CVS Health Corporation — Q2 2016 Form 10-Q
Reporting period: Three and six months ended June 30, 2016; filed August 2, 2016. CVS Health operates Pharmacy Services, Retail/LTC and Corporate businesses. Results include Omnicare, acquired in August 2015, and Target pharmacies and clinics, acquired in December 2015, so reported growth reflects acquisitions as well as underlying business performance.
Financial performance
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Net revenue | $43.725B | $37.169B | $86.940B | $73.501B |
| Gross profit | $7.015B | $6.402B | $13.759B | $12.566B |
| Operating profit | $2.350B | $2.262B | $4.526B | $4.394B |
| Net income attributable to CVS Health | $924M | $1.272B | $2.070B | $2.493B |
| Diluted EPS | $0.86 | $1.12 | $1.90 | $2.19 |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $4.023B | $3.021B |
- Q2 revenue grew 17.6% and six-month revenue grew 18.3%. Gross profit increased 9.6% and 9.5%, respectively; operating profit rose 3.9% and 3.0%.
- Gross margin was 16.0% in Q2 versus 17.2% a year earlier, and 15.8% for the six months versus 17.1%. Operating margin was 5.4% versus 6.1% in Q2, and 5.2% versus 6.0% for the six months.
- Net income fell 27.4% in Q2 and 17.0% for the six months. The periods included a $542M loss on early debt extinguishment; Q2 net interest expense also rose to $280M from $166M. Diluted EPS comparisons additionally reflect lower weighted-average shares following repurchases.
- Pharmacy Services Q2 revenue rose 20.7% to $29.5B, while operating profit increased to $1.038B from $940M; segment gross margin declined to 4.6% from 5.1%. Retail/LTC revenue rose 16.0% to $20.0B, while operating profit rose to $1.705B from $1.681B; segment gross margin declined to 29.2% from 30.9%.
- Six-month operating cash flow increased by $1.0B, which management attributed primarily to timing of Medicare Part D payments. Investing cash outflow was $1.231B, including $1.102B of capital expenditures. Financing cash outflow was $4.126B, including $3.960B of share repurchases and $929M of dividends. Cash declined to $1.127B from $2.459B at year-end.
- At June 30, total reported debt was approximately $28.6B: $745M short-term debt, $2.291B current long-term debt and $25.600B long-term debt. Long-term debt was rated Baa1 by Moody’s and BBB+ by S&P, both with stable outlooks. Commercial paper outstanding was $745M; the company reported no borrowings under its $3.5B backup credit facilities.
Changes, outlook and notable matters
- Acquisitions, pharmacy network claim growth, specialty pharmacy expansion and higher same-store pharmacy sales supported revenue growth. Management cited continued pricing and reimbursement pressure, price compression and a shift toward lower-margin pharmacy revenue as factors weighing on margins.
- Retail/LTC same-store pharmacy sales rose 3.9% in Q2, but front-store same-store sales fell 2.5%, with softer customer traffic cited. Pharmacy same-store sales were adversely affected by generic introductions and reimbursement pressure.
- Pharmacy Services processed 22.6% more pharmacy network claims in Q2; total generic dispensing reached 85.4%, versus 83.9% a year earlier. Management expected generic dispensing to continue rising, but at a slower pace, and expected competitive pricing and reimbursement pressures to continue.
- The company issued $3.5B of notes in May and used proceeds for general corporate purposes and debt repayment. Tendering notes generated the $542M Q2 charge. A further approximately $102M early-extinguishment loss was expected in Q3 following a July redemption.
- Acquisition-related integration costs in Retail/LTC were $81M for Q2 and $142M for the six months. A $32M charitable contribution to the CVS Foundation and a $32M gain from a credit-card-company legal settlement were recorded in operating expenses.
- No specific numerical earnings or revenue guidance is provided in this filing text. Management said operating cash flows, commercial paper and potential future borrowings were expected to fund cash needs and long-term initiatives. It also identified acquisition integration, reimbursement and competitive pressures, regulatory compliance, and legal proceedings as risks.
- CVS was monitoring potential exposure under approximately 91 legacy store lease guarantees following Vestis/Bob’s Stores bankruptcy; it said it could not estimate a loss range. The filing also describes multiple legal and government investigations. The company said outstanding legal accruals were not material individually or in aggregate, while noting outcomes and potential losses for several matters could not be estimated.
- The independent accountant performed an interim review, not an audit, and reported no material modifications needed for GAAP conformity. Management stated disclosure controls were adequate and effective; integration of acquired businesses’ internal controls was ongoing.
Investor verification priorities
- Separate acquisition-driven growth from organic growth and assess the acquired businesses’ contribution and integration progress.
- Track gross-margin trends, PBM price compression, reimbursement rates, generic mix and retail front-store performance.
- Assess whether operating cash flow remains strong after the disclosed Medicare Part D payment-timing effect, alongside capital spending, dividends and buybacks.
- Verify debt levels, borrowing costs, the subsequent debt-redemption charge and maintenance of investment-grade credit ratings.
- Monitor Bob’s Stores lease guarantees, ongoing government investigations and litigation, including matters for which CVS cannot estimate potential losses.