10-Q 1 cvs-20170930x10q.htm 10-Q cvs_Current_Folio_10Q

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

 

Washington, D.C.  20549

 

FORM 10‑Q

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended September 30, 2017

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                    to                   .

 

Commission File Number 001‑01011

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CVS HEALTH CORPORATION

(Exact name of registrant as specified in its charter)

 

Delaware

05‑0494040

(State of Incorporation)

(I.R.S. Employer Identification Number)

 

One CVS Drive, Woonsocket, Rhode Island 02895

(Address of principal executive offices)

 

Registrant’s telephone number, including area code: (401) 765‑1500

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S‑T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☒ No ☐

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b‑2 of the Exchange Act.

 

 

 

 

Large accelerated filer ☒

    

Accelerated filer ☐

Non-accelerated filer ☐ (Do not check if a smaller reporting company)

 

Smaller reporting company ☐

 

 

Emerging growth company ☐

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  ☐

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒

 

Common Stock, $0.01 par value, issued and outstanding at October 31, 2017:

1,012,992,425 shares

 

 

 

 


 

INDEX

 

 

 

Page

Part I 

 

 

 

 

 

Item 1. 

Financial Statements

3

 

 

 

 

Condensed Consolidated Statements of Income (Unaudited) – Three and Nine Months Ended September 30, 2017 and 2016

3

 

 

 

 

Condensed Consolidated Statements of Comprehensive Income (Unaudited) – Three and Nine Months Ended September 30, 2017 and 2016

4

 

 

 

 

Condensed Consolidated Balance Sheets (Unaudited) – As of September 30, 2017 and December 31, 2016

5

 

 

 

 

Condensed Consolidated Statements of Cash Flows (Unaudited) – Nine Months Ended September 30, 2017 and 2016

6

 

 

 

 

Notes to Condensed Consolidated Financial Statements (Unaudited)

7

 

 

 

 

Report of Independent Registered Public Accounting Firm

24

 

 

 

Item 2. 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

25

 

 

 

Item 3. 

Quantitative and Qualitative Disclosures About Market Risk

42

 

 

 

Item 4. 

Controls and Procedures

42

 

 

 

Part II 

 

43

 

 

 

Item 1. 

Legal Proceedings

43

 

 

 

Item 2. 

Unregistered Sales of Equity Securities and Use of Proceeds

43

 

 

 

Item 6. 

Exhibits

44

 

 

 

Signatures 

45

 

 

 

 


 

 

 

 

 

Part I

Item 1

 

CVS Health Corporation

Condensed Consolidated Statements of Income

(Unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

September 30, 

 

September 30, 

In millions, except per share amounts

    

2017

    

2016

    

2017

    

2016

 

 

 

 

 

 

 

 

 

 

 

 

 

Net revenues

 

$

46,181

 

$

44,615

 

$

136,380

 

$

131,555

Cost of revenues

 

 

39,055

 

 

37,123

 

 

115,739

 

 

110,304

Gross profit

 

 

7,126

 

 

7,492

 

 

20,641

 

 

21,251

Operating expenses

 

 

4,627

 

 

4,668

 

 

14,232

 

 

13,885

Operating profit

 

 

2,499

 

 

2,824

 

 

6,409

 

 

7,366

Interest expense, net

 

 

245

 

 

253

 

 

744

 

 

816

Loss on early extinguishment of debt

 

 

 —

 

 

101

 

 

 —

 

 

643

Other expense

 

 

192

 

 

 7

 

 

206

 

 

23

Income before income tax provision

 

 

2,062

 

 

2,463

 

 

5,459

 

 

5,884

Income tax provision

 

 

777

 

 

921

 

 

2,115

 

 

2,271

Income from continuing operations

 

 

1,285

 

 

1,542

 

 

3,344

 

 

3,613

Loss from discontinued operations, net of tax

 

 

 —

 

 

(1)

 

 

(8)

 

 

(1)

Net income

 

 

1,285

 

 

1,541

 

 

3,336

 

 

3,612

Net income attributable to noncontrolling interest

 

 

 —

 

 

(1)

 

 

(1)

 

 

(2)

Net income attributable to CVS Health

 

$

1,285

 

$

1,540

 

$

3,335

 

$

3,610

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic earnings per share:

 

 

 

 

 

 

 

 

 

 

 

 

Income from continuing operations attributable to CVS Health

 

$

1.26

 

$

1.44

 

$

3.26

 

$

3.34

Loss from discontinued operations attributable to CVS Health

 

$

 —

 

$

 —

 

$

(0.01)

 

$

 —

Net income attributable to CVS Health

 

$

1.26

 

$

1.44

 

$

3.25

 

$

3.34

Weighted average shares outstanding

 

 

1,016

 

 

1,068

 

 

1,022

 

 

1,076

Diluted earnings per share:

 

 

 

 

 

 

 

 

 

 

 

 

Income from continuing operations attributable to CVS Health

 

$

1.26

 

$

1.43

 

$

3.25

 

$

3.32

Loss from discontinued operations attributable to CVS Health

 

$

 —

 

$

 —

 

$

(0.01)

 

$

 —

Net income attributable to CVS Health

 

$

1.26

 

$

1.43

 

$

3.24

 

$

3.32

Weighted average shares outstanding

 

 

1,020

 

 

1,073

 

 

1,026

 

 

1,082

Dividends declared per share

 

$

0.50

 

$

0.425

 

$

1.50

 

$

1.275

 

See accompanying notes to condensed consolidated financial statements.

 

3


 

CVS Health Corporation

Condensed Consolidated Statements of Comprehensive Income

(Unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended September 30, 

 

Nine Months Ended September 30, 

In millions

    

2017

    

2016

    

2017

    

2016

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

1,285

 

$

1,541

 

$

3,336

 

$

3,612

Other comprehensive income:

 

 

 

 

 

 

 

 

 

 

 

 

Foreign currency translation adjustments, net of tax

 

 

 8

 

 

(3)

 

 

 6

 

 

37

Net cash flow hedges, net of tax

 

 

 —

 

 

 1

 

 

 1

 

 

 2

Pension and other postretirement benefits, net of tax

 

 

151

 

 

 —

 

 

151

 

 

 —

Total other comprehensive income (loss)

 

 

159

 

 

(2)

 

 

158

 

 

39

Comprehensive income

 

 

1,444

 

 

1,539

 

 

3,494

 

 

3,651

Comprehensive income attributable to noncontrolling interest

 

 

 —

 

 

(1)

 

 

(1)

 

 

(2)

Comprehensive income attributable to CVS Health

 

$

1,444

 

$

1,538

 

$

3,493

 

$

3,649

 

See accompanying notes to condensed consolidated financial statements.

 

4


 

CVS Health Corporation

Condensed Consolidated Balance Sheets

(Unaudited)

 

 

 

 

 

 

 

 

 

 

September 30, 

 

December 31, 

In millions, except per share amounts

    

2017

    

2016

 

 

 

 

 

 

 

Assets:

 

 

 

 

 

 

Cash and cash equivalents

 

$

2,485

 

$

3,371

Short-term investments

 

 

75

 

 

87

Accounts receivable, net

 

 

12,440

 

 

12,164

Inventories

 

 

14,147

 

 

14,760

Other current assets

 

 

776

 

 

660

Total current assets

 

 

29,923

 

 

31,042

Property and equipment, net

 

 

9,914

 

 

10,175

Goodwill

 

 

38,169

 

 

38,249

Intangible assets, net

 

 

13,303

 

 

13,511

Other assets

 

 

1,544

 

 

1,485

Total assets

 

$

92,853

 

$

94,462

 

 

 

 

 

 

 

Liabilities:

 

 

 

 

 

 

Accounts payable

 

$

7,899

 

$

7,946

Claims and discounts payable

 

 

9,807

 

 

9,451

Accrued expenses

 

 

8,404

 

 

6,937

Short-term debt

 

 

110

 

 

1,874

Current portion of long-term debt

 

 

2,293

 

 

42

Total current liabilities

 

 

28,513

 

 

26,250

Long-term debt

 

 

23,386

 

 

25,615

Deferred income taxes

 

 

4,442

 

 

4,214

Other long-term liabilities

 

 

1,644

 

 

1,549

 

 

 

 

 

 

 

Shareholders’ equity:

 

 

 

 

 

 

CVS Health shareholders’ equity:

 

 

 

 

 

 

Preferred stock, par value $0.01: 0.1 shares authorized; none issued or outstanding

 

 

 

 

Common stock, par value $0.01: 3,200 shares authorized; 1,712 shares issued and 1,013 shares outstanding at September 30, 2017 and 1,705 shares issued and 1,061 shares outstanding at December 31, 2016

 

 

17

 

 

17

Treasury stock, at cost: 698 shares at September 30, 2017 and 643 shares at December 31, 2016

 

 

(37,764)

 

 

(33,452)

Shares held in trust: 1 share at September 30, 2017 and December 31, 2016

 

 

(31)

 

 

(31)

Capital surplus

 

 

32,009

 

 

31,618

Retained earnings

 

 

40,779

 

 

38,983

Accumulated other comprehensive income (loss)

 

 

(147)

 

 

(305)

Total CVS Health shareholders’ equity

 

 

34,863

 

 

36,830

Noncontrolling interest

 

 

 5

 

 

 4

Total shareholders’ equity

 

 

34,868

 

 

36,834

Total liabilities and shareholders’ equity

 

$

92,853

 

$

94,462

 

See accompanying notes to condensed consolidated financial statements.

 

5


 

CVS Health Corporation

Condensed Consolidated Statements of Cash Flows

(Unaudited)

 

 

 

 

 

 

 

 

 

Nine Months Ended

 

 

September 30, 

In millions

    

2017

    

2016

Cash flows from operating activities:

 

 

 

 

 

 

Cash receipts from customers

 

$

133,055

 

$

128,545

Cash paid for inventory and prescriptions dispensed by retail network pharmacies

 

 

(110,788)

 

 

(106,371)

Cash paid to other suppliers and employees

 

 

(11,230)

 

 

(11,020)

Interest received

 

 

15

 

 

14

Interest paid

 

 

(869)

 

 

(954)

Income taxes paid

 

 

(2,040)

 

 

(2,194)

Net cash provided by operating activities

 

 

8,143

 

 

8,020

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

 

Purchases of property and equipment

 

 

(1,412)

 

 

(1,607)

Proceeds from sale-leaseback transactions

 

 

265

 

 

230

Proceeds from sale of property and equipment and other assets

 

 

20

 

 

22

Acquisitions (net of cash acquired) and other investments

 

 

(502)

 

 

(333)

Purchase of available-for-sale investments

 

 

 —

 

 

(40)

Maturities of available-for-sale investments

 

 

21

 

 

76

Net cash used in investing activities

 

 

(1,608)

 

 

(1,652)

 

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

 

Increase (decrease) in short-term debt

 

 

(1,764)

 

 

340

Proceeds from issuance of long-term debt

 

 

 —

 

 

3,455

Repayments of long-term debt

 

 

 —

 

 

(5,185)

Purchase of noncontrolling interest in subsidiary

 

 

 —

 

 

(39)

Payment of contingent consideration

 

 

 —

 

 

(26)

Dividends paid

 

 

(1,539)

 

 

(1,384)

Proceeds from exercise of stock options

 

 

314

 

 

277

Payments for taxes related to net share settlement of equity awards

 

 

(70)

 

 

(72)

Repurchase of common stock

 

 

(4,361)

 

 

(4,000)

Other

 

 

(1)

 

 

(6)

Net cash used in financing activities

 

 

(7,421)

 

 

(6,640)

Effect of exchange rate changes on cash and cash equivalents

 

 

 

 

 2

Net decrease in cash and cash equivalents

 

 

(886)

 

 

(270)

Cash and cash equivalents at the beginning of the period

 

 

3,371

 

 

2,459

Cash and cash equivalents at the end of the period

 

$

2,485

 

$

2,189

 

 

 

 

 

 

 

Reconciliation of net income to net cash provided by operating activities:

 

 

 

 

 

 

Net income

 

$

3,336

 

$

3,612

Adjustments required to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

 

Depreciation and amortization

 

 

1,857

 

 

1,847

Goodwill impairment

 

 

135

 

 

 —

Losses on settlements of defined benefit pension plans

 

 

187

 

 

 —

Stock-based compensation

 

 

173

 

 

166

Loss on early extinguishment of debt

 

 

 —

 

 

643

Deferred income taxes and other noncash items

 

 

271

 

 

119

Change in operating assets and liabilities, net of effects from acquisitions:

 

 

 

 

 

 

Accounts receivable, net

 

 

(280)

 

 

(1,714)

Inventories

 

 

620

 

 

(337)

Other current assets

 

 

(212)

 

 

 2

Other assets

 

 

(15)

 

 

(86)

Accounts payable and claims and discounts payable

 

 

330

 

 

1,570

Accrued expenses

 

 

1,670

 

 

2,149

Other long-term liabilities

 

 

71

 

 

49

Net cash provided by operating activities

 

$

8,143

 

$

8,020

See accompanying notes to condensed consolidated financial statements.

 

6


 

CVS Health Corporation

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Note 1 – Accounting Policies

 

Basis of Presentation

 

The accompanying unaudited condensed consolidated financial statements of CVS Health Corporation and its subsidiaries (collectively, “CVS Health” or the “Company”) have been prepared in accordance with the rules and regulations of the U.S. Securities and Exchange Commission (“SEC”) regarding interim financial reporting. In accordance with such rules and regulations, certain information and accompanying note disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) have been condensed or omitted, although the Company believes the disclosures included herein are adequate to make the information presented not misleading. These condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto, which are included in Exhibit 13 to the Company’s Annual Report on Form 10‑K for the year ended December 31, 2016 (“2016 Form 10‑K”).

 

In the opinion of management, the accompanying unaudited condensed consolidated financial statements include all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the results for the interim periods presented. Because of the influence of various factors on the Company’s operations, including business combinations, certain holidays and other seasonal influences, net income for any interim period may not be comparable to the same interim period in previous years or necessarily indicative of income for the full year.

 

Principles of Consolidation

 

The condensed consolidated financial statements include the accounts of the Company and its majority-owned subsidiaries and variable interest entities (“VIEs”) for which the Company is the primary beneficiary. All material intercompany balances and transactions have been eliminated.

 

The Company continually evaluates its investments to determine if they represent variable interests in a VIE. If the Company determines that it has a variable interest in a VIE, the Company then evaluates if it is the primary beneficiary of the VIE. The evaluation is a qualitative assessment as to whether the Company has the ability to direct the activities of a VIE that most significantly impact the entity’s economic performance. The Company consolidates a VIE if it is considered to be the primary beneficiary.

 

Assets and liabilities of VIEs for which the Company is the primary beneficiary were not significant to the Company’s condensed consolidated financial statements. VIE creditors do not have recourse against the general credit of the Company.

 

Fair Value of Financial Instruments

 

The Company utilizes the three-level valuation hierarchy for the recognition and disclosure of fair value measurements. The categorization of assets and liabilities within this hierarchy is based upon the lowest level of input that is significant to the measurement of fair value. The three levels of the hierarchy consist of the following:

 

·

Level 1 – Inputs to the valuation methodology are unadjusted quoted prices in active markets for identical assets or liabilities that the Company has the ability to access at the measurement date.

 

·

Level 2 – Inputs to the valuation methodology are quoted prices for similar assets and liabilities in active markets, quoted prices in markets that are not active or inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the instrument.

 

·

Level 3 – Inputs to the valuation methodology are unobservable inputs based upon management’s best estimate of inputs market participants could use in pricing the asset or liability at the measurement date, including assumptions about risk.

 

7


 

As of September 30, 2017, the carrying value of cash and cash equivalents, short-term investments, accounts receivable, accounts payable, and the contingent consideration liability included in accrued expenses approximated their fair value due to the nature of these financial instruments. The Company invests in money market funds, commercial paper and time deposits that are classified as cash and cash equivalents within the accompanying condensed consolidated balance sheets, as these funds are highly liquid and readily convertible to known amounts of cash. These investments are classified within Level 1 of the fair value hierarchy because they are valued using quoted market prices. The Company’s short-term investments of $75 million at September 30, 2017 consist of certificates of deposit with initial maturities of greater than three months when purchased that mature within one year from the balance sheet date. These investments, which are classified within Level 1 of the fair value hierarchy, are carried at fair value, which approximated historical cost at September 30, 2017. The carrying amount and estimated fair value of the Company’s total long-term debt was $25.7 billion and $27.0 billion, respectively, as of September 30, 2017. The fair value of the Company’s long-term debt was estimated based on quoted prices currently offered in active markets for the Company’s debt, which is considered Level 1 of the fair value hierarchy.

 

Related Party Transactions

 

The Company has an equity method investment in SureScripts, LLC (“SureScripts”), which operates a clinical health information network. The Pharmacy Services and Retail/LTC segments utilize this clinical health information network in providing services to its client plan members and retail customers. The Company expensed fees for the use of this network of approximately $5 million and $7 million in the three months ended September 30, 2017 and 2016, respectively, and expensed fees for the use of this network of approximately $29 million in the nine months ended September 30, 2017 and 2016. The Company’s investment in and equity in earnings of SureScripts for all periods presented is immaterial.

 

The Company has an equity method investment in Heartland Healthcare Services (“Heartland”). Heartland operates several long-term care pharmacies in four states. Heartland paid the Company approximately $36 million and $46 million for pharmaceutical inventory purchases during the three months ended September 30, 2017 and 2016, respectively, and approximately $106 million and $116 million for pharmaceutical inventory purchases during the nine months ended September 30, 2017 and 2016. Additionally, the Company performs certain collection functions for Heartland and then passes those customer cash collections back to Heartland. The Company’s investment and equity in earnings of Heartland for all periods presented is immaterial.

 

Discontinued Operations

 

In connection with certain business dispositions completed between 1991 and 1997, the Company retained guarantees on store lease obligations for a number of former subsidiaries, including Bob’s Stores and Linens ‘n Things, both of which subsequently filed for bankruptcy. See “Note 12 – Commitments and Contingencies” to the condensed consolidated financial statements. The Company’s discontinued operations include lease-related costs which the Company believes it will likely be required to satisfy pursuant to its lease guarantees.

 

New Accounting Pronouncements Recently Adopted

 

In July 2015, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2015-11, Inventory, which amends Accounting Standard Codification (“ASC”) Topic 330. This ASU simplifies current accounting treatments by requiring entities to measure most inventories at “the lower of cost and net realizable value” rather than using lower of cost or market. This guidance does not apply to inventories measured using the last-in, first-out method or the retail inventory method. The Company adopted this standard effective January 1, 2017. The adoption of this new guidance did not have any impact on the Company’s condensed consolidated results of operations, financial position or cash flows.

 

In March 2016, the FASB issued ASU No. 2016-09, Improvements to Employee Share-Based Payment Accounting, which amends the accounting for certain aspects of shared-based payments to employees in ASC Topic 718, Compensation - Stock Compensation. The new guidance eliminates the accounting for any excess tax benefits and deficiencies through equity, and requires all excess tax benefits and deficiencies related to employee share-based compensation arrangements to be recorded in the income statement. This aspect of the guidance is required to be applied prospectively. The guidance also requires the presentation of excess tax benefits on the statement of cash flows as an operating activity rather than a financing activity, a change which may be applied prospectively or retrospectively. The

8


 

guidance further provides an accounting policy election to account for forfeitures as they occur rather than utilizing the estimated amount of forfeitures at the time of issuance. The Company adopted this guidance effective January 1, 2017. The primary impact of adopting this guidance was the recognition of excess tax benefits in the income statement instead of recognizing them in equity. This income statement guidance was adopted on a prospective basis. As a result, a discrete tax benefit of $18 million and $51 million was recognized in the income tax provision in the three and nine months ended September 30, 2017, respectively.

 

The Company elected to retrospectively adopt the guidance on the presentation of excess tax benefits in the statement of cash flows. The following is a reconciliation of the effect of the resulting reclassification of the excess tax benefits on the Company’s condensed consolidated statement of cash flows for the nine months ended September 30, 2016:

 

 

 

 

 

 

 

 

 

 

 

 

    

As Previously

    

 

 

    

 

 

In millions

 

Reported

 

Adjustments

 

As Revised

Cash paid to other suppliers and employees

 

$

(11,092)

 

$

72

 

$

(11,020)

Net cash provided by operating activities

 

 

7,948

 

 

72

 

 

8,020

Excess tax benefits from stock-based compensation

 

 

72

 

 

(72)

 

 

 —

Net cash used in financing activities

 

 

(6,568)

 

 

(72)

 

 

(6,640)

Reconciliation of net income to net cash provided by operating activities:

 

 

 

 

 

 

 

 

 

Accrued expenses

 

 

2,077

 

 

72

 

 

2,149

 

The Company elected to continue to estimate forfeitures expected to occur to determine the amount of compensation cost to be recognized in each period. None of the other provisions in this guidance had a material impact on the Company’s condensed consolidated financial statements.

 

In March 2017, the FASB issued ASU 2017-07, Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost, which amends ASC Topic 715, Compensation – Retirement Benefits. ASU 2017-17 requires entities to disaggregate the current service cost component from the other components of net benefit cost and present it with other current compensation costs for related employees in the income statement and present the other components of net benefit cost elsewhere in the income statement and outside of operating income. Only the service cost component of net benefit cost is eligible for capitalization. The guidance is effective for interim and annual periods beginning after December 15, 2017. Early adoption is permitted as of the beginning of any annual periods for which an entity’s financial statements have not been issued. Entities are required to retrospectively apply the requirement for a separate presentation in the income statement of service costs and other components of net benefit cost and prospectively adopt the requirement to limit the capitalization of benefit costs to the service component. The Company adopted the income statement presentation aspects of this new guidance on a retrospective basis effective January 1, 2017. Nearly all of the Company’s net benefit costs for the Company’s defined benefit pension and postretirement plans do not contain a service cost component as most of these defined benefit plans have been frozen for an extended period of time. The following is a reconciliation of the effect of the reclassification of the net benefit cost from operating expenses to other expense in the Company’s condensed consolidated statements of income for the three and nine months ended September 30, 2016:

 

 

 

 

 

 

 

 

 

 

 

 

    

As Previously

    

 

 

    

 

 

In millions

 

Reported

 

Adjustments

 

As Revised

Three Months Ended September 30, 2016

 

 

 

 

 

 

 

 

 

Operating expenses

 

$

4,675

 

$

(7)

 

$

4,668

Operating profit

 

 

2,817

 

 

 7

 

 

2,824

Other expense

 

 

 —

 

 

 7

 

 

 7

Nine Months Ended September 30, 2016

 

 

 

 

 

 

 

 

 

Operating expenses

 

 

13,908

 

 

(23)

 

 

13,885

Operating profit

 

 

7,343

 

 

23

 

 

7,366

Other expense

 

 

 —

 

 

23

 

 

23

 

In January 2017, the FASB issued ASU 2017-04, Simplifying the Test for Goodwill Impairment, which amends ASC Topic 350, Intangibles – Goodwill and Other. This ASU requires the Company to perform its annual, or applicable interim, goodwill impairment test by comparing the fair value of each reporting unit with its carrying amount. An impairment charge must be recognized at the amount by which the carrying amount exceeds the fair value of the reporting unit; however, the charge recognized should not exceed the total amount of goodwill allocated to that reporting unit. Income tax effects resulting from any tax deductible goodwill should be considered when measuring a goodwill impairment charge, if applicable. The guidance in ASU 2017-04 is effective for annual or interim goodwill impairment

9


 

tests in fiscal years beginning after December 15, 2019. The Company elected to early adopt this standard as of January 1, 2017. At the date of adoption of this new guidance, the guidance did not have any impact on the Company’s condensed consolidated results of operations, financial position or cash flows.

 

New Accounting Pronouncements Not Yet Adopted

 

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606). ASU 2014-09 outlines a single comprehensive model for companies to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. In March 2016, the FASB issued ASU 2016-08, “Principal Versus Agent Considerations (Reporting Revenue Gross Versus Net),” which amends the principal-versus-agent implementation guidance and in April 2016 the FASB issued ASU 2016-10, “Identifying Performance Obligations and Licensing,” which amends the guidance in those areas in the new revenue recognition standard. Both ASUs were issued in response to feedback received from the FASB-International Accounting Standards Board joint revenue recognition transition resource group. The new revenue standard is effective for annual reporting periods (including interim reporting periods within those periods) beginning January 1, 2018. The Company chose not to early adopt the new standard. Companies have the option of using either a full retrospective or a modified retrospective approach to adopt the standard. The Company intends to adopt the new standard on a modified retrospective basis. The Company formed a project team to assess and implement the new revenue standard and is substantially complete in documenting its accounting policies applying the new revenue guidance. The Company does not expect that the implementation of the new standard will have a material effect on the Company's consolidated results of operations, cash flows or financial position. The new standard will however require more extensive revenue-related disclosures. The Company has identified one difference in its Retail/LTC Segment related to the accounting for its ExtraBucks Rewards customer loyalty program, which is currently accounted for under a cost deferral method. Under the new standard, this program will be accounted for under a revenue deferral method; however, the difference is not expected to be material.

 

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). Lessees will be required to recognize a right-of-use asset and a lease liability for virtually all of their leases (other than leases that meet the definition of a short-term lease). The liability will be equal to the present value of lease payments. The asset will be based on the liability, subject to adjustment, such as for initial direct costs. For income statement purposes, a dual model was retained, requiring leases to be classified as either operating or finance leases. Operating leases will result in straight-line expense (similar to current operating leases) while finance leases will result in a front-loaded expense pattern (similar to current capital leases). Lessor accounting is similar to the current model, but updated to align with certain changes to the lessee model (e.g., certain definitions, such as initial direct costs, have been updated) and the new revenue recognition standard. The standard is effective for public companies for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. Early adoption is permitted. The Company believes that the new standard will have a material impact on its consolidated balance sheet. The Company is currently evaluating the effect that implementation of this standard will have on the Company’s consolidated results of operations, cash flows, financial position and related disclosures.

 

In August 2016, the FASB issued ASU No. 2016-15, Classification of Certain Cash Receipts and Cash Payments. ASU 2016-15 is intended to add or clarify guidance on the classification of certain cash receipts and payments in the statement of cash flows and to eliminate the diversity in practice related to such classifications. The guidance in ASU 2016-15 is required for annual reporting periods beginning after December 15, 2017, with early adoption permitted. The Company is currently evaluating the effect on its consolidated statement of cash flows of adopting this accounting guidance.

 

In November 2016, the FASB issued ASU 2016-18, Statement of Cash Flows, which amends ASC Topic 230. This ASU requires entities to show the changes in the total of cash, cash equivalents, restricted cash and restricted cash equivalents in the statement of cash flows. As a result, entities will no longer be required to present transfers between cash and cash equivalents and restricted cash and restricted cash equivalents in the statement of cash flows. When cash, cash equivalents, restricted cash and restricted cash equivalents are presented in more than one line item on the balance sheet, the new guidance requires a reconciliation of the totals in the statement of cash flows to the related captions in the balance sheet. Entities will also have to disclose the nature of their restricted cash and restricted cash equivalent balances. The guidance is effective for fiscal years beginning after December 15, 2017 and interim periods within those years. Early adoption is permitted. Entities are required to apply the guidance retrospectively. The Company is currently evaluating the effect of adopting this accounting guidance.

 

10


 

Note 2 – Goodwill and Intangible Assets

 

Goodwill is not amortized, but is subject to annual impairment reviews, or more frequent reviews if events or circumstances indicate there may be impairment.

 

Below is a summary of the changes in the carrying value of goodwill by segment for the nine months ended September 30, 2017:

 

 

 

 

 

 

 

 

 

 

 

 

 

Pharmacy

 

 

 

 

 

 

In millions

    

Services

    

Retail/LTC

    

Total

Balance, December 31, 2016

 

$

21,637

 

$

16,612

 

$

38,249

Acquisitions

 

 

 —

 

 

52

 

 

52

Foreign currency translation adjustments

 

 

 —

 

 

 3

 

 

 3

Impairment

 

 

 —

 

 

(135)

 

 

(135)

Balance, September 30, 2017

 

$

21,637

 

$

16,532

 

$

38,169

 

During 2017, the Company began pursuing various strategic alternatives for its RxCrossroads (“RxC”) reporting unit. In connection with this ongoing effort, the Company performed an interim goodwill impairment test in the second quarter of 2017. In conjunction with the impairment test, the fair value of the RxC reporting unit was estimated to be lower than the carrying value, resulting in a $135 million goodwill impairment charge within operating expenses during the second quarter of 2017. The fair value of the RxC reporting unit was determined using a combination of a discounted cash flow method and a market multiple method. During the second quarter of 2017, the Company also performed an impairment test of the intangible assets of the RxC reporting unit and none were impaired. During the third quarter of 2017, the Company performed its required annual impairment tests and concluded there was no impairment of goodwill or trade names.

 

On November 6, 2017, the Company entered into a definitive agreement to sell RxC to McKesson Corporation for $735 million. The transaction is subject to a working capital adjustment and is expected to close in the first quarter of 2018, subject to customary regulatory approvals.

 

The following is a summary of the Company’s intangible assets as of September 30, 2017 and December 31, 2016:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

September 30, 2017

 

December 31, 2016

 

 

    

Gross

    

 

 

    

Net

    

Gross

    

 

 

    

Net

 

 

 

Carrying

 

Accumulated

 

Carrying

 

Carrying

 

Accumulated

 

Carrying

 

In millions

 

Amount

 

Amortization

 

Amount

 

Amount

 

Amortization

 

Amount

 

Trademark (indefinitely-lived)

 

$

6,398

 

$

 —

 

$

6,398

 

$

6,398

 

$

 

$

6,398

 

Customer contracts and relationships and covenants not to compete

 

 

11,848

 

 

(5,345)

 

 

6,503

 

 

11,485

 

 

(4,802)

 

 

6,683

 

Favorable leases and other

 

 

1,151

 

 

(749)

 

 

402

 

 

1,123

 

 

(693)

 

 

430

 

 

 

$

19,397

 

$

(6,094)

 

$

13,303

 

$

19,006

 

$

(5,495)

 

$

13,511

 

 

 

Note 3 – Share Repurchase Programs

 

During the nine months ended September 30, 2017, the Company had the following outstanding share repurchase programs, both of which had previously been authorized by the Company’s Board of Directors:

 

 

 

 

 

 

 

 

In billions

    

 

 

    

 

 

 

 

 

 

 

 

 

Authorization Date

 

Authorized

 

Remaining

November 2, 2016 (“2016 Repurchase Program”)

 

$

15.0

 

$

13.9

December 15, 2014 (“2014 Repurchase Program”)

 

 

10.0

 

 

 —

 

Each of the 2014 and 2016 Repurchase Programs, which were effective immediately, permitted the Company to effect repurchases from time to time through a combination of open market repurchases, privately negotiated transactions, accelerated share repurchase transactions, and/or other derivative transactions. Each of the repurchase programs could be modified or terminated by the Board of Directors at any time. The 2014 Repurchase Program was completed during the second quarter of 2017.

 

11


 

During the three months ended September 30, 2017, the Company repurchased an aggregate of approximately 5.0 million shares of common stock for approximately $0.4 billion pursuant to the 2016 Repurchase Program. During the nine months ended September 30, 2017, the Company repurchased an aggregate of approximately 55.4 million shares of common stock for approximately $4.4 billion pursuant to the 2014 and 2016 Repurchase Programs. This activity includes the accelerated share repurchase agreements (“ASRs”) described below.

 

Pursuant to the authorization under the 2014 Repurchase Program, effective August 29, 2016, the Company entered into two fixed dollar ASRs with Barclays Bank PLC (“Barclays”) for a total of $3.6 billion. Upon payment of the $3.6 billion purchase price on January 6, 2017, the Company received a number of shares of its common stock equal to 80% of the $3.6 billion notional amount of the ASRs or approximately 36.1 million shares, which were placed into treasury stock in January 2017. The ASRs were accounted for as an initial treasury stock transaction for $2.9 billion and a forward contract for $0.7 billion. In April 2017, the Company received 9.9 million shares of common stock, representing the remaining 20% of the $3.6 billion notional amount of the ASRs, thereby concluding the ASRs. The remaining 9.9 million shares of common stock delivered to the Company by Barclays were placed into treasury stock and the forward contract was reclassified from capital surplus to treasury stock in April 2017.

 

At the time they were received, the initial and final receipt of shares resulted in an immediate reduction of the outstanding shares used to calculate the weighted average common shares outstanding for basic and diluted earnings per share.

 

Note 4 – Pension Settlements

 

As of December 31, 2016, the Company sponsored seven defined benefit pension plans. Two of the plans are tax-qualified plans that are funded based on actuarial calculations and applicable federal laws and regulations. The other five plans are unfunded nonqualified supplemental retirement plans. All seven of these plans are closed to new participants. During the three months ended September 30, 2017, the Company settled the pension obligations of its two tax-qualified plans by irrevocably transferring pension liabilities to an insurance company through the purchase of group annuity contracts and through lump sum distributions. These purchases, funded with pension plan assets, resulted in pre-tax settlement losses of $187 million in the three months ended September 30, 2017, related to the recognition of accumulated deferred actuarial losses. The settlement losses are included in other expense in the condensed consolidated statement of income.

 

Note 5 – Accumulated Other Comprehensive Income

 

Accumulated other comprehensive income consists of foreign currency translation adjustments, unrealized losses on cash flow hedges executed in previous years associated with the issuance of long-term debt, and changes in the net actuarial gains and losses associated with pension and other postretirement benefit plans. The following table summarizes the activity within the components of accumulated other comprehensive income.

12


 

Changes in accumulated other comprehensive income (loss) by component is shown on the following tables:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended September 30, 2017 (1)

 

  

 

 

  

 

  

Pension and

  

 

 

 

 

 

 

 

Losses on

 

Other

 

 

 

 

 

Foreign

 

Cash Flow

 

Postretirement

 

 

 

In millions

 

Currency

 

Hedges

 

Benefits

 

Total

Balance, June 30, 2017

 

$

(129)

 

$

(4)

 

$

(173)

 

$

(306)

Other comprehensive income before reclassifications

 

 

 8

 

 

 —

 

 

 —

 

 

 8

Amounts reclassified from accumulated other comprehensive income (2)

 

 

 —

 

 

 —

 

 

151

 

 

151

Net other comprehensive income

 

 

 8

 

 

 —

 

 

151

 

 

159

Balance, September 30, 2017

 

$

(121)

 

$

(4)

 

$

(22)

 

$

(147)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended September 30, 2016 (1)

 

  

 

 

  

 

  

Pension and

  

 

 

 

 

 

 

 

Losses on

 

Other

 

 

 

 

 

Foreign

 

Cash Flow

 

Postretirement

 

 

 

 

 

Currency

 

Hedges

 

Benefits

 

Total

Balance, June 30, 2016

 

$

(125)

 

$

(6)

 

$

(186)

 

$

(317)

Other comprehensive income (loss) before reclassifications

 

 

(3)

 

 

 

 

 —

 

 

(3)

Amounts reclassified from accumulated other comprehensive income (2)

 

 

 —

 

 

 1

 

 

 —

 

 

 1

Net other comprehensive income (loss)

 

 

(3)

 

 

 1

 

 

 —

 

 

(2)

Balance, September 30, 2016

 

$

(128)

 

$

(5)

 

$

(186)

 

$

(319)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Nine Months Ended September 30, 2017 (1)

 

  

 

 

  

 

  

Pension and

  

 

 

 

 

 

 

 

Losses on

 

Other

 

 

 

 

 

Foreign

 

Cash Flow

 

Postretirement

 

 

 

 

 

Currency

 

Hedges

 

Benefits

 

Total

Balance, December 31, 2016

 

$

(127)

 

$

(5)

 

$

(173)

 

$

(305)

Other comprehensive income before reclassifications

 

 

 6

 

 

 —

 

 

 —

 

 

 6

Amounts reclassified from accumulated other comprehensive income (2)

 

 

 —

 

 

 1

 

 

151

 

 

152

Net other comprehensive income

 

 

 6

 

 

 1

 

 

151

 

 

158

Balance, September 30, 2017

 

$

(121)

 

$

(4)

 

$

(22)

 

$

(147)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Nine Months Ended September 30, 2016 (1)

 

  

 

 

  

 

 

  

Pension and

  

 

 

 

 

 

 

 

Losses on

 

Other

 

 

 

 

 

Foreign

 

Cash Flow

 

Postretirement

 

 

 

 

 

Currency

 

Hedges

 

Benefits

 

Total

Balance, December 31, 2015

 

$

(165)

 

$

(7)

 

$

(186)

 

$

(358)

Other comprehensive income before reclassifications

 

 

37

 

 

 

 

 —

 

 

37

Amounts reclassified from accumulated other comprehensive income (2)

 

 

 

 

 2

 

 

 —

 

 

 2

Net other comprehensive income

 

 

37

 

 

 2

 

 

 —

 

 

39

Balance, September 30, 2016

 

$

(128)

 

$

(5)

 

$

(186)

 

$

(319)


(1)

All amounts are net of tax.

(2)

The amounts reclassified from accumulated other comprehensive income for losses on cash flow hedges are recorded within interest expense, net on the condensed consolidated statements of income. The amounts reclassified from accumulated other comprehensive income for pension and other postretirement benefits are included in other expense on the condensed consolidated statements of income.

 

Note 6 – Stock-Based Compensation

 

A summary of stock-based compensation for each of the respective periods is as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

September 30, 

 

September 30, 

In millions

    

2017

    

2016

    

2017

    

2016

Stock-based compensation:

    

 

 

    

 

 

    

 

 

    

 

 

Stock options

 

$

15

 

$

20

 

$

49

 

$

60

Restricted stock units

 

 

50

 

 

38

 

 

124

 

 

106

Total stock-based compensation

 

$

65

 

$

58

 

$

173

 

$

166

13


 

 

During the nine months ended September 30, 2017, the Company granted approximately 4 million stock options with a weighted average fair value of $9.43 and a weighted average fair value exercise price of $78.05. The Company had approximately 21 million stock options outstanding as of September 30, 2017 with a weighted average exercise price of $75.09 and a weighted average contractual term of 3.87 years. During the nine months ended September 30, 2017, the Company granted approximately 3 million restricted stock units with a weighted average fair value of $78.35. The Company had approximately 6 million restricted stock units unvested as of September 30, 2017 with a weighted average fair value of $87.20.

 

Note 7 – Sale-Leaseback Transactions

 

The Company finances a portion of its store development program through sale-leaseback transactions. The properties are generally sold at net book value, which approximates fair value, and the resulting leases typically qualify and are accounted for as operating leases. The Company does not have any retained or contingent interests in the stores and does not provide any guarantees, other than a guarantee of lease payments, in connection with the sale-leaseback transactions. Proceeds from sale-leaseback transactions totaled $265 million and $230 million for the nine months ended September 30, 2017 and 2016, respectively.

 

Note 8 – Store Closures

 

In December 2016, the Company announced an enterprise streamlining initiative designed to reduce costs and enhance operating efficiencies to allow the Company to be more competitive in the current health care environment. In connection with the enterprise streamlining initiative, the Company announced its intention to rationalize the number of retail stores by closing approximately 70 underperforming stores during the year ending December 31, 2017. During the three and nine months ended September 30, 2017, the Company closed five and 68 retail stores, respectively, and recorded charges of $6 million and $211 million, respectively, within operating expenses in the Retail/LTC Segment. The charges are primarily comprised of provisions for the present value of noncancelable lease obligations.

 

The noncancelable lease obligations associated with stores closed during the nine months ended September 30, 2017 extend through the year 2039. In connection with the enterprise streamlining initiative, the Company expects to record additional charges of approximately $9 million during the fourth quarter of 2017 as it continues to rationalize the number of retail stores.

 

Note 9 – Interest Expense, Net

 

The following are the components of interest expense, net:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

September 30, 

 

September 30, 

In millions

    

2017

    

2016

    

2017

    

2016

Interest expense

 

$

250

 

$

258

 

$

759

 

$

830

Interest income

 

 

(5)

 

 

(5)

 

 

(15)

 

 

(14)

Interest expense, net

 

$

245

 

$

253

 

$

744

 

$

816

 

 

Note 10 – Earnings Per Share

 

Earnings per share is computed using the two-class method. Options to purchase 10.9 million and 9.9 million shares of common stock were outstanding, but were not included in the calculation of diluted earnings per share, for the three and nine months ended September 30, 2017, respectively, because the exercise prices of the options were greater than the average market price of the common shares and, therefore, the effect would be antidilutive. For the same reason, options to purchase approximately 7.7 million and 6.4 million shares of common stock were outstanding, but were not included in the calculation of diluted earnings per share for the three and nine months ended September 30, 2016, respectively.

 

14


 

The following is a reconciliation of basic and diluted earnings per share from continuing operations for the respective periods:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

Nine Months Ended