CVS Health Corporation — Q3 2017 Form 10-Q
Business context and period. CVS Health operates Pharmacy Services (PBM and related pharmacy services), Retail/LTC (retail pharmacies, clinics, long-term care and RxCrossroads) and Corporate. This unaudited quarterly report covers the three and nine months ended September 30, 2017; comparisons are with the corresponding 2016 periods. The interim financial statements received an independent accountant’s review, not an audit.
Financial performance
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Net revenue | $46.181B | $44.615B | $136.380B | $131.555B |
| Gross profit | $7.126B | $7.492B | $20.641B | $21.251B |
| Operating profit | $2.499B | $2.824B | $6.409B | $7.366B |
| Net income attributable to CVS Health | $1.285B | $1.540B | $3.335B | $3.610B |
| Diluted EPS | $1.26 | $1.43 | $3.24 | $3.32 |
| Gross margin | 15.4% | 16.8% | 15.1% | 16.2% |
| Operating cash flow | — | — | $8.143B | $8.020B |
Revenue and segment trends. Q3 revenue rose 3.5%, while gross profit fell 4.9% and operating profit fell 11.5%; CVS-attributable net income declined 16.6%. Pharmacy Services revenue grew 8.1% in Q3 to $32.896B, supported by claim volume, new business, brand inflation and specialty pharmacy, but segment gross profit fell 8.4% to $1.645B amid price compression and Medicare Part D timing. Retail/LTC revenue declined 2.7% to $19.593B and operating profit declined to $1.553B from $1.778B. Retail same-store sales fell 3.2%; same-store pharmacy sales fell 3.4%, with network restrictions and reimbursement pressure weighing on results. The shift toward the lower-margin Pharmacy Services segment also reduced consolidated gross margin.
Cash, debt and liquidity. At September 30, cash and cash equivalents were $2.485B, down from $3.371B at year-end 2016. Current assets were $29.923B and current liabilities $28.513B, implying working capital of approximately $1.410B. Balance-sheet debt totaled approximately $25.8B, including short-term debt; long-term debt’s reported carrying value was $25.7B and estimated fair value $27.0B. Nine-month investing cash outflow was $1.608B, including $1.412B in property and equipment purchases; financing cash outflow was $7.421B. CVS repurchased $4.361B of shares and paid $1.539B in dividends during the period. It reported $110M of commercial paper outstanding, no borrowings under its backup facilities, and compliance with debt covenants. Management said operating cash flow, commercial paper and sale-leasebacks, among other sources, should fund expected needs.
Material changes and unusual items
- Q3 other expense was $192M, primarily reflecting $187M of pretax losses from settling the company’s two tax-qualified pension plans. The settlements transferred pension liabilities to an insurer and included lump-sum distributions.
- Year-to-date operating expenses included a $135M RxCrossroads goodwill impairment and $211M of store-closure charges. CVS closed 68 stores through September; it expected about $9M of additional closure charges in Q4.
- Hurricane-related expenses were approximately $55M in Q3, primarily in Retail/LTC.
- Share repurchases totaled approximately 55.4 million shares for $4.4B in the first nine months. The declared dividend was $0.50 per share for Q3, up from $0.425.
- Effective tax rates were 37.7% for Q3 and 38.7% year to date. Share-based compensation accounting generated discrete tax benefits of $18M and $51M, respectively.
Outlook, risks and contingencies
- CVS said retail prescription growth would remain negatively affected for the rest of 2017 by restrictions on participation in certain networks, though to a lesser extent than in the first nine months. It expected generic dispensing rates to keep rising, at a slower pace. The filing does not provide a clear quantified earnings or revenue forecast.
- On November 6, 2017, CVS entered an agreement to sell RxCrossroads to McKesson for $735M, subject to working-capital adjustment and regulatory approvals; closing was expected in Q1 2018.
- Management reported the LTC reporting unit’s estimated fair value exceeded carrying value by only approximately 1%. It warned that weaker-than-expected performance could result in a material impairment.
- Legal and regulatory matters include government investigations and subpoenas involving PBM pricing and Medicare claims, pharmacy practices and controlled substances, as well as opioid-related lawsuits and insulin-pricing litigation and investigations. CVS said accrued legal matters were not material individually or in aggregate, but it could not estimate possible losses beyond accruals for many matters and cautioned that adverse developments or regulatory changes could materially affect its business.
- Key business risks cited include reimbursement and pricing pressure, client retention and contract renewals, restricted pharmacy networks, Medicare Part D competition, regulation, litigation, and changing consumer and drug-market dynamics.
Important facts for investors to verify
- Whether Pharmacy Services growth can offset Retail/LTC sales weakness and ongoing margin compression.
- How much the Q3 earnings decline reflects recurring operations versus pension settlement, hurricane and restructuring-related items.
- Whether the RxCrossroads sale closes on expected terms and timing, and whether the LTC unit’s limited impairment cushion changes.
- Developments and potential financial exposure in the disclosed government investigations, opioid matters and pricing-related litigation.
- Debt and cash-flow trends alongside continued dividends and share repurchases; the filing does not give a quantified forward earnings outlook.