Walgreens Boots Alliance Inc (WBA) — Q1 2024 Earnings Call Transcript

Good morning. Thank you for joining us for the Walgreens Boots Alliance earnings call for the first quarter of fiscal year 2024. I'm Tiffany Kanaga, Vice President of Global Investor Relations. Joining me on today's call are Tim Wentworth, our Chief Executive Officer; and Manmohan Mahajan, our Interim Global Chief Financial Officer. In addition, John Driscoll, President of US Healthcare; Rick Gates, Senior Vice President and Chief Pharmacy Officer at Walgreens; and Tracey Brown, President of Walgreens Retail and Chief Customer Officer, will participate in Q&A. As always, during the conference call, we anticipate making projections and forward-looking statements based on our current expectations. Our actual results could differ materially due to a number of factors, including those listed on slide two, and those outlined in our latest Form 10-K filed with the Securities and Exchange Commission. We undertake no obligation to publicly update any forward-looking statement after this presentation, whether as a result of new information, future events, changes in assumptions or otherwise. You can find our press release and the slides referenced on this call in the Investors section of the Walgreens Boots Alliance website. During this call, we will discuss certain non-GAAP financial measures. These measures are reconciled to the most directly comparable GAAP financial measures and the reconciliations are set forth in the press release. You may also refer to the slides posted to the Investors section of our website for reconciliations of non-GAAP measures to the most comparable GAAP measures discussed during this earnings call. I will now turn the call over to Tim.

Thanks, Tiffany, and good morning, everyone. When I joined you for the last earnings call in October, I had not yet begun my role as CEO. But I shared how I believe that leading WBA is a once-in-a-lifetime opportunity with a tremendous brand, legacy, and neighborhood presence. Today, 10 weeks into my tenure, I'm even more certain of my decision. I am pleased to be here today to share our results, our outlook, and my broader convictions around how we can build on our strong pharmacy foundation to partner across healthcare services and drive sustainable value. As you are by now aware, WBA started fiscal 2024 with unplanned results despite a weak retail environment in the U.S. First quarter adjusted EPS came in at $0.66, reflecting execution and cost discipline in U.S. Retail Pharmacy, continued strong performance in International, and progress with profitability initiatives in U.S. Healthcare. We are maintaining full year adjusted EPS guidance against the challenging backdrop. I must give credit here to the hard work and dedication of our teams. We are navigating the accumulating consumer pressures from inflation and depleted savings and somewhat slower-than-anticipated market trends in pharmacy script volumes, including impacts from a weaker respiratory season and Medicaid redetermination. Retail customers in the United States are under stress and making deliberate choices to seek value, evidenced in our own brands being up 90 basis points in the quarter, while demand for seasonal and discretionary categories remains weak. At the same time, our teams executed well during the quarter on delivering pharmacy services, including vaccines and maintaining our overall share of script volume in the US. International was once again a bright spot in the quarter, building on last year's solid growth; upside was led by Boots UK with further share gains in retail, while both retail and pharmacy delivered gross profit improvements despite inflationary cost pressures. Germany also achieved share gains. In U.S. Healthcare, we are on track to achieve significant year-on-year profit improvement. VillageMD is rapidly realigning operating costs with sales. The team is executing on several initiatives, from revenue cycle management to procurement with operational actions spanning the organization. As VillageMD focuses on increasing density in their highest opportunity markets, I want to remind you of the previously announced plans to optimize their footprint and exit approximately 60 clinics in nonstrategic markets. As of today, they are nearly halfway there, having already exited 27. Additionally, VillageMD is driving patient panel growth and achieved 23% year-over-year growth in full risk lives and 9% growth in fee-for-service volumes. Work is underway to implement targeted marketing efforts, leveraging Walgreens' expertise and patient touchpoints, and we expect benefits over time as we learn and further develop our provider-based risk strategy. So macroeconomic conditions are clearly difficult for retailers, and I fully acknowledge the structural headwinds in our core pharmacy business and the growing pains in our Healthcare segment. None of this is a surprise to me. I came to WBA with my eyes wide open, with a clear mandate to act, with everything on the table in terms of putting our business on the right track. In that context, we are taking swift actions to right-size costs and increase cash flow across the company. We remain on pace toward $1 billion in cost savings this year. Our U.S. organizational efforts have resulted in a planned headquarter support office workforce reduction of approximately 20%. Over the past two months, we have prioritized projects and capital spending to focus on the customer-facing activities that matter most. First quarter CapEx was over $100 million lower year-over-year, on track to a $600 million reduction for the full year. We also remain on schedule to deliver $500 million in working capital benefits in fiscal 2024. An additional meaningful and necessary step to strengthen our long-term balance sheet and cash position; today, we are announcing a 48% reduction in our quarterly dividend payment to $0.25 per share starting in March. This action will free up capital to invest in driving sustainable growth in the pharmacy and healthcare businesses, as well as paying down debt. At the same time, we will continue to deliver a competitive dividend yield, as the Board and I continue to view the dividend as a critical component of the overall attractiveness of WBA to many of our shareholders. Our financial flexibility is also supported by other strategic actions, with some already underway and others under consideration. In November, we monetized an additional portion of our Cencora stake with nearly $700 million in proceeds. We also took advantage of the higher interest rate environment to secure a full buy-in for the Boots pension plan with Legal & General to ensure the benefits of all 53,000 members. A buyout scheduled in calendar 2025 will eliminate the company's plan obligations and commitments. Furthermore, we continue to evaluate our existing portfolio, sharpening our strategic focus on U.S. Retail Pharmacy and Healthcare with our remaining investments in Cencora, BrightSpring, and other minority interests providing financial flexibility. Let me be clear. We have hard work ahead of us in our journey to simplify and strengthen WBA, but also good momentum with important early actions that we've taken. And there are a number of building blocks already in place for a sharper healthcare strategy, positioning us well for long-term profitable growth. Walgreens is a dependable, trusted, and convenient local healthcare destination for patients, and we have the ability and, frankly, the market mandate to be a valued independent partner of choice in healthcare services. As John Driscoll detailed last quarter, we are leveraging our local presence to engage with patients across our thousands of stores and through our assets across the care continuum on behalf of payors, providers, and pharma to help them achieve their objectives at scale. I can tell you from my early days with the team and from meetings with our partners and prospects, there is a lot to be excited about here. But our competitive advantage is not just our neighborhood footprint and convenience, with 10 million customers visiting us at Walgreens in store or online every day; our stores are access points on the best corners in America. More specifically, we have over 85,000 people on our teams who directly engage with patients and are trusted providers in their communities. Walgreens has the unique ability, through our well-established physical presence and iconic brand, for our people to drive trusted, meaningful connections. We are enabling pharmacists to spend less time on tasks and more time on meaningful interactions and providing essential care, from health screenings to immunizations to diagnostic testing and treatment. Our network of micro-fulfillment centers is helping to stabilize staffing and pharmacy hours, reduce workflow pain points, and free up capacity to drive the outcomes that matter most to our patients and partners. You'll remember in October, we mentioned a pause in the rollout to optimize productivity. We are happy with our continued progress and the importance of these centers in our overall strategy. We are also piloting virtual pharmacy to redefine connected care, further increase patient access, enhance workplace flexibility, and extend our pharmacist reach. Finally, we are partnering with academia, and specifically, key schools of pharmacy, to explore ways to attract, recruit, and create a dynamic workplace for the next generation of pharmacists. Our relationships with pharmacy deans are integral to our strategy and can help us advance the profession, and so we are forming an advisory council to guide us in our transformation. I look forward to personally working with the deans with our first meeting in March to ensure Walgreens is the preferred employer in the pharmacy space. I want to thank our pharmacy teams for their tireless efforts on the front lines of healthcare delivery in this country. Let me give you one example of how we can build on our established assets in a capital-efficient way to expand services and support patients and partners. Our clinical trials offering: we are partnering with pharma companies and leveraging our community presence and patient engagement to help drive greater patient diversity in clinical research. In a short span, we are already improving participation and equity at double the national average. To date, we have signed over 25 contracts, with a robust pipeline of opportunities ahead. Shields is another example of our strength serving hospital systems and has consistently delivered strong margin-accretive results ahead of plan. Sales were up 27% in the first quarter, driven by meaningful growth at existing customers as well as new partner contract signings. We expect Shields to continue to leverage and benefit from the rapid growth in the broader specialty market and our intense focus on accelerating hospital-owned specialty pharmacy programs. Our specialty pharmacy assets will be an important focus going forward. And while we have work to do, we are pleased to be executing our next steps with gene and cell therapy. The FDA anticipates approval of more than 20 gene and cell therapies by 2025, and this is an exciting opportunity for patients with rare conditions and for Walgreens specialty pharmacies. In the coming months, you will hear more from us on our initiatives in specialty. Finally, let me touch on reimbursement models and dynamics. We continue to see the benefits of more comprehensive and responsive discussions with payors as they are realizing the broad set of value drivers that WBA can deliver. We are committed to and entering into pay-for-performance contracts beyond core dispensing as we advance our adherence and outcomes capabilities within our pharmacy platform. In addition, we welcome and will work with payor and PBM partners on any model that recognizes and reimburses pharmacies for the unmatched value we provide patients, including pharmacy services, as well as those models that can ensure more transparency and predictability in reimbursement. With that, I'll hand it over to Manmohan to review our financial results and recent execution in further detail.

Thank you, Tim, and good morning, everyone. Overall, first quarter results were in line with our expectations. Sales increased 8.7% on a constant currency basis. US Retail Pharmacy grew at 6.4%. International delivered 4.4% growth. And US Healthcare pro forma sales increased 12%. Adjusted EPS of $0.66 declined 44% on a constant currency basis, mainly driven by lower US retail sales and a 21 percentage point headwind from a higher adjusted effective tax rate. Strong international growth and improved profitability in our U.S. Healthcare segment positively impacted adjusted EPS. GAAP net loss for the first quarter included $278 million after-tax charge for fair value adjustments on variable prepaid forward derivatives related to Cencora shares. Remember, in the first quarter of last year, we recognized a $5.2 billion after-tax charge for opioid-related claims and lawsuits and a $0.9 billion after-tax gain on sale of Cencora shares. Now I will cover the US Retail Pharmacy segment. Sales increased 6.4% versus the prior year quarter, driven by brand inflation in pharmacy and higher contributions from pharmacy services. Sales growth was partially offset by a 6.1% decline in the retail business. AOI declined 37.2% year-on-year, mainly driven by lower retail sales volume and margin, including higher levels of shrink. AOI was positively impacted by execution in our pharmacy services and progress on cost savings initiatives. Let me now turn to US Pharmacy. Pharmacy comp sales increased 13.1%, mainly driven by brand inflation and higher contribution from pharmacy services. COVID-19 vaccines have now shifted to a commercial model consistent with other vaccinations. Comp scripts grew 1.8%, excluding immunizations, in line with the overall prescription market. The ongoing impact of Medicaid redeterminations and a weaker flu and respiratory season continued to negatively impact overall market growth. Third-party data showed flu, cold, and respiratory activity was down 13.5% compared to the prior year quarter. Within Pharmacy Services, our vaccines portfolio, which includes flu, COVID, RSV, and other routine vaccinations, performed well in the quarter. Pharmacy adjusted gross profit declined slightly in the quarter, with margin negatively impacted by reimbursement pressure net of procurement savings and brand mix impacts. Turning next to our US Retail business. Challenging macroeconomic conditions and an anticipated slow start to the cough, cold, flu season contributed to a weaker retail performance year-on-year. Comparable sales declined 5% in the quarter. There are three main drivers. First, a weaker respiratory season had an impact of approximately 160 basis points through the health and wellness category. Cough, cold, flu serves as a primary script driver. As a result, we also experienced lower attachment sales due to the weaker season, which are incremental to the 160 basis points impact. Second, customers continue to pull back on discretionary spending and actively seek out promotional opportunities. As a result, we saw an approximately 90 basis points impact from weaker holiday seasonal sales. Lastly, our decision to close most of our stores on Thanksgiving this year to further support our store team members led to a headwind of about 60 basis points. While these factors resulted in lower sales across all categories, we experienced more pronounced declines in consumables and general merchandise and in health and wellness. Retail gross margin was negatively impacted by 110 basis points due to higher shrink. Retail shrink continues to be a systemic issue across the retail industry. Turning next to the International segment. And as always, I will talk in constant currency numbers. The International segment performed better than our expectations in the quarter. Total sales increased 4.4%, with Boots UK up 6.2% and Germany wholesale growing 3.7%. Segment adjusted gross profit increased by 7%, outpacing sales growth, with Boots UK driving strong retail growth. Adjusted operating income grew 15%, including the impact from inflationary cost pressures. Let's now cover Boots UK in detail. Comp pharmacy sales grew 0.8%. Comp retail sales increased 9.8%, with growth across all categories, led by beauty and health and wellness. We also saw year-on-year growth across all store formats, with flagship and travel locations performing particularly well. Boots increased retail market share for the 11th consecutive quarter, led by beauty. Boots.com sales increased 17.5% year-on-year and represented 19.2% of our UK retail sales. Turning next to US Healthcare. US Healthcare segment results were in line with our expectations. This is the second consecutive quarter of significant improvement in AOI and adjusted EBITDA compared to the prior year. First quarter sales of $1.9 billion increased by 95% compared to the prior year, reflecting the acquisition of Summit Health by VillageMD and growth across all businesses. On a pro forma basis, segment sales increased 12%. VillageMD sales of $1.4 billion were up 14% on a pro forma basis. The year-on-year increase was driven by growth in full risk lives, better same-clinic performance, and increased productivity in the Summit Health multi-specialty business. Shields increased sales by 27% as new health system contracts and expansion of existing partnerships led to a 42% increase in the number of patients on service in the quarter versus the prior year. Adjusted EBITDA was a loss of $39 million, reflecting investment in VillageMD, partly offset by profitable growth at Shields and CareCentrix. Adjusted EBITDA increased $84 million compared to last year, with improvement across all businesses. We are making progress to accelerate profitability at VillageMD, and profit growth from all other businesses contributed positively in the quarter. Turning next to cash flow. Overall, free cash flows were in line with our expectations. Operating cash flows in the quarter were negatively impacted by anticipated seasonal inventory build and timing of payor reimbursement. Capital expenditures declined by $104 million versus the first quarter of fiscal '23. Free cash flow was down $671 million versus the prior year, driven by the phasing of working capital and lower earnings, partially offset by lower capital expenditures. As Tim mentioned, we are on track to reduce capital expenditures by approximately $600 million year-over-year and to deliver working capital improvement of $500 million. I will now turn to guidance. We are maintaining our fiscal '24 adjusted EPS guidance. We expect certain incremental tailwinds and headwinds in a challenging environment compared to our prior outlook. On the tailwinds, with strong execution to date, we now expect pharmacy services to deliver ahead of our initial plan. We also anticipate an improvement in our full-year adjusted effective tax rate as a result of tax planning initiatives, with a revised range of 15% to 17%, compared to the prior outlook of 19% to 20%. On the headwinds: first, we expect the pullback in consumer spending and shifting behaviors will continue to impact our retail sales in the US in the short term, while improving in the second half. We now expect retail comp sales for fiscal '24 to decline low single-digits compared to the prior outlook of flat. Second, we expect approximately $125 million in reduced sale and leaseback gains versus our prior outlook. As we explained in October, this is the last year of anticipated sale leaseback transactions. Lastly, we also forecast slightly lower overall market volume growth for prescriptions compared to our previous expectations. Importantly, as we build on the first quarter progress in US Healthcare, we continue to expect segment adjusted EBITDA to be breakeven at the midpoint of the guidance range. This represents an increase of $325 million to $425 million over fiscal '23. The improvement is mainly driven by actions taken to accelerate profitability at VillageMD, robust growth at Shields, and cost discipline. Next, I will discuss factors impacting the phasing of earnings in the second quarter versus the second half of the fiscal year. In the second quarter, we will be lapping adjusted EPS of $1.16 in the prior year quarter. Three factors are expected to have an outsized impact on the year-over-year comparison. First, we anticipate lower contributions from sale and leaseback activity. Second, we're incorporating impacts of consumer pressures on spending and sentiment, and higher shrink on our retail business. Lastly, we expect these headwinds to be partly offset by a lower tax rate in the second quarter due to the phasing of tax planning initiatives. Looking ahead to the second half of fiscal '24, there are four key drivers for our improving earnings profile. First, as we have previously discussed, we expect actions to lower our cost base will continue to ramp over the year. Second, we expect US Healthcare segment profitability will scale over the balance of the year, mainly driven by benefits from optimizing the clinic footprint, growing patient panels, and realigning costs at VillageMD, and growth across all the businesses. Third, we cautiously expect a modest level of retail market growth against an easier second half comparison. Finally, our tax rate was elevated in the first quarter. We expect favorability in the remainder of the year. With that, let me now pass it back to Tim for his closing remarks.

To summarize what you've heard from us today, we executed on our plans in the first quarter despite the challenging environment, and we also recognize there is still plenty of work to be done. The future of healthcare and this company both require innovative new thinking. My headline to you is that everything is on the table to deliver greater shareholder value. We have the experience and the license to deeply examine our business and make the changes that position us well going forward. Having spent time with our team members and our business, I'm encouraged by the significant opportunity to build on our legacy pharmacy strength and our trusted brand, to evolve healthcare and the customer experience. We are not pivoting away from our position as the premier neighborhood retail pharmacy, but we are instead redefining what we can do to help payors, providers, and pharma achieve their goals. The reasons I joined WBA weren't just validated in these discussions; they are even more true than I had anticipated. I have a strong team in place to drive execution who are effectively working together to deliver for all of our stakeholders while I work through several leadership transitions. In the coming weeks and months, we look forward to engaging with you, our customers, our fellow teammates, and our shareholders as we listen, learn, and move quickly to create sustainable value. Now I would like to open the line for questions.

Good morning. Thanks for all the comments, Tim. I want to go back to your comments around the reimbursement model. You talked about pay-for-performance, you talked about the unmatched value, transparency, and predictability. How much of that do you think can be driven by Walgreens and Walgreens putting a new model in place? And as we think about just what's happened with the margins in drug retail over a number of years, what do you think can be a sustainable margin when we think about the drug retail business?

Good morning, Lisa. Thank you. To address how Walgreens can influence market shifts, we see ourselves as a significant retail player and partner to pharmacy benefit managers and health plans, which allows us to create value in various ways that will help them succeed in their markets. We believe we can play a critical role through our relationships, contracts, and the risks we undertake, particularly in the value we can generate in-store by interacting with patients on behalf of these payers. While we know changes in reimbursement models take time, there is strong messaging in the marketplace indicating that the future value creation from retail pharmacies will not simply come from reducing drug costs. The real opportunities lie elsewhere for payers and patients. We are committed to pursuing this path and have demonstrated our ability to operate within cost-plus and transparent models. We have a solid cash program, positioning us as a valuable partner for those embracing more innovative approaches in the market. Regarding guidance on drug margins, I cannot provide specifics, but it is evident that evolving innovation and reimbursement in pharmacy will likely be tied to the level of service we offer to patients. We have observed what effective models look like in specialty areas, as well as the challenges that arise when services are not compensated appropriately. We are confident in the value we can create through our pharmacy services and the role our pharmacists play in ensuring patients adhere to their medications safely, ultimately ensuring that payers receive the expected value. We are well-positioned to lead the evolution of these models.

Thank you, and congrats on your first quarter.

Thank you.

Yes. Good morning, guys, and I'll echo Lisa's sentiment; welcome aboard, Tim. I guess, Tim, as you look at the business from where you stand right now, you've kind of said that everything is on the table. But could you spend a little bit talking about what you think is part of the Walgreens core business, the WBA core business, and kind of what might be ancillary? And kind of maybe talk about how you're spending your time and where you think your strategic focus is most important right now.

Thank you, George, for the question. It’s a great opportunity to discuss what we have ahead of us. We possess a strong set of assets that I believe will be essential in the future. However, I want to emphasize that I am still in the early stages, and there is much work to be done. Our goal is to align our cash flows, balance sheet, and financial models to support investment in our company for growth. The primary focus remains on our stores. It's important to clarify that we are not moving away from our commitment to community-based engagement with patients through both our pharmacy services and the store experience. That commitment is central to our strategy. What we are examining is the optimal store footprint. This year, we plan to optimize approximately 200 stores, and we are on track to achieve that. We will continue to evaluate our model based on where we need to be, where we can create value, and where we can eliminate waste. I firmly believe we will continue to act as a critical neighborhood resource for patients, emphasizing human interaction, which I see as pivotal for the future of healthcare in this country. In addition to this, I’ve had three years of experience during the recent pandemic, which reinforced my view of Walgreens as a vital public health resource. We have demonstrated this through our pharmacy services, and we are actively investing to enhance our capabilities. This includes using technology to streamline processes and free up pharmacists, enabling us to expand services such as testing and vaccinations while continuing to counsel patients effectively. Furthermore, we have strong businesses in CareCentrix and Shields that provide significant value to payers in risk management partnerships. These assets seem to offer real value and potential synergies with our retail pharmacy operations. There are also exciting opportunities within our clinical trials business that leverage our resources efficiently. While I won’t detail every asset we have, I want to emphasize our ongoing investments, such as in VillageMD, which we are managing closely. Our focus will be on creating sustained value for payers, patients, health systems, and PBMs. If we cannot achieve a fair return on our investments, we will refrain from pursuing them. However, I see ample opportunities to generate high returns within our services sector. To sum it up, we will be transitioning our approach from a healthcare-focused strategy to a health services strategy, leveraging our retail pharmacy foundation for this purpose, which I believe is an excellent basis for building a health services business due to the level of engagement.

Okay. And if I could have a quick follow-up. I guess, do you think of the care delivery business as kind of core to the business in the way you frame the person-to-person aspect?

When would you define care delivery?

The Village and some of the assets?

So we like that investment. We're working closely with them. As Manmohan mentioned in his prepared remarks, there's no question that they have put themselves on a good path, both in terms of their costs and their footprint, getting to a place where they're going to be meaningfully growing and profitable. So we like that as an investment. I think that as a future growth area for us beyond the Village investment, which we're very committed to, I would not expect to see us investing in additional primary care assets in our portfolio of investments.

Very helpful color. Thanks, Tim.

Thank you for taking my question, and welcome back, Tim. I wanted to discuss your comments regarding specialty. Given your background in specialty, I would appreciate hearing more about this. You spoke in detail about Walgreens potentially becoming a significant player in this segment. If I'm correct, Shields is one of the few specialty pharmacies that has access to nearly all limited distribution specialty drugs available. Considering the changing dynamics in this market over the next few years, particularly with some ongoing regulatory scrutiny, what opportunities do you foresee for Walgreens and Shields specifically?

Thanks. I'll begin and then let John share more since he has been closely involved with the Shields business, which has an exceptional management team and is a great partner to health systems. First, I want to clarify that Walgreens specialty has access to limited distribution drugs and Shields has access to us. Shields works on behalf of health systems to build networks and manage patient pharmacy programs, which are crucial for these health systems. Often, this is the only area where they can earn a profit, making us a very important partner. Regarding our Walgreens specialty assets, we have community and central fill operations, and we are developing gene and cell therapy due to strong interest from pharmaceutical companies. We believe we have strong core assets. Under John's and Rick's leadership, we are ensuring that these assets are focused sharply on the payer market. Since I arrived, we have secured several wins, getting included in the networks of large Blue Cross Blue Shield regional plans. However, this is not enough; we must win a larger share of patients based on the quality of our service and cost-effectiveness. We are currently assessing our strategies to improve patient access. Nonetheless, Shields is a crucial enabler of our specialty strategy for these pharmacies. John, do you have any additional insights to share?

I think you nailed it, Tim. I think the only thing I'd add is we're not just growing with payors; we're growing beyond Blue's plans, with other payors. What Shields does an exceptionally good job and in a growing market is leveraging a clinical pharmacy model, which delivers more adherence and better outcomes. It's a great example where there's a lot of detail involved of us being paid for performance, and that's growing in terms of building on Walgreens franchise with large hospital systems and small hospital systems around America. But it's based on execution, which I think there's still a lot of runway both from a payor and from a health system perspective, and obviously, the underlying specialty drug market that is only going to get larger and more complicated, which I think plays to the Shields and the Walgreens strengths.

Great. And if I could just follow up on George's question. Tim, you kind of said that you probably are looking to invest in more care delivery assets kind of like VillageMD, but could we expect more types of partnerships with entities like Pearl as a way to kind of expand continued access to care?

Yes, that is the short answer. We believe that VillageMD and City provide an excellent environment for us to develop and test services while showing that they are effective in helping achieve their goals, which also contributes to our growth. From our viewpoint, this is the foundation for becoming a preferred partner for various organizations. While VillageMD has established presence in certain regions, there are areas where they are not active, presenting significant opportunities for us to partner in those markets to expand our business and assist them in growing theirs.

Thank you. On pharmacy, we've been hearing from Walgreens and that pharmacy services are the key to driving better reimbursement for several years. It looks like we're seeing that in vaccines today; the broader reimbursement pressure continues. You have a peer saying that you've hit a floor on unit cost offsets. Independents are saying the same, and it can't go lower. Do you share the view that we've hit a floor, or that reimbursement pressure has reached a level you can't go past in '24 or '25? Perhaps more importantly, given your PBM experience, does Walgreens have the leverage needed to drive more fair reimbursement or new models?

In my 25 years at PBM, I've observed that the landscape keeps changing, affecting all market players, including retailers, particularly regarding rebates and acquisition costs. We believe there's not much left in terms of further reductions. As a PBM aiming to provide value, my strategies include retail network design. However, pushing retailers beyond a reasonable limit won't yield sufficient value for the PBM. It's far more advantageous to focus on ensuring certainty around value rather than just unit costs. While I won't claim we've hit the lowest point, we've had successful negotiations for 2024 with various PBMs and are nearly finished with our plans for '24, with promising indicators for '25. We aim to facilitate a gradual shift in the marketplace toward a value-based model that benefits end users and patients. I refuse to declare there’s a definitive floor, as competition continues irrespective of changing reimbursement models. We will compete based on our strengths and areas we can control. Over the next three to four years, I see us assuming a leadership role that benefits PBMs. Our goal is to support PBMs in increasing prescription volume through our stores, which requires us to be not just a great patient experience but also an effective payor partner. We are actively engaged in understanding payors' strategies for creating value. Notably, two major PBMs have indicated they are responding more to market demands than in the past, particularly concerning pass-through or transparent models, reflecting the proactive initiatives they are launching that we can engage with effectively. This increased market demand emphasizes the urgency for us to accelerate our value creation, ensuring we are compensated for our efforts and equipping our payors to succeed. Rick, would you like to add anything?

Yes, Charles, this is Rick. The one thing I'll add is that we've been very successful at making sure that we are negotiating straight and core dispensing as one rate, and anything else, value add, is a separate rate. So when you think about pay-for-performance contracts or you think about any of our services like vaccinations or test, test, and treat, those are completely separate reimbursements that we're getting. So we've been very specific on how we contract so that we can be laser sharp on how we look at the unit economics of our script dispensing.

Hi. Good morning. Thanks for the question. So just Tim, a follow-up on the reimbursement model because, obviously, it's a big focus for investors. I think you mentioned in Lisa's question that you think it would take some time. Do you have a guesstimate on how long it would take to implement? And maybe putting your payor hat on since that was the majority of your career, why do you think payors would be open to such a change? What would be the main drivers for them? And maybe what would be the benefit for them long-term? And what would be the benefit for Walgreens long-term?

The implementation time is not short, especially for PBM and health plan selling cycles. I expect to see significant changes within one to two years. For new sales, particularly for small groups, there could be a rapid uptake if the market demands it. However, I want to underscore that the market previously showed reluctance towards transparency. Back in 2005, while engaging with Towers Watson, we were securing traditional deals alongside transparent ones because the market preferred the PBM to retain the risk. Currently, the evolving plan designs are creating a demand for cost transparency in medications, helping patients avoid surprises at the pharmacy. Employers want to ensure their employees understand their benefits, which is driving some of that demand. Though I’ll let the PBM explain their motivations for launching new programs, it seems to be part of the trend. Additionally, the regulatory environment is shifting in response to existing concerns, meaning that meaningful implementations are not achievable in just six months. We have already begun discussions to support these models and could switch to a cost-plus approach almost immediately. We are ready to compete on this basis. Payors see the benefit in maintaining valuable pharmacy benefits in a competitive labor market. They want these benefits to be clear and not confusing, which is where these models may help. For us, the goal is to be compensated fairly for our services without having to heavily subsidize patient products in an unprofitable way. Historically, there was adequate incentive to dispense generics, and now we see over 90% generic dispensing rates, making it difficult to continue cross-subsidizing generics to support brand products. This dynamic needs to change, especially for pharmacies and patients managing high-deductible plans. I believe the pressure will lead to lasting changes in reimbursement practices.

Great. Thank you. Very helpful.

Thanks and thanks so much for taking my question. In your prepared remarks around guidance, you mentioned that your expectations were around market growth in the pharmacy, maybe being a little bit lower now. I just love any clarity on what that meant and what might be driving that. And then secondly, more a strategic question for Tim. Given your history and everything else as you think about pharmacy services, does it benefit Walgreens to own a PBM?

Sure. As you think about the prescription market growth, as we shared the outlook in October, our guidance was that we're going to grow in line with market on the prescription side. What we've continued to see in the first quarter is the market is growing at a slower pace. And that’s really driven by two factors. First is the weaker respiratory season, and the second is the impact or continued impact of Medicaid redetermination. So as we're thinking about the full year now versus October, we expect the overall market growth to slow down roughly around 50 basis points versus previous estimates.

Well, I'll turn the first part of your question over to Manmohan and then be happy to answer the second part. I don't believe that's the best direction for us. I truly enjoy being independent and have expressed this before. I appreciate being able to collaborate across the ecosystem in a way that fosters trust. The economics of delivering high-quality service and competitive costs favor larger PBMs for clear reasons, as they generate significant value through scale. Acquiring a smaller PBM isn't a sensible option for us. I would prefer to partner with every PBM rather than own a minor one.

Understood. Can I ask a quick follow-up if possible. This morning, Lilly announced a new program called Lilly Direct. I don't even know if you guys were able to see it. But it sounds like something that maybe you could participate in. They're talking about having a third-party online pharmacy fulfillment service, and they're going to use existing pharmacies to help dispense. I don't know if you've had a look at that. But is that something that you're talking about in terms of some of the services you might be able to offer or work with something like this? Or how would this impact Walgreens?

No, it's a great question, and we did see it this morning. My preface is, as I've mentioned, we can work inside of almost any reimbursement model and be a service provider to payors as well as patients as well as pharma. With that said, I can touch it over to Rick, who can speak a little bit as it relates to sort of how we think about that program and others like it that may evolve in the market.

I think, Tim, you hit I think what we can talk about right now. I think what I would say is that, obviously, transparency for consumers and anything that lowers drug costs to consumers, we think is a good thing. Obviously, we are supportive of those types of programs. We work with all of our partners, be it payor, PBM, or pharma partners in order to help deliver against those. So is it an opportunity? Absolutely, and we certainly would support and work with Lilly on that.

Guys, thanks so much for all the details on this call. It's been great.

Thanks.

Hi, everyone. Thank you for the question, Tim. I want to expand on what you mentioned about the pay-for-performance contracts you have implemented so far. Could you share the focus of the contracts you have signed? Additionally, as we consider the overall potential, do you have an estimate of what percentage of those contracts currently includes some form of that element, and how do you see that improving in the future? Thank you.

Yes, I will let Rick answer, but I want to mention that I spoke with the CEO of a very large payor last week. They expressed interest in meeting with our teams to discuss collaboration for 2025, specifically regarding Medicare Advantage. There are several broader market dynamics that will eventually influence our contracting process and the creative discussions we can have. Rick, could you share your thoughts on the current state of play?

Yes. I would just say that, obviously, most of the pay-for-performance contracts still sit within the Medicare Part D space. So obviously, we not only contract on specific deliverables, but we obviously plan operationally on how we're going to deliver against the ones that make sense so that we can deliver value within the ecosystem. We are starting to see in the Medicaid space that they are starting to have contracts come through. Obviously, generally then it would move into the commercial space. I think just reiterate what Tim said; our ability to deliver on these pay-for-performance contracts gives us more credibility to actually enter in more going forward.

Good morning, and thank you for your time. I want to revisit the discussion about reimbursement. It seems you see significant potential to increase your business share with payors for your services. Could you elaborate on the sustainability of that growth? Additionally, how does this fit into your growth strategy for the upcoming quarters?

Sure. As we discussed, collaborating with various payors directly allows us to share what value we are delivering. That focus allows us to work in a more strategic manner. There is a lot to build upon over the coming quarters, and the needs of the patients, especially with the evolution of pharmacy, is a great opportunity to leverage our strengths in the market. I believe we are well positioned for long-term sustainable growth by reiterating our commitment to providing better care and value in the pharmacy segment. Great. Thank you. So, in summary, and thanks for dialing in. We are pleased with our first quarter results, but we recognize we have a lot of work to do. It is still early. The market continues to be, particularly for retailers, challenging. I think we're responding really very well. We have a very supportive Board. You've seen the changes we've already been supported to make, and we have additional things that we are looking to do. We are on a path, but we are nowhere near even the halfway point of the kind of things that we believe we can do long term to build a really powerful health services company on the back of and leveraging an excellent community asset that today we call a retail pharmacy. The exciting thing for me is that we are on that path and that the results so far have been what we would have hoped for despite being very challenging and having to make some very, very difficult decisions. To me, the thing that I go home and get excited about every day is, after we talk to payors and we talk to the marketplace, we talk to pharma, and we find out the level of need and interest they have in Walgreens being a preferred partner. Over the coming quarters, we look forward to giving you greater clarity as it relates to what that's going to look like in our future, and we look forward to doing that. Thanks very much.