EX-13.1 14 ex131.htm EXHIBIT 13.1 Exhibit


Exhibit 13.1
Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis should be read in conjunction with the audited consolidated financial statements and Cautionary Statement Concerning Forward-Looking Statements that are included in this Annual Report.

Overview of Business

CVS Health Corporation, together with its subsidiaries (collectively, “CVS Health,” the “Company,” “we,” “our” or “us”), is the nation’s premier health innovation company helping people on their path to better health. Whether in one of its pharmacies or through its health services and plans, CVS Health is pioneering a bold new approach to total health by making quality care more affordable, accessible, simple and seamless. CVS Health is community-based and locally focused, engaging consumers with the care they need when and where they need it. The Company has more than 9,900 retail locations, approximately 1,100 walk-in medical clinics, a leading pharmacy benefits manager with approximately 92 million plan members, a dedicated senior pharmacy care business serving more than one million patients per year, expanding specialty pharmacy services, and a leading stand-alone Medicare Part D prescription drug plan. CVS Health also serves an estimated 38 million people through traditional, voluntary and consumer-directed health insurance products and related services, including rapidly expanding Medicare Advantage offerings. The Company believes its innovative health care model increases access to quality care, delivers better health outcomes and lowers overall health care costs.

On November 28, 2018 (the “Aetna Acquisition Date”), the Company acquired Aetna Inc. (“Aetna”) for a combination of cash and CVS Health stock (the “Aetna Acquisition”). The Company acquired Aetna to help improve the consumer health care experience by combining Aetna’s health care benefits products and services with CVS Health’s more than 9,900 retail locations, approximately 1,100 walk-in medical clinics and integrated pharmacy capabilities with the goal of becoming the new, trusted front door to health care. Under the terms of the merger agreement, Aetna shareholders received $145.00 in cash and 0.8378 CVS Health shares for each Aetna share. The transaction valued Aetna at approximately $212 per share or approximately $70 billion. Including the assumption of Aetna’s debt, the total value of the transaction was approximately $78 billion. The Company financed the cash portion of the purchase price through a combination of cash on hand and by issuing approximately $45 billion of new debt, including senior notes and term loans (see “Liquidity and Capital Resources” later in this document). The consolidated financial statements for the year ended December 31, 2018 reflect Aetna’s results subsequent to the Aetna Acquisition Date.

On October 10, 2018, the Company and Aetna entered into a consent decree with the United States Department of Justice (the “DOJ”) that allowed the Company’s proposed acquisition of Aetna to proceed, provided Aetna agreed to sell its individual standalone Medicare Part D prescription drug plans. As part of the agreement reached with the DOJ, Aetna entered into a purchase agreement with a subsidiary of WellCare Health Plans, Inc. for the divestiture of Aetna’s standalone Medicare Part D prescription drug plans effective December 31, 2018. On November 30, 2018, Aetna completed the sale of its standalone Medicare Part D prescription drug plans. Aetna’s standalone Medicare Part D prescription drug plans had an aggregate of approximately 2.3 million members as of December 31, 2018. Aetna will provide administrative services to, and will retain the financial results of, the divested plans through 2019.

As a result of the Aetna Acquisition, the Company added the 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 insurance products, are included in the Company’s Corporate/Other segment. The Company now has four reportable segments: Pharmacy Services, Retail/LTC, Health Care Benefits and Corporate/Other.

Overview of the Pharmacy Services Segment

The Pharmacy Services segment provides a full range of pharmacy benefit management (“PBM”) solutions, including plan design offerings and administration, formulary management, retail pharmacy network management services, mail order pharmacy, specialty pharmacy and infusion services, Medicare Part D services, clinical services, disease management services and medical spend management. The Pharmacy Services segment’s clients are primarily employers, insurance companies, unions, government employee groups, health plans, Medicare Part D prescription drug plans (“PDPs”), Medicaid managed care plans, plans offered on public health insurance exchanges and private health insurance exchanges, other sponsors of health benefit plans and individuals throughout the United States. In addition, the Company is a national provider of drug benefits to eligible beneficiaries under the Medicare Part D prescription drug program. The Pharmacy Services segment operates retail specialty pharmacy stores, specialty mail order pharmacies, mail order dispensing pharmacies, compounding pharmacies and

Page 1


branches for infusion and enteral nutrition services. During the year ended December 31, 2018, the Company’s PBM filled or managed approximately 1.9 billion prescriptions on a 30-day equivalent basis.

Overview of the Retail/LTC Segment

The Retail/LTC segment sells prescription drugs and a wide assortment of general merchandise, including over-the-counter drugs, beauty products, cosmetics and personal care products, provides health care services through its MinuteClinic® walk-in medical clinics and conducts long-term care (“LTC”) pharmacy operations, which distribute prescription drugs and provide related pharmacy consulting and other ancillary services to chronic care facilities and other care settings. Prior to January 2, 2018, the Retail/LTC segment also provided commercialization services under the name RxCrossroads®. The Company divested its RxCrossroads subsidiary on January 2, 2018. As of December 31, 2018, the Retail/LTC segment operated more than 9,900 retail locations, over 1,100 MinuteClinic® locations as well as online retail pharmacy websites, LTC pharmacies and onsite pharmacies. During the year ended December 31, 2018, the Retail/LTC segment filled approximately 1.3 billion prescriptions on a 30-day equivalent basis. In December 2018, the Company held approximately 26% of the United States retail pharmacy market.

Overview of the Health Care Benefits Segment

The Health Care Benefits segment is one of the nation’s leading diversified health care benefits providers, serving an estimated 38 million people as of December 31, 2018. The Health Care Benefits segment has the information and resources to help members, in consultation with their health care professionals, make better informed decisions about their health care. The Health Care Benefits segment offers a broad range of traditional, voluntary and consumer-directed health insurance products and related services, including medical, pharmacy, dental, behavioral health, medical management capabilities, Medicare Advantage and Medicare Supplement plans, PDPs, Medicaid health care management services, workers’ compensation administrative services and health information technology products and services. The Health Care Benefits segment’s customers include employer groups, individuals, college students, part-time and hourly workers, health plans, health care providers (“providers”), governmental units, government-sponsored plans, labor groups and expatriates.

Overview of the Corporate/Other Segment

The Company presents the remainder of its financial results in the Corporate/Other segment, which consists of:

•
Management and administrative expenses to support the overall operations of the Company, which include certain aspects of executive management and the corporate relations, legal, compliance, human resources, information technology and finance departments; and
•
Products for which the Company no longer solicits or accepts new customers such as large case pensions and long-term care insurance products.


Page 2


Results of Operations

Summary of Consolidated Financial Results
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Change
 
Year Ended December 31, 
 
2018 vs. 2017
 
2017 vs. 2016
In millions
2018
    
2017
    
2016
 
$
 
%
 
$
 
%
Revenues:
 
 
 
 
 
 
 
 
 
 
 
 
 
Products
$
183,910

 
$
180,063

 
$
173,377

 
$
3,847

 
2.1
 %
 
$
6,686

 
3.9
 %
Premiums
8,184

 
3,558

 
3,069

 
4,626

 
130.0
 %
 
489

 
15.9
 %
Services
1,825

 
1,144

 
1,080

 
681

 
59.5
 %
 
64

 
5.9
 %
Net investment income
660

 
21

 
20

 
639

 
3,042.9
 %
 
1

 
5.0
 %
Total revenues
194,579

 
184,786

 
177,546

 
9,793

 
5.3
 %
 
7,240

 
4.1
 %
Operating Costs:
 
 
 
 
 
 


 


 


 


Cost of products sold
156,447

 
153,448

 
146,533

 
2,999

 
2.0
 %
 
6,915

 
4.7
 %
Benefit costs
6,594

 
2,810

 
2,179

 
3,784

 
134.7
 %
 
631

 
29.0
 %
Goodwill impairments
6,149

 
181

 
—

 
5,968

 
3,297.2
 %
 
181

 
—
 %
Operating expenses
21,368

 
18,809

 
18,448

 
2,559

 
13.6
 %
 
361

 
2.0
 %
Total operating costs
190,558

 
175,248

 
167,160

 
15,310

 
8.7
 %
 
8,088

 
4.8
 %
Operating income
4,021

 
9,538

 
10,386

 
(5,517
)
 
(57.8
)%
 
(848
)
 
(8.2
)%
Interest expense
2,619

 
1,062

 
1,078

 
1,557

 
146.6
 %
 
(16
)
 
(1.5
)%
Loss on early extinguishment of debt
—

 
—

 
643

 
—

 
—
 %
 
(643
)
 
(100.0
)%
Other expense (income)
(4
)
 
208

 
28

 
(212
)
 
(101.9
)%
 
180

 
642.9
 %
Income before income tax provision
1,406

 
8,268

 
8,637

 
(6,862
)
 
(83.0
)%
 
(369
)
 
(4.3
)%
Income tax provision
2,002

 
1,637

 
3,317

 
365

 
22.3
 %
 
(1,680
)
 
(50.6
)%
Income (loss) from continuing operations
(596
)
 
6,631

 
5,320

 
(7,227
)
 
(109.0
)%
 
1,311

 
24.6
 %
Loss from discontinued operations, net of tax
—

 
(8
)
 
(1
)
 
8

 
(100.0
)%
 
(7
)
 
700.0
 %
Net income (loss)
(596
)
 
6,623

 
5,319

 
(7,219
)
 
(109.0
)%
 
1,304

 
24.5
 %
Net (income) loss attributable to noncontrolling interest
2

 
(1
)
 
(2
)
 
3

 
(300.0
)%
 
1

 
(50.0
)%
Net income (loss) attributable to CVS Health
$
(594
)
 
$
6,622

 
$
5,317

 
$
(7,216
)
 
(109.0
)%
 
$
1,305

 
24.5
 %
 
 
 
 
 
 
 
 
 
 
 
 
 
 

Commentary - 2018 compared to 2017

Revenues
•
Total revenues increased $9.8 billion or 5.3% in 2018 compared to 2017. The increase in total revenues was due to a 2.7% increase in Pharmacy Services segment revenue, a 5.8% increase in Retail/LTC segment revenue and the impact of the Aetna Acquisition (primarily reflected in the Health Care Benefits segment) which occurred in November 2018.
•
Please see “Segment Analysis” later in this document for additional information about the revenues of the Company’s segments.

Operating expenses (including goodwill impairments)
•
Operating expenses increased $8.5 billion or 44.9% in 2018 compared to 2017. The increase in operating expenses was primarily due to higher operating expenses in the Retail/LTC segment including increased goodwill impairment charges in 2018, the impact of the Aetna Acquisition and an increase in acquisition-related transaction and integration costs. The increase was partially offset by a lack of charges associated with store closures in 2018.
•
Operating expenses as a percentage of total revenues was 14.1% in 2018, an increase of 380 basis points compared to 2017. The increase in operating expenses as a percentage of total revenues in 2018 was primarily due to the goodwill impairment charges in the Retail/LTC segment in 2018.
•
Please see “Segment Analysis” later in this document for additional information about the operating expenses of the Company’s segments.

Page 3


Operating income
•
Operating income decreased $5.5 billion or 57.8% in 2018 compared to 2017. The decrease was primarily due to the increase in operating expenses described above, continued price compression in the Pharmacy Services segment and reimbursement pressure in the Retail/LTC segment. The decrease was partially offset by increased prescription volume, improved purchasing economics and the addition of Aetna.
•
Please see “Segment Analysis” later in this document for additional information about the operating income of the Company’s segments.

Interest expense
•
Interest expense increased $1.6 billion during 2018, primarily due to financing activity associated with the Aetna Acquisition. See Note 8 ‘‘Borrowings and Credit Agreements’’ to the consolidated financial statements for additional information.

Other expense (income)
•
Other expense decreased $212 million during 2018, primarily due to 2017 reflecting a $187 million loss on settlement of the Company’s defined benefit pension plans.

Income tax provision
•
The Tax Cuts and Jobs Act (the “TCJA”) was enacted on December 22, 2017. Among numerous changes to existing tax laws, the TCJA permanently reduced the federal corporate income tax rate from 35% to 21% effective January 1, 2018. The Company completed its assessment of the TCJA’s final impact in December 2018 and recorded an additional tax benefit of approximately $100 million.
•
The Company’s effective income tax rate was 142.4% in 2018 compared to 19.8% in 2017. The increase in the effective income tax rate was primarily due to the goodwill impairment charges in the Retail/LTC segment in 2018, the majority of which are not deductible for income tax purposes, and an income tax benefit of $1.5 billion in 2017 which reflected the remeasurement of the Company’s net deferred income tax liabilities as a result of the enactment of the 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 corporate income tax rate in 2018 to 21% from 35% in 2017.

Loss from discontinued operations
•
In connection with certain business dispositions completed between 1991 and 1997, the Company retained guarantees on store lease obligations for a number of former subsidiaries, including Linens ‘n Things, which filed for bankruptcy in 2008, and Bob’s stores, which filed for bankruptcy in 2016. The Company’s loss from discontinued operations includes lease-related costs required to satisfy its Linens ‘n Things and Bob’s Stores lease guarantees.
•
The Company incurred a loss from discontinued operations, net of tax, of $8 million in 2017. Results from discontinued operations were immaterial in 2018.
•
See “Discontinued Operations” in Note 1 ‘‘Significant Accounting Policies’’ to the consolidated financial statements for additional information about discontinued operations and Note 16 ‘‘Commitments and Contingencies’’ to the consolidated financial statements for additional information about the Company’s lease guarantees.

Commentary - 2017 compared to 2016

Revenues
•
Total revenues increased $7.2 billion or 4.1% in 2017 compared to 2016. The increase in total revenues was due to a 8.9% increase in Pharmacy Services segment revenue, partially offset by a 2.1% decrease in Retail/LTC segment revenue.
•
The increase in generic dispensing rates in 2017 negatively affected both the Pharmacy Services and Retail/LTC segment revenues in 2017 compared to 2016.
•
Please see “Segment Analysis” later in this document for additional information about the revenues of the Company’s segments.

Operating expenses (including goodwill impairments)
•
Operating expenses increased $542 million, or 2.9%, in 2017 compared to 2016. The increase in operating expenses primarily relates to (i) higher operating expenses in the Retail/LTC segment including an increase of $181 million in charges associated with the closure of retail stores in connection with the Company’s enterprise streamlining initiative and a $181 million goodwill impairment charge related to the RxCrossroads reporting unit; and (ii) higher operating expenses

Page 4


in the Pharmacy Services segment due to 2016 reflecting the favorable impact of a reversal of an accrual of $85 million in connection with a legal settlement. The increase was partially offset by lower acquisition-related transaction and integration costs due to the bulk of the integration costs related to the acquisition of Omnicare, Inc. (“Omnicare”) being incurred in 2016.
•
Operating expenses as a percentage of total revenues was 10.3% in 2017, a decline of 10 basis points compared to 2016. The decline in operating expenses as a percentage of total revenues in 2017 was primarily due expense leverage from revenue growth.
•
Please see “Segment Analysis” later in this document for additional information about the operating expenses of the Company’s segments.

Operating income
•
Operating income decreased $848 million or 8.2% in 2017 compared to 2016. The decrease was primarily driven by the previously announced restricted networks that excluded CVS Pharmacy, continued price compression in the Pharmacy Services segment, reimbursement pressure in the Retail/LTC segment and the increased operating expenses described above.
•
Please see “Segment Analysis” later in this document for additional information about the operating income of the Company’s segments.

Interest expense
•
Interest expense decreased $16 million during 2017, primarily due to the Company’s debt issuance and debt tender offers that occurred in 2016 which resulted in overall more favorable interest rates on the Company’s long-term debt. See Note 8 ‘‘Borrowings and Credit Agreements’’ to the consolidated financial statements for additional information.

Other expense (income)
•
Other expense increased $180 million during 2017, primarily due to 2017 reflecting a $187 million loss on settlement of the Company’s defined benefit pension plans.

Loss on early extinguishment of debt
•
The loss on early extinguishment of debt of $643 million in 2016 relates to the redemption of approximately $4.2 billion aggregate principal amount of certain of the Company’s senior notes (see Note 8 ‘‘Borrowings and Credit Agreements’’ to the consolidated financial statements). As a result of the redemption, the Company paid a premium of $583 million in excess of the debt principal, wrote off $54 million of unamortized deferred financing costs and incurred $6 million in fees.

Income tax provision
•
The Company’s effective income tax rate was 19.8% in 2017 compared to 38.4% in 2016. The decrease in the effective income tax rate was primarily due to the provisional impact of the TCJA, including the revaluation of net deferred tax liabilities.
•
As the result of the reduction of the corporate income tax rate under the TCJA, the Company estimated the revaluation of its net deferred tax liabilities and recorded a provisional noncash income tax benefit of approximately $1.5 billion in 2017.

Loss from discontinued operations
•
Please see the Commentary - 2018 compared to 2017 section above for additional information about the Company’s discontinued operations.
•
The Company incurred losses from discontinued operations, net of tax, of $8 million and $1 million in 2017 and 2016, respectively.


Page 5


Outlook for 2019

The Company expects 2019 to be a transition year as it integrates the Aetna Acquisition and focuses on key pillars of its growth strategy. The Company believes that it is on track to exceed its 2020 target for synergies from the Aetna Acquisition. The Company also expects that the following challenges may have a disproportionate adverse impact on, and reduce, the operating income of its Pharmacy Services and Retail/LTC segments in 2019 compared to 2018:

•
Ongoing pharmacy reimbursement pressure in the Pharmacy Services and Retail/LTC segments and reductions in the traditional offsets to those pressures, including a declining benefit from the introduction of new multi-source generic prescription drugs and lower benefits from generic dispensing rate increases;
•
The reimbursement pressure in the Pharmacy Services segment is projected to be exacerbated by the cumulative effect on rebate guarantees of lower brand name drug price inflation and a modest 2019 selling season; and
•
The Retail/LTC segment is projected to be impacted by structural and Company specific challenges in the long-term care space as well as the annualization of the Company’s 2018 investment of a portion of the savings from the TCJA in wages and benefits.

The Company is taking specific actions designed to address these challenges and position it well in 2020 and beyond. These actions include new product and service initiatives in its Pharmacy Services and Retail/LTC segments, introducing a new PBM client contracting model, accelerating the action plan designed to improve the performance of the LTC business and initiating a new enterprise cost reduction effort. The Company also is continuing to evaluate its assets and the roles they play in enabling the Company’s core strategies.

The Company’s current expectations described above are forward-looking statements. Please see “Cautionary Statement Concerning Forward-Looking Statements” below for information regarding important factors that may cause the Company’s actual results to differ from those currently projected and/or otherwise materially affect the Company.


Page 6


Segment Analysis

The Company has three operating segments, Pharmacy Services, Retail/LTC and Health Care Benefits, as well as a Corporate/Other segment. The Company evaluates the performance of its operating segments based on operating income (loss) and operating income (loss) before the effect of (i) nonrecurring charges or gains and (ii) certain intersegment activities. The following is a reconciliation of the Company’s segments total revenues and operating income (loss) to the consolidated financial statements:
 
 
 
 
 
 
 
 
 
 
 
 
In millions
Pharmacy
Services(1)(2)
 
Retail/LTC(2)
 
Health Care Benefits(2)
 
Corporate/ Other
 
Intersegment
Eliminations(2)
 
Consolidated
Totals
2018
 
 
 
 
 
 
 
 
 
 
 
Total revenues (3)
$
134,128

 
$
83,989

 
$
5,549

 
$
606

 
$
(29,693
)
 
$
194,579

Operating income (loss) (4)(5)
4,699

 
620

 
276

 
(805
)
 
(769
)
 
4,021

2017
 
 
 
 
 
 
 
 
 
 

Total revenues (7)
130,601

 
79,398

 
—

 
16

 
(25,229
)
 
184,786

Operating income (loss) (4)(5(7)
4,657

 
6,558

 
—

 
(936
)
 
(741
)
 
9,538

2016
 
 
 
 
 
 
 
 
 
 

Total revenues (7)
119,965

 
81,100

 
—

 
18

 
(23,537
)
 
177,546

Operating income (loss) (4)(5)(6)(7)
4,570

 
7,437

 
—

 
(900
)
 
(721
)
 
10,386

 
 
 
 
 
 
 
 
 
 
 
 
_____________________________________________ 
(1)
Total revenues of the Pharmacy Services segment include approximately $11.4 billion, $10.8 billion and $10.5 billion of Retail Co-Payments for 2018, 2017 and 2016, respectively. See Note 1 ‘‘Significant Accounting Policies’’ to the consolidated financial statements for additional information about Retail Co-Payments.
(2)
Intersegment eliminations relate to intersegment revenue generating activities that occur between the Pharmacy Services segment and the Retail/LTC segment for 2018, 2017 and 2016. Effective November 28, 2018, intersegment eliminations also relate to intersegment revenue generating activities that occur between the Health Care Benefits segment, the Pharmacy Services segment and/or the Retail/LTC segment.
(3)
Corporate/Other segment revenues for 2018 include interest income of $536 million related to the proceeds of the $40 billion principal amount of unsecured floating rate notes and unsecured fixed rate senior notes the Company issued on March 9, 2018 (collectively, the “2018 Notes”). This amount is for the period prior to the close of the Aetna Acquisition, which occurred on November 28, 2018.
(4)
Retail/LTC segment operating income for 2018, 2017 and 2016 includes $7 million, $34 million and $281 million, respectively, of acquisition-related integration costs. The integration costs in 2018 and 2017 are related to the acquisition of Omnicare. The integration costs in 2016 are related to the acquisitions of Omnicare and the pharmacy and clinic businesses of Target Corporation (“Target”). Retail/LTC segment operating income for 2018 and 2017 also includes goodwill impairment charges of $6.1 billion related to the LTC reporting unit and $181 million related to the RxCrossroads reporting unit, respectively. In addition, Retail/LTC segment operating income for 2017 and 2016 includes $215 million and $34 million, respectively, of charges associated with store rationalization and asset impairment charges in connection with planned store closures related to the Company’s enterprise streamlining initiative. Retail/LTC segment operating income for 2018 also includes a $43 million loss on impairment of long-lived assets primarily related to the impairment of property and equipment and an $86 million loss on the divestiture of the Company’s RxCrossroads subsidiary.
(5)
Corporate/Other segment operating loss for 2018, 2017 and 2016 includes $485 million, $40 million and $10 million, respectively, of divestiture and acquisition-related transaction and integration costs included in operating expenses in the consolidated statements of operations. The transaction and integration costs in 2018 are related to the acquisitions of Aetna and Omnicare. The transaction and integration costs in 2017 are related to the acquisitions of Aetna and Omnicare and the divestiture of RxCrossroads. The integration costs in 2016 are related to the acquisitions of Omnicare and the pharmacy and clinic businesses of Target.
(6)
Pharmacy Services segment operating income for 2016 includes the reversal of an accrual of $88 million in connection with a legal settlement.
(7)
Amounts revised to reflect the reclassification of interest income from interest expense, net to net investment income within total revenues to conform with insurance company presentation which increased total revenues and operating income by $21 million and $20 million in 2017 and 2016, respectively.


Page 7


Pharmacy Services Segment

The following table summarizes the Pharmacy Services segment’s performance for the respective periods:
 
 
 
 
 
 
 
Change
 
Year Ended December 31,
 
2018 vs. 2017
 
2017 vs. 2016
In millions
2018
 
2017
 
2016
 
$
 
%
 
$
 
%
Revenues:
 
 
 
 
 
 


 


 


 


Products
$
130,264

 
$
126,770

 
$
116,639

 
$
3,494

 
2.8
 %
 
$
10,131

 
8.7
%
Premiums
3,361

 
3,558

 
3,069

 
(197
)
 
(5.5
)%
 
489

 
15.9
%
Services
490

 
268

 
255

 
222

 
82.8
 %
 
13

 
5.1
%
Net investment income (1)
13

 
5

 
2

 
8

 
160.0
 %
 
3

 
150.0
%
Total revenues
134,128

 
130,601

 
119,965

 
3,527

 
2.7
 %
 
10,636

 
8.9
%
Cost of products sold
125,107

 
121,799

 
111,949

 
3,308

 
2.7
 %
 
9,850

 
8.8
%
Benefit costs
2,805

 
2,810

 
2,179

 
(5
)
 
(0.2
)%
 
631

 
29.0
%
Operating expenses (2)
1,517

 
1,335

 
1,267

 
182

 
13.6
 %
 
68

 
5.4
%
Operating expenses % of revenues
1.1
%
 
1.0
%
 
1.1
%
 
 
 
 
 
 
 
 
Operating income (1)
$
4,699

 
$
4,657

 
$
4,570

 
$
42

 
0.9
 %
 
$
87

 
1.9
%
Operating income % of revenues
3.5
%
 
3.6
%
 
3.8
%
 
 
 
 
 
 
 
 
Revenues (by distribution channel): (8)
 
 
 
 
 
 


 


 


 


Pharmacy network (3)(4)
$
83,261

 
$
80,891

 
$
73,686

 
$
2,370

 
2.9
 %
 
$
7,205

 
9.8
%
Mail choice (5)
46,934

 
45,709

 
42,783

 
1,225

 
2.7
 %
 
2,926

 
6.8
%
Other (4)
3,920

 
3,996

 
3,494

 
(76
)
 
(1.9
)%
 
502

 
14.4
%
Pharmacy claims processed: (6)(7)
 
 
 


 


 


 


Total
1,889.8

 
1,781.9

 
1,639.2

 
107.9

 
6.1
 %
 
142.7

 
8.7
%
Pharmacy network (3)
1,601.4

 
1,516.7

 
1,387.7

 
84.7

 
5.6
 %
 
129

 
9.3
%
Mail choice (5)
288.4

 
265.2

 
251.5

 
23.2

 
8.7
 %
 
13.7

 
5.4
%
Generic dispensing rate: (6)(7)
 
 
 
 
 
 
 
 
 
 
 
 
 
Total
87.3
%
 
87.0
%
 
85.9
%
 
 
 
 
 
 
 
 
Pharmacy network (3)
87.9
%
 
87.7
%
 
86.7
%
 
 
 
 
 
 
 
 
Mail choice (5)
83.9
%
 
83.1
%
 
81.4
%
 
 
 
 
 
 
 
 
Mail choice penetration rate (6)(7)
15.3
%
 
14.9
%
 
15.3
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
_____________________________________________ 
(1)
Amounts revised to reflect the reclassification of interest income from interest expense, net to net investment income within revenues to conform with insurance company presentation which increased both net investment income and operating income by $5 million and $2 million in 2017 and 2016, respectively.
(2)
Pharmacy Services segment operating expenses in 2016 include the reversal of an accrual of $88 million in connection with a legal settlement.
(3)
Pharmacy network revenues, pharmacy network claims processed and pharmacy network generic dispensing rate do not include Maintenance Choice® activity, which is included within the mail choice category. Pharmacy network is defined as claims filled at retail and specialty retail pharmacies, including the Company’s retail pharmacies and LTC pharmacies, but excluding Maintenance Choice activity.
(4)
Amounts revised for 2017 and 2016 to reflect the reclassification of Medicare Part D premium revenues from pharmacy network revenues to other revenues.
(5)
Mail choice is defined as claims filled at a Pharmacy Services mail facility, which includes specialty mail claims inclusive of Specialty Connect® claims picked up at a CVS Pharmacy retail store, as well as prescriptions filled at the Company’s retail pharmacies under the Maintenance Choice program, which permits eligible client plan members to fill their maintenance prescriptions through mail order delivery or at a CVS Pharmacy retail store for the same price as mail order..
(6)
Includes the adjustment to convert 90-day prescriptions to the equivalent of three 30-day prescriptions. This adjustment reflects the fact that these prescriptions include approximately three times the amount of product days supplied compared to a normal prescription.
(7)
The pharmacy claims processed, generic dispensing rate and mail choice penetration rate in 2016 have been revised to convert 90-day prescriptions to the equivalent of three 30-day prescriptions.
(8)
Excludes net investment income.


Page 8


Commentary - 2018 compared to 2017

Revenues
•
Total revenues increased $3.5 billion, or 2.7%, to $134.1 billion in 2018 compared to 2017. The increase was primarily due to increased total pharmacy claims volume, partially offset by continued client pricing pressures.
•
As you review the Pharmacy Services segment’s performance in this area, you should consider the following important information about the business:
•
The Company’s mail choice claims processed, on a 30-day equivalent basis, increased 8.7% to 288.4 million claims in 2018 compared to 265.2 million claims in 2017. The increase in mail choice claims was primarily driven by the continued adoption of Maintenance Choice offerings and an increase in specialty pharmacy claims.
•
During 2018, the average revenue per mail choice claim, on a 30-day equivalent basis, decreased by 5.6% compared to 2017 as a result of price compression.
•
The Company’s pharmacy network claims processed, on a 30-day equivalent basis, increased 5.6% to approximately 1.6 billion claims in 2018 compared to approximately 1.5 billion claims in 2017. The increase in the pharmacy network claim volume was primarily due to net new business.
•
During 2018, the average revenue per pharmacy network claim processed, on a 30-day equivalent basis, decreased 2.7% compared to 2017 as a result of continued price compression.
•
The Company’s total generic dispensing rate increased to 87.3% in 2018 compared to 87.0% in 2017. The continued increase in the Company’s generic dispensing rate was primarily due to the impact of new generic drug introductions and the Company’s ongoing efforts to encourage plan members to use generic drugs when they are available and clinically appropriate. The Company believes its generic dispensing rate will continue to increase in future periods, albeit at a slower pace. This increase will be affected by, among other things, the number of new brand and generic drug introductions and the Company’s success at encouraging plan members to utilize generic drugs when they are available and clinically appropriate.

Operating expenses
•
Operating expenses in the Pharmacy Services segment include selling, general and administrative expenses, depreciation and amortization related to selling, general and administrative activities and administrative payroll, employee benefits and occupancy costs.
•
Operating expenses increased $182 million, or 13.6%, in 2018 compared to 2017. The year over year increase in operating expenses was primarily due to:
•
Growth in the business, including acquisitions; and
•
The reinstatement of the Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act of 2010’ s (as amended, collectively, the “ACA’s”) health insurer fee (“HIF”) in 2018;
•
Partially offset by the realization of partially reserved receivables in 2017 which reduced operating expenses.
•
Operating expenses as a percentage of total revenues remained relatively consistent at 1.1% and 1.0% in 2018 and 2017, respectively.

Operating income
•
Operating income increased $42 million, or 0.9%, to $4.7 billion in 2018 compared to 2017. The increase in operating income was primarily due to increased claims volume and improved purchasing economics, partially offset by continued price compression and the increased operating expenses described above.
•
As you review the Pharmacy Services segment’s performance in this area, you should consider the following important information about the business:
•
The Company’s efforts to (i) retain existing clients, (ii) obtain new business and (iii) maintain or improve the rebates and/or discounts the Company receives from manufacturers, wholesalers and retail pharmacies continue to have an impact on operating income. In particular, competitive pressures in the PBM industry have caused the Company and other PBMs to continue to share with clients a larger portion of rebates and/or discounts received from pharmaceutical manufacturers. In addition, marketplace dynamics and regulatory changes have limited the Company’s ability to offer plan sponsors pricing that includes retail network “differential” or “spread,” and the Company expects these trends to continue. The “differential” or “spread” is any difference between the drug price charged to plan sponsors, including Medicare Part D plan sponsors, by a PBM and the price paid for the drug by the PBM to the dispensing provider.

Page 9


Commentary - 2017 compared to 2016

Revenues
•
Total revenues increased $10.6 billion, or 8.9%, to $130.6 billion in 2017 compared to 2016. The increase was primarily due to growth in pharmacy network and specialty pharmacy volume as well as brand name drug price inflation, partially offset by continued price compression and increased generic dispensing.
•
As you review the Pharmacy Services segment’s performance in this area, you should consider the following important information about the business:
•
The Company’s mail choice claims processed, on a 30-day equivalent basis, increased 5.4% to 265.2 million claims in 2017 compared to 251.5 million claims in 2016.
•
During 2017, the Company’s average revenue per mail choice claim, on a 30-day equivalent basis, increased by 1.7% compared to 2016. The increase was primarily due to growth in specialty pharmacy and brand name drug price inflation.
•
The Company’s pharmacy network claims processed, on a 30-day equivalent basis, increased 9.3% to approximately 1.5 billion claims in 2017 compared to approximately 1.4 billion claims in 2016. The increase was primarily due to increased volume from net new business.
•
During 2017, the average revenue per pharmacy network claim processed remained flat on a 30-day equivalent basis.
•
The Company’s total generic dispensing rate increased to 87.0% in 2017 compared to 85.9% in 2016. The increase in the Company’s generic dispensing rate was primarily due to the impact of new generic drug introductions, and the Company’s ongoing efforts to encourage plan members to use generic drugs when they are available and clinically appropriate.

Operating expenses
•
Operating expenses increased $68 million, or 5.4%, in 2017 compared to 2016. The year over year increase in operating expenses was primarily due to an $88 million reversal of an accrual in connection with a legal settlement in 2016 and an increase in costs associated with the growth of the business. The increase was partially offset by the realization of partially reserved receivables in 2017 which reduced operating expenses.
•
Operating expenses as a percentage of revenues remained relatively consistent at 1.0% and 1.1% of revenues in 2017 and 2016, respectively.

Operating income
•
Operating income increased $87 million, or 1.9%, to $4.7 billion in 2017 compared to 2016. The increase in operating income was primarily due to growth in specialty pharmacy, higher generic dispensing and favorable purchasing economics, partially offset by price compression and the increased operating expenses described above.


Page 10


Retail/LTC Segment

The following table summarizes the Retail/LTC segment’s performance for the respective periods:
 
 
 
 
 
 
 
Change
 
Year Ended December 31,
 
2018 vs. 2017
 
2017 vs. 2016
In millions
2018
 
2017
 
2016
 
$
 
%
 
$
 
%
Revenues
 
 
 
 
 
 

 

 

 

Products
$
83,175

 
$
78,522

 
$
80,275

 
$
4,653

 
5.9
 %
 
$
(1,753
)
 
(2.2
)%
Services
814

 
876

 
825

 
(62
)
 
(7.1
)%
 
51

 
6.2
 %
Total revenues
83,989

 
79,398

 
81,100

 
4,591

 
5.8
 %
 
(1,702
)
 
(2.1
)%
Cost of products sold (1)
59,906

 
56,066

 
57,339

 
3,840

 
6.8
 %
 
(1,273
)
 
(2.2
)%
Operating expenses (2)(3)(4)(5)(6)
23,463

 
16,774

 
16,324

 
6,689

 
39.9
 %
 
450

 
2.8
 %
Operating expenses % of revenues
27.9
%
 
21.1
 %
 
20.1
 %
 
 
 
 
 
 
 
 
Operating income (1)(2)(3)(4)(5)(6)
$
620

 
$
6,558

 
$
7,437

 
$
(5,938
)
 
(90.5
)%
 
$
(879
)
 
(11.8
)%
Operating income % of revenues
0.7
%
 
8.3
 %
 
9.2
 %
 
 
 
 
 
 
 
 
Revenues (by major goods/service line):
 
 
 
 
 
 

 

 

 

Pharmacy
$
64,179

 
$
59,528

 
$
60,838

 
$
4,651

 
7.8
 %
 
$
(1,310
)
 
(2.2
)%
Front Store
19,055

 
18,769

 
19,123

 
286

 
1.5
 %
 
(354
)
 
(1.9
)%
Other
755

 
1,101

 
1,139

 
(346
)
 
(31.4
)%
 
(38
)
 
(3.3
)%
Prescriptions filled (7)
1,339.1

 
1,230.5

 
1,223.5

 
108.6

 
8.8
 %
 
7.0

 
0.6
 %
Revenue increase (decrease):
 
 
 
 
 
 
 
 
 
 
 
 
 
Total
5.8
%
 
(2.1
)%
 
12.6
 %
 
 
 
 
 
 
 
 
Pharmacy
7.8
%
 
(2.2
)%
 
15.9
 %
 
 
 
 
 
 
 
 
Front Store
1.5
%
 
(1.9
)%
 
0.3
 %
 
 
 
 
 
 
 
 
Total prescription volume (7)
8.8
%
 
0.6
 %
 
18.6
 %
 
 
 
 
 
 
 
 
Same store sales increase (decrease): (8)
 
 
 
 
 
 
 
 
 
 
 
 
 
Total
6.0
%
 
(2.6
)%
 
1.9
 %
 
 
 
 
 
 
 
 
Pharmacy
7.9
%
 
(2.6
)%
 
3.2
 %
 
 
 
 
 
 
 
 
Front Store
0.5
%
 
(2.6
)%
 
(1.5
)%
 
 
 
 
 
 
 
 
Prescription volume (7)
9.1
%
 
0.4
 %
 
3.6
 %
 
 
 
 
 
 
 
 
Generic dispensing rate
87.5
%
 
87.3
 %
 
85.7
 %
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
_____________________________________________ 
(1)
Cost of products sold and operating income for 2017 include $2 million of acquisition-related integration costs related to the acquisition of Omnicare.
(2)
Operating expenses and operating income in 2018, 2017 and 2016 include $7 million, $32 million and $235 million, respectively, of acquisition-related integration costs. In 2018 and 2017, the integration costs related to the acquisition of Omnicare. In 2016, the integration costs related to the acquisitions of Omnicare and the pharmacy and clinic businesses of Target.
(3)
Operating expenses and operating income for 2018 and 2017 include goodwill impairment charges of $6.1 billion related to the LTC reporting unit and $181 million related to the RxCrossroads reporting unit, respectively.
(4)
Operating expenses and operating income for 2017 and 2016 include $215 million and $34 million, respectively, of charges associated with store rationalization and asset impairment charges in connection with planned store closures related to the Company’s enterprise streamlining initiative.
(5)
Operating expenses and operating income for 2018 include a $43 million loss on impairment of long-lived assets primarily related to the impairment of property and equipment.
(6)
Operating expenses and operating income for 2018 include an $86 million loss on the divestiture of the Company’s RxCrossroads subsidiary.
(7)
Includes the adjustment to convert 90‑day, non-specialty prescriptions to the equivalent of three 30‑day prescriptions. This adjustment reflects the fact that these prescriptions include approximately three times the amount of product days supplied compared to a normal prescription.
(8)
Same store sales and prescription volume exclude revenues from MinuteClinic, and revenue and prescriptions from stores in Brazil, LTC operations and commercialization services.
 

Page 11


Commentary - 2018 compared to 2017

Revenues
•
Total revenues increased approximately $4.6 billion, or 5.8%, to $84.0 billion in 2018 compared to 2017. The increase was primarily driven by increased prescription volume and brand name drug price inflation, partially offset by continued reimbursement pressure and the impact of recent generic introductions.
•
As you review the Retail/LTC segment’s performance in this area, you should consider the following important information about the business:
•
Front store same store sales increased 0.5% in 2018 compared to 2017. Front store sales in 2018 continued to benefit from increases in health product sales.
•
Pharmacy same store sales increased 7.9% in 2018 compared to 2017. The increase was driven by the 9.1% increase in pharmacy same store prescription volumes on a 30-day equivalent basis due to (i) continued adoption of patient care programs, (ii) collaborations with PBMs, and (iii) the Company’s preferred status in a number of Medicare Part D networks during 2018. The increase was also due to the impact of year over year brand name drug price inflation that occurred primarily in the first three months of 2018.
•
Pharmacy revenue continues to be adversely affected by the conversion of brand name drugs to equivalent generic drugs, which typically have a lower selling price. The generic dispensing rate grew to 87.5% in 2018 compared to 87.3% in 2017. In addition, pharmacy revenue growth has also been negatively affected by continued reimbursement pressure.
•
2017 revenues include approximately $0.4 billion related to the Company’s RxCrossroads subsidiary which was sold on January 2, 2018.
•
Pharmacy revenue growth has been adversely affected by industry challenges in the LTC business, such as continuing lower occupancy rates at skilled nursing facilities, as well as the deteriorating financial health of many skilled nursing facilities which resulted in a number of customer bankruptcies in 2018.
•
Pharmacy revenue in 2018 continued to benefit from the Company’s ability to attract and retain managed care customers and the increased use of pharmaceuticals by an aging population as the first line of defense for health care.

Operating expenses (including goodwill impairments)
•
Operating expenses in the Retail/LTC segment include store payroll, store employee benefits, store occupancy costs, selling expenses, advertising expenses, depreciation and amortization expense and certain administrative expenses.
•
Operating expenses increased $6.7 billion, or 39.9%, in 2018 compared to 2017. The increase in operating expenses in 2018 was primarily due to:
•
A goodwill impairment charge of $6.1 billion in 2018 in the LTC reporting unit (see Note 5 ‘‘Goodwill and Other Intangibles’’ to the consolidated financial statements), as compared to a $181 million goodwill impairment charge in the RxCrossroads reporting unit recorded in 2017 in connection with the upcoming sale of RxCrossroads. See the discussion of goodwill under “Critical Accounting Policies” later in this document;
•
An $86 million pre-tax loss on the sale of the RxCrossroads subsidiary in 2018;
•
A $43 million impairment of long-lived assets in 2018; and
•
An increase in operating expenses due to (i) the investment of a portion of the savings from the TCJA in wages and benefits, (ii) increased prescription volume described previously, (iii) incremental costs associated with operating more stores and (iv) other investments in the business to drive revenue growth;
•
Partially offset by lower operating expenses as a result of a lack of charges associated with store closures in 2018, for which the Company incurred $215 million in connection with its enterprise streamlining initiative in 2017; and
•
A decrease in hurricane-related expenses of $25 million in 2018 compared to 2017.
•
Operating expenses as a percentage of total revenues were 27.9% in 2018 compared to 21.1% in 2017. The increase in operating expenses as a percentage of total revenues was driven by the increased goodwill impairment charges in 2018.

Operating income
•
Operating income decreased $5.9 billion, or 90.5%, to approximately $620 million in 2018 compared to 2017. The decrease in operating income was driven primarily by the increased operating expenses described above.

Page 12


•
As you review the Retail/LTC segment’s performance in this area, you should consider the following important information about the business:
•
The Company’s pharmacy operating income has been adversely affected by the efforts of managed care organizations, PBMs and governmental and other third-party payors to reduce their prescription drug costs, including the use of restrictive networks, as well as changes in the mix of business within the pharmacy portion of the Retail/LTC Segment. If the reimbursement pressure accelerates, the Company may not be able grow revenues, and its operating income could be adversely affected.
•
The increased use of generic drugs has positively impacted the Company’s operating income but has resulted in third-party payors augmenting their efforts to reduce reimbursement payments to retail pharmacies for prescriptions. This trend, which the Company expects to continue, reduces the benefit the Company realizes from brand to generic product conversions.

Commentary - 2017 compared to 2016

Revenues
•
Total revenues decreased approximately $1.7 billion, or 2.1%, to $79.4 billion in 2017 compared to 2016. The decrease was primarily due to a decline in same store sales as a result of the previously-announced marketplace changes that restrict CVS Pharmacy from participating in certain networks.
•
As you review the Retail/LTC segment’s performance in this area, you should consider the following important information about the business:
•
Front store same store sales declined 2.6% in 2017 compared to 2016 and were negatively impacted approximately 30 basis points due to the absence of leap day in 2017. The decrease was primarily driven by softer customer traffic and efforts to rationalize promotional strategies, partially offset by an increase in basket size.
•
Pharmacy same store sales declined 2.6% in 2017 compared to 2016. Pharmacy same store sales were negatively impacted by approximately 390 basis points due to recent generic introductions. Same store prescription volumes increased 0.4%, despite the approximately 420 basis point negative impact from previously-discussed marketplace changes that restrict CVS Pharmacy from participating in certain networks.
•
Pharmacy revenue continues to be negatively impacted by the conversion of brand name drugs to equivalent generic drugs, which typically have a lower selling price. The generic dispensing rate grew to 87.3% in 2017 compared to 85.7% in 2016. In addition, pharmacy revenue growth has also been negatively affected by the mix of drugs sold, continued reimbursement pressure and the lack of significant new brand name drug introductions.
•
Pharmacy revenue in 2017 continued to benefit from the Company’s ability to attract and retain managed care customers, and the increased use of pharmaceuticals by an aging population as the first line of defense for health care.

Operating expenses (including goodwill impairment)
•
Operating expenses increased $450 million, or 2.8% in 2017. The increase in operating expenses in 2017 was due primarily to:
•
An increase of $181 million in charges associated with the closure of retail stores in connection with the Company’s enterprise streamlining initiative;
•
A goodwill impairment charge of $181 million related to the RxCrossroads reporting unit, which was subsequently sold on January 2, 2018;
•
Hurricane related costs of $55 million; and
•
Costs associated with new store openings
•
Operating expenses as a percentage of total revenues were 21.1% in 2017 compared to 20.1% in 2016. The increase in 2017 was primarily due to a decline in expense leverage with the loss of business from the previously discussed marketplace changes that restrict CVS Pharmacy from participating in certain networks.

Operating income
•
Operating income decreased $879 million, or 11.8%, to approximately $6.6 billion in 2017 compared to 2016. The decrease in operating income was driven primarily by the increased operating expenses described above and reimbursement pressure.


Page 13


Health Care Benefits Segment

On November 28, 2018, the Company completed the Aetna Acquisition. The Health Care Benefits segment is the equivalent of the former Aetna Health Care segment.

The following table summarizes the Health Care Benefits segment’s performance for the period from November 28, 2018 to December 31, 2018:
In millions
 
Revenues:
 
Products
$
164

Premiums
4,819

Services
521

Net investment income
45

Total revenues
5,549

Cost of products sold
147

Benefit costs
3,873

Operating expenses
1,253

Operating income
$
276

 
 

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.

Health Care Benefits segment medical membership as of December 31, 2018 was as follows:
 
 
 
 
 
 
In thousands
Insured
 
ASC (1)
 
Total
Medical membership:
 
 
 
 
 
Commercial
3,871

 
13,888

 
17,759

Medicare Advantage
1,758

 
—

 
1,758

Medicare Supplement
793

 
—

 
793

Medicaid
1,128

 
663

 
1,791

Total medical membership
7,550

 
14,551

 
22,101

 
 
 
 
 
 
_____________________________________________ 
(1)
Represents self-insured membership under Administrative Services Contracts.

Medical Membership
Medical membership as of December 31, 2018 remained relatively consistent compared with December 31, 2017, reflecting decreases in Commercial insured and Medicaid products, largely offset by increases in Commercial ASC and Medicare products.

Corporate/Other Segment

Commentary - 2018 compared to 2017

Revenues
•
Revenues in 2018 reflect (i) revenues associated with products for which the Company no longer solicits or accepts new customers, such as large case pensions and long-term care insurance products, that were acquired in the Aetna Acquisition and (ii) interest income related to the $40 billion of senior notes issued on March 9, 2018 to partially fund the Aetna Acquisition.


Page 14


Operating expenses
•
Operating expenses within the Corporate/Other segment include executive management, corporate relations, legal, compliance, human resources, information technology, finance related costs and acquisition-related transaction and integration costs. After the Aetna Acquisition Date, such operating expenses also include operating costs to support the large case pensions and long-term care insurance products acquired in the Aetna Acquisition.
•
Operating expenses increased $437 million, or 45.9%, in 2018 compared to 2017. The increase was primarily driven by an increase in acquisition-related transaction and integration costs of $454 million in 2018.

Commentary - 2017 compared to 2016
 
Operating expenses
•
Operating expenses within the Corporate/Other segment include executive management, corporate relations, legal, compliance, human resources, information technology, finance related costs and acquisition-related transaction and integration costs.
•
Operating expenses increased $34 million, or 3.7%, in 2017 compared to 2016. The increase was due to (i) ongoing investments in strategic initiatives, (ii) increased employee benefit costs and (iii) increased divestiture and acquisition-related costs, primarily related to $34 million of transaction costs in 2017 associated with the Aetna Acquisition.

Liquidity and Capital Resources

Cash Flows

The Company maintains a level of liquidity sufficient to allow it to meet its cash needs in the short-term. Over the long term, the Company manages its cash and capital structure to maximize shareholder return, maintain its financial condition and maintain flexibility for future strategic initiatives. The Company continuously assesses its regulatory capital requirements, working capital needs, debt and leverage levels, debt maturity schedule, capital expenditure requirements, dividend payouts, potential share repurchases and future investments or acquisitions. The Company believes its operating cash flows, commercial paper program, credit facilities, sale-leaseback program, as well as any potential future borrowings, will be sufficient to fund these future payments and long-term initiatives.

The net change in cash, cash equivalents and restricted cash for the years ended December 31, 2018, 2017 and 2016 is as follows:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Change
 
Year Ended December 31,
 
2018 vs. 2017
 
2017 vs. 2016
In millions
2018
 
2017
 
2016
 
$
 
%
 
$
 
%
Net cash provided by operating activities
$
8,865

 
$
8,007

 
$
10,141

 
$
858

 
11
 %
 
$
(2,134
)
 
(21
)%
Net cash used in investing activities
(43,285
)
 
(2,877
)
 
(2,470
)
 
(40,408
)
 
1,405
 %
 
(407
)
 
16
 %
Net cash provided by (used in) financing activities
36,819

 
(6,751
)
 
(6,761
)
 
43,570

 
(645
)%
 
10

 
—
 %
Effect of exchange rate changes on cash, cash equivalents and restricted cash
(4
)
 
1

 
2

 
(5
)
 
(500
)%
 
(1
)
 
(50
)%
Net increase (decrease) in cash, cash equivalents and restricted cash
$
2,395

 
$
(1,620
)
 
$
912

 
$
4,015

 
(248
)%
 
$
(2,532
)
 
(278
)%
 
 
 
 
 
 
 
 
 
 
 
 
 
 


Page 15


Commentary - 2018 compared to 2017

•
Net cash provided by operating activities increased by $858 million in 2018 due primarily to the timing of client payments and the timing of payments for the Company’s Medicare Part D operations.
•
Net cash used in investing activities increased by $40.4 billion in 2018 largely driven by the Aetna Acquisition in November 2018. In addition, cash used in investing activities reflected the following activity:
•
Gross capital expenditures remained relatively consistent at approximately $2.0 billion and $1.9 billion in 2018 and 2017, respectively. During 2018, approximately 21% of the Company’s total capital expenditures were for new store construction, 32% were for store, fulfillment and support facilities expansion and improvements and 47% were for technology and other corporate initiatives.
•
The Company did not complete any sale-leaseback transactions in 2018 compared to $265 million in 2017. Under the sale-leaseback transactions, the properties generally are sold at net book value, which generally approximates fair value, and the resulting leases generally qualify and are accounted for as operating leases. The specific timing and amount of future sale-leaseback transactions will vary depending on future market conditions and other factors.
•
Net cash provided by financing activities was $36.8 billion in 2018 compared to net cash used in financing activities of $6.8 billion in 2017. The cash provided by financing activities in 2018 primarily related to long-term borrowings to partially fund the Aetna Acquisition.

Commentary - 2017 compared to 2016

•
Net cash provided by operating activities decreased by $2.1 billion, in 2017 due primarily to the timing of payments for the Company’s Medicare Part D operations.
•
Net cash used in investing activities increased by $407 million in 2017 largely driven by an increase in acquisition activity as compared to 2016. In addition, cash used in investing activities reflected the following activity:
•
Gross capital expenditures in 2017 totaled approximately $1.9 billion, a decrease of $306 million compared to prior year. The decrease in 2017 capital expenditures is due to the Target integration being completed in 2016. During 2017, approximately 25% of the Company’s total capital expenditures were for new store construction, 30% were for store, fulfillment and support facilities expansion and improvements and 45% were for technology and other corporate initiatives.
•
Proceeds from sale-leaseback transactions totaled $265 million in 2017 compared to $230 million in 2016.
•
Net cash used in financing activities was $6.8 billion in both 2017 and 2016 as net borrowings and net payments to shareholders were relatively flat in both years.

Included in net cash used in investing activities for the years ended December 31, 2018, 2017 and 2016 was the following store development activity (1):
 
 
 
 
 
 
 
2018
 
2017
 
2016
Total stores (beginning of year)
9,846

 
9,750

 
9,665

New and acquired stores (2)
148

 
179

 
132

Closed stores (2)
(27
)
 
(83
)
 
(47
)
Total stores (end of year)
9,967

 
9,846

 
9,750

Relocated stores (2)
34

 
30

 
50

 
 
 
 
 
 
_____________________________________________ 
(1)
Includes retail drugstores, certain onsite pharmacy stores, retail specialty pharmacy stores and pharmacies within Target stores.
(2)
Relocated stores are not included in new and acquired stores or closed stores totals.

Short-term Borrowings

Commercial Paper and Back-up Credit Facilities
The Company had approximately $720 million and $1.3 billion of commercial paper outstanding at weighted average interest rates of 2.8% and 2.0% as of December 31, 2018 and 2017, respectively. In connection with its commercial paper program, the Company maintains a $1.75 billion 364-day unsecured back-up revolving credit facility, which expires on May 16, 2019, a $1.25 billion, five-year unsecured back-up revolving credit facility, which expires on July 1, 2020, a $1.0 billion, five-year

Page 16


unsecured back-up revolving credit facility, which expires on May 18, 2022, and a $2.0 billion, five-year unsecured back-up revolving credit facility, which expires on May 17, 2023. The credit facilities allow for borrowings at various rates that are dependent, in part, on the Company’s public debt ratings and require the Company to pay a weighted average quarterly facility fee of approximately .03%, regardless of usage. As of December 31, 2018 and 2017, there were no borrowings outstanding under any of the back-up credit facilities.

Bridge Loan Facility
On December 3, 2017, in connection with the Aetna Acquisition, the Company entered into a $49.0 billion unsecured bridge loan facility commitment. The Company paid $221 million in fees upon entering into the agreement. The fees were capitalized in other current assets and were amortized as interest expense over the period the bridge loan facility commitment was outstanding. The bridge loan facility commitment was reduced to $44.0 billion on December 15, 2017 upon the Company entering into a $5.0 billion term loan agreement. The Company recorded $56 million of amortization of the bridge loan facility fees during the year ended December 31, 2017, which was recorded in interest expense in the consolidated statements of operations.

On March 9, 2018, the Company issued unsecured senior notes with an aggregate principal amount of $40.0 billion (see “Long-term Borrowings - 2018 Notes” below). At this time, the bridge loan facility commitment was reduced to $4.0 billion, and the Company paid $8 million in fees to retain the bridge loan facility commitment through the Aetna Acquisition Date. Those fees were capitalized in other current assets and were amortized as interest expense over the period the bridge loan facility commitment was outstanding. The Company recorded $173 million of amortization of the bridge loan facility commitment fees during the year ended December 31, 2018, which was recorded in interest expense in the consolidated statement of operations. On October 26, 2018, the Company entered into a $4.0 billion unsecured 364-day bridge term loan agreement to formalize the bridge loan facility discussed above. On November 28, 2018, in connection with the Aetna Acquisition, the $4.0 billion unsecured 364-day bridge term loan agreement terminated.

Federal Home Loan Bank of Boston
Since the Aetna Acquisition Date, a subsidiary of the Company is a member of the Federal Home Loan Bank of Boston (the “FHLBB”). As a member, the subsidiary has the ability to obtain cash advances, subject to certain minimum collateral requirements. The maximum borrowing capacity available from the FHLBB as of December 31, 2018 was approximately $790 million. As of December 31, 2018, there were no outstanding advances from the FHLBB.

Long-term Borrowings

2018 Notes
On March 9, 2018, the Company issued an aggregate of $40.0 billion in principal amount of the 2018 Notes for total proceeds of approximately $39.4 billion, net of discounts and underwriting fees. The net proceeds of the 2018 Notes were used to fund a portion of the Aetna Acquisition. The 2018 Notes are comprised of the following:
 
 
In millions
 
3.125% senior notes due March 2020
$
2,000

Floating rate notes due March 2020
1,000

3.35% senior notes due March 2021
3,000

Floating rate notes due March 2021
1,000

3.7% senior notes due March 2023
6,000

4.1% senior notes due March 2025
5,000

4.3% senior notes due March 2028
9,000

4.78% senior notes due March 2038
5,000

5.05% senior notes due March 2048
8,000

Total debt principal
$
40,000


Term Loan Agreement
On December 15, 2017, in connection with the Aetna Acquisition, the Company entered into a $5.0 billion term loan agreement. The term loan facility under the term loan agreement consists of a $3.0 billion three-year tranche and a $2.0 billion five-year tranche. The term loan agreement allows for borrowings at various rates that are dependent, in part, on the Company’s debt ratings. In connection with the Aetna Acquisition, the Company borrowed $5.0 billion (a $3.0 billion three-year tranche

Page 17


and a $2.0 billion five-year tranche) under the term loan agreement in November 2018. The Company terminated the $2.0 billion five-year tranche in December 2018 with the repayment of the borrowing. As of December 31, 2018, the Company had $3.0 billion outstanding under the three-year tranche of the term loan agreement.

Aetna Related Debt
Upon the closing of the Aetna Acquisition, the Company assumed long-term debt with a fair value of $8.1 billion with stated interest rates ranging from 2.2% to 6.75%.

2016 Notes
On May 16, 2016, the Company issued $1.75 billion aggregate principal amount of 2.125% unsecured senior notes due June 1, 2021 and $1.75 billion aggregate principal amount of 2.875% unsecured senior notes due June 1, 2026 (collectively, the “2016 Notes”) for total proceeds of approximately $3.5 billion, net of discounts and underwriting fees. The 2016 Notes may be redeemed, in whole at any time, or in part from time to time, at the Company’s option at a defined redemption price plus accrued and unpaid interest to the redemption date. The net proceeds of the 2016 Notes were used for general corporate purposes and to repay certain corporate debt.

Early Extinguishment of Long-Term Debt
On May 16, 2016, the Company announced tender offers for (i) any and all of its 5.75% senior notes due 2017, its 6.60% senior notes due 2019 and its 4.75% senior notes due 2020 (collectively, the “Any and All Notes”) and (ii) up to $1.5 billion aggregate principal amount of the 4.75% Senior Notes due 2022 issued by its wholly-owned subsidiary Omnicare, the 5.00% Senior Notes due 2024 issued by Omnicare, its 3.875% Senior Notes due 2025, its 6.25% Senior Notes due 2027, its 4.875% Senior Notes due 2035, its 6.125% Senior Notes due 2039 and its 5.75% Senior Notes due 2041 (collectively, the “Maximum Tender Offer Notes” and together with the Any and All Notes, the “Notes”). On May 31, 2016, the Company increased the aggregate principal amount of the tender offers for the Maximum Tender Offer Notes to $2.25 billion. The Company purchased approximately $835 million aggregate principal amount of the Any and All Notes and $2.25 billion aggregate principal amount of the Maximum Tender Offer Notes pursuant to the tender offers, which expired on June 13, 2016. In connection with the purchase of the Notes, the Company paid a premium of $486 million in excess of the debt principal, wrote off $50 million of unamortized deferred financing costs and incurred $6 million in fees, for a total loss on early extinguishment of long-term debt of $542 million, which was recorded in income from continuing operations in the consolidated statement of operations for the year ended December 31, 2016.

On June 27, 2016, the Company notified the holders of the remaining Any and All Notes that the Company was exercising its option to redeem the outstanding Any and All Notes pursuant to the terms of the Any and All Notes and the Indenture dated as of August 15, 2006, between the Company and The Bank of New York Mellon Trust Company, N.A. Approximately $1.1 billion aggregate principal amount of Any and All Notes was redeemed on July 27, 2016. In connection with that redemption, the Company paid a premium of $97 million in excess of the debt principal and wrote off $4 million of unamortized deferred financing costs, for a total loss on early extinguishment of long-term debt of $101 million, which was recorded in income from continuing operations in the consolidated statement of operations for the year ended December 31, 2016.

See Note 8 ‘‘Borrowings and Credit Agreements’’ and Note 12 ‘‘Shareholders’ Equity’’ to the consolidated financial statements for additional information about debt issuances, debt repayments, share repurchases and dividend payments.

Derivative Financial Instruments

The Company uses derivative financial instruments in order to manage interest rate and foreign exchange risk and credit exposure. The Company’s use of these derivatives is generally limited to hedging risk and has principally consisted of using interest rate swaps, treasury rate locks, forward contracts, futures contracts, warrants, put options and credit default swaps. As of December 31, 2018 and 2017, the Company had outstanding derivative financial instruments (see Note 1 ‘‘Significant Accounting Policies’’ to the consolidated financial statements).

Debt Covenants

The Company’s back-up revolving credit facilities, unsecured senior notes, unsecured floating rate notes and term loan agreement (see Note 8 ‘‘Borrowings and Credit Agreements’’ to the consolidated financial statements) contain customary restrictive financial and operating covenants. These covenants do not include an acceleration of the Company’s debt maturities in the event of a downgrade in the Company’s credit ratings. The covenants do not materially affect the Company’s financial or operating flexibility. As of December 31, 2018, the Company was in compliance with all of its debt covenants.

Page 18


Debt Ratings 

As of December 31, 2018, the Company’s long-term debt was rated “Baa2” by Moody’s and “BBB” by Standard & Poor’s (“S&P”), and its commercial paper program was rated “P-2” by Moody’s and “A-2” by S&P. In December 2017, subsequent to the announcement of the proposed acquisition of Aetna, Moody’s changed the outlook on the Company’s long-term debt to “Under Review” from “Stable.” Similarly, S&P placed the Company’s long-term debt outlook on “Watch Negative” from “Stable.” Upon the issuance of the 2018 Notes on March 9, 2018, S&P lowered its corporate credit rating on the Company’s long-term debt to “BBB” from “BBB+” and changed the outlook from “Watch Negative” to “Stable.” On November 27, 2018, S&P lowered its rating on the long-term debt of Aetna to “BBB” from “A.” On November 28, 2018, upon the completion of the Aetna Acquisition, Moody’s lowered its rating on CVS Health Corporation’s long-term debt to “Baa2” from “Baa1.” Additionally, Moody’s changed the outlook on CVS Health Corporation’s long-term debt to “Negative” from “Under Review” and changed the outlook on the long-term debt of Aetna to “Negative” from “Stable.” In assessing the Company’s credit strength, the Company believes that both Moody’s and S&P considered, among other things, the Company’s capital structure and financial policies as well as its consolidated balance sheet, its historical acquisition activity and other financial information. Although the Company currently believes its long-term debt ratings will remain investment grade, it cannot guarantee the future actions of Moody’s and/or S&P. The Company’s debt ratings have a direct impact on its future borrowing costs, access to capital markets and new store operating lease costs.

Share Repurchase Programs

During the year ended December 31, 2018, the Company did not repurchase any shares of common stock. See Note 12 ‘‘Shareholders’ Equity’’ to the consolidated financial statements for additional information about share repurchases for the years ended December 31, 2017 and 2016.

Quarterly Cash Dividend

In December 2015, the Company’s Board of Directors (the “Board”) authorized a 21% increase in our quarterly common stock cash dividend to $0.425 per share effective in 2016. This increase equated to an annual dividend rate of $1.70 per share. In December 2016, the Board authorized an 18% increase in our quarterly common stock cash dividend to $0.50 per share effective in 2017. This increase equated to an annual dividend rate of $2.00 per share. During 2018, the Company maintained its quarterly dividend of $0.50 per share and expects to maintain its quarterly dividend of $0.50 per share throughout 2019.

Off-Balance Sheet Arrangements

In connection with executing operating leases, the Company provides a guarantee of the lease payments. The Company also finances a portion of its new store development through sale-leaseback transactions, which involve selling stores to unrelated parties and then leasing the stores back under leases that generally qualify and are accounted for as operating leases. The Company does not have any retained or contingent interests in the sold stores, and does not provide any guarantees, other than a guarantee of the lease payments, in connection with the transactions. In accordance with generally accepted accounting principles, the Company’s operating leases are not reflected on the consolidated balance sheets.

Between 1995 and 1997, the Company sold or spun off a number of subsidiaries, including Bob’s Stores and Linens ‘n Things (each of which subsequently filed for bankruptcy), and Marshalls. In many cases, when a former subsidiary leased a store, the Company provided a guarantee of the former subsidiary’s lease obligations. When the subsidiaries were disposed of, the Company’s guarantees remained in place, although each initial purchaser agreed to indemnify the Company for any lease obligations the Company was required to satisfy. If any of the purchasers or any of the former subsidiaries fail to make the required payments under a store lease, the Company could be required to satisfy these obligations.

As of December 31, 2018, the Company guaranteed approximately 85 such store leases (excluding the lease guarantees related to Linens ‘n Things), with the maximum remaining lease term extending through 2029. Management believes the ultimate disposition of any of the remaining lease guarantees will not have a material adverse effect on the Company’s consolidated financial condition or future cash flows. Please see “Results of Operations - Summary of Consolidated Financial Results - Commentary - 2018 compared to 2017 - Loss from discontinued operations” previously in this document for further information regarding the Company’s guarantee of certain Linens ‘n Things’ store lease obligations.


Page 19


Contractual Obligations

The following table summarizes certain estimated future obligations by period under the Company’s various contractual obligations at December 31, 2018. The table below does not include future payments of claims to health care providers or pharmacies because certain terms of these payments are not determinable at December 31, 2018 (for example, the timing and volume of future services provided under fee-for-service arrangements and future membership levels for capitated arrangements).
 
 
 
 
 
 
 
 
 
 
 
Payments Due by Period
In millions
Total
    
2019
    
2020 to 2021
    
2022 to 2023
    
Thereafter
Operating leases
$
27,980

 
$
2,690

 
$
4,943

 
$
4,343

 
$
16,004

Capital lease obligations
1,241

 
74

 
146

 
146

 
875

Contractual lease obligations with Target (1)
2,074

 
—

 
—

 
—

 
2,074

Lease obligations for discontinued operations
12

 
4

 
8

 
—

 
—

Long-term debt
72,903

 
1,242

 
16,150

 
12,699

 
42,812

Interest payments on long-term debt (2)
37,949

 
3,061

 
5,595

 
4,594

 
24,699

Other long-term liabilities on the consolidated balance sheet (3)
 
 
 
 
 
 
 
 
 
Future policy benefits (4)
6,728

 
575

 
1,200

 
952

 
4,001

Unpaid claims (4)
2,742

 
816

 
644

 
413

 
869

Policyholders’ funds (4)(5)
1,266

 
632

 
127

 
86

 
421

Other liabilities
1,705

 
455

 
911

 
100

 
239

Total
$
154,600

 
$
9,549

 
$
29,724

 
$
23,333

 
$
91,994

 
 
 
 
 
 
 
 
 
 
_____________________________________________ 
(1)
The Company leases pharmacy and clinic space from Target. See Note 6 ‘‘Leases’’ to the consolidated financial statements for additional information regarding the lease arrangements with Target. Amounts related to the operating and capital leases with Target are reflected within the operating leases and capital lease obligations above. Amounts due after the remaining estimated economic lives of the buildings are reflected herein assuming equivalent stores continue to operate through the term of the arrangements.
(2)
Interest payments on long-term debt are calculated using outstanding balances and interest rates in effect on December 31, 2018.
(3)
Payments of other long-term liabilities exclude Separate Accounts liabilities of approximately $3.9 billion because these liabilities are supported by assets that are legally segregated and are not subject to claims that arise out of the Company’s business.
(4)
Total payments of future policy benefits, unpaid claims and policyholders’ funds include $1.2 billion, $2.7 billion and $339 million, respectively, of reserves for contracts subject to reinsurance. The Company expects the assuming reinsurance carrier to fund these obligations and has reflected these amounts as reinsurance recoverable assets on the consolidated balance sheets.
(5)
Customer funds associated with group life and health contracts of approximately $2.3 billion have been excluded from the table above because such funds may be used primarily at the customer’s discretion to offset future premiums and/or for refunds, and the timing of the related cash flows cannot be determined. Additionally, net unrealized capital gains on debt and equity securities supporting experience-rated products of $10 million, before tax, have been excluded from the table above.

Restrictions on Certain Payments

In addition to general state law restrictions on payments of dividends and other distributions to shareholders applicable to all corporations, health maintenance organizations (“HMOs”) and insurance companies are subject to further regulations that, among other things, may require those companies to maintain certain levels of equity (referred to as surplus) and restrict the amount of dividends and other distributions that may be paid to their equity holders. These regulations are not directly applicable to CVS Health as a holding company, since CVS Health is not an HMO or an insurance company. In addition, in connection with the Aetna Acquisition, the Company made certain undertakings that require prior regulatory approval of dividends by certain of its HMOs and insurance companies. The additional regulations and undertakings applicable to the Company’s HMO and insurance company subsidiaries are not expected to affect the Company’s ability to service the Company’s debt, meet other financing obligations or pay dividends, or the ability of any of the Company’s subsidiaries to service their debt or other financing obligations. Under applicable regulatory requirements and undertakings, at December 31, 2018, the maximum amount of dividends that may be paid by the Company’s insurance and HMO subsidiaries without prior approval by regulatory authorities was approximately $584 million in the aggregate.

The Company maintains capital levels in its operating subsidiaries at or above targeted and/or required capital levels and dividends amounts in excess of these levels to meet liquidity requirements, including the payment of interest on debt and shareholder dividends. In addition, at the Company’s discretion, it uses these funds for other purposes such as funding share and debt repurchase programs, investments in new businesses and other purposes considered advisable.


Page 20


As of December 31, 2018, the Company held investments of $531 million that are not accounted for as Separate Accounts assets but are legally segregated and are not subject to claims that arise out of the Company’s business. See Note 3 ‘‘Investments’’ to the consolidated financial statements for additional information on investments related to the 2012 conversion of an existing group annuity contract from a participating to a non-participating contract.

Solvency Regulation

The National Association of Insurance Commissioners (the “NAIC”) utilizes risk-based capital (“RBC”) standards for insurance companies that are designed to identify weakly-capitalized companies by comparing each company’s adjusted surplus to its required surplus (the “RBC Ratio”). The RBC Ratio is designed to reflect the risk profile of insurance companies. Within certain ratio ranges, regulators have increasing authority to take action as the RBC Ratio decreases. There are four levels of regulatory action, ranging from requiring an insurer to submit a comprehensive financial plan for increasing its RBC to the state insurance commissioner to requiring the state insurance commissioner to place the insurer under regulatory control. At December 31, 2018, the RBC Ratio of each of the Company’s primary insurance subsidiaries was above the level that would require regulatory action. The RBC framework described above for insurers has been extended by the NAIC to health organizations, including HMOs. Although not all states had adopted these rules at December 31, 2018, at that date, each of the Company’s active HMOs had a surplus that exceeded either the applicable state net worth requirements or, where adopted, the levels that would require regulatory action under the NAIC’s RBC rules. External rating agencies use their own capital models and/or RBC standards when they determine a company’s rating.

Quantitative and Qualitative Disclosures About Market Risk

On November 28, 2018 the Company completed the Aetna Acquisition. As of December 31, 2018, the Company’s earnings and financial condition were exposed to interest rate risk, credit quality risk, market valuation risk, foreign currency risk and commodity risk. As of December 31, 2017, the Company had outstanding interest rate derivative instruments related to its long-term debt and believed that its exposure to interest rate risk (inherent in the Company’s debt securities portfolio) was not material. We refer you to Note 1 ‘‘Significant Accounting Policies’’ to the consolidated financial statements.

Evaluation of Interest Rate and Credit Quality Risk

The Company manages interest rate risk by seeking to maintain a tight match between the durations of assets and liabilities when appropriate. The Company manages credit quality risk by seeking to maintain high average credit quality ratings and diversified sector exposure within its debt securities portfolio. In connection with its investment and risk management objectives, the Company also uses derivative financial instruments whose market value is at least partially determined by, among other things, levels of or changes in interest rates (short-term or long-term), duration, prepayment rates, equity markets or credit ratings/spreads. The Company’s use of these derivatives is generally limited to hedging risk and has principally consisted of using interest rate swaps, treasury rate locks, forward contracts, futures contracts, warrants, put options and credit default swaps. These instruments, viewed separately, subject the Company to varying degrees of interest rate, equity price and credit risk.  However, when used for hedging, the Company expects these instruments to reduce overall risk.

Investments

The Company’s investment portfolio supported the following products at December 31, 2018:
In millions
 
Experience-rated products
$
1,063

Remaining products
17,191

Total investments
$
18,254

 
 

Investment risks associated with experience-rated products generally do not impact results of operations. The risks associated with investments supporting experience-rated pension and annuity products in the large case pensions business in the Company’s Corporate/Other segment are assumed by the contract holders and not by the Company (subject to, among other things, certain minimum guarantees). Assets supporting experience-rated products may be subject to contract holder or participant withdrawals.

The debt securities in the Company’s investment portfolio had an average credit quality rating of A at December 31, 2018, with approximately $3.9 billion rated AAA at December 31, 2018.  The debt securities that were rated below investment grade (that

Page 21


is, having a credit quality rating below BBB-/Baa3) were $1.1 billion at December 31, 2018 (of which 6% at December 31, 2018, supported experience-rated products).

At December 31, 2018, the Company held $373 million of municipal debt securities that were guaranteed by third parties, representing 2% of total investments at December 31, 2018. These securities had an average credit quality rating of AA- at December 31, 2018 with the guarantee. These securities had an average credit quality rating of A- at December 31, 2018 without the guarantee. The Company does not have any significant concentration of investments with third party guarantors (either direct or indirect).

The Company generally classifies debt securities as available for sale, and carries them at fair value on the consolidated balance sheets.  At December 31, 2018, approximately 1% of debt securities were valued using inputs that reflect the Company’s assumptions (categorized as Level 3 inputs in accordance with accounting principles generally accepted in the United States of America). See Note 4 ‘‘Fair Value’’ to the consolidated financial statements, which is incorporated by reference herein, for additional information on the methodologies and key assumptions used to determine the fair value of investments. For additional information related to investments, see Note 3 ‘‘Investments’’ to the consolidated financial statements, which is incorporated by reference herein.

The Company regularly reviews debt securities in its portfolio to determine whether a decline in fair value below the cost basis or carrying value is other-than-temporary. When a debt security is in an unrealized capital loss position, the Company monitors the duration and severity of the loss to determine if sufficient market recovery can occur within a reasonable period of time. If a decline in fair value is considered other-than-temporary, the cost basis or carrying value of the debt security is written down. The write down is then bifurcated into its credit and non-credit related components. The amount of the credit-related component is included in net income, and the amount of the non-credit related component is included in other comprehensive income/loss, unless the Company intends to sell the debt security or it is more likely than not that the Company will be required to sell the debt security prior to its anticipated recovery of the debt security’s amortized cost basis. Accounting for other-than-temporary impairment (“OTTI”) of debt securities is considered a critical accounting estimate. The information under the heading “Critical Accounting Policies - Other-Than-Temporary Impairment of Debt Securities” contained in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in the Annual Report is incorporated by reference herein.

Evaluation of Market Valuation Risks

The Company regularly evaluates its risk from market-sensitive instruments by examining, among other things, levels of or changes in interest rates (short-term or long-term), duration, prepayment rates, equity markets and/or credit ratings/spreads. The Company also regularly evaluates the appropriateness of investments relative to management-approved investment guidelines (and operates within those guidelines) and the business objectives of its portfolios.

On a quarterly basis, the Company reviews the impact of hypothetical net losses in its investment portfolio on the Company’s consolidated near-term financial condition, results of operations and cash flows assuming the occurrence of certain reasonably possible changes in near-term market rates and prices. Interest rate changes (whether resulting from changes in treasury yields or credit spreads or other factors) represent the most material risk exposure category for the Company. The Company has estimated the impact on the fair value of market sensitive instruments based on the net present value of cash flows using a representative set of likely future interest rate scenarios. The assumptions used were as follows: an immediate increase of 100 basis points in interest rates (which the Company believes represents a moderately adverse scenario and is approximately equal to the historical annual volatility of interest rate movements for intermediate-term available-for-sale debt securities) and an immediate decrease of 15% in prices for domestic equity securities.

Assuming an immediate 100 basis point increase in interest rates and immediate decrease of 15% in the prices for domestic equity securities, the theoretical decline in the fair values of market sensitive instruments at December 31, 2018 is as follows:

•
The fair value of long-term debt would decline by $3.9 billion ($4.9 billion pretax). Changes in the fair value of long-term debt do not impact financial condition or results of operations.
•
The theoretical reduction in the fair value of investment securities partially offset by the theoretical reduction in the fair value of interest rate sensitive liabilities would result in a net decline in fair value of $364 million ($461 million pretax) related to continuing non-experience-rated products. Reductions in the fair value of investment securities would be reflected as an unrealized loss in equity, as the Company classifies these securities as available for sale. The Company does not record liabilities at fair value.


Page 22


Based on overall exposure to interest rate risk and equity price risk, the Company believes that these changes in market rates and prices would not materially affect consolidated near-term financial condition, results of operations or cash flows as of December 31, 2018.

Evaluation of Foreign Currency and Commodity Risk

As of each of December 31, 2018 and 2017, the Company did not have any material foreign currency exchange rate or commodity derivative instruments in place and believes its exposure to foreign currency exchange rate risk and commodity price risk is not material.

Evaluation of Operational Risks

The Company also faces certain operational risks, including risks related to information security, including cybersecurity. The Company and its vendors have experienced a variety of cyber attacks, and the Company and its vendors expect to continue to experience cyber attacks going forward. Among other things, the Company has experienced automated attempts to gain access to public facing networks, brute force, SYN flood and distributed denial of service attacks, attempted malware infections, vulnerability scanning, ransomware attacks, spear-phishing campaigns, mass reconnaissance attempts, injection attempts, phishing, PHP injection and cross-site scripting. The Company also has seen an increase in attacks designed to obtain access to consumers’ accounts using illegally obtained demographic information. The Company is dedicating and will continue to dedicate significant resources and incur significant expenses to maintain and update on an ongoing basis the systems and processes that are designed to mitigate the information security risks it faces and protect the security of its computer systems, software, networks and other technology assets against attempts by unauthorized parties to obtain access to confidential information, destroy data, disrupt or degrade service, sabotage systems or cause other damage. The impact of the cyber attacks the Company has experienced through December 31, 2018 has not been material to its operations or results of operations. The Board and the Audit Committee of the Board (“the Audit Committee”) are regularly informed regarding the Company’s information security policies, practices and status.

Critical Accounting Policies

The Company prepares the consolidated financial statements in conformity with generally accepted accounting principles, which require management to make certain estimates and apply judgment. Estimates and judgments are based on historical experience, current trends and other factors that management believes to be important at the time the consolidated financial statements are prepared. On a regular basis, the Company reviews its accounting policies and how they are applied and disclosed in the consolidated financial statements. While the Company believes the historical experience, current trends and other factors considered, support the preparation of the consolidated financial statements in conformity with generally accepted accounting principles, actual results could differ from estimates, and such differences could be material.

Significant accounting policies are discussed in Note 1 ‘‘Significant Accounting Policies’’ to the consolidated financial statements. Management believes the following accounting policies include a higher degree of judgment and/or complexity and, thus, are considered to be critical accounting policies. The Company has discussed the development and selection of these critical accounting policies with the Audit Committee, and the Audit Committee has reviewed the disclosures relating to them.


Page 23


Revenue Recognition

Pharmacy Services Segment
The Pharmacy Services segment sells prescription drugs directly through its mail service dispensing pharmacies and indirectly through the Company’s retail pharmacy network. The Company’s pharmacy benefit arrangements are accounted for in a manner consistent with a master supply arrangement as there are no contractual minimum volumes and each prescription is considered a separate purchasing decision and distinct performance obligation transferred at a point in time. PBM services performed in connection with each prescription claim are considered part of a single performance obligation which culminates in the dispensing of prescription drugs.

The Company recognizes revenue using the gross method at the contract price negotiated with its clients when the Company has concluded it controls the prescription drug before it is transferred to the client plan members. The Company controls prescriptions dispensed indirectly through its retail pharmacy network because it has separate contractual arrangements with those pharmacies, has discretion in setting the price for the transaction and assumes primary responsibility for fulfilling the promise to provide prescription drugs to its client plan members while also performing the related PBM services.

Revenues include (i) the portion of the price the client pays directly to the Pharmacy Services segment, net of any discounts earned on brand name drugs or other discounts and refunds paid back to the client, (ii) the United States Centers for Medicare & Medicaid Services (“CMS”) subsidized portion of prescription drugs dispensed to the Company’s Silverscript PDP members, (iii) the price paid to the Pharmacy Services segment by client plan members for mail order prescriptions and the price paid to retail network pharmacies by client plan members for retail prescriptions (“Retail Co-Payments”), and (iv) claims based administrative fees for retail pharmacy network contracts. Sales taxes are not included in revenue.

The Company recognizes revenue when control of the prescription drugs is transferred to customers, in an amount that reflects the consideration the Company expects to be entitled to in exchange for those prescription drugs. The Company has established the following revenue recognition policies for the Pharmacy Services segment:

•
Revenues generated from prescription drugs sold by mail service dispensing pharmacies are recognized when the prescription drug is delivered to the client plan member. At the time of delivery, the Company has performed substantially all of its performance obligations under its client contracts and does not experience a significant level of returns or reshipments.
•
Revenues generated from prescription drugs sold by third party pharmacies in the Company’s retail pharmacy network and associated administrative fees are recognized at the Company’s point-of-sale, which is when the claim is adjudicated by the Company’s online claims processing system and the Company has transferred control of the prescription drug and performed all of its performance obligations.

The Company recognizes revenue using the net method for contracts under which the Company acts as an agent or does not control the prescription drug prior to transfer to the client.

The Company records revenue net of manufacturers’ rebates that are earned by its clients based on their plan members’ utilization of brand-name formulary drugs. The Company estimates these rebates at period-end based on actual and estimated claims data and its estimates of the manufacturers’ rebates earned by its clients. The estimates are based on the best available data at period-end and recent history for the various factors that can affect the amount of rebates due to the client. The Company adjusts its rebates payable to clients to the actual amounts paid when these rebates are paid or as significant events occur. Any cumulative effect of these adjustments is recorded against revenues as identified. Adjustments generally result from contract changes with clients or manufacturers that have retroactive rebate adjustments, differences between the estimated and actual product mix subject to rebates, or whether the brand name drug was included in the applicable formulary. The effect of adjustments between estimated and actual manufacturers’ rebate amounts has not been material to the Company’s results of operations or financial condition.

The Company also adjusts revenues for refunds owed to clients resulting from pricing guarantees and performance against defined service and performance metrics. The inputs to these estimates are not subject to a high degree of subjectivity or volatility. The effect of adjustments between estimated and actual performance refund amounts has not been material to the Company’s results of operations or financial condition.

The Pharmacy Services segment participates in the federal government’s Medicare Part D program as a PDP through the Company’s SilverScript subsidiary. Revenues include insurance premiums earned by the PDP, which are determined based on the PDP’s annual bid and related contractual arrangements with CMS. The insurance premiums include a beneficiary premium,

Page 24


which is the responsibility of the PDP member, and can be subsidized by CMS in the case of low-income members, and a direct premium paid by CMS. Premiums collected in advance are initially recorded within other insurance liabilities and are then recognized ratably as revenue over the period in which members are entitled to receive benefits.

In addition to these premiums, the Pharmacy Services segment receives additional payments each month from CMS related to catastrophic reinsurance, low-income cost sharing subsidies and coverage gap benefits. If the subsidies received differ from the amounts earned from actual prescriptions transferred, the difference is recorded in either accounts receivable, net or accrued expenses.

The Company estimates variable consideration in the form of amounts payable to, or receivable from, CMS under a risk-sharing feature of the Medicare Part D program design, referred to as the risk corridor, and adjusts revenue based on calculations of additional subsidies to be received from or owed to CMS at the end of the reporting year.

Retail/LTC Segment
Retail Pharmacy
The Company’s retail drugstores recognize revenue at the time the customer takes possession of the merchandise. For pharmacy sales, each prescription claim is its own arrangement with the customer and is a performance obligation, separate and distinct from other prescription claims under other retail network arrangements. Revenues are adjusted for refunds owed to the third party payer for pricing guarantees and performance against defined value-based service and performance metrics. The inputs to these estimates are not subject to a high degree of subjectivity or volatility. The effect of adjustments between estimated and actual pricing and performance refund amounts have not been material to the Company’s results of operations or financial condition.

Revenue from Company gift cards purchased by customers is deferred as a contract liability until goods or services are transferred. Any amounts not expected to be redeemed by customers (i.e., breakage) are recognized based on historical redemption patterns.

Customer returns are not material to the Company’s results of operations or financial condition. Sales taxes are not included in revenue.

Loyalty Program
The Company’s customer loyalty program, ExtraCare®, is comprised of two components, ExtraSavingsTM and ExtraBucks® Rewards. ExtraSavings are coupons that are recorded as a reduction of revenue when redeemed as the Company concluded that they do not represent a promise to the customer to deliver additional goods or services at the time of issuance because they are not tied to a specific transaction or spending level.

ExtraBucks Rewards are accumulated by customers based on their historical spending levels. Thus, the Company has determined that there is an additional performance obligation to those customers at the time of the initial transaction. The Company allocates the transaction price to the initial transaction and the ExtraBucks Rewards transaction based upon the relative standalone selling price, which considers historical redemption patterns for the rewards. Revenue allocated to ExtraBucks Rewards is recognized as those rewards are redeemed. At the end of each period, unredeemed rewards are reflected as a contract liability.

Long-term Care
Revenue is recognized when control of the promised goods or services is transferred to customers in an amount that reflects the consideration the Company expects to be entitled to in exchange for those goods or services. Each prescription claim represents a separate performance obligation of the Company, separate and distinct from other prescription claims under customer arrangements. A significant portion of the revenue from sales of pharmaceutical and medical products are reimbursed by the federal Medicare Part D program and, to a lesser extent, state Medicaid programs. The Company monitors its revenues and receivables from these reimbursement sources, as well as other third party insurance payors, and reduces revenue at the revenue recognition date to properly account for the variable consideration due to anticipated differences between billed and reimbursed amounts. Accordingly, the total revenues and receivables reported in the Company’s consolidated financial statements are recorded at the amount expected to be ultimately received from these payors.

Patient co-payments associated with Medicare Part D, certain state Medicaid programs, Medicare Part B and certain third party payors typically are not collected at the time products are delivered or services are rendered, but are billed to the individuals as part of normal billing procedures and subject to normal accounts receivable collections procedures.

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Walk-In Medical Clinics
For services provided by the Company’s walk-in medical clinics, revenue recognition occurs for completed services provided to patients, with adjustments taken for third party payor contractual obligations and patient direct bill historical collection rates.

Health Care Benefits Segment
Health Care Benefits revenue is principally derived from insurance premiums and fees billed to customers. Revenue is recognized based on customer billings, which reflect contracted rates per employee and the number of covered employees recorded in the Company’s records at the time the billings are prepared. Billings are generally sent monthly for coverage during the following month.

The Company’s billings may be subsequently adjusted to reflect enrollment changes due to member terminations or other factors. These adjustments are known as retroactivity adjustments. In each period, the Company estimates the amount of future retroactivity and adjusts the recorded revenue accordingly. As information regarding actual retroactivity amounts becomes known, the Company refines its estimates and records any required adjustments to revenues in the period in which they arise. A significant difference in the actual level of retroactivity compared to estimated levels would have a significant effect on the Company’s results of operations.

Additionally, premium revenue subject to the ACA’s minimum medical loss ratio (“MLR”) rebate requirements is recorded net of the estimated minimum MLR rebates for the current calendar year. The Company estimates minimum MLR rebates payable by projecting MLRs for certain markets, as defined by the ACA, for each state in which each of its insurance entities operates. The claims and premiums used in estimating such rebates are modified for certain adjustments allowed by the ACA and include a statistical credibility adjustment for those states with a number of members that is not statistically credible.

Furthermore, the ACA’s permanent risk adjustment program transfers funds from qualified individual and small group insurance plans with below average risk scores to plans with above average risk scores. Based on the risk of the Company’s qualified plan members relative to the average risk of members of other qualified plans in comparable markets, the Company estimates its ultimate risk adjustment receivable or payable for the current calendar year and reflects the pro-rata year-to-date impact as an adjustment to premium revenue. In this analysis, the Company considers the estimate of the average risk of members of other qualified plans in comparable markets the most critical assumption. The Company estimates its ultimate risk adjustment receivable or payable using management’s best estimates, which are based on various data sources, including but not limited to market risk data compiled by third party sources as well as pricing and other regulatory inputs. See Note 1 ‘‘Significant Accounting Policies’’ to the consolidated financial statements for additional information on the ACA’s risk adjustment program.

Other-Than-Temporary Impairments of Debt Securities

The Company regularly reviews its debt securities to determine whether a decline in fair value below the cost basis or carrying value is other-than-temporary. If a decline in fair value is considered other-than-temporary, the cost basis or carrying value of the debt security is written down. The write-down is then bifurcated into its credit and non-credit related components. The amount of the credit-related component is included in results of operations, and the amount of the non-credit related component is included in other comprehensive income, unless the Company intends to sell the debt security or it is more likely than not that it will be required to sell the debt security prior to its anticipated recovery of its amortized cost basis. The Company analyzes all facts and circumstances believed to be relevant for each investment when performing this analysis, in accordance with applicable accounting guidance.

Among the factors considered in evaluating whether a decline in fair value is other-than-temporary are whether the decline results from a change in the quality of the debt security itself, whether the decline results from a downward movement in the market as a whole, and the prospects for realizing the carrying value of the debt security based on the investment’s current and short-term prospects for recovery. For unrealized losses determined to be the result of market conditions (for example, increasing interest rates and volatility due to conditions in the overall market) or industry-related events, the Company determines whether it intends to sell the debt security or if it is more likely than not that it will be required to sell the debt security before recovery of its amortized cost basis. If either case is true, the Company recognizes an OTTI, and the cost basis/carrying amount of the debt security is written down to fair value.

The risks inherent in assessing the impairment of a debt security include the risk that market factors may differ from projections and the risk that facts and circumstances factored into the Company’s assessment may change with the passage of time. Unexpected changes to market factors and circumstances that were not present in past reporting periods are among the factors that may result in a current period decision to sell debt securities that were not impaired in prior reporting periods.

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Vendor Allowances and Purchase Discounts

Pharmacy Services Segment
The Pharmacy Services segment receives purchase discounts on products purchased. Contractual arrangements with vendors, including manufacturers, wholesalers and retail pharmacies, normally provide for the Pharmacy Services segment to receive purchase discounts from established list prices in one, or a combination, of the following forms: (i) a direct discount at the time of purchase, (ii) a discount for the prompt payment of invoices or (iii) when products are purchased indirectly from a manufacturer (e.g., through a wholesaler or retail pharmacy), a discount (or rebate) paid subsequent to dispensing. These rebates are recognized when prescriptions are dispensed and are generally calculated and billed to manufacturers within 30 days of the end of each completed quarter. Historically, the effect of adjustments resulting from the reconciliation of rebates recognized to the amounts billed and collected has not been material to the Company’s results of operations or financial condition. The Company accounts for the effect of any such differences as a change in accounting estimate in the period the reconciliation is completed. The Pharmacy Services segment also receives additional discounts under its wholesaler contracts if it exceeds contractually defined purchase volumes. In addition, the Pharmacy Services segment receives fees from pharmaceutical manufacturers for administrative services. Purchase discounts and administrative service fees are recorded as a reduction of cost of products sold.

Retail/LTC Segment
Vendor allowances received by the Retail/LTC segment reduce the carrying cost of inventory and are recognized in cost of products sold when the related inventory is sold, unless they are specifically identified as a reimbursement of incremental costs for promotional programs and/or other services provided. Amounts that are directly linked to advertising commitments are recognized as a reduction of advertising expense (included in operating expenses) when the related advertising commitment is satisfied. Any such allowances received in excess of the actual cost incurred also reduce the carrying cost of inventory. The total value of any upfront payments received from vendors that are linked to purchase commitments is initially deferred. The deferred amounts are then amortized to reduce cost of products sold over the life of the contract based upon purchase volume. The total value of any upfront payments received from vendors that are not linked to purchase commitments is also initially deferred. The deferred amounts are then amortized to reduce cost of products sold on a straight-line basis over the life of the related contract.

There have not been any material changes in the way the Company accounts for vendor allowances and purchase discounts during the past three years.

Inventory

Inventories are valued at the lower of cost or net realizable value using the weighted average cost method.

The value of ending inventory is reduced for estimated inventory losses that have occurred during the interim period between physical inventory counts. Physical inventory counts are taken on a regular basis in each store and a continuous cycle count process is the primary procedure used to validate the inventory balances on hand in each distribution center and mail facility to ensure that the amounts reflected in the accompanying consolidated financial statements are properly stated. The accounting for inventory contains uncertainty since management must use judgment to estimate the inventory losses that have occurred during the interim period between physical inventory counts. When estimating these losses, a number of factors are considered which include, but are not limited to, historical physical inventory results on a location-by-location basis and current physical inventory loss trends.

The total reserve for estimated inventory losses covered by this critical accounting policy was $328 million as of December 31, 2018. Although management believes there is sufficient current and historical information available to record reasonable estimates for estimated inventory losses, it is possible that actual results could differ. In order to help investors assess the aggregate risk, if any, associated with the inventory-related uncertainties discussed above, a ten percent (10%) pre-tax change in estimated inventory losses, which is a reasonably likely change, would increase or decrease the total reserve for estimated inventory losses by approximately $33 million as of December 31, 2018.

Although management believes that the estimates discussed above are reasonable and the related calculations conform to generally accepted accounting principles, actual results could differ from such estimates, and such differences could be material.


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Goodwill and Identifiable Intangible Assets

Identifiable intangible assets
Identifiable intangible assets consist primarily of trademarks, trade names, customer contracts/relationships, covenants not to compete, technology, provider networks, value of business acquired and favorable leases. These intangible assets arise primarily from the determination of their respective fair market values at the date of acquisition. Amounts assigned to identifiable intangible assets, and their related useful lives, are derived from established valuation techniques and management estimates.

Recoverability of definite-lived intangible assets
The Company evaluates the recoverability of definite-lived intangible assets whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. These long-lived assets are grouped and evaluated for impairment at the lowest level at which individual cash flows can be identified. When evaluating these long-lived assets for potential impairment, the Company first compares the carrying amount of the asset group to the asset group’s estimated future cash flows (undiscounted and without interest charges). If the estimated future cash flows are less than that carrying amount of the asset group, an impairment loss calculation is prepared. The impairment loss calculation compares the carrying amount of the asset group to the asset group’s estimated future cash flows (discounted and with interest charges). If required, an impairment loss is recorded for the portion of the asset group’s carrying value that exceeds the asset group’s estimated future cash flows (discounted and with interest charges).

The long-lived asset impairment loss calculation contains uncertainty since management must use judgment to estimate each asset group’s future sales, profitability and cash flows. When preparing these estimates, the Company considers historical results and current operating trends and consolidated sales, profitability and cash flow results and forecasts. These estimates can be affected by a number of factors including, but not limited to, general economic and regulatory conditions, efforts of third party organizations to reduce their prescription drug costs and/or increased member co-payments, the continued efforts of competitors to gain market share and consumer spending patterns.

There were no material impairment losses for definite-lived intangible assets recognized in any of the three years ended December 31, 2018, 2017 or 2016.

Recoverability of indefinitely-lived intangible assets
Indefinitely-lived intangible assets are subject to annual impairment reviews, or more frequent reviews if events or circumstances indicate that their carrying value may not be recoverable. Indefinitely-lived intangible assets are tested by comparing the estimated fair value of the asset to its carrying value. If the carrying value of the asset exceeds its estimated fair value, an impairment loss is recognized and the asset is written down to its estimated fair value.

The indefinitely-lived intangible asset impairment loss calculation contains uncertainty since management must use judgment to estimate fair value based on the assumption that, in lieu of ownership of an intangible asset, the Company would be willing to pay a royalty in order to utilize the benefits of the asset. Fair value is estimated by discounting the hypothetical royalty payments to their present value over the estimated economic life of the asset. These estimates can be affected by a number of factors including, but not limited to, general economic conditions, availability of market information as well as the profitability of the Company.

There were no material impairment losses recognized on indefinitely-lived intangible assets recognized in any of the three years ended December 31, 2018, 2017 or 2016.

Recoverability of goodwill
Goodwill represents the excess of amounts paid for acquisitions over the fair value of the net identifiable assets acquired. Goodwill is subject to annual impairment reviews, or more frequent reviews if events or circumstances indicate that the carrying value may not be recoverable. Goodwill is tested for impairment on a reporting unit basis. The impairment test is calculated by comparing the reporting unit’s fair value with its net book value (or carrying amount), including goodwill. The fair value of the reporting units is estimated using a combination of a discounted cash flow method and a market multiple method. If the net book value (carrying amount) of the reporting unit exceeds its fair value, the reporting unit’s goodwill is considered to be impaired and an impairment is recognized in an amount equal to the excess.

The determination of the fair value of the reporting units requires the Company to make significant assumptions and estimates. These assumptions and estimates primarily include, but are not limited to, the selection of appropriate peer group companies; control premiums and valuation multiples appropriate for acquisitions in the industries in which the Company competes;

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discount rates; terminal growth rates; and forecasts of revenue, operating income, depreciation and amortization, capital expenditures and future working capital requirements. When determining these assumptions and preparing these estimates, the Company considers each reporting unit’s historical results and current operating trends; consolidated revenues, profitability and cash flow results and forecasts; and industry trends. These estimates can be affected by a number of factors including, but not limited to, general economic and regulatory conditions, market capitalization, efforts of customers and payers to reduce costs including their prescription drug costs and/or increase member co-payments, the continued efforts of competitors to gain market share and consumer spending patterns.

2018 goodwill impairment tests
As discussed in Note 5 ‘‘Goodwill and Other Intangibles’’ to the consolidated financial statements, during 2018, the LTC reporting unit continued to experience industry wide challenges that have impacted management’s ability to grow the business at the rate that was originally estimated when the Company acquired Omnicare and when the 2017 annual goodwill impairment test was performed. These challenges include lower client retention rates, lower occupancy rates in skilled nursing facilities, the deteriorating financial health of numerous skilled nursing facility customers which resulted in a number of customer bankruptcies in 2018, and continued facility reimbursement pressures. In June 2018, LTC management submitted its initial budget for 2019 and updated the 2018 annual forecast which showed a projected deterioration in the financial results for the remainder of 2018 and in 2019, which also caused management to update its long-term forecast beyond 2019. Based on these updated projections, management determined that there were indicators that the LTC reporting unit’s goodwill may be impaired and, accordingly, management performed an interim goodwill impairment test as of June 30, 2018. The results of that interim impairment test showed that the fair value of the LTC reporting unit was lower than the carrying value, resulting in a $3.9 billion pre-tax goodwill impairment charge in the second quarter of 2018. The fair value of the LTC reporting unit was determined using a combination of a discounted cash flow method and a market multiple method. In addition to the lower financial projections, higher risk-free interest rates and lower market multiples of peer group companies contributed to the amount of the second quarter 2018 goodwill impairment charge.

During the third quarter of 2018, the Company performed its required annual impairment tests of goodwill. The results of these impairment tests indicated that there was no impairment of goodwill. The results of the annual goodwill impairment tests showed the fair values of the Pharmacy Services and Retail Pharmacy reporting units exceeded their carrying values by significant margins and the fair value of the LTC reporting unit exceeded its carrying value by approximately 2%.

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 projected financial results for 2019 compared to the analyses performed in the second and third quarters of 2018 primarily due to continued industry and operational challenges, which also caused management to make further updates to its long-term forecast beyond 2019. The updated projections continue to reflect industry wide challenges including lower occupancy rates in skilled nursing facilities, the significant deterioration in the financial health of numerous skilled nursing facility customers and continued facility reimbursement pressures. Based on these updated projections, management determined that there were indicators that the LTC reporting unit’s goodwill may be impaired and, accordingly, an interim goodwill impairment test was performed during the fourth quarter of 2018. The results of that impairment test showed that the fair value of the LTC reporting unit was lower than the carrying value, resulting in an additional $2.2 billion goodwill impairment charge in the fourth quarter of 2018. In addition to the lower financial projections, lower market multiples of peer group companies also contributed to the amount of the fourth quarter 2018 goodwill impairment charge. The fair value of the LTC reporting unit was determined using a methodology consistent with the methodology described above for the analyses performed during the second and third quarters of 2018.

As of December 31, 2018, the remaining goodwill balance in the LTC reporting unit is approximately $431 million.

Although the Company believes the financial projections used to determine the fair value of the LTC reporting unit in the fourth quarter of 2018 are reasonable and achievable, the LTC reporting unit may continue to face challenges that may affect the Company’s ability to grow its business at the rate estimated when such goodwill impairment test was performed. These challenges and some of the key assumptions included in the Company’s financial projections to determine the estimated fair value of the LTC reporting unit include client retention rates, occupancy rates in skilled nursing facilities, the financial health of skilled nursing facility customers, facility reimbursement pressures, the Company’s ability to execute its senior living initiative, the Company’s ability to make acquisitions and integrate those businesses into its LTC operations in an orderly manner, as well as the Company’s ability to extract cost savings from labor productivity and other initiatives. The Company has made a number of additions and changes to its LTC management team to better respond to these challenges. The estimated fair value of the LTC reporting unit also is dependent on earnings multiples of market participants in the pharmacy industry, as well as the risk-free interest rate environment, which impacts the discount rate used in the discounted cash flow valuation method. If the Company

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does not achieve its forecasts, it is reasonably possible in the near term that the goodwill of the LTC reporting unit could be deemed to be impaired again by a material amount.

2017 and 2016 goodwill impairment tests
The Company recorded $181 million in goodwill impairment charges in 2017 related to the RxCrossroads reporting unit. During the third quarter of 2017, the Company performed its required annual impairment test of goodwill. The goodwill impairment tests showed that the fair values of the Pharmacy Services and Retail Pharmacy reporting units exceeded their carrying values by significant margins and the fair values of the LTC and RxCrossroads reporting units exceeded their carrying values by approximately 1% and 6%, respectively. On January 2, 2018, the Company sold its RxCrossroads reporting unit to McKesson Corporation for $725 million.

The Company did not record any goodwill impairment charges during 2016.

Health Care Costs Payable

At December 31, 2018, 80% of health care costs payable are estimates of the ultimate cost of (i) services rendered to members but not yet reported to the Company and (ii) claims which have been reported to the Company but not yet paid (collectively, “IBNR”). Health care costs payable also include an estimate of the cost of services that will continue to be rendered after the financial statement date if the Company is obligated to pay for such services in accordance with contractual or regulatory requirements. The remainder of health care costs payable is primarily comprised of pharmacy and capitation payables, other amounts due to providers pursuant to risk sharing agreements and accruals for state assessments. The Company develops its estimate of IBNR using actuarial principles and assumptions that consider numerous factors. See Note 1 ‘‘Significant Accounting Policies’’ to the consolidated financial statements for additional information on the Company’s reserving methodology.

The Company has considered the pattern of changes in its completion factors when determining the completion factors used in its estimates of IBNR as of December 31, 2018. However, based on historical claim experience, it is reasonably possible that the Company’s estimated weighted average completion factors may vary by plus or minus 16 basis points from the Company’s assumed rates, which could impact health care costs payable by approximately plus or minus $194 million pretax.

Management considers historical health care cost trend rates together with its knowledge of recent events that may impact current trends when developing estimates of current health care cost trend rates. When establishing reserves as of December 31, 2018, the Company increased its assumed health care cost trend rates for the most recent three months by 3.5% from health care cost trend rates recently observed. However, based on historical claim experience, it is reasonably possible that the Company’s estimated health care cost trend rates may vary by plus or minus 3.5% from the assumed rates, which could impact health care costs payable by plus or minus $299 million pretax.

Income Taxes

Income taxes are accounted for using the asset and liability method. Deferred tax assets and liabilities are established for any temporary differences between financial and tax reporting bases and are adjusted as needed to reflect changes in the enacted tax rates expected to be in effect when the temporary differences reverse. Such adjustments are recorded in the period in which changes in tax laws are enacted, regardless of when they are effective. Deferred tax assets are reduced, if necessary, by a valuation allowance to the extent future realization of those losses, deductions or other tax benefits is sufficiently uncertain.
Significant judgment is required in determining the provision for income taxes and the related taxes payable and deferred tax assets and liabilities since, in the ordinary course of business, there are transactions and calculations where the ultimate tax outcome is uncertain. Additionally, the Company’s tax returns are subject to audit by various domestic and foreign tax authorities that could result in material adjustments based on differing interpretations of the tax laws. Although management believes that its estimates are reasonable and are based on the best available information at the time the provision is prepared, actual results could differ from these estimates resulting in a final tax outcome that may be materially different from that which is reflected in the consolidated financial statements.

The tax benefit from an uncertain tax position is recognized only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the consolidated financial statements from such positions are then measured based on the largest benefit that has a greater than 50% likelihood of being realized upon settlement. Interest and/or penalties related to uncertain tax positions are recognized in the income tax provision. Significant judgment is required in determining uncertain tax positions. The Company has established

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accruals for uncertain tax positions using its judgment and adjusts these accruals, as warranted, due to changing facts and circumstances.

Business Combinations

The Company accounts for business combinations using the acquisition method of accounting which requires that the assets acquired and liabilities assumed be recorded at the date of the acquisition at their respective fair values. The excess of purchase price over the fair value of assets acquired and liabilities assumed is recorded as goodwill. Determining the fair value of identifiable assets, particularly intangible assets, and liabilities acquired also requires management to make estimates, which are based on all available information and in some cases assumptions with respect to the timing and amount of future revenues and expenses associated with an asset. The most critical assumptions used in determining the fair value of intangible assets include customer attrition, membership growth and revenue growth. In determining the estimated fair value for intangible assets, the Company typically utilizes the income approach, which discounts the projected future net cash flow using an appropriate discount rate that reflects the risks associated with such projected future cash flows. Determining the useful life of an intangible asset also requires judgment, as different types of intangible assets will have different useful lives and certain assets are considered to have indefinite useful lives.

New Accounting Pronouncements

See Note 1 ‘‘Significant Accounting Policies’’ to the consolidated financial statements for a description of new accounting pronouncements applicable to the Company.

Holders of Common Stock

As of February 19, 2019, there were 27,266 registered holders of the Company’s common stock according to the records maintained by the Company’s transfer agent.

Cautionary Statement Concerning Forward-Looking Statements

The Private Securities Litigation Reform Act of 1995 (the “Reform Act”) provides a safe harbor for forward-looking statements made by or on behalf of the Company. In addition, the Company and its representatives may, from time to time, make written or verbal forward-looking statements, including statements contained in the Company’s filings with the United States Securities and Exchange Commission (the “SEC”) and in its reports to stockholders, press releases, webcasts, conference calls, meetings and other communications. Generally, the inclusion of the words “anticipate,” “believe,” “estimate,” “expect,” “intend,” “project,” “should,” “will” and similar expressions identify statements that constitute forward-looking statements. All statements addressing operating performance of CVS Health Corporation or any subsidiary, events or developments that the Company projects, expects or anticipates will occur in the future, including statements relating to corporate strategy; revenue growth; adjusted revenue growth, earnings or earnings per common share growth; adjusted operating income or adjusted earnings per common share growth; free cash flow; debt ratings; inventory levels; inventory turn and loss rates; store development; relocations and new market entries; retail pharmacy business, sales results and/or trends and operations; PBM business, sales results and/or trends and operations; specialty pharmacy business, sales trends and operations; LTC pharmacy business, sales results and/or trends and operations; Health Care Benefits business, sales results and/or trends, medical cost trends, medical membership growth, medical benefit ratios and operations; the Company’s ability to attract or retain customers and clients; Medicare Part D competitive bidding, enrollment and operations; new product development; and the impact of industry and regulatory developments, as well as statements expressing optimism or pessimism about future results of operations or events, are forward-looking statements within the meaning of the Reform Act.

The forward-looking statements are and will be based upon management’s then-current views and assumptions regarding future events and operating performance, and are applicable only as of the dates of such statements. The Company undertakes no obligation to update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise.


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By their nature, all forward-looking statements involve risks and uncertainties. Actual results may differ materially from those contemplated by the forward-looking statements for a number of reasons as described in the Company’s SEC filings, including those set forth in the Risk Factors section within the CVS Health Corporation’s 2018 Annual Report on Form 10-K, and including, but not limited to:

•
Risks to our brand and reputation, the Aetna Acquisition, data governance risks, effectiveness of our talent management and alignment of talent to our business needs, and potential changes in public policy, laws and regulations present overarching risks to our enterprise in 2019 and beyond.
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Our brand and reputation are two of our most important assets; negative public perception of the industries in which we operate, or of our industries’ or our practices, can adversely affect our businesses, results of operations, cash flows and prospects.
•
Data governance failures can adversely affect our reputation, businesses and prospects. Our use and disclosure of members’, customers’ and other constituents’ sensitive information is subject to complex regulations at multiple levels. We would be adversely affected if we or our business associates or other vendors fail to adequately protect members’, customers’ or other constituents’ sensitive information.
•
We face significant competition in attracting and retaining talented employees. Further, managing succession for, and retention of, key executives is critical to our success, and our failure to do so could adversely affect our future performance.
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We are subject to potential changes in public policy, laws and regulations, including reform of the United States health care system, that can adversely affect the markets for our products and services and our businesses, operations, results of operations, cash flows and prospects.
•
Our enterprise strategy may not be an effective response to the changing dynamics in the industries in which we operate, or we may not be able to implement our strategy and related strategic projects.
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Efforts to reduce reimbursement levels and alter health care financing practices could adversely affect our businesses.
•
Gross margins in the industries in which we operate may decline.
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Our results of operations are affected by the health of the economy in general and in the geographies we serve.
•
We operate in a highly competitive business environment. Competitive and economic pressures may limit our ability to increase pricing to reflect higher costs or may force us to accept lower margins. If customers elect to self-insure, reduce benefits or adversely renegotiate or amend their agreements with us, our revenues and results of operations will be adversely affected. We may not be able to obtain appropriate pricing on new or renewal business.
•
We may lose clients and/or fail to win new business. If we fail to compete effectively in the geographies and product areas in which we operate, including maintaining or increasing membership in our Health Care Benefits segment, our results of operations, financial condition and cash flows could be materially and adversely affected.
•
We are exposed to risks relating to the solvency of our customers and of other insurers.
•
We face risks relating to the market availability, pricing, suppliers and safety profiles of prescription drugs that we purchase and sell.
•
We face risks related to the frequency and rate of the introduction and pricing of generic drugs and brand name prescription drug products.
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Possible changes in industry pricing benchmarks and drug pricing generally can adversely affect our PBM business.
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Product liability, product recall or personal injury issues could damage our reputation.
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We face challenges in growing our Medicare Advantage and Medicare Part D membership.
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We face challenges in growing our Medicaid membership, and expanding our Medicaid membership exposes us to additional risks.
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A change in our Health Care Benefits product mix may adversely affect our profit margins.
•
We may not be able to accurately forecast health care and other benefit costs, which could adversely affect our Health Care Benefits segment’s results of operations. There can be no assurance that the future health care and other benefit costs of our Insured Health Care Benefits products will not exceed our projections.
•
A number of factors, many of which are beyond our control, contribute to rising health care and other benefit costs. If we are unable to satisfactorily manage our health care and other benefit costs, our Health Care Benefits segment’s results of operations and competitiveness will be adversely affected.
•
The reserves we hold for expected claims in our Insured Health Care Benefits products are based on estimates that involve an extensive degree of judgment and are inherently variable. Any reserve, including a premium deficiency reserve, may be insufficient. If actual claims exceed our estimates, our results of operations could be materially adversely affected, and our ability to take timely corrective actions to limit future costs may be limited.
•
Extreme events, or the threat of extreme events, could materially increase our health care (including behavioral health) costs. We cannot predict whether or when any such events will occur.
•
Legislative and regulatory changes could create significant challenges to our Medicare Advantage and Medicare Part D revenues and results of operations, and proposed changes to these programs could create significant additional challenges.

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Entitlement program reform, if it occurs, could have a material adverse effect on our businesses, operations and/or results of operations.
•
We may not be able to obtain adequate premium rate increases in our Insured Health Care Benefits products, which would have an adverse effect on our revenues, MBRs and results of operations and could magnify the adverse impact of increases in health care and other benefit costs and of ACA assessments, fees and taxes.
•
Minimum MLR rebate requirements limit the level of margin we can earn in our Insured Health Care Benefits products while leaving us exposed to higher than expected medical costs. Challenges to our minimum MLR rebate methodology and/or reports could adversely affect our results of operations.
•
Our business activities are highly regulated. Our Pharmacy Services, Medicare Advantage, Medicare Part D, Medicaid, dual eligible, dual eligible special needs plan, small group and certain other products are subject to particularly extensive and complex regulations. If we fail to comply with applicable laws and regulations, we could be subject to significant adverse regulatory actions or suffer brand and reputational harm which may have a material adverse effect on our businesses. Compliance with existing and future laws, regulations and/or judicial decisions may reduce our profitability and limit our growth.
•
If our compliance or other systems and processes fail or are deemed inadequate, we may suffer brand and reputational harm and become subject to regulatory actions or litigation which could adversely affect our businesses, results of operations, cash flows and/or financial condition.
•
Our litigation and regulatory risk profile are changing as a result of the Aetna Acquisition and as we offer new products and services and expand in business areas beyond our historical core businesses of Retail/LTC and Pharmacy Services.
•
We routinely are subject to litigation and other adverse legal proceedings, including class actions and qui tam actions. Many of these proceedings seek substantial damages which may not be covered by insurance. These proceedings may be costly to defend, result in changes in our business practices, harm our brand and reputation and adversely affect our businesses and results of operations.
•
We frequently are subject to regular and special governmental audits, investigations and reviews that could result in changes to our business practices and also could result in material refunds, fines, penalties, civil liabilities, criminal liabilities and other sanctions.
•
We are subject to retroactive adjustments to and/or withholding of certain premiums and fees, including as a result of CMS RADV audits. We generally rely on health care providers to appropriately code claim submissions and document their medical records. If these records do not appropriately support our risk adjusted premiums, we may be required to refund premium payments to CMS and/or pay fines and penalties under the False Claims Act.
•
Programs funded in whole or in part by the U.S. federal government account for a significant portion of our revenues. The U.S. federal government and our other government customers may reduce funding for health care or other programs, cancel or decline to renew contracts with us, or make changes that adversely affect the number of persons eligible for certain programs, the services provided to enrollees in such programs, our premiums and our administrative and health care and other benefit costs, any of which could have a material adverse effect on our businesses, results of operations and cash flows. In addition, an extended federal government shutdown or a delay by Congress in raising the federal government’s debt ceiling could lead to a delay, reduction, suspension or cancellation of federal government spending and a significant increase in interest rates that could, in turn, have a material adverse effect on our businesses, results of operations and cash flows.
•
Our results of operations may be adversely affected by changes in laws and policies governing employers and by union organizing activity.
•
We must develop and maintain a relevant omni-channel experience for our retail customers.
•
We must maintain and improve our relationships with our retail and specialty pharmacy customers and increase the demand for our products and services, including proprietary brands. If we fail to develop new products, differentiate our products from those of our competitors or demonstrate the value of our products to our customers and members, our ability to retain or grow our customer base may be adversely affected.
•
In order to be competitive in the increasingly consumer-oriented marketplace for our health care products and services, we will need to develop and deploy consumer-friendly products and services and make investments in consumer engagement, reduce our cost structure and compete successfully with new entrants into our businesses. If we are unsuccessful, our future growth and profitability may be adversely affected.
•
Our results of operations may be adversely affected if we are unable to contract with manufacturers, providers, suppliers and vendors on competitive terms and develop and maintain attractive networks with high quality providers.
•
If our service providers fail to meet their contractual obligations to us or to comply with applicable laws or regulations, we may be exposed to brand and reputational harm, litigation or regulatory action. This risk is particularly high in our Medicare, Medicaid, dual eligible and dual eligible special needs plan programs.
•
Continuing consolidation and integration among providers and other suppliers may increase our medical and other covered benefits costs, make it difficult for us to compete in certain geographies and create new competitors.

Page 33


•
We may experience increased medical and other benefit costs, litigation risk and customer and member dissatisfaction when providers that do not have contracts with us render services to our Health Care Benefits members.
•
Customers, particularly large sophisticated customers, expect us to implement their contracts and onboard their employees and members efficiently and effectively. Failure to do so could adversely affect our reputation, businesses, results of operations, cash flows and prospects. If we or our vendors fail to provide our customers with quality service that meets their expectations, our ability to retain and grow our membership and customer base will be adversely affected.
•
We are subject to payment-related risks that could increase our operating costs, expose us to fraud or theft, subject us to potential liability and disrupt our business operations.
•
Our and our vendors’ operations are subject to a variety of business continuity hazards and risks, any of which could interrupt our operations or otherwise adversely affect our performance and results of operations.
•
We and our vendors have experienced cyber attacks. We can provide no assurance that we or our vendors will be able to detect, prevent or contain the effects of such attacks or other information security (including cybersecurity) risks or threats in the future.
•
The failure or disruption of our information technology systems or the failure of our information technology infrastructure to support our businesses could adversely affect our reputation, businesses, results of operations and cash flows.
•
Our business success and results of operations depend in part on effective information technology systems and on continuing to develop and implement improvements in technology. Pursuing multiple initiatives simultaneously could make this continued development and implementation significantly more challenging.
•
Sales of our products and services are dependent on our ability to attract and motivate internal sales personnel and independent third-party brokers, consultants and agents. New distribution channels create new disintermediation risk. We may be subject to penalties or other regulatory actions as a result of the marketing practices of brokers and agents selling our products.
•
We also face other risks that could adversely affect our businesses, results of operations, financial condition and/or cash flows, which include:
•
Failure of our corporate governance policies or procedures, for example significant financial decisions being made at an inappropriate level in our organization;
•
Inappropriate application of accounting principles or a significant failure of internal control over financial reporting, which could lead to a restatement of our results of operations and/or a deterioration in the soundness and accuracy of our reported results of operations; and
•
Failure to adequately manage our run-off businesses and/or our regulatory and financial exposure to businesses we have sold, including Aetna’s divested standalone Medicare Part D, domestic group life insurance, group disability insurance and absence management businesses.
•
Goodwill and other intangible assets could, in the future, become impaired.
•
We would be adversely affected if we do not effectively deploy our capital. Downgrades or potential downgrades in our credit ratings, should they occur, could adversely affect our brand and reputation, businesses, cash flows, financial condition and results of operations.
•
Adverse conditions in the U.S. and global capital markets can significantly and adversely affect the value of our investments in debt and equity securities, mortgage loans, alternative investments and other investments, our results of operations and/or our financial condition.
•
We have limited experience in the insurance and managed health care industry, which may hinder our ability to achieve our objectives as a combined company.
•
The Aetna Acquisition may not be accretive, and may be dilutive, to our earnings per share, which may adversely affect our stock price.
•
We may fail to successfully combine the businesses and operations of CVS Health and Aetna to realize the anticipated benefits and cost savings of the Aetna Acquisition within the anticipated timeframe or at all, which could adversely affect our stock price.
•
Our future results may be adversely impacted if we do not effectively manage our expanded operations following completion of the Aetna Acquisition.
•
We may have difficulty attracting, motivating and retaining executives and other key employees following completion of the Aetna Acquisition.
•
The Aetna integration process could disrupt our ongoing businesses and/or operations.
•
Our indebtedness following completion of the Aetna Acquisition is substantially greater than our indebtedness on a stand-alone basis and greater than the combined indebtedness of CVS Health and Aetna existing prior to the announcement of the transaction. This increased level of indebtedness could adversely affect our business flexibility and increase our borrowing costs.
•
We will continue to incur significant integration-related costs in connection with the Aetna Acquisition.

Page 34


•
We expect to continue to pursue acquisitions, joint ventures, strategic alliances and other inorganic growth opportunities, which may be unsuccessful, cause us to assume unanticipated liabilities, disrupt our existing businesses, be dilutive or lead us to assume significant debt, among other things.
•
We may be unable to successfully integrate companies we acquire.
•
As a result of our expanded international operations, we face political, legal and compliance, operational, regulatory, economic and other risks that we do not face or are more significant than in our domestic operations.

The foregoing list is not exhaustive. There can be no assurance that the Company has correctly identified all the risks that affect it. Additional risks and uncertainties not presently known to the Company or that the Company currently believes to be immaterial also may adversely affect the Company’s businesses. Should any risks or uncertainties develop into actual events, these developments could have a material adverse effect on the Company’s businesses, results of operations, cash flows and/or financial condition. For these reasons, you are cautioned not to place undue reliance on the Company’s forward-looking statements.


Page 35


Management’s Report on Internal Control Over Financial Reporting

Management is responsible for establishing and maintaining adequate internal control over financial reporting. The Company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of the Company’s consolidated financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on the Company’s consolidated financial statements. In order to ensure the Company’s internal control over financial reporting is effective, management regularly assesses such control and did so most recently for its financial reporting as of December 31, 2018.

Management conducted an assessment of the effectiveness of the Company’s internal control over financial reporting based on the criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 Framework). This evaluation included review of the documentation, evaluation of the design effectiveness and testing of the operating effectiveness of controls. The Company’s system of internal control over financial reporting is enhanced by periodic reviews by the Company’s internal auditors, written policies and procedures and a written Code of Conduct adopted by the Company’s Board of Directors, applicable to all employees of the Company. In addition, the Company has an internal Disclosure Committee, comprised of management from each functional area within the Company, which performs a separate review of disclosure controls and procedures. There are inherent limitations in the effectiveness of any system of internal control over financial reporting.

On November 28, 2018, the Company completed its acquisition of Aetna Inc. (“Aetna”). Management’s assessment of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2018 excludes Aetna from that assessment as permitted under SEC rules. Aetna’s operations are included in the Company’s consolidated financial statements for the period from November 28, 2018 to December 31, 2018 and represented 21% of the Company’s consolidated total assets as of December 31, 2018 and 3% of the Company’s consolidated total revenues for the year ended December 31, 2018.

Based on management’s assessment, management concluded that the Company’s internal control over financial reporting is effective and provides reasonable assurance that assets are safeguarded and that the financial records are reliable for preparing financial statements as of December 31, 2018.

Ernst & Young LLP, the Company’s independent registered public accounting firm, is appointed by the Board of Directors and ratified by the Company’s shareholders. They were engaged to render an opinion regarding the fair presentation of the Company’s consolidated financial statements as well as conducting an audit of internal control over financial reporting. Their accompanying reports are based upon audits conducted in accordance with the standards of the Public Company Accounting Oversight Board (United States).

February 28, 2019


Page 36


Report of Independent Registered Public Accounting Firm
 
To the Shareholders and the Board of Directors of CVS Health Corporation
 
Opinion on Internal Control over Financial Reporting
 
We have audited CVS Health Corporation’s internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). In our opinion, CVS Health Corporation (the Company) maintained, in all material respects, effective internal control over financial reporting as of December 31, 2018, based on the COSO criteria.
 
As indicated in the accompanying Management’s Report on Internal Control Over Financial Reporting, management’s assessment of and conclusion on the effectiveness of internal control over financial reporting did not include the internal controls of Aetna Inc., which is included in the 2018 consolidated financial statements of the Company and constituted 21% of total assets as of December 31, 2018 and 3% of revenues for the year then ended. Our audit of internal control over financial reporting of the Company also did not include an evaluation of the internal control over financial reporting of Aetna Inc.
 
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of the Company as of December 31, 2018 and 2017, the related consolidated statements of operations, comprehensive income (loss), shareholders’ equity and cash flows for each of the three years in the period ended December 31, 2018, and the related notes and our report dated February 28, 2019 expressed an unqualified opinion thereon.
 
Basis for Opinion
 
The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
 
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects.
 
Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
 
Definition and Limitations of Internal Control over Financial Reporting
 
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
 
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
 
/s/ Ernst & Young LLP
Boston, Massachusetts
February 28, 2019

Page 37


Consolidated Statements of Operations
 
For the Years Ended December 31,
In millions, except per share amounts
2018
 
2017
 
2016
Revenues:
 
 
 
 
 
Products
$
183,910

 
$
180,063

 
$
173,377

Premiums
8,184

 
3,558

 
3,069

Services
1,825

 
1,144

 
1,080

Net investment income
660

 
21

 
20

Total revenues
194,579

 
184,786

 
177,546

Operating costs:
 
 
 
 
 
Cost of products sold
156,447

 
153,448

 
146,533

Benefit costs
6,594

 
2,810

 
2,179

Goodwill impairments
6,149

 
181

 
—

Operating expenses
21,368

 
18,809

 
18,448

Total operating costs
190,558

 
175,248

 
167,160

Operating income
4,021

 
9,538

 
10,386

Interest expense
2,619

 
1,062

 
1,078

Loss on early extinguishment of debt
—

 
—

 
643

Other expense (income)
(4
)
 
208

 
28

Income before income tax provision
1,406

 
8,268

 
8,637

Income tax provision
2,002

 
1,637

 
3,317

Income (loss) from continuing operations
(596
)
 
6,631

 
5,320

Loss from discontinued operations, net of tax
—

 
(8
)
 
(1
)
Net income (loss)
(596
)
 
6,623

 
5,319

Net (income) loss attributable to noncontrolling interests
2

 
(1
)
 
(2
)
Net income (loss) attributable to CVS Health
$
(594
)
 
$
6,622

 
$
5,317

 
 
 
 
 
 
Basic earnings (loss) per share:
 
 
 
 
 
Income (loss) from continuing operations attributable to CVS Health
$
(0.57
)
 
$
6.48

 
$
4.93

Loss from discontinued operations attributable to CVS Health
$
—

 
$
(0.01
)
 
$
—

Net income (loss) attributable to CVS Health
$
(0.57
)
 
$
6.47

 
$
4.93

Weighted average basic shares outstanding
1,044

 
1,020

 
1,073

Diluted earnings (loss) per share:
 
 
 
 
 
Income (loss) from continuing operations attributable to CVS Health
$
(0.57
)
 
$
6.45

 
$
4.91

Loss from discontinued operations attributable to CVS Health
$
—

 
$
(0.01
)
 
$
—

Net income (loss) attributable to CVS Health
$
(0.57
)
 
$
6.44

 
$
4.90

Weighted average diluted shares outstanding
1,044

 
1,024

 
1,079

Dividends declared per share
$
2.00

 
$
2.00

 
$
1.70

 
 
 
 
 
 

See accompanying notes to consolidated financial statements.

Page 38


Consolidated Statements of Comprehensive Income (Loss)
 
 
 
 
 
 
 
For the Years Ended December 31,
In millions
2018
 
2017
 
2016
Net income (loss)
$
(596
)
 
$
6,623

 
$
5,319

Other comprehensive income (loss), net of tax: