Walgreens Boots Alliance Inc (WBA) — Q3 2024 Earnings Call Transcript

Good morning. Thank you for joining us for the Walgreens Boots Alliance earnings call for the third quarter of fiscal year 2024. I am Tiffany Kanaga, Vice President of Investor Relations. Joining me on today’s call are Tim Wentworth, our Chief Executive Officer; and Manmohan Mahajan, Global Chief Financial Officer. In addition, Mary Langowski, President of U.S. Healthcare; Rick Gates, Senior Vice President and Walgreens’ Chief Pharmacy Officer; 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 2 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 statements 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 Investor 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. While this quarter's results were not in line with our expectations, I want to start today by sharing some reflections on what I've observed since joining WBA. I'm at Walgreens today because I believe in the future of retail pharmacy and particularly, in our future. We are motivated by the trust Americans place every day in their Walgreens Pharmacy and the experience we provide them in our stores and with our digital offerings is important in their lives. Over our 125-year heritage, we have earned the right to engage with patients and customers in a way that few others can rival. I believe that this human-to-human interaction is an imperative in healthcare and the core foundation of our business is the relationship we have with our customers. Through our nationwide footprint, we touched nearly 9 million lives a day as the leading independent integrated retail pharmacy and healthcare provider. This dynamic is why PBMs, payers, providers, and pharma choose to work with Walgreens. Looking back over the last several quarters, we've built a world-class leadership team, including five new members. We now have the right people in place who are already executing with a sense of urgency on a turnaround for our business. All of this is underscored by our 330,000 passionate and dedicated team members who differentiate us and deliver exceptional customer and patient experiences every day. The bottom line is that I'm confident WBA will be a leader in the future of healthcare with pharmacy and retail at its center. And the long-term potential of the company will be shaped by offerings built around the relationship that we've nurtured with our customers over time. But we also acknowledge where we are today and what we need to do to realize our longer-term ambitions. The severity and duration of the challenges in the operating environment have only added urgency to our strategic and operational review, and we are addressing them directly. Our review has been a significant driver of action as we assess both our existing Retail Pharmacy business and our collection of strategic assets. I will unpack the series of conclusions we have reached in greater detail after Manmohan and I review the quarterly results. For the third quarter, we delivered adjusted earnings per share of $0.63, reflecting significant challenges in the U.S. Retail Pharmacy business stemming from a worse than expected consumer environment and challenging pharmacy industry trends, partially offset by strength in U.S. healthcare and international. In light of these factors, we are reducing our full year outlook, which Manmohan will take you through in more detail. In U.S. Retail Pharmacy, we witnessed continued pressure on the U.S. consumer. Our customers have become increasingly selective and price sensitive in their purchases. In response, we invested in targeted promotion and price decisions, which have driven traffic and will generate improved customer loyalty, but they weigh on near-term profitability as we refine our approach. We remain relentlessly focused on enhancing the front of store and creating the right omnichannel experience for our customers while driving in-store efficiencies. We also continue to face an incrementally challenging pharmacy industry. Recent trends such as branded mix impacts and increased regulatory and reimbursement pressures, including fluctuations in NADAC pricing have negatively impacted pricing dynamics. Additionally, the script market is growing but continues to trail below pre-pandemic growth levels. These headwinds have affected our performance and are materially weighing on our ability to serve patients profitably. We are at a point where the current pharmacy model is not sustainable and the challenges in our operating environment require we approach the market differently. For example, we are in active discussions with our PBM and payer partners to align incentives and ensure we are paid fairly. We are also working with our suppliers and partnering directly with pharma companies to build out specialty pharmacy, clinical trials and other services, which Walgreens is uniquely positioned to facilitate given our physical footprint and the trust we've already established with patients. In U.S. healthcare, we had another quarter of positive adjusted EBITDA and year-on-year growth, driven by continued growth and disciplined cost management at VillageMD along with strength at shields. Following last quarter's actions to right-size VillageMD's footprint, the business is now on a clearer path to profitability as it continues to add lives and optimize its cost structure. In International, the business continues to perform strongly and in line with expectations. Boots U.K. delivered meaningful retail comp growth and achieved another sequential quarter of market share gains from strength in both physical and digital channels. We continued to execute with discipline across the organization to drive further cost out and prioritize free cash flow. We remain on track to deliver $1 billion in cost savings this year. As we look ahead to the remainder of the year, we are operating under the following assumptions. We expect the operating environment to remain challenging. We do not expect an improvement in the U.S. retail environment. And finally, we expect script volume growth to remain muted and anticipate continued pressures on pharmacy margins. In light of these factors, we are reducing our outlook. We now expect to deliver adjusted earnings per share of $2.80 to $2.95 for the fiscal year 2024. While we acknowledge that this range is wider than normal, we believe it is prudent given fluctuations in recent pharmacy industry trends. Consistent with our historic approach, we will provide our outlook for fiscal 2025 on our fiscal year end call in October, but we expect the current trends I've outlined to persist into next year. Before going into details of our strategic review, I'll now turn it over to Manmohan to review our financial results.

Thank you, Tim, and good morning, everyone. Third quarter sales grew 2.5% on a constant currency basis. U.S. retail pharmacy increased 2.3%. International was up 1.6% and U.S. Healthcare delivered sales growth of 7.6%. As Tim mentioned, overall results were below our expectations. Adjusted EPS of $0.63 decreased 37% year-over-year on a constant currency basis. This was driven by a $0.24 impact from lower sale leaseback gains, a challenging U.S. retail environment and recent pharmacy trends. Our U.S. healthcare and international segments continued to perform in line with our expectations, and we continue to deliver on our goals related to cost and CapEx reduction and working capital initiatives. As a reminder, last year's GAAP results included after-tax impairment charges of $323 million related to pharmacy license intangible assets in Boots U.K.. Let's move on to the year-to-date highlights. Sales increased 5.6% on a constant currency basis. Adjusted EPS declined 25% on a constant currency basis due to the softer U.S. retail pharmacy performance and significantly lower sale leaseback gains. This was partly offset by cost-saving initiatives, improved profitability in U.S. healthcare and a lower adjusted effective tax rate. GAAP net loss was $5.6 billion compared to a loss of $2.9 billion in the first nine months of fiscal 2023. The first nine months of fiscal 2024 included certain non-cash impairment charges related to VillageMD goodwill as detailed last quarter. The prior year period included a $5.5 billion after-tax charge for opioid-related claims and lawsuits partly offset by a $1.5 billion after-tax gain on the sale of Cencora and Option Care Health shares. Now let me cover U.S. Retail Pharmacy segment. Comparable sales grew 3.5% year-on-year driven by brand inflation and pharmacy and prescription volume, partly offset by a decline in retail sales. AOI decreased 48% versus the prior year quarter. Approximately 70% of this decline relates to lower sale leaseback gains lapping reduced incentive accruals in the prior year and lower Cencora equity income. Challenging retail and pharmacy industry trends also negatively impacted AOI in the current period. Sale leaseback gains net of incremental rent expense, resulted in a $277 million headwind to AOI in the quarter. As discussed three months ago, we do not anticipate any material benefits from sale-leaseback gains going forward. Headwinds in the retail and pharmacy businesses were partly offset by cost savings initiatives. Let me now turn to U.S. Pharmacy. Pharmacy comp sales increased 5.7% driven by brand inflation and volume growth. Comp scripts excluding immunization grew 1.7% in the quarter. We are tracking in line with the overall prescription market year-to-date. However, overall prescription market growth remains below expectations, primarily due to Medicaid redeterminations. Pharmacy adjusted gross margin declined versus the prior year quarter driven by brand mix impacts, reimbursement pressure reflecting last year's negotiations, lower COVID testing demand and incremental pressure from certain generic launches with procurement dynamics similar to brands. Recent fluctuations in NADAC drove an incremental $20 million of the partial quarter impact. Turning next to our U.S. retail business, comparable retail sales declined 2.3% in the quarter. As Tim mentioned, the consumer backdrop remains a challenge. With this continued channel shift and a sustained pullback in discretionary spending, we have responded by lowering prices across health and wellness, personal care and seasonal categories. Where we invested in price and promotions, we saw returns in sales and unit lift. At the same time, value-seeking behavior and new product launches year-to-date helped to drive our own brand penetration up 65 basis points in the quarter. While we're seeing early signs of customers responding to our actions, retail gross margin declined more than previously anticipated due to our price and promo investments this year lapping last year's margin recovery actions as well as higher levels of shrink. This was partly offset by positive impact on gross margin from our category performance improvement initiatives, which are tracking in line with our expectations as we deepen our relationships with select suppliers. Turning next to the international segment, and as always, I will talk in constant currency numbers. Total sales grew 1.6% with Boots U.K. increasing 1.6% and Germany Wholesale up 4.9%. Segment adjusted gross profit increased 2% with growth across all businesses. Adjusted operating income was down 17% due to lapping real estate gains in the prior year period. Let's now cover Boots U.K. in detail. Boots U.K. continues to perform well. Comp pharmacy sales were up 5.8%. Comp retail sales increased 6% with all categories showing growth. Across formats, destination health and beauty, flagship and travel locations performed particularly well. Boots.com sales increased 13.8% year-on-year and represented nearly 16% of our U.K. retail sales. Turning next to U.S. Healthcare. The U.S. Healthcare segment delivered its second consecutive quarter of positive adjusted EBITDA. Third quarter sales of $2.1 billion increased 8% compared to prior year quarter. VillageMD sales of $1.6 billion grew 7% year-on-year. The increase was driven by growth in full risk and fee-for-service lives, partly offset by the impact of clinic closures. Shields sales were up 24% driven by growth within existing partnerships. Adjusted EBITDA was $23 million, an improvement of $136 million compared to last year, driven by rightsizing costs, improved productivity at VillageMD and continued robust growth at Shields. Turning next to cash flow. Operating cash flow in the first nine months of fiscal 2024 was negatively impacted by $785 million in payments related to legal matters, $386 million in annuity premium contributions related to Boots Pension Plan and underlying seasonality. Capital expenditures declined by $497 million versus the first nine months of fiscal 2023. As a result, free cash flow was down by approximately $1.1 billion versus the prior year. We continue on pace to achieve a year-over-year reduction of $600 million in capital expenditures and $500 million in working capital initiatives in fiscal 2024. I will now turn to guidance. We are lowering our fiscal 2024 adjusted EPS guidance to $2.80 to $2.95. The updated range versus our expectations three months ago incorporates two key items. First, the U.S. consumer environment has not improved and is driving higher promotional activity, negatively impacting retail margin. We continue to expect fiscal 2024 retail comp sales to be down approximately 3%. Second is the continuation of worse-than-expected pharmacy margin headwinds. Pharmacy margins in the second half include impact from certain generic launches with procurement dynamics similar to brands, fluctuations in NADAC, inflation and mix within branded drugs and lower overall market growth. We are maintaining full year expectations for U.S. Healthcare segment adjusted EBITDA to be breakeven at the midpoint of the guidance range. We continue to expect our adjusted effective tax rate to be under 5%. Our revised full year guidance range implies fourth quarter adjusted EPS of approximately $0.39 at the midpoint. While we're not providing fiscal 2025 guidance today, let me offer key considerations to bridge from fourth quarter to next year. Seasonality impacts all of our businesses and the fourth quarter is typically the lowest quarter of the year. Additionally, we expect profitability growth in U.S. healthcare and international segments. However, as Tim mentioned, there are other factors discussed on today's call that we assume will impact fiscal 2025. Our decision to wind down the sale-leaseback program, sales of Cencora shares and a more normalized adjusted effective tax rate are expected to have an approximately $0.75 impact in fiscal 2025. In retail, despite easing comparisons, we do not anticipate significant improvement in the U.S. consumer spending backdrop. We are especially seeing signs of strain on the lower-income consumer, driven by accumulated inflation and depleted savings. While we're adopting our model, these changes will take time. We expect to see some pharmacy headwinds continue in fiscal 2025. However, we are focused on stabilizing pharmacy margins as we continue to have active discussions with our PBM, payer, and supplier partners. We have more hard work ahead of us, and we are focused on building a solid foundation for the future. Driving the stabilization of our business and returning to longer-term enterprise growth.

Thanks, Manmohan. Let me now turn to our strategic review. Since launching our strategic and operational review at the beginning of the calendar year, we have been clear-eyed on what we're trying to achieve and everything has been on the table. We have a deep understanding of the opportunities and complexities, and we have come to a number of important conclusions. Some will take more time to execute as we maximize optionality, but all of them are aligned around three principles to drive long-term shareholder value. First, to simplify and focus our business. Second, to use our core foundation, our relationship with our customers to grow and expand in capital-efficient ways into adjacent areas. And third, to continue to identify opportunities to deliver profitable growth, generate meaningful cash flow, and strengthen our strategically-relevant businesses today and long-term. Before unpacking the details, I want to reinforce the most important conclusion from our review. The Retail Pharmacy experience will be more important to the healthcare industry in the years ahead, but it will evolve. With widespread demand for convenient healthcare solutions, including chronic diseases, and nationwide labor shortages, the pharmacy and pharmacists have never been more important. Our Retail Pharmacy business is uniquely positioned to expand the role we play in the lives of our patients who have come to expect and need retail pharmacy at the center of their care. So, let me begin this discussion around our strategic decisions with our core business, U.S. Retail Pharmacy. The success of the business hinges on an efficient, highly relevant customer experience, and we've launched a multifaceted action plan for improvement. As the convenient destination for millions of customers and driving $27 billion of retail sales, the store and its digital channels are central to our strategy and consumer experience. But the customers involved, demographics, and preferences have shifted, and we need to reposition and operate our stores accordingly. Currently, 75% of our U.S. stores contribute roughly 100% of segment AOI. For the remaining 25% of the stores in our network, which are not currently contributing to our long-term strategy, changes are imminent. To start, we are finalizing a multifactor store footprint optimization program, which we expect will include the closure of a significant portion of these underperforming stores over the next three years. Plans to finalize this number are in motion, and we will update you in due course. For the remaining portion of this cohort, we are taking action to return them to profitability and deliver an improved customer experience. We will contemplate additional closures if performance does not improve, which includes external factors such as reimbursement rates. While it is not an easy decision to close a store, we will work to minimize customer disruptions and, importantly, as we have done in the past, we intend to redeploy the vast majority of the workforce in those stores that we close. In addition to these closures, we are taking a series of actions and making investments to enhance the customer and patient experience across several key areas. First, we are reevaluating our assortment to ensure its relevancy, leveraging select partners and our own brands. This means we will work with fewer partners who are helping us win. For example, in the last quarter alone, we've removed eight national brands and redeployed those SKUs towards our own brands and preferred partners within health and wellness categories. We are sharpening our focus as a destination for areas we are uniquely positioned to lead such as health and beauty and women's health. We are accelerating our digital and omnichannel offerings to meet our customers when, where, and how they want to engage. We continue to deliver approximately 80% of same-day delivery orders within one hour and we see upside for improvement. As the ultra-convenient option for our over 120 million myWalgreens loyalty members, we have plans to meaningfully build our loyalty program. We are doubling down on our efforts to define the future of pharmacy in this country. As I mentioned earlier, this starts with changing the dialogue with payers and PBMs to ensure we are paid fairly for the value we provide. We are also investing in the industry's best talent. For example, as we focus on leading in the development and elevation of the pharmacy industry profession, we are partnering with critical stakeholders such as our Deans Advisory Council to help advance our work environment and make WBA the practice setting destination of choice for pharmacy talent. Just two weeks ago, we spent two full days with 14 deans of pharmacy across our country engaging in productive discussions to reinvigorate the community pharmacy labor supply chain. And we are enhancing our pharmacy services, like immunizations, to attract more patients through an improved experience and enhanced digital solutions. We've significantly decreased the average wait time per customer in the highest volume stores, and this is a result of several initiatives underway to improve the patient experience and increase retention. Finally, with a mindset for driving continuous improvement throughout the organization, we are committed to operating with excellence and identifying further efficiencies in both our headquarters and our retail operations. We are restructuring our organization around these conclusions to streamline and ensure efficient development and deployment of services to go to market as one Walgreens with more impact for our industry partners and to help close critical gaps in delivery of healthcare. In that regard, Mary Langowski, our President of U.S. Healthcare, will assume responsibility for operations of specialty pharmacy, pharma and manufacturer relations and contracting, supply chain, and all services development and deployment. With these operations now under one team, we will be better aligned to go where the market is moving, sharpen our contracting, operate more efficiently, and achieve better economic outcomes. And Rick Gates, our Chief Pharmacy Officer, will take on an even greater role in defining the future of pharmacy from a strategic, operational and labor force perspective. Turning to our broader portfolio, we have evaluated every non-retail pharmacy asset, prioritizing strategic fit, profit growth potential, and cash flow generation. With that in mind, we have already stopped or will stop initiatives that distract from our focus and will grow in areas that create longer-term shareholder value. Let me touch on several of our larger assets. Our review of Boots UK showed that we have attractive options to unlock value in this business. While we believe there is significant interest in Boots at the right time, its growth, strategic strength, and cash flow remain key contributors to the company. We are committed to continuing to invest in Boots UK and find innovative ways for this business to fulfill its potential. Moving next to VillageMD, which currently includes three distinct assets in VillageMD, Summit Health, and CityMD, we believe in the future of these businesses and intend to remain an investor and partner. But as part of our persistent focus on value creation for WBA, we are collaborating with leadership toward an endpoint to rapidly unlock liquidity, enhance optionality, and position them for additional growth. As it relates to Shields, its performance, growth, and leadership team remain best-in-class and serve as a complement to our core specialty business in the market. We are not taking action at this time. We are committed to executing on all of these decisions in a timely manner that maximizes shareholder value while creating optionality. And I look forward to providing more details as we progress. Before opening the call up for Q&A, let me leave you with four thoughts. First, our core retail pharmacy business is relevant, but will be different. Second, we have the right team and the right strategy to enhance our focus, strengthen our own execution, and ultimately turn around the business performance. Third, there is a clear market need for our services, but our economics are not currently structured in a way that is sensible for our shareholders. We have a firm grasp of the issues and are working to address these challenges in our business model. Fourth, while it may take time, and there's a great deal of work underway, I am confident we are executing on the conclusions from our strategic review thoughtfully and urgently to deliver the Walgreens that our country needs. With that, let's begin Q&A.

Thanks very much. And Tim, thanks for all the comments and the color. I really just want to understand just a couple of things a little bit better. One, you know you started with your core thoughts, and that the core will be different than what we see today. So one, what do you view as the future of pharmacy? And within that, can you talk about the conversations that you're having with payers and PBMs around what the new reimbursement model will look like? And then just my second question would be, just when we think about the financial side. You've called out NADAC pricing on Medicaid, and I think Manmohan said that it was $20 million in this quarter. Is that a material number when we think about, you know, going forward, if you can put any numbers around that would be great. Thanks.

Thanks, Lisa. I'll quickly address the future of pharmacy and then let Mary Langowski provide more detail about our payer discussions. While I won’t go into specifics, it’s clear that these conversations have evolved both in tone and content, and they are positive. Now, regarding the future of retail pharmacy, which is part of a broader experience, we are focusing on meeting consumers where they are today and where they need us to be. This involves several elements in both the front and back of the store. I won’t take too much time to detail everything, but at the front, we've discussed our footprint, which allows for a more rational investment outlook, meeting our customers’ expectations for both the store experience and product assortment. This includes a streamlined approach to national brands, aiming for deeper relationships with fewer choices to enhance economics and outcomes. I recently saw an exciting presentation on our loyalty program, which emphasizes engagement with our most valuable customers, along with initiatives like home delivery and omnichannel strategies. We are also empowering our store managers with more flexibility and significantly altering their compensation to encourage better performance in their stores. In the back of the store, Rick and the team have made significant progress in automating workflows. Although we had previously paused our investment in backend automation, we are now moving forward, committed to increasing efficiency and freeing up labor for more critical tasks. We’ve also collaborated with deans from 15 pharmacy schools and their association to lead in community pharmacy, focusing on curriculum design to inspire pharmacists from an early age about the potential of community pharmacy to build long-term patient relationships. We take the labor supply chain seriously, considering its effectiveness and the skills of our workforce. Our contracting strategy also plays a significant role in the back of the store, and I received an email yesterday from a major vaccine manufacturer CEO, eager for us to engage with their upcoming innovations. There’s much happening at both ends, and we have a clear vision for the necessary number of stores moving forward. More details will follow. Now, I’ll pass it to Mary to elaborate on the payer conversations, which I believe have been very constructive, and then to Manmohan.

Yes. Thank you, Tim. And thank you, Lisa. Quite frankly, we are laser focused on being paid fairly for the value we provide. And you know, put simply, the playbook is a bit dated and does not account for, nor does it adequately or fairly pay for the role and value that we think the pharmacist is bringing in delivering services. We also don't think it accounts adequately for the complexity that we now face in the system. And it certainly doesn't facilitate putting pharmacotherapy and behavioral interventions at the center of chronic disease management in this country. We think that has to change. And so we're collaborating with our PBM partners across the industry to make those changes.

Yes. Hi, Lisa. Regarding NADAC, I have a few thoughts. First, we've observed significant fluctuations in the index over the past several months. We experienced a $20 million impact in the quarter, but keep in mind that this was only a partial quarter impact. Fortunately, we have seen some improvement since the index was updated in June. However, we are adopting a cautious approach for Q4 and the guidance for the year. This variability in NADAC is one of the reasons we provided a broader range for our fiscal year guidance at this time.

Yes. Thanks for taking the question. Tim, I wanted to touch a little bit more on, on the strategy to looking at this 25% of stores that are underperforming. And a lot of these are under probably long-term leases. And I just wondering, sort of what your cash flow position is to be able to affect getting out of these leases perhaps earlier than intended. And maybe also, when you look at these stores, how much of the underperformance is just purely a broad retail issue of just a weak consumer versus maybe stores that are facing higher levels of shrink. And thus, when you close those stores, does that solve a lot more of your margin problem all at once?

Thank you, Charles. I'll address the first part. Regarding leases, one positive aspect is that we opened stores over an extended period in highly sought-after locations across America. As we close some stores, we see the chance to manage leases more strategically rather than simply maintaining them as drug stores for an extended time. An important part of our strategic review is to approach store closures and leases differently, which will help minimize potential issues. While we do have some lease obligations on our balance sheet, we believe they can be reduced. We're revisiting some leases we had deemed inactive because we believe there is potential value there. We plan to be very disciplined with our leases, and this is an essential factor in our decision-making about which stores to close. It's important to note that this analysis is multifaceted and detailed. Regarding the profitability impact and the factors influencing a store's performance or the benefits of closing a store, I'll hand it over to Tracey Brown, our stores president, to provide further insights because the situation isn't solely about high shrink stores. Tracey?

Yes. Thank you, Tim, and thank you, Charles. So as Tim has mentioned, this is a multi-factored disciplined way of looking at where to close. Yes, shrink is an issue in some stores, but we have our eyes on our high shrink stores all the time. The second thing is consumer behavior, consumer trends and where you look at the market and where our stores are located in terms of the markets that are growing versus the markets that are declining. Third, you actually have to look at the competitive landscape in each of these markets. And then the fourth thing that I would say is we are actually looking at how we are leveraging our assortment in these markets. So there are multiple levers that we look at that go into the model that drive underperformance. The other thing that I will say is there are stores that would be on this bubble, we're also taking a focused approach on those stores to get them in the right context. And I guess the last thing that I would say, Charles, this is a multi-level set of factors that come into play between ourselves, between local state officials and between law enforcement. There are a lot of players in these markets that need to partner with us in order to make sure that we are growing those that need to grow and those that are not, we're taking the appropriate action.

Yes. Let me just add to that because that is such an important point from a policy and our country standpoint. The fact of the matter is we know that we are the last company standing in a lot of places. We are the only thing standing between those places and being pharmacy deserts. And our goal is not simply to be the last one to leave. Our goal is to actually find new ways to work together, whether it's a State Medicaid programs, whether it is local law enforcement and so forth for them to do their jobs so that we can do our jobs and continue to provide care in those communities.

Thank you. I have two related questions regarding gross margin in the pharmacy. First, looking at the retail gross margin, it seems to be at a low point compared to the last 10 years. Can you provide more details about the discounting you have undertaken and your expectations for that through the fourth quarter, including how you anticipate it will decline? Secondly, concerning NADAC, if it was $20 million over the past month, and you're taking a conservative approach for this full quarter, are you expecting further expansion as it transitions from Medicaid to commercial, or do you believe we have already reached the peak during this time?

Sure. I'm going to pass it to Manmohan in just a second. What I'd say is, first of all, as it relates to commercial and NADAC, I believe what Rick would say, if I pass it over to him would be that while we do have some commercial contracts that use NADAC, those conversations we're having around sort of neutrality in terms of outcomes, that's actually the easier part of NADAC, quite frankly. As it relates to the gross margin in pharmacy, I will pass it to Manmohan and as I quickly would point out, gross margin is not only discounting, it is also mix and so forth. And so Manmohan, if you want to talk more about that.

Certainly. Regarding the gross margin in the retail pharmacy sector, there are a few key points to note. Firstly, during the third quarter, we anticipated an improvement in the environment, but it did not materialize as expected. Consequently, we concentrated on investing in pricing and promotions, which has resulted in increased unit sales. However, this approach has had a short-term negative impact on gross margin, and we foresee this trend continuing into the fourth quarter. Additionally, another factor affecting our year-over-year gross margin is the rise in shrinkage, which we have discussed in previous calls. This trend is increasing, and Tracey and her team are implementing measures to return it to historical levels. On the pharmacy side, we are experiencing several themes affecting our margins. The fluctuations in NADAC have been significant; while there was some improvement following changes in June, the month-to-month variability is making us cautious about potential developments in the fourth quarter. Furthermore, there are specific market dynamics we encountered in Q3 that may also persist in Q4. For instance, certain generic product launches are following procurement dynamics similar to that of branded products, negatively influencing our pharmacy gross margin. Lastly, the mix of products in the branded category is also adversely affecting margins. This summarizes the factors influencing our margins this quarter.

Hi. Good morning. Thank you. I have 2 questions. One is just about your commentary around prescriptions and not back to prepandemic level. I guess I find that a little surprising just because overall healthcare utilization is so strong. So, do you think it's a market share issue? Is it a pharmacist issue? I know you lost some pharmacists during the pandemic. Maybe if you can provide some updates on that. I know you mentioned Medicaid, but it was my understanding Medicaid is pretty small as a percentage of total revenue. So any other detail would be great. And then my second question is just, I guess, bigger picture. I know you're not giving all the details about the strategic review, but your stock is down a lot premarket. Like do you have a sense for maybe some of your longer-term investors, when you think you could stabilize operating profit in the Retail segment and free cash flow? Is it like a 2026 timeframe? Like any update on the timeframe when you think you can recover this business would be great? Thanks.

Sure. We share the same goal as implied in your second question, which is to be very clear about our strong conviction regarding the core business we are reshaping. Walgreens will be quite different in many respects, providing a new experience. However, we are seeing stabilization and a clear growth trajectory for that business. This process will take time. While we are not providing specific guidance, it will take quarters, not months. It's not likely to be multiple years, but it will require a certain period for us to prove to you and our consumers that we are worthy of their loyalty. Regarding the dynamics of market share and the slower growth you mentioned, it is true that this isn't solely due to Medicaid, although it plays a role. The challenges with Medicaid reenrollment, particularly impacting our urban stores, are one factor, and we are exploring closer relationships with Medicaid as part of our discussions. Rick, would you like to expand on this further?

Yes. And I think as you look at volume, I think we stated that we are growing with the market right now. So, it's not just a Walgreens thing, it is a market dynamic. And so when you look at Medicaid redetermination as an example, Medicaid enrollment really ballooned during the pandemic as, obviously, they were not moving people outside of the Medicaid coverage. And so what we've seen is that states have continued to move patients out. We're seeing upwards of closer to 18 million to 20 million individuals who've moved out of Medicaid coverage and either they have to go out and find coverage like either discount cards, individual plans, or get into commercial plans. And so we've seen a dynamic where they actually have not picked up coverage as quickly and utilization has dropped. And so what I think we're seeing is that pandemic, we were running closer to 4%, 4.5% towards the end of it from a market growth perspective, pre-pandemic was closer to 2.5%. And I think what we're seeing right now is we're actually running below the 2.5% from a market perspective and obviously, we're trying to track with that.

Thanks. Thanks for taking my question. I guess I wanted to expand on Charles' question a little bit. If we were to just do simple math of the stores that you've identified, the 25% stores. And let's just say those stores were gone as of today, what would be the financial impact on the company right now? Like what would be the change in terms of your gross profit or your EBIT or however you want to define it? And then the follow-up to that is, of those 25 stores, I appreciate you calling out that you expect to retain most of the workforce. What is the expectation on the retention of Rx of the scripts in those stores? Meaning, usually when you close a store or relocate a store, you oftentimes are able to keep a vast majority of those scripts. Has there been an analysis of that done yet? Thank you.

Thanks for the question. I'll take the second half, which is absolutely, that's a key part of the analysis and underlying assumptions that we have experience with. Obviously, as you may know, we've been closing multiple hundreds of stores over the last several years and we've gotten very good at being able to not only move those scripts in those patients, more importantly, but also to predict sort of what the drop-off would be based on certain circumstances. So, it is a key part of the analysis. The short answer is we retain nearly all of them, not all of them necessarily but nearly all of them and certainly in a way that makes the underlying overall economics of closing the store makes sense. As it relates to essentially a pro forma of what the business looks like with all of that gone, which would be fairly complex because of a number of factors that you have to assume and that we have assumed, but we wouldn't want to necessarily put out their guidance right now. I'll let Manmohan talk a bit more though about those dynamics.

Yes, certainly. From an analytics standpoint regarding the closures, I want to highlight two key points: we're evaluating 25% of our overall footprint, and as Tim emphasized, not all of these are foreclosures. We are conducting a thorough analysis on a store-by-store basis to identify opportunities for performance improvement and determine which locations require action. Tracy mentioned several factors influencing our decisions, but I’d like to focus on the financial aspect. Ultimately, the decision hinges on cash flow analysis—whether it's positive to keep a store open or to close it. Generally, closing a location tends to benefit our cash flow and adjusted EPS. Regarding retention, Tim also pointed out that we have closed 2,000 locations in the past decade, so we have a solid understanding of what to expect in terms of retention based on store location.

Yes, and let me be clear about one additional thing. We are extremely focused on the fact that closing those stores means we have to reduce our fixed costs that support those stores as well. So, if you're trying to model it, what you would need to do is assume some percentage of stores and then back out the fixed cost because we will be highly disciplined at ensuring that any fixed costs that are being carried by those stores are also removed, which is what makes closing the stores in part very attractive.

Hi, guys thanks for taking my question. I have a question. This might be best for Mary, but maybe Tim, I'd love for you to weigh in on the future of the U.S. Healthcare strategy. Just given the plan to exit VillageMD, and the idea that value-based strategies often take a few years in order to get profitable versus some of your near-term profitability goals. What's the forward take on the need to be in the value-based strategy for the best of U.S. Healthcare? And could we see this become more of a fee-for-service asset going forward?

Yes. I will let Mary. I would remind all the listeners, Mary joined about three months ago and brings tremendous experience and relationships in this space, understands it well. And I want to be clear; we are big believers in value-based healthcare. Actually, pharmacy is the value-based healthcare provider in the ecosystem. Quite frankly, if you really look at cost for outcomes and the work that we can do to impact those outcomes, so we love the fact that we actually own what will be seen over the next 20 years and needed as the most valuable part of the healthcare ecosystem. And frankly, the most accessible, that's number one. Number two, as it relates to VillageMD and that model, we like that model. That's why we've said we would continue to have some investment and it's participate in their growth. It will take time and as I said, we are looking for a different horizon for what we're going to be investing in strategically under our own leadership. But Mary, do you want to talk more generally about that question as it relates to U.S. Healthcare strategy and Village in fee-for-service versus value.

Yes, absolutely. In the U.S. Healthcare business, we are laser focused on being extremely disciplined around where we will focus, what we will do and importantly, what we'll stop doing. So there are areas where we'll grow and double down. And those areas fit the lens Tim articulated earlier. Those things have high-growth potential. They build on our core business. We're streamlining how we operate, as we discussed around going to market with higher impact, how we develop services and how we partner across the industry with payers, health systems, at-risk providers as well as pharma manufacturers. And then third, we'll stop things and frankly, we already have stopped certain things that don't fit this lens or create near-term value. In some cases, we'll exit or restructure those things. So it's important that we stay laser-focused on that. With respect to value-based care, we have already articulated that we don't have plans to continue to invest in brick-and-mortar owned primary care practices. Now having said that, we believe strongly, as Tim said, in value-based care as well as in VillageMD, and we believe in these businesses and payers believe in these businesses and consumers, frankly, love getting their care in these types of businesses. But what we've stated, and I'll say it again, is we'll be a partner to VillageMD in an ongoing way. We'll continue to be an investor. But what we're really looking to do is invest in capital-light services to be a broader partner across the industry. With a range of providers and with a range of payers as well as a range of pharmaceutical manufacturers. And we think we're really well positioned to do that, particularly based on the conversations we've already been having over the last three months. We are very complementary to a lot of players in the system, and they frankly want what we have that they don't have, which is reach our ability to reach people, our ability to engage them and our ability to create interventions in really critical moments. So that's what we're planning to do.

Great. Thanks everyone for the questions and for dialing in. Just to leave you with a couple of thoughts. First of all, our team is very clear that we are in a turnaround. We have a clear eye view of the things we need to do we have gone very deep in understanding every part of this business and being realistic about the baseline we're resetting for growth. Second, we have a team that is literally, I believe, one of the best teams any company could ever have. I am extremely blessed to work with a group of folks who not only work effectively together but are relentlessly focused on the challenge and most importantly, highly committed and believe in the future of our business, the retail pharmacy experience that patients and payers and pharma companies need us to be. Retail pharmacy is central to the future of the experience that we're going to create and the growth that we will have. It is necessary, but it will be different and over the coming quarters, we look forward to showing you as well as telling you how it will be different and the kind of results that it will achieve in a more capital-friendly way. And finally, we are very clear about our role as stewards of capital and making investments that make sense. We have some great assets that are part of our company today. We're going to be thoughtful about how we continue to improve the value of those assets, or do other things that make sense based on our longer-term strategy. So thanks again. We look forward to sharing more in the coming quarters.