |
|---|---|---|---|
| Total revenue | $61.646 billion | $45.743 billion | Up 34.8%, primarily reflecting Aetna |
| Operating income (GAAP) | $2.690 billion | $1.996 billion | Up 34.8% |
| Adjusted operating income | $3.595 billion | $2.293 billion | Non-GAAP; excludes specified items, including intangible amortization |
| Net income attributable to CVS Health | $1.421 billion | $998 million | Up 42.4% |
| Diluted EPS | $1.09 | $0.98 | Up from prior year |
| Operating cash flow | $1.948 billion | $2.355 billion | Down $407 million |
| Cash, cash equivalents and restricted cash | $6.168 billion | $4.295 billion at Dec. 31, 2018 | Quarter-end balance |
Interest expense rose to $782 million from $523 million, mainly due to Aetna acquisition financing. The effective tax rate was 26.4%, versus 32.1%. The company declared a $0.50 per-share dividend.
Segment trends: Pharmacy Services revenue rose 3.1% to $33.558 billion, but adjusted operating income fell 4.2% to $947 million amid price compression and Anthem-related investment. Retail/LTC revenue increased 3.3% to $21.115 billion, while adjusted operating income declined 18.9% to $1.489 billion, affected by reimbursement pressure, LTC weakness and higher expenses. Health Care Benefits reported $17.870 billion in revenue and $1.562 billion in adjusted operating income, primarily reflecting the Aetna acquisition; the prior-year segment consisted principally of SilverScript, making comparison limited. Its medical benefit ratio was 84.0%.
Balance sheet, debt and liquidity
At March 31, 2019, CVS reported total assets of $219.768 billion, total liabilities of $159.762 billion and shareholders’ equity of $60.006 billion. Current assets were $47.857 billion and current liabilities $50.631 billion. Debt comprised $3.005 billion of short-term debt, $3.893 billion of current long-term debt and $67.888 billion of long-term debt. The company had approximately $3.0 billion of commercial paper outstanding at a 2.74% weighted-average rate and no borrowings under its backup revolving credit facilities. It reported compliance with debt covenants and investment-grade ratings of Baa2 from Moody’s and BBB from S&P.
Operating cash flow was lower partly because of the timing of customer, client and CMS payments; Q1 2018 included a CMS advance payment. Investing cash outflow was $891 million. Financing provided $816 million, versus $38.140 billion in Q1 2018, which included substantial borrowing to fund Aetna. CVS paid $649 million in dividends and repaid $882 million of long-term debt during the quarter.
Material changes and unusual items
- Aetna contributed substantially to revenue, benefit costs, operating expenses and the expanded Health Care Benefits segment. Acquisition financing also increased interest expense; total debt at quarter-end was about $74.8 billion.
- Adoption of the lease standard added $20.992 billion of operating lease right-of-use assets and $20.764 billion of operating lease liabilities at March 31. The company said adoption materially affected the balance sheet but did not materially affect operating results or cash flows.
- CVS recorded a $135 million store rationalization charge, primarily for impairment of lease assets, and planned to close 46 underperforming retail pharmacies in Q2 2019.
- Q1 2019 adjusted operating income of $3.595 billion excludes $622 million of intangible amortization, $148 million of acquisition-related integration costs and the $135 million store charge. These are non-GAAP adjustments, not additional GAAP earnings.
- Prior-year LTC goodwill impairments totaled $6.1 billion; remaining LTC reporting-unit goodwill was approximately $431 million. The filing says further impairment is reasonably possible if forecasts are not achieved.
Outlook, risks and contingencies
Management characterized 2019 as a transition year while integrating Aetna and said CVS was on track to exceed its 2020 Aetna synergy target. It did not provide a clear numeric full-year revenue or earnings forecast in the supplied filing text. Management cited expected pressure on Pharmacy Services and Retail/LTC operating income from reimbursement pressure, reduced generic-drug offsets, lower brand-price inflation and rebate-guarantee effects, as well as LTC industry challenges. Planned responses included a new PBM contracting model, LTC performance actions and an enterprise cost-reduction effort. CVS also projected that 2020 Medicare Advantage benchmark rates would increase funding for its Medicare Advantage business, excluding the health insurer fee, by approximately 2.0% versus 2019.
Key exposures include extensive government oversight and audits, potential Medicare risk-adjustment premium refunds, PBM pricing and rebate investigations, opioid-related litigation, prescription-pricing claims, and other health care regulatory and legal proceedings. CVS said it could not reasonably estimate losses beyond recorded accruals for many matters and that outcomes could be material. The filing also identifies integration and leverage risks from Aetna, ongoing pharmacy reimbursement and margin pressure, medical-cost and reserve-estimation uncertainty, and possible further LTC goodwill impairment. CVS reported no material changes in market-risk exposure and no material changes to the risk factors in its 2018 Form 10-K.
Investor verification checklist
- Track Aetna integration, realized synergies, integration costs and whether the company achieves its stated 2020 synergy objective.
- Assess debt reduction, interest burden, credit ratings and cash generation against the substantial post-acquisition debt load.
- Monitor Pharmacy Services and Retail/LTC margins, reimbursement trends, rebate guarantees, generic-drug economics and LTC performance.
- Review Health Care Benefits medical-cost trends, benefit reserves, membership mix and potential CMS audit or risk-adjustment adjustments.
- Follow the planned 46 store closures, related charge and possible further LTC goodwill impairment.
- Check developments in material litigation, regulatory investigations and the court approval process for the Aetna consent decree.