Walgreens Boots Alliance Inc (WBA) — Q1 2019 Earnings Call Transcript

Good morning, ladies and gentlemen and welcome to our first quarter earnings call. I am here today with Stefano Pessina, our Executive Vice Chairman and Chief Executive Officer of Walgreens Boots Alliance; James Kehoe, our Global Chief Financial Officer; and Alex Gourlay, Co-Chief Operating Officer of Walgreens Boots Alliance and President of Walgreens. Before I hand you over to Stefano to make some opening comments, I will as usual take you through the legal Safe 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 for a discussion of risk factors as they relate to forward-looking statements. In today’s presentation, we will use certain non-GAAP financial measures. We refer you to the appendix in the presentation materials available on our Investor Relations website for reconciliations to the most directly comparable GAAP financial measures and related information. You will find a link to the webcast on our Investor Relations website at investor.walgreensbootsalliance.com. After this call, the presentation and webcast will be archived on the website for 12 months. I will now hand you over to Stefano.

Thank you, Gerald and hello everyone. Today, we have as a company reported a solid set of quarterly results. Our businesses are used to working in challenging market conditions. But in some of our markets, we have experienced the most difficult trading environment that I can remember. Given this backdrop, it is a testament to the tenacity and determination of our teams that we have reported increased sales, net earnings, and earnings per share. We have continued our work to build on our partnerships in the quarter. We have started some new partnerships and we have begun testing a number of new initiatives. Alex will talk to you about this in a few minutes, but it is important to point out that these partnerships covered the whole spectrum of our business in healthcare, beauty, convenience, retail, logistics, and services. I am also particularly excited by our new strategic partnership with Verily in which we will become the first choice of retail pharmacy development and commercial partner for them, given the complete healthcare focus of Verily and the leading-edge nature of much of the work that they are doing. This is a fantastic opportunity to bring these products and programs to a wide patient population quickly and efficiently to the benefit of the patients and the payers at the same time. Going forward, the agreement with Verily will see us collaborate closely on the development of new products and concepts, higher linked programs among our employee base, while preparing plans for wide public commercialization. This partnership is not just designed to broaden the range of each of our offerings, but also to help us accelerate the transformation of our own businesses and to prepare our company for the future. It is a further step in our plans to accelerate digitalization with much more to follow. Digitalization of the company is a huge challenge but represents significant opportunities. We are still developing our plans, but we will connect better with the consumer, improve operations of our stores, simplify what we do today, and enhance our digital capabilities that will make us fit for the future. We are continuing to invest in our core IT system to improve core processes and operations. Alex will tell you more about our partnership with Verily in a few moments. Of course, a key part of preparing for the future is establishing the right cost-based structure and infrastructure for the business as we look to the future in an increasingly automated and digitized world. James will tell you about the new program we are putting in place to achieve this. But first, I will ask him to take us through the quarterly results. James?

Thank you, Stefano and good morning everyone. Overall, we delivered a solid set of results in the quarter. GAAP EPS increased 45% to $1.18 per share and adjusted EPS increased 14.1% on a reported and constant currency basis. Operating cash flow in the first quarter was $460 million. This reflected seasonal working capital investments and the integration of the acquired Rite Aid stores. We are confirming our full year guidance with 7% to 12% growth in adjusted EPS on a constant currency basis. Now, let’s look at the results in more detail. Sales increased by 9.9%, including the currency headwind of 1.5%. On a constant currency basis, sales were up 11.4%, reflecting the acquisition of the Rite Aid stores and organic sales growth of 4.3%. Adjusted operating income declined by 3.3% and there are a couple of factors playing out here. Firstly, you will recall that we guided to $150 million of incremental store and labor investments in 2019. The first-quarter investment was $30 million and this reduced adjusted operating income by 165 basis points. Secondly, we had a weak quarter in the Retail Pharmacy International segment and this reduced adjusted operating income growth by 390 basis points. Approximately half of the Retail Pharmacy International variance was due to weak UK market conditions, with the balance due to exceptional events that distort year-on-year comparisons. Adjusted EPS increased 14.1% to $1.46 per share, driven by 8 percentage points from U.S. tax reform and a 4 percentage point contribution from our share repurchase program. GAAP EPS increased 45% to $1.18 per share. The prior year period included the impairment of our equity method investment in Guangzhou Pharmaceuticals and a loss from the company’s equity earnings in AmerisourceBergen. Now, let’s look at the performance of our divisions starting with Retail Pharmacy USA. Sales were up 14.4%, reflecting the acquired Rite Aid stores and solid organic sales growth of 4.6%. Adjusted gross profit increased 6.1%, reflecting mid-single-digit growth in both pharmacy and retail, including the contribution from the acquired Rite Aid stores. Adjusted SG&A spend increased 8.1% entirely due to the acquired Rite Aid stores. Excluding Rite Aid, adjusted SG&A spend declined 2.6%, driven by continued strong cost discipline which more than offset our previously announced investments in store wages and strategic initiatives. Adjusted SG&A was 18.2% of sales, an improvement of 100 basis points compared to the year-ago quarter. On the same basis, adjusted SG&A as a percentage of sales has now improved for 22 consecutive quarters. Adjusted operating income increased 0.1% in the quarter. As you look at the quarter, please remember that it includes $30 million of store and labor investments, which reduced profit growth by around 220 basis points. Adjusted operating margin was 5.4%, 0.7 percentage points lower than the prior year due to reimbursement pressure and the continued shift to specialty. Now, let’s look at more detail at pharmacy. Total pharmacy sales increased 17.5%, mainly reflecting Rite Aid with organic growth coming in at 7.6%. Our central specialty business grew 50% year-on-year and comp pharmacy sales increased 2.8%. The number of retail prescriptions filled on a 30-day adjusted basis, including immunizations increased 11.4%. We saw continued improvement in comp prescription growth. Compared to the fourth quarter of fiscal 2018, comps improved sequentially, up 2% this quarter versus 1.3% last quarter. Prescription growth benefited from the transfer of scripts from our Rite Aid stores and this largely offset the Medicare Part D network changes. In addition, last year’s comps benefited from a 60 basis point impact from hurricanes. This led to first-quarter market share of 22.4%, up approximately 180 basis points compared to last year. Pharmacy gross profit increased mid-single digit versus the prior year. The pharmacy gross margin evolution reflected the continued shift to specialty, which accounted for around 180 basis points, and reimbursement pressure. These factors were partially offset by procurement savings. Finally, we will begin to lap the margin dilutive FEP specialty contract in January 2019. Turning next to our retail business, retail sales increased 6% reflecting the sales contribution from the acquired Rite Aid stores. Comp retail sales declined 3.2%, impacted by two key factors that explain around 290 basis points. Firstly, we continued to deemphasize select products and this impacted performance by 180 basis points with approximately 150 basis points due to tobacco. Secondly, we were facing a tough year ago comp number that was boosted by the impact of hurricanes and a very strong cough-cold flu season. Together, these were approximately 110 basis points. Retail gross profit increased mid-single-digit and excluding Rite Aid, retail gross margins expanded by 60 basis points. This quarter, we have continued to expand our partnerships in healthcare, beauty and convenience and Alex will talk about these later. Turning now to Retail Pharmacy International which as usual is in constant currency, sales decreased by 3.6% in a challenging UK market, excluding the impact of the divestiture of our Boots contract manufacturing business and a change in loyalty accounting, sales decreased by 2.3%. UK comp pharmacy sales declined by 3.5%, mainly due to temporarily higher prices in the prior year, caused by shortages in certain generic drugs. Boots UK comp retail sales declined by 2.6%. Improved market share performance was more than offset by a very weak retail environment. SG&A costs increased slightly compared to last year. Adjusted operating income declined 34.6%. Approximately half of the decline was due to the weak UK market conditions and the balance was due to exceptional items and phasing, including the prior year divestment, the change in loyalty accounting, and the timing of pharmacy payments. Clearly, we expect significantly improved performance in the coming quarters. With sales being down in line with the market, we are taking steps to improve our operational performance. Overall, however, we were competitive in the quarter. We estimate that the traditional retail market declined by 5.9% in the categories in which we operate. Excluding the impact of the Toys R Us bankruptcy, we estimate the market declines by 3%, but we did gain market share in the quarter and the trend is improving. We have invested in online growth and Boots UK online sales increased in the low teens. Several important initiatives are underway to improve our revenue performance. In pharmacy and healthcare, we are developing a true omni-channel experience in stores and online. In beauty, we are continuing to develop our online and in-store offerings. We will be launching new and innovative leading beauty brands. And in the second half, we are looking to modernize the experience in our beauty halls, starting with our top 25 stores. We will align our cost base with the new market dynamics and this will be addressed as part of our global cost program. Turning now to the Pharmaceutical Wholesale division, which we will also discuss in constant currency. The division delivered another solid quarter with sales up 6.6% led by continued strong growth in emerging markets. Adjusted operating income increased 3.1%, reflecting higher sales and a higher contribution from AmerisourceBergen. Turning next to cash flow, operating cash flow was $460 million. Free cash flow reflects higher seasonal working capital investments and $177 million due to the acquired Rite Aid stores. Good management of both receivables and inventories led to a further reduction in our cash conversion days. Cash capital investment was $470 million, $92 million higher than the prior year, including the impact of Rite Aid store conversions. Let’s turn now to our guidance for the year. We are confirming our full-year guidance and expect constant currency adjusted EPS growth of 7% to 12% in fiscal 2019. As a reminder, this guidance includes select store and labor investments of $150 million and EPS headwind of 2% and share repurchases contribute around 5% to EPS growth. While we are not providing updated guidance, we have included a currency sensitivity analysis in the appendix. As of today, currencies result in an adverse EPS impact of approximately $0.07 compared to $0.04 at the time of our original guidance announcement. Overall, as we look forward, we expect to be back-end weighted as cost-saving programs kick in in the latter part of the year. Additionally, currency is quite volatile right now, especially in the short term. Last quarter, I mentioned that our guidance for the full-year included savings from upcoming strategic cost management programs. We would now like to update you on our current thinking. We have had a rigorous focus on cost reduction since WBA was set up four years ago and we have made strong progress. The first phase delivered significant synergies from the merger, for example, by combining head offices and creating our generic purchasing office. The second phase focused more on operational efficiency, in supply chain and in our store operations. In addition, we boosted our retail margins through aggressive promotional effectiveness and SKU rationalization. In the third phase, leveraging our investment in systems and processes and recognizing the change in customer behavior, we aim to simplify our operations and reduce the cost of running the business. While we have made solid progress, we are only halfway through the systems investments and there is still a lot more to be done. Finally, we do have a good track record of controlling SG&A. As I have just mentioned, in our Retail Pharmacy USA division, we have now reduced adjusted SG&A as a percentage of sales versus the year-ago quarter for 22 consecutive quarters. We are now launching a new phase of transformational cost management. This program will allow us to counteract margin pressure, create a lean operating model, and fuel the investments to make WBA agile and fit for the future. Encouragingly, we see significant opportunities over a multiyear period. The program is multi-faceted. Firstly, we will continue to optimize performance within each division. Secondly, we are launching new global programs to implement smart spending and smart organization. Finally, we are embarking on a digital transformation across the company. The program starts now and scales up over time. We are moving quickly to optimize divisional performance. We are already restructuring our retail businesses in Chile and Mexico to address low margins in both markets. The pace has been impressive with the programs largely executed in less than three months. Although the cost savings here are relatively small, it shows our agility and speed in addressing the cost structure. In our Pharmaceutical Wholesale division, we will improve the effectiveness of our warehouse network and commercial operations to improve profitability in select markets. We expect this part of the program to deliver savings of between $65 million and $75 million per annum. One-time costs are expected to be between $150 million and $170 million, of which the cash component will be around 90%. The returns are attractive. More importantly, we are undertaking a global review of our cost base and have engaged a center to assist in this. We have just started a global smart spending and smart organization program and we will adopt a zero-based approach. We are starting with a 16-week assessment phase to review and validate the size of the prize. The program will build on ongoing initiatives and a strong track record especially in the U.S. Initially, we will focus on our largest markets, the U.S. and UK and our global functions followed by our other markets. Finally, and as Stefano covered upfront, we aim to digitize the enterprise to drive enhanced capabilities and lower operating costs. We are targeting excess of $1 billion in annual cost savings by the end of the third year and we target attractive returns on the overall project. Expect regular updates as we work through the various initiatives. Thank you. And I’ll now hand you over to Alex.

Thank you, James, and hello, everyone. Before I look at the individual initiatives we have underway, I’d like to remind you of the overall objective of the work we are doing in our retail businesses, most particularly in Walgreens. Our ambition is to enhance our customer focus to the point where we contribute positively to every aspect of our customers’ lives. We cannot be all things to all people, but we aim to have something in our offering that can contribute to all the areas of our customers’ data life that are important to them and that we can provide in a convenient way. By true convenience, I mean, a combination of three things. The first is clearly our traditional convenience, the physical proximity to our customer. At any time in their daily life they are almost certainly going to be within easy reach of Walgreens. This gives us a huge advantage. We are there when our customers need us. The second element of convenience really builds on the first. In the world we are living today, we must create a company that can interact with our customers, however, wherever, and whenever is right for them. We can’t wait for them to come to our stores. We must be able to interact with them on their phone, online, via an app, which can fit on any technology platform, on their watch or through voice technology to the speakers in the family room, kitchen, or car, whatever is right for them. I’m not talking about just a state-of-the-art website or app; it is more than that, as we must ensure that we as an organization are geared up to completely integrate the physical world with the particular and personalized interfaces that customers have access to and want to use. We have a huge head start in getting this right. Our physical proximity means we are already close at hand to translate the digital world into real physical action, whether in the delivery of goods or services. Of course, the final element of convenience is a true and properly curated convenience retail offering. This means the right products at the right price, but not every product at the absolute lowest price. The basis of our customer proposition must be the right mix of convenience, services, and specialty retail. Getting this right ensures customer loyalty and underpins the strong values that our brand stands for. You’re seeing our approach to this in the partnerships we are developing. We are building on our own experience and expertise in pharmacy, healthcare, and health and beauty retailing, by bringing new brands and services to our customers through a series of partnerships with experts in their relevant fields. Working with partners who have the best-in-class expertise and offerings, we are setting new standards for delivery of goods and services in the retail pharmacy channel and in the marketplace as a whole. Although we are in the early stage in many of these initiatives, customer response so far has been positive. Our work to develop our healthcare offer in-store is accelerating with the deployment of further LabCorp locations at Walgreens patient service centers. It is still very early for the trial we are conducting with Humana in Kansas City of the partners and primary care clinics in-store. We still need to validate the business model and the economics of the clinics, but patient response has been very promising, and I believe it has a good chance that this may provide a template for primary care in many of our stores. Our partnerships with Birchbox, Spin Telecom, and most recently, Kroger, each in different ways show how working with experts has the potential to truly differentiate our customer offering in-store. Working with FedEx is a clear demonstration of how we can grow these partnerships beyond just the retail offering to enhance and expand on our own services. The announcement of our next-day delivery service nationwide was another processing customer service from Walgreens. Turning to international retail, Boots continues to be strongly positioned in the UK, both as a brand and as a mass pharmacy-led health and beauty specialist. However, we recognize the need to modernize our customer proposition and the team has started work on this already, in particular, focusing on new products, propositions, and the in-store beauty experience of personalizing, and digitalizing further the whole beauty experience. To enable these necessary changes, the team is also looking at shifting where we invest today, aligning to the company’s overall cost transformation plan. Then, of course, it is our new relationship with Verily, our new partner to develop, pilot, and bring to market products and services to the pharmacy. This partnership starts with offering the already successful Onduo diabetes management service, which comes out of Verily’s joint venture with Sanofi to an employee base to help them manage their health, improve their quality of life, and provide better service and support, all at the lowest cost. We’re also enthusiastic about kicking off a medication adherence pilot project that will explore new data and device technologies. Adherence is arguably one of the most costly real-world barriers to improving patient outcomes. These are just the first of a number of initiatives in the pipeline with Verily in the management of chronic conditions. We also hope to look at opportunities in disease state monitoring. It is exciting to have the opportunity to be a part of the innovative development work that Verily is doing, which has the potential to be a strong and important partnership for both companies. I’m also pleased to say that we have expanded our relationship with Alibaba by beginning to roll out the ability to use Alipay in our stores in the U.S. We’ve already enabled the system in 25 stores and plan to offer payment by Alipay in at least 3,500 stores in the USA by the end of February. This has particular significance for our valuable Chinese customer population, who can now not only buy our products via our dedicated store and Alibaba’s Tmall in Asia, but will now be able to shop in the U.S. using Alipay as they would at home. The Alipay system not only processes payments internationally but identifies places for customers where it is accepted and allows targeted promotions via the platform, enabling us to market directly to these customers in a highly focused and personalized way. Overall, we are following a theme; all that we are doing fits into an overall plan in developing our offering and the structure to offer materially enhanced, focused, and over time more personalized and bespoke service to each and every one of our customers. As we increasingly use technology to achieve our overarching aims, we are generating a wealth of data and understanding that will allow us to become even better at delivering all these things to our customers and become a more efficient company over time. The use of data is another area where we are working quickly to transform and enhance our company. As Stefano has mentioned in the past, this is another opportunity where we are actively looking for partnerships to accelerate our work. So that is the latest updates on our retail transformation. I will now hand you back to Stefano.

Thank you, Alex. You have heard how we are looking to the future and actively building the capabilities, partnerships and perhaps most importantly, a mindset that we will be displaying, both for the future growth of our company. Of course, what we are doing is a continuation of a process of change that we have been fulfilling for some time. But as the pace of change accelerates in our market, it is important for us to increase our own pace of change. We must remain architect of our own destiny rather than have our future defined by others. Our markets are changing around the world. While the drivers that are fueling these are different in retail and pharmacy, the importance of transforming our business to address these changing markets is equally key to both areas. The initiatives that we have spoken about today have already begun to impact the businesses, improving efficiency, reducing costs and reshaping our company to better support our future growth. As Alex has said, our future builds on our strength, our physical reach and our healthcare focus. These are the foundations of our relationship with our customers, the patients, the payers, and a healthcare provider. Today, you have heard how we plan to bridge the transition to the future, while maintaining our economic growth by reducing our costs and deploying technology actively in our business and doing this efficiently and effectively. We believe the transformation program we have announced today has the capacity to counter the trading pressure we are facing in a number of our markets. It will support our growth until the work we are doing to change and update our offerings and engage in new income streams in healthcare matures enough to compensate for the inevitable pressure of cementing pharmacy and the dealer work to differentiate our consumer offering, which delivers the growth in retail. So all in all, this was a quarter of progress within the company and solid financial performance overall. This, I believe, sets the tone for the year as a whole as we work to deliver on the initiatives we have underway. As ever, we have a lot of work to do and there are many moving parts both in our markets and in our company, but I remain confident that we have available to us all that we need to deliver for our customers and investors and do what is needed to ensure the future of this company as a strong, healthy, and prosperous business, improving the life and well-being of the communities we serve for many years to come. Thank you. Now we will take your questions.

Yes, good morning guys. Thanks for taking the question. I guess, James, my first question for you would be on the $1 billion cost savings program that you guys have outlined. I guess, can you talk about expected cost to deliver the program, maybe sources of the synergies by region and how much do you think flows to the bottom line versus gets reinvested in the business?

Hi, it’s James here. So at this stage, we are announcing the intention on the program and some parts of it are confidential. So what we have given you is the key first step and we’ve shown you the metrics of some additional downsizing in Mexico, Chile, and in Pharmaceutical Wholesale, so we have a pretty good grasp on this part of it. We have quantified the one-time costs relating to that and we took a charge in Q3 of $30 million and we’ve actually completed the actions in Chile and Mexico. I don’t want to give the exact number, but we have an internal rate of return on this combined program, just as the initial part of it, of 40% to 50%, so the returns are highly attractive and our decisions are extremely DCF driven. The second big part is what we call smart spending and smart organization: we have engaged Accenture to assist, they have a certain tool set which is zero-based budgeting, and we have initial estimates from them as to the potential size of the prize that is possible. What we haven’t estimated yet is the magnitude of the cost to implement. What I would say is, rather than you extrapolate the first part of the program, the first part of the program includes some warehouse consolidations, that includes exiting some stores which are more expensive. When you do zero-based budgeting and you reduce travel cost or consulting costs, the cost to implement is zero, and the savings come very quickly. As you move into organizational aspects, the costs increase and you could plan on somewhere between 6 months and 1 year of severance, but we have no estimate yet as to how much would come from people cost as opposed to non-people cost. What we have is a large comfort around the $1 billion that we’ve put in place, and our job is actually to beat it. What will happen going forward, we started a 16-week assessment, at the end of that 16 weeks, we will have enormous transparency and granularity. We will know who spends what on what, down to the lowest level on who spends on travel and consulting, and we will start rolling out savings programs immediately after the 16 weeks. What we will do for the first 16 weeks, we’ll confirm the size of prize that we intend to target. So, that’s step number two. The last step is digitization of a company that’s more complex, it involves engaging partners to help in this journey. One example this morning was Verily; that’s one piece of the puzzle, and there are other pieces that will come together reasonably quickly. It involves fixing core systems, transporting our technology from today’s technology to new technologies. The estimates on that are tough to call; we have large ambitions related to this that are not included in the $1 billion per se, because they are tough to quantify. So I guess, to summarize, we’re extremely comfortable with the $1 billion over three years, and that’s an annual cost-saving number. We expect to hit it by the end of the third year. We expect to come back to you, I call it, 4 to 6 months with detailed one-time costs on implementation, and then don’t extrapolate the first piece of the program in terms of one-time costs. Typically, I’ve done two of these programs before; typically out of a $1 billion at least 70% comes from non-people costs and the cost to implement travel and consulting are zero. But if you start looking at your placement of your offices and moving offices, then it becomes more expensive. So it all depends on the actions the leadership team intends to take and those actions will determine in the next 4 to 6 months.

Okay and if I might have a quick follow up for Alex I guess, Alex, I know the Humana partnership in Kansas City is early but I guess, can you tell us anything you’ve learned thus far about how it’s progressing to maybe the economics for Walgreens and kind of what the blue-sky case for that partnership looks like?

Yes, no, it’s really early. I mean, the key thing is the reaction of the customers or the patients to having a primary care center focused on seniors in a pharmacy, so the convenience factor is obvious and is coming through. We have connected the pharmacist more to the healthcare professional through just a physical location, so the end-to-end care individual patients are really clear, particularly in Medicare Advantage, and the atmosphere has become more of a healthcare atmosphere than a convenience atmosphere as well. These are just anecdotal, but we’re really pleased with how it’s going and the relationship between the companies is very positive in terms of that location. As we look forward, we think that across the USA, we’ll be able to do a number of these locations as a hub and spoke idea. We have a number of really great properties which are in corners of America which don’t have the population that supports a pharmacy, but not necessarily a strong fund. The world has changed, so we think that one of the obvious things we can do here is utilize the space better by claiming more this health care hub and destination. So far, so good, really, really early days, but encouraging from a point of view of engaging customers, particularly seniors in their healthcare needs.

Hi thanks good morning everybody. So last quarter you talked about at least 3.5% core operating profit growth within the overall EPS growth guidance of plus 7% to plus 12%. I guess, I’m just curious given the minus 4% profit decline just posted here in the fiscal first quarter, can it be assumed you could still hit the low end of that target for the full year? And also, can you just confirm maybe in terms of percentage points or some other variable, just how much savings maybe recognized in fiscal 2019 from this new cost cutting program within the guidance?

Okay I’ll answer another question as well, which is how do we think about the strategic cost management or transformational cost management one is, we see it as a multi-year program that consistently will help us to offset our reimbursement pressure in the market. It’s been a concern out there which is how much more SG&A can you reduce in the business to help offset gross margin changes, so we see it as enabling our long-term targets, not incremental to the long-term targets, and the program gives us increasing confidence in our ability to deliver consistent EPS growth over multi-year periods. So getting back to the first quarter, we’re not giving guidance, we’re not changing our guidance on the full year, so we remain comfortable with the guidance range we provided at the beginning of the year, and after one quarter it’s far too early to call. But let me try and dissect the first quarter because it is fair; our operating income was down, EPS was up 14%, and there were two key drivers. One is, tax reform generated a favorability of 8%, so we were boosted by taxes, our massive cash generation allowed us to redeploy and repurchase shares, and that generated 4%. As you look at the operating income of 3%, there are two big factors in there: one is we are reinvesting in the U.S. business and I did call out that cost approximately 165 basis points on the total corporation. The other one is we did have a couple of unusual events that we did to start the RPI segment. These are things like we sold a Boots Contract Manufacturing business and with the benefit of hindsight, we should have restated our adjusted results; we changed loyalty accounting in the UK in line with U.S. CC guidance and with the benefit of hindsight we should have restated those two items alone that come for almost 200 basis points. So we kind of have these 200 basis points plus another 165 basis points, so all of the decline in operating income is due to these items. Now that’s not an excuse, right? But we’re less preferred by the 3% in the quarter because we’re cycling through some tough distortions. As you look forward, we think the plan will be, as I said in my comments, back-end weighted and all I suggest you do is go look at the solution of operating income by quarter in the prior year. Last year we had a very strong first half and somewhat weaker second half, so we feel more comfortable in the second half because we’re going to be lapping quite low operating income growth in the second half, and actually quarter one and quarter two delivered average operating income growth last year of 5%. So we’re lapping some fairly high numbers in the prior year period. But as all I’m saying is this is how you should maybe think about the first-half, second half, and we have an easier comparison when we get into the second half of the year. But in terms of guidance, we’re just confirming we didn’t do a re-plan on the basis of quarter one; we feel comfortable, we understand the quarter one progression, and we have some distorting items year-on-year that make the quarter messy to present, but it doesn’t push us off track on any of our goals. So thanks.

Steve, and I remind you that we have never missed the guidance.

Your drop back is pretty impressive.

When we do a guidance we think very carefully about it.

Great thanks very much and good morning Alex. I just want to go back to some of the comments around the partnership? And maybe James as well give some thoughts around the margin of these new relationships versus the traditional business. I know I appreciate your comments it’s going to take time. I appreciate that. We think about Humana, we think about LabCorp and some of the others, but when I think about how the model plays out several years from now, will the margins from these relationships be equal to what we have in a traditional business, better than, or will it be a hindrance to the margin we see today?

Thanks, hi good morning. I think the way to think about it is that we’ve been reducing and cutting in the main unprofitable SKUs and reducing less profitable cash. That’s what we’ve been doing for the last two years, there has, as James said in his prepared remarks, sales. So we’ve been doing already clearing space really to just that he offers. So, of course, we have a tight IRR and investment guidance and we always have had and will always have. So I think this is fair to assume as we start to scale and roll out these initiatives, they will be critical to the overall profitability of the box; otherwise we wouldn’t do it. To be honest, the second thing I would think about is the whole active port driver. In my prepared remarks, I spoke a lot about the proximity to customers and customers more and more are loving small boxes, easier to navigate parking lots, and driving just more convenience in their lives. I am really focusing on how do we drive more customers not just through mobile technology, but also into very convenient locations to go about their daily lives. Probably the best example because it's the most mature example is FedEx. We have the growth when I was seeing through the whole grocery platform, which is now virtually in every Walgreens, including the Rite Aid stores which I just purchased. The growth there is substantial in terms of the number of people coming to pick up and drop off their parcels. That’s one example which is, you know, more material. So again, I wouldn’t discuss the impact on fruitful and health on the core health and beauty categories going forward as well. So this is a real transformation of the drugstore model; it’s early stages, but we can encourage that when you put the right products with the right expertise behind it and good value, our convenience is a natural advantage for us in the marketplace.

And you have seen, look at Verily. Verily is a fantastic company as you know because they’re very innovative, they’re investing a lot in new solutions and at a certain point they felt the need of the opportunity to have a better link with people to really dialogue with real patients, the physical patients. So naturally they have thought of us because we have this attitude to use the fantastic footprint that we have to help other people to develop the idea to sell their products. And if we cannot become, if we want to have for healthcare particularly in the future, this will be a point of reference of how they look and this is what we try to do. And of course, you can imagine that if we will be able to be even more a point of reference than we are today, of course our future will be quite good.

As you think about this transformation, what’s the timeline of the transformation and is this 3 years, is this 5 years, is this 10 years? How do we think about it from an investor perspective?

It will take years; let’s say years, whether this will be 3 or 5, it’s difficult to say because the main of this fact that they take a lot of time to come to a real fruition. We have also to understand that, and of course the effects that we are doing an incredible effort to digitize the company; if we use digitalization for not only improving the efficiency of the company, but also to offer many, many more services to our customers, that we make all these processes simpler and we will accelerate this process.

Hi this is Elizabeth in for Ross. I was just wondering if you could unpack a little bit more of the sources of the same store prescription growth in the U.S.? Thanks.

I will revise all the I think as we said in previous earnings update, made this season last year starting January 1, 2018 was not as we had hoped for, so we went from preferred to non-preferred specifically in the end of the business, so always was there, quite a chunk of scripts and market share. We have invested at January 1, 2019 and obviously we will be through that phase. In addition to that, we’ve been able to continue to see a great partnership with UnitedHealth and Urgent Care again. I think that’s looking good for January 1, 2019, which has been a good contributor to 2018 as well. And on top of that, of course, we are working in a more preferred relationship with Cigna for the first time on January 1, 2019 as well. So on the fastest growing, because maybe I think we’re going to be in better shape than we are this year and probably growing at the market, which is of course what we intend to do, if not outperform the market. There is a partnership with Prime that goes from strength to strength in a commercial business and, of course, that’s another important market for us. So we’re still in pretty good about next year relative to this year; you see the trend has improved with some good operational initiatives in terms of adherence and initiatives along with genetic switching and entity programs. All of these have gone well, and of course, on top of that, we’ve been very pleased with the attention of prescriptions in the quiet Rite Aid books of business as well. So overall, we think we’re going to have a solid year in 2019 and feel good about particularly comparing to meet the 2018 numbers.

Perfect that’s helpful and one quick follow-up on more of a housekeeping question. What was your overall U.S. same-store sales total not pharmacy or front end for the quarter?

It was, I think it was down.

Yes, the 4.6 organic is two components; we’ve got the overall same store which I believe is around 1% and then you get the specialty business, with the specialty business growing at 50%. So as you look at the numbers, the organic is driven by specialty. You have got really solid pharmacy gains growing at 2% versus which is sequentially much better than the quarter four performance. So actually quarter four was up 1.3%, but it was boosted by hurricanes, you take that out 60 basis points. There is quite a significant step up in performance versus Q4.

Okay, thank you that’s helpful.

Hi, can you talk about results in the retail international division? Operating income was behind our expectations; how long will the reimbursement pressure last over in the UK and what are you doing to offset that? Thanks.

Yes, it’s Alex here. Yes, I mean, I think the reimbursement pressure in the UK has been consistent for years; I would say I have a lot of experience there and this is no exception. I think the thing that’s different a little bit is that for the first time we have seen prescription items actually flat to slightly down in the marketplace. I think the government is also working to take items off the national formula that used to be on it and asking customers to pay for it and over the counter. So, I think that’s probably the one change we have seen in the last period, which again contracts volume. But the thing to remember on the positive side there is a global sum in the UK which is our main business. On top of that, the global sum is shared amongst those with a registered pharmacy. Therefore, overall, we can manage quite a straightforward formula, which is that we know that we are going to have to become more efficient year after year after year. It’s a pretty steady trend going forward. The big issue in the retail international business this time was really the performance directly of our retail business. And as I think James described very well in prepared remarks, about half that issue was driven by market conditions. As James said, we are actually getting more comfortable with our performance in terms of market share and we believe in the measured market we grew market share in the quarter. But obviously, the market is very down; the other half of the issue in retail international business in the UK was driven by one-offs and James described them really well. We have payment changes from the NHS payments. It’s actually a timing issue. We had a change in loyalty. We are looking for loyalty, which was an official change that we followed. And thirdly, we had the sale of BCM. So again, I think.

Just to emphasize that I want to be clear on pharmacy; year-on-year pharmacy is entirely due to generic drug shortages in the prior year that artificially boosted the prior year. We are not losing share; we actually have no reimbursement pressure because the UK government has confirmed year-on-year funding across the broad industry. If you go to the retail business in the UK, we gained share in all four categories. Now, the problem is the category declines accelerated in Q4 and that’s something we are watching closely. It’s been a very weak season in the last few months and you can read it in all the headlines in the UK, but I want to emphasize our share is quite strong in the UK.

And also, in terms of actions, James mentioned obviously the cost program, which will be important; and secondly, we are really reimagining our beauty offer. We have new products and new brands coming in the future that we have signed up. And of course, as Stefano has mentioned and James mentioned, the digitalization of it is a big opportunity as well.

Great. Thanks very much.

Good morning and thanks for taking the question. Just to kind of wrap up a lot of the thematic questions you have been asked today, particularly around the partnership model. As you think about all the various ones and the various different stages they are in, and Stefano, I know you said you think 3 to 5 years is your kind of intermediate timeline for the store transitioning. At what point do we start to see that incremental contribution from the financials of the partnerships? I am not just talking about people coming into the store, but any specific fees, any specific revenues that you are generating specifically from some of these partnerships start to manifest itself? And are there any at this point that are big enough in order to really move the needle on your operating profit?

Well, they will start to contribute when we will be able to hold them over in quantities. Of course, if we have 15 stores or 20 stores they will not – the contribution will be there, but it’s really small. When we will have thousands of stores, we will start to see the contribution. For instance, for FedEx, we have a contribution which is of course is not in the billions, but it’s significant. And this will be the case for all day partnerships that we will be able to allow once we will be convinced that these partnerships are profitable. And this is why it takes some time for us to test a partnership, but we are not trashing, we prefer to wait, but to be sure that the partnership is profitable because we have to invest a certain capital to expand those partnerships to many, many stores, and of course we want the usual return on our capital. So at the end those partnerships will have a significant contribution to what we do direct, not just indirect as Alex was saying that of course it will be also important, but direct contribution.

And just one quick clarification if you don’t mind, regarding the second half weighting, James, was that referring specifically to EBIT performance, EPS performance, or both?

It primarily relates to adjusted operating income; I think that’s the best measure of the challenge in lapping the numbers. So first half, second half, you can look at it by quarter, but also Q1 and Q2 EPS on an average basis was higher in the second EPS, but it’s a more market comparison when you actually look at the adjusted operating income.

Okay, thanks so much. Can you give us an update on the MedExpress relationship with United and Urgent Care? Is that a relationship progressing according to plan and is that something you expected plan to continue going forward? Thanks.

Thanks, Aaron. Yes, it’s Alex here. Yes, we are testing on the ground and as Stefano said in the last answer, we are waiting to see exactly how they perform. That was always the plan with Optum and UnitedHealth, sorry, was to do that. And they are performing roughly as we had expected in terms of what we are seeing, but we have not made anymore decisions of expansion or doing things differently at this stage.