CVS Health Corporation (NYSE:CVS) Q3 2023 Earnings Call Transcript

CVS Health Corporation (NYSE:CVS) Q3 2023 Earnings Call Transcript November 1, 2023

CVS Health Corporation misses on earnings expectations. Reported EPS is $1.75 EPS, expectations were $2.13.

Operator: Good morning or good afternoon, all and welcome to today’s Third Quarter 2023 CVS Health Earnings Call. My name is Adam, and I’ll be your operator for today. [Operator Instructions] I will now hand the floor to Larry McGrath to begin. So Larry, please go ahead when you are ready.

Larry McGrath: Good morning, and welcome to the CVS Health third quarter 2023 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 Tom Cowhey, Interim Chief Financial Officer. Following. Following our prepared remarks, we’ll host a question-and-answer session that will include additional members of our leadership team. Our press release and slide presentation are being posted to our website, along with our Form 10-Q that we filed this morning with the SEC. Today’s call is also being broadcast on our website, where it will be archived for one year. During this call, we will make certain forward-looking statements.

A woman signing a healthcare plan document in her home office.

Our forward-looking statements are subject to significant risks and uncertainties that could cause actual results to differ materially from currently projected results. We strongly encourage you to review the reports we file with the SEC regarding these risks and uncertainties. In particular, those that are described in the cautionary statement concerning forward-looking statements and risk factors in our most recent annual report filed on Form 10-K, our quarterly reports on Form 10-Q, the most recent of which was filed this morning and our recent filings on Form 8-K, including this morning’s earnings press release. During this call, we will use non-GAAP measures when talking about the company’s financial performance and financial condition and you can find a reconciliation of these non-GAAP measures in this morning’s press release and then the reconciliation document posted to our Investor Relations portion of our website.

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

Karen Lynch: Thank you, Larry. Good morning, everyone, and thanks for joining our call. Today, we reported strong third quarter results, highlighting the power of our diversified business model. We delivered adjusted EPS of $2.21 and adjusted operating income of nearly $4.5 billion. Our consolidated revenues for the quarter of almost $90 billion reflect an increase of nearly 11% over the prior year. And once again, we generated outstanding operating cash flows, bringing our year-to-date total to $16.1 billion. We are reconfirming our guidance range for 2023 adjusted EPS of $8.50 to $8.70, this reflects execution against our strategy with strong performance in our Pharmacy & Consumer Wellness segment and continued momentum in our Health Services segment, offsetting incremental Medicare Advantage medical cost pressures in our Health Care Benefits segment.

The power of our integrated model is clear. We demonstrated this with the significant progress made in restoring our Medicare Advantage Star ratings. Our 2024 rating show that we will have 87% of our Medicare Advantage members and plans rated 4 stars or better. We accomplished this in a very short period of time by utilizing the full breadth of CVS Health touch point with our members. We improved CAP stores by an average of two-thirds of a point by driving powerful consumer insights to design experiences that address the unique needs of our members. We also made improvements beyond CAP. For example, to address HEDIS and patient safety measures, our Medicare Advantage team worked closely with CVS Pharmacy and Caremark to help members improve medication adherence, remove costs and transportation barriers and ensure members completed critical tests, screenings and preventive services.

As a result of these efforts, among many others, Aetna was the top performer in both the Part D patient safety and HEDIS domain. Our 2024 Star ratings will improve our position in the ’25 plan year and will enhance our position well into the future. Medicare Advantage is a key strategic growth area for our business. While it’s still early in the 2024 annual enrollment period, we are confident that our competitive offering and attractive benefit design will meet consumer expectations. Aetna continues to be a leader in zero-dollar premium product and approximately 84% of Medicare eligibles will have access to Aetna plans in this category in 2024. We are also expanding the breadth of our D-SNP footprint and now cover more than two-thirds of Medicare eligibles, up 6% from last year.

Our D-SNP strategy focuses on offering the coordinated medical management these members need to live healthier life, including introducing them to care delivery options such as Oak Street Health, where appropriate. Our ability to offer access to convenient sites of care and the integrated benefits that seniors value most will position us to grow at or above the market in 2024. Turning now to how we are unlocking sources of value in health care. This quarter we announced the creation of Cordavis, a wholly-owned subsidiary of CVS Health. We have an established history of innovating to find ways to lower drug spend and to ensure that people we serve have access to the medications they need to stay healthy. Cordavis continues that history of innovation, the biosimilar market in the U.S. is expected to be a $100 billion opportunity by 2029.

It represents one of the biggest sources of drug cost savings for consumers and the U.S. health care system. Through Cordavis, we are working directly with manufacturers to bring a portfolio of biosimilar products to the market driving our growth and ensuring that our customers and clients will realize the significant savings potential available through biosimilars for years to come. Let’s turn to our performance in the quarter. In our Health Care Benefits segment, we grew revenues to more than $26 billion, an increase of nearly 17% and delivered adjusted operating income of $1.5 billion. Medical membership in the third quarter grew to 25.7 million, an increase of 1.4 million members versus the prior year, reflecting growth across multiple product lines, including individual exchange, Medicare and commercial.

We continue to experience elevated utilization trends in our Medicare Advantage business, primarily in outpatient and supplemental benefits such as dental, behavioral health, OTC and flex card. Given the elevated cost trends that have emerged this year, we are executing on plans to unlock additional revenue, clinical and network opportunities to help alleviate these pressures. In our Health Services segment, revenues grew to near $47 billion, an increase of more than 8%. Adjusted operating income grew nearly 11% to $1.9 billion. These results once again reflect impressive performance in our Pharmacy Services business, where our commitment to lower drug costs and deliver innovative clinical solutions drive value for our consumers and our clients.

In the 2024 selling season, our renewals are substantially complete and our retention remains strong in the high 90s, excluding the Centene contract. Our sales strategy for new business has been successful capturing over 60% of national employers that moved PBM. Turning to our care delivery assets. We are scaling capabilities to accelerate growth at both Signify and Oak Street. We are progressing on our initiatives to create integrated health experiences across multiple channels, including Aetna, Signify, CVS Retail Health and CVS Pharmacy. For Oak Street Health, we are using these channels to educate Medicare eligible adults about the health services they need and can receive in our primary care clinic. While it’s still early, the results of these initiatives are encouraging, and we are excited to share more details at our Investor Day in December.

For Signify Health, we are connecting more CVS Pharmacy patients to Signify for in-home evaluation and other services in the home. Our trusted relationship with 90 million patients at the pharmacy counter is a powerful connection and the most frequent engagement in health care. By utilizing our pharmacist connection, we have been able to reach more than 50% of Aetna members that Signify was previously unable to reach, enhancing the opportunity to more effectively engage these members in their care. This initiative has surpassed our initial conversion rate goals, and we are excited by the prospects of scaling our capabilities in 2024 and beyond. Turning to our Pharmacy & Consumer Wellness segment. Revenues grew to nearly $29 billion, up 6% versus the prior year.

We generated $1.4 billion of adjusted operating income in the quarter in line with our results in the prior year. Performance in our retail pharmacy business was strong. Same-store pharmacy sales increased nearly 12% versus the prior year, primarily driven by pharmacy drug mix and brand inflation. Same-store prescription growth when excluding the impact of COVID grew by 3.5%. Turning to our consumer engagement strategy. Our digital [Technical Difficulty] nearly 12% versus the prior year, primarily driven by pharmacy drug mix and brand inflation. Same-store prescription growth when excluding the impact of COVID grew by 3.5%. Turning to our consumer engagement strategy. Our digital platform is helping consumers navigate and simplify their health journey.

Our digital reach continues to grow with now over 55 million unique customers an increase of nearly 20% versus last year. This strong growth has been powered by our focus on innovating and delivering on experiences that matter most for our customers. We have been removing barriers to digital adoption and making it easier for customers to access the services they seek such as pharmacy refills and advanced scheduling for immunizations online. Our strong digital engagement and enhanced capabilities will strengthen our ability to drive seasonal flu, COVID, an RFD immunization awareness and connect patients to our CVS locations for these important health services. Before I turn it over to Tom to discuss our financial results, I’d like to highlight some recent changes to our leadership team.

As we previously announced, I would like to welcome Brian Kane as our new President of Aetna. Brian’s extensive industry experience will be critical as he and his team worked to deliver consumer-centric, holistic health care to the more than 35 million members served by Aetna. In mid-October, we also announced that Shawn Guertin, our Chief Financial Officer and President of the Health Services business is taking a leave of absence due to unforeseen family health reasons. Tom Cowhey has been appointed to the role of Interim CFO, and Mike Pykosz has assume the role Interim President of Health Services. Both Tom and Mike are well positioned to continue to seamlessly execute on our strategy. Finally, I would like to thank our colleagues for the commitment and dedication they show every day to support our customers, our clients and our patients.

I will now turn the call over to Tom to provide more details on our results and our guidance. Tom?

Tom Cowhey: Thank you, Karen, and good morning, everyone. Our third quarter results continue to demonstrate the power of our execution and the value of our diversified enterprise. This quarter, we saw strength across key metrics such as revenue, adjusted earnings per share and cash flow from operations. A few total company highlights. Third quarter revenues of nearly $90 billion increased by double-digit percentages over the prior year quarter, reflecting strong growth across each of our businesses. We delivered adjusted operating income of nearly $4.5 billion and adjusted EPS of $2.21, representing growth of approximately 2% versus the prior year. These increases were primarily due to continued strong execution in our pharmacy services operations, partially offset by pressure in Health Care Benefits and the inclusion of Oak Street Health results.

Our ability to generate cash remains outstanding with year-to-date cash flow from operations of $16.1 billion. Cash flows benefited from the timing of CMS payments that are expected to normalize in the fourth quarter. Excluding this impact, our year-to-date cash flows from operations remained strong at approximately $11 billion. Shifting to the details for our Health Care Benefits segment. We delivered strong revenue growth versus the prior year. Third quarter revenue of $26.3 billion increased nearly 17% year-over-year, reflecting growth across all product lines, but primarily attributable to Medicare and our individual exchange products. Membership grew to 25.7 million, an increase of 54,000 members sequentially, reflecting growth in our individual exchange and Medicare businesses, partially offset by the impact of Medicaid redeterminations.

Adjusted operating income of $1.5 billion in the quarter declined approximately 6% versus the prior year. This decline was driven by a higher medical benefit ratio, partially offset by higher net investment income. Our Medical Benefit ratio of 85.7% increased 230 basis points from the prior year quarter, primarily reflecting lower prior period development as well as higher Medicare Advantage utilization inside the quarter. Utilization pressure was primarily attributable to the categories Karen highlighted earlier, including outpatient and supplemental benefits such as dental, behavioral health, OTC and flex cards. Further, we also experienced individual exchange growth in the special enrollment period that exceeded our expectations. These members, particularly when added late in the year, will drive a higher MBR.

As a result, our higher individual exchange growth is also contributing to our updated MBR guidance for the full year. We continue to closely watch utilization trends in our other lines of business. But at this stage, we have not observed any other trends that we would consider inconsistent with our total expectations. Days claims payable at the end of the quarter was 50.3, up 3.4 days sequentially and reserve growth exceeded premium growth sequentially. Overall, we remain confident in the adequacy of our reserves. Our Health Services segment, which includes our Pharmacy Services business and our Health Services operations, generated revenue of approximately $47 billion, an increase of more than 8% year-over-year. This increase was driven by pharmacy drug mix, growth in specialty pharmacy, brand inflation and the addition of Signify and Oak Street.

These increases were partially offset by the impact of continued client price improvements. Adjusted operating income of nearly $1.9 billion grew approximately 11% year-over-year primarily driven by strong execution and improved purchasing economics, partially offset by ongoing client price improvements. Total pharmacy claims processed in the quarter declined by less than 1% versus the prior year, and were only down 40 basis points when excluding COVID-19 vaccinations. This decline was primarily attributable to the New York Medicaid carve-out and lower COVID-19 vaccinations, partially offset by net new business. Total pharmacy membership remains steady at approximately 110 million members. We continue to be encouraged by the performance and growth of our Health Services assets.

Signify completed 655,000 in-home evaluations in the quarter, an increase of 7% versus the same period last year and generated revenue growth of 21%. The Oak Street ended the quarter with 192 centers and 191,000 at-risk lives. We’ve grown by 31 centers versus the prior year quarter and are on track to open a total of 35 new centers this year, ramping to 50 to 60 centers in 2024. Oak Street also significantly increased revenue in the quarter, growing 44% compared to the same quarter last year. Oak Street’s clinical model continues to demonstrate exceptional performance. Last week, CMS released the 2022 savings performance of all ACO REACH participants. Oak Street was among the top 5% of program participants, generating a meaningful gross savings rate of 21%.

Moving to our Pharmacy & Consumer Wellness segment. We generated revenue of nearly $29 billion, up 6% versus the prior year, nearly 9% on a same-store basis, reflecting the impact of pharmacy drug mix, increased prescriptions and brand inflation. These revenue increases were partially offset by continued reimbursement pressure, the impact of recent generic introductions, a decrease in store count, and decreased COVID-19 related volume. Adjusted operating income of $1.4 billion was in line with the prior year, driven by continued reimbursement pressure and lower COVID contributions, largely offset by improved drug purchasing, increased prescription volumes and lower expenses. Same-store pharmacy sales were up nearly 12%, driven by drug mix, a 2.7% increase in same-store prescription volumes and brand inflation.

The increase in same-store prescription volumes, excluding the impact of COVID-19 vaccinations was 3.5%. As we continue to execute on our store closure initiative, having closed 564 out of 900 planned stores. We encourage investors to focus on same-store metrics to understand underlying growth. Our front store business continues to exhibit resiliency in the face of industry challenges, underscoring the value we offer consumers. Same-store sales for the front store were down 2.2%, primarily due to declines in cough, cold and flu and OTC test kits. Excluding the impact of OTC test kits, same-store front sales were in line with the prior year. Shifting to the balance sheet. Our liquidity and capital position remains excellent. Our ability to generate cash flow remains a core strength of our organization and the enterprise continues to identify new opportunities to further optimize our balance sheet.

Through the third quarter, we generated cash flow from operations of $16.1 billion, including the CMS prepayment I discussed earlier. We ended the quarter with approximately $2.7 billion of cash at the parent and unrestricted subsidiaries. This quarter, we returned $779 million to shareholders through our quarterly dividend. We remain committed to maintaining our current investment-grade ratings while preserving flexibility to deploy capital strategically. Turning now to our full year outlook for 2023. We are reaffirming our adjusted EPS of $8.50 to $8.70. This primarily reflects our performance through the third quarter and the continuation of higher Medicare Advantage medical cost trend for the remainder of 2023, offset by strength in our Pharmacy & Consumer Wellness and Health Services segments.

In the Health Care Benefits segment, we now expect our 2023 medical benefit ratio to be approximately 86%, primarily driven by the previously mentioned impact of higher Medicare Advantage utilization as well as the impact of higher than expected individual exchange growth during the special enrollment period. As a result, we now expect adjusted operating income for the segment to be in a range of $5.63 billion to $5.76 billion. Our individual exchange business is expected to reduce adjusted operating earnings in 2023, largely a function of late year growth. However, this business is now poised to reach an annualized run rate of more than $6 billion of revenue, and we are well positioned to earn a positive margin in this business in 2024 based on specific actions our teams are implementing including pricing adjustments.

In our Health Services segment, we are updating our adjusted operating income guidance to a range of $7.18 billion to $7.31 billion, reflecting the strong execution year-to-date in our Pharmacy Services business, and our expectation of continued strength for the remainder of the year. In our Pharmacy & Consumer Wellness segment, we now expect adjusted operating income in a range of $5.76 billion to $5.86 billion, primarily driven by higher contributions from seasonal immunizations, partially offset by lower-than-expected script volume, primarily attributable to Medicaid redeterminations. Shifting to our cash flow. Given our strong performance year-to-date, we now anticipate full year 2023 cash flow from operations to be at the upper end of our range of $12.5 billion to $13.5 billion.

Our expectation for capital expenditures is now $2.5 billion to $2.7 billion. We are also updating our adjusted effective tax rate to 24.9% and our share count to 1.291 billion. You can find additional details on the components of our updated 2023 guidance on our Investor Relations web page. Before I conclude my prepared remarks, I want to give you an update on the headwinds and tailwinds for 2024, starting with the headwinds. As we previously discussed, the decline in our Star ratings for benefit year 2024 will pressure our Medicare Advantage margins. We now expect the impact to be closer to the low end of our previously communicated range of $800 million to $1 billion. We continue to expect the current level of elevated utilization in our Medicare Advantage book to persist and at an abundance of caution, are maintaining a provision for further utilization pressure in 2024.

As previously discussed, contributions from Centene will decline as the contract ends on January 1, 2024. We expect a lower contribution in our PCW segment related to COVID, consumer softness and incremental labor investments, and we expect the 340B headwind from 2023 to annualize in 2024. Shifting to the tailwinds for 2024. We expect underlying growth in our core businesses. We now expect the savings from our previously announced actions and cost initiatives coming at the higher end of our guidance. We expect a positive contribution from the pricing of our individual exchange business as well as commercial pricing actions. We believe we have the opportunity to capture value from our newly created for Cordavis business. And we expect incremental contributions from our Health Services businesses, net of the impact from previously discussed clinic expansion.

At this distance, based on the sum total of these headwinds and tailwinds, including the uncertainty created by our recent utilization trends, we believe it is prudent for investors to ground their expectations for 2024 adjusted EPS at the low end of our previously communicated preliminary guidance range of $8.50 to $8.70. At our Investor Day in December, we will provide detailed 2024 guidance and updated views on our long-term growth algorithm. To conclude, we remain focused on operational execution and sustainable growth as we advance our goal of becoming the leading health solutions company for consumers. We look forward to providing more detailed updates on our progress against our strategy in December. With that, we’ll now open the call to your questions.

Operator?

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Q&A Session

Operator: Thank you. [Operator Instructions] And the first question today comes from Justin Lake from Wolfe Research. Justin, your line is open. Please go ahead.

Justin Lake: Thanks. Wanted to see, if we can get some more color on Medicare Advantage cost brand, specifically, what did you see through the quarter, what did you assume for these value cards versus what kind of was expected? And then can you talk about how you think the business is going to perform in 2024, right? It looks like you invested in benefits there. So, maybe you could just tell us where you think margins are this year, where you think they’re going to be next year, and then hopefully, walk us through where — how investors should think about improvement in 2025 and beyond to as you reprice this business and get your stars back, et cetera. Thanks.

Tom Cowhey: Good morning, Justin. Thanks for the question. Bear with me, there’s a lot to go through here. So, let me walk you through a couple of ways that we’d like you to think about 2024, really make sure that you understand what’s happened in ’23, and then I’ll turn it over to Brian to talk about some of your other questions. So, you remember on our second quarter call, we discussed that we were seeing 100 bps to 110 bps of Medicare pressure in the first half. And that was driven by higher-than-expected utilization in outpatient and some supplemental benefits such as dental and behavioral health. We carried forward that pressure into the second half, resulting in an increase for the total company of about 50 bps to the total year MBR guide.

We further indicated that we had captured a portion of the outreach — outpatient trend pressure in our bids in 2024 and that the remaining pressure we did not incorporate was reflected in the 2024 guide. We also put a placeholder in for additional utilization in our 2024 preliminary guidance range. So, as you look then at the third quarter, we’re experiencing higher utilization than we anticipated. The main driver of this pressure continues to be Medicare Advantage, but a less impactful notable driver is continued strong growth in the individual exchange product through the SEP. So, this SEP membership, particularly when it’s added late in the year, carries a higher-than-average MBR. So, if you look specifically then at Medicare, we’ve continued to see elevated utilization in outpatient, including additional pressure in the second quarter.

We’ve also seen incremental pressure in supplemental benefits in the third quarter, particularly dental, behavioral health, and OTC and flex cards. So, OTC and flex cards is a differentiator for our 2023 plan design, but it’s also an important part of how we’re planning to grow in 2024 and part of our bid strategy. The cards allot members a fixed amount of cash typically on a quarterly basis that they can use for OTC as well as food among other purchases. To date, we’ve seen meaningfully higher levels of utilization in the use of these cards than we had anticipated in our 2023 pricing and in our initial outlook. If you roll that forward to the full-year guide, we’ve raised the MBR by 75 basis points to 80 basis points. 10 basis points to 15 basis points is primarily related to the exchange product growth in the SEP and its impact on our MBR.

The remaining 65 bps is related to Medicare Advantage where we presume that the elevated level of trend we observed in the third quarter persist into the fourth quarter, net of some revenue offsets that represents about $550 million of pressure in Medicare. It’s important to note, though, as you look at our full-year guidance, reduction in HCB, there are about 250 million of favorable non-MBR items, which include things like net investment income, fees, and also expenses. And a portion of these tailwinds are expected to persist into 2024. So, as we think about how the MBR pressure in ’23 then impacts ’24, as I mentioned, our ’24 MA bid contemplated higher MA utilization for outpatient and supplemental benefits, although the current experience exceeds the pricing provision.

As it specifically relates to OTC and flex cards, we recognized how customers value this benefit that it would be an important part of how we were going to market in 2024 in the sale of our products. And therefore, we proactively assumed higher utilization in those cards, which is much more consistent with how 2023 has actually played out. Consequently, 25 bps of the incremental 65 bps of the pressure this quarter was contemplated in pricing on account of the OTC and flex cards, while the remaining 40 bps was not. So, as you think about that 40 bps of exposure, there’s a couple of things that we think are offsets. First, as we progressed our stars mitigation and contract diversification efforts, we’re now projecting the 2024 stars will be at the low — the impact will be at the low end of our expectations, or about $800 million versus the prior midpoint expectation of $900 million.

Second, we’ve repriced our individual exchange members as we get into to move forward towards our target margins in 2024. The incremental individual exchange membership coming through SEP actually provides upside opportunity in ’24 as these members get properly documented for risk adjustment. Third, the net investment income tailwinds that we’ve seen will almost certainly persist in light of the current macro environment, which was not previously contemplated. And finally, we expect to achieve the high end of our enterprise cost reduction initiatives, which we previously talked about being $700 million to $800 million next year. All together, we believe these tailwinds can offset a meaningful portion of the incremental 2024 Medicare headwind.

But we’re encouraging investors to focus on the lower half of our ’24 guidance range until we understand where trends are going to stabilize. It’s worth noting, out of an abundance of caution, we preserve the excess 2024 Medicare utilization provision that we talked about in the second quarter inside our updated guidance range for 2024. Brian?

Brian Kane: Thanks, Tom. Let me talk a little bit about the utilization just to build on what Tom was saying and then we can talk about the benefit design, and Justin, your question on margins. With respect to utilization, just to echo what Tom said, obviously, we’ve been through the bids in detail really to understand all the detailed utilization assumptions. And I would just say, after all — everything is fully baked in, including the utilization breakage that Tom discussed, the guide, I believe, fully reflects what’s in our pricing as well as utilization break. So, I feel good about where we are for the 2024 guide that Tom laid out. Just with respect to some other categories, I think it’s important to say that none of the other service categories, besides the outpatient and some of the supplemental benefits that Tom went through, are showing any pressure in-patient is well-controlled, for example, as well as other service categories.