CVS Q1 Earnings Review: Contract Losses Hurt Bottom Line

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CVS (NYSE:CVS) announced disappointing first quarter earnings on May 2. The company’s performance was impacted by lost contracts with the Department of Defense and Prime Therapeutics to its rival Walgreens. The new deals came into effect in December and January, respectively, and significantly impacted the company’s operating profits, which were 18% lower than the prior year quarter. It also affected the bottom line, which was reported at 93 cents per share, almost 11% lower than the figure in the prior year quarter. However, the company’s top line witnessed a 3% growth year over year (y-o-y) and reported $44.5 billion in sales, comfortably beating the Reuters’ compiled analyst estimates of $44.2 billion. The growth in the company’s revenues was fueled by the strong performance of its Pharmacy Services Segment, partially offset by weak performance of the Retail/Long Term Care Segment. The company’s adjusted earnings decreased marginally over the prior year quarter to $1.17 per share, which were notably better than market estimates of $1.10.

CVS closed 60 retail stores during the quarter and opened another 27, which took its store count to 9,676 at the end of Q1 2017. Looking at its performance in the current quarter, the company reiterated its EPS guidance for full year 2017 of $5.77 to $5.93.

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CVS had an impressive first quarter in terms of its Pharmacy Services segment, which reported an increase of $2.5 billion in revenues. The increase in revenues was primarily due to net new business, which was reported at $5.4 billion, and growth in specialty pharmacy. However, the increase in sales of generic medicines impacted the company’s top line for the quarter. The company’s generic dispensing rate (GDR) was 87.5% for the quarter, an increase of 180 basis points year over year. The segment’s gross margins were 3.5% for the quarter, a decline of 30 basis points y-o-y. The company attributed price compression and the changing mix of its business as the reasons for the decline in gross margin.

However, the revenues of Retail/LTC segment were significantly impacted by the loss of contracts and lower same store sales, and were reported almost 4% lower than the prior year quarter. Pharmacy same store sales dipped 4.7% while same store prescription volumes declined 1.4%, on a 30-day equivalent basis. The network changes, coupled with one fewer day in the quarter, impacted the same store prescription volumes by almost 6 percentage points. The segment’s gross margins rose 35 basis points over the prior year quarter to 29.3%. The increase in gross margins was primarily attributed to higher generic sales and improved product mix, offset by loss of contracts and reimbursement pressures.

CVS’s free cash flow for the quarter increased by almost 67% y-o-y to $3.1 billion, primarily due to increased cash from operating activities. The company’s full year free cash flow guidance is in the range of $6 to $6.4 billion.

In the current quarter, CVS expects the loss of contracts to continue to impact the performance of the Retail/LTC segment, which is expected to report a decline in revenues in the range of 2.5% to 4.25%. However, PBM is expected to continue its strong performance and should report revenue growth in the range of 9% to 10.75% y-o-y. For the current quarter, the company is expected to generate adjusted EPS in the range of $1.29 to $1.33, with the higher end of the guidance implying growth of 1% y-o-y. The company expects the current year to be a “rebuilding one” as it continues to look for avenues to compensate the loss of contracts.

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