CVS Health Corporation — Q2 2017 Form 10-Q
Reporting period: Three and six months ended June 30, 2017. CVS operates Pharmacy Services, Retail/LTC, and Corporate segments. Amounts are in U.S. dollars; financial statement amounts are in millions except per-share data.
Financial performance and liquidity
- Q2 revenue: $45.685 billion, up 4.5% year over year. Gross profit was $6.935 billion, down 1.1%; gross margin fell about 85 basis points to 15.2%. Operating profit declined 10.2% to $2.117 billion.
- Q2 earnings: Income from continuing operations was $1.097 billion versus $924 million. Net income attributable to CVS Health was $1.098 billion versus $924 million; diluted EPS was $1.07 versus $0.86. The prior-year quarter included a $542 million debt-extinguishment loss. Lower weighted-average share count also supported per-share results.
- First-half results: Revenue was $90.199 billion, up 3.7%; gross profit was $13.515 billion, down 1.8%, with gross margin down about 85 basis points to 15.0%. Operating profit was $3.910 billion versus $4.542 billion. Net income attributable to CVS Health was $2.050 billion versus $2.070 billion; diluted EPS increased to $1.98 from $1.90.
- Segment trends: Q2 Pharmacy Services revenue rose 9.5% to $32.325 billion and operating profit rose to $1.135 billion from $1.039 billion. Retail/LTC revenue declined 2.2% to $19.554 billion and operating profit fell to $1.411 billion from $1.711 billion. Retail/LTC results included impairment and store-closure charges.
- Cash flow: First-half operating cash flow was $5.532 billion, up from $4.086 billion, primarily reflecting timing of Medicare Part D payments. Investing used $1.174 billion; financing used $5.635 billion. Cash declined $1.277 billion to $2.094 billion.
- Balance sheet and debt: At June 30, cash and short-term investments totaled $2.169 billion; current assets were $29.404 billion and current liabilities $26.857 billion. Short-term debt was $1.100 billion and long-term debt, including its current portion, was $25.664 billion. The company reported compliance with debt covenants and no borrowings on its backup credit facilities.
- Capital returns: CVS repurchased about 50.4 million shares for approximately $4.0 billion in the first half and paid $1.028 billion in dividends. The declared dividend was $0.50 per share for Q2.
Material changes, outlook, and risks
- Pharmacy Services growth reflected new business, higher network claim volume, brand inflation, and specialty pharmacy growth; price compression and generic dispensing partly offset gains. Its total generic dispensing rate rose to 87.2% in Q2 from 85.9%.
- Retail/LTC was pressured by lower same-store sales, reimbursement pressure, generic conversions, and marketplace network restrictions that reduced CVS Pharmacy prescription volume. Management expected those restrictions to continue weighing on prescription growth for the rest of 2017. Management expected generic dispensing rates to keep rising, but more slowly.
- Q2 included a $135 million RxCrossroads goodwill impairment after the company pursued strategic alternatives for the reporting unit. First-half store-closure charges were $205 million; CVS had closed 63 stores and expected about $15 million of additional closure charges in the remainder of 2017. The filing does not provide full-year earnings guidance.
- First-half discontinued operations included a $15 million after-tax-adjusted charge of $15 million net of $6 million tax related to Bob’s Stores lease guarantees; the reported first-half discontinued-operations loss was $8 million. Lease guarantees for about 86 former-subsidiary stores remained, with terms extending as far as 2047.
- Material uncertainties include regulatory and government investigations, litigation involving pharmacy pricing, PBM practices, controlled substances and opioid claims, and evolving healthcare regulation. CVS said it could not reasonably estimate possible losses beyond amounts accrued for the described legal matters; accrued legal matters were not material individually or in aggregate to its financial position.
- Management said operating cash flows, commercial paper, sale-leaseback arrangements and potential borrowings were expected to fund needs and planned initiatives. Long-term debt ratings were investment grade with stable outlooks at Moody’s and S&P. CVS identified lease accounting changes as expected to materially affect its balance sheet; it did not expect adoption of the new revenue standard to have a material financial-statement effect.
Most important facts for investors to verify
- Whether Retail/LTC same-store sales, prescription volume, and reimbursement trends stabilize, especially given network restrictions.
- Whether Pharmacy Services growth and new business offset PBM price compression and the continued sharing of manufacturer rebates with clients.
- The effect of the RxCrossroads strategic review, impairment assumptions, and any subsequent impairment or disposition.
- Actual remaining store-closure costs and the financial exposure from legacy lease guarantees and Bob’s Stores bankruptcy proceedings.
- Developments and potential financial consequences in opioid, Medicare/Medicaid, PBM pricing, insulin and other government investigations and litigation.
- Cash-flow sustainability after the Medicare Part D payment-timing benefit, and the company’s debt and capital-return priorities.
The interim financial statements were reviewed by the independent auditor, not audited.