CVS Health Corporation — Q2 2020 Form 10-Q
Reporting period: Three and six months ended June 30, 2020; comparisons are with the same 2019 periods. Figures are in U.S. dollars; financial amounts are in millions unless stated otherwise. CVS operates Pharmacy Services, Retail/LTC, Health Care Benefits and Corporate/Other businesses.
Financial performance
| Metric | Q2 2020 | Q2 2019 | First half 2020 | First half 2019 |
|---|---|---|---|---|
| Revenue | $65,341 | $63,431 | $132,096 | $125,077 |
| Operating income | $4,680 | $3,332 | $8,138 | $6,022 |
| Net income attributable to CVS Health | $2,975 | $1,936 | $4,982 | $3,357 |
| Diluted EPS | $2.26 | $1.49 | $3.79 | $2.58 |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $10,424 | $7,286 |
Q2 revenue grew 3.0%; first-half revenue grew 5.6%. Q2 operating margin was approximately 7.2% versus 5.3%; first-half margin was 6.2% versus 4.8%. First-half operating cash flow increased 43.1%. Cash and cash equivalents were $14,869 at June 30, compared with $5,683 at December 31, 2019; cash, cash equivalents and restricted cash totaled $15,145.
Q2 GAAP operating income increased 40.5%, while adjusted operating income rose to $5,328 from $4,031. First-half adjusted operating income was $9,441 versus $7,626. Adjusted operating income is a non-GAAP measure; adjustments include intangible amortization and acquisition integration costs, and the 2019 first half also included a $135 store rationalization charge.
Segments and material changes
- Health Care Benefits: Q2 revenue rose 6.1% to $18,468 and adjusted operating income increased to $3,464 from $1,438. The medical benefit ratio fell to 70.3% from 84.0%; management attributed the sharp improvement principally to deferred elective procedures and other discretionary care during the pandemic. First-half MBR was 76.4% versus 84.0%.
- Retail/LTC: Q2 revenue increased 1.0% to $21,662, but adjusted operating income fell 36.7% to $1,057. Front-store same-store sales declined 4.5%; prescription volume fell 1.1%. Management cited reduced traffic and new prescriptions, COVID-related costs, reimbursement pressure and $27 of uninsured store damage and inventory losses from civil unrest.
- Pharmacy Services: Q2 revenue was broadly flat at $34,889; adjusted operating income increased 2.4% to $1,327. Specialty growth and better purchasing economics were partly offset by client losses and price compression. Claims volume rose, while lower provider visits reduced new therapy prescriptions.
- Corporate/Other: Q2 adjusted operating loss widened to $343 from $202, reflecting lower investment income and higher pandemic-response and transformation costs.
Liquidity, debt and capital
At June 30, total assets were $235,495 and total liabilities were $167,140. Current assets of $62,506 were slightly below current liabilities of $63,694. Long-term debt carrying value was $63,481 and current debt was $8,192; total debt principal was $72,438. The company issued $4.0 billion of senior notes in March, with net proceeds of approximately $3.95 billion held in cash or short-term investments at quarter-end. It paid $1,315 in dividends during the first half and made no share repurchases. The quarterly dividend declared was $0.50 per share.
Operating cash flow benefited from approximately $1.3 billion of deferred estimated tax payments, $225 of deferred payroll taxes and lower medical utilization. The company said it expected to pay approximately $1.0 billion of 2020 health insurer fee in Q3. It had no commercial paper outstanding or borrowings under its backup credit facilities and was in compliance with debt covenants. Debt ratings were Baa2 at Moody’s and BBB at S&P.
Outlook, risks and unusual items
- CVS did not provide a numerical full-year earnings forecast in the supplied filing text. Management warned that COVID-19’s duration, economic effects, utilization patterns and government responses were uncertain and could have a material adverse impact. Earnings cadence may remain unlike historical patterns.
- Management expected higher Health Care Benefits utilization in the second half of 2020, potentially returning near historical levels, alongside COVID-related investments, premium credits and minimum medical-loss-ratio rebates. The unusually low Q2 MBR therefore may not persist.
- The company estimated its 2020 health insurer fee at approximately $1.0 billion; the fee is nondeductible for federal tax purposes and was repealed for years after 2020. Operating expenses included $248 in Q2 and $519 in the first half for the estimated fee.
- Other stated pressures include recession-related membership and payment-collection risks, investment-income and portfolio-value declines, Retail/LTC reimbursement pressure, PBM pricing competition, provider costs, and extensive healthcare regulation.
- Contingencies include opioid-related litigation, PBM and prescription-pricing cases and investigations, usual-and-customary pricing claims, CMS risk-adjustment audits, and other government inquiries. The company said legal accruals were not material, but it could not estimate possible losses beyond amounts accrued for the described matters.
- Goodwill impairment is a risk if forecasts are not achieved, particularly for the LTC reporting unit, whose goodwill was $431 and whose 2019 fair value exceeded carrying value by about 9%. The Commercial Business reporting unit’s 2019 excess was about 4%.
- After quarter-end, on July 31, CVS sold its Coventry workers’ compensation business for $850, subject to working-capital adjustment, and expected a pretax gain of approximately $225 in Q3.
Important facts for investors to verify
- Whether medical utilization rebounded as anticipated in the second half, and the resulting impact on MBR, rebates and benefit costs.
- How much first-half cash-flow strength reflected temporary tax and payroll deferrals and unusually low medical utilization.
- Debt maturities and refinancing, including the $2.75 billion of notes due July 2020 shown at quarter-end as current debt.
- Progress on Retail/LTC reimbursement trends, PBM client retention and price compression, and the sustainability of segment profit changes.
- The outcome and potential financial exposure from legal, regulatory and CMS audit matters, plus goodwill valuation sensitivities.
- Completion economics and recognition of the Coventry divestiture gain, including the final working-capital adjustment.