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CEO's Shareholder Letter

Larry J. Merlo

Dear Fellow Shareholders:

Today’s health care system faces a broad range of challenges, from its complexity and lack of support for patients, to a focus on episodic care in a fee-for-service environment. Moreover, fragmentation among various stakeholders all too often leaves patients struggling to manage and coordinate their own care. These factors have led to unnecessary, avoidable spending and inferior outcomes for patients. In fact, research shows that up to 25 percent of the more than $2 trillion the United States spends annually on treating patients with chronic conditions is preventable.

I believe that CVS Health is best positioned to tackle these challenges and remake the consumer health care experience. Through our CVS Pharmacy® locations and unique suite of integrated assets, we can open a new front door to health care that is both easier to use and less expensive. What are some of these assets? They include our CVS Caremark® pharmacy benefits business, MinuteClinic® , Coram® infusion services, Accordant® nurse care management, and, of course, our transformative acquisition of Aetna® completed in November 2018.

Aetna acquisition creates multiple opportunities for medical cost savings and long-term growth

One of the nation’s leading diversified health care benefits companies, Aetna broadens CVS Health’s reach and allows us to play a larger role in the health care system. Its focus on the consumer has long mirrored CVS Health’s. Aetna employees have built trusted relationships with 22 million members and created new digital tools and analytical capabilities to proactively engage consumers in their health. At the same time, the company has built solid relationships with high-quality providers.

Aetna forms the cornerstone of our new Health Care Benefits segment, which also incorporates our SilverScript® Medicare Part D business in 2019. The nation’s largest standalone Part D Prescription Drug Plan is now part of one of the fastest growing Medicare Advantage providers in the country. Among new options for 2019, we have introduced SilverScript Allure. This enhanced plan offers reduced costs on many brand name drugs through the application of point-of-sale rebates.

I’m pleased to report that we have a clear line of sight on more than $750 million of combined company synergies by the end of 2020, and we have begun to execute on our plan to achieve that goal. The majority of these synergies will be derived from the reduction of corporate expenses and the integration of our operations.

The integration of CVS Health’s and Aetna’s core capabilities represents a much larger, longer-term opportunity. We are already executing on several initiatives we believe will drive above-market growth in this rapidly changing health care environment. Among them, we are expanding our Medicare Advantage business by adding membership in existing markets and through continued geographic expansion. We see opportunities as well within Medicaid, building upon the success we’ve had with recent wins in Kansas and Florida, and are also working to strengthen our commercial offerings.

At the community level, we are creating differentiated products and services that will drive meaningful value for both consumers and payors. For example, CVS Health can better manage five common chronic conditions through the tighter integration of pharmacy and medical benefits, a rich clinical data set, and our local assets. We also expect to reduce avoidable hospital readmissions, improve access to lower-cost sites of care, optimize primary care through MinuteClinic, and develop a series of comprehensive programs to better manage complex chronic diseases, such as kidney care and oncology.

Importantly, we will make these solutions available to more than just Aetna’s members. An open platform model will serve the needs of all payors, and we expect to have these offerings in the market for the 2021 selling season.

The expected medical cost savings will have a tremendous impact on CVS Health’s financial performance as well. Success at slowing the rise in medical costs translates into additional underwriting margin for our health plan customers and for Aetna. We plan to take a portion of those savings and reinvest them back into the business to improve our competitive positioning and, ultimately, increase membership. By introducing new, higher-margin programs and services, we will create a platform that customers want to use and that results in improved retention.

We continued to generate significant free cash flow and returned more than $2 billion to shareholders

We clearly have reason to be confident in our operating model’s ability to drive profitable, long-term growth and enhance shareholder value. That said, 2018 was not free of challenges as we took $6.1 billion of goodwill impairment charges related to our long-term care business. As a result, GAAP operating income for the year declined by 57.8 percent.

Revenues for the year increased by 5.3 percent to a record $194.6 billion, with GAAP diluted earnings per share from continuing operations of ($0.57). Adjusted earnings per share* was $7.08, an increase of 19.9 percent versus 2017. These numbers include Aetna’s performance only since the close of the acquisition at the end of November. CVS Health continued to generate significant cash flow in 2018. Cash flow from operations totaled $8.9 billion, with free cash flow reaching $6.8 billion. We used part of our free cash flow to return $2 billion to shareholders based on a dividend of $2.00 per share. We already announced in late 2017 that, due to the Aetna acquisition, we would suspend any dividend increases as well as our share repurchase program. In the near term, we plan to use our free cash flow to fund our dividend and pay down debt to get to our targeted leverage ratio.

Multiple drivers spurred PBM revenue gains as clients embraced new cost-saving options

CVS Caremark enjoyed a strong 2018, with revenues rising 2.7 percent to $134.1 billion. Specialty pharmacy was also a key driver of PBM revenue in 2018, with rising volumes stemming from net new business. Operating income for the segment rose to $4.7 billion. Gross new business wins from our 2019 selling season totaled $4.2 billion, resulting in $1.7 billion in net new business. Client satisfaction was evident in our 98 percent retention rate.

Current and new clients have responded enthusiastically to our Guaranteed Net Cost model, a new approach to pricing PBM services that we announced in December. We have also seen rapid adoption of the real-time benefits solution that we introduced in late 2017. Meanwhile, our Maintenance Choice® offerings continue to attract new customers. Maintenance Choice gives plan members the choice of obtaining their 90-day maintenance medications by mail or at any CVS retail pharmacy with no increase in co-pay or payor pricing. At the end of 2018, we had nearly 28 million lives enrolled.

In-store prescription volumes continued to rise while we also introduced new concept stores and pilot programs

Despite reimbursement pressures, revenues rose by 5.8 percent to $84.0 billion in our Retail/LTC segment. That result was due primarily to a 9.1 percent increase in same store prescription volumes (on a 30-day equivalent basis), the continued adoption of our patient care programs, alliances with PBMs and health plans, our inclusion in a number of additional Part D networks this year, and brand drug price inflation. CVS Pharmacy’s share of U.S. retail prescriptions now exceeds 25 percent.

Our retail pharmacies are foundational to our community health strategy and one of the keys in our efforts to simplify the patient journey. To that end, we are opening a series of HealthHUB® concept stores that will be a testing ground for a new retail engagement model that brings health care services to consumers in a more convenient, more accessible, and more customer-focused manner. As we pilot new programs and service offerings, we will identify the solutions that are most effective and roll them out more broadly across our footprint. We have also recently launched multiple pilot programs to improve the management of chronic conditions for many of Aetna’s members.

In the front of the store, we successfully executed on our plan for top- and bottom-line growth through improved customer personalization and engagement. We are on a continued journey to understand and anticipate the unique needs of each customer that will help us deliver the most relevant experience to meet their needs. We continue to leverage our ExtraCare® loyalty program and data analytics to identify and elevate the categories and brands our customers love. Based on a customer’s individual preference and propensity to buy in the near future, we can recommend the right brand at the right time in any of our sales channels—bringing personalization to the next level.

GHG reductions, anti-smoking initiatives, and efforts at combating opioid addiction highlight our CSR commitments

We take a great deal of pride in the depth and breadth of our corporate social responsibility (CSR) commitments—from ambitious efforts at combating opioid addiction to our “Be the First” initiative to deliver the nation’s first tobacco-free generation. You can read more about our CSR activities on page 14. I do want to acknowledge here, though, the nearly $100 million that CVS Health and the CVS Health Foundation contributed in 2018 to a broad range of community health programs and disaster relief efforts through a combination of grants, in-kind product contributions, and volunteer hours.

I am also gratified that our greenhouse gas (GHG) emission-reduction targets were approved by the Science Based Targets initiative (SBTi). As part of our goal, CVS Health is committed to reducing absolute scope 1 and 2 GHG emissions 36 percent by 2030 from a 2010 base year. We have also committed to have 70 percent of our suppliers by emissions set science-based reduction targets on their scope 1 and 2 emissions by 2023. For a comprehensive review of our efforts, I encourage you to visit CVSHealth.com to download the newly published CVS Health 2018 Corporate Social Responsibility Report.

In closing, I want to thank our board of directors, our shareholders, and the more than 290,000 colleagues who contribute on a daily basis to our work as health care innovators. If you haven’t already done so, please take a few minutes to read the pages that preceded this letter to learn more about the extraordinary work we are doing to create a better health care experience for the patients and clients that we serve. We are developing a uniquely powerful new platform that will enable us to transform the consumer health care experience.

Larry signature
Larry J. Merlo
President and Chief Executive Officer
February 28, 2019