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spk03: Good morning. My name is Jessa, and I will be your conference operator today. At this time, I would like to welcome everyone to the Walgreens Boots Alliance, Inc. Third Quarter 2019 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press star, then the number one on your telephone keypad. If you would like to withdraw your question, please press the pound key. Thank you. Mr. Gerald Gradwell, you may begin your conference.
spk05: Good morning, ladies and gentlemen, and welcome to our third quarter earnings call. I'm here today with Stefano Pessina, our Executive Vice Chairman and Chief Executive Officer of Walgreens Boots Alliance, James Kehoe, our Global Chief Financial Officer, and Alec Gurley, Co-Chief Operating Officer of Walgreens Boots Alliance and President of Walgreens. Before I hand you over to Stefano to make some opening comments, I will, as usual, take you through the legal safe harbour and cautionary declarations. Certain statements and projections of future results made in this presentation constitute forward-looking statements that are based on our current market competitive and regulatory expectations and are subject to risks and uncertainties that could cause actual results to vary materially. Except to the extent required by the law, we undertake no obligation to update publicly any forward-looking statements after this presentation, whether as a result of new information, future events, changes in assumptions, or otherwise. please see our latest Form 10-K and 10-Q for a discussion of risk factors as they relate to forward-looking statements. In today's presentation, we will use certain non-GAAP financial measures. We refer you to the appendix in the presentation materials available on our Investor Relations website for reconciliations to the most directly comparable GAAP financial measures and related information. You'll find a link to the webcast on our investor relations website at investor.walgreensbootsalliance.com. After the call, this presentation and webcast will be archived on the website for 12 months. I will now hand you over to Stefano.
spk08: Thank you, Gerald, and hello, everyone. After what was a very disappointing second quarter for us, it is pleasing to be able to report that this quarter has been broad in line with our expectations. That said, The pressures we have seen for some time continue to impact our businesses, and we still have a lot to do to deliver the transformation that will allow us to get ahead of the market trends again and return our company to strong and consistent growth. We were clear that the action we were undertaking to address the market changes takes time, and the impact will therefore not fully be reflected in our financial performance until future financial years. But we have been working hard to accelerate our plans and programs. I have repeatedly said that we have within our company the skills and the assets we need to address the challenges we face as our markets evolve and transform. Last quarter, We told you that we would focus on accelerating the work we are doing to transform our company. We are doing that. The transformational cost management programs that we began early this year is one of the underlying foundations of the changes we need to make. Most importantly, this program will help drive a structural change in the company. making us a more efficient, more agile, and more responsive organization. It is expected to provide a significant portion of the funding required for our major technology upgrade and development investments. And, of course, an element of it will help to give us a bridge in our financial performance as we restructure our businesses to better meet the needs of of an ever more rapidly changing market. James and Alex will address some of these points as they talk you through the quarter, which I will ask them to do now. James?
spk10: Thank you, Stefano, and good morning, everyone. Third quarter adjusted EPS was $1.47, a constant currency decline of 2.4% versus prior year. The results were slightly ahead of our expectations, and included some timing benefits from the fourth quarter. Overall, we are tracking well against our strategic goals. We are quite encouraged by U.S. con sales, which were exactly what we needed to deliver to stay on track to meet our full year expectations. And while it is still early days, our transformational cost management program is very much on track and accelerating. Based on our performance in the quarter, we are reaffirming our full-year adjusted EPS guidance. We continue to expect the year to be roughly flat on a constant currency basis. Let's now look in more detail at the numbers. In the third quarter, sales increased 0.7%. On a constant currency basis, sales were up 2.9%. mainly due to growth in retail pharmacy USA and a strong performance from our pharmaceutical wholesale division. Adjusted operating income declined 11.7% or 10.4% on a constant currency basis. This was mainly due to lower pharmacy margins and a decline in front-of-store sales in the U.S. and lower results in BootsUK. Adjusted EPS declined 4% to $1.47, a decrease of 2.4% on a constant currency basis. This includes a 5.8 percentage point contribution from our share repurchase program. Gap operating income declined 24.7%, including $86 million of expenses relating to the implementation of our transformational cost management program, and $115 million relating to our share of resource burdens impairment of far medium. In total, these adjustments account for more than 50% of the year-on-year decline. Gap EPS declined 16.5%, to $1.13 per share. Year-to-date sales increased 4.9%, including a currency headwind of 1.9%. On a constant currency basis, year-to-date sales were up 6.8%, reflecting 7.7% growth in retail pharmacy USA and 8% growth in pharmaceutical wholesale. Adjusted operating income declined 8.9%, or 7.8% on a constant currency basis. This was more than offset by a 4.8 percentage point contribution from share repurchases and 3.2% from tax, contributing to an increase in adjusted EPS, which was up 1.6% on a constant currency basis. Now, let's look at the performance of our divisions, starting with Retail Pharmacy USA. Sales increased 2.3% in the quarter. mainly due to pharmacy brand inflation and pharmacy script growth. Organic sales increased 2.9%. Adjusted gross profit declined 3.9%, and gross margin declined 140 basis points, mostly due to pharmacy. Adjusted SG&A spend decreased 0.7%, and adjusted SG&A was 17.3% of sales, an improvement of 0.5 percentage points compared to the year-ago quarter. Adjusted operating income declined 13.8% in the quarter. Procurement savings, pharmacy script growth, and continued SG&A savings were not enough to offset reimbursement pressure and the lower front of store sales. These results also included store and labor investments of $40 million in the quarter, equivalent to approximately 270 basis points of adjusted operating income. Now, let's look in more detail at pharmacy. Total pharmacy sales increased 4.3%, reflecting higher brand inflation, prescription volume growth, and a strong growth in central specialty. which grew 8.6% year on year. Comp pharmacy sales increased 6%, and comp prescriptions grew 4.7% in the quarter, a strong improvement on the first half growth of 1.9%. Market share was 21.2% in the quarter, down 50 basis points versus prior year, due entirely to our store optimization program. Pharmacy gross profit declined versus prior year, as script growth was more than offset by lower gross margin. Gross margin was around 150 basis points lower than last year due to continued reimbursement pressure, adverse mix associated with brand inflation, and a 50 basis point impact due to the faster growing specialty business. These impacts were partially offset by procurement savings. The key to offsetting long-term reimbursement pressure is building scale, driving efficiency, and creating a sizable healthcare services business. Turning next to our U.S. retail business, total retail sales decreased 2.9% and were negatively impacted by our store optimization program. Comp retail sales declined 1.1%, an improvement on the first half comp decline of 3.5%. Tobacco accounted for 150 basis points of the comp sales decline, but we did benefit from a 65 basis point tailwind as a result of the cough cold flu season. Retail gross profit declined, mostly due to lower sales, which, as I mentioned earlier, were negatively impacted by our store optimization program. Gross margin was down slightly, by 20 basis points, an improving trend versus the second quarter, as we rebalanced our promotional mix. We expect to see a continued improvement in gross margin trends in the fourth quarter, turning next to retail pharmacy international. As usual, I'll talk to constant currency numbers. Total sales declined 1.6%. mainly due to a 1% decline in Boots UK in a challenging market. Boots UK comp pharmacy sales increased 0.8%, reflecting prescription growth in the quarter, whereas comp retail sales declined 2.6% as we continued to gain share in a weak market. Our beauty reinvention is now in place in 26 stores, and we remain on track to introduce 25 new brands in 2019. Adjusted operating income was down 10.5% due to weak retail sales and lower pharmacy margins in the UK. Our UK pharmacy business was impacted by temporary industry-wide NHS underfunding and higher generic pricing. These impacts were only partially offset by prescription volume growth. We are taking actions to address our UK cost base, and I will cover these a little later. Turning now to the pharmaceutical wholesale division, which I'll also discuss in constant currency, the division delivered another strong quarter, with sales up 8.3%, led by emerging markets. Our UK performance was aided in part by a customer contract change mentioned last quarter, which contributed 2.3% to revenue growth. Adjusted operating income increased 9.4%, reflecting strong gains in Turkey and solid results from our European business. Turning next to cash flow, operating cash flow was 3.2 billion for the first nine months of the year, Free cash flow was $2 billion. Operating cash flow was impacted by headwinds of around $1.4 billion. We are lapping a one-time prior year working capital benefit of $502 million. Cash tax payments are $395 million higher, mainly as a result of U.S. tax reform. This year includes legal settlements of $276 million, and we have $200 million of cash costs relating to the ongoing Rite Aid store optimization and integration and the transformational cost management program. Underlying working capital increased approximately $500 million, primarily due to higher sales. Cash capital investment was $1.2 billion for the first nine months, $264 million higher than the prior year. This was due mostly to the impact of the Rite Aid store conversions. Turning now to our transformational cost management program, we remain on target to deliver $1.5 billion in annual cost savings by fiscal 2022. Our smart spending benchmarking is complete. Targets and execution plans are set up, and we're accelerating a wide-ranging program to reduce pharmacy cost to fill. The 20% headcount reduction at our Boots UK headquarters and the reorganization of our U.S. field supervision structure are now complete. On digitalization, the Microsoft Cloud migration is moving at pace. and we have now started working on optimizing our many IT vendors. Work has also begun on building out compelling consumer value propositions. Given the difficult market conditions in the UK, we have completed the review of our store portfolio and have started a store optimization program that will impact around 200 locations over the course of the next 18 months. Many of these 200 stores are loss-making, and approximately two-thirds of them are within walking distance of another Boots store. While the stores we plan to close represent around 8% of our store base, we expect the revenue impact will be around 1%. We do not expect a significant impact on colleagues as we plan to redeploy to nearby stores. We are also reviewing our real estate footprint in the US and accelerating the pace of change, especially in our US supply chain. More to follow in the coming months as we work through these key opportunities. Turning to guidance. As I mentioned earlier, the third quarter was slightly ahead of our expectations, aided by some timing benefits. As a result, We are reaffirming our full year guidance and we expect adjusted EPS to be roughly flat on a constant currency basis. As a reminder, last quarter we told you to expect a range of plus or minus 2%. Given the normal level of volatility in a business of this size, we feel this range is still appropriate. Let me just give you a couple of assumptions. As you update your models, you should now be building in six cents of negative currency impacts. And this is two cents worse than our prior guidance. We continue to project full-year share repurchases of $3.8 billion, contributing 4.8 percentage points to adjusted EPS growth. And we now project a full-year adjusted effective tax rate of around 15.5%. compared to our earlier guidance of 16 to 17%. The lower rate reflects non-recurring discrete benefits and changes to our geographic mix. When we provided our original fiscal 19 guidance, we highlighted incremental store and labor investments of around $150 million. As we accelerate the pace of our digital investments, We now expect total incremental spend of approximately $175 million, with a significant portion of the additional spend coming in the fourth quarter. Let me finish by highlighting the change in revenue trends coming from Rite Aid. We saw positive revenue contributions from the Rite Aid acquisition in the first two quarters of the year. From this quarter on, Rite Aid is actually a headwind to reported revenue. due to the ongoing store optimization program. I'll now hand you over to Alex, and he will update you on some of the business initiatives we have underway in the U.S.
spk11: Thank you, James, and hello, everyone. During the quarter, we continue to make progress on our four strategic priorities, accelerating digitalization, transforming and restructuring our retail offering, creating a neighborhood healthcare destination around a more modern pharmacy, and rolling out a transformational cost management program. We're also continuing to develop our omni-channel offering. Our Walgreens app has now been downloaded 57.3 million times, up 10.5% since last year. Around 26% of Walgreens retail retail scripts were initiated through digital channels in the quarter, up 18.4% since last year. And we've also increased our active balance reward members to 90.2 million. In retail, our leading beauty brand, Number 7, performed exceptionally well in the quarter. In Walgreens, sales of Number 7 were up by over 50%, helped by the launch and advertising of the Number 7 laboratory's line-correcting booster serum. And our other retail partners saw significant growth. In addition to beauty, we're working on refreshing our own brand portfolio in Walgreens to drive sales and improve the customer value proposition. During the past two years, over 60% of the Walgreens' own brand product portfolio have been relaunched or rebranded, enhancing the customer offer through better value and quality to deliver improvements in sales and margin. This work is ongoing. Red Aid is very much on track. Against our store optimization program, we've completed 631 of the planned 750 store closures, and we continue to see good customer retention. As for the remaining Walgreens-owned RedAid stores, 394 have been successfully converted to Walgreens, and we expect to complete the RedAid integration by the end of fiscal year 2020. We've taken further steps to develop our neighborhood health destinations, working with our partners, including LabCorp and Humana, and as we announced during the quarter, VillageMD. With VillageMD, we'll be opening five state-of-the-art primary care clinics in the Houston area, by the end of the year, branded Village Medical at Walgreens. We also remain on track to open 125 LabCorp outlets in Walgreens stores this year. And finally on Kroger, the teams are working well together, and so far the initial customer response has been positive. I'll now hand you back to Stefano.
spk08: Thank you, Alex. So, as you have heard, we have broadly delivered what we expected. But we have a lot of work ahead to get the business growing again. We have been working hard to initiate or accelerate the changes we need to keep us in line with or leading the market. We are investing heavily in updating our systems and infrastructure, creating efficiencies and capabilities, which will give us scope for development for many years to come. We are developing new ways to engage with our customers, introducing new services and products through new channels. We are working with partners who bring us skills, resources, scale, and expertise that complement our own. To accelerate our development, give us access to new thinking and markets, and allow us to create significant new income streams. At the same time, we are continuing our focus on transforming our traditional areas of business to address the challenges of our core markets. Economic and reimbursement pressures have long been and remain a fact of life for us. Over the years, we have developed various different levels to mitigate the impact of this pressure. In recent years, a major element of this mitigation has been improvement in generic procurement, made possible by changes in the global generic manufacturing sector, ongoing patent expires, and significant development in the actual procurement process, all of which have led to continued improvement in buying terms. These buying benefits have enabled us to compensate for the significant demands made on us by payers. As we have made clear, the level to which we can mitigate current and future reimbursement pressure through a generic procurement has reduced, although it will continue to be an important lever for many years to come. Recognizing this, We are accelerating other levers to mitigate the pressures. We have more to do to cause savings and efficiency, and we expect consistent savings well into the future. There is no doubt that over time, we also have to build a range of services and service levels that drive benefits for our payer partners. We believe that the future of pharmacy is aligned to a wider range of healthcare services provided efficiently and conveniently in a community setting. This is why we are exploring partnerships with a wide range of innovative experts in various fields, allowing us to offer a better service more effectively and at a lower cost to ourselves than we would be able to do if we had set these services up on our own or paid a significant premium for them. Of course, many of these services are still being tested or are still in development. Let's be clear, however. While a number of partnerships we are piloting have the potential to have a meaningful impact on our business, no single one of these will define or frame our future. In truth, it will be a combination of products and services working together in the convenience of a community pharmacy that will follow the basis of our future customer proposition. The mixture of products and services will inevitably bring together a range of complex and differentiated business models. Their economics will be, at least in part, based on changes to individuals' health, condition management, and overall well-being over many years. The consequence of getting these services right has a huge potential benefit for us, for our partners, and for our customers. But if we rush into them without truly understanding the operational or financial models, we run the risk of wasting an extraordinary amount of time, resources, and more. We must be sure of what we are doing before we enter into these businesses in scale. Today, many people are looking at our company, indeed at our sector, focused on the immediate risks they perceive us to face. And I understand this. We are far from complacent about the pressures we face. However, we can see the inherent strength of our business. There is an ever-increasing demand for effective, efficient, and convenient support for people to manage their health conditions while living productive and fulfilling lives in their local communities. The unique positioning of community pharmacy and our place in the sector gives us practical and financial scale, reach, and strength. It gives us a robust platform on which to evolve and transform our company to meet the ever-changing needs of the markets we serve. And it gives us a fantastic foundation from which to deliver innovation, growth, and value for our customers and our shareholders for many years to come. Thank you. Now we will take your questions.
spk03: Thank you. At this time, if you would like to ask a question, please press star followed by the number one on your telephone keypad. Your first question comes from the line of Stephen Valliquette from Barclays. Please go ahead.
spk13: Great.
spk03: Thanks.
spk13: Good morning, Stefano and James. Thanks for taking the question. So as the U.S. retail pharmacy business remains difficult really for all types of stores and operators across the entire industry, We're getting the sense that there could be an additional opportunity among the larger mass merchandisers in the U.S. for a store within a store deal where a Walgreens or a CVS could take over the pharmacies within a specific large U.S. mass merchandiser. So I'm just curious to hear about your current appetite for an opportunity like this right now in the U.S., given the simultaneous store rationalization program that you're going through right now and also your other initiatives in the U.S., Thanks.
spk11: Hi, Steve. It's Alec here. You know, one of our strategies clearly there is to grow volume and to make our business bigger to get scale. So we are also partnership is really important to us, as we've said many, many times. So as the market changes, and these changes are real, you can see the fact that the number of pharmacies in the U.S. is in decline as measured for the first time for a long time. You know, we are obviously open to partnership in this area. We bring scale. We bring expertise. And we're investing, as Stefano said in his remarks and James said, in pharmacy and the pharmacy supply chain. So we're open and, of course, we'll look for every opportunity available, providing it makes fiscal sense for us, our partners, and improves the quality of our business.
spk13: Okay. Just one other quick one. As we think about the narrow network opportunities for calendar 20, Just curious if you see the potential for meaningful market share shifts for 2020 among the large retail pharmacies like yourselves, given the level of RFP activity, or do you think it's going to be a quieter year for calendar 20 just in terms of narrow network opportunities and potential market share shifts within the marketplace?
spk11: I'd say this all again. We think it's probably more normal. Again, we've laid out our plans in terms of the item growth that we expect to and we think it's a more normal year. Now, of course, within that, there's always opportunities and there's always challenges, but we think it's probably a more normal year in 2020. Okay, got it.
spk04: Okay, thanks.
spk03: Your next question comes from the line of Robert Jones from Goldman Sachs. Please go ahead.
spk14: Great. Thanks for the questions. James, you mentioned that the results included some timing benefits from the fourth quarter. I'm just curious if you could share the source of of those benefits and anything around the size of those benefits would be helpful.
spk10: Okay. Yeah, roughly, we had two impacts in the quarter. One was timing, and I would say that's around $0.03, so $35 million is our best estimate. And the other one is we also highlighted in the comments, we're ramping up the amount of spending in store labor and now digital and development expenses. but we've increased the spending on the full year by 150 to, from 150 to 175. There's about a cent of that in the fourth quarter. So think about roughly around 50 million, you know, around four-ish cents was it. And when you get to the two timing items, one was two cents of the three cents was essentially the timing of payroll contracts when you do the compliance and true up whether you hit outcomes or whether you hit volumes in certain tiers. And that's the normal course of business, but we expected that in Q4. And then ascent is coming from expense timing. We accelerated some real estate savings from Q4 into Q3. So it was actually one of the quieter quarters in terms of volatility. Very few surprises. You know, what's interesting here, maybe I'll take the opportunity, as you start looking out into Q4, because this takes some income out of Q4, Our Q4 target is actually quite, you know, when you start working through it and you start working out your estimates, bear in mind we had two large one-time items last year. And on an EPS basis, we're cycling through these. The first one is you'll recall there was a large true up, a curtailment benefit relating to retiree medical. That was $110 million. And then in the prior quarter of last year, we made an adjustment for legal costs, which was one time, and that was approximately 60. So that's another 5 cents. So if you think about it, we have a 10 percentage point headwind on EPS in Q4. So we actually, when you dissect Q4, we're looking forward to pretty good improving margin trends on the gross margin. And the headwind is all on the overheads, and it's all due to one-time items in the prior years. So I think, you know, as you shift through this, the volatility in Q3 was actually quite low. When you get into Q4, when you get into Q4, think more that we have two large items last year. So actually when you analyze the results, the core performance is actually quite, it's improving quite a bit. I hope that's helpful.
spk14: That's very helpful. That's really helpful, James. Thank you. And I just want to follow up. In the prepared remarks, you guys highlighted again that you're reviewing the real estate footprint in the U.S. I'm just wondering if you could elaborate a little bit just your thoughts around how we should be thinking about, you know, the store rationalization. Is this going to be a bigger focus, or is this kind of just ongoing course of business at this point?
spk11: Hi. Hi, Bob Salek here. Yeah, this is more ongoing course of business. You know, this is regular. We have – well over 9,000 drug stores in America. Therefore, you know, things change. Customer shift opportunities move. We're also thinking about new formats, as we spoke before, and answer previous questions. So this is just normal business.
spk10: And just to add, though, you know, the calculations are complex. We have to look at the lease portfolio. It's a store-by-store assessment. And the teams are working through 9,500 stores. which is quite the heavy workload. We just recently confirmed the 200 stores in the UK, and we'll move ahead aggressively on that. And it's quite interesting as you go through it. About 60% of the stores in the UK that we're closing lose money. Not all of them, but some of the others are very like the Rite Aid optimization, where it is, think of it as a file buy. So we close two stores close to each other in the UK, and sometimes they're five-minute walking distance, and you're transferring over to Scripps, but you're taking out fixed cost structure. So the calculations are quite complex. You have to assess, are you leaving a trading area, which we generally don't like to do. We want to preserve our presence both in the U.K. and in the U.S. I would highlight that in the U.K., You know, we highlighted in the comments we're reducing the store count by 8%. The impact on revenue is around 1%, so I don't want to call it rounding. But it has no strategic impact on our ability to maintain the strength of our position in the U.K. I would actually argue, on the contrary, it makes us even stronger because we're a profitable operator in the U.K. market.
spk14: Great. Thanks for all that.
spk03: Your next question comes from the line of Justin Lake from Wolf Research. Please go ahead.
spk01: Hi, this is Eugene Dalton for Justin. Quick question on the U.S. pharmacy gross margin. It declined 150 basis points year-over-year, if we read it correctly. And it seems like Q3 was a clean quarter to compare year-over-year because the FEP specialty contract lapsed. How should we think about this going forward? Is this a rate of decline in the near term that we should consider?
spk10: I'll take a shot. I'll ask Alec to weigh in afterwards. I think we've cycled through the FEP contract, especially business growing at 8.6%. We would expect it always to go at faster than the core business, so it will always be somewhat dilutive to margins. One other thing, there's other dynamics in the quarters. So in the quarter, we sold more branded, and the margin on branded is lower than it is on generic, and that creates a mix impact as well. And that's as significant as any other impact. And the problem is we can't project with accuracy the individual mix in any single quarter, but But if you take out a lot of these mixed items, the core reimbursement net of procurement and other mitigations was actually a pretty solid quarter. We do expect some improvement in both retail and gross margin, sorry, retail and pharmacy gross margins in Q4. That's as far as we're willing to go. So this is This is not something you should take and extrapolate out as 150 basis points on pharmacy. We do expect some improvements in the trend in Q4. But mix and everything else plays into it. It would be a very long discussion. Alec?
spk11: Yeah, I think in terms of how we feel that the margin is going forward, we've always stated we recognize reimbursement pressure is there and will stay there. And it's how do we compensate for it. And as James has just said, you know, we are seeing, you know, the ability to compensate more in Q4 and Q3 as the trends come through. I think in particular, a couple of areas which are just interesting going forward. First of all, we are getting paid more for, I would say, value-based contracts, particularly in Medicare D. So we're starting to hit some of the performance targets, which is encouraging. And I think also we continue to have the opportunity to work differently in some networks. For example, again, I would point to the Prime contract we did some time ago where we have a different approach to the marketplace where we're really much more transparent. And again, that process, we believe, is going to become more, I would say, available to the market going forward than it has been in the past. So reimbursement doesn't go away. The margin is under pressure, as we've often said, but we continue to be innovative, we work creatively, and we work hard on new levers as well as the old levers that we've spoken about a lot.
spk10: Any comments we make on the Q4 margins, these are obviously all factored into our full-year guidance. We're just giving you the perspective that we had a tough Q2 on reimbursement, which was one of the highest numbers in history. Q3 was the top quarter as well. We will, as we said in the previous call, we will start to see an improving trend in Q4 on the gross margin side. But the caution is to call out those two large one-time items that are putting pressure on overheads. And, you know, the good news on that is they don't repeat in the future. It's just impacting people.
spk11: Got it. Thank you.
spk10: Okay.
spk03: Your next question comes from the line of Ricky Goldwasser from Morgan Stanley. Please go ahead.
spk02: Yeah, hi. Good morning. Last quarter, you directed us to fiscal year 2020 EBIT being moderating up year over year in the flat APS. Are you still, with everything you're seeing in the marketplace, are you still expecting this?
spk10: Don't need to. You know, Ricky, we're going to just comment on current year, 2019. We don't want to get into a practice of going back to discussing long-term models or 2020 guidance. What we will be doing is in the next conference call, we will give comprehensive guidance on all of the assumptions around 2020. So we're not going back to a discussion on the... We just refer people back to the previous material that we placed out there in Q2.
spk02: Okay. And then just to follow up, in the preferred remark when you talked about the review of the portfolio, I think you also said that you're kind of like looking at the U.S. supply chain for additional improvements. Can you give us a little bit more color on what the opportunity there and what are you seeing in terms of generic deflation trends as a headwind?
spk11: Yeah, so I'll maybe split the – I think we've answered the portfolio question already, Ricky, so I'll move on to maybe the second question, supply chain. You know, I would say we're halfway into our replacement of our core supply chain system for retail in the USA. The SAP HANA S4 software is going into stores and into DCs. So it's very clear that we now have opportunities with new tools, capabilities and data, especially the speed of the data we didn't have before. So as that goes through, we will get more updates in terms of what that means in terms of projections. But we're encouraged by the progress there, but we're only halfway through it. I think secondly, we've just hired, as you saw quite recently, a very experienced global supply chain leader, Colin Nielsen. And again, we're working hard with the team to really understand how to be even more focused on the new capabilities that are being in the business going forward. I think in terms of genetics, as Stefano said in his pre-prepared remarks, you know, we continue to be very, very pleased with the performance of our WeBad office. You know, and again, we see the opportunity going forward to continue to drive value through that WeBad office into a global platform, but also into America. So I think that's how we see the supply chain piece moving. What was the third part of the question? Generic deflation. I mean, we don't see any difference to what's been recorded in the marketplace, to be honest. We see this, I would say, low single-digit deflation, as everybody else has spoken about. We see generics coming off patents in a way that's been described by others. And, of course, we pay a lot of attention to this because it has a material impact on our on our ability to register cost of goods, and we feel comfortable that all that's captured in the guidance that we gave last quarter.
spk10: Yeah, and Ricky, just to add in, you know, the low single-digit, Alec refers to, includes new molecules. If you strip out new molecules, the most recent quarter, at least these are our numbers, not market numbers, we saw deflation of around 9%. Right? So it's still up at a healthy clip, and that will support continued savings in generic procurement. And, you know, this is the, you know, the prior quarter was a 9.4%. So it's still up there in a healthy high single digit. Then the market builds in new molecules. I'm very excited about the supply chain piece going in the U.S. because we now have teams set up looking to shrink, you know, so stock losses, whether that's theft in store or at stock losses in warehouses. And we're using teams from Microsoft. So this shows the benefit of the bigger Microsoft agreement. They've put data scientists on this. They're helping us build data lakes to understand what is going on, the true causes of shrink and how to eliminate it. And these are $100, $200 million opportunities. And that's without getting into the working capital side of it. So I don't want that to be lost. You know, once we have SAP for HANA in place across the 9,500 stores. That's stock visibility that we don't have today. And we expect significant reductions in the level of inventory required to be held at store levels. So, you know, but this is a lot. will be huge, so you would expect that exiting 2020, we're starting to see material reductions in inventory levels.
spk03: Thank you.
spk04: Thank you.
spk03: Your next question comes from the line of Eric Percher from Nefron Research. Please go ahead.
spk09: Thank you. I'd like to dig in on the international performance, and I understand we've seen some of the generic pricing changes You also made a comment about weakness or temporary weakness in underfunding. Could you expand on that and how incremental is it to the pressures that we've already spoken about the last 12 to 18 months?
spk11: Hi, Eric. It's Alec here. Yeah, I mean, let me start with the last question first, which is the underfunding point. You know, the UK government pay in a certain way. I don't want to go into detail of it, but fundamentally it's a market payment for all the pharmacies in the UK. And if you go into what's called the PSNC website, there's more details there about how that works. So we are pretty convinced there's been underfunding in the last period. And, of course, working within the pharmacy contractors and the PSNC, we're now debating that with the government in a positive way as a new contract is put in place. So that's what we refer to. And, of course, we can't make any further comments until that negotiation is complete. But I think in terms of the overall performance of the boots business, you know, we are making good progress in terms of reinvigorating the boots model in the UK in very difficult times. I don't have to tell you how difficult the marketplace is there. For example, this morning, we opened a fantastic new store, a new concept store in Covent Gardens. There was queues around the corner. And this is a health, wellness, and beauty concept store, which will not only feed the future of goods, but could also, of course, give us some great ideas for the U.S. market as well. On top of that, we've done a lot of digitalization. We've digitalized the Advantage card, which is still the most popular card in the U.K. by some way in terms of... beauty and treat cards, and a lot of customers use it. I think it's well into 17 million holders today. We've also created digital pharmacy. We've launched that for the first time in the U.K. in terms of managing prescriptions, causing some of the great ideas that we passed across from Walgreens as part of the merger. And, of course, the cost program James already referred to in his remarks in terms of moving money from maybe the older model into investing in the future of the boots business. So that's the story, really. We're using the current market situation to make sure that we're investing in our future, and we're seeing some interesting lead indicators of performance. And, of course, we'll give you more updates as that develops.
spk09: And is your PF&C comment suggesting that your business is now adjusted for the changes that have been made to date, and you have some hope that there might be some improvement moving forward, but you're basing the business on where we sit today.
spk11: Yeah, absolutely. I would say that's an accurate reflection of where we are.
spk10: Yeah, that's a fair point. I would emphasize the word temporary. So we expect an improvement in Q4 and back to normal levels of funding next year.
spk09: Yeah. That's helpful. And could you just, on the potential store reduction, you mentioned that employees may move to other stores. Can you help us with the way that you run those stores and maybe employment where you could see, I guess, the revenue impact only 1%, but it is 8% of the store base. Will you continue to carry all of the employee costs?
spk11: Yeah, I mean, it's really straightforward. These are relatively small pharmacies. James said two-thirds are within walking distance of another Boots pharmacy. And the main cost there, to be honest, is the cost of the pharmacist. We have pharmacist turnover like any company would have, and we simply see that as a way of being able to manage the cost while retaining quality people that we need to take care of customers and communities. And remember, we learned a very important lesson here in the USA that if you retain the familiar face of the pharmacist and the healthcare assistants in the local pharmacy, then very often the customers will transfer the script to the people who they know and trust. So this is economically important to us as well.
spk10: Yeah, and it's 8% of the stores, it's 3%, I believe, of the square footage. So that the employee impact is much lower than the percentage of stores. And then the revenue impact is much lower because they're less efficient stores. So it's actually quite logical. And then there's a fair amount of turnover in general in an employee base of 56,000 people in the UK. So there's a fair amount of turnover. And I think we've seen in the past, you manage to place the majority of people. Absolutely, yeah. Thank you.
spk03: Your next question comes from the line of Ross Muecken from Evercore. Please go ahead.
spk12: Hi, this is Elizabeth Anderson in for Ross. I was wondering if you could expand on some of the comments that Stefano made about generic procurement, in particular sort of areas of future savings that you see.
spk11: Hi, it's Alec here. Yeah, I think I'll say what I said already, and Stefan said it very clearly. You know, we still have a very efficient, effective, and innovative model out of WeBad, and we continue to walk in a dimension which we think is slightly different. We prefer to have contracts with manufacturers that give them certainty of supply so that we get certainty of supply back in the marketplace. That's really important to our customers and allows us to plan together in a different way, and that's how we work. Having said that, we all know that the level of opportunity, as Stefan said, is changing going forward. It's not we're not going to make savings. We will make savings. It's just changing. So, you know, we've set up some innovative partnerships already. You know, the partnership we set up with Express Script examples. One, we were combining, you know, the volume from a PBM with the volume from a retail pharmacy. And we continue to look at other ways of making sure that we've got the right scale and mix of partners going into WeBad going forward. I think, secondly, the manufacturers are thinking differently as well. And again, we can't talk on their behalf, but you've probably heard some of the things they've been saying. And we think that our approach to buying in partnership with them and the way that we organize how we work with them will continue to give us advantage in the future going forward. Of course, in the future, other markets may open up. We don't know that in reality, and we're not banking on that particularly in how we see the plan going forward. But clearly, you know, things will change in one direction and could change again in And having a global perspective and global volumes we think will give us global opportunities in the future as well.
spk12: Okay, thanks. That's very helpful.
spk03: Your next question comes from the line of Glenn Santangelo from Guggenheim. Please go ahead.
spk07: Yeah, thanks for taking my question. I just wanted to follow up on this reimbursement issue one more time. You know, if I heard you correctly, one of the main keys you keep pointing to is that in order to combat the reimbursement pressure, you'll need scale. But yourself and your closest competitor, you guys have more scale than anyone else in the marketplace, and you seem to be having issues. And so I was wondering if you could comment more broadly on the 65,000 to 70,000 pharmacy counters out there. I mean, they must be obviously feeling more pressure than you, and I was kind of curious, are you starting to see that? that total number come down? And I guess my question is, can the reimbursement pressure subside until some of the capacity comes out of the market?
spk11: Again, I think we said already, the way that we measure the market internally, we are starting to see some pharmacies close. I think these numbers are pretty open in the marketplace as well. So that is starting to happen. and not reopen. So I think that is a fact that you can check, obviously, out there. I think, secondly, you're going to have to look at the comments from other competitors in the marketplace to see the pressure that we are all feeling in the marketplace. The other side of the coin is that we continue to believe strongly that the community care in the pharmacy, the physical location in the community with the pharmacist available and accessible, you know, is a really great opportunity for not just pharmacy, but for healthcare, all connected through data, all connected with other healthcare professionals, all connected to bringing forward new solutions going forward. That's why we are so excited about the work we're doing, not just with Microsoft, but with, as Stefan said, other relevant partners. For example, Verily, we've announced as well, and LabCorp. and I can assure you the list could go on in terms of the people who are talking to us and we are talking to them. So we are really confident about the future of pharmacy. We're really confident that the model that we see today will change, driven by new technologies, and the same need that customers and patients have always had, which is to have a conversation with their local pharmacist in their local community.
spk07: Hey, Alex, maybe if I could just follow up on the one sort of comment you were talking about with respect to some of the partnerships. I mean, over the last year and a half, we talked a lot about the JV strategies and trying to crack the code of generating additional foot traffic. And, you know, it seems like there's been mixed results on that front. And maybe I'm wondering if you could just sort of reiterate exactly where the strategy stands today and maybe what has worked better than what you might have thought and what maybe hasn't worked as well as what you thought. And I'll stop there. Thanks.
spk11: Thank you. I'll give an example of where we are very comfortable, which is our FedEx partnership. Again, we are seeing the footfall that we expected. We are seeing the halo from that footfall that we expected, i.e. new customers to Walgreens. And we're also seeing the opportunities to work closely with the FedEx team strategically to develop new customer propositions you know, in the corner drugstore. So that would be one example that we are very comfortable with. And, of course, you know, going forward, you know, there will be other partnerships which are really interesting. We mentioned already the Kroger partnership is going well, and the customer reaction has been positive. So, again, that's another example where, you know, we believe that Kroger are really our experts in food, and they can help to really improve our customer proposition and our value over time. But time will tell, you know, if we can find, you know, the right – that works for both companies and also for customers.
spk04: Okay, thanks.
spk03: Your next question comes from the line of Michael Cherney from Bank of America. Please go ahead.
spk00: Good morning, and thanks for all the callers so far. Just thinking about 4Q, I know you had talked about a number of the moving pieces and some of the reimbursement true-ups that you've seen so far year-to-date. With regards to the removal of pressure on retail pharmacy gross margins, or at least less pressure, I guess what gives you the confidence? Why do you think it should get better? Is there something in mix? Is there something in timing? Is it just the annualization, or I guess the within-year annualization of those pressures that you've talked about relative to last quarter and this quarter? I guess I just want to know a little bit more about the why relative to the sequential gross margin improvement.
spk10: Yeah, I think it's... It's a little bit of everything you said, actually, because you have to go back on a journey. Q2 was reimbursement pressure, which we said I think exceeded 30% of the full-year reimbursement pressure. So we would have said an unprecedented level. We saw it go back to more of a normalized level in Q3, but we saw some slowness on the procurement savings in Q3. We're going to see both of the variables equalize in Q4. So it gets back to you can't really look at it as reimbursement. It's reimbursement net of the mitigation. The biggest two are one is procurement savings, and there's been some timing between Q3 and Q4 there. When you get to volume, I want to highlight we had a great quarter in Q3. You know, we set some fairly challenging goals internally. You know, bear in mind, we had script volume for the first half on a comp basis below 2%. So to come in on the high fours was something, you know, we needed to do it, and we need those kind of numbers. That's number one. We were also very pleased with the way retail came in. You know, if you strip it back a little bit, it's down 1.1. We were tracking in the first half, you know, a pretty disappointing 3.5% comp store declines. So the change on change is quite impressive. You know, we won't deliver exactly the same numbers, but we will continue to hold on to some of these trend improvements. You know, I think what will happen in Q4 is you will see a little bit the stabilization of the top line outlook together with some improvement in bulk businesses on the margin side. So it's a confluence of trends. And then I highlight again, then you've got these two big one-time items in overhead. So, you know, it's too early to call victory in Q4, obviously, but that's where our current expectation is improved gross margins and continued stabilization of scripts and same-store sales in retail. I hope that helps you as you think through it.
spk05: Okay. Thank you. I'm afraid that's probably all we have time for. I know we haven't got to all your questions, but as ever, the IR team are around to answer them all. And I'm sorry for those of you who didn't get to ask questions today. We'll be back again next quarter. Thank you very much indeed.
spk03: This concludes today's conference call. You may now disconnect.
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