Walgreens Boots Alliance Inc (WBA) — Q4 2024 Earnings Call Transcript

Good morning. Thank you for joining us for the Walgreens Boots Alliance earnings call for the fourth 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, Global Chief Financial Officer. In addition, Mary Langowski, President of US 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. Also in the room this morning is Eric Wasserstrom, Senior Vice President of Investor Relations. 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 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. 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 non-GAAP financial measures. These measures are reconciled to the most directly comparable GAAP financial measures set forth in the press release. We encourage you to review the comparable GAAP measures and reconciliation to non-GAAP values in the other earnings materials we provided. I will now turn the call over to Tim.

Thanks, Tiffany, and good morning, everyone. Our fourth quarter and fiscal full year results reflected our focused execution on several critical initiatives against a challenging backdrop for our consumer. When I joined, I had three immediate priorities. First, build a new management team. Second, address items within our control that could improve our financial condition within the year. And third, undertake a strategic review of our collection of valuable assets to lay the groundwork for our longer-term turnaround. With respect to the short-term actions, we successfully hit our three declared goals, cutting costs by over $1 billion, reducing CapEx by over $700 million and realizing over $600 million in benefits from working capital initiatives. These factors contributed to our positive cash flow in the fourth quarter and helped achieve full year cash flow that was also positive. Building on this momentum is critical as we turn our executional focus to stabilizing our core economics, improving our operating cash flow and strengthening our balance sheet beyond the $1.9 billion net debt reduction achieved in fiscal 2024. Equally important, we have conducted a thorough strategic review. Coming out of this work, we are focused on two guiding principles with clear operational and financial priorities. The first guiding principle relates to our operating model. WBA is reorienting to its legacy strength as a retail pharmacy-led company. This allows us to leverage our strategic assets of consumer trust, convenience, and relevance. Our position of trust stems from the millions of interactions our consumers have with our pharmacy personnel every day. We will continue to take actions now and for the long term to be the first choice for retail pharmacy and health services. Having earned our consumers' trust, we also want to be accessible and convenient but we need to be appropriately sized. Consequently, we are announcing an expanded footprint optimization program. We have over 8,000 stores, of which the majority, approximately 6,000, are profitable. This solid base supports our conviction in a retail pharmacy-led model that is relevant to our consumers, and we intend to invest in these stores over the next several years. Part of the funding for this investment will come from accelerating the closure of underperforming stores. We expect to close approximately 1,200 of those over the next three years and reduce the fixed costs associated with them. Executing on this program will realign our footprint to a healthier store base that we believe will enable us to respond more dynamically to shifts in consumer behavior and buying preferences. Our ability to respond to a changing environment needs to improve and was a critical objective of our strategic review. We intend to close this competitive gap with some of our peers who have invested in similar capabilities over the past several years. While the decision to close a store is never easy, we feel confident in our ability to continue to serve our customers and intend to follow our historic practice to redeploy the majority of the workforce in those stores that we close. In addition to being trusted and convenient, we must be relevant to today's consumer. To this end, we are reevaluating our merchandising strategy to offer a refreshed assortment of products, including our own brands. By being more selective with national brands and expanding our own brands, we are sharpening our focus as a destination for categories for which we believe we are uniquely positioned to lead, like health and wellness and specifically women's health. We launched over 300 new owned brand SKUs this year and expect to launch another 300-plus in fiscal 2025. Our second guiding principle is a disciplined financial model, which targets strong free cash flow generation and appropriate leverage. Our focus in the near term is on improving our operating cash flows through cost and working capital management while establishing the baseline for AOI growth. In fiscal 2025, we expect to realize $500 million in working capital initiatives and $150 million in further CapEx reduction. In addition, we are focused on monetizing non-core assets to generate cash. Chief among this is VillageMD. While our plans with this investment may take several different forms, in all scenarios related to VillageMD, we are committed to redeploying any proceeds to reduce our net debt and improve the health of our balance sheet. Our efforts around VillageMD are just one example of how, on a go-forward basis, we are maximizing optionality around our portfolio of assets. As we consider if and when to appropriately monetize these assets, we will continue to harvest gains from our portfolio of public equities, Cencora and BrightSpring, to generate cash and further enable debt reduction. As we go forward, we have three priorities, to stabilize pharmacy margin, advance the execution of our retail strategy, and improve our net debt position. This emphasis on improving the strength and quality of our balance sheet underscores Manmohan's leadership in establishing our financial priorities to which he will speak in a few moments. Let me now bring some visibility to the status of our discussions surrounding pharmacy margin and reimbursement rates. We continue to be confident that we are in a multi-year process to reframe our relationship with PBMs on reimbursement. We are changing the dialogue to ensure we both procure drugs at a fair price and that we are paid fairly for the value that we provide. As part of our efforts, we have worked with some PBMs to bring more stability and predictability to our reimbursement while maintaining broad network access. It continues to be our goal to serve as many patients and communities as possible. However, going forward, Walgreens will make difficult decisions if a PBM will not provide reasonable reimbursement for our services in order to maintain our presence in communities across America. Today, we have visibility into reimbursement for approximately 80% of the anticipated script volume in fiscal 2025. We are pleased with the willingness that some of our PBM partners have shown to consider current trends and adjust reimbursement such as rebalancing brands and generics, and we look forward to working with those partners on how we can grow together. Several significant contracts are in the process of being negotiated over the next year, and we will pursue rational reimbursement that ensures we are paid fairly. Turning to NADAC. Based on the latest data, we have seen it begin to stabilize. However, it is critical that regulators work alongside us and industry groups to implement a solution that reduces future instability and ensures that NADAC is a predictable product benchmark for pharmacy reimbursement. Finally, outside of working with PBMs and payers to evolve reimbursement, we continue to progress efforts to broaden and deepen the services we get paid for. Provider status and other new payment arrangements remain a key opportunity for us to fully deploy our pharmacist capabilities, lighten the burden on the broader healthcare system, and further stabilize and improve our overall pharmacy economics. Many of our actions across this turnaround will take time, but I am confident that we have the right team, the right focus, and the right strategy. Manmohan will detail our expectations for fiscal 2025 in a moment. Our most recent quarterly results underscore the importance of executing with intent to stabilize the core business irrespective of the macroeconomic backdrop. We have a lot of work to do, and 2025 will be an important rebasing year to drive longer-term value creation. And before I conclude, I wanted to say a few things about how we're supporting the communities recently impacted by Hurricanes Helene and Milton. Our thoughts are with all our patients, customers, team members and everyone else that's been impacted by these natural disasters. In times of crisis, it's heartening to see the generosity of America's response. At Walgreens, we've leveraged our public-private partnerships to implement a national PIN pad program with the American Red Cross to raise over $5 million, which has been used to donate water and other urgent supplies for the communities in need. Walgreens has also made a donation to the American Red Cross Hurricane Helene Fund. In terms of the impact to us, about 1,050 of our stores were brought offline by the storms or in preparation for them, but we have restored all but 16 of them. We're working to ensure we continue to provide essential services to these impacted communities. I will now turn it over to Manmohan to review our financial results.

Thank you, Tim, and good morning, everyone. Overall, fourth quarter results were in line with our expectations. Thematically, the quarter reflected the same trends that characterized our full year results with pressure on US Retail Pharmacy partly offset by growth in our US Healthcare segment, while our International business continues to perform in line with our expectations. Adjusted EPS of $0.39 decreased 41% year-over-year on a constant currency basis. Approximately 70% of this decline relates to lower sale leaseback gains, lapping the reversal of incentive accruals in the prior year, and lower Cencora equity income. Headwinds in the US Retail Pharmacy businesses were partly offset by cost savings initiatives and growth in US Healthcare business. GAAP results for the quarter included certain non-cash charges. We recognized a $2.3 billion charge for valuation allowance on deferred tax assets. These deferred tax assets were primarily related to opioid liabilities recognized in prior periods and remain available for the company to offset potential future income, including gains from monetizing assets. We also recognized $696 million in impairment charges for CareCentrix goodwill and our equity investment in Chinese pharma company, GuoDa. As a reminder, last year's GAAP results included certain charges related to opioid claims and lawsuits. Let's move on to the full year highlights. Adjusted EPS of $2.88 declined 28% on a constant currency basis due to the softer US Retail Pharmacy performance and significantly lower sale leaseback gains. This was partly offset by cost savings initiatives and improved profitability in US Healthcare. GAAP net loss was $8.6 billion compared to a loss of $3.1 billion in fiscal '23. GAAP results included certain non-cash impairment charges related to VillageMD goodwill in the second quarter. The prior year period included a $5.5 billion after-tax charge for opioid-related claims and lawsuits partly offset by a $1.7 billion after-tax gain on sale of Cencora and Option Care Health shares. Now, let me cover the US Retail Pharmacy segment. Comparable sales grew 8.3% year-on-year, driven by pharmacy and partly offset by a decline in retail sales. AOI decreased 60% versus the prior year quarter. Approximately two-thirds of this decline relates to lower sale leaseback gains, lapping the reversal of incentive accruals in the prior year, and lower Cencora equity income. Headwinds in the retail and pharmacy businesses were partly offset by cost-saving initiatives. We exceeded our goal of $1 billion in cost savings for the year with most of the benefit recognized in the US Retail Pharmacy segment. Let me now turn to US Pharmacy. Pharmacy comp sales increased 11.7%, driven by brand inflation and mix impacts. Comp scripts excluding immunizations grew 2.6% in the quarter. We continue to track in line with the overall prescription market year-to-date. Pharmacy-adjusted gross margin declined versus the prior year quarter, negatively impacted by net reimbursement pressure, brand inflation, and mix impacts. Recent fluctuations in NADAC resulted in $17 million of impact in the quarter versus the prior year. Turning next to the US retail business. Comparable retail sales declined 1.7% in the quarter. As Tim mentioned, the consumer backdrop remains a challenge. We see this with our customer as sales pressure in the quarter was almost entirely driven by non-essential categories. We continue to refine our pricing and promotion strategy, which helped to improve gross profit margin in the quarter. At the same time, value-seeking behavior and new product launches during the year have driven our own brand penetration up 70 basis points in the quarter, finishing at over 17% of sales to end the year. Retail adjusted gross margin improved year-over-year, positively impacted by category mix towards health and wellness products, partly offset by higher shrink levels. Turning next to the International segment. Total sales grew 3.7%, with Germany wholesale increasing 8.2% and Boots UK up 2.3%. Segment adjusted gross profit increased 2% with growth across all businesses. Adjusted operating income was down 11% primarily due to lapping real estate gains in the year-ago period. Boots UK continues to perform well. Comp retail sales increased 6% with continued market share gains and all categories showing growth. Boots.com sales increased 19% year-on-year and represented 15% of our UK retail sales. Turning next to US Healthcare. The US Healthcare segment finished ahead of expectations for the year, delivering $66 million in adjusted EBITDA. Sales of $2.1 billion increased 7% compared to the prior year quarter. VillageMD sales of $1.5 billion grew 7% year-on-year. The increase was driven by growth in full-risk lives and fee-for-service revenue, partly offset by the impact of clinic closures. Shields sales were up 28%, driven by growth within existing partnerships. Adjusted EBITDA for the fourth quarter was $65 million, an improvement of $94 million compared to last year driven by cost discipline at VillageMD and growth from Shields. Turning next to cash flow. Operating cash flow of $1 billion for fiscal '24 was negatively impacted by $934 million in payments related to legal matters and $386 million in annuity premium contributions related to the Boots Pension Plan. We exceeded our target of $600 million in capital expenditure reductions in fiscal '24, delivering $736 million in savings versus fiscal '23. Similarly, we also exceeded our target of $500 million of benefits from working capital initiatives in fiscal '24. Free cash flow of $23 million declined by $642 million versus the prior year due to lower earnings, higher payments related to legal matters, and phasing of working capital, partly offset by lower capital expenditures. Looking at the fourth quarter, free cash flow of $1.1 billion increased 98% compared to the prior year period. The increase was driven by benefits from working capital initiatives, lower legal payments, and lower capital expenditures. Over the course of fiscal '24, we reduced our net debt by nearly $2 billion and our lease obligations by over $1 billion, and our liquidity position is healthy. We ended the year with $3.2 billion in cash and cash equivalents and $5.8 billion of revolver capacity. Looking ahead, one of our key priorities is to strengthen the balance sheet condition of the company. We are focused on improving our cash flow generation and net debt position through a combination of operational actions and asset monetization activities. These priorities have significant influence on our expectations for this upcoming fiscal year, which I will detail now. As Tim underscored, our priorities for fiscal 2025 is to stabilize our core operations while we made progress on the longer-term strategic and operational turnaround. This view is reflected in our adjusted EPS guidance of $1.40 to $1.80. This guidance is based on three central assumptions. First, in US pharmacy, we anticipate continued pressure on reimbursement rates. We have negotiated approximately 80% of the contract volume for calendar year 2025. Due to the multi-year nature of these contracts, there is still more progress to be made, but we believe we are taking incremental steps towards our goal of reducing the impact of reimbursement pressure on pharmacy margin. The second major assumption is that our customer is likely to remain under pressure and continue to show the same price-sensitive shopping behavior that we experienced in fiscal '24. In response to this dynamic, we are executing a number of retail initiatives over multiple periods. In the near term, we're taking cost actions to improve our operating leverage, including the accelerated optimization of our fiscal footprint. We expect these closures to be accretive to our cash flows in fiscal 2025. Lastly, we expect growth in our Healthcare segment and in the International segment. We expect to close approximately 1,200 stores over the next three years, with about 500 targeted to close in fiscal 2025. Within fiscal '25, we expect this activity to be weighted towards the back half of the year. We are prioritizing closing locations that are cash flow negative, underperforming stores where we own the locations and ones where lease expirations are coming due in the next few years. This focus is expected to partially mitigate the incremental burden of dark rent. The economic benefits of this approach should begin to be tangible in fiscal '25. By accelerating the scope of our footprint optimization program and focusing on stores with weakest cash generation, we expect to reduce our working capital needs and improve our cash flows over the next 12 months. We expect the in-year benefit from footprint optimization program to be approximately $100 million of AOI with positive cash contributions, including the cash benefits from working capital and sales of owned stores, net of closure costs. Over time, these actions should also enable us to fund the investments we plan to make in higher-performing stores as we look to improve our customers' in-store experience. For this year, we're prioritizing investment in those stores that should be the recipients of the scripts, merchandise, and the foot traffic from the stores we're closing. We are continuously evaluating our footprint, and this includes all our stores to ensure we operate with the best possible footprint. Let's now turn to additional guidance line items. We are providing additional guidance on certain enterprise and segment-level line items for modeling purposes. We expect at the midpoint of our guidance range for adjusted EPS, about 60% of the year-over-year decline reflects the impact of a higher tax rate and lower contributions from sale leaseback gains and Cencora earnings. On a corporate level, we're anticipating higher interest expense due to lapping prior year gains on bonds. Let me cover segment level details next. For the US Retail Pharmacy segment, at the midpoint of the range, we expect a year-over-year decline in AOI of $1.1 billion. Approximately 40% of this decline is driven by headwinds from sale leaseback gains and prior Cencora share sales. We anticipate that fiscal '25 will be the last year of headwinds from sale leaseback gains. Excluding these impacts, we expect headwinds from net reimbursement pressure and retail to drive the remaining year-over-year declines, partially offset by the impact of the footprint optimization program. We expect the overall market growth for script volume to be between 2.5% to 3% with our total prescription growth impacted by store closures. We expect vaccinations to be slightly lower compared to fiscal year '24. Guidance assumes no significant changes to the recent trends impacting pharmacy margin including brand inflation, mix, authorized generics and continuation of most recent trends in NADAC. We expect retail comparable sales of negative 2% to negative 3%. Lastly, we expect adjusted EBITDA for the US Healthcare segment to improve by $250 million, and in fiscal year '25 we expect adjusted EBITDA to range from $280 million to $350 million. Let's conclude with cash flow and capital allocation. We expect our efforts to stabilize retail sales and pharmacy margin to take hold over time. In the near term, we will continue to bolster our free cash flows through working capital optimization initiatives, as well as rightsizing our capital expenditures. In fiscal '25, we expect working capital initiatives to generate approximately $500 million of free cash flows and capital expenditure reductions of approximately $150 million. We anticipate an AOI headwind of approximately $400 million from lower sale leaseback gains and Cencora equity earnings. This will not impact free cash flow. In fiscal 2024, we began to refocus our financial philosophy, which includes decisions to simplify our financial reporting, such as the wind-down of the sale-leaseback program and Cencora share sales, but also in terms of capital allocation priorities. As we monetize assets in fiscal '24, we reduced our net debt position by $1.9 billion. This is a good start, but there is still more work to be done to continue to strengthen our balance sheet in the coming years. Given this imperative, we intend to further monetize non-core assets. Additionally, we expect our lease liabilities to decline further due to the conclusion of our sale-leaseback program and as we execute against our footprint optimization program. We believe these actions will improve our cash position and financial flexibility as we focus on reducing net debt while supporting the successful execution of our turnaround over the next few years. With that, let me pass it back to Tim.

Thanks, Manmohan. Before opening the call up for Q&A, let me leave you with a few closing thoughts. We are confident that we have the right team and the right strategy, and we are laser-focused on two principles: that we are a retail pharmacy-led organization and that the economics of this model must be disciplined and sustainable. To this end, we intend to meaningfully strengthen our balance sheet over the next few years, and there is a clear path to doing so as we work to stabilize our financial performance, monetize non-strategic assets, reduce our lease exposure, and address our net debt position. We will adopt a flexible and pragmatic capital allocation strategy. We believe our reorientation to retail pharmacy has a bright future. We're engaging in a multi-year program with a long-term goal of appropriately sized and well-positioned fleet of stores and an industry-leading customer experience across consumer channels. We believe the adjacent strategic businesses in which we've invested can incrementally contribute to value creation over the long term. We are in the early stages of a turnaround that will take time, but the fiscal fourth quarter was an important building block in the foundation of this turnaround, and we expect further progress in fiscal 2025. With that, let's take questions. Operator?

Good morning, and thanks for taking my question. Tim, I just want to focus on a couple of things. One, would just be some of the comments that were made early on around the restructuring of the reimbursement, when you talk about 80% visibility, you also talked about very difficult decisions around maybe contracting going forward. So how do I, one, balance that when I think about improving rates? Do we expect improvement rates in 2025? Is this more of like a three-year plan? And then secondly, when you think about those difficult decisions, are you thinking about leaving some networks? How do I put all those pieces together?

Thanks and good morning, Lisa. To address your question about 2025, we anticipate a decrease in reimbursement pressure based on the trend we're seeing, which aligns with a pattern we've discussed previously. I was optimistic that payers were becoming more reasonable regarding what we could offer. As retailers pull less from the market, it supports this trend. In 2025, we expect to see improvements in this area. Additionally, all stakeholders, including PBMs, payers, and our competitors, recognize that the dynamics have shifted. This is evident in the productive discussions we've had where we’ve successfully secured contracts, utilizing various mechanisms tailored to specific circumstances. We are flexible in how we adjust risk and ensure we do not face unmanageable reimbursement pressures that would be unsustainable and unnecessary. Regarding the remaining 20% of conversations, they are also constructive. I want to emphasize that we are prepared to make tough choices if we feel we're not being fairly compensated. This doesn't imply we're raising prices; rather, we are stabilizing the downward pressure without withdrawing funds from the market through purchasing or generic dynamics that would otherwise allow us to enhance our reimbursement levels. This is a crucial topic for our investors and the market overall. For the 20% of challenging conversations, we are open to stepping away from a business line if it does not make financial sense. I believe the payers understand this, and I am confident that over the next two to three years, we will redefine the approach to reimbursement discussions.

That's very helpful. And just one follow-on. That would be, as we think about the cadence of '25, I know Manmohan talked about the store closings impacting more the back half of the year. Anything else you would call out as I think about how earnings will develop in '25?

Yeah. From a cadence perspective, Lisa, you ought to think about maybe the same trend as we have seen in the last couple of years. We do have roughly around 500 closures, which are back-half weighted. But then we also had closures in the second half of fiscal '24. So we're going to see the benefit from store closure continue to scale within '25 and then beyond over the next few years as well.

Operator, next question?

Thanks for all the details on free cash flow. I just had a question on timing. I know, Tim, in your prepared remarks, you talked about fiscal 2025 is a rebasing year. You want to get AOI to a point where you can grow. Is that fiscal 2025 or do we really have to wait until you're able to stabilize these PBM contracts and grow from there? So, any timing that you can provide on when you think would be a base to grow from? And then secondly, I think last conference call, you talked about negotiating on some vendor contracts. Can you provide any update on that progress? That would be great. Thank you.

Yeah, I'm sorry, could you just repeat your second question, which contract?

I think some supplier contracts, whether it's drug distribution or anything in the front store. I think the company has talked about maybe the potential of being able to renegotiate the contracts. So any progress on that would be great.

Sure. Thanks. So, first from a timing standpoint, as you can appreciate, we've said all along, this is a multi-year turnaround. This is a rebasing year in '25. We're not giving three-year guidance at this point other than to say that we believe this re-platforming of the company and the things that we've said we are going to do are already putting us in position for growth in the longer term. I'll let Manmohan give you any additional color as it relates to the longer-term perspective. Regarding Cencora, we have a longer-term arrangement with them that goes until '29. We meet with them regularly to evaluate how they can help us. We're not going to give any updates at this time, but there is a meaningful dialogue, and we believe that there are ways we can work together to grow.

Sure. We are not providing long-term guidance today, but as Tim mentioned, our goal is to increase AOI and free cash flows over the next three years. For fiscal '25, the guidance we shared suggests earnings of about $0.80 to $0.85, with approximately 60% of the impact coming from a higher tax rate, the recent sale of Cencora shares, and reduced sale-leaseback contributions. Fiscal '25 serves as a better quality baseline. We anticipate around $250 million in equity earnings from Cencora in fiscal '25, which will be recognized in fiscal '26. From a business performance standpoint, we expect growth in US Healthcare and internationally for fiscal '25. As Tim noted, we will focus on improving pharmacy margins and retail sales in the US, with benefits from these initiatives expected to scale over the next three years. For fiscal '25, we will also maintain cost discipline, which includes the footprint optimization program announced today, expected to contribute around $100 million to our results. This outlines our outlook for fiscal '25 and some of the factors influencing our longer-term strategy.

Yeah. Good morning, guys. And, Manmohan, maybe I missed this, but are you able to talk about the discrete impact of the store closures in fiscal 2025 and maybe from a run rate basis to the US Pharmacy business? And then my follow-up question would be, are you able to provide any color on earnings cadence in the US Pharmacy segment as we think about the progression of fiscal '25 just kind of given the slope of how earnings have progressed recently? I think that would be helpful. Thank you.

Sure. So far, store closure benefits in the year, we expect roughly around $100 million contribution to AOI in fiscal '25 and that will continue to scale into '26 and '27 as we close more locations over time. So that's a run rate. From a cash perspective, we expect footprint optimization to be accretive in the year as well. Simple way to think about this is that the benefit from working capital as we close locations and monetize inventory outweighs the closure cost in the year. So that's on the store closure. On the cadence side, we're going to be pretty much in line with how the cadence has played out over the last couple of years. So, don't expect significant changes there, first half versus second half.

Thanks for taking the question. I just want to follow up on Lisa's question. Tim, you mentioned that with 80% of the contract volume renegotiated, it's lower, but is that going to remain stable going forward? So, for that 80%, it seems to be establishing a new baseline. Additionally, I appreciate all the comments regarding free cash flow, but can you provide some insight into what free cash flow will look like for fiscal '25? There are many moving parts involved, and it appears we're still facing negative free cash flow for the year. Could you give us an idea of what the high end and low end of the EPS guidance might be? Thank you.

Sure. Thanks. And I'll let Manmohan take the second question. As it relates to the contracts, again, I want to reinforce that it is an ongoing and dynamic process. When I call it a reset, it's a structural reset rather than a one-off. Those contracts are typically multiyear, which is why it's going to take us a few years to work through them. The 80% is an actual number, and I'm not surprised that the remaining contracts are the ones that require more work. So we'll get there. Manmohan, do you want to take the second question?

Sure. So, from a free cash flow perspective, for '25, a couple of things to consider. First is we expect adjusted operating income to decline in '25. Roughly around $400 million of that is due to the lower sale leaseback contribution and lower earnings from Cencora. Those items do not affect free cash flow. So we just wanted to flag that. Legal payments in fiscal year '25 are expected to slightly increase, before they go down in '26. We're working to offset these headwinds from working capital optimization of roughly around $500 million in the year and on the CapEx side, we expect reductions of approximately $150 million. Those are the building blocks for free cash flow. Lastly, we will continue to take a pragmatic approach to capital allocation going forward.

Thank you. A question on US Healthcare given the guiding principles you laid out, Tim. I guess question one is, is there any component here that's key to the strategy of rebasing around the Retail Pharmacy customer? And then, Manmohan, maybe I'll ask you about VillageMD. The focus here, you mentioned profitability or profitable growth from the other elements of the business. Is there a reduction in investment or stabilization in the underlying VillageMD operation?

Sure. Thanks for that, Eric. First of all, it starts with our clinicians and our team, which is the underlying asset that enables us to look at other services for payers or pharma. Our US retail strategy is a healthcare strategy, and it's crucial. I would then say what's probably not as well appreciated is our specialty pharmacy, being the largest independent specialty pharmacy. Having those assets and the team we have is a tremendous starting point for growth. Other complementary services like Shields are also critical. We haven't baked all kinds of upside into our guidance, but we believe these will take time. Manmohan can provide you a bit more context on VillageMD.

Yeah, sure. From a US Healthcare segment perspective, a couple of themes throughout the year have been growth at Shields and improvement at VillageMD driven by a significant cost reduction program. We expect these themes to continueed as we move into '25, with an expectation of cost benefits at VillageMD for the year, including the effects of closures executed in fiscal '24. We expect their contribution margin to also improve slightly year-over-year driven by higher fee-for-service volume.

Thank you for taking my question. Regarding store closures, I'm curious about what you think you will retain over time in terms of prescriptions and foot traffic. Is there a specific percentage you have in mind as you assess this? It was previously thought to be 70%, is it around 50% now? How do you view this in relation to your guidance?

That's an important dimension, one of a number of dimensions that we've evaluated regarding the 2,000 stores we spoke about last quarter and the 1,200 that we've announced that we will close. The recapture rate is critical and we look at that as it relates to store level dynamics. There is no one number, but we are precise about it. It's not as simple as a number, but it is a piece that we look at. We have experience both buying files and moving patients, as we've closed stores, and we are confident in our ability to engage our patients, including through home delivery.

Thanks. And if I can ask a quick follow-up. You talked a lot about deleveraging and getting your net debt down and improving free cash flow. I didn't necessarily hear full endorsement of the current dividend. How do you think about that? Is the dividend as it’s part of the strategy for shareholders going forward?

What you heard Manmohan say is that we have adopted a flexible and pragmatic capital allocation strategy. We will continue to monitor and make changes to our capital allocation, including better aligning our dividend with our long-term earnings power if we believe that that's appropriate. Those conversations are continual, and I don't have any news for you today. We believe that in the near term we can continue to monetize non-strategic assets to improve our balance sheet, but everything's on the table.

Hey, guys. Thanks so much for the commentary and additional color. I have a question on the working capital improvement. Can you help me parse out sort of how you're thinking? Obviously those come from a variety of different things. You talked about suppliers, store closures. Can you think through the bucket of that and how to think about it on a multiyear basis, like, how much is coming from stores versus supplier agreements and other factors?

I'll let Manmohan take it other than just saying that it results from many aspects well managed and executed by a team focused on working capital. I've never been prouder of a team managing these items. It's not just one thing; it's execution across various dimensions of the business.

Yeah, sure. For us, our goal is always to look at all components of cash conversion cycle. As you think about some initiatives in fiscal '24, we wanted to optimize our inventory levels and monetize unproductive inventory. Things like Nucleus, our micro-fulfillment centers, are also giving us the ability to optimize inventory. We also have initiatives on our account receivables improving timing, as well as rightsizing our accounts payable timing. So we look at all components. Store closure will create opportunities to optimize remaining inventory across our network, generating free cash in the year.

Got it. That's very helpful. And then just as a quick follow-up, how do you feel about the operational expense improvements? You've made significant progress over the years. How much more opportunity do you see, especially in US retail?

If we close 1,200 stores as we plan over the next two to three years, then there are no question stranded costs to go after. Our goal is to be out ahead of those closures as it relates to managing costs. It is now the culture of the company, and we continue to see meaningful opportunity across our business to do things more efficiently. We have a management team really focused on this, and while the opportunity is not as big as it was $4 billion ago, we will continue driving improvements. We're looking to invest back into our stores as we right-size our support system.

Good morning. Thanks for taking the question. Maybe just diving back in on the US Healthcare side, I appreciate the color you gave on the various different moving pieces, particularly in VillageMD, but also the dynamic expectations on monetization. Is there anything that's holding you back on that front in moving faster? I know, Tim, it's something you've talked about since you started about recognizing the need to fit the business. What are some of the thought processes for understanding the checkpoints you need to see to complete a process for monetization?

The key asset in the US Healthcare business where we are looking to monetize is VillageMD. Our goal is to do it without destroying value unnecessarily. The process has been longer than we would have hoped, but we are being very methodical in trying to preserve that value. We believe VillageMD is a great business, and we're engaged in a process to position it well for growth. We will keep you updated as we progress.

Hey, guys. Thanks for taking my question. Just going beyond into the VillageMD topic again. You have a lot of cost reduction that's been going on. But I was hoping you could walk us through any other margin improvement initiatives beyond just cost takeout and location closures? And looking forward, you did announce a new CCO hire that has value-based experience that's very relevant to this business. How should we think about how Jason fits in this puzzle?

Jason is great. We're more excited than we planned on based on his conversations with payers, pharma and his colleagues. Margin expansion isn't just from cost cutting; we have growth initiatives Mary is incubating now. Bringing Jason on is a clear signal that we believe we have valuable services to offer. We haven’t constructed a fully detailed upside into our guidance yet, but we believe it will take time. The sales cycles in a B2B are not short. Mary has built a great team focused on specialty pharma services, data analytics and others.

Thank you, Tim. We've said before that the US Healthcare business focuses on a disciplined growth strategy emphasizing near-term shareholder value creation and cost discipline. We've exited non-core programs and are focused on growth across our current core and adjacent assets, including specialty pharmacy, Shields, and data analytics. Jason will drive the commercialization and B2B partnerships.

Thanks to everyone for dialing in this morning. I reflect on my almost year here at Walgreens, building a brand-new team in Chicago, driving a disciplined approach to capital, achieving aggressive goals for expenses, working capital, and CapEx, while also reducing our net debt by $1.9 billion and simplifying our financial reporting. We have a lot of work to do, but the fiscal fourth quarter was an important building block in the foundation of our turnaround, and we expect further progress in fiscal 2025. Thank you.