Walgreens Boots Alliance Inc (WBA) — Q3 2015 Earnings Call Transcript

Thank you, Stephanie, and good morning everyone. Welcome to our fiscal 2015 third quarter earnings conference call. Today, Stefano Pessina, our Executive Vice Chairman and Chief Executive Officer, and George Fairweather, our Executive Vice President and Global Chief Financial Officer, will take you through our third quarter results. Also joining us on the call and available for questions is Alex Gourlay, Executive Vice President and President of Walgreens. You can find a link to our webcast on our Investor Relations website at investor.walgreensbootsalliance.com. After the call, this presentation and a webcast will be archived on our website for 12 months. Certain statements and projections of future results made in this presentation constitute forward-looking statements that are based on our current markets, 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 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, Form 10-Q, and other filings for a discussion of risk factors as they relate to forward-looking statements. As a reminder, today's presentation includes certain non-GAAP financial measures. We refer you to the appendix of the presentation materials available on our Investor Relations website for reconciliations to the most directly comparable GAAP financial measures and related information. With that, I'll turn the call over to Stefano for some opening comments.

Thank you, Gerald. Good morning everyone and welcome to our fiscal third quarter earnings call. The past six months have been significant for us in delivering on the benefit of the merger and structuring the business for the future, but there is a lot more to do. As you have seen today, I have been appointed by the Board as Chief Executive Officer, replacing the Interim appointment that I was previously fulfilling. The Board has decided that bearing in mind the pace of change and the amount that we have still to do, there is a benefit to stability at the senior level in the organization and to focus on the operational and strategic task before us, rather than appointing, orientating, and educating someone new to the business during the period. The role presents me with certain personal and logistical challenges, but with the support of the Board and particularly of Jim Skinner as our Executive Chairman, I have agreed to accept the appointment in the best interest of the company, my colleagues, and of course my fellow shareholders. Today, I am pleased to be announcing another strong financial performance, indeed the first quarter to reflect a full three months of the combined company. Although it may not always appear so from outside the business, it has been a very busy period for us since I last talked to you. As I have mentioned, our focus has naturally been on putting in place the changes and the restructuring we need in order to deliver the full benefits of the enlarged company and position the company for growth in the immediate long term. Given that the deal was consummated only six months ago, we are still in the early stages of this process, but we have been working hard and fast to deliver on our plan, in fact better than our plan, and I am pleased to say that the benefits of this work are already beginning to be seen in our results with reasonable growth in revenues and margins and continuous strong cash generation. Really, the first avenues in which you can see the impact are tight cost control and disciplined financial management, but I want to assure you that we give our operations the investment they need to grow and prosper. We have accelerated our cost reduction process and have reaped certain benefits earlier than expected in this quarter. Of course, we cannot extract these benefits more than once. However, the process of identifying benefits is ongoing, not final, so when we have completed this first wave of restructuring, we will reveal it and review all areas of our business to identify further potential cost-saving. I must commend my colleagues throughout the company for their willingness and openness to accept change, even when it is most uncomfortable in the interest of improving and growing our company, and I would assure them that change is a sign of life and if embraced in this manner, it becomes more of an ally than an enemy. It’s a reminder that while we must prioritize our work if we have to achieve everything we want to and promise to, we cannot ignore any element of the business when it comes to our pursuit of efficiency and best practice. I will hand over to George now for him to take you through the results for the quarter and give you some color on what I have just said. George?

Thank you, Stefano. Good morning everyone, and good afternoon to those listening in Europe. Today, I will begin my remarks by highlighting key points from our fiscal 2015 third quarter results. Next, I'll provide insights into the performance of each of our three divisions and update you on our cost savings initiatives and synergy programs. I will wrap up with our updated guidance for fiscal year 2015 and discuss our goals for fiscal year 2016. As Stefano mentioned, the benefits from the work done since Walgreens Boots Alliance was formed at the end of December are already reflected in our financial results, allowing us to deliver another strong quarter. For the highlights, net sales for the quarter were $28.8 billion, a 48.4% increase compared to the same quarter last year. Operating income on a GAAP basis was $1.4 billion, while adjusted operating income was $1.7 billion, driven by the consolidation of Alliance Boots and growth in our Retail Pharmacy USA segment. GAAP net earnings attributable to Walgreens Boots Alliance were $1.3 billion, or $1.18 per diluted share, and adjusted net earnings were $1.1 billion, or $1.02 per diluted share. This marks a 59.5% increase in GAAP net earnings per diluted share and a 22.9% increase in adjusted earnings per diluted share compared to the same quarter last year. Net interest expense for the quarter was $151 million, and our adjusted tax rate was 30%. The average number of diluted shares outstanding for the quarter was $1.1 billion, including the cost of 144 million shares issued as part of the second step consideration for Alliance Boots. It is important to note that last year's third quarter included three-month equity earnings due to Walgreens' 45% interest in Alliance Boots, whereas this year reflects fully consolidated results. Now, I will explain the reconciliation from GAAP diluted EPS to adjusted diluted EPS. The GAAP earnings of $1.18 per diluted share reconcile to adjusted earnings of $1.02 per diluted share. The net adjustment of $0.16 per share includes $0.05 for LIFO provision cost in Retail Pharmacy USA, $0.06 for amortization of acquisition-related intangibles, and an additional $0.11 for restructuring-related costs from our cost optimization and store closure programs. These adjustments were offset by the removal of a $0.29 gain on our warrants to acquire Amerisource Bergen shares and a net 9% gain from special items, including the release of a capital loss valuation allowance totaling $0.12, combined with a $0.01 loss on the sale of Walgreens infusion services, and $0.02 from an adjusted tax rate true-up. Next, I'll discuss the performance of each of our three divisions for the quarter. Our results are reported in three segments: Retail Pharmacy USA, Retail Pharmacy International, and Pharmaceutical Wholesale. The segment reporting includes the allocation of synergy benefits and corporate overhead costs. Responding to feedback from our Analyst Day in April, we are providing additional detail on segment performance in the press release and this presentation. We have included gross profit, SG&A, and operating profit on both a GAAP and adjusted basis for each segment, and we plan to continue this practice moving forward. Starting with the Retail Pharmacy USA segment, total sales for the quarter were $20.4 billion, a 5.3% increase over the third quarter of the previous year. As a reminder, we sold the majority stake in Walgreens infusion services on April 7. Our share of earnings from the company now flows through post-tax earnings from equity method investments in the income statement. Comparable store sales in this division increased by 6.3%. SG&A on a GAAP basis was $4.5 billion and $4.3 billion on an adjusted basis. We have made significant progress in controlling SG&A expenses this quarter, aided by our cost savings program, which is a key driver of year-on-year performance. Thus, GAAP operating income for Retail Pharmacy USA was $1 billion, while adjusted operating income was $1.3 billion. Examining the pharmacy segment of Retail Pharmacy USA in further detail, comparable store sales for pharmacy increased 9.1% for the quarter. We filled 226 million prescriptions, including immunizations, on a 30-day adjusted basis, which is a 3.8% increase compared to last year's quarter, with prescriptions filled in comparable stores up 4.1%. We continue to see a positive impact and growth in Medicare Part D scripts along with positive underlying share trends. Our retail prescription market share on a 30-day adjusted basis rose to 19.3% in the quarter, up 20 basis points. However, the positive sales growth was largely offset by pharmacy gross margin pressure, consistent with our expectations. Retail product sales increased by 2% overall, with comparable store sales rising by 1.6%. The growth in retail sales was largely driven by strong performance in key destination categories, including health and wellness. We are pleased with our progress in driving profitable sales growth and margin expansion while maintaining a focus on operating efficiencies and working capital management. Additionally, we have enhanced our successful Balance Rewards program by launching Balanced Rewards with everyday points, allowing our active customers a more consistent platform for earning loyalty points on most transactions. We also promote healthy lifestyle choices by awarding points for positive health decisions. Moving to the Retail Pharmacy International division, this division focuses on pharmacy-led health and beauty retail businesses across eight countries. By the end of the quarter, we operated 4,565 retail stores, adding six during the quarter. Our largest operations are Boots in the UK, followed by Mexico, along with pharmacies in Chile, Thailand, Norway, The Republic of Ireland, The Netherlands, and Lithuania. Total sales for this division in the quarter were $3.3 billion, with GAAP operating income at $205 million and adjusted operating income at $249 million. The adjusted operating margin was 7.6% for the quarter, an increase of 1.5 percentage points over the second quarter, which included only January and February performance. As is typical, margins were lower during these early months of the year due to seasonality. Now, looking more closely at the division's performance, comparable store sales growth for the quarter on a pro forma constant currency basis was 3.1%. This reflects Boots UK growth of 2.4%, supplemented by higher growth in emerging markets, especially Mexico and Chile, where we are making solid progress integrating these businesses acquired by Alliance Boots in August 2014. In the UK, Boots resale sales benefited from strong performance in both the beauty and retail health care categories. Orders placed on our UK website boots.com saw a remarkable 50% increase compared to the previous year, with two-thirds of these orders collected in-store. At our Analyst Day in April, we emphasized the importance of our product brands, and we're pleased with the increasing sales of No7, our award-winning beauty brand, attributed partly to the recent launch of the No7 Protect & Perfect ADVANCED Serum. This innovative product is the first serum in the UK clinically proven to deliver exceptional anti-wrinkle results that improve over time. In addition to developing our current product brands, we are also expanding our portfolio, as seen in our recent acquisition of Liz Earle from Avon, a premium skincare brand known for its natural ingredients and recognition as one of the leading botanical brands in the UK. Turning now to our Pharmaceutical Wholesale division, total sales for this quarter were $5.7 billion. On a pro forma basis, excluding acquisitions and disposals and assuming constant currency, sales rose 0.2% compared to the same quarter last year. As previously discussed, the wholesale performance in any quarter varies based on larger geography performance, including the UK, Germany, France, and Turkey, along with our unique business model. GAAP operating income for the division was $162 million, and adjusted operating income was $171 million. The adjusted operating income margin remained steady at 3%, aligning with our expectations. The main driver for profit growth continues to be our synergy program, with net synergies in the third quarter totaling $194 million, amounting to $504 million for the fiscal year thus far. As previously noted, these synergies are primarily derived from our drug procurement activities, putting us on track to achieve our target of at least $650 million in net synergies for fiscal year 2015. For fiscal 2016, we anticipate reaching at least $1 billion in combined quantifiable net synergies. As we enhance collaboration within our management team, we are also identifying and acting on additional synergies, though many of these are challenging to quantify. While driving our synergy program, we are also focused on cost control, aiming for $1.5 billion in cost savings by the end of fiscal 2017. The expected pretax charges related to this program are projected to be between $1.6 billion and $1.8 billion, with approximately 60% expected to be cash. Progress was made this quarter in reorganizing our retail pharmacy USA field operations, and we continue to optimize the corporate office for this division. Of the roughly 200 planned U.S. store closures, nine were closed this quarter, with an additional 70 to 80 closures projected by the end of the fiscal year. We have also reduced the IT cost structure in the USA, which will enable significant system investments moving forward. In June, we announced a reduction in approximately 700 non-store-based roles in Retail Pharmacy International. During this quarter, we incurred pretax charges of $160 million for the program, which included $102 million of asset impairments, $34 million of severance costs, and $24 million in real estate costs. Now moving on to cash flow and capital deployment. GAAP operating cash flow was $1.8 billion for the quarter and $4.2 billion for the first nine months. Free cash flow was $1.6 billion for the quarter and $3.3 billion for the first nine months. Net debt at the end of the quarter stood at $11.8 billion. Our top priority for capital deployment is investing in future growth, both through capital expenditure and selective M&A. During the quarter, we invested $247 million in capital expenditure, totaling $890 million for the first nine months. Key areas for capital investment include stores and IT and digital capabilities, which are essential for achieving and maintaining a sustainable competitive advantage while enhancing our omni-channel efforts. This quarter benefited in part from stricter capital investment controls, but we aim to maintain stringent oversight over capital expenditures to ensure appropriate returns, without depriving the business of necessary investments. You can expect future quarters to see a slight increase in capital expenditures compared to what we are reporting today. We are focused on improving cash flow through working capital efficiencies, especially in Retail Pharmacy USA. A primary focus has been on inventory management for both pharmacy and retail products. This quarter, we improved our inventory days of supply in the U.S. by approximately six days compared to the prior year. We also see opportunities for further working capital improvements over time. Concurrently, we are optimizing our real estate assets, executing sale and lease-back transactions totaling about $300 million in the third quarter. As previously stated, we aim to run an efficient balance sheet, completing approximately $237 million of share repurchases in the quarter under our $3 billion authorization, bringing total purchases under this program to $331 million. This program is ongoing, and we are committed to completing it by the end of fiscal 2016. Additionally, we announced today our plan to redeem legacy Walgreens bonds totaling approximately $1.75 billion. This redemption will be financed from existing cash resources. At the end of the quarter, cash and cash equivalents were $4.4 billion, giving us the capacity to proceed with this along with our share repurchase program. Regarding dividends, we have announced a 6.7% increase in our quarterly dividend to $0.36 per share, raising the annual rate from $1.35 to $1.44 per share. We remain dedicated to our long-term dividend payout ratio target of 30% to 35%. Now, let me outline our full-year outlook for fiscal 2015. In our second quarter earnings release, we had set an adjusted EPS guidance range of $3.45 to $3.65 for fiscal year 2015. Given our strong third quarter results and increased visibility for the year-end, we are glad to increase and narrow our adjusted EPS guidance for fiscal year 2015 to a range of $3.70 to $3.80. This range anticipates adjusted interest expense of around $150 million in the fourth quarter, an adjusted tax rate of approximately 29% for the full year, a diluted share count of about 1.05 billion shares, and estimated foreign exchange rates that reflect current market conditions for the remainder of the fiscal year. When we provided our fiscal year 2015 guidance in April, we indicated that we viewed the second half of the fiscal year differently than the first half, expecting lower adjusted earnings per diluted share in the second half, with the third quarter higher than the fourth quarter. This expectation remains; we anticipate fourth quarter adjusted earnings per diluted share to be sequentially lower for several reasons, primarily due to seasonality affecting sales and product mix. The summer months are typically our weakest, particularly in the Retail Pharmacy USA segment. In the U.S., we often see sequential declines in pharmacy volume growth and retail product sales. Additionally, the timing and phasing of specific expenses related to our cost plan in the U.S. will impact the fourth quarter relative to the third quarter. Now moving on to fiscal year 2016, we are reaffirming our previously stated adjusted EPS goal of $4.25 to $4.60 for fiscal year 2016. This range assumes an annual adjusted tax rate in the high 20s, a full weighted average diluted share count of approximately 1.1 billion, and no significant changes to current currency exchange rates. It's worth noting that since establishing this goal a year ago, the dollar has appreciated significantly, affecting our currency translation exposure, which primarily depends on movements in the Pound Sterling against the dollar. A 1% shift in the Pound Sterling relative to the dollar from current levels could impact our adjusted EPS by roughly $0.01 per share. Given the current situation in Greece, where we fortunately have no business interests, we expect some degree of volatility in the currency markets in the coming months. With that, I will turn the call back to Stefano.

Thank you, George. So I hope that you will agree that these are a very solid set of results. This level of performance, and we are far from being complacent about the challenges we face and the hard work it will take to deliver everything we want, and that’s our mission. But we are making good progress and traveling in the right direction. And I believe all of my colleagues recognize the challenges and work will be needed to overcome them. But are as convinced as ever about the immense potential of our company as a global pharmacy-led, health and well-being enterprise. We are in markets that are changing, here in the U.S. where you are seeing this quite dramatically. But as I have said many times, that we are at the beginning of a new chapter for our company and are actively reviewing every opportunity that the changing environment offers us, as we work to deliver the true potential of our company. I strongly believe that we have a significant role to play in shaping the future of our industry. I thank you for your continued support, but I also acknowledge that the best way to thank you is to deliver on our plans. And I can assure you we fully intend to continue to do so. With that, I think we will open it up for questions, Gerald?

Thank you. Stephanie, you want to take over?

Thank you very much, and I'm asking questions for myself and Eric Percher, who is not available today. I think our main question would be talking about the big difference, the spread between the growth in pharmacy scripts and the growth in dollars. Maybe you could talk a little bit about what the drivers are, some of it is Hep C, but maybe you could talk a little bit about inflation in both branded and generic drugs. And then I will have one other question.

Good morning. Alex here. Thanks for the question. Yeah, the inflation we're managing the effect of that inflation pretty well in the business. We have very good plans and the team has done a good job to get that done. So one of the differences in the space we are seeing is generic inflation, but we are managing that effect really pretty satisfactorily. And that of course is built into our future guidance as well.

Would you describe inflation in branded pharmaceuticals as a positive for the margin?

I think it's marginal at the moment in terms of that. But again, for example, slight improvement because of generics as generics come in the market, both this year and next year. But again, the key thing here is that we forecasted this, we're planning it, and it’s really consistent with our expectations.

If I can add something, you have also to take into account that we have different businesses in our company. And some of these businesses, like the wholesale business or like WBAD, are taking advantage of certain inflation.

Okay, that's very helpful. Thank you. And then I just have a follow-up question to talk about on the front end margin improved and I think you've talked about not just the operating margin but the gross margin. Maybe you could talk a little bit about changes that you might have made in terms of promotional strategies or the way you are marketing that might have driven a better gross margin in the front end.

Yeah, Meredith, it’s Alex again. Yeah, we've been really on this strategy now for five quarters. So we're pleased with the progress we're making. The key things that we have done is that we stopped really promotions that were driving sales, particularly in some consumable categories, but not really helping the product at all. And we are focused much more on the mix, and making sure that we're much more focused on really the health and wellness in beauty care categories, and that's really proven beneficial and as George said in the script today, we have launched a new platform called Everyday Points and that is to make sure again that people who are coming to us more regularly and are picking up on the destination categories are getting a better platform and more reasons to come back to Walgreens. No, it's still early days. We have a lot of work to do and a lot of opportunity ahead of us, and it will be a step-by-step process, but the basic things we're doing is reducing unprofitable promotions and making sure that we focus more investment in our best customers and more investments in our destination categories.

Great, thank you very much.

I think really the first point to come through, as I sort of touched in the prepared comments was the primary component that we got to think about is the seasonality between the quarters which impact the sales and product mix. I'm thinking about the summer months very much tends to be our weakest months particularly in Alex’s business at Retail Pharmacy USA segment.

So two questions: one on Walgreen USA costs, what would you guys peg the normal increase, annual increase in SG&A at? It would be 2% to 3% absent cost-cutting and then of the $1.5 billion that you identified, did you see any of that in the third quarter, and how much, and what do you think you see in the fourth? And then just lastly it did look like pharmacy margin improved a decent amount sequentially, which was a little surprising, what were the couple of things that may have driven that?

Alex, maybe you can.

Yeah, there are a number of questions there John. So good morning again. So starting over with the cost question, I think as George said really, clearly, we made solid progress against our $1.5 billion cost program, and of course we started a bit earlier in the U.S. in terms of what we announced. And I would say that we are seeing SG&A in the U.S. business down slightly year-on-year on a comparative basis, which is pleasing but also really what we had planned to do. And I think as George also said there is a bit of phasing here between quarter three and quarter four, and importantly from a continuation of business point of view, we are in quarter four this year. We're making sure that we'll continue to invest in the things that customers value the most from us to make sure we keep the growth going forward and investing more in our customers and more in the things that customers see.

I think John, you also asked a question on pharmacy margin, and really just reinforcing what I said earlier, we did see in the U.S. the positive sales growth but that was substantially offset by the pharmacy gross margin pressure, but that was absolutely consistent with our expectation, so there is no change from what we were expecting when we last talked to you.

Did it get better sequentially or no, right.

We're discussing John's year-on-year and quarter-on-quarter reporting, and it was in line with our expectations. The renewals that have come through are exactly what we anticipated.

The market, it’s Stefano here, of course, the market it's evolving. What is important is to be able to anticipate what happens and to take this into account when you budget and I believe that this year we are doing exactly this. We are absolutely aligned with what we were expecting.

Hi, thanks very much and good morning. Stefano, you talked about the challenges that the U.S. market and other markets are facing. We hear CMS talking about 50% of payments moving towards what they are calling fee for value. Can you talk about strategically, where do you think Walgreens needs to be positioned, we're seeing lots of consolidation, whether it's managed care or other players, is it that you need to be the biggest retail provider in the U.S. and therefore best positioned to partner with those that are taking on risks? Do you view yourself as more of a risk-bearing entity over time? How do you think about your relationship, whether it’s with managed care or PBMs and strengthening those going forward?

I have said many times that I believe that the American markets will go through a substantial wave of consolidation horizontally and vertically. I have said very clearly that we want to be part of this, at the right time with the right partner. We are open to any kind of combination that could improve the value of our company and we are looking actively around us to understand which is the best option for us. But please don’t forget that we are looking actively not just in the U.S. but even in other countries because we consider ourselves a global company.

And would you say that the priorities are more U.S. driven or globally driven or does it depend on the specific opportunity that comes across your desk?

Well, the priority is the deal that you can do, and it depends on where you can fit.

Okay, great. And then just my follow-up question would just be around the synergies and you talked a lot about them coming from the procurement side of things. Can you maybe talk about where you think you are George, or Alex, or Stefano as far as what inning are we in, and as far as obtaining the synergies that you expected from WBAD? Are we close to getting the full benefit from them or is there still a good portion of the future synergies that will still come from the procurement side?

We are absolutely in line with what we were forecasting and maybe George you can give more details, but we will do what we were expecting and what we announced.

What I would like to add is that we are on track to achieve our target this year, aiming for $1 billion from measurable synergies. However, as a merged organization, we are discovering numerous best practices and ideas that we are sharing and implementing. As we integrate further, there are synergies that are difficult to quantify in numerical terms, but we are progressing through this phase. From previous mergers, like the one between Alliance UniChem and Boots, we know these types of synergies are significant. We are reallocating personnel, which will help us strengthen the organization considerably.

I would add, George, that we are considering the buying synergies that are quite clear and easily forecasted. However, there will definitely be many synergies that will become apparent in the future. When two companies merge, it often takes three to four years to discover new ways to realize these synergies.

Good morning or good afternoon guys, based upon on where you are and thanks for taking the questions. First one is for Alex. People have jumped in a bit on what margins have looked like. I guess we are further along in the year. Can you talk about what payer negotiations are looking like for kind of 1.1 contract restarts and I guess if things are proceeding according to expectation and how that squares with the fiscal ‘16 guidance that you guys have provided?

Hi George, yeah absolutely. So really as we expected and square on the guidance that we have given as well and I think the team have done a good job again in anticipating and making sure that we’ve projected well and managed, as you said, in a very good way.

Okay and then a follow-up I guess for George and for Stefano, which is, we're not too far away now from March of '16 when the first tranche of the ABC warrants become exercisable. I guess should we think about whether or not there is any contribution from ABC equity earnings built into the fiscal '16 guidance and does Walgreens want to be a larger stock owner of Amerisource Bergen or should we think of the warrants as a value creation vehicle for Walgreens? Thank you.

When we made the deal, our goal was to enhance our profits, but we also had strategic objectives in mind. We have always believed that better coordination between wholesalers and retailers generates significant synergies. The reasons for the deal remain valid. We have announced our intentions, and you will see the impact of these agreements at the appropriate time.

Really not a lot to add to that. I mean we will look at the right time, take the decision at the time. In terms of the accounting again, we will also look at that at the appropriate time. But from where we are today we anticipate being able to account for that as an equity method investment but clearly that will have to be confirmed and discussed as to where we direct that.

Hi, good morning and congratulations on the quarter. Just a couple of questions here. First of all, George you highlighted some of the differences between this quarter and the upcoming quarter. Can you just share with us more details on the headwinds versus the tailwinds that we should be thinking of between the fourth and third quarter?

I think really the first point to come through, as I sort of touched in the prepared comments was the primary component that we got to think about is the seasonality between the quarters which impact the sales and product mix. I'm thinking about the summer months very much tends to be our weakest months particularly in Alex’s business at Retail Pharmacy USA segment, where we would see typically the sequential declines in the growth of both pharmacy volume and retail product sales. The other factor is when the phasing and timing of certain expenses are, from in terms of the fourth quarter relative to the third quarter and clearly when you go through the sort of programs that we are letting you try and discuss with you, but equally you need to keep everyone very focused on the business and driving through all the programs that Alex is working on. So there is always an element of timing on those where they eventually and how quickly we can deliver some of those. We are clearly going as fast as we feel we can in a straight line. There are other areas I talked about, I mean clearly currency is a factor, as I touched on. But increasingly we have in terms of the internal factors we got pretty good visibility to our forecasting process and hence we're confident to both narrow and increase the guidance range for this year.

You mentioned closing down another 70 to 80 stores in the upcoming quarter. Should we expect that to be reflected in the gross margin line or the SG&A line?

Yeah, you'll see that particularly through the SG&A line. Obviously we lose a few sales, but mostly sales we’ve successfully transferred into adjacent stores. I think as you know we also closed a number of stores last year and we got up this again. So the SG&A will come down and overall we will benefit and we will lose a few sales and a few basis points of margin.

Okay, great and then one market-related question. We are seeing a lot of your competitors making strategic moves around specialty. When you think about kind of like specialty as an opportunity for you, do you think that this is something that you can build internally by leveraging retail infrastructure in the U.S.? Or is this something that you think you need to go outside to add these capabilities? And also, how do you think about the specialty opportunity, U.S. versus ex-U.S. in Europe?

We are open to all opportunities and are continuously analyzing potential avenues for growth. When the right opportunities arise, we will be ready to pursue them.

Yeah and if I can also add as well, Ricky that we are very focused on organic growth as well. We have got a very good model in the USA in community pharmacy and we're building relationships there with the doctors and with also you need access to get innovative treatments, also, and there’s like HIV and cystic fibrosis we have opportunities that we can grow organically. So again we are not talking. This is an important business for us, and we are growing organically specifically in the USA.

Thanks for the questions and Stefano, congratulations on the appointment. Obviously a number of moving pieces, but just really trying to get a better gauge of the underlying core U.S. business. And you guys talked about making good progress on the restructuring program, but is there any more details you can share with us on the savings that you've been able to generate to date? And then any breakdown of those savings, obviously across the segments would be really helpful in us being able to track the underlying business a little bit better.

We have an effort to be as clear as possible.

I really appreciate your understanding. What's coming through is that in our previous discussion, we mentioned it wasn't practical for us to restate everything on a comparable basis regarding both costs and margins. That's why we provided the adjusted figures. The cost savings program is primarily focused on retail pharmacy in the USA, as we mentioned last time, and while we are making progress internationally, that aspect is much further along in terms of the program. We are on track with our expectations, although it may not follow a straight line in a structured manner. This is why we aimed to give you some perspective on comparability. I acknowledge that some of you found the retail pharmacy international margin a bit lower than anticipated in the second quarter, but keep in mind it only had two months in and seasonal fluctuations are involved. The last quarter traditionally sees lower sales, and as we approach the crucial holiday season, we anticipate leveraging the fixed cost base, which will eventually reflect in our net margins due to seasonality. I understand how challenging it is to model this, which is why we provided guidance for the future.

No, I respect that too and I understand the comparability year-over-year is tough. I guess I was talking more specifically about just identifying what the cost cutting was in the actual quarter, this quarter itself. And maybe I'm missing something, but I wouldn't think that would be that difficult to identify store closing, headcount reduction.

If I can maybe help a little bit, I mean we've done a good review of all of the projects that we are focusing on in Q2. I think we've been really clear within the business that we are focusing back in our core business of retail pharmacy front-end products, specialty. And therefore all of the other areas where we are building out maybe potential future products we looked at to reduce the spend in some of these areas, to get more focused back on the core business. So that really has been visiting our projects and we are really very confident that the four and the $1.5 billion in savings that can be achieved.

To really reinforce what Alex just said, we've been putting a lot of internal work into the whole process of how we evaluate new initiatives, how we track initiatives. The graphs are not working and then you stop them, you don't let them drag on, if something really isn't working, you give it a good go and you stop it. New initiatives we've got a lot of, what I would describe as financial rigor that has been increasingly put in place really over the last 12 months. Alex you have put a lot in place when you took overall responsibility for the Walgreens business and we're continuing to do that. And I think it's that rigor that we're seeing then in terms of some of the SG&A coming through.

That makes sense. And I guess just one quick follow-up on Part D network specifically, there was a big initiative from your predecessors to get deeper into some of these preferred networks. I am curious how the economics of those networks have compared to your expectation. I know it’s only about six months in. And then based on that feedback, any thoughts on your continued participation in these preferred networks going forward. Thanks.

Yeah, hi, it’s Alex again. No, this is a really important customer, a really important market segment, it’s a segment that’s growing rapidly. So we remain very committed to this and in terms of, as I've said before we are in terms of next year’s plans have almost completed all the contracts to their expectations in terms of margins that we planned for. So very committed to this business and we are moving forward in serving our patients. Importantly for us of course we are only at the end of the first stage. The second stage we just have, how do you make sure that you really look after the patients and the customers who come to your pharmacy and make sure you get the appropriate level of pull-through in volume for your assets and that's the bit we are now turning attention to.

Hi. Thank you. Congratulations on another great quarter and congratulations, Stefano. My question is just really around beauty, just curious how the tests are going in New York and Phoenix, are there any findings you could share from that? Particularly interested in if you think you're getting a sales lift in the aisle and if you're seeing much traction from No7.

Of course you know the importance that we give to our brands and No7 is having a fantastic brand in the UK and internationally, and it's one of our really hopes for the future in daily wear, but maybe Alex you can say what you are doing now for No7 and what you are expecting from it?

Yeah. We rolled No7 into just over 400 Walgreens and Duane Reade stores in Phoenix and then in New York City. And the Phoenix rollout is just over 12 months old and we will be able to measure the impact both on No7 sales, on Boots brand product sales, and also on the beauty piece, and we're pleased with what we're seeing. So we are now trying to plan for the next stage of evolution of No7 and the Boots brand in Walgreens and the Duane Reade in the USA and we'll come out with these plans when they're ready, but we are pleased with the results. Personally, I am also pleased that we were able to acquire the Soap & Glory brand and also here this morning Liz Earle, going forward, the more unique products that we're able to get into the Walgreens beauty and healthcare offer, the more unique that will make our offer going forwards in what is a very competitive marketplace. So again, I'm very pleased with the brand’s performance, very pleased with the progress that Ken Murphy and the team has made and the brand organization is still very young and looking forward to getting these unique products in front of our customers in Walgreens in the future.

And as a follow-up, what were you thinking for the timing of the full rollout?

Yeah, we'll come back with that. I mean we're really, I said before, we're just doing the work now, we’ve got to get this right. This is a bigger space, it’s a fantastic brand as Stefano said in Europe and is growing really well in Europe. So we'll come back when we're ready but we are not in position.

Hi, I just wanted to inquire how comparable the US SG&A number is on a year-over-year basis, because it looked like there were some overhead allocations that changed versus a year ago.

They are not directly comparable due to the allocation of corporate expenses across the three divisions. We are also assigning synergies related to the economic benefits. Unfortunately, this means the results are not directly comparable, and we need to be cautious about that. However, we are pleased with the progress in reducing SG&A and are on track to deliver the program we announced last quarter.

So the numbers that are presented were down, but I guess on an apples-to-apples basis was the SG&A percentage down?

I'd say there isn't a direct comparison available. That's the challenge we face, and as we mentioned when we completed the deal, our priority was to finalize it quickly. However, this allowed us to revisit everything for a more accurate comparison. We're making good progress, and that's the main point I want to convey.

Okay, and I understand you're not announcing the international segments year-ago performance as well. But is there anything you can give us in terms of health indicators for margin and profitability on those international segments even though you don’t have a GAAP presentation for us.

We are pleased with the performance at Retail Pharmacy International. Boots, being the largest component, is doing well despite challenges in the market, particularly seen in some supermarket sectors. This reflects the strength of our differentiated retail offerings, especially in beauty, where Boots is well-known. Our loyalty card program has been very effective, especially with the Balance Rewards and the advanced card program in the UK. Additionally, the omni-channel approach, allowing customers to order online through Boots.com and pick up in-store, is significant, supported by our extensive UK geography and 2,500 locations. We can also utilize our wholesale organization for delivery in a profitable manner that meets customer expectations. This is a crucial aspect. As with any year, some markets perform better than others, but the division has delivered solid performance consistently over the years.

And just on the International Retail Pharmacy, there was some commentary in the analyst meeting that the margin focus for growth was really shifting away to more of a sales growth story. Was there gross margin declines as you go through that transition to driving sales?

We've obviously not given the specifics on the comparability, because we don't have the numbers on that same U.S. GAAP, but I continue to say that the business has performed solidly, and we are pleased with the performance in what's been a tough retail environment in the UK and that’s fundamentally important. On the NHS side, on the pharmacy side clearly the government seeks to continue to contain growth in healthcare expenditure. And so we haven't seen the details of the settlement yet, that’s probably going to be towards the option, we’ll have to wait and see on the timing on that. But we continue to see pressure in that area as we've seen for a number of years. So no real change but that pressure continues.

Stephanie, I think we have time for just one more caller please, if we could.

Hi good morning guys and congrats. So as you think about sort of the M&A landscape happening around you, obviously as far as you talked about lots of consolidation happening in managed care, we’ve seen it in generics, we’ve seen in the PDM space, where do you think, in terms of what is happening around you, it’s most relevant to kind of your business or what are you watching most? And how do you think, particularly on the managed care side, any of the changes there, how does that make you think about your longer-term positioning from a healthcare perspective in this market?

As I have said, we can clearly see the need or the opportunity for horizontal and vertical consolidation in our industry and this is happening. In reality, I believe that this is good news for us because the consolidation, the horizontal consolidation will create a clear market and will give us more opportunities in the future. What we will be able to do specifically is a little too early to say, but I repeat we want to be one of the players in this space and we see a lot of opportunities and the opportunities are really open along the chain, along the space of this healthcare industry.

And I guess just quickly, just staying on the M&A theme, and I will keep this to my last question, but you and your team have been remarkably savvy deal makers over the course of your long career and have created maximum amount of value. How much of the challenge is it today with where global equity markets are from a valuation standpoint, obviously understanding the financing markets are wide open, but valuations are pretty elevated and so how do you think about that in the context of your capital allocation goals, particularly on the deal side? Does it argue for smaller transactions or a certain geography? I am just trying to get a sense for how that plays into your thinking and the timing aspects of it.

As you know, we have always been prudent with potential acquisitions, so we will, if we will have an opportunity, we will analyze this opportunity very rationally and we will do it just if this will create additional value. It’s true the market is now quite bullish, but it’s also true that the cost of money is still quite low and there are other ways to create value, not just acquisitions, so we are analyzing all the opportunities. If we will see an opportunity which fits our strategy and which can create value, we will take action.

Great, thank you so much.

Thank you.

Okay, ladies and gentlemen that was our final question. Thank you all for joining us today. Feel free to contact myself or Ashish if you have any further questions. I know some of you do. And with that, thank you very much indeed. We will conclude our call.