CVS Health Corporation — Q3 2020 Form 10-Q
Reporting period: Three and nine months ended September 30, 2020. Amounts are in U.S. dollars; financial statement amounts are in millions unless stated otherwise. CVS operates Pharmacy Services, Retail/LTC, Health Care Benefits and Corporate/Other businesses.
Financial results
| Metric | Q3 2020 | Q3 2019 | Nine months 2020 | Nine months 2019 |
|---|---|---|---|---|
| Total revenue | $67.1 billion | $64.8 billion | $199.2 billion | $189.9 billion |
| Operating income | $3.249 billion | $2.928 billion | $11.387 billion | $8.950 billion |
| Net income attributable to CVS Health | $1.224 billion | $1.530 billion | $6.206 billion | $4.887 billion |
| Diluted EPS | $0.93 | $1.17 | $4.72 | $3.75 |
| Adjusted operating income (non-GAAP) | $3.622 billion | $3.947 billion | $13.063 billion | $11.573 billion |
Revenue grew 3.5% in Q3 and 4.9% year to date. Operating margin was approximately 4.8% in Q3 versus 4.5% in 2019, and 5.7% year to date versus 4.7%. Q3 operating income increased 11.0%, but attributable net income fell 20.0%, principally reflecting a $766 million loss on early debt extinguishment and a higher effective tax rate. Nine-month attributable net income rose 27.0%.
Q3 adjusted operating income declined 8.2% year over year; the nine-month measure increased 12.9%. These non-GAAP figures exclude specified items, including intangible amortization, integration costs and divestiture gains or losses.
Segment performance
- Pharmacy Services: Q3 revenue decreased 0.9% to $35.7 billion, while adjusted operating income increased 12.5% to $1.619 billion, supported by purchasing economics and specialty pharmacy growth. Client losses and price compression remained offsets. Claims processed rose 3.7%.
- Retail/LTC: Q3 revenue increased 5.9% to $22.7 billion. Adjusted operating income fell 6.9% to $1.412 billion amid reimbursement pressure, pandemic-related costs and long-term-care weakness. Prescription volume rose 4.6%.
- Health Care Benefits: Q3 revenue grew 8.8% to $18.7 billion, but adjusted operating income fell 24.1% to $1.080 billion, partly due to planned COVID-related investments and divestitures. Medical benefit ratio rose to 84.0% from 83.3%. Year-to-date adjusted operating income increased 36.4%, benefiting from deferred elective and discretionary care; the nine-month MBR fell to 78.9% from 83.7%.
Cash flow, liquidity and debt
- Nine-month operating cash flow was $12.298 billion, up from $10.214 billion. Investing activities used $4.300 billion and financing activities used $4.420 billion. Cash, cash equivalents and restricted cash increased $3.578 billion during the period.
- At September 30, cash and cash equivalents were $9.256 billion; total current assets were $59.211 billion and current liabilities $62.044 billion. The filing reports no commercial paper or revolving-credit borrowings outstanding and approximately $6 billion of unused backup revolving credit facilities.
- Long-term debt carrying value was $66.995 billion, including $5.443 billion classified as current and $61.552 billion as long term. Total debt principal was $67.721 billion. The company issued approximately $8 billion of notes during 2020 and tendered $6 billion of notes in August, incurring the $766 million extinguishment loss.
- CVS reported compliance with debt covenants. Long-term debt was rated Baa2 by Moody’s and BBB by S&P at quarter-end.
- The quarterly dividend was $0.50 per share; $1.50 per share was declared for the first nine months. No common shares were repurchased in the period.
Material changes, outlook and risks
- COVID-19: The pandemic reduced discretionary medical utilization and elective procedures, supporting year-to-date Health Care Benefits results, but also reduced new prescriptions and retail traffic and added operating costs. Management warned that utilization could normalize, provider unit costs could rise, and membership, collections and investment income could be adversely affected. The overall impact remained uncertain and could be material.
- Q4 expectations: Management expected Pharmacy Services to benefit from specialty growth and purchasing economics, partially offset by client losses and price compression. Retail/LTC faced continued reimbursement pressure and pandemic costs, partly offset by diagnostic testing. Health Care Benefits expected more-normal medical utilization, continued COVID-related customer/member investments and seasonal costs. The filing provides no numerical full-year earnings guidance in the supplied text.
- Divestiture and subsequent receipt: CVS sold its Workers’ Compensation business on July 31 for approximately $850 million and recorded a $271 million pretax gain. On October 22, after quarter-end, it received $313 million under the ACA risk-corridor program; CVS expected to recognize about $305 million pretax and $220 million after tax in Q4.
- Health insurer fee: The 2020 fee added $774 million of operating expense for the first nine months; approximately $1.0 billion was paid. The fee was repealed for years after 2020.
- Goodwill and operating risks: The annual goodwill test found no impairment, but the Commercial Business and LTC reporting units exceeded carrying value by only approximately 6% and 12%, respectively. CVS warned that underperformance could lead to a material LTC goodwill impairment; LTC goodwill was $431 million. The filing also cites economic, regulatory, reimbursement, cyber, supply-chain and pandemic-related uncertainties.
- Legal and regulatory matters: CVS disclosed ongoing prescription-pricing, PBM/rebate, opioid, prescription-processing, provider-payment and Medicare/Medicaid audit matters, among others. Management said accrued legal matters were not material individually or in aggregate, but outcomes could be material and it generally could not estimate potential losses beyond accrued amounts. It also guaranteed 76 former-subsidiary store leases, with terms extending through 2030.
Important facts for investors to verify
- How much of year-to-date Health Care Benefits earnings benefited from temporarily reduced medical utilization, and how results respond as care utilization normalizes.
- Whether Pharmacy Services can offset client losses and price compression with specialty growth and improved purchasing economics.
- Retail/LTC reimbursement trends and the financial health of LTC customers, including implications for the LTC goodwill valuation.
- The effects of COVID-related credits, rebates, mandated coverage and medical-cost trends on Q4 and future medical benefit ratios.
- Debt repayment and refinancing plans, liquidity needs and the effect of the $766 million debt-tender loss on reported earnings versus ongoing performance.
- Developments in major litigation, government audits and investigations, and any resulting financial exposure or changes to business practices.