01—Abstract
Summary
Summary of the 10-K filed February 14, 2018. Cited figures are marked; the original filing is the authoritative source.
CVS Health's FY2017 10-K (filed February 14, 2018) presents a company in transition.
Consolidated net revenues rose 4.1% to $184.8 billiona, but gross profit fell 1.1% to $28.5 billion and gross margin compressed to 15.4% (from 16.3%), driven by the mix shift toward the lower-margin Pharmacy Services segment and ongoing price compression and reimbursement pressure. Operating profit declined 8.2% to $9.5 billion. Diluted EPS rose to $6.44 from $4.90, but that increase is flattered by a provisional $1.5 billion non-cash tax benefit from the Tax Cuts and Jobs Act, which lowered the effective tax rate to 19.8% from 38.4%.
Excluding that benefit, earnings would have been meaningfully lower. The dominant investor issue is the proposed ~$69 billionb equity (~$77 billion including Aetna's debt) acquisition of Aetna, announced December 3, 2017, at $145 in cash plus 0.8378 CVS shares per Aetna share. The deal is expected to close in the second half of 2018 and requires shareholder and regulatory approvals.
CVS expects to incur about $45.0 billionc of new acquisition debt and assume roughly $8.2 billion of Aetna debt, which increases leverage substantially. Both Moody's and S&P have placed CVS ratings under review for possible downgrade, and a $2.1 billion termination fee applies in certain circumstances. Share repurchases were suspended in Q4 2017, and the company repurchased about $4.4 billion of stock during the year.
Within the segments, Pharmacy Services grew revenue 8.9% to $130.6 billiond on specialty and network growth, but its gross margin is only 4.6%. Retail/LTC revenue fell 2.1% to $79.4 billion, with same-store sales down 2.6% after CVS Pharmacy lost participation in certain PBM networks. Retail/LTC operating profit fell 11.4%, and the segment absorbed $215 million in store-closure charges and a $181 million goodwill impairment on RxCrossroads, which was subsequently sold to McKesson for $725 million.
Aetna itself was about 12.3% of consolidated revenue in 2017. Goodwill and intangibles total $52.1 billion, which creates impairment risk, particularly for the LTC reporting unit, whose fair value exceeded carrying value by only about 1%.
02—Key points
Key Highlights
- Net revenues increased 4.1% to $184.8 billion, but gross profit declined 1.1% to $28.5 billion and gross margin fell to 15.4% from 16.3%, reflecting mix shift toward lower-margin PBM business and pricing pressure.
- Operating profit fell 8.2% to $9.5 billion; diluted EPS of $6.44 was boosted by a provisional ~$1.5 billion TCJA deferred tax benefit that lowered the effective tax rate to 19.8% from 38.4%.
- Proposed Aetna acquisition (~$69B equity value, ~$77B including debt) at $145 cash plus 0.8378 CVS shares per Aetna share, expected to close in 2H 2018 pending shareholder and regulatory approvals.
- Financing the Aetna deal requires ~$45.0 billion of new debt plus assumption of ~$8.2 billion of Aetna debt; Moody's and S&P have placed CVS ratings under review for possible downgrade.
- Pharmacy Services revenue grew 8.9% to $130.6 billion, while Retail/LTC revenue declined 2.1% to $79.4 billion on a 2.6% same-store sales decline tied to lost network participation.
- Retail/LTC absorbed $215 million in store-closure charges and a $181 million RxCrossroads goodwill impairment; RxCrossroads was sold to McKesson for $725 million on January 2, 2018.
- Share repurchases were suspended in Q4 2017 after $4.4 billion of buybacks in 2017; quarterly dividend held at $0.50 ($2.00 annualized) with the company expecting to maintain it through 2018.
03—One dollar
Follow one dollar
Of each $1.00 of revenue in FY2017, CVS Health Corp kept $0.04.
- Revenue$184.79B100.0%
- Cost of revenue−$156.24B84.6%
- Gross profit$28.55B15.4%
- Operating costs−$19.01B10.3%
- Operating income$9.54B5.2%
- Interest, other & tax−$2.92B1.6%
- Net income$6.62B3.6%
Where FY2017 revenue went
$184.79B- Cost of revenue: $156.22B, 85% of revenue
- Net income: $6.62B, 3.6% of revenue
- Operating costs: $19.03B, 10% of revenue
- Interest, other & tax: $2.92B, 1.6% of revenue
Kept 3.6% as net incomeNet income $6.62B · 3.6%Interest, other & tax $2.92B · 1.6%
Full revenue history →04—Financials
Financial Highlights
Figures from 10-KFY2017filed February 14, 2018Financial Statements
FY2017 against FY2016
| Line item | FY2017FY2016 | Change |
|---|---|---|
| Revenue | $184.79B$177.55B | +4.1% |
| Cost of Revenue | $156.22B$148.67B | +5.1% |
| Gross Profit | $28.55B$28.86B | −1.1% |
| Operating Expenses | $18.81B$18.45B | +2.0% |
| Operating Income | $9.54B$10.39B | −8.2% |
| Interest Expense | $1.06B$1.08B | −1.5% |
| Net Income | $6.62B$5.32B | +24.5% |
| EPS (Basic) | $6.47$4.93 | +31.2% |
| EPS (Diluted) | $6.44$4.90 | +31.4% |
| Shares Outstanding (Basic) | 1.02B1.07B | −4.9% |
| Shares Outstanding (Diluted) | 1.02B1.08B | −5.1% |
05—Questions
Frequently Asked Questions
Why did gross profit and operating profit decline even though revenue grew?
Revenue growth came mainly from the Pharmacy Services segment, which operates at a gross margin of only 4.6% versus 29.4% in Retail/LTC. This mix shift, along with continued PBM price compression, reimbursement pressure in retail pharmacy, and lost prescriptions from restrictive network changes, reduced consolidated gross margin to 15.4%. Operating profit also fell due to $215 million in store-closure charges, a $181 million goodwill impairment, $57 million in hurricane costs, and $34 million in Aetna transaction costs.
How much will the Aetna acquisition add to CVS's debt, and what does that mean for investors?
CVS expects to raise about $45.0 billion of new acquisition debt and assume roughly $8.2 billion of Aetna's existing debt, which would make its indebtedness substantially greater than either company's standalone level. That increases interest costs and reduces financial flexibility, and it puts pressure on the credit ratings. Management expects the deal to be accretive to EPS in the second full year after closing, but that projection is preliminary and could change. Investors should weigh the leverage increase against the projected synergies.
Is the 2017 EPS increase sustainable?
Not entirely. Diluted EPS from continuing operations rose to $6.45 from $4.91, but a provisional ~$1.5 billion non-cash tax benefit from the Tax Cuts and Jobs Act accounts for a large share of that gain, with the effective tax rate dropping to 19.8% from 38.4%. The benefit is provisional and may be revised when the 2017 tax return is filed in 2018. Underlying operating profit actually declined, so the normalized earnings trend is weaker than the headline figure suggests.
What are the main risks to the Retail/LTC business?
Retail/LTC faces declining same-store sales (down 2.6% in 2017), loss of prescription volume after CVS Pharmacy was excluded from certain PBM networks, continued generic-drug price deflation, and lower occupancy at skilled nursing facilities that pressures LTC pharmacy volume. The LTC reporting unit's fair value exceeded its carrying value by only about 1%, so further deterioration could trigger a material goodwill impairment.
What happens if the Aetna deal fails?
If the merger is not completed, CVS may owe Aetna a $2.1 billion termination fee in certain circumstances, and it will still bear transaction and financing costs. The filing also notes that CVS's stock price and future results could be negatively affected by the failure. Share repurchases, which were suspended during the pending deal, could resume, as about $13.9 billion remained authorized under the 2016 program at year-end 2017.
06—Continue