CVS Health : Q3 2022 Transcript

Event Type: Q3 2022 Earnings Call (Corrected version)

Date: 2022-11-02

Company: CVS Health Corp.

Ticker: CVS-US

COMPANY PARTICIPANTS

Laurence McGrath - CVS Health Corp., SVP-Business Development & Investor Relations Karen S. Lynch - CVS Health Corp., President, Chief Executive Officer & Director Shawn M. Guertin - CVS Health Corp., Chief Financial Officer & Executive Vice President Daniel P. Finke - CVS Health Corp., Executive Vice President & President-Health Care Benefits

Alan M. Lotvin - CVS Health Corp., Executive Vice President, CVS Health, and President, CVS Caremark.

OTHER PARTICIPANTS Lisa C. Gill - Analyst Justin Lake - Analyst Michael Cherny - Analyst A.J. Rice - Analyst

Eric Percher - Analyst Elizabeth Anderson - Analyst Erin Wilson Wright - Analyst

MANAGEMENT DISCUSSION SECTION

Operator

Ladies and gentlemen, good morning, and welcome to the CVS Health Third Quarter 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow CVS Health's prepared remarks, at which point we will review instructions on how to ask your questions. As a reminder, today's conference is being recorded.

I would now like to turn the call over to Larry McGrath, Senior Vice President of Business Development and Investor Relations for CVS Health. Please go ahead.

Laurence McGrath

Good morning, and welcome to the CVS Health Third Quarter 2022 Earnings Call and Webcast. I'm Larry McGrath, Senior Vice President of Business Development and Investor Relations for CVS Health. I'm joined this morning by Karen Lynch, President and Chief Executive Officer; and Shawn Guertin, Executive Vice President and Chief Financial Officer. Following our prepared remarks, we'll host a question-and-answer session that will include Dr. Alan Lotvin, President, Pharmacy Services; Daniel Finke, President, Health Care Benefits; Michelle Peluso, Chief Customer Officer and Retail Co-President; and Prem Shah, Chief Pharmacy Officer and Retail Co-President.

Our press release and slide presentation have been posted to our website along with our Form 10-Q that we filed this morning with the SEC. Today's call is being broadcast on our website where it will be archived for one year.

During this call, we will make certain forward-looking statements reflecting current views related to our future financial performance, future events, industry and market conditions including the impacts related to the ongoing COVID-19 pandemic, as well as the expected consumer benefits of our products and services and our financial projections and the benefits of the proposed acquisitions of Signify Health, Inc. and the associated integration plans, expected synergies, and revenue opportunities. Our forward-looking statements are subject to significant risks and uncertainties that could cause actual results to differ materially from currency projected results, including with respect to the ongoing COVID-19 pandemic and the proposed acquisition and the integration of Signify Health. We strongly encourage you to review the reports we file with the SEC regarding these risks and uncertainties including our most recent annual report on Form 10-K, our recent current reports on Form 8-K, this morning's earnings press release, and our Form 10-Q.

During this call, we will use non-GAAP measures when talking about the company's performance and financial conditions, and you can find a reconciliation of these non-GAAP measures in this morning's press release and in the reconciliation document posted to the Investor Relations portion of our website.

With that, I'd like to turn the call over to Karen.

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Karen?

Karen S. Lynch

Thank you, Larry.

Good morning, everyone, and thanks for joining our call today.

CVS Health delivered another outstanding quarter. Based on our strategic progress and confidence in our execution, we are raising our adjusted earnings per share guidance for the third consecutive time this year to a range of $8.55 to $8.65.

During the third quarter, we grew revenue by 10% versus the prior year to over $81 billion and grew adjusted operating income by nearly 4% over the prior year to $4.2 billion. Adjusted earnings per share in the quarter was $2.09, an increase of over 6% from the prior year. Our cash flow from operations was $9.1 billion in the third quarter and $18.1 billion year-to-date.

Throughout 2022, we've consistently executed on our strategy centered around expanding our capabilities in health care delivery. We are increasingly delivering broader access to quality care, simpler journeys, and better outcomes at lower cost across our channels.

With the announced acquisition of Signify Health, we will strengthen our engagement with consumers. We will add best-in-class capabilities that enable in-home services and care coordination as well as a platform to accelerate value-based decision enablement. Together, we will have a strong foundation for developing new product offerings consistent with our payer-agnostic approach. We project that this transaction will close in the first half of 2023.

We continually evaluate our portfolio of assets for nonstrategic areas that do not fit our long term priorities. In October, we reached an agreement to sell bswift and are actively exploring strategic alternatives for Omnicare. As we divest assets, we'll continue to invest in areas aligned with our strategy with a disciplined approach to capital allocation.

This morning, we made an important announcement on our ongoing opioid legal matter. In late October, we began a mediation to resolve substantially all opioid lawsuits and claims against CVS Health by states, political subdivisions, and tribes. We reached an agreement in principle to pay approximately $5 billion over 10 years beginning in 2023, an outcome that is in the best interests of all parties and one that will help put a decade-old issue behind us as we continue to focus on delivering a superior health experience for the millions of consumers who rely on us.

Let's turn to each of our foundational businesses and discuss their strong results.

The Health Care Benefits segment had another strong quarter. Revenues for this segment grew nearly 10% year- over-year with adjusted operating income of $1.5 billion. Our medical benefit ratio of 83.5% improved by 230 basis points versus the prior year driven by a lower impact from COVID and medical cost trends that remained favorable.

Enrollment in our Medicare and Commercial businesses was strong this quarter with our individual Medicare advantage and PDP portfolio exceeding market growth once again. The 2023 Medicare annual enrollment period is underway, and we are well positioned for another year of growth in our individual Medicare and dual eligible products.

We remain a leader in offering zero dollar premium plans with more than 73% of our plans in that category. We also continued our geographic expansion in the D-SNP market and now offer plans to 61% of D-SNP eligible population, up more than 8% year-over-year.

We were disappointed that the Star Rating on our national PPO contract fell to 3.5 stars after nearly a decade-long track record of performing at 4 stars or better. We have a strong history of delivering affordable high quality plan benefits and a commitment to continuous improvement. Improving our star performance continues to be a top priority for the company. We have the right actions in place to improve our star rating with our ongoing quality and experience efforts as we address the specific measures scored on the member surveys that contribute to star ratings.

We will continue to focus on our members and invest in programs and processes specifically designed to simplify and improve their health care experience. This is an important priority for the company.

In our Commercial business, our growth is driven by the combination of our competitive cost structure, our integrated benefit design, and services that utilize CVS Health platforms and capabilities. We achieved a key milestone this quarter with more than 2 million members enrolled in our integrated Aetna and Caremark product.

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This important goal demonstrates the value we provide our customers through our combined CVS Health offerings, a strong proof point of our strategy.

Turning to our ACA individual exchange platform, we expanded our footprint and will be available in a total of 12 states beginning in January of 2023, covering 5.5 million lives or nearly 40% of the individual exchange population. Our co-branded product offerings include instant access to providers with 24/7 virtual care and face-to-face access in our MinuteClinic locations. We are committed to helping provide access to affordable care for all Americans.

Finally, our Medicaid platform continues to be an important area for growth. We grew our OhioRISE program after successful implementation and have been chosen by the State of Louisiana to serve a portion of their Medicaid eligible children due to the deep expertise we've built to engage and support children, their caregivers, and their families. We've expanded our capabilities with a focus on quality and member engagement through our CVS Health community channels as we enter a robust bid period.

In Pharmacy Services, our revenue grew nearly 11%, with adjusted operating income of $1.9 billion. Specialty Pharmacy revenue grew 22% year-over-year, driven by our industry-leading cost management and service excellence that continue to differentiate us in the marketplace. We closed out another successful selling season, driving $3.5 billion of growth new business for 2023 and a client retention rate of nearly 98%, evidence of the strength of our portfolio of capabilities. Efforts are underway to support a successful welcome season for our members.

Last week, we learned that Centene decided to move their business to a competitor in 2024. While we hope to continue our relationship with Centene and bid to do so, we also maintained our pricing discipline. For the remainder of the contract, we will work with Centene to facilitate a seamless transition for members.

Even after moving this contract, our purchasing power and our ability to drive value for our customers will not be diminished. Our demonstrated success in growing lives under management and revenue is a testament to our high quality service, compliance capabilities, and specialty pharmacy excellence. Our Pharmacy Services segment will remain an important driver of growth within CVS Health in the years to come.

Our Retail/Long-Term Care segment also continues to outperform expectations. Revenues in the quarter grew nearly 7% versus the prior year with $1.4 billion in adjusted operating income. Performance in both the front-store and pharmacy was strong. Front-store sales were up approximately 4%, driven by growth across the majority of our categories. Demand for COVID vaccines and over-the-counter tests, as well as cough, cold, and flu products, remain high. In pharmacy, scripts grew 1.8% year-over-year in the third quarter or 3.6% excluding COVID vaccines. This growth helped propel our retail pharmacy business to another quarter of year-over-year market share gains, extending a trend that started in the first quarter of 2020.

Our community retail health destinations play a strengthening role in the overall well-being of the consumers we serve. As demand for health products and services continues to be elevated, we are implementing new digital capabilities that provide a seamless and convenient consumer experience. Now, most of our pharmacists are empowered to prescribe Paxlovid COVID antiviral treatment. Our investments in omni-channel health are enhancing transparency and helping consumers better manage their overall health.

While there is growing economic uncertainty and recession expectations in 2023, we are well positioned across our foundational businesses to manage through these potential headwinds. We are increasingly delivering connected experiences and health solutions that improve overall well-being. More and more, we are there for every meaningful moment of our consumers' health.

Throughout 2022, we've made significant progress advancing our strategy, building a strong foundation for health care delivery, and expanding our health service offering and developing new products. In October, we announced that Dr. Amar Desai has joined CVS Health to lead our health care delivery strategy. Dr. Desai's experience in transforming the health care system and driving value-based care will accelerate our vision of becoming the leading health solutions company and our efforts to improve health care for consumers.

2022 has also been an important year for growing our digital presence and capabilities. This quarter, we added another approximately 1 million digital customers. CVS Health now serves more than 46 million unique digital customers, an impressive 11 million more since this time last year. Our digitally-ledomni-channel health approach prioritizes experience that matter most for consumers. This includes advancing our digital tools for a seamless and convenient experience, leading to higher engagement and satisfaction.

For example, we recently launched a new functionality that drives more choice and convenience for patients filling prescriptions. Patients can expedite urgent prescriptions, have visibility into out-of-pocket costs, and track their order status, all before even coming in to our pharmacy.

We continue to make strong progress on ESG. For example, we are working to decrease disparities with our focus on women's health as it relates to accessing quality and convenient health care. As part of our Here For Her

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initiative, we are launching a variety of new MinuteClinic virtual care services to support women's health that will be available 24/7.

And finally, I want to take this opportunity to again thank our CVS Health colleagues, especially those in Florida and Puerto Rico who face natural disasters. Our teams pulled together to ensure care continuity for our customers and the communities that we serve.

I will now turn it over to Shawn for a deeper look into our operational and financial results and outlook.

Shawn M. Guertin

Thank you, Karen, and good morning, everyone.

Our third quarter results reflect the continuation of the strong performance observed in the first half of 2022 as we exceeded our expectations for revenue, cash flow generation, and adjusted earnings per share. This momentum allows us to again raise our 2022 adjusted EPS guidance to a range of $8.55 to $8.65 per share.

A few highlights regarding overall company performance.

Third quarter revenues of over $81 billion increased by 10% year-over-year, reflecting robust growth across each of our operating segments. We delivered adjusted operating income of $4.2 billion and adjusted EPS of $2.09, representing increases of 3.9% and 6.1% versus prior year, respectively. Our ability to generate cash remains strong. Our cash flow from operations was $9.1 billion in the third quarter and $18.1 billion year-to-date. Cash flows in the quarter benefited from the timing of CMS payments that are expected to normalize in the fourth quarter.

Looking at performance by business segment, in Health Care Benefits we delivered strong revenue and adjusted operating income growth versus the prior year. Third quarter revenue of $22.5 billion increased by nearly 10% over the prior-year quarter. Membership grew 2.5% year-over-year despite the divestiture of 283,000 lives from Aetna International earlier this year.

Our Medicare franchise remains a strong growth opportunity for us, adding 75,000 members sequentially across our portfolio of solutions for individuals and employers. Underlying growth in our Commercial business also remained strong. We are excited about the prospects of our individual exchange business, which now includes 12 states as of January 1, 2023. The sequential decline in Medicaid membership is driven by a previously disclosed contract loss, partially offset by the ongoing suspension of redeterminations.

Adjusted operating income of $1.5 billion increased 39.6% year-over-year primarily due to the impact of higher COVID costs in third quarter 2021, COVID pricing actions we took this year and strong underlying performance partially offset by incremental investments to support growth in the business and net realized investment portfolio losses. Our medical benefit ratio of 83.5% improved 230 basis points year-over-year, reflecting lower impact from COVID and medical cost trends that remain modestly favorable to our pricing assumptions.

Consistent with last quarter, medical cost trends in our Commercial business remain generally in line with pre- pandemic trended baselines, and government remains slightly lower than the pre-pandemic trended baselines.

Consolidated days claims payable at the end of the quarter was 54.9, up 0.6 days sequentially as reserves grew at a modestly higher rate than premiums.

Overall, we remain confident in the adequacy of our reserves.

In the Pharmacy Services business, our ability to deliver industry-leading drug trend for our clients, our specialty management capabilities, and outstanding customer service levels continued to drive growth. During the third quarter, revenue of over $43 billion increased by nearly 11% year-over-year driven by pharmacy claims growth, Specialty Pharmacy, and brand inflation partially offset by the impact of continued client price improvements.

Total Pharmacy claims processed increased by 3.6% above prior year and 4.5% when excluding COVID-19 vaccinations primarily attributable to new business in 2022 and increased utilization. Total Pharmacy membership remains steady, exceeding 110 million members as growth in commercial and government lives helped to offset significant membership losses from the California Medicaid carve-out that started this year.

Adjusted operating income of $1.9 billion grew nearly 6% year-over-year driven by improved purchasing economics including increased contributions from the products and services of our group purchasing organization. This was partially tempered by ongoing client price improvements. Quarterly contribution from our 340B product lines improved in the third quarter, in line with our estimates as covered entities addressed manufacturer conditions for program participation.

In our Retail/Long-Term Care segment, we delivered strong revenue growth and adjusted operating income above our expectations despite mixed COVID-related trends and continued economic uncertainty. Specifically, during the

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third quarter, revenue of $26.7 billion grew nearly 7%, reflecting increased prescription in front-store volume including the sale of COVID-19over-the-counter test kits as well as pharmacy drug mix and brand inflation. These increases were partially offset by a decrease in COVID-19 diagnostic testing and vaccinations, the impact of recent generic introductions, and continued pharmacy reimbursement pressure.

Adjusted operating income of $1.4 billion declined 18.9% versus prior year driven by decreased COVID-19 diagnostic testing and vaccinations, continued pharmacy reimbursement pressure, as well as increased investments in the segment's operations and capabilities. These decreases were partially offset by the increased prescription in front-store volume, improved generic drug purchasing, and the favorable impact of business initiatives.

Pharmacy prescription volume grew 1.8% year-over-year, reflecting increased utilization. Excluding the impact of COVID, pharmacy prescription volume increased by 3.6% year-over-year.

Turning to the balance sheet, our liquidity and capital position remain excellent. Year-to-date, we generated cash flow from operations of $18.1 billion and ended the quarter with $7.9 billion of cash at the parent and unrestricted subsidiaries. Cash flows during the quarter were positively impacted by the early receipt of $3.2 billion of CMS payments which will normalize in the fourth quarter.

During the quarter, we repaid $2.6 billion of long-term debt. Through our quarterly dividend, we returned $726 million to shareholders. We remain committed to maintaining our investment-grade ratings while also having the flexibility to deploy capital strategically for capability-focused M&A.

A few other items worth highlighting for investors.

We continue to experience the impact of market volatility on our investment portfolio and recorded net realized capital losses of approximately $110 million in the quarter. These losses emerged predominantly in the HCB segment.

We were not immune to the impacts of Hurricane Ian and recorded losses of approximately $40 million related to damages from the storm.

We recorded a pre-tax loss on assets held for sale of $2.5 billion related to the write-down of our Long-Term Care business, Omnicare, where we're in the process of exploring strategic alternatives. We also recorded pre-tax charges of $5.2 billion for legal settlements related to agreements in principle with certain states and governmental entities to resolve opioid claims.

Consistent with past practice, these GAAP impacts have been excluded from our adjusted operating metrics.

Turning to our 2022 outlook, we are raising the midpoint of our adjusted earnings per share guidance by $0.10 to a range of $8.55 to $8.65. This increase reflects favorable underlying third quarter performance in Retail and HCB, an improved Q4 outlook for the Retail/LTC segment, and slight improvement in the full year outlook for tax rate and share counts, partially offset by the anticipated impact of market volatility on net investment income for the HCB business.

We are narrowing our full year adjusted operating income guidance in Health Care Benefits to a range of $5.96 billion to $6.02 billion. This reflects the previously discussed strong underlying fundamental performance offset by continued caution on our outlook for investment income given the volatile rate environment. Our outlook also contemplates the extension of the public health emergency into the early part of the first quarter of 2023.

For the Retail/LTC segment, we are raising and narrowing full year guidance as follows: revenue increases to a range of $102.7 billion to $104 billion, adjusted operating income guidance increases by $105 million at the midpoint to a range of $6.66 billion to $6.72 billion.

We now forecast that we will administer 28 million COVID-19 vaccinations in 2022 with approximately 70% already administered through the third quarter of 2022. We expect full year diagnostic testing volumes of approximately $17 million which is down from our prior outlook. However, we now expect higher sales of over-the-counter test kits exceeding 65 million units or nearly triple the number of kits sold last year.

In aggregate, we expect these three categories of COVID-driven items to continue to produce over $3 billion of revenue in 2022, a decline of approximately 29% versus 2021, but reflective of the endemic tail of COVID on our Retail business.

Our updated outlook also contemplates higher levels of investment spending in the fourth quarter as we continue to invest in our workforce and enhance our customer experience.

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