CEO's Shareholder Letter

Dear Fellow Shareholders:

Health care continues to evolve rapidly in the United States. Despite the ongoing changes as well as uncertainty surrounding health care reform, CVS Health believes that the winners in our industry will be those who drive more affordable, accessible, and effective care. We are uniquely positioned to meet any challenges head on and pivot as needed to address any policy changes.

We continue to have the most extensive suite of enterprise assets, each of which would be a market leader on a standalone basis. Yet what really sets them apart is our ability, largely through technology, to integrate pharmacy care from the payor to the provider to the patient. Our success at integrating our assets enables us to offer innovative services and to deliver additional value to stakeholders. Products such as Maintenance Choice® and Specialty Connect® are unmatched in the marketplace. They remain the gold standard in giving patients choice while also delivering substantial savings to payors. Moreover, with our truly integrated assets, we have a full view of each patient and a single patient record for prescriptions and care regardless of the CVS Health channel used.

We think of our CVS Pharmacy® locations as the “front door of health care.” They give us a significant advantage in the marketplace as the retailization of health care continues, with consumer-directed health plans putting more incentive into the hands of patients to make cost-effective decisions regarding their health. Our research has found that face-to-face interactions are two to three times more effective than other interactions at increasing adherence and improving health outcomes. Importantly, CVS Health also owns the last mile in the delivery of care. Our unmatched touch points-from retail and mail to specialty, medical clinics, long-term care, and infusion-put us in direct contact with health care consumers every day.

This letter will provide additional insight into these topics as well as update you on our results across the enterprise. We have many accomplishments to look back on, including a successful PBM selling season, superior specialty growth, and the progress we made at integrating the 2015 acquisitions of Omnicare and the pharmacies and clinics of Target. We also excelled at managing rising drug costs-or “trend.” As always, I’ll start with a brief overview of CVS Health’s financial performance and outlook.

Robust cash flow provides a strong platform for future growth

In 2016, we benefited from our ongoing focus on the three key financial pillars that we consider essential to maximizing shareholder value:

  • Driving productive, long-term growth;
  • Generating significant levels of free cash flow; and
  • Optimizing capital allocation.

Net revenues for the year increased nearly 16 percent to a record $177 billion, while adjusted earnings per share (EPS) rose 13 percent to $5.84. The compound annual growth rate in operating profit and adjusted EPS puts us at the high end of the steady state growth targets we introduced in 2013.

We experienced strong organic prescription growth across the enterprise in 2016, augmented by the Omnicare and Target acquisitions. Moreover, the successful CVS Caremark® PBM selling season of 2015 led to growth in our membership base and claims in 2016.

That said, we do expect to experience some headwinds in the near term that will slow earnings growth in 2017, driven primarily by pharmacy network changes announced late in 2016 that are causing some retail prescriptions to migrate out of our pharmacies. Additionally, our entire industry is facing uncertainty surrounding health care reform. All of these factors contributed to a 19 percent decline in CVS Health’s stock price in 2016, although we have still outperformed both the S&P 500 Index and the Dow Jones Industrial Average on a five- and 10-year basis.

We have already developed a four-point plan that will help us generate more robust levels of earnings growth in the years ahead. First, we will leverage our enterprise capabilities and CVS Pharmacy’s compelling retail value proposition to partner more broadly with other PBMs and health plans. Our recent announcement that OptumRx members now have the option to fill their 90-day prescriptions at a CVS Pharmacy is just one example.

Second, we will continue to innovate to bring new, integrated PBM products to market that capitalize on the benefits inherent in our integrated model. Take Maintenance Choice, which gives plan members the option of receiving their 90-day prescriptions in the mail or through in-store pickup. Its latest iteration, now in the pilot phase, brings convenience to the next level by offering same-day delivery within two to three hours to a member’s home or workplace.

Third, we have launched an enterprise streamlining initiative that we expect to result in nearly $3 billion in cumulative savings by 2021. It includes enhancing the efficiency of our shared services functions, optimizing our pharmacy delivery platform, and rationalizing our store footprint. As part of the latter, we expect to close approximately 70 stores in 2017. Many are located close to our CVS Pharmacy locations within Target stores.

Finally, we have significant cash generation capabilities that provide us with a variety of ways to grow and return value to shareholders. Free cash flow totaled $8.1 billion in 2016, and we returned $6.3 billion to shareholders through dividends and share repurchases during the year. After increasing our quarterly dividend by 21 percent for 2016, our board of directors has approved an additional 18 percent increase for 2017. That marks our 14th consecutive year of increasing the dividend. We will also continue to repurchase shares, taking advantage of the recent decline in our stock price. Through dividends and share repurchases, we expect to allocate more than $7 billion in 2017 to enhancing total returns for shareholders.

As exemplified by Omnicare and Target, we also use our cash flow for strategic acquisitions and other ventures that supplement our existing asset base and provide a platform for long-term growth. We will continue to identify such opportunities in the future, always taking a disciplined approach to deploying capital. With well-laddered debt maturities and a high triple-B credit rating, we have a healthy balance sheet that provides flexibility and allows us to maximize shareholder value for the long term. In fact, we took advantage of the favorable interest rate environment in 2016 to reduce long-term debt levels and the associated interest expense.

PBMs are a key part of the solution to reining in rising drug prices

Before discussing CVS Caremark’s performance, I want to address the ongoing rhetoric around drug pricing. New launches at elevated price points and increasing prices of older drugs have contributed to a sense that government interventions are necessary. Some market participants have attempted to paint PBMs as “middle men” in the pharmacy supply chain, taking outsized profits at the expense of patients and payors. This is simply not true. PBMs are the solution, not the problem. That’s why both public and private payors continue to count on PBMs as indispensable partners that help to manage their drug trend.

Numerous evaluations from the Federal Trade Commission, Congressional Budget Office, and other government agencies have consistently concluded that PBMs operate in a highly efficient market and drive real savings to the health care economy. And CVS Caremark’s array of cost management solutions have helped to reduce client costs, from an unmanaged gross trend of 11 percent to a managed trend of only 3.2 percent in 2016. In addition, a recent industry study showed that every dollar invested in PBM services returned $6 in savings for clients and members. So, the value of PBMs is quantitatively pretty clear.

Now, it is a bigger challenge to negotiate lower prices when there is basically a single product in a category. So, we will continue to encourage the need to create competition within therapeutic classes as a solution to reducing the cost of drugs; whether it’s clearing out the FDA backlog of potential drug approvals, many of which are generics, or increasing the speed to market of new biosimilar agents.

High satisfaction rates, integrated offerings, and trend management capabilities are driving growth in CVS Caremark’s book of business

CVS Caremark’s integrated model continued to resonate in the marketplace, helping us achieve strong top- and bottom-line growth in 2016. In a highly competitive 2017 selling season, gross new business wins totaled $7.9 billion. That represents more than half of all revenue from clients that switched PBMs. Health plans accounted for approximately two-thirds of our wins, with employers, unions, and government entities comprising the rest.

With our 97 percent retention rate, net new business for 2017 totaled $4.4 billion. This new business provides an important platform to grow dispensing across the enterprise. As an example, let’s look at payors that came on board in 2015. While their members filled 8.4 million retail prescriptions in one of our channels before these payors were clients, we expect their members to fill more than 29 million scripts through one of our channels in 2017. That will be an important driver of share gains.

Payors have different reasons for choosing CVS Caremark, from our high client and member satisfaction scores to our ability to control trend. We accomplish the latter in a variety of ways. Among them, CVS Health has been the industry leader in formulary innovations. In 2012, we became the first PBM to exclude high-cost drugs from our formulary in favor of less expensive clinical equivalents. In 2017, we will continue to lead the market in formulary strategy with the inclusion of biosimilars as a key component as well as a new indication-based formulary. We are also monitoring hyperinflationary drug pricing on a real-time basis, enabling rapid response to help reduce the impact on our clients.

Complementing our partnership with health plans, we have broad expertise in government programs. SilverScript® is the nation’s largest Medicare Part D (Med D) Prescription Drug Plan (PDP), and we are proud that it earned four stars on the government’s annual quality measurement system for the second consecutive year.

SilverScript began 2017 with 5.5 million captive PDP lives, including Employee Group Waiver Plans, up 10 percent from the previous year. We serve and support a total of 12.3 million lives under management when you include the Med D and MA-PD offerings of more than 40 of our health plan clients. We provide these clients with operational and consultative services that include making formulary and plan design recommendations. That has helped improve their star ratings and enabled them to grow faster than the market. While the Med D market has averaged 4.8 percent annual growth since 2013, our clients have seen their Med D membership rise by 7.6 percent.

CVS Specialty’s unique capabilities help us address the increasing complexity in the industry’s fastest-growing sector

Revenue from the specialty prescriptions we dispense and manage grew to $50 billion in 2016. That is a 27 percent increase over 2015. Since 2013, our dispensed specialty revenue has grown at a compound annual growth rate of 26 percent, compared with 22 percent for the industry. Specialty remains the industry’s fastest-growing sector, and our 28 percent share of the market leads our competitors by a wide margin.

Many factors have contributed to our strong performance. Payors value our capabilities in price as well as utilization and site of care management. And our NovoLogix® technology platform allows us to manage all specialty medications, including those paid under the medical benefit. Even our most sophisticated health plan clients who have been managing specialty on their own can realize incremental savings when they take advantage of our full range of management tools.

The complexity of the market and the growing impact of specialty pharmacy on overall drug spending make our integrated PBM/specialty model more relevant than ever. Adherence has risen by 11.4 percent among those enrolled in Specialty Connect®. Like Maintenance Choice, this product offers specialty patients the option of having their medications delivered by mail or to their CVS Pharmacy location for pick-up. Specialty Connect users choose the latter option 54 percent of the time.

Access to new drugs has also played an important role in our performance. Some of these drugs have had limited distribution, and manufacturers can be discriminating evaluators when choosing specialty pharmacy partners. We have secured access to 30 of the 35 limited distribution products generally used in our channels and that have launched in the past two years. That success is a testament to the level of service our specialty pharmacy offers. In 2017, we are rolling out an enhanced specialty model that will further streamline the entire prescription process for physicians and patients while lowering costs for payors.

CVS Pharmacy’s industry-leading care programs and high adherence rates make us a valuable strategic partner

CVS Pharmacy same store prescription volumes rose by 3.6 percent in 2016, with same store pharmacy sales up 3.2 percent. With front store same store sales declining by 1.5 percent, total same store sales increased by 1.9 percent. CVS Pharmacy locations now fill more than 1 billion prescriptions annually, and we have captured a 23.8 percent share of U.S. retail prescriptions. Size, scale, and expertise matter in health care. We have more than 9,600 locations with 27,000 retail pharmacists and 73,000 pharmacy technicians who help patients get on—and stay on—their medications.

Non-adherence costs the U.S. health care system hundreds of billions of dollars each year. Our deep clinical expertise and industry-leading care programs drive best-in-class adherence rates. For example, we have demonstrated better adherence results than our key competitors for patients with diabetes, hypertension, and high cholesterol. Innovations such as first-fill counseling, our signature Pharmacy Advisor® program, and ScriptSync® are just a few of the programs that are driving these improved health outcomes.

The market innovations we are driving through our retail pharmacy’s integration with CVS Caremark have certainly played an important role in our growth. That said, it’s worth noting that 55 percent of retail prescription growth since 2013 has been driven by share gains with other payors. They value the clinical solutions/capabilities that CVS Pharmacy brings to market to keep their members healthy.

We are successfully leveraging the Omnicare and Target acquisitions; MinuteClinic continues to enhance our value proposition

Now let me bring you up to date on our Omnicare and Target acquisitions. I’ll start with Omnicare, the nation’s leading provider of pharmacy services to the long-term care market. Omnicare dispenses approximately 100 million scripts annually to more than 1 million patients. We are using our retail footprint and extensive operational expertise to help improve efficiency and productivity in Omnicare’s core business of serving skilled nursing facilities. For example, 77 percent of Omnicare’s customers live within three miles of a CVS Pharmacy. That means we can fill prescriptions for them much more quickly in emergency situations. We have several initiatives underway as well to accelerate growth in the assisted living and independent living markets.

Moving on to Target, last year’s acquisition of its nearly 1,700 pharmacies expanded our retail footprint by more than 20 percent. It also gave us a presence in new regions such as Seattle, Denver, Portland, and Salt Lake City. We have successfully completed the integration and are now focused on converting more of Target’s 30 million weekly guests into CVS Pharmacy customers. We are making good progress and moving in the right direction, with script performance improving versus prior quarters. This is driven by the strength of our patient care programs as well as Maintenance Choice.

The Target deal included the acquisition of nearly 80 retail clinics that we have since rebranded as MinuteClinic locations. In total, we operate more than 1,100 clinics across 33 states, three times more than our next-largest competitor. And MinuteClinic’s nearly 3,000 nurse practitioners and physician assistants have logged more than 34 million patient visits to date.

MinuteClinic enhances the CVS Pharmacy value proposition in a variety of ways. Perhaps most importantly, it is up to 80 percent less expensive than other sites of care, such as the emergency room. In 2017, approximately 4 million CVS Caremark plan members will have an opportunity to benefit from the MinuteClinic Savings Strategy program. This integrated offering provides PBM members with reduced or zero co-pays. MinuteClinic is also partnering with health systems on population health strategies and engaging patients through a convenient and consumer-friendly experience. In fact, MinuteClinic and the Department of Veterans Affairs recently partnered to expand access to high-quality and convenient health care services for veterans in Northern California.

Health and Beauty, ExtraCare®, and digital initiatives drive front store performance

In the front of the store, we have focused on ways of enhancing the pharmacy experience and driving profitable margin growth for the enterprise. Our emphasis on health and beauty-categories closely tied to pharmacy-helped us accomplish both. Health and beauty offer profit margins that are higher than the average of other front-store categories, and sales have grown at a compound annual growth rate of 3.5 percent since 2011. We also continued to have success with store brands, which offer higher margins than national brands and now comprise more than 22 percent of front store sales. We believe that their penetration rate can reach 25 percent in the coming years.

Among other front store initiatives, we have continued to shift our promotional dollars from mass circulars to digital and personalized offers. In particular, we have focused on the top 30 percent of customers that account for 75 percent of our margins. The ExtraCare loyalty program, now in its 19th year, helps us identify and engage these higher-value shoppers.

Our digital offerings complement and leverage our brick-and- mortar locations to make the shopping experience even more convenient. As an example, we launched CVS Curbside in roughly 4,000 stores across 40 markets in late 2016. With this new service, customers can use the CVS smartphone app to have purchases delivered to their car when they pull up to the store. For parents with young children or people with mobility issues, we believe that this is a compelling offering. We expect to add a similar option for pharmacy as well.

Our social responsibility initiatives include a major anti-tobacco effort

No discussion of CVS Health would be complete without acknowledging the broad and ambitious social responsibility initiatives underway across the enterprise. You can read about them in detail in our comprehensive 2016 corporate social responsibility (CSR) report, which will be available in May. I’ll mention just a couple here.

We completed the removal of tobacco products from our stores in 2014. Through the Be the First initiative we launched in 2016, we have made a five-year, $50 million commitment to help people lead tobacco-free lives. We are supporting education, advocacy, tobacco control, and healthy behavior programming in partnership with organizations uniquely positioned to tackle this public health challenge. In addition to our tobacco-related efforts, through Project Health we have provided more than $113 million worth of free health services, such as biometric screenings and health insurance education, at select CVS Pharmacy locations throughout the United States and Puerto Rico. These efforts support our corporate purpose of helping people on their path to better health.

In closing, I want to thank our board of directors, our shareholders, and the 250,000 colleagues who have played a significant role in CVS Health’s achievements. Because of them, we are able to deliver a compelling business model that offers benefits in savings, accessibility, and outcomes across the health care spectrum. If you haven’t done so already, I encourage you to read the rest of this report to learn more about our unique capabilities.

Sincerely,

Larry J. Merlo

Larry J. Merlo
President and Chief Executive Officer
February 9, 2017