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spk03: Ladies and gentlemen, thank you for standing by and welcome to the Walgreens Booth Alliance, Inc. First Quarter 2020 Earnings Conference Call. At this time, all participants are in listen-only mode. After the speaker's presentation, there'll be a question and answer session. To ask a question during the session, you'll need to press star 1 on your telephone. If you require any further assistance, please press star 0. I would now like to hand the conference over to your speaker today, Gerald Gradwell, Senior Vice President of Special Projects and Investor Relations. Please go ahead.
spk08: Good morning, ladies and gentlemen, and welcome to our first 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 statement after this presentation, whether as a result of new information, future events, changes in assumptions, or otherwise. Please see our latest Form 10-K 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.
spk10: Thank you, Gerald, and hello, everyone. As you will see from our figures, it has been a slow start to the financial year with a competitive U.S. pharmacy environment and soft trading conditions in the U.K. That said, as you will hear, there are a number of items affecting the year-on-year comparisons. And given the initiatives we have underway, we are maintaining our full year guidance. In the quarter, we continue to make progress against all four of our core strategic priorities. We are making progress in moving our data resources to a new and more flexible cloud-based infrastructure with the significant benefits that brings. We have also made good progress with the development of new services to build on this new infrastructure. to enhance our customer experiences, make our teams more efficient and effective, and open new opportunities for our businesses. Clearly, this work on the digitalization of our company must and does closely tie in with our work to modernize our retail offering and the shape and structure of our retail footprint. At the same time, we are working with partners to redefine the delivery of healthcare in the community and the important role of pharmacy in the immediate and longer-term future. And all of this is, of course, supported and fueled by our transformational cost management program, which has made substantive progress during the quarter. Finally, we have also continued to make progress on a number of significant partnerships, both established and new, to enhance our offering and efficiency and to help drive growth in our businesses. In the quarter, we entered into a procurement joint venture with Kroger, building on the already strong relationship that has been formed between Kroger and Walgreens. And, we announced a joint venture with McKesson to bring together our two businesses in Germany, improving our reach and scale with a focus on enhancing the efficiency and performance of our combined wholesale operations in the significant German pharmaceutical wholesale market. I will come back to make a few comments on the future at the end of our presentation. But now I will ask James and Alex to take us through the results in a little more detail. James? Thank you, Stefano, and good morning.
spk05: Adjusted EPS was $1.37, 5.7% lower than prior year on a constant currency basis. The year-on-year comparison was impacted by around 5 percentage points of adverse items, including the year-on-year bonus impact. In Retail Pharmacy USA, strong cost management and improved retail comp sales were offset by lower gross margin. Retail Pharmacy International continued to be negatively impacted by a challenging UK market, and we saw continued strong performance from pharmaceutical wholesale. Our transformational cost management program is very much on track. and we expect to achieve annual cost savings in excess of $1.8 billion by 2022. Cash generation was very strong in the quarter, with free cash flow of $674 million, $684 million better than prior year. And finally, we are maintaining our guidance for fiscal year 20 of flat adjusted earnings per share on a constant currency basis with a range of plus or minus 3%. Looking forward, we see improved core business trends with, however, some noise in the second quarter as we cycle through the timing of reimbursement payments and year-on-year bonus impacts. These result in an expected EPS headwind of around 13%, but both of these items were budgeted in fiscal year 20 and have no impact on full-year guidance. Let's now look in more detail at the results. First quarter sales were up 1.6%, including a currency headwind of 0.7%. On a constant currency basis, sales were up 2.3%. Adjusted operating income declined 15.4% on a constant currency basis, reflecting lower gross margin in the U.S. and a difficult U.K. market. Adjusted EPS was $1.37, a constant currency decline of 5.7%. Our share repurchase program contributed 4 percentage points of growth and an additional 5.7 percentage points came from a favorable tax rate as we benefited from a number of discrete items. The result included adverse items of over five percentage points, including the year-on-year bonus impact, mark-to-market adjustments, and lapping prior year supplier funding. GAAP EPS declined 19.8% to 95 cents and also reflected costs relating to the Rite Aid transaction and the implementation of the Transformational Cost Management Program. Now, let's move to Retail Pharmacy USA. Sales increased 1.6% in the quarter, with 2.9% growth in pharmacy, partially offset by lower retail sales. Note that the sales growth includes a negative impact of 50 basis points, due to our store optimization programs. Adjusted gross profit declined 4.9% due to lower pharmacy and retail gross profit. Adjusted SG&A spend decreased 1.6% in the quarter and was 17.6% of sales, an improvement of 0.6 percentage points versus prior year. The decline in SG&A clearly shows our strong execution against our transformational cost management program, with savings more than offsetting incremental investments, the impact of inflation, and the year-on-year bonus impact. Adjusted operating income declined 16.2% as the SG&A savings were not enough to offset the decline in gross profit and the adverse items I mentioned earlier. In total, these adverse items accounted for over six percentage points of the decline in operating income. Now, let's look in more detail at pharmacy. Total pharmacy sales increased 2.9% versus prior year, reflecting continued brand inflation and script volume growth. Central specialty sales continued to grow nicely. up 9.3% versus prior year. Comp pharmacy sales were up 2.5%, and comp scripts grew 2.8%. While this was weaker than expected, we have seen improved growth in recent weeks. Market share for the quarter was 20.9%, down 55 basis points versus prior year, including the impact from our store optimization program. Adjusted gross profit decreased mid-single digit, as the impact of procurement savings and script growth was more than offset by reimbursement pressure. Turning next to our U.S. retail business, total retail sales declined 2.2% in the quarter, impacted by store optimization. Comp retail sales declined 0.5% and continued to show an improving trend. Excluding tobacco and e-cigarettes, comp sales were up 0.8%. As you know, we are exiting the sale of e-cigarettes. While this did not have a significant impact on comps this quarter, it will have a bigger impact from the next quarter onwards. and we continue to anticipate a full year EPS impact of around 6 cents. We saw solid comp growth in our core categories with health and wellness up 3.3% and beauty up 2.5%. We estimate a tailwind of around 80 basis points from cough, cold, flu. Retail adjusted gross profit declined low single digits due to lower sales including the impact of store optimization programs, higher shrink, and the timing of prior year supplier funding. Adjusted gross margin declined slightly. However, excluding the higher shrink and supplier funding timing, underlying category margins were in line with prior year. Turning next to retail pharmacy international, And as usual, I'll talk to constant currency numbers. Sales decreased 2.7%, mainly due to the UK and Chile. Boots UK comp pharmacy sales increased 0.9% in the quarter, reflecting relatively higher NHS reimbursement levels and increased sales from services, partly offset by lower script volume. Boots UK comp retail sales declined 2.9% as the UK high street continued to be very challenging. However, overall, we held market share. Adjusted operating income was down 39.1%, mainly due to lower UK retail sales volume and margins. The results include an adverse impact of 13 percentage points from the year-on-year bonus impact and higher technology investments. Turning now to the pharmaceutical wholesale division, which I'll also discuss in constant currency. The pharmaceutical wholesale division delivered another strong quarter, with sales up 8.3%, led by emerging markets, and the UK. The change in the customer contract, which I've mentioned before, helped our UK performance, contributing 1.4% to the overall sales growth. We have now lapped the impact of this contract change. Adjusted operating income increased 4.9%, reflecting strong revenue performance and a higher contribution from AmerisourceBergen. The strategic joint venture with McKesson aims to drive sustainable, profitable growth in the largest pharmaceutical drug market in Europe by leveraging scale and improving efficiency. Midterm, we expect the JV to be EPS accretive and to accelerate our pharmaceutical wholesale profit growth. Turning next to cash flow. Operating cash flow was $1.1 billion, up $601 million versus prior year. Free cash flow was strong at $674 million, up $684 million on prior year. Our key working capital initiatives are on track. We are removing excess inventory from the system, and we have started to extend payment terms to industry leading levels. And we have a strong pipeline of initiatives to fuel our cash flow generation over a multi-year period. Let's turn now to our transformational cost management program. In October, we raised our annual cost savings target to in excess of $1.8 billion by fiscal 2022. We now have a very robust pipeline, and our savings initiatives are gaining momentum. This gives us a much higher level of confidence that we can exceed the $1.8 billion target. Importantly, these savings will allow us to fund the investments needed to create new and innovative business models. Let me now give you some detail on our activities in the quarter. On smart spend, we are accelerating our energy management efficiency program, and we see opportunities to ramp up our procurement activities in goods not for resale. The energy management program is interesting. New LED lighting saves money, is environmentally friendly, and improves the store experience for consumers. This is a perfect example of save to invest to grow. On smart organization, we're undertaking an end-to-end process review in Boots UK, covering all major business processes with the aim of transforming how we operate, ultimately leading to a lean and effective operating model. We are now actively planning the implementation of global business services and We have implemented a second wave of headquarter cost reductions in Mexico, Chile, and Thailand. On divisional optimization, we have completed 114 of the 200 Walgreens store closures and 28 of the 200 Boots UK closures. We continue to test new store formats in the U.S., and we're now operating 23 small stores with encouraging results. On IT, we have started implementation of a new operating model and our vendor optimization work is progressing well. For example, we recently selected Tata Consulting Services as our new partner to accelerate the work on our critical pharmacy operating system. On digitalization, We have prioritized investments in mass personalization and reinventing the pharmacy prescription journey. Now, I'll hand over to Alec.
spk09: Thank you, James. I'm now updating some of the actions we've taken in the U.S. during the quarter, starting with our retail offering. Our strategic partnership with Kroger is progressing well. The initial Kroger Express pilot in Northern Kentucky has been running for just over one year, and the pilot in Knoxville, Tennessee, for five months. We've seen very positive results so far with a strong sales lift. Building on the success of these pilots, we formed a group procurement office, Retail Procurement Alliance, with Kroger in December to purchase both of our private label goods. We expect this joint venture to deliver cost savings, encourage sourcing innovation, and generate efficiencies across the supply chains. Our strategy of focusing on the higher margin health and wellness and beauty categories is delivering benefits and both delivered solid performances in the quarter. Our flagship number seven beauty brand performed well with sales up in the mid-teens reflecting a nationwide advertising campaign and a new e-commerce site. And we have introduced an enhanced skincare offering in over 900 stores which we expect to drive future performance. Moving on to healthcare, we've opened the second of five VillageMD primary care locations in Houston. Our wellness partnership with Jenny Craig is progressing well, and we're on track to open approximately 100 locations by the end of January. We're also in the process of converting our optical pilots to the 4Eyes brand, which offers improved insurance coverage and stronger consumer brands. In specialty, I'm delighted to say that all 300 community-based specialty pharmacies have received URAC accreditation. And we continue to believe that a strong community-based presence alongside our central field capability provides the best access for these important medications to our patients and the marketplace. In partnership with UnitedHealthcare, we continue to create new opportunities for growth in Medicare Advantage. We are very pleased with customer adoption of the new co-branded Medicare Advantage product, which started selling from October 15th, 2019. And finally, we are also opening 14 UnitedHealthcare patient resource centres, designed to help our customers navigate their insurance and healthcare needs within Wogan stores. Turning next to digitalisation, our fine care platform now has 32 healthcare service providers, spanning over 46 services. We continue to develop our patient medication adherence programs to deliver better clinical outcomes. Our Save a Trip refill program now has 3 million patients signed up, an increase of over 25% since last quarter. Our consumers continue to demand a convenient omni-channel retail shopping experience. I'm pleased to say we had record-breaking sales on wogies.com on the Black Friday weekend, up over 45% versus the prior year. and with particularly strong performance in retail products and photo. Overall, our omni-channel business continues to grow. Our Walgreens app has now been downloaded 60 million times, up 12% since last year. Around 33% of Walgreens retail refill scripts eligible for digital refill were entered via digital channel in the quarter, up almost 18% since last year. And we have increased our balance reward members to 89.9 million. Finally, Walgreens digitally initiated sales reached over $3.7 billion in the quarter, up around 9% year over year. Next, I'll update you on initiatives we've undertaken in Retail Pharmacy International, starting with retail. In Butch UK, as you know, we've introduced a beauty reinvention programme to 26 of our flagship beauty halls in the second half of last year. I'm pleased to report that we've seen an improved performance in these stores in line with our expectations. Building on this, we've rebalanced the retail space in 200 of our largest stores and have introduced 20 new beauty brands. Since the quarter end, we have signed an exclusive UK franchise agreement with Mothercare, a British retailer and brand specialising in products for mothers, babies and children. We will be selling Mothercare branded goods across the UK and online. Moving on to healthcare. Our purpose-built pharmacy operating system has been rolled out to over 1,400 Boots UK stores, allowing our pharmacists to provide a greater level of customer service, even more efficiency and over time a wider range of new pharmacy offerings. And we continue to develop new healthcare services with diagnostics where our pharmacists now have the ability to write prescriptions for certain conditions. I mentioned last quarter that we are developing new initiatives in digital healthcare with plans for expanding pharmacy services to improve the customer journey and broaden access to healthcare. We launched our online pharmacy in May 2019, which has made solid progress in the market. We've made further good progress on digitalization. Our online business, Boost.com, delivers strong growth with sales up 12% versus prior year in the quarter. We also saw a record-breaking Black Friday weekend with resulting online sales up around 25%. And finally, we have agreed on exclusive partnership to offer omni-channel photo and personalized gifting services in the UK and Ireland. I'm going to hand you back to Stefano for his closing comments.
spk10: Thank you, Alex. As you have heard, this year has opened with a number of challenges. The many changes that are impacting the global healthcare sector are generating some difficult conditions for our businesses. That said, change always brings opportunity. We must act to meet the challenges and ensure we make the most of the opportunities we see. Seeing these opportunities and mindful of the challenges ahead, we are maintaining our full year guidance for the year. We continuously review our group to ensure we have the right mix of businesses to maximize our performance in a dynamic sector. Pursuing our strategic priorities is having a real impact in driving our businesses. The changes in our markets are obscuring some of the positive impacts we are having, but this will not be the case forever. I have said before, and I will say again, I strongly believe in an expanded role for pharmacy and in our company's ability to to play a significant part in shaping how healthcare is delivered in the community going forward. I believe this as much today as I ever have. I believe we have true financial strength as a business. As we have demonstrated this quarter, we have an extraordinary ability to generate strong and sustainable cash flow. And we have many opportunities to deploy this cash flow to create real value. I remain convinced that we have in our company and through our partnership an extraordinary foundation on which to build. The work that we are doing today is creating a strong and flexible engine for growth in our businesses for many years to come. Thank you. Now we will take your questions.
spk03: At this time, I'd like to remind everyone, in order to ask a question, please press star and the number 1 on your telephone keypad. Your first question comes from the line of Robert Jones from Goldman Sachs. Your line is open.
spk00: Great. Thanks for taking the question. I know there's a lot of moving pieces, and it's only the first quarter, but if I just take a step back, clearly EPS was down around 6% in the quarter below the full 5%. Fiscal year guidance, it sounds like, James, if I'm hearing you correctly, you know, next quarter, given some of the moving pieces, you could see an even steeper decline in EPS. You know, I guess if we think about the back half, could you maybe just give us the building blocks or the things that you guys have visibility into that gives you confidence that the back half can get you into that flat plus or minus 3% EPS for the year?
spk05: Yeah, absolutely. An expected question, obviously. Let me just give you a little bit of context on the first quarter, however, first. You know, I think the only real surprise we had in the first quarter was on script volume. It did come in weaker than we expected. We were thinking of a number of around 4%, and we came in at 2.8. That's the piece that, and I want to be clear, Our internal budget was 137, and we came in on our budget. What we had was a favorability on tax, offsetting script growth in Q1. So that was the one thing we were disappointed on. We had a lot of stuff we were very happy about. So free cash flow was off the charts. We beat our internal budget by hundreds of millions. Largely driven by programs we're implementing in the U.S., As Stefano said in his comments, the transformational cost management program, and that's key to the answer to your question, is I would classify it right now as well ahead of track, particularly due to actions in the U.S. and the U.K. And other items I'd highlight that shouldn't be lost on you. We finally, we have nailed one of the first steps in the Kroger relationship. We think it's extremely positive that we have started up a GPO. And I think it'll lead to many good things in the future. And then finally, a strategic deal in a problematic German wholesale market, which we think will drive tremendous value longer term. So we think there was a lot of good things that happened, and script growth was the one that was more challenging. Let me give you a perspective looking forward. And actually, we're a little bit surprised as well. We're seeing quite strong momentum in the current month of December. So we believe when we call out five percentage points of items in the first quarter, we're probably under-calling that. There were clear shifts between, call it the Thanksgiving period, Christmas periods, and I don't want to give the precise number, but our script growth is in solid mid-single-digit growth in the month of December. So we're clearly feeling that we're not really reading why the shifts are happening that well. We know cough, cold, flu is driving some of the buoyancy in December. So we are seeing signals that what we are counting on to hit our full year guidance, we do need our script growth to be in the three and a half to four kind of percent, maybe four and a half, depending on the quarter. But right now in December, we're seeing numbers in excess of that. So script growth is the key one. The other key one is that will drive increasing performance as we exit the year. Obviously, as you take out costs, the cost takeout is over the course of the year. So, you know, the savings roughly in the first quarter are around 15%. So of the total goal of, we haven't given the number, it's a large number, we're less than 15% in Q1. As we exit the year, we'll be at double the run rate of savings. So overheads will become a much more significant driver in the second half. And I do want to point out for that, for a company of our size with the amount of overheads we have, the total overheads were down 1.6% in the quarter. And the context, and I think it's important to have the context, we did say that the combination of inflation and volume impacts is about 400 million. You have the bonus year-on-year that's in the region of 350, 400 million. And we have incremental investments of 100 million to 150 million. So it will give you some indication of the size of the cost management initiative. And, you know, I think we'll come back next quarter with probably more visibility on the potential further opportunity on the cost program. But I'll just finish answering your question. I think if you were to do your model again for the full year, we will probably have a slight favorability in taxes. So call it somewhat 0.6, 0.7% on the full year. And we will have more coming from overheads and probably slightly less coming from gross profit because we had a miss in the first quarter on Scripps. So that's why we feel it's basically the overheads and some tax opportunity that we feel we can offset the, call it the Scripps, under delivery in Q1. Does that cover what you were looking for?
spk00: No, that's tremendously helpful. I guess just one other. Probably anticipated question, again, just around the Prime relationship in the wake of the Prime Express Cigna announcement. Just wanted to get any update on how you guys are viewing the Prime relationship and the impact to the Alliance RxJV, just as we think about how that relationship played out for you this past year relative to your expectations for how it would contribute in 2020 would be helpful. Thank you.
spk09: Hi Bob, it's Alec here. Yeah, we have re-contracted with Prime in a direct relationship. So Prime is now working with Express Scripts as a PVM, working with us in a direct relationship. So we anticipate to hold our market share with Prime and potentially grow as the Prime model will be more competitive in the marketplace. Our relationship with Prime continues to be a very strong one. and we continue to work very well with Independent Blues. So, we are happy with the situation. In terms of the impact, obviously, we've readjusted the margin a bit, but it really was in forecast and budget. So, we had expected this impact and had planned for it. On the AllianceRx side, AllianceRx actually is doing Okay, at the moment. But again, we have a great relationship with Prime. We're speaking to them about how do we adapt to an ever-changing specialty marketplace, which is becoming even more important for both of us. And we expect to have conversations next year along these lines to improve that model further. So all is good from our point of view. And we wish Prime every success with their new model and the network. We feel very confident that we will benefit from that relationship in the future. Thank you.
spk02: Your next question comes from the line of Eric Preacher from Nefron Research. Your line is open.
spk12: Thank you, and thanks for the commentary on the cadence with respect to volume and cost. Maybe to hit on one other item, reimbursement and the impact on 1-1-20. I know you gave us a 13% number that I think was reimbursement and bonus, but can you provide a little bit more context on what the outlook is as we move from Q1 into Q2 on 1.1.20?
spk05: Yeah, the 13% reference was to Q2, and we're specifically highlighting two things in the quarter. And I would say it's like 7% due to reimbursement timing, and the other is 6% is due to bonus year-on-year. And the reason we called out the... The Q2 reimbursement is, it really is a timing item. It's the true up of prior year contracts that occurs typically in the April, May, June timeline of the year. And as it happened in the prior year, there was no true up. So it's not really a reimbursement impact year on year in terms of increasing contract prices. It's a contractual true up of the contract for a prior year. And it's quite a large number because it impacts seven percentage points. We didn't actually call out anything on Q1. What we said about Q1 is reimbursement was actually broadly in line with the plans we had put together. Because if you recall when we gave guidance, we said at the time that I think 58% or 60% of all of our contracts were already defined when we gave guidance. So we had a fairly decent line of sight to the full year reimbursement. and we came within $20 million of the reimbursement estimate for the first quarter. So we were actually quite pleased with that because it's quite difficult to forecast reimbursement. And, you know, we have looked back on some of our prior guidance on the quarters, and the reason for giving something on Q2 just is to highlight this exceptional reimbursement timing drew up. Right now, as we sit, we have no reason to call... any different outlook on reimbursement for the full year. We should presume that means plus or minus $50 million. So we were pleasantly surprised with the Q1 on that side. And I reiterate, our issue in pharmacy and Q1, nothing to do with procurement, nothing to do with reimbursement. They were actually net, probably slightly positive. It was probably, it was all skip volume. It was just lighter than we would have planned it to be.
spk12: That's really helpful. And reimbursement in the U.K., it sounds like NHS funding did improve, but we didn't see it in the revenue line. Was this simply the new contract, or have you seen any makeover for the lack of payment last year?
spk09: Again, there's really two stories here. One is, as you say, there has been a stabilisation of payment, which is in the marketplace, can be seen on the NHS site. And secondly, we have taken some actions to reduce loss-making services that we have in the UK and to make them more profitable. As a result of that, we've lost some volume, not as much volume as we had expected, to be honest, but some volume. And we're quite pleased with the retention of customers with these actions. And that's what's caused a slight further decrease in terms of our revenue in the UK. It's not reimbursement. It's actions we've taken to reduce loss-making services that we were offering.
spk12: Thank you.
spk03: Your next question comes from the line of Elizabeth Anderson from Evercore. Your line is open.
spk04: Hi, good morning, guys. A couple of times you've mentioned or sort of alluded to potentially a little bit of a changing competitive environment in the U.S. pharmacy or perhaps some pressure on or versus your expectations in the quarter in terms of script growth. Could you comment more broadly on sort of what you're seeing there and sort of your thoughts on how that's progressing?
spk09: Hi, Elizabeth. I think, you know, as the consolidation in the market has really accelerated both vertically and horizontally, And as, for example, the Prime Express deal is a good example of this, the PBMs are working more closely together. That's clearly putting more pressure on the marketplace for better pricing. And that's really what we're alluding to. So we are working hard, as James has said, as we always have done, to mitigate that pressure through our cost programs and through driving volume. As James again said very clearly, we were disappointed with the volume growth in Q1. Part of that was timing, as James has said, and part of that is because of the fact that we lost some access to some, particularly some Medicaid networks during the summer that is rolling into this year. And as we spoke to, I think it was the last quarter, you know, we're working investigating, I would say, with AdvanceRx and Centene, you know, the opportunity for us to become more efficient together and offer a new model in the Medicaid business. We recognise that we are undershared there and we have to operate differently in that marketplace. In Medicare, you know, we continue to do very well with UnitedHealthcare. We're really pleased with the relationship and the new MA plan, as we spoke to in the in the changes in January 1. Obviously, we're doing less well with the other strong performer, which is Aetna Insurance. They've done really well, and we're doing less well with them for maybe obvious reasons. But in the whole, we feel we're going to be there or thereabouts in Medicare. Then in commercial, I've already said in a reply previously that we're very pleased to have renewed the contract with Prime, which, again, is a very important book of business for us in the commercial network. So I think that's the picture from our point of view. And I hope that's – I don't know if I helped to answer the question, Elizabeth, but that's how we see it. And it all underpins the 3.5% to 4% volume growth that we expect to see in the full year.
spk04: Okay, perfect. That's very helpful. Thank you.
spk03: Your next question comes from the line of Lisa Gill from J.P. Morgan. Your line is open. Thanks very much. Good morning.
spk13: I wanted to start with just some thoughts around branded inflation as well as generic procurement in the current market. You know, as we think about the growth margins and how this will impact it, I'm just wondering, James, first, can you just talk about what's in your current expectation and guidance?
spk05: What we saw in – I'll tell you what we've seen in Q1. We saw branded inflation of around 4%, and we – most of the market reads seem to be that deflation, and this is on a constant mixed basis, so like for like SKUs, deflation of around 4%. We would say that internally, on generics, sorry, on generics, and maybe I'll ask Alec to weigh in, and then two is we would be outperforming versus that 4%. We'd probably be in mid to high-ish single digit, and... we generally are projecting that kind of number going forward, somewhere in the mid to high single-digit deflation mix adjustment, which is probably, you know, quarters will change versus market, but generally that's what we're seeing in the market, and we're delivering slightly better in terms of cost reduction in the P&L. I don't know, Alex, do you want to add?
spk09: Yeah, I think that's the answer, Lisa. That's what we're seeing, and we continue to... to feel very good about our global operation. And we've delivering just slightly beyond market average reductions in cost of goods. So that's exactly what we're seeing. Yeah.
spk13: And then, you know, Alex, you talked about a number of healthcare initiatives and updates. Two that you didn't touch on today would be LabCorp and Humana. One, on the LabCorp side, can you just talk about where you are today? Are you on track? On the Humana side, any plans to expand? You did talk about United on the Medicare Advantage side, but I'm curious what you're doing with Humana. And then just more broadly speaking, the strategic priority for expanding the role of pharmacy, as you know, I'm a big believer in that as well. But with the reimbursement pressure, do you ever see that subsiding in any way where you can actually get ahead of that, where you can start to change the paradigm? And I know I've asked this for multiple years, but do you finally think that you can start to see that on the horizon as you start to have bigger and bigger relationships like, you know, north of 100 million lives now in a combination of Prime and Express. You think about large relationships like United.
spk09: Yeah, so I think maybe start with the Humana questions. So we've opened up our third partners in primary care. It looks very good and is operating really well. And the relationship between the pharmacist and doctors is really close. So we continue to feel really good about that relationship. A very small but important test joint venture. And of course, we've opened up two also with a company called Village MD, which I'm sure you know, down in Houston. There'll be five in total by the end of February. And again, we are very, very pleased with how that's operating already. We've taken a small stake in that company, Village MD as well, which we're pleased to do. And we see that partnership of the doctor and the pharmacist has been fundamental to the future of community healthcare delivery going forward in core to our model. And we're learning lots about how we can do two things, take cost out of the system together and get customers to understand and take their medications better and change their lifestyles. And so it's really interesting work and it points to maybe your last question. So that's on Humana. On LabCorp, we're bang on track. in terms of number of service centres opened. I think we'll have well over 100 in the ground by the end of this quarter. I think that's really bang on track and they're performing well. We are seeing NPS scores and the usage of the centres on or above our expectations. So we're very pleased with that programme and we expect to have 600 and maybe more we don't know yet in the ground within the four years as we promised. Finally, on the role of the pharmacist, we are working really hard to get our new system in. As James spoke to in prepared remarks, we're going to be accelerating that system from the current pace. That will be fundamental. It will be in the cloud. The data will be in the cloud. It will be fundamental to taking the workload out and freeing up our pharmacists to really drive that new future. We're seeing increased payments from certain insurers and PBMs, particularly in Medicare D, who we really like working with United because they are stretching to this in terms of getting the payment, but they're very clear on the goalposts. that we have to hit to get the payment and we've been successful in achieving that. I do believe that other insurance companies will follow their lead and the government eventually will also make sure that we have clear KPIs going forward as well. So yeah, it's a longer play for sure, but we are really committed to it and we're making more progress than appears right now in our numbers. and we continue to keep on pushing this. It's fundamental to pharmacy and fundamental, we believe, to a more efficient healthcare system in the U.S.
spk13: And then just so I understand this, none of that is in your expectation for 2020. I heard you say longer term a couple of times in this conversation, so should we anticipate that this could potentially impact fiscal 2021 or 2022? How do we just think about it from a timing perspective?
spk09: Yeah, we're already earning some money back. As you know, the famous direct or indirect rebates is a debate you'll know well. So we are earning more money back than we did previously. And the amount of money available to us is growing. And our ability to get at that money grows as we get our systems in. And of course, we're also deploying pharmacists, specifically called pharmacists, outcome pharmacists. I think we have about 150 now in our network who are specifically working to achieve these performance outcomes. So I think this will start to affect 21 and 22. it's already given us some relief in 20 as well. There's improved money in our forecast for performance networks.
spk03: Okay, great. Thank you for the comments. Your next question comes from the line of Sue Ramanoff from Morningstar. Your line is open.
spk11: Thank you for taking the question. The background you've given on a lot of initiatives has been great. Perhaps maybe... specialty has become such a big component of your business. I mean, is that mix also impacting the margins as well?
spk05: Yeah, we call that out in the quarter. It's impacted by about 50 basis points because it's growing at high single digit versus the pharmacy scripts of 2.8%. So it's driving adverse mix of 50 basis points.
spk11: And I guess that makes sense. I mean, do the initiatives that you're kind of putting in place help expand those margins or also provide kind of that long-term wellness and part of the healthcare transformation?
spk09: Yeah, absolutely, Sue. I mean, we strongly believe in having a community presence. And as you know, we have two models. We have one which are close to doctors who are practicing in specialty, for example, oncology. And then we have pharmacies inside of hospitals and healthcare systems. We have 300 plus of these and we've now got URAC accreditation for them all. So every single pharmacy that we now run in the community, which is very unusual, I believe, with the first achievers, has got that accreditation. That means that we're more attractive to the manufacturers because they know that we'll take full care of the patient. And more and more patients are living longer with diseases in communities. So we believe the local model will become important to the future of healthcare delivery. And there will always be a central, full model, I'm sure, but we believe the local model will become more and more important. Also, we announced our relationship with Shields. Shields is a very interesting platform that's working with healthcare systems, and we have a lot of relationships with healthcare systems, as you know, to make sure that as patients leave hospitals, they maintain themselves on the drugs being dispensed primarily by the hospital pharmacy. So again, we're investing both in technology with Shields and also in Overland as well in terms of data and tracking customers in low community pharmacies to make sure pharmacists can actually take care of these customers as they live more often at home. And we're also, of course, working closely with Prime, as we said already, to make sure that we have a really efficient and effective system central model. And most importantly of all, we have outstanding relationships with the manufacturers, really driven both through our relationship with Emersos Bergen and also the work that Arnella does with her team at global level to make sure that we have the very best relationships. So as these manufacturers are bringing these new and unique products to the market, we feel as a global partner, we can apply our capabilities for them in the U.S. market through that relationship.
spk03: Your next question comes from line of Eric Caldwell from Baird. Your line is open.
spk07: Thank you very much. I know it's difficult to parse this out with the store closings in the UK as well as the shift to more services from volume perhaps, but could you give us a clear sense on the impact of the NHS reimbursement scheme change either quarter over quarter or year over year? And then, you know, how did that really stack up compared to your expectations? It sounds okay, but I'd like to get a little more detail on that in terms of not only the quarter over quarter, but also, you know, how that progresses through the next few quarters. Thank you.
spk09: Sure, yeah, no, it's Alec here. No, it was exactly as we expected. So the quarter for pharmacy, both in volume, as I said already, was slightly below on the market in terms of underlying business, but we gave up some scripts because of some unprofitable services. in terms of margin, exactly as we had expected. And it's tracking too, as we expect. It's relatively easy to track this because the government have re-signed a five-year contract with the industry through what's called the PSNC, which represents all pharmacies in the UK. It's a one contract. So we can track this quite carefully. It does vary sometimes from quarter to quarter, but it's trued up in a way which is transparent. So we feel very confident that we've got a good line of sight to this. We feel very confident that we are working operationally very well in the UK. And we have an initial piece of work there, which is called Pharmacy of the Future. And the idea here really is to transform the operating model for pharmacy in the UK. This will take some time, of course. We've already maxed out the investment. We're investing strongly in a new pharmacy system. We've rolled out to 1,400, which is well over half the Bootsy state. And it's now present in all the home countries, including Scotland, most recently. So again, we're feeling pretty good about the visibility. We're not feeling as good about the profitability of pharmacy. We believe that that needs to improve further so that we can reinvest back in community pharmacy properly in the years ahead. But we are very committed to getting that operating model understood and changed over time.
spk05: Yeah. If you wanted to characterize the year of prior year, it was a tough year for pharmacy, where there were a lot of one-time impacts coming from NHS funding. And there'll be a general this year recovery from that. It was surprising. We were within $500,000 of the gross profit targets for pharmacy in the UK. It was a bang-on target. We are looking at a fairly sizable improvement in gross profit in the business this year. So, Alec mentioned it earlier in his comments. We have some marginal profitability businesses on the sidelines, and we're aggressively driving the improvement of those. So, don't be surprised if you see script volumes and market share going down slightly. We're addressing the profitability of subcategories that we don't think are strategic to the company, and we definitely don't want to be in marginal profitability positions. So a bit of a shift in the orientation in the business, slightly more to profitability. So it just, as you're modeling it out, don't get fixated by script declines because the core business is actually quite solid and solid in the core. Yep.
spk07: Got it. Thank you very much.
spk05: Just one point on the UK, though, as we go through it. You know, we did have a rough quarter in retail, and it really does come down to the market. And our share, we held share overall. Quite interestingly, though, we've seen in the last couple of weeks, and it's maybe a little bit important as you think through your modeling, you know, we had a rough quarter, you know, a 40% decline. Now, there was a lot of one-time items in there. Probably half of that was one-time adverse items, just generally. Okay. But as you think through this, we saw a very, very strong Christmas period. There's huge phasing going on in many of our primary markets. The whole December month started out extremely slow. The second last week of the month was extremely strong with high single-digit revenue growth. And the last week of the year, we again had mid to high single-digit growth across our key categories. And we're still getting in and dissecting just what happened, but December performance is quite a bit more positive than the quarter we just came out of. And the double surprise was it was achieved with higher margins than prior year. So we're rebalancing the commercial approach in the UK and we're not chasing volume at any cost. And surprisingly, We're seeing better volumes, and we're seeing better margins. Now, it's only two weeks, so it's too early to shout success, but we've seen a better performance across December across the entire, the main two markets, actually, and both businesses have done quite well in the Christmas period, very well actually.
spk03: Your next question comes from a line of Kevin Calendo from UBS. Your line is open.
spk06: Hi. Thanks for taking my call. You mentioned you had 60% of your PBM contracts set when you gave guidance, and now you've renewed prime. What remains outstanding, and how much variance is there really at this point? Could there be in reimbursement as we look out over the rest of the year? Hi, Kevin.
spk09: It's Alec here. It's virtually. I mean, there'll be some small networks which can change mid-year for sure, but the vast majority now is is contracted, the vast majority. I can't give a precise number, but if I was giving an estimate, it'd be well over 90, because I go back, the consolidation of market is very clear. And yeah, so that's where we are. So we feel we have a good line of sight in this fiscal year. And again, we'll start renegotiating the majority of the MED-D contracts as we move through the summer months, but that'll be for starting January 1st, 2021.
spk06: And the renewal prime, that takes you through, is it more than a one-year contract, meaning like the express relationship won't have any impact on that at all going forward? That's correct, yeah.
spk09: I mean, we don't disclose the length of the contracts, but this is a multi-year deal, typical of a longish commercial contract.
spk06: Got it. And one last one. Have you guys looked at the OECD proposals around multinational corporation tax rules. They're obviously still just proposals, but wondering if they were implemented, would it in any way impact Walgreens or WeBad or anything like that?
spk05: You know, we have a, I would say, a quite expert tax group, and they're extremely active. They're all over this. You know, I think you have to wait until dust settles on these things, but... We would obviously realign the corporate structure according to new legislation as it comes along. We think the WIBAT is in the right location. It delivers attractive tax positions, but it's all vetted and approved by all jurisdictions globally, and it's in line with current policy. As policies change globally, we'll adapt to the policies and But, you know, we have an attractive tax rate compared to our peers by quite a number of percentage points. And, you know, we'll try and maintain that as much as possible. But you can be sure the team is all over this. And we don't see any short-term risk.
spk06: Great. Thanks so much. That's really helpful.
spk03: Our last question comes from Michael Schierney from Bank of America. Your line is open.
spk01: Thanks for squeezing me in here. So I want to tie back, I guess, a big picture question. At the beginning, you talked about the broader strategy you're taking. I know you mentioned the role of pharmacy going forward. You've highlighted a number of the various different partnerships. I guess as you think about the next, call it rest of this fiscal year, two, three years, what are some of the checkpoints you're looking for relative to the partnership model, relative to the strategy, relative to the EBIT contribution from all of these to essentially declare success or if some of them aren't going to kind of cut bait. And how does that play into the broader thought process around the organization and the role and where you sit in the market on a go-forward basis given as well that you're also going through a pretty broad restructuring of both the cost base and the store footprint?
spk09: Thanks, Michael. Yeah, it's Alec here. So I think if we start with our priorities and start with the reimagining of the drugstore and new retail offerings, we're probably more advanced with the Kroger relationship. And the reason why that's quite important is because it allows us to do two things. It allows us to work with them on the convenience model, which is really important to drive footfall into our physical stores. And also really important from a consumer point of view, the redefinition of conveniences is such a big change in the marketplace. So we're feeling really good about that. I said in my prepared remarks, we are seeing substantial sales growth, both in the box itself and also in the categories that we are supporting. We've also launched our own products, I think we're going to have them in about just over 15, 16, 17 Kroger stores. So, therefore, this gives an opportunity to put our health and beauty composition and private label and own brands into their customers' views as well. Then lastly, when you put together the two customer sets, you know, we serve together around about 20 million customers a day between us. So we have a strong, strong presence in American households and our ability, therefore, to work with them being the genuine food expert of America and us being very, very competent, we believe, in pharmacy health and to some extent beauty categories that relate to health care and wellness. We believe that's going to be a strong opportunity. The procurement structure allows us to earn money in the short to medium term. And, of course, we'll be working together on other issues in the supply chain and also on other issues in procurement, we believe, as well in the future. So that's one area where I think we have made good progress, both tactically and strategically. With healthcare, you know, we are well into testing quality brands and quality offers in partnership with others. You know, so the acceleration of our lessons learned in optical is one example of it. We were working with Grand Vision, who are renowned as a quality optical retailer with access to insurance and the very best brands. We really are delighted to get more opportunity to put doctors into our stores alongside pharmacists. And we believe that while that will be a longer-term model, we know from experience in Europe that that model can be really effective in delivering end-to-end primary care in communities. And last but not least, you know, the fine care platform that we have built very quietly with an internal team is really growing. And we believe that will be a digital marketplace that will become very important to us into the market in the future, but will take time to grow. So that's really where we are in terms of that measure. So expect some improvement. Some contribution over time in the retail side, faster than the contribution maybe in the healthcare side, but the healthcare side will come through the halo of scripts over time and the access to more.
spk05: Maybe one, we didn't get this question, but progress on digitalization in the quarter. We've just launched two major initiatives, launched and funded, and I want to And I go back to the previous guidance we gave. We've got $500 million of capital expenditures behind digital and development, plus about $100 to $150 of expense this year. And we launched two big initiatives in the last month. One is on mass personalization, and that's how do you use your marketing dollars more effectively to target a better connection with the consumer. We believe it will... significantly underpin, particularly the retail revenue profile for a multi-year period. And these are not small investments. They're in the 50 to 100 million range. The second one is the prescription journey. And I use that one very generically, but it's, again, it's a similar size of investment. And it's on a two-speed. We're not waiting for the core systems to be upgraded. It's on a parallel journey. And this is a two-ish year journey. And what's it going to do? It's going to connect the consumer much more closely with the prescription, how they want it delivered, how they want to pay for it, the transparency of the cost of it, and the options we give consumers and getting closer to consumers. And the second thing it will do, it will take friction out of the system, which means it will reduce the cost to fill a prescription. So we're working on initiatives that don't just boost takeout costs, but they actually boost revenue and the connectivity to patients and consumers longer term. And don't let that be lost. These investments are large, and they're multi-year, and they will also drive long-term revenue and sustainable growth.
spk01: And I guess just quickly, how do you balance all of those investments in long-term initiatives against some of the quarterly volatility and reimbursement risk and the moving pieces on the transformational cost program that you see.
spk09: It's tough.
spk01: Yeah, it's not easy.
spk09: But we have a program management approach. We have got a lot of capable people, but it's not easy. We're paying a lot of attention to the future and to today, as you can tell by the comments that James and I have made.
spk05: A lot of these funds go through the transformational cost management program, and Alec, myself, and Ornella, and the head of HR, sit on the... We already have four people on it, so it's a small team that takes decisions quickly. And frankly, some of these are tough trade-offs. And in some quarters, you theoretically can't afford it, but you have to do it, or otherwise you're going to damage the long-term future of the company. But this is the problem, Stefano.
spk10: You have a strategy. Our strategy has always been a medium-long-term strategy. And we believe in the pharmacy. We believe in the role that the pharmacies will have in future. Of course, the pharmacy will have to be able to satisfy the needs of the patients and the needs of the customers. And we are working in that direction. Not all the pharmacies will survive in future. Not all the pharmacies will be important in the local economy of the cities, of the villages. We try to be a pharmacy that can have a role. And of course we have to invest. We have to invest now for the future. If we work just for the next quarter, maybe we will have a little better results, But at the end, we will probably create a problem for the long survival of our stores, of our pharmacies. And now you have to take a decision. Either you... believe in a strategy which is focused on the long term, or you just try to look at the next quarter, and maybe you try to do deals just to, let's say, make easier or less evident the problems that you have. We have decided to work for the long term, and I hope that at the end we will be right.
spk03: There are no further questions at this time. I turn the call back over to the presenters.
spk08: Thank you very much indeed. Thank you. I know that not everyone that wanted to ask a question got to ask a question, but as ever, the IR team are here and will take your calls during the courses today and tomorrow and the rest of the week. And we look forward to speaking to you all again next quarter. Thank you very much indeed.
spk03: This concludes today's conference call. You may now disconnect.
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