Walgreens Boots Alliance Inc (WBA) — Q4 2017 Earnings Call Transcript

Good day, ladies and gentlemen, and welcome to the Walgreens Boots Alliance Fourth Quarter 2017 Earnings Conference Call. As a reminder, this conference call is being recorded. I would now like to turn the conference over to Gerald Gradwell, Senior Vice President, Investor Relations. Please begin. Hello, and welcome to our earnings call. Stefano Pessina, our Executive Vice Chairman and Chief Executive Officer; and George Fairweather, Executive Vice President and Global Chief Financial Officer, will take you through our results as usual. Alex Gourlay, Co-Chief Operating Officer of Walgreens Boots Alliance, is also here and will join us for questions. 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. 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 and 10-Q 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, and 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. Before I hand you over to George to review our results, I would just like to draw your attention to the announcement made by CVS last night, in case anyone may not have seen it. CVS announced a new PBM, performance-based pharmacy network focused on reducing costs and improving clinical outcomes. Formed through a partnership between CVS pharmacy and Walgreens and including a number of community-based independently owned pharmacies across the United States, this initiative creates a 30,000 store network to service CVS's Caremark PBM clients and their members. As this new network has been announced since the year-end, we did not comment on it in the presentation of our results today, but we will be happy to take any questions you may have on it following our presentation. Given how much we have to cover today, our presentation will run slightly longer than usual, I am pleased to say only slightly. But we will still allow the full hour for questions at the end of the presentation. I will now hand you over to George to take you through the numbers.

Thank you, Gerald. We have delivered a strong business performance in the year, both in terms of adjusted profit and cash flow despite currency headwinds and some challenging market conditions. In the fourth quarter, we recognized, of course, that our GAAP numbers have been significantly impacted by the Rite Aid-related costs, including the merger termination fees. However, overall, on an adjusted basis, the final quarter was better mainly due to U.S. pharmacy volumes and market share continuing to grow in line with our strategy. As you know, on 29th June, we announced a $5 billion share repurchase program. During the quarter, we purchased $3.8 billion of shares, and since the fiscal year-end, have completed the repurchases. In keeping with our commitment to operate as efficient a balance sheet as possible, we've decided to add an additional $1 billion to the program. This is in addition to our routine anti-dilutive share repurchases. Of course, our other recent news was Rite Aid regulatory clearance in September, which I'll come onto shortly. First, I will take you through our fourth quarter results. As we indicated throughout the year, we expected the fourth quarter to be particularly strong. As you can see, this is the case. Currency had a negative impact, the U.S. dollar being around 4.4% stronger versus sterling than in the comparable quarter last year. This impact was less significant than in the first three quarters. Sales for the quarter were $30.1 billion, up 5.3% versus the comparable quarter. On a constant currency basis, sales were up 6.4%. GAAP operating income was $1.1 billion, a decrease of 2.3%. GAAP net earnings attributable to Walgreens Boots Alliance were $802 million, down 22.1% and diluted EPS was $0.76. This was 20% lower than the comparable quarter last year due to Rite Aid-related costs, mainly merger termination fees. Adjusted operating income was $1.9 billion, up 21.2%, and in constant currency, up 22.3%. Adjusted net earnings attributable to Walgreens Boots Alliance were $1.4 billion, up 18.8%, and in constant currency, up 19.1%. Adjusted diluted net earnings per share was $1.31, up 22.4%. The adjusted effective tax rate, which we calculate excluding the equity income from AmerisourceBergen, was 24.6%. This was 6.3 percentage points higher than in the same quarter last year. When you'll recall, we particularly benefited from positive discrete items. Our core tax rate, which excludes discrete tax impacts, was in line with our rate in the third quarter. So turning now to the performance of our segments, starting with Retail Pharmacy USA. Retail Pharmacy USA sales were $22.3 billion, up 7.5% over the year-ago quarter, comparable store sales increasing by 3.1%. Adjusted gross profit was $5.6 billion, up 4.3% over the year-ago quarter, reflecting an increase in both pharmacy and retail. Adjusted SG&A was 18.9% of sales, an improvement of 1.8 percentage points compared to the year-ago quarter. Adjusted SG&A as a percentage of sales has improved versus comparable quarters for 17 consecutive quarters. Adjusted operating margin was 6.3%, up 1 percentage point, resulting in adjusted operating income of $1.4 billion, up 27.5%. So next, let's look in more detail at pharmacy. U.S. pharmacy total sales were up 12.6%. We filled 250.2 million prescriptions on a 30-day adjusted basis including immunizations, an increase of 9%. On a comparable basis for stores, which excludes central specialty, our pharmacy sales increased by 5.6% with scripts filled up 8.7%. This was primarily due to strong volume growth from Medicare Part D and the positive impact of our strategic pharmacy partnerships. Within sales, volume growth and brand inflation were partially offset by reimbursement pressure and the impact of generics. Our reported market share of retail prescriptions in the quarter on the usual 30-day adjusted basis was 20.5%, up approximately 120 basis points over the year-ago quarter. Total retail sales were down 3.9% on the same quarter last year. This includes the impact of the previously announced closure of certain e-commerce operations. Comparable retail sales were down 2.1% in the quarter, with declines in consumables and general merchandise, while the personal care categories were partially offset by growth in the beauty and health and wellness categories. Compared to prior quarters, comparable sales were lower, partially through changes to our promotional plans as we focused on delivering improved margins. Gross profit and margin were higher than in the same quarter last year, mainly due to actions we took in the fourth quarter last year to put in place foundations for long-term growth. In addition, margin was higher due to the changes to promotions, as I just mentioned, and improved mix as we increasingly focus on higher-margin categories. On the last call I told you that we were implementing a program in approximately 1,500 stores to simplify our offering and improve our retail operational performance. This program has now been completed, and we're starting to see the early benefits, including ongoing efficiencies and reduced working capital. Our beauty differentiation program has driven profit and margin improvement as our own brands continued to perform well. Beauty category sales in beauty differentiation stores continued to be markedly better than in other stores, supported by strong sales growth of No7 and Soap & Glory. In line with our strategy of introducing new owned brands to our U.S. stores, we launched two terrific cosmetics brands during the quarter. CYO is our new and exciting makeup collection developed by Boots in Nottingham, which is designed to encourage our younger customers to be colorful and creative. We have, in addition, launched Sleek MakeUP in Walgreens stores and online after a successful launch in Boots two years ago. Sleek is one of our fastest-growing brands in the UK, with a young, ethnically diverse customer base. Since the year-end, we have launched a brand-new skincare range, YourGoodSkin, which is exclusive to Walgreens and Boots. Developed by our scientists, the product is designed to promote visibly healthier skin. As well as developing our offer of own brands, as I said on the last earnings call, we are introducing our enhanced beauty offering to over 1,000 additional stores. This program is expected to be completed in the next few weeks, bringing the total number of stores with the enhanced beauty offering to around 2,900. So now let's look at the results of the Retail Pharmacy International division. Sales for the division were $2.9 billion, down 0.4% in constant currency. Comparable store sales decreased 0.2% in constant currency. Comparable pharmacy sales were up 0.5% on a constant currency basis due to higher prescription volumes in the UK, with Boots UK comparable pharmacy sales up 1.2%. Comparable retail sales for the division decreased 0.5%, with Boots UK's comparable retail sales decreasing 1.3%. This was due to a decline across a number of product categories, with beauty being impacted by the timing of new product launches. We've continued our work on cost control in the quarter, while putting in place the foundations for future growth. Adjusted gross profit for the division was down 0.8% in constant currency to $1.2 billion, mainly due to lower retail gross profit. This was more than compensated by lower adjusted SG&A, which was down versus the year-ago quarter on a constant currency basis. As a percentage of sales, adjusted SG&A on a constant currency basis was 0.9 percentage points lower at 32.8%, reflecting work we have done to reduce costs, particularly in the UK. Adjusted operating margin was 8.9%, up 0.8 percentage points in constant currency. This resulted in adjusted operating income of $261 million, an increase of 8.9%, again, in constant currency. This was a much better performance than in the first three quarters due to the measures we've taken to reduce costs. So now let's look at our Pharmaceutical Wholesale division. Sales for the division were $5.4 billion, up 5.4% versus the same quarter last year on a constant currency basis. This was ahead of the company's estimate of market growth weighted on the basis of country wholesale sales, with growth in emerging markets and the UK being partially offset by challenging market conditions in Continental Europe. Adjusted operating margin, which excludes ABC, was 2.5%, down 0.3 percentage points on a constant currency basis. This was mainly due to lower gross margin, including some generic procurement pressures in the quarter. The division benefited from $84 million in adjusted earnings from ABC, up $34 million versus the same quarter last year, mainly due to our increased level of ownership. Adjusted operating income was $221 million, up 11.5% in constant currency. So now let me turn to the full year numbers for fiscal 2017. As I've said, this has been a strong financial year, with results coming in just above the top end of our guidance. In summary, GAAP diluted net earnings per share of $3.78 was down 1%. This decrease primarily reflects a number of special items, including, as I said previously, the Rite Aid merger termination fees. Importantly, our adjusted diluted earnings per share increased by 11.1% to $5.10, up 12.9% in constant currency. The adjusted effective tax rate was 23.2%. During the year, we particularly benefited from favorable discrete items. As ever, the tax rate also reflects the geographic mix of our pre-tax earnings and the U.S. taxation of our non-U.S. entities. Operating cash flow was $2 billion in the quarter and $7.3 billion in the full fiscal year. Over the course of the year, our working capital inflow was $1.5 billion, reflecting improved payables and lower days inventory. As a result of our focus on driving working capital efficiency, over the last two years, we've generated $2.9 billion of positive cash flow. Cash capital expenditure in the quarter was $439 million. For the fiscal year, expenditure totaled $1.4 billion, which was broadly in line with last year. We continued to invest in key areas to develop our core customer proposition, including our stores and U.S. beauty program, as well as the upgrades to our IT systems, which we've previously talked about. Overall, this resulted in free cash flow for the quarter of $1.6 billion and an impressive $5.9 billion in the full fiscal year. In addition to the share repurchase program, which I mentioned earlier, in the fourth quarter, we made early repayments of $2.6 billion of debt to further optimize our balance sheet. So turning next to Rite Aid. As you know, in September, we secured regulatory clearance for the purchase of 1,932 Rite Aid stores and related assets. We're delighted to be completing this transaction, which will extend our network, particularly in the Northeast and Southern states. In the past week, we've acquired the first stores to confirm the operational readiness of the key Rite Aid transitional IT systems. We will then begin acquiring stores in phases with completion anticipated in spring 2018. To deliver the full benefit of the acquisition, we must, of course, fully integrate and rebrand the retained stores into the Walgreens network. This is a relatively complex, time-consuming and costly process. Initially, Rite Aid is providing transitional services for all acquired stores. Over time, we will transfer these stores onto Walgreens' existing IT systems prior to rebranding as Walgreens with our full retail offer. We expect to complete the integration of the acquired stores and related assets within the next three years. The acquisition-related costs of this are estimated to be approximately $750 million. In addition, we plan to invest around $500 million in incremental capital expenditure on store conversions and related activities. As previously announced, we expect to realize synergies of over $300 million per annum, which we anticipate realizing within the next four years. Following regulatory clearance, we have been able to complete a comprehensive review of the combined store portfolio to determine the scope for optimizing locations. This has resulted in our decision to close approximately 600 stores and related assets over an 18-month period, beginning in spring 2018. We estimate the cost of this program to be approximately $450 million, substantially all cash spend. The resulting cost savings are expected to be approximately $300 million per annum by the end of the fiscal year 2020. We will, of course, when reporting our adjusted operating results, adjust out both the acquisition-related and optimization program costs. So turning now to guidance for fiscal 2018. We're expecting adjusted diluted net earnings per share to be in the range of $5.40 to $5.70. As usual, this guidance is based on current exchange rates remaining constant for the rest of the fiscal year. As we've said before, we do not expect the Rite Aid transaction to significantly impact adjusted diluted net earnings per share in this period. As I'm sure you'll appreciate, the recent hurricanes have been very challenging and continue to be so in Puerto Rico, where Walgreens is the largest pharmacy chain. We are very proud of all our people who have worked tirelessly to give our customers access to the medicines they need. Based on our work to date, our initial estimates indicate that the cost of the storm damage and store closures could be around $90 million. The majority of this is in Puerto Rico. We plan to adjust for this when reporting our first quarter results. The damage to Puerto Rico's infrastructure continues to impact everyday life, including trading in our stores. We estimate that in the first quarter, this could adversely impact adjusted earnings per share by a few cents. Moving on to Med Part D. Although it's not our usual practice to comment on future sales expectations, given recent market speculation, I feel that it's worthwhile to point out that in 2018, we're expecting Walgreens to grow its Med Part D business year-over-year. While not material, you should also note that our partnership agreement with Fareva, which includes the sale of our contract manufacturing business, this will commence at the end of October. As a result, in the future, we won't have these low margin sales within Retail Pharmacy International. Thinking about phasing, we expect this year to be more balanced between the two halves. I will now hand over to Stefano for his concluding comments.

Thank you, George. So as you have heard, another strong quarter, and for us, a busy quarter to round off a very busy financial year. It has been another year of good financial growth, delivered in a variety of ways, but all coming back to the hard work, determination, and commitment of our team. It's amazing to think how much we have achieved in such a comparatively short period of time when you bear in mind that it is less than three years since we completed the transaction to create the Walgreens Boots Alliance. Over the past three years, we have delivered growth of over 50% in adjusted diluted net earnings per share, averaging over 15% compound annual growth year-on-year during the period. I appreciate that looking from the outside, it may be easy to underestimate how much progress has been made. Economic progress is clear. And however people may choose to view it, the earning growth that we have delivered has been impressive. Since we started this project to create Walgreens Boots Alliance, we have delivered on our promises and more. It has been a real delivered value to our shareholders. We have always been clear that we deliver growth in many different ways. Part of the benefit of a large and complex organization like Walgreens Boots Alliance is that its size and scope gives us many different opportunities in many different areas, both commercially and geographically. And so our task of managers becomes more about deciding where best to use our resources in order to create the most value. Naturally, in part, these decisions are influenced by where we know we have proven strength and experience. I would characterize those strengths as being primarily around operational expertise, financial expertise, and strategic expertise. Alex and Ornella are continuing their work to deliver the transformation we need in our businesses to keep them relevant and deliver a healthy mixture of operational and financial growth from our core operation. The work and skills needed differ business by business and country by country, which is why during this stage in our company development, the structure we have with Co-COOs is appropriate given the huge amount of hands-on work that is needed. For all of our businesses, we are constantly balancing the benefits of investing for growth, developing new services and products, and controlling costs. We are still some way from where we need to be overall across the company, but we are making good progress and I measure the work we need to do to continue this progress as pure opportunity. From time to time, I hear some concerns raised about the amount of growth we will be able to deliver from financial or economic restructuring of our business. I do not see this as an issue at all. I see it as essential for any company to be as focused on its economic health, every bit as much as it is on its operational health. Also, as I have said, I believe our focus on the financial efficiency of our organization is a key strength. The work that we are doing to structure a robust and efficient company and transform the value businesses within it, is at the same time, providing us with an extraordinary range of opportunities to announce the economic efficiency of our business. Make no mistake, these are true cash benefits. It is real and tangible value creation. Then there is a need to use the benefits of all these operational and financial work to invest in the continued growth of the business and further value enhancement for our shareholders. In September, we saw in the U.S. our acquisition of assets from Rite Aid move from review to execution, a process that I will not deny took far longer and was far more complicated than I had expected. We were always optimistic that the deal could be structured in a way that could be acceptable to all parties. While the deal we have ended up doing was very different from what we originally announced, it was not so very different from what I had originally envisaged. And now, I am pleased we are finally able to get on with the process of bringing these stores into our group and undertaking the next phase of review and transformation work within our U.S. network. This is the latest and perhaps most public transaction in a range of deals and partnership we have announced over the year, including our innovative strategic partnership with FedEx and Fareva and our minority investment in the pending acquisition of America. This range of deals is aimed at both developing our core businesses today and putting in place the foundation for developing new products and services for the future. Of course, all of this is very much a work-in-progress. We are an organization in transformation and that will always be the case. We are an organization that works in markets that are constantly changing, and we must change and adapt to them and with them. Change is good. Change is a sign of life. Change brings opportunities. Our challenge is to make sure our businesses are ready for change, embrace change, at times, even drive change, both within our organization and in our markets overall. We achieved that by continuing our work to help ensure that we are delivering the right products and services at the right price and in the right way to differentiate us to our customers, whoever and wherever they may be. To do so, we must continue our work to ensure that our structure, system, and skills are right. We must continue to study our market and ourselves, truly understand our strengths and play to them, truly understand our weaknesses and address them. Sometimes, internally through hard work and effort, sometimes with partners, sometimes by bringing new skills and experience into the organization. You may not recognize it, but I see us doing this across our businesses every day. The changes are often individually small, but they all adapt to deliver a far more dynamic organization with a far more dynamic approach and mindset. Our markets contain a compelling mixture of personal well-being, huge economic scale, and political attention. These factors attract a lot of comment and commentary, which in turn, leads to a lot of speculation and noise, all with an agenda, reflecting their point of view. As a management team, we must see through this noise to recognize the true underlying trends and dynamic of our markets and manage our businesses in a way that addresses the market, not the commentary. So as I hope you can see, I remain very optimistic about our company. We have achieved a great deal, delivered a great deal in the past year, indeed, in the past few years, and I still see truly massive opportunities ahead of us. We have come a long way in creating an organization that is well placed to embrace these opportunities and in many ways, lead the market in approach and vision. In a company with many businesses in many areas, we have many moving parts, which give us great flexibility in how we respond to our markets and fully embrace the opportunities I have spoken about. We have many levers in our organization to deliver growth and value. We have set our guidance at the level that we know can bring all these together. And as you have heard, we are, again, giving adjusted earnings per share guidance that reflects the double-digit growth we seek to achieve. In coming to this guidance we have, as ever, considered our assessment of the many headwinds that our businesses face as well as the drivers inherent in our markets, to offer what we believe is a realistic view of our prospects for the year ahead. We never give guidance lightly and I am proud of our track record of delivering against the targets that we set for ourselves. In the year ahead, you can be assured that I and my entire team will be continuing our work operationally, economically and strategically to make sure we have the right structure, people, skills and strategy to continue to deliver real growth and value, not just for the year ahead, but well, well beyond that. Thank you. Now I will hand you back to Gerald.

Thank you, Stefano. We'll now open the lines for your questions.

Hey good morning guys and thanks for taking the questions. And I guess, Alex, I have two questions for you. In the U.S. business, I guess, can you break out the difference between pricing pressure and client mix as it relates to gross margin? And then I guess, where do you think this stabilizes? And then on the retail side of the business, how do you separate the impact of promotional changes from what might be other channels or players taking share? Thanks.

Hi, George. Thanks so much. I think on the first question, I think we've been really clear that reimbursement pressure is part of our life and we have very clear levers that we use to address this. On the pricing side, we have a fantastic organization in WBAD and a real partnership philosophy. And you saw recently that we've also now joined that up with Express Scripts to help us to deal with that pricing pressure on that side. Also in terms of the mix of the businesses, you can see that we are very open to different networks for different types of business, government and commercial. And also we are partnering with everyone in the market including, as Gerald said this morning, our partnership with of course CVS, and of course with our partnership this year, the pricing has been driven a lot by our AllianceRx partnership, so fundamentally changed our position in specialty. We don't see any of that changing going forward. The one bigger opportunity we have, of course, on that side of it is, of course, the work on print optimization, which gives us another lever in which to manage the cost of reimbursement and pricing on the pharmacy side. So we see that – that's how we see it today. On the retail side, we made a deliberate change when we do this consistently, but maybe more aggressively in Q4 in the promotional side. And that was the additional impact that you primarily saw in terms of the trend change in our front-end sales. And as George said in his prepared remarks, we improved both the margin and the gross margin in the front end. And again, we are seeing good growth in beauty. In fact, if you look over the last two years against front-end sales, we've seen a 60 basis points improvement in the beauty category in that period of time. So we see our strategies working in both the retail side and the pharmacy side, and we continue to work hard, as Stefano said in his prepared remarks, to drive these opportunities as they come with different partners in different ways.

Okay. Maybe as a quick follow-up then. I don't know if George would update us. As the business has evolved, the profit contribution front of store versus back of the store, any direction or color?

Really nothing to – I really don't have much to add to what we said in the prepared statements and just what Alex has said. Just I think the one thing I would add to Alex, if you remember in the third quarter when we were looking at gross profit percentage and RPI, I drew attention to the fact that we'd obviously post the establishment of the AllianceRx Walgreens Prime joint venture, which we consolidate. If you recall, I said that impacted the mix by about 100 basis points, and of course, we didn't have a full three months in at that time. So it's just worth bearing that in mind. But I mean, we're very pleased, as you can see, with the progress that we're making in both the retail and the pharmacy part of our business in the States.

Okay. I appreciate the color, guys. Thank you.

Thanks, George.

Thanks very much. First, I just wanted to start with Stefano's comment around new products and services for the future and trying to bring that change to healthcare. You talked about the relationship with Caremark on the network side. What we consistently hear is about this idea around member engagement. What are the things that are changing in the pharmacy? And is it changing the way you're being reimbursed? Are you seeing new elements of risk that you've got to see a certain amount of outcome in order to be able to drive the reimbursement that you're getting? I just want to understand how do we think about some of these new relationships as well as some of the new products and services that you'll bring in this new world of engagement.

Hi, Lisa. It's Alex here. I think, as you clearly see from the CVS announcement yesterday and previous ones that we have also been involved in, health outcomes are becoming more important in all of the networks and for all of the peers. And I think that you can see that in the Med D networks and you can also see that in some commercial networks as well. Again, we can't be explicit in terms of what we get and don't get paid for and how that affects the overall payment to pharmacies, but more of a payment slowly but surely over time we see as being driven by the role of the pharmacist and the service they provide to the patient in the pharmacy that drives different behaviors and different outcomes. I think that's very clear. And that's slow, but it's certainly happening and we saw something very similar in Europe, particularly in the UK. So, we have a lot of experience in our group as the model changes to more peer services for outcomes rather than just dispensing tablets into a bottle. That is for sure. I think the networks are also changing, as you can clearly see. They are becoming more nodal, not just on the Med D and the Medicaid sides, but also on the commercial sides. That's very much driven by the strategies of the PBMs and the insurance companies. And we are very open and very happy to speak to anyone about our network. The deal with Rite Aid, as we said on many occasions, was to improve our network. And then through that improvement in reach was to improve the quality of that network for the peers and the customers that we serve.

Great. And then just my second question would just be for George around the key assumption as we think about fiscal 2018. I know we see the EPS, we see your assumptions around FX, but anything else that you can help us understand? I know there were comments that your Medicare Part D business will actually grow, when I think some people in the market thought perhaps it wouldn't going into 2018. You've shown that you can have the leverage that you talked about is to bring in these new scripts. But is there any other key metrics that we should think about as we go into 2018? And should we be thinking that you can grow U.S. operating profit growth as we go into 2018?

I very much tried in my prepared remarks to really point you in the direction of our thinking. Obviously, we don't give specific guidance on adjusted operating growth in total or in our divisions, but I think from what you've said, you'll gather that we're very confident that we can continue to grow our business through that combination of driving the top line, managing the margins and obviously, keeping a very, very tight control of the costs because saving costs is very much our way of life. The one thing I would sort of just, I think, remind everyone is, of course, that in this new fiscal year, we'll have a full year of contribution from the Prime acquisition which resulted in the forming of our AllianceRx business.

Okay, great. I'm sorry, did you have something else, George?

Yeah, so I'll just add one thing. Remember that our strategy in the front end is a very important lever as well here. So there's costs, as George has mentioned, where we're actively preparing and managing costs ahead of the game and I think we have a very strong track record, I think it was 17 consecutive quarters where we've reduced our cost as a percent of sales. We're making strong progress in key elements of our front end strategy and, again, that will play through the year. And of course, as George has said, our partnerships with Prime and also with UnitedHealth in Med D is an important partnership. So again, I would just point to the many different ways that we have developed our front end – sorry, our overall U.S.A. business as evidence that we can continue to grow operating profit going forward.

Perfect. Thank you.

It's Stefano. But if you look, we have said this every time, but if you look at the adjusted operating income, and particularly at the overall group at adjusted operating income, the overall group, you will see that we are very constant – this number is very constant, very flat over the years. So you have to expect in the future that this will probably be a little weaker because, as you have understood, we will have the full integration of AllianceRx and, of course, as you know, the specialty products have a very lower margin. So they will have an effect in the full year. But you can see that even this year, we have been able to compensate for the partial effect that we have hit just on part of the year and there we are coming with an overall margin which is quite constant. So we have shown that we are able to take action at many, many different levers.

Right. So just so I have that straight, when we think about specialty, it's going to be a higher dollar amount, obviously, but a lower margin percentage. So your EBIT dollars will grow, but when we think about the margin of the business, could have a headwind just like you talked about in this quarter as we think about 2018. Am I correct in that?

Yes, I think as George said in the previous answer, absolutely. The specialty business, as you know well, we will grow much faster than the past but the margin is much smaller. But it's still a very good business and a very important business, as half the market will be specialty by 2020.

Okay. Great. Thank you so much.

Thanks for the questions. Just wanted to go back to the aggressive shift we've seen to preferred and narrow networks over the last few years. And it seems like it's certainly posed some challenges for retail pharmacies to grow gross profit dollars during this transition. Just curious how we should be thinking about this shift and the impact to the business as we look out into 2018 on the gross profit dollar growth expectations within the U.S. pharmacy business.

Hi, Robert. Again, it's going to be a similar answer, I'm sorry, but it's really a similar answer. As Stefano said in his prepared remarks, we will look carefully at what we are achieving and we'll look carefully to what we can achieve and we use all the levers available to us, as you'd expect. So we are confident that we can grow our share, as George said in prepared remarks, in Med D and in the other books of business. So volume will continue to grow. We continue to work hard with partners to gain access in the networks that are available to us, both commercial and government. And again, the announcement last night was another example of that. And of course, we continue to really work hard to make sure that we give real incentives, effectively, to our peers, as they want to be paid not just in the cost to fill the products, but to develop services with them that will change the model over time. So we are in the market, we work with the market, we adapt to the market. And I think our evidence is very good. So we remain really positive that the 120 basis points growth that we have achieved in the dispensing market will continue to be held and we remain very positive that over time, particularly with the acquisition of the assets of Rite Aid, that we'll continue to grow market share in pharmacy volume and retain and grow gross profit dollars.

At the end of the day – Stefano here. At the end of the day, we give guidance, look at what we have done in the past, how we have given our guidance, the results that we have delivered at the end. Everything is in our guidance. And though you have to look at it – and our guidance, it's really the synthesis of all the elements of our businesses. We couldn't be clearer than that.

No, I appreciate that. I think it's just the building blocks to get to the EPS that I think we were just looking for a little bit more on. But I had just one follow-up for George on cash flow. As I look at the costs associated with the cost transformation initiative, continues to trend a little bit above where we were looking for. Can you just give us a sense as you think about the cash cost expenses associated with the cost savings programs as we look out into 2018? Just trying to get a better handle on modeling cash flow for the coming year.

Well, the main cost transformation program, obviously, we completed that last year and we were delighted with the results and the costs, as you've seen, have come in exactly where we anticipated them to be. In terms of the store optimization program that we've announced today, clearly the majority of that is cash and then we're going to have the investment in the capital in the Rite Aid stores and the conversion and the rebranding. And so we've tried to give that factor into guidance. But I'm very confident about our ability to continue to deliver a really strong cash flow. I think as I explained in my remarks, we had another very strong year for cash flow in the year just ended, the same as the prior year. We were really able to really continue, in particular, to improve our working capital efficiency. We talk a lot about driving cost efficiency, which is a way of life, but similarly continuing to improve working capital is a way of life as well. And so I'm very confident that we're going to continue to really be a very strong cash generative business going forward. And obviously, when it comes to the returns on all the projects that we do, similarly as I think we've said on many times, we're very disciplined in the way we evaluate all our capital expenditure and investment programs. And I'm very confident that we'll get the returns on those.

Just one example. Over summer, we decided to simplify the stores in Walgreens and we did 1,500 stores in a matter of weeks. And that was really designed to not just face into some cost challenges in these lower stores in terms of lower-volume stores for front end, but also get working capital out and I can tell you successfully achieve both of these in a very short period of time and give us lessons for the rest of this period as well.

Got it. Thanks for all the color.

This is Bryan Ross on for Brian Tanquilut. I had a question on the store rationalization program. I guess how are you – you talked about 600 stores and how are you thinking about the optimal set of these Rite Aid stores that you'll ultimately retain? I mean, is it more focused on retaining the stores with end markets where you already have a sizable presence? Is it bolstering outside of that? And how are you thinking about it in terms of – you talked about before about the preferred networks and that Rite Aid would be a nice asset to add to your assets for those networks. But I guess, how are you thinking about the trade-off between the access and maybe some of the more productive Rite Aid stores?

Hi, Bryan. Thanks for the question. Yeah, it really was quite simple. Post the transaction, the team's really looked at it location by location. And really, the vast majority of these closures will be Rite Aid and the vast majority are actually – being closed are within one mile of another drugstore that we own going forward. So it really is a micro level and real detail and also we have a very strong record of file transfers. We understand how to do it. We understand the economics of it very clearly. And I think as the numbers that George described in terms of the value of this $300 million by spending approximately $450 million, you can see this is economically a very good thing to do. But also because mainly within one mile of each other, it means that the network, the ones remaining, really, is buying on our strategy. It really is about improving access to Walgreens in the future and in Northeast and the south of the country.

Okay, great. Thank you. And then just a follow-up on – I guess, from our math, about half the stores that you're getting from Rite Aid have, I guess, already gone through a remodeling type of phase and what are your thoughts on – can you talk about the additional investment in some CapEx? Are you – and then even related to the stores that you'd be closing, the majority of the stores that you're keeping, have those, I guess, what's the view on that in terms of how many have been remodeled or kind of going forward, what you'll be doing to improve those stores?

Yes. Thanks, Bryan. Again, as you know, the sizable amount of these stores, not the majority in this occasion, have been remodeled. So therefore, they are in good shape. However, there are some which are very important just from a network point of view that would require some additional capital. And also as we develop the front-end proposition in Walgreens further, we'll have the opportunity to move some of that investment with a good return also into these stores. So again George has mentioned a figure for, not just for integration, but a figure also of $0.5 billion. I think it was more or less for capital improvement into the stores that we're buying and remaining open going forward.

Okay. Thanks for the color.

Maybe I should work at Walgreens. So it might be a better career than what we have here, with MiFID coming.

You're welcome.

Yes, look, I'm open. Got to call the regulators though. So honestly, so much of this investment story is about the gross margin right now, especially in U.S. retail. You guys came historically the last few years, a management team that came from Europe where your gross margin was very good in Retail Pharmacy. U.S. is in the mid-20s, you're 40%-plus ex-U.S. My question is, when you look at the stores where you've done beauty, you've done mix enhancement, you've done simplification, could you give us some proxy for how much gross margin improvement you've actually seen in those stores? And that's it. Thanks.

Eric, if you worked for Walgreens, you know that you'd know the answer, but unfortunately, we can't give you the answer. We don't give that level of detail, and I'm really sorry we can't give that. But we keep on reassuring you that we understand the model really well. We are working diligently to apply that model appropriately in the U.S.A. and we believe we're making strong progress and you can see that coming through at an economic value that Stefano described. So again, we're into almost 3,000, 2,900 stores with the differentiation. We have farther to go much more opportunity there. You can see that we have also materially improved the cost of goods, both in the retail side and also on the generic side, again, that constant working with suppliers and long-term ways to make that happen. And you can see how we are carefully investing our cash as well as our operating costs to drive improvements in volume and also improvements in customer experience. Our internal Net Promoter Score and many of our brand measures are improving going forward towards more pharmacy-led health, wellness, and beauty retailer. So we continue to work diligently on this model. We continue to believe strongly that we absolutely know more about the American market has achieved it. We understand the customer is changing, we understand the market is changing, and we will adapt appropriately. So again, I don't know what more we can say. We can't give you any more detail. But I promise you that we are satisfied with the progress we are making.

And you see, you said that coming from the UK, we are used to better margin and higher margins. But if you look at the pharmacy, the pharmacy in the UK is quite under pressure and it has been under pressure for decades, I would say. And the way that we have – the reason why we have developed both with this increasing margin on the front of the stores – the shop or creating a completely new model, is just because over time, we had to cope with a margin in the pharmacy, which initially was very, very good, as it shrunk over time and we have to compensate. So we go out to adapt. In the U.S., the margin of the pharmacy is still decent. It's under pressure, yes, but we have so many levers to compensate for it that we are not particularly worried. But in the meantime, we are trying to create a new model that will help us to keep overall the profit of the company at the level which we believe satisfactory.

And also, Eric, I mean, I would encourage you to take a trip to the UK, see how we continue to improve the model in the UK. For example, our holiday season started really strong in the UK because the gifting in that marketplace is really strong this year. So again, I think we often have a conversation in this call about the U.S.A. only. We have a model in Europe which we continue to improve and continue to drive, and I think it's worth sometimes understanding that model even more in terms of looking at the whole group and what we can bring to the know-how to the American market.

That's great. Thanks very much. And I'm going to go ahead and hit submit on that resume, so let me know.

Thank you.

Yeah, hi, good morning. So obviously, you talk about the fact that the market is changing and the customers are changing and partnerships are key to your strategy. But as the landscape continues to evolve and CVS is tracking their partners, there have been some are very similar to yours, and we hear about Amazon evaluating a potential entry, how are these changes impacting your strategic thinking of partnerships versus M&A going forward?

No, I have to tell you that the market is changing, but it's not changing in a direction which was from us. So our strategy substantially doesn't have to change. Our idea of partnership, our idea of trying to adapt our stores to a future different reality is practically still the same. Of course, we are adapting, of course, we are learning and we make some changes from the experience that we have, due to the experience that we have, but the basic strategy is still the same. And we are just, as we have said many, many times, we are just building the strategy piece by piece. We have to create, I have said this many, many times, the right platform to build the future company. And we have worked on that and you can see that now, things are changing. You can see that we are constantly delivering. You'll see that we are not only constantly controlling our costs, but are also now expanding our sales. And of course, all the different trials and tests that we have done in these years are coming to fruition. I would think of something we have already spoken about, our collaboration with FedEx, the fact that now FedEx is practically, it's everywhere in our store, except Puerto Rico, I believe, that FedEx is everywhere in our stores. Whilst we have really tested the case, I feel the execution has been quite fast. In seven, eight months, we have a hold over the FedEx pickup and delivery point in all of our stores. And this is just the first phase as we said because now, we will use this to create a fantastic network to deliver to the customers directly from our pharmacies. And so you'll see that we are consistent with what we were saying in the past.

Hi, Ricky. Again, just on the FedEx point, I just want to say what a fantastic partnership we have here. And also when you think about the idea of the last mile and having the ability to really deliver in the last mile, we believe this FedEx partnership, which we've rolled out in a matter of months to every single drugstore apart from those affected by the hurricane, as Stefano said, is not available to our customers and to FedEx's business partners as well. So I think that's just one quick example of how we are rapidly changing with the market as it rapidly changes. And I think that this idea of the last mile, which many people are struggling with, particularly the online business, is a big customer problem. Piracy is a big customer problem. We believe that with the best last mile, working with people at FedEx and many others, we can solve some of these problems for businesses and for customers and that's what we intend to do.

So just a thought on the FedEx partnership, so do we think about it both as addressing the omni-channel, but also competing more effectively with mail?

So, Ricky, I didn't quite catch your question. Could you repeat your question? I apologize. I couldn't quite hear the end of your question.

Just on the FedEx partnership, should we think about the opportunity not just as response to kind of like that omni-channel, but also as more effectively competing with mail?

In pharmacy, yeah, I mean, obviously, that's an opportunity going forward. We look at – we work hard on costs and still reducing that cost in the pharmacy. We are very convenient, close to many, many customers, both patients and people who buy retail products, I said before. So that's an opportunity for sure that we are looking at and I'm going to let you know if we do anything about it. But that is certainly one of the opportunities with this partnership. Well, the main cost transformation program, obviously, we completed that last year and we were delighted with the results and the costs, as you've seen, have come in exactly where we anticipated them to be. In terms of the store optimization program that we've announced today, clearly the majority of that is cash and then we're going to have the investment in the capital in the Rite Aid stores and the conversion and the rebranding. And so we've tried to give that factor into guidance. But I'm very confident about our ability to continue to deliver a really strong cash flow. I think as I explained in my remarks, we had another very strong year for cash flow in the year just ended, the same the prior year. We were really able to really continue, in particular, to improve our working capital efficiency. We talk a lot about driving cost efficiency, which is a way of life, but similarly continuing to improve working capital is a way of life as well. And so I'm very confident that we're going to continue to really be a very strong cash generative business going forward. And obviously, when it comes to the returns on all the projects that we do, similarly as I think we've said on many times, we're very disciplined in the way we evaluate all our capital expenditure and investment programs. And I'm very confident that we'll get the returns on those.

Just one example, over summer, we decided (50:06) to simplify stores in Walgreens, and we did 1,500 stores in a matter of weeks. And that was really designed to not just face into some cost challenges in these lower stores in terms of lower-volume stores for front end, but also get working capital out, and I can tell you we successfully achieved both of these in a very short period of time and give us lessons for the rest of this period as well.

Got it. Thanks for all the color.

This is Bryan Ross on for Brian Tanquilut. I had a question on the store rationalization program. I guess how are you – you talked about 600 stores and how are you thinking about the optimal set of these Rite Aid stores that you'll ultimately retain? I mean, is it more focused on retaining the stores with end markets where you already have a sizable presence? Is it bolstering outside of that? And how are you thinking about it in terms of – you talked about before about the preferred networks and that Rite Aid would be a nice asset to add to your assets for those networks. But I guess, how are you thinking about the trade-off between the access and maybe some of the more productive Rite Aid stores?

Hi, Bryan. Thanks for the question. Yeah, it really was quite simple. Post the transaction, the team's really looked at it location by location. And really, the vast majority of these closures will be Rite Aid and the vast majority are actually – being closed are within one mile of another drugstore that we own going forward. So it really is a micro level and real detail and also we have a very strong record of file transfers. We understand how to do it. We understand the economics of it very clearly. And I think as the numbers that George described in terms of the value of this $300 million by spending approximately $450 million, you can see this is economically a very good thing to do. But also because mainly within one mile of each other, it means that the network, the ones remaining, really, is buying on our strategy. It really is about improving access to Walgreens in the future and in Northeast and the south of the country.

Okay, great. Thank you. And then just a follow-up on – I guess, from our math, about half the stores that you're getting from Rite Aid have, I guess, already gone through a remodeling type of phase and what are your thoughts on – can you talk about the additional investment in some CapEx? Are you – and then even related to the stores that you'd be closing, the majority of the stores that you're keeping, have those, I guess, what's the view on that in terms of how many have been remodeled or kind of going forward, what you'll be doing to improve those stores?

Yes. Thanks, Bryan. Again, as you know, the sizable amount of these stores, not the majority in this occasion, have been remodeled. So therefore, they are in good shape. However, there are some which are very important just from a network point of view that would require some additional capital. And also as we develop the front-end proposition in Walgreens further, we'll have the opportunity to move some of that investment with a good return also into these stores. So again, George has mentioned a figure for, not just for integration, but a figure also of $0.5 billion.

Okay. Thanks for the color.

Maybe I should work at Walgreens. So it might be a better career than what we have here, with MiFID coming.

You're welcome.

Yes, look, I'm open. Got to call the regulators though. So honestly, so much of this investment story is about the gross margin right now, especially in U.S. retail. You guys came historically the last few years, a management team that came from Europe where your gross margin was very good in Retail Pharmacy. U.S. is in the mid-20s, you're 40%-plus ex-U.S. My question is, when you look at the stores where you've done beauty, you've done mix enhancement, you've done simplification, could you give us some proxy for how much gross margin improvement you've actually seen in those stores? And that's it. Thanks.

Eric, if you worked for Walgreens, you know that you'd know the answer, but unfortunately, we can't give you the answer. We don't give that level of detail, and I'm really sorry we can't give that. But we keep on reassuring you that we understand the model really well. We are working diligently to apply that model appropriately in the U.S.A. and we believe we're making strong progress and you can see that coming through at an economic value that Stefano described. So again, we're into almost 3,000, 2,900 stores with the differentiation. We have farther to go much more opportunity there. You can see that we have also materially improved the cost of goods, both in the retail side and also on the generic side, again, that constant working with suppliers and long-term ways to make that happen. And you can see how we are carefully investing our cash as well as our operating costs to drive improvements in volume and also improvements in customer experience. Our internal Net Promoter Score and many of our brand measures are improving going forward towards more pharmacy-led health, wellness, and beauty retailer. So we continue to work diligently on this model. We continue to believe strongly that we absolutely know more about the American market has achieved it. We understand the customer is changing, we understand the market is changing, and we will adapt appropriately. So again, I don't know what more we can say. We can't give you any more detail. But I promise you that we are satisfied with the progress we are making.

And you see, you said that coming from the UK, we are used to better margin and higher margins. But if you look at the pharmacy, the pharmacy in the UK is quite under pressure and it has been under pressure for decades, I would say. And the way that we have – the reason why we have developed both with this increasing margin on the front of the stores – the shop or creating a completely new model, is just because over time, we had to cope with a margin in the pharmacy, which initially was very, very good, as it shrunk over time and we have to compensate. So we go out to adapt. In the U.S., the margin of the pharmacy is still decent. It's under pressure, yes, but we have so many levers to compensate for it that we are not particularly worried. But in the meantime, we are trying to create a new model that will help us to keep overall the profit of the company at the level which we believe satisfactory.

And also, Eric, I mean, I would encourage you to take a trip to the UK, see how we continue to improve the model in the UK. For example, our holiday season started really strong in the UK because the gifting in that marketplace is really strong this year. So again, I think we often have a conversation in this call about the U.S.A. only. We have a model in Europe which we continue to improve and continue to drive, and I think it's worth sometimes understanding that model even more in terms of looking at the whole group and what we can bring to the know-how to the American market.

That's great. Thanks very much. And I'm going to go ahead and hit submit on that resume, so let me know.

Thank you.

Yeah, hi, good morning. So obviously, you talk about the fact that the market is changing and the customers are changing and partnerships are key to your strategy. But as the landscape continues to evolve and CVS is tracking their partners, there have been some are very similar to yours, and we hear about Amazon evaluating a potential entry, how are these changes impacting your strategic thinking of partnerships versus M&A going forward?

No, I have to tell you that the market is changing, but it's not changing in a direction that was from us. So our strategy substantially doesn't have to change. Our idea of partnership, our idea of trying to adapt our stores to a future different reality is practically still the same. Of course, we are adapting, of course, we are learning and we make some changes from the experience that we have, due to the experience that we have, but the basic strategy is still the same. And we are just, as we have said many, many times, we are just building the strategy piece by piece. We have to create, I have said this many, many times, the right platform to build the future company. And we have worked on that and you can see that now, things are changing. You can see that we are constantly delivering. You'll see that we are not only constantly controlling our costs, but are also now expanding our sales. And of course, all the different trials and tests that we have done in these years are coming to fruition. I would think of something we have already spoken about, our collaboration with FedEx, the fact that now FedEx is practically, it's everywhere in our store, except Puerto Rico, I believe, that FedEx is everywhere in our stores. Whilst we have really tested the case, I feel the execution has been quite fast. In seven, eight months, we have a hold over the FedEx pickup and delivery point in all of our stores. And this is just the first phase as we said because now, we will use this to create a fantastic network to deliver to the customers directly from our pharmacies. And so you'll see that we are consistent with what we were saying in the past.