Walgreens Boots Alliance Inc (WBA) — Q2 2018 Earnings Call Transcript

Good morning, ladies and gentlemen, and welcome to our 2018 second quarter earnings call. As usual, I'm here today with Stefano Pessina, our Executive Vice Chairman and Chief Executive Officer of Walgreens Boots Alliance; Alex Gourlay, Co-Chief Operating Officer of Walgreens Boots Alliance and President of Walgreens; and George Fairweather, our Global Chief Financial Officer. We're presenting in a slightly different format today to try and give you a better overall picture of our thinking, where we are with the business and where we want to be. We would welcome any feedback you may have on the updated format to ensure we're addressing your needs. I will shortly hand you over to Stefano to make some opening comments and host the call. Before I do so, however, there are some things that never change; so I'd ask for your indulgence and attention please while I take you through the legal Safe Harbor and cautionary declarations. Certain statements and projections of future results made in this presentation constitute forward-looking statements that are based on our current market, competitive and regulatory expectations and are subject to risks and uncertainties that could cause actual results to vary materially. Except to the extent required by the law, we undertake no obligation to update publicly any forward-looking statement after this presentation, whether as a result of new information, future events, changes in assumptions or otherwise. Please see our latest Form 10-K and 10-Q for discussion of risk factors as they relate to forward-looking statements. In today's presentation we will use certain non-GAAP financial measures, we refer you to the appendix in the presentation materials available on our Investor Relations website for reconciliations to the most directly comparable GAAP financial measures and related information. You'll find a link to the webcast on our Investor Relations website at investor.walgreensbootsalliance.com. After the call, this presentation and webcast will be archived on the website for 12 months. I'll now hand you over to Stefano who I should say is slightly under the weather today with a bad cold; so if he sounds a little hoarse, that's why. Stefano?

Thank you, Gerald. If you would have seen from this morning's announcement, it has been a rather good financial quarter for the Company. We've re-run the progress in our key numbers. It is despite what has widely been seen in the retail markets as rather mixed stuff for the year. George will run you through the numbers, but before then, I would like to say a few words about our markets and strategy and ask Alex to give you some insights about how we are interpreting and implementing that strategy in our daily operations. So I would like to start by reminding you why we believe that we are at the heart of an extraordinary dynamic sector despite it apparently being a little out of favor at the moment and why we have such conviction about our future. Fundamentally, we see ourselves as being in very attractive markets, the pressure of pharmacy adjusted elements of the overall pressure in the healthcare system. In the U.S., this is mainly the reimbursement pressure from the payers, the PBMs and the health plans. Although as I have always predicted, these are now pretty much one and the same and signify the pressure the payers are under from their customers. It is a sign that everyone recognizes the need to control the inevitable growth in demand. Population continues to age; with increased life expectancy comes increased expectation for quality of life and increased demand for healthcare. In the U.S. alone, over half of all prescription drugs are taken by the over 65, and this percentage is even higher in many entirely state-funded healthcare systems in other countries. The cost of care continues to rise. The relative attractiveness of medication-based treatments to keep people leading productive lives in the community continues to increase as the cost of medication remains materially lower than the total cost of healthcare. The innovation in healthcare means demand is infinite and most markets manage cost by managing supply. Against this backdrop, we see different approaches to managing healthcare spend. In most countries around the world, these have been achieved through government intervention either to limit reimbursement, limit availability of treatment, or more usually, some combination of the two. The most sophisticated systems combine these with some element of free-market economics. The United States is one of the markets with the greatest element of such free-market economics built into the system. But with some 18% of U.S. GDP already spent on healthcare, significantly more than any other country in the world, everyone recognizes that the U.S. system can be more efficient. The greater the element of free-market economics in the healthcare system, the greater the scope for us and the greater the number of ways in which we can add value through reducing overall costs of care and working with that to evolve the way in which healthcare is both delivered and funded. We have outstanding experience and a strong track record of success in managing our business to play an active role in the management of our area of healthcare costs. We have shown that we can tie commercially while doing so, sharing the benefits and at times the growing pains of the market with partners in the relevant healthcare system. This has made us a trusted partner for patients, payers, governments and providers; most notably, the drug companies, and of course has been the foundation on which our team has delivered many years of excellent financial performance. In the market we are applying the strategies that have systematically delivered us a combination of cost control and commercial growth in other markets. I can summarize our approach really quite simply. The main points of our strategy are to drive growth and consolidate volume through organic growth partnerships, acquisitions, and use this volume to buy best-in-class, and most importantly, significantly better than our competitors. Control costs optimizing financial efficiency and leveraging our financial strength. We rigorously apply financial discipline in everything we do from day-to-day operations to business development. Differentiate ourselves where we can through value, quality of service, exclusivity, or innovation; and our own trends form a strong point of differentiation. Build a portfolio of complementary businesses across a broad geography to provide protection from the unique cycles in any one area. Reinvest for both organic and external growth and foster a portfolio of opportunities to give us multiple levers for growth. Naturally, we must adapt these approaches specifically to the conditions in each of our markets. And in the U.S., it's no different; in fact, if anything, these approaches are more relevant to the U.S. than to many other markets. I can honestly say that there is nothing that we have done in the U.S., indeed anywhere across the Company, that cannot be traced directly back to one or more of these themes. And of course, underlying these are two basic principles; the need for dynamism ensuring that we move with and indeed lead the market and the strength of leadership and management ensuring we have the right team with the right skills and experience. Our announcement of James Kehoe's appointment to join us as Chief Financial Officer from June 1 reinforces our ability to attract exceptional skills and experience. It also demonstrates the commitment of our current team to remain engaged in our future and to maintain the team as much as the Company to keep it relevantly strong. Don't take these as an indication that I am going anywhere; there is still a lot for me to do, but it is an indication that we are committed as a team at every level in our organization. George has done outstanding work as CFO over many years which we all thank him for, and he has a lot more to contribute to the Company. Thinking of other members of the team who have done great work but still have a lot more to do, this is probably an appropriate time for me to hand you over to Alex, who will tell you about how we are implementing our strategic approach in the U.S.

Thank you, Stefano. I'm going to focus today on the U.S. as this represents so much of our activity. Stefano has defined a strategy succinctly, and the evidence of the strategy in action is clear from our recent earnings performance and in stores, although of course a lot more goes on behind the scenes. As I said, everything we do eventually comes back to the service we give to the patients and customers and how we deliver for our partners. Before I talk about the future, let me review how we apply our strategy in the U.S. market today. Besides what we've had to do, we have done a lot of work to collect the data we needed and apply it in the way we needed. As you know, we are investing considerably in our systems and are spending a lot of time getting pointed in the right direction and working even better. Overall, we have spent over $500 million to-date on building, testing, and implementing new systems; we're on track and in addition, in the next 3 years we anticipate investing more than $500 million in this area of transformation of our business which will, in turn, lead to further cost savings and efficiencies. We're starting to get good data from our stores, and we're making progress toward what we need. We're now running the balanced rewards program as a data and customer insight tool as much as the marketing program as it was designed to be. We now have 88.6 million active users who are working to simplify the program, but we now have available data from nearly 3 years of excellent customer data. We're partway through updating other core retail systems which will give us a full suite of data enabling us to better mine the business and provide a platform for future growth. Those are working in a number of other key systems. We've been very open about the fact that our pharmacy management system, although state-of-the-art when we implemented it some 25 years ago and still performing very well given its age, has some constraints in its ability to handle the future needs of the business and our markets. This is a big priority for us; the work is progressing on track and we've been significantly helped by recent experiences of developing for assistance elsewhere in the Company. In addition, some of the work George and his team are doing within Walgreens to update the financial assistance and processes is already giving additional visibility on our financial performance on a much more timely basis which is helping us track and respond to changes much more quickly. As ever, there is more to do, but the combination of management data and customer insight has really begun to kick-in and they form a great deal of change in our business. Turning now to pharmacy; as you know, one of our top priorities has been to grow volume and keeping with Stefano's strategic gain. It is pretty clear to us 3 years ago that our cost base was designed for a volume of prescriptions that have been lost but not fully replaced. We did some work to validate the information we have in the markets and compare that with our own internal information; it was clear with updates in our thinking and approach. The implication was a significant shift in our approach, which we had to work hard to manage, significantly cutting out places to bring us back into line with the market, but also focusing on improving our service standards, particularly availability of prescriptions and speed of service. In this, we had to meet the judgment call on the network, our position in the communities we serve, and service levels would make us attractive at market prices. We made this judgment based on extensive consultations everywhere with peers, and both the legwork and the consultation paid off. Once again this quarter, you've seen prescription volumes grow and our market share increase to the highest level we have ever reported, 21.4%. Over the past few years, we have grown our market share by over 200 basis points. While volumes and market share come and go as contracts shift, I'm confident that we are now back to a position where we are competing strongly. Despite any short-term shifts in the market, we are well positioned to see volume and market share growth over time. This gives us a strong basis on which to review our pharmacy operations and improve them in areas where we can generate more value for both ourselves and our partners, and look at ways to improve costs and efficiency over time to augment the growth we will see in volumes. Of course, as you know, this team in Switzerland are using these volumes alongside those of our procurement partners to do a truly fantastic job in terms of getting us great buying terms, but we do not and cannot rely solely on buying. The procurement work is there to support the pharmacies, and volume counts in procurement. Specialty growth can also be seen clearly in this quarter's performance as we continue to develop our Alliance RX partnership with Prime Therapeutics and extend the number of successful community specialty pharmacies. The products here that we have recently added will enhance specialty pharmacy, a total of 23 Walgreens community-based specialty pharmacy sites. Overall, I believe we are well positioned to grow specialty market share in the future. In the retail side of the business, despite being an area of much discussion, we are at an early stage. Over the last 3 years, we have been focused on driving profitable growth, looking at the comparative quarter 3 years ago on our usual adjusted basis; we delivered higher retail gross profit through improving gross margin by over 300 basis points. This progress has been made through a combination of good solid retail management and focusing promotions and planning with rigorous financial discipline, which Stefano has already mentioned. Through changes in merchandising and product mix, we have followed our strategy of differentiation and increased penetration of our own brands while significantly improving margins. This has been achieved in competitive markets by driving improvements in our health and wellness offerings; we made good progress but not perhaps as quickly as I would have hoped, but the new store formats we're working on will provide a platform for us to accelerate this growth. Of course, there have been many areas we've been able to make progress within the existing store formats such as optimization of ranges and promotional activity, all of which have delivered improvements in performance. This can be clearly seen in our beauty differentiation rollouts in partnership with our suppliers; we have extended the rollout to our own 2,800 stores having more brands including our own brands. It's not just about improving the look and feel, but making sure we have the skills and training in our own team to support this work. Since we concluded the rollout, beauty sales in beauty differentiation stores have outperformed our non-beauty differentiation stores in the quarter, accounting for a retail margin differential of around 2 percentage points. We intend to continue this and add more stores on more cash registers for beauty. In the new store format, we'll bring together elements such as optical, hearing care, and pharmacy along with further testing of value, loyalty, and supply chain initiatives. We plan to bring together all of this learning in the pilot stores which we will begin launching in the coming months, as we mentioned in our first-quarter updates. I would stress that the new formats are as much about bringing Walgreens up to date as they are about envisioning the future; they will provide a platform from which we can deliver future services, retail offerings, and accessible healthcare. The pilot stores will also provide a platform for the existing initiatives we've already introduced. Such strategic partnerships with FedEx are already available in almost all of our Walgreens stores, all performing very well. Equally, there are areas unique to us that don't have the scale or expertise to optimize in our grid. We've gone for some quick wins, but known our position for more fundamental change. The development of the new store formats also provides us with the opportunity to develop a wider range of services at different value propositions. The acquisition of the Rite Aid stores has now been completed, which accelerates the development of our network during this transitional phase, despite our previous comments that there will be no material attrition from Rite Aid at the fiscal year. Another key initiative developing is our digital presence, which is not just a buzzword but increasingly of true relevance in the healthcare area, as well as obviously in retail, and again, while it is a challenge, we have not been sitting still in this area. Our app has been downloaded 50.6 million times, and has a 5-star customer rating on the U.S. App Store. During the second quarter, around 21% of Walgreens retail prescriptions were initiated through digital channels, up almost 3 percentage points versus the comparable quarter last year. With all these initiatives, while there is a long way to go, we must not lose sight of the shifts in the market while we are transforming the business. We have many great opportunities at stake and many paths that we can choose to follow as we drive our business forward to create a more differentiated customer proposition in the USA. My job is to ensure that we are the right team, with the right tools, and the right focus; to ensure we have the dynamism that Stefano talked about reaching all parts of our operations. That's why in the U.S., we have paid to invest in $100 million per annum and increased wages beginning later this calendar year. Putting the systems in place, as I said in my opening comments, is an example of providing the right tools and the forthcoming appointment of Sebastian and James to head our booths is a good example of how we can broaden and renew the skill base of our team, and how we execute our planned succession within our operations. I'm delighted to share this work with you; we've also been able to keep the experience of leadership within the business. Now, over to George.

Thank you, Alex. We are pleased with our overall progress, both in the quarter and through the first half of the fiscal year, and we continue to expect to have a solid year. Today, we have raised our guidance for fiscal 2018. In the quarter, our key profit metrics were all up on the comparable quarter last year both on a reported and constant currency basis. As we announced this morning, on a reported basis, sales were up 12.1%, adjusted operating income was up 7.3%, and adjusted diluted net earnings were up 16.6%. Most importantly, adjusted diluted net earnings per share increased by 27.2%. This very strong growth was in part due to the U.S. tax law changes, our share buyback program and, of course, good growth in adjusted operating income. On a GAAP basis, diluted net earnings per share increased by 38.8%, the key difference between GAAP and adjusted growth being the cost transformation program in the same quarter last year, partially offset by the provisional net discrete tax expense. For completeness, here are the first half financial highlights showing adjusted diluted net earnings per share growth of 22.4%. So, turning now to the performance of our divisions in the quarter, starting with retail pharmacy USA. Retail pharmacy USA total sales, comparable store sales and adjusted gross profit all increased versus the comparable quarter last year with adjusted gross profit being higher in both pharmacy and retail. At the same time adjusted SG&A as a percentage of sales has improved versus comparable quarters for 19 consecutive quarters; these together resulted in adjusted operating income increasing by 6.3%. So let's look in more detail at pharmacy where we've continued to make good progress. U.S. pharmacy sales were up significantly, increasing by 18.7%. This was primarily due to higher prescription volume including central specialty and mail following the formation of Alliance RX Walgreens prime and from the acquired Rite Aid stores. On a comparable basis, pharmacy sales increased by 5.1%, partially due to higher volume. Reimbursement pressure on generics had a negative impact, partially offset by brand inflation. The number of retail prescriptions filled on a 30-day adjusted basis including immunizations increased by 9.1%, leading to an increase in reported market share in the quarter to 21.4%, up 100 basis points. On a comparable basis, prescriptions filled increased 4%, this was primarily due to the positive impact of our strategic pharmacy partnerships and Medicare Part D. As in the first quarter, we delivered higher pharmacy gross profit despite ongoing reimbursement pressure and a higher proportion of specialty which adversely impacted gross margin by around 190 basis points. So turning next to retail. Total retail sales were 0.7% lower. Comparable retail sales were down 2.7% as we continue to focus on delivering improved margins. This action resulted in a higher retail gross profit than in the comparable quarter last year. As Alex has said, looking at the comparable quarter 3 years ago, we have improved adjusted retail gross margin by over 300 basis points. Next, let's look at retail pharmacy international. Retail pharmacy international total and comparable store sales on a constant currency basis were lower this quarter, with market conditions continuing to be tough, particularly in retail. Comparable pharmacy sales increased by 0.6% with the UK being up 1%, mainly due to mix. Comparable retail sales decreased 2.8% with the UK being 3.3% lower. As I indicated on our January earnings call, our trading has been challenging; we are managing our businesses well to address this. In particular, we are managing our cost base very tightly. As a result, we've been able to increase adjusted operating income on a constant currency basis by 6.6%. So now let's look at our pharmaceutical wholesale division. Sales increased by 3.4% on a constant currency basis; this was behind our estimate of market growth weighted on the basis of our country wholesale sales due to challenging market conditions in certain continental European countries, partially offset by strong performance in emerging markets. Adjusted operating income was down 1.3% on a constant currency basis, generic procurement margin pressures being largely offset by higher adjusted earnings from AmerisourceBergen, primarily due to the U.S. tax law changes. So turning next to cash flow. We continue to deliver strong cash generation. Operating cash flow in the quarter was $2.2 billion. During the quarter, our working capital inflow was $502 million reflecting our seasonal reduction in inventories. Cash capital expenditure was $288 million. We continue to invest in key areas to develop and differentiate our core customer proposition, as well as the upgrades to our IT systems which Alex has referred to. Overall, this resulted in free cash flow of $1.9 billion. This brings our free cash flow for the first half to $2.5 billion which is another strong performance. So turning next to tax. Now that we have better clarity on the tax benefit for this year and beyond, I thought it would be useful to explain the impact. The adjusted effective tax rate for the quarter which we calculated excluding ABC was 16.5%; this was lower than in the same quarter last year, primarily due to the recent U.S. tax law changes. For the first half, the tax rate on the same basis was 20.3%. The core tax rate in our half-year income statement is a blended rate. As we have in August fiscal year end, this reflects 4/12th of the old U.S. tax rate and 8/12th of the new rate. Our GAAP effective tax rate in the second quarter was 27.4% compared with 19% for the comparable period last year. This was significantly impacted by a provisional net discrete tax expense of $184 million associated with the new U.S. tax law. This net figure consists of current estimates of $794 million of transition taxes payable over the next 8 years, partially offset by a $610 million reduction in deferred tax. In terms of the fiscal year 2018 cash tax benefit, we now expect this to be more than $350 million; this compares with our previously announced estimate of over $200 million. All these figures are current estimates which we will continue to refine. Finally, turning to guidance for the full financial year. We now expect adjusted diluted net earnings per share to be in the range of $5.85 to $6.05. Our guidance now incorporates the U.S. tax law changes. The expected benefits are now marginally higher than the $0.35 per share upper end of our previously indicated range. As we said before, we do not expect Rite Aid to significantly impact this year's adjusted diluted net earnings per share, and as usual, this guidance is based on current exchange rates remaining constant for the rest of the fiscal year. I'll now hand you back to Stefano.

Thank you, George. So from what you have heard, I hope that you can see we remain very confident in the robustness of our business and our ability to drive growth in it. The results that we have delivered today demonstrate the real value we are creating, as we continue the transformation of our business and our updated guidance reflects the confidence we have in our ability to continue to deliver solid financial returns. The strength of a Company like Walgreens Boots Alliance does not lie entirely with the momentary position of any single business in the Company or its specific business cycle. It lies in our ability to bring multiple businesses and multiple opportunities to bear, to manage our portfolio against our market position and our partnership to create opportunities, to deliver a consistent performance as a company overall. We have a great deal of experience of doing this and despite the ever-changing markets that we see, we remain confident that we can continue to do that going forward. So to conclude, as we look ahead, we are optimistic as we have always been. Thank you. We will now take any questions you may have.

Hi, this is Elizabeth in for Ross. Given the reasons for industry consolidation, how has that changed your view, if at all, on any of your capital allocation priorities?

Well, it doesn't change it at all. We have our strategy and we follow our strategy trying to be consistent in what we believe. I have just announced what our principles are, and of course, we are always willing to do a deal if the deal is consistent with what we expect from it, if we have the right return, if we can see a way to gain back indication that we have used for the deal. So we are always open to the deal, we are open to joint ventures, to collaborations with other partners in order to extract synergies, to extract benefits that we can share, possibly investing capital but not enormous amounts of capital. If all these would not be possible in spite of our cost and attention to the market, we will return somehow the money today to shareholders. We are a good cash-generative company, and of course we have to use the money that we create. We will try to reserve M&A if possible; otherwise, we will give back the money to the shareholders.

And in addition, your Alliance RX partnership seems to be going great; what do you think is resonating with clients about your offering?

I mean, it's really early stages, so we are pleased with where we are. I think there are a couple of things; we are able to work differently in terms of the visibility of the partnership and what the payers are seeing within that partnership. Clearly, there is more to do here, but that's one part of it. The second part of it is that we're able to connect some of the customers to our local specialty pharmacies, which are handling the additional new drugs that we've been able to acquire as a result of that, both in partnership with Alliance RX and the expansion of our local community pharmacies within all of these networks. So we feel good about where we are; we think we have a more local model that is more relevant along with the great partnership with Prime Therapeutics.

I guess just looking back, scripts growth, up 4% on a same-store basis was maybe a little lighter than what we were expecting, given the residual benefit we thought you'd still have from the Prime arrangement and obviously a very strong flu season. Could you maybe just comment on what you saw as far as volumes on scripts in the quarter? And then, I know earlier this year you had talked about the back half seeing script growth in the 2% to 3% range; I wanted to see if that was still a valid target?

I think that remember as investors in Q2, they meet the wins of last year, and it happened obviously January 1; so Q2 does contain an element of that. Secondly, the flu season was unusual in the sense that it was very strong in December and January, but relatively weak overall; it was a pretty normal flu season from our point of view. So I wouldn't say there was much impact, I don't know volumes there. Going forward, as we said before, we still expect to grow in the back half of the year and also we expect to grow going forward. We have seen some additional marketing activities from our competition which, again, is impacting some of the volume; this is pretty much as we said, and we're very confident that we are in a really strong comparative position, not just for this year but for the future as well. And of course, last but not the least, very importantly, the smooth transfer of the Rite Aid businesses that we have purchased will, of course, be a big boost to volumes in the second part of this fiscal and calendar year.

I guess just one quick follow-up or clarification on the plan to increase wages; I think you mentioned by $100 million; that won't affect this fiscal year, is that correct? I think you said it would start in fiscal '19. And then, I guess more importantly, any sense you can give us on where you think this puts you relative to others in the market where you're competing for hourly wage earners?

Yes, we haven't given a date yet, but we did say based on this calendar year; so you can assume that it will have little or no effect on this fiscal year. In terms of the marketplace, we review this all the time, and there are quite a lot of announcements we've made regarding others in the marketplace, and we're confident what we're doing later this year will keep us in a very competitive situation. We continue to invest in our people in the long-term. While this really has nothing to do with the tax benefits that George outlined in his prepared remarks, this was already something that we planned to do but obviously was helped by the fact that we had some leeway as well.

First, I’d like to ask George about the guidance change, specifically the updated guidance compared to your initial outlook for the quarter. It seems that the majority of the benefit is coming from the tax change. Are there any alterations to your internal operating assumptions related to the guidance that we should consider as the main sources of change? I also have a quick follow-up for Alex.

Yes, you've summarized it pretty well. Our updated guidance really reflects no change to our core growth assumptions, which you can see from the midpoint to midpoint; you'll see that it's really primarily from the expected tax reform benefit, so really no change. Just to add to that, I think as we said in the last two earnings calls; we said that we expect fiscal '18 to be more balanced between the two halves and that was the case in fiscal '17.

As we consider the payer environment, we have observed the Cigna-Express and CVS-Aetna deals. Are you noticing any factors that raise concerns about potential future reimbursement pressure on the commercial side due to payer consolidation, or do you believe the alignment of these payer organizations will not affect future reimbursement?

No, it's too early in any case to see or to work out the effects. But remember that for sure there will be some negative effect in this consolidation, but there will be many positive effects because we are in a free market and so the people who have not taken part in the consolidation will be more willing to negotiate with those who are independent of the market. It's too early to see the effect, but overall, we would expect a slightly positive effect for us.

Thanks, George. I have nothing to add, just to those remarks, I see it the same way.

My first question is on the new store format; just if you can kind of help us quantify what type of capital investment do you envision as required per store and how should we think about the cadence of the rollout?

These really are tests based on a lot of things we've learned in the last 3 years, both on the front-end product mix, and also importantly, some tests that we've conducted in the markets separately with healthcare services along with our new digital platform that we already have in place. So really putting all of that together; this is a test, so we really haven't got any more information on rollouts. In terms of affordability, I think we've been very clear that we are fiscally very disciplined, and we will work within the normal rules that we have in the business about returns that we would expect to get from any initiative, including rolling out a format. Our experience in the past has been that you can achieve a reasonable return in a small footprint like Walgreens by shifting the mix, inducing more services, and improving the overall value proposition and that's exactly what we intend to do in these formats. It's proven that case and then when we're ready, we'll come back and let you know how that looks in terms of plan.

This is our typical approach. We conduct a trial with a limited budget, and after refining the trial, we ensure it meets our needs before expanding it. We believe it's important to take that extra time to confirm our strategy, so when we do scale up to many locations, we have a model that, while not perfect, is quite solid. Ultimately, this process helps us save money, as it reduces the risk of launching a trial format or making changes that require additional adjustments. We strive to avoid unnecessary expenditures.

My follow-up question is regarding United and Aetna moving to point-of-service rebates for fully insured members. Will this affect the pharmacy economics related to co-pays? Additionally, I noticed that your front-end comparisons were down 0.27 for the quarter. How should we consider the impact of your decision to rationalize SKUs when evaluating comparisons on a same SKU basis?

We actually believe that point-of-service is a good thing for the customer, so we indeed see this as a good move forward; it creates more visibility. We don't expect that to lead to anything more than the normal reimbursement pressure that we've seen consistently over the years as a result of this. But we expect that pharmacy experiences to get better, which should help us from an efficiency point of view and a customer care perspective, but clearly, we will see what happens when our colleagues in the industry roll out these initiatives. On the front-end comps, we have been consistent in saying and I think the number we gave today about the 300 basis points is an important data point that we are driving for profitable growth. Part of that was a significant SKU reduction in the bottom quarter over stores last year and I don't have any specific data to offer you today, but we are pleased with the performance of these stores and are moving that thinking forward as an important part of simplifying our offer, both for people who serve as customers and also importantly, for customers who want to have a really good experience overall. One of the things we have seen is good improvements in MPS as a result of that work. There is more management to do and more work to do but we remain confident in this approach and that's why we're accelerating it.

George, I understand your comments around guidance primarily being tax, but what did the quarter look like versus your internal expectations? Would it be nice to see a straight execution; so I'm just trying to understand the way that we had it modeled versus your internal expectations?

Overall, the year-to-date is very much turning out as we had anticipated, hence really what we said today about the guidance for the full year.

Stefano, I know you often receive this question; the first question today was about capital allocation. Reflecting on our January discussion regarding vertical integration, you suggested there might be more resistance to the CVS-Aetna deal. I want to gain a clearer understanding of your perspective. I get that you are evaluating deals based on financial returns, but do you feel there is a strategic necessity from your current viewpoint? Or is it simply a matter of pursuing opportunities that meet our financial criteria if they arise? I'm looking to better comprehend your strategic thinking on this matter.

From a strategic perspective, I truly believe that our market, including our pharmacies and stores, will need to undergo significant changes in the future. While we certainly have to make many changes strategically, I don't believe that these changes can only happen through a merger with a health plan. This is one approach to reshaping the market, but it should only be considered if the value gained justifies the price. There are various other models we can explore. Our stores will need to transform considerably, and the way we cater to consumers is shifting dramatically. There is much work to be done, whether or not we merge with a health plan or collaborate with other entities in the market. I see the primary transformation ahead not solely as a merger with a major player but rather as adapting our stores to meet the future demands of customers. Observing developments in Asia and the initiatives by companies like Alibaba shows that we must think differently about the future, which is something unavoidable. While merging with an insurance company, a pharmacy benefit manager, or wholesalers is one option, it is not the only path forward; the competitive landscape in the future will not solely hinge on these mergers.

Just curious here now that you completed the purchase of the 1,900 plus Rite Aid stores; just curious if there is anything that has surprised you on the upside or downside now that you have all these assets under your ownership?

No, we're really pleased to have gotten to this point, as you can imagine, and the process has been good; nothing surprised us on the upside or downside, and we remain confident that we will be able to execute what is still quite a big plan. Adopting over 1,900 stores into your network is not straightforward; we still have a lot to do, but we remain confident it's on plan and will give us the returns that we expected.

And then just quickly, just to throw it out there since nobody else brought it up; are you able to comment at all on these broad news articles from a month or two ago suggesting there were talks going on between ABC and Walgreens on the potential buyout of the rest of ABC that you don't currently own? Just curious again, just to throw it out there. Thanks.

We don't comment on any market speculation.

Maybe people are curious about that.

So I want to go back to Lisa's question a little bit regarding the store of the future; I think Stefano you talked about some of the changes you're seeing globally. As you think about the positioning of where the stores are right now along with some of the partnerships you're doing, whether it's with Lab Corp but obviously with express business. How do you think about the transition of that moving target in terms of staying ahead of whatever you think the consumer might demand in the future versus the investments that you're making now to make sure that you can react to those demands?

With the additional services you can provide, they represent a crucial source of revenue and profit. Beyond that, it’s evident that the more services we can offer, the easier it will be to attract and retain customers. As we look to the future, we must deliver our services in a more sophisticated manner, understanding our customers better and anticipating their needs. While this is commonly acknowledged, it’s essential to ensure that the company sees value from this effort, which is complex. However, this doesn’t mean we shouldn't expand and lead in today's world; we must strive to enhance our company’s efficiency and profitability. These two goals can coexist. As I mentioned earlier, I foresee that pharmacies will look quite different in 5-10 years. Meanwhile, if we can secure a favorable deal with someone that provides substantial returns, not only in earnings per share but also in internal rate of return and cash return, we would be very eager to pursue it.

And then George, one just quick clarification question on the tax savings; I'm not a CPA, so I won't admit that I'm an expert here. But if you think about the difference between the original $200 million cash tax benefit, it led to about $0.30 to $0.35 based on your previous guidance. The guidance for the midpoint in terms of the official change was $0.37; you increased that tax benefit by $150 million. How do we think about the bridge in terms of those two numbers?

They are essentially two quite different numbers due to the structure of the tax law. To think about it, if you consider the rate, the half-year adjusted effective tax rate was 20.3%, including a discrete charge of about 0.5%. This implies that for the full year, we expect to be around the 20% mark, give or take for any discrete changes. Regarding the cash tax for this year, when we first set our estimates after the law was enacted, we quickly learned more details about timing and other factors. We took great care to ensure that the numbers we published were strong estimates we were confident in. This caution contributed to the increases. I also addressed the deferred tax and repatriation tax, which required some time to properly estimate and report. It's quite complex, and since our fiscal year began four months before the tax reform, we need to account for a full year's impact moving forward. All the figures mentioned are provisional under accounting standards and will be finalized within 12 months, with ongoing refinements as needed.

So the 20% should be a good tax rate for the second half of the year or the annualized full rate? I just want to make sure we get this right.

I mean, as a proxy, the way the accounting works; for the first half of the year, businesses have to forecast the full-year rate before discreet and based on the forecast and that is what you use for the half-year. So the half-year rate is a good indication, but it can vary obviously depending on the mix. In the second half it's different versus what we forecasted internally this time and it can also change depending on the discreet, which of course varies quarter by quarter; some quarters they could be positive, some quarters it could be charged.

So as the discussion on consolidation brought to bear, it sounds like you would expect that there will be some pressure over time on volume and reimbursement; that's a reasonable expectation based on current commentary. I wanted to get your thoughts on both past three years of what you've seen in share gain and reimbursement. How do you view the steady state of growth? What do you think the opportunities for growth over the next three years look similar given those headwinds on consolidation? And then on reimbursement pressure, are we at a point where your relationships have evolved to a place where there may not be as much pressure as we've seen in the last couple of years?

I think it's always hard to have a crystal ball over 3 years, but yes, we are assuming that we have the same opportunity to grow as we have done the last 3 years. So I think in terms of volume, that would be a reasonable assumption to take. In terms of margin pressure, it's harder to anticipate at the moment, but we see the same trends right now; so as we build and think forward and consider how we are preparing the business for the future as Stefano mentioned earlier within the pharmacy, we're looking for similar reimbursement pressure as in the past, which will ebb and flow a bit year to year, but there is no indication there is going to be anything materially different. What is going to be different we think is the ability to take care of customers better and connect them better to a total offer. Going forward, we mentioned quite a lot about our investments in data and technology; we're doing that for a reason, which is to provide a more joined-up experience for our customers and we see pharmacy as the area where we have got, in the next 3 years, probably more opportunity going forward. So I would be happy to see the future in pharmacy in the next 3 years.

On that investment, I heard you speak to data and efficiency; I would think that your peers are also going to be looking at clinical capabilities to make these transactions impact costs. What is your view on investment today and the ability to impact the pharmacists enabled in this part of the care team?

We see it the same way. I’ll go back to what Stefano said many times and I agree with this; you don't have to be vertically integrated to be able to provide the same services to the payers, as well as to the patients. You can assume with the investments we're making that we are going down the same route, and of course, we're working hard at that right now.

And I just wanted to squeeze in the $90 million legal benefit this quarter; could you just define that for us?

We really have nothing else to add to that, Eric. I mean I know obviously we can't speak about it, it is what it is, so we have nothing else to add.

At some places, it's just an accrual related to ongoing U.S. regulatory models.

We have our ways to review carefully the potential risks that we have, and we are accounting for consistently what we see.

Thank you, thank you all for your questions. As I mentioned in the beginning, this was a new format in the presentation for us, so while we're talking to, anyone who wishes to talk to us afterwards, the IR team are all here, Ashish, Debra, Jay, Patrick, and myself to take your questions over the next few days, and any feedback you have on the presentation format will be much appreciated as well. Thank you very much indeed.