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Next Results Announcement

CVS Health

Revenues

$54.2b

Adjusted EPS

$2.14

For the three months ended 12.31.18

Quarterly Highlights

Consolidated

As a result of the acquisition of Aetna Inc. (“Aetna”), which closed November 28, 2018, the Company established a new Health Care Benefits segment, which is the equivalent of the former Aetna Health Care segment. Certain aspects of Aetna's operations, including products for which the Company no longer solicits or accepts new customers, such as large case pensions and long-term care products, are included in the Company's Corporate/Other segment.

Revenues increased 12.5% and 5.3% for the three months and year ended December 31, 2018, respectively, compared to the prior year. Revenue growth was primarily driven by increased pharmacy network claims in the Pharmacy Services segment, increased prescription volume in the Retail/LTC segment and the addition of Aetna. The increase was partially offset by continued price compression in the Pharmacy Services segment and reimbursement pressure in the Retail/LTC segment, as well as increased generic dispensing.

Operating income declined in both the three months and year ended December 31, 2018 compared to the prior year primarily due to the goodwill impairment charges in the Retail/LTC segment discussed below.

Adjusted operating income increased 4.5% and 2.5% for the three months and year ended December 31, 2018, respectively, compared to the prior year. Earnings growth was primarily driven by increased prescription volume, improved purchasing economics and the addition of Aetna, partially offset by continued price compression in the Pharmacy Services segment and reimbursement pressure in the Retail/LTC segment.

Net loss for both the three months and year ended December 31, 2018 was driven primarily by the goodwill impairment charges in the Retail/LTC segment discussed below, the majority of which are not deductible for income tax purposes, and the increase in interest expense due to the 2018 financing associated with the acquisition of Aetna.

The effective income tax rate was 517.1% and 142.4% for the three months and year ended December 31, 2018, respectively, compared to (17.0)% and 19.8% for the three months and year ended December 31, 2017, respectively. The increase for both periods is due to the goodwill impairment charges in the Retail/LTC segment discussed below, the majority of which are not deductible for income tax purposes, and an income tax benefit of $1.5 billion recorded in the three months and year ended December 31, 2017 which reflected the remeasurement of the Company's net deferred income tax liabilities as a result of the enactment of the Tax Cuts and Jobs Act (“TCJA”). The increase was partially offset by a lower federal corporate income tax rate in 2018 compared to the prior year as a result of the enactment of the TCJA, which reduced the federal corporate income tax rate in 2018 from 35% to 21%.

Pharmacy Services Segment

Revenues increased 2.2% and 2.7% in the three months and year ended December 31, 2018, respectively, compared to the prior year due to increased total pharmacy claims volume, partially offset by continued client pricing pressures.

Total pharmacy claims processed increased 5.6% and 6.1%, on a 30-day equivalent basis, in the three months and year ended December 31, 2018, respectively, compared to the prior year primarily driven by net new business and the continued adoption of Maintenance Choice® offerings.

Operating income increased 2.6% and 0.9% in the three months and year ended December 31, 2018, respectively, compared to the prior year driven by continued pricing compression.

Retail/LTC Segment

Revenues increased 5.4% and 5.8% in the three months and year ended December 31, 2018, respectively, compared to the prior year. The increase in revenues was primarily driven by increased prescription volume and branded drug price inflation, partially offset by continued reimbursement pressure and the impact of recent generic introductions.

Front store revenues remain approximately 23% of total Retail/LTC segment revenues. Front store revenues increased in the three months and year ended December 31, 2018 compared to the prior year primarily driven by increases in health product sales.

Total prescription volume grew 8.6% and 8.8%, on a 30-day equivalent basis, for the three months and year ended December 31, 2018, respectively, compared to the prior year. The growth was driven mainly by the continued adoption of patient care programs and collaborations with PBMs as well as preferred status in a number of Medicare Part D networks during 2018.

Operating income (loss) for the three months and year ended December 31, 2018 reflects goodwill impairment charges of $2.2 billion and $6.1 billion, respectively, related to the LTC reporting unit (described further below). In addition to the goodwill impairment charges, the decline in operating income also was due to increased operating expenses as a result of the investment of a portion of the savings from the TCJA in wages and benefits.

The LTC business has continued to experience industry wide challenges that have impacted our ability to grow the business at the rate that was originally estimated when the Company acquired Omnicare, Inc. in 2015. These challenges include lower occupancy rates in skilled nursing facilities, significant deterioration in the financial health of numerous skilled nursing facility customers which resulted in a number of customer bankruptcies in 2018, and continued facility reimbursement pressures. As a result of these challenges, a goodwill impairment charge of $3.9 billion was recorded during the second quarter of 2018. During the fourth quarter of 2018, the LTC reporting unit missed its forecast primarily due to operational issues and customer liquidity issues, including one significant customer bankruptcy. Additionally, LTC management submitted an updated final budget for 2019 which showed significant additional deterioration in the reporting unit's projected financial results for 2019 compared to the analysis performed in the second quarter of 2018, primarily due to continued industry and operational challenges, which also caused management to make further updates to their long term forecast beyond 2019. Based on these updated financial projections, management determined that there were indicators that the goodwill of the LTC business may be further impaired, and accordingly, an interim goodwill impairment test was performed as of December 31, 2018. The results of the impairment test showed that the fair value of the LTC business was lower than the carrying value resulting in a $2.2 billion goodwill impairment charge. In addition to the lower financial projections, lower market multiples of the peer group companies contributed to the amount of the goodwill impairment charge.

Health Care Benefits Segment

Revenues and operating income for the Health Care Benefits segment include results for the period from November 28, 2018 to December 31, 2018 and therefore are not directly comparable to the former Aetna Health Care segment results for the fourth quarter of 2017.

Medical membership as of December 31, 2018 remained relatively consistent compared with September 30, 2018, reflecting decreases in Commercial insured and Medicaid products, largely offset by increases in Commercial ASC and Medicare products.

Guidance

The Company expects 2019 to be a year of transition as it integrates Aetna and focuses on the key pillars of its growth strategy to create a more consumer-centric health care experience. The Company faces certain headwinds that are having a disproportionate impact on 2019 compared to prior years. Pharmacy reimbursement pressure without the full benefit of traditional offsets is the most significant driver. Historically, reimbursement pressure has been primarily offset by growth in generics as well as inflation on branded pharmaceuticals. The Company will experience a large year-over-year headwind from a lower contribution from break open generics as well as lower branded drug inflation. Additionally, the Company is facing challenges in the long-term care space.

As a result, the Company is taking certain steps to mitigate these headwinds. First, the Retail/LTC segment is enhancing product and service offerings in the front store, while working on a new contract strategy that aligns reimbursement with the products and services it provides to increase adherence and save patients money. Second, the Pharmacy Services Segment will continue to focus on its new Guaranteed Net Cost pricing model, which provides more transparency, simplicity for and alignment with its clients. Third, the Company continues to make progress on its plan to improve its long-term care operations, focusing on operating efficiencies and opportunities with assisting living facilities. Fourth, the Company is expanding its cost reduction efforts across the enterprise, leveraging the legacy productivity initiative work that has already been started. And last, the Company is evaluating all of its assets and the roles they play in enabling the core strategies of the new company.

Taking into account these factors, the Company’s full year 2019 consolidated GAAP operating income is projected to be in the range of approximately $11.8 billion to $12.1 billion and adjusted operating income in the range of approximately $14.8 billion to $15.2 billion. GAAP diluted EPS from continuing operations is projected to be in the range of $4.88 to $5.08 and Adjusted EPS is projected to be in the range of $6.68 to $6.88. The adjustments between GAAP operating income and GAAP diluted EPS from continuing operations and adjusted operating income and Adjusted EPS include adding back amortization of intangible assets and integration costs related to the acquisition of Aetna. The Company expects to continue to generate strong cash flows in 2019, with projected cash flows from operations of between approximately $9.8 billion and $10.3 billion.