CEO's Shareholder Letter

Dear Fellow Shareholders:

CVS Health enjoyed a successful 2015 that was highlighted by excellent performance across our enterprise and two key acquisitions that support our strategy for growth in an evolving health care market. That strategy is focused on creating superior value for patients, payors, and providers through an unmatched suite of integrated assets.

From our nationwide retail footprint to our leading pharmacy benefits management (PBM) and specialty businesses, and now our leading presence in long-term pharmacy care, we have forged a competitive advantage that is helping us benefit from a broad range of market trends. They include the implementation of the Affordable Care Act, the aging U.S. population, and increased prescription utilization. Of the roughly 710 million prescriptions added to the market over the past five years, CVS Health has captured 39 percent through one of our dispensing channels. In other words, we are growing our share of an expanding market.

CVS Health is truly a one-of-a-kind company that helps patients get the care they need through the channel that works best for them. Products such as Maintenance Choice®, Specialty ConnectTM, and Pharmacy Advisor® remain unmatched in the marketplace. In specialty, we have unparalleled capabilities to holistically manage patients, provide clinical support, and drive superior outcomes. As clients look to drive down overall health care costs, our growing volumes—along with our Red Oak generic sourcing venture with Cardinal Health—create unparalleled scale and purchasing expertise that help them best accomplish this.

And we certainly aren’t standing still. We broadened our reach in 2015 with the acquisition of Omnicare, the nation’s leading provider of pharmacy services to the long-term care market. Omnicare dispenses 100 million scripts annually to approximately 2 million patients. We also grew our core pharmacy business with the purchase of more than 1,670 pharmacies and nearly 80 retail clinics from Target Corporation. This transaction, which closed in December, expanded our pharmacy count by 20 percent and our number of clinics by 8 percent. I’ll have more to say about both of these acquisitions, but let me first offer a brief overview of CVS Health’s financial performance.

Record revenue and earnings helped us return more than $6 billion to shareholders

Once again, we met or exceeded all of our key financial targets through our ongoing focus on three pillars that we consider essential to maximizing shareholder value:

  • Productive, long-term growth;
  • Generating significant free cash flow; and
  • Optimizing capital allocation.

Net revenues for the year increased 10 percent to a record $153 billion, while adjusted earnings per share (EPS) rose nearly 15 percent to $5.16 on a comparable basis. That excludes amortization, acquisition-related costs, and a charge related to a disputed 1999 legal settlement in 2015; it excludes amortization and the loss on the early extinguishment of debt in 2014. Looking back at the steady state targets we introduced in 2010 for the subsequent five-year period, I am happy to report that the company’s growth hit the higher end of each target range. Operating profit has risen at a 10 percent compounded annual growth rate (CAGR), while adjusted EPS has grown at a 14 percent CAGR.

CVS Health generated $6.5 billion in free cash flow during 2015 and returned more than $6 billion to shareholders through dividends and share repurchases. Our board of directors increased our quarterly dividend by 27 percent and approved an additional 21 percent increase for 2016. That marks our 13th consecutive year of increases and keeps us on track to reach a 35 percent dividend payout ratio target by 2018. We expect to return more than $5 billion to shareholders in 2016 through dividends and share repurchases.

The Omnicare and Target deals represent efficient strategic uses of our capital that will help drive long-term growth. Even after financing both acquisitions through debt, we still have a strong balance sheet with well-laddered debt maturities. We maintain a high triple-B credit rating that allows CVS Health to continue to effectively finance the working capital needs of the company.

While the stock market has been tumultuous, CVS Health shares produced a total return of 2.9 percent in 2015 to outperform the major indices. Over the same period, the S&P 500 Index and the Dow Jones Industrial Average returned 1.4 percent and 0.2 percent, respectively. We have notably outperformed these indices on a three-, five-, and 10-year basis as well.

High retention rates and new business wins reflect the value of the CVS Caremark® PBM model

The capabilities of CVS Caremark remain unmatched in the PBM marketplace, fueling strong top- and bottom-line growth in 2015. Another highly successful selling season resulted in $14.8 billion in gross new client business to start 2016. While health plans accounted for roughly 80 percent of our wins, we were also very successful in the employer segment with more than 90 new clients totaling $1.8 billion in revenue. With a 98 percent client retention rate, net new client business for 2016 totaled $12.7 billion.

We are winning with our strong record of service and execution, our competitive pricing, and by bringing unique solutions to the market to meet a broad range of client concerns. Surveys have shown that cost control is our clients’ top priority. This is followed by a variety of additional factors, with each of our client channels having different priorities. Our flexibility and expertise in addressing them has certainly been key to our success.

We led the market with the first formulary exclusions in 2012, ensuring patient access to high-quality medications at the lowest possible cost to clients. Since that time, we’ve identified additional exclusions on an annual basis. Most recently, we took bold steps in 2015 with Hepatitis C medications and PCSK9 inhibitors. These expensive therapies are key potential drivers of rising costs—or “trend”—for clients. Through our strategies, we expect to have saved clients $6.4 billion for the five-year period through 2016. Oversight and strategic pharmacy management cut our clients’ trend by more than half in 2015, despite record levels of drug price increases. This past year we also launched a valuable surveillance and reporting tool—Interactive Rx Insights—that allows our sales team to simulate the impact of plan designs and show clients how specific solutions reduce the impact of trend drivers.

Our Medicare Part D (Med D) business had another successful Annual Enrollment Period for 2016. The SilverScript® Prescription Drug Plan (PDP) added 500,000 lives, raising total enrollment to 5 million captive PDP lives, including Employee Group Waiver Plans. When adding the Med D lives we manage for our health plan clients, the total rises to more than 11 million Med D lives under management, up 41 percent from the prior year, and making us the clear leader in the Med D space. Through our enterprise clinical capabilities, we have an unmatched ability to drive Med D Star ratings—for SilverScript as well as our health plan clients’ offerings. In fact, SilverScript was the largest PDP to achieve a four-star rating, and 73 percent of our clients’ lives were enrolled in a high performing plan for the 2016 plan year.

Our specialty business, with its breadth of offerings, has been a key driver of revenue gains

Throughout 2015, we continued to capture an outsized share of the specialty market, the industry’s fastest-growing sector. Our CVS SpecialtyTM business is the nation’s largest, and our growth has outpaced both the industry overall and that of our nearest competitor. In 2015, revenues from the specialty drugs we dispensed and managed across the enterprise totaled nearly $40 billion, increasing 32 percent over the prior year.

CVS Specialty offers all the traditional capabilities that payors expect from a specialty pharmacy. We’ve raised the bar as well by offering a unique range of differentiated solutions through our integrated model. Take our highly popular Specialty ConnectTM offering, which gives specialty patients the option of picking up their medications at any CVS Pharmacy® location or having the medication delivered by mail. More than 54 percent of our specialty patients prefer in-store pickup—along with the opportunity to consult with a pharmacist face-to-face—and we’ve served more than 100,000 of them in this way since we rolled out the program in 2014. Among specialty patients that opt for in-store pickup, we’ve seen adherence improve by 11.4 percent.

Our differentiated offerings also include Accordant® rare disease case management and Coram® infusion services, both of which make CVS Specialty particularly attractive to manufacturers who want to launch new drugs through limited distribution networks. Only CVS Specialty has the NovoLogix® technology platform, enabling us to help our clients manage all specialty medications including those paid under the medical benefit.

Retail pharmacy growth has outpaced our competitors while the Target deal further broadens our reach

At CVS Pharmacy, same store sales increased 1.7 percent in 2015. Pharmacy same store sales rose 4.5 percent, while front store same store sales decreased 5 percent, driven primarily by our exit from tobacco sales in 2014. CVS Pharmacy filled 21.6 percent of all retail prescriptions in 2015 to lead the U.S. retail drugstore market. In fact, our retail prescription business has grown at twice the rate of the overall market since 2010.

Although our integrated model has certainly played a key role in these results, nearly 44 percent of our prescription growth since 2013 has been driven by share gains from non-CVS Caremark payors. This is due in part to the many programs we have put in place to provide all customers with excellent service and value. Our growth has also led to valuable economies of scale. For example, our labor cost to fill prescriptions has fallen by approximately 13 percent (excluding wage inflation) over the past five years.

Our stores are also playing an important role in what we call the retailization of health care. With the rise in consumer- directed health plans, it is imperative that patients stay on their medications. We encourage appropriate patient behavior through our industry-leading adherence programs. Additionally, the Affordable Care Act has led increasing numbers of individuals to choose their own health plans on public exchanges. We can effectively support health plan partners with in-store displays and service centers that support their outreach efforts.

I’ve already touched on the Target deal, which has expanded our presence to regions such as Seattle, Denver, Portland, and Salt Lake City. Across the enterprise, you can now find a CVS Health location in every U.S. state. We are currently in the process of rebranding these assets as CVS Pharmacy® and MinuteClinic® locations. CVS Pharmacy stores have typically filled twice the number of prescriptions as Target pharmacies, so these new locations represent a significant opportunity to drive script growth and profitability. In addition to the acquired Target locations, we opened 161 new stores in 2015. Factoring in closings, net units increased by 130 stores.

For our PBM business, members now have approximately 9,600 CVS Pharmacy locations to choose from. That’s up from about 7,800 in 2014. This enhances the relevance of Pharmacy Advisor, Maintenance Choice, and our other integrated offerings since more members will benefit from easier access to them.

Health and Beauty and ExtraCare® are driving front store gains; CVS MinuteClinic™ expands its scope of services

In the front of the store, our average basket size in 2015 (after excluding the impact of our exit from tobacco) increased 2 percent—and 4 percent in our core health and beauty businesses. These results are gratifying given the lackluster trend in overall shopping visits across the retail landscape. Health and beauty offer higher margins and growth opportunities than other front store categories, and we are expanding our emphasis on both through a combination of store remodelings, merchandising enhancements, and improved product mix.

Among other front store initiatives, shoppers have responded enthusiastically to our expanded healthy food options. We’ve also continued to strengthen our position with Hispanic customers, the fastest-growing demographic in the United States, by launching CVS Pharmacy y más™ in 12 locations in Miami. These stores offer hundreds of Hispanic products and services not found in traditional drugstores, and we saw sales in the test stores increase by an average of 10 percent. We expect to expand on this concept in 2016.

The ExtraCare loyalty program, now in its 18th year, continues to play an indispensable role in driving profitable front store sales across all our stores. It helps identify our higher-value shoppers so we can build on our relationship with them through personalized promotions. Such shoppers represent 30 percent of our retail customer base, but they are responsible for driving more than 80 percent of sales in the front of the store.

It has been more than a year since we stopped selling tobacco in our stores, a move that better aligned our business practices with our goals as a health care company. At the time, we also reasoned that removing a convenient location to buy cigarettes could decrease overall tobacco use. A new study conducted by our CVS Health Research Institute has shown that approximately 95 million fewer packs were sold in states where CVS Pharmacy has a 15 percent or greater share of the retail pharmacy market compared to states without a large CVS Pharmacy presence. We continue to promote smoking cessation in a variety of other ways, with our 30,000 pharmacists and 3,100 nurse practitioners taking the lead.

The expansion of CVS MinuteClinic continued in 2015, with the number of locations at year end totaling 1,135 in 33 states and Washington, D.C. That includes the 79 clinics we acquired from Target. More than 50 percent of the U.S. population now lives within 10 miles of a MinuteClinic, and we operate more retail clinics than all our competitors combined. CVS MinuteClinic plays an important, complementary role with traditional medical practices. Through our 2015 implementation of the Epic electronic health record platform, we are now sharing information with approximately 275 health systems and provider organizations. The Epic platform has also allowed us to expand the CVS MinuteClinic scope of services to cover 28 of the 50 most common primary care diagnoses.

CVS MinuteClinic has been exploring a number of transformative digital offerings, such as telehealth, to improve access and convenience. This is just one of the many ways in which we have been working to enhance our digital capabilities across the enterprise to strengthen engagement with patients and providers. For example, we’ve added several features to the CVS Pharmacy app that have improved the customer experience in the pharmacy as well as the front of the store. Benefits include improved adherence as well as savings of both time and money.

The aging population has created new growth opportunities and was a key driver of our Omnicare acquisition

The nation’s aging population will play a major role in the evolving health care market, and it will create new opportunities for CVS Health. The number of people 65 or older is expected to grow 18 percent in just the next five years—and 38 percent through 2025. This demographic utilizes more than double the number of prescriptions of the under-65 population, creating a long-term tailwind for the industry. Increased utilization, combined with growth in specialty medications, is expected to fuel a 6 percent rise in prescription expenditures annually over the next decade.

With this projected growth in prescription expenditures, it’s important to keep in mind that pharmacy care remains the most cost-effective way of reducing overall health care costs. Getting and keeping patients on the necessary medications to manage chronic diseases can drive billions of dollars in costs out of the system. Compared with our peers, we have more ways in which we can touch patients to help drive adherence and improve outcomes— from our retail, mail, and specialty pharmacies to our MinuteClinic locations and now through Omnicare.

Approximately 70 percent of people over age 65 are likely to require some form of long-term care service and support. The Omnicare acquisition bolsters our ability to serve this population across the continuum of senior care. Omnicare’s nationwide footprint includes a significant presence in both the assisted living and skilled nursing facility settings, giving us broad reach and an ability to leverage clinical insights to improve care.

Through our combined enterprise assets, we will also bridge some of the historic gaps in Omnicare’s offerings to better address the unmet needs of these high-risk populations. For example, Omnicare’s robust offering for the skilled nursing facility market did not include a complete solution to address care coordination issues during a patient’s admittance or discharge. With roughly 9,600 retail locations, we can ensure the timeliness of medication adherence through first-fill and emergency prescriptions, reducing the potential for costly hospital readmissions. In addition, we’ve launched an integrated discharge solution that will coordinate care and offer the CVS Health suite of services to patients returning home. We are developing integrated solutions for the assisted living, independent living, and home care markets as well.

Before signing off, I must note with pride the more than $80 million we contributed to our communities in 2015 through the CVS Health Foundation, CVS Health Charity Classic, corporate grants, gifts in-kind, and employee giving. That total also includes the more than $7.5 million raised for the American Lung Association’s LUNG FORCE as well as Stand Up to Cancer through our two in-store campaigns. Moreover, our remarkable colleagues volunteered their time to a broad range of community outreach programs and donated nearly $1 million to the causes they care most about. They also supported the CVS Health Employee Relief Fund that helps colleagues who have suffered significant hardship as a result of a natural disaster, family death, medical emergency, or other unforeseen events.

In closing, I am confident that our leadership across the pharmacy spectrum will help us continue to drive superior value for our health care partners and shareholders. As we expand our core pharmacy business, we will also broaden our reach into new health care channels and make investments to drive sustainable enterprise growth. On behalf of our board of directors and our more than 240,000 colleagues who work hard each and every day to help people on their path to better health, thank you for investing in CVS Health.


Larry J. Merlo

Larry J. Merlo
President and Chief Executive Officer
February 9, 2016