Walgreens Boots Alliance, Inc. (NASDAQ:WBA)
Q2 2016 Results Earnings Conference Call
March 05, 2016, 08:30 AM ET
Gerald Gradwell - Senior Vice President, Investor Relations and Special Projects
Stefano Pessina - Executive Vice Chairman and Chief Executive Officer
George Fairweather - Executive Vice President and Global Chief Financial Officer
Alex Gourlay - Executive Vice President of Walgreens Boots Alliance, Inc. and President of Walgreens
Alvin Concepcion - Citigroup Global Markets, Inc.
Robert Willoughby - Credit Suisse
Eric Kutcher - Barclays
Ricky Goldwasser - Morgan Stanley
Robert Jones - Goldman Sachs
Lisa Gill - JPMorgan
George Hill - Deutsche Bank
Eric Caldwell - Robert W. Baird
David Larsen - Leerink Partners
John Heinbockel - Guggenheim Securities
Eric Bosshard - Cleveland Research
Charles Rhyee - Cowen and Company
Good day, ladies and gentlemen, and welcome to the Walgreens Boots Alliance Second Quarter 2016 Earnings Conference Call. At this time, all participants are in a listen only mode. Later, there will be a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder today's call is being recorded.
I would now like to turn the conference over to Gerald Gradwell, Senior Vice President, Investor Relations and Special Projects of Walgreens Boots Alliance. Sir, you may begin.
Thank you, and good morning, everyone. Welcome to our fiscal 2016 second quarter earnings call.
Today, Stefano Pessina, our Executive Vice Chairman and Chief Executive Officer, and George Fairweather, Executive Vice President and Global Chief Financial Officer, will take you through our results in greater detail. Also joining us on the call and available for questions is Alex Gourlay, Executive Vice President of Walgreens Boots Alliance and President of Walgreens.
You can find a link to our webcast on our Investor Relations website at investor.walgreensbootsalliance.com. After the call, this presentation and a webcast will be archived on our website for 12 months.
Certain statements and projections of future results made in this presentation constitute forward-looking statements that are based on our current market, competitive, and regulatory expectations and are subject to risks and uncertainties that could cause actual results to vary materially. Except to the extent required by law, we undertake no obligation to update publicly any forward-looking statements after this presentation, whether as a result of new information, future events, changes in assumptions, or otherwise. Please see our latest Form 10-K and other filings for a discussion of risk factors as they relate to forward-looking statements.
As a reminder, today's presentation includes certain non-GAAP financial measures, and we refer you to the appendix of the presentation materials available on our Investor Relations website for reconciliation to the most directly comparable GAAP financial measures and related information.
With that I will turn the call over to Stefano for some opening comments.
Thank you, Gerald. Good morning, everyone, and welcome to our second quarter 2016 earnings call. It is a pleasure to be talking to you all today, although I must say that these quarterly earnings calls always present me with my challenge. The work that we are doing within our businesses around the company is far reaching and over time we will have a confirmative impact. But quarter-to-quarter it is not always easy to find new things to say or to demonstrate the changes in our company other than by the meticulous taking of the detail numbers and that is naturally what George is here to do.
My role on these calls is to put the results in the context of a bigger picture, but that bigger picture though it will look very different over the years to come, does not show great [indiscernible] of a time and frankly, we should all be glad about that as stability is generally a good thing.
The changes we are making must be managed carefully and progressively if they are to have a long term and sustainable impact on the company. This quarter we have continued to make good progress in driving cost out, establishing even more efficient working practice and in factoring the company appropriately for the future.
We can see the impact of this in the company's results announced today with adjusted net earnings attributable to Walgreens Boots Alliance diluted share up 11% compared to the same quarter last year to $1.31. All three divisions have we believe delivered a very creditable financial performance, but there is plenty more to do and we are still at a relatively early stage in this process.
Since last quarter results, we have made good progress in developing the company with a more focused mindset and strategic direction and I will talk about this later in our presentation, but for now I will handover to George to talk us through the financial performance.
Thank you, Stefano. Good morning everyone and good afternoon to those listening in Europe. Overall we view our second quarter performance as quite good, particularly given the number of headwinds including the weak cough, cold, flu season and currency translation.
So beginning as usual with the key financial highlights for the quarter, net sales were $30.2 billion up 13.6% versus the same quarter a year ago. This increase was largely due to the consolidation of Alliance Boots for the entire second quarter this year and to sales growth in our Retail Pharmacy USA division. Foreign currency translation adversely affected sales by approximately $750 million or 2.4%. This was due to the strengthening of the U.S. dollar.
On an adjusted basis operating income was $2.1 billion up 15.2% of net earnings attributable to Walgreens Boots Alliance were $1.4 billion up 14.4% and diluted earnings per share were $1.31 up 11.0%. These results are of course not directly comparable with the second quarter of fiscal 2015 due to Alliance Boots transaction in December 2014 and the resulting changes in our consolidated group and segmental reporting.
We have now lapped the closing of that transaction and we'll have fully comparable quarterly results beginning in the third quarter. On a GAAP basis, operating income was $1.9 billion up 35.1%. The GAAP net earnings level our performance versus last year was impacted by a number of accounting factors. The most significant being last year's non-cash gain on the remeasurement fair value of our previously held equity investment in Alliance Boots and the change in fair value adjustments on our AmerisourceBergen warrants. As a result, GAAP net earnings attributable to Walgreens Boots Alliance were $930 million and diluted EPS were $0.85.
This is a leap year our second quarter results benefited from one extra day versus last year. We have also prepared all comparable sales and prescription figures to include only the first 28 days of February. For completeness, here are the numbers for the first of half of fiscal 2016. I will not go through those in great detail, but you will note that adjusted diluted earnings per share of $2.34 is up 18.2% versus the same period a year ago.
So turning now to our segmental performance. Total Retail Pharmacy USA sales for the quarter were $21.5 billion an increase of 2.1% over the same quarter a year ago. Sales on a comparable store basis increased by 2.2%. This sales growth was driven by increased market share partially offset by the sale of a controlling interest in our infusion business last April and the weak cough, cold, flu season which was particularly strong in the comparable period last year.
Adjusted gross margin increased 10 basis points to 27.7% primarily due to procurement efficiencies. This resulted in $6.0 billion of adjusted gross profit up 2.8%. Adjusted SG&A was $4.3 billion an increase of 30 basis points as we continued to focus on store efficiencies and controlled corporate costs. Adjusted operating income was $1.6 billion up 2.1% giving an adjusted operating margin of 7.6%. Excluding Walgreens share of equity earnings in Alliance Boots in the year ago quarter, adjusted operating income for the division grew by 10% and adjusted operating margin by 60 basis points.
So turning now to look in more detail at Pharmacy. Pharmacy sales were up 3.2% for the quarter, 233 million prescriptions were filled on a 30-day basis including immunizations. It was an increase of 3.9%. On a comparable store basis, pharmacy sales increased by 3.7% with comparable scripts filled up 2.8%. We view this as a good performance, particularly given the weak cough, cold and flu season this year which we estimate are the 30 basis points negative impact on comparable scripts.
Reported incidents of flu across the USA declined by 16% compared with the year ago quarter according to IMS Health. Overall, our retail prescription market share on a 30-day adjusted basis increased by 19.5% up approximately 20 basis points over the year ago quarter, again as reported by IMS Health. Our increase in comparable store scripts was driven by Medicare Part D growth strategy where we grew market share.
Consistent with our expectations we experienced a decline in Pharmacy gross margins, which were impacted by ongoing reimbursement pressure and changes in mix, including an increased contribution from Medicare Part D. As you know, the new Medicare Part D rates came into effect on January 01 this year. Our second-quarter results therefore included two months of the new rates, but looking ahead our third and fourth quarters will reflect their full impact. As we've said before, we continue to anticipate gross margin pressure in Pharmacy, but remain confident in our ability to grow the business over time.
Retail product sales were up 30 basis points compared with the second quarter of 2015 with sales on a comparable basis down 30 basis points. Gross margin increased compared with the year ago quarter. Again, we are pleased with these results given the weak cough, cold, and flu season. We estimate this headwind had an impact of approximately 100 basis points on comparable sales this quarter. We saw good performances over Christmas and New Year with strong sales in giftables and candy.
Wellness, another area of focus also performed well driven by sales of vitamins and first-aid products. We also made good progress in driving sales of No 7 during the quarter. As I have mentioned before, we are on track to rollout our differentiated beauty offering to an additional 1600 stores beginning this summer. This will increase the total number of stores with this beauty offering to approximately 2000 by the end of calendar 2016.
So let me now provide more detail on our Retail Pharmacy International division. Total Retail Pharmacy International sales for the quarter were $3.7 billion with pro forma constant currency comparable store sales up 2.3%. Adjusted gross profit was $1.5 billion with an adjusted gross margin of 41.1%.
As you are aware, this quarter is not directly comparable with the same quarter last year which did not include December 2014. December is a very significant sales month, but typically has a slightly lower gross margin reflecting a higher proportion of gifting items. Adjusted SG&A was $1.2 billion and adjusted operating income was $335 million. The adjusted operating margin of 9.1% was higher than the year ago period due to the seasonally strongest month of December being part of our second quarter this year.
So looking more closely at the segment, comparable pharmacy sales on a pro forma constant currency basis were up 2.6% and comparable retail sales were up 2.1%. Comparable pharmacy sales in British UK increased by 3.0% as a result of an increase in average item value and additional high-value drugs dispensed in hospital pharmacies. Comparable retail sales at British UK were up 1.8% driven by good performance over the holiday period.
Growth in our boots.com 'order and collect' service was strong with seasonal categories on our beauty product brands such as No7 and Soap & Glory being key drivers. Liz Earle also performed very well in the quarter both in-store and online. We are continuing the UK rollout of Liz Earle and Sleek which we acquired in November. Outside the UK sales growth continued to be particularly strong in the Republic of Ireland.
Turning now to our Pharmaceutical Wholesale division. Total sales for Pharmaceutical Wholesale were $5.6 billion. On a pro forma constant currency basis, excluding acquisitions and disposals, comparable sales increased by 1.6% over the same quarter in 2015. This was in line with our estimate of market growth weighted on the basis of our country wholesale sales.
Turkey, the UK and Norway performed well, while the French and Russian markets remained challenging. Adjusted operating income for the division was $155 million in the quarter and adjusted operating income margin was 2.8%. Going forward the Pharmaceutical Wholesale division will include our share of net earnings attributable to our equity method investment in AmerisourceBergen.
I'll now just take a few moments to explain how we will account for this. As you know following the exercise of our first tranche warrants on March 18 we own 34.2 million shares or approximately 15% of the outstanding shares of AmerisourceBergen. We will account for this investment using equity method accounting subject to a two-month reporting lag. The lag synchronizes our reporting with the end of the quarterly fiscal periods.
Due to the lag in our third quarter we will only recognize our share of equity income for a couple of weeks, but of course we will recognize a full quarter of equity income in our fourth fiscal quarter based on AmerisourceBergen's quarter ending June, 30. From a funding perspective, we used approximately $1.2 billion from existing cash on hand to exercise the warrants.
Combined net synergies in the quarter from the Alliance Boots program were $329 million taking the cumulative total for this fiscal year to $617 million. We are well on track to deliver our goal of reaching at least $1 billion of combined net synergies in fiscal 2016. We are also continuing to make good progress in delivering our $1.5 billion cost-saving program by the end of fiscal 2017 and are well on track to achieve this.
Operating cash flow in the quarter was $2.4 billion driven by our combination of operational performance and cash conversion from the sale of seasonal inventory. Cash capital expenditure in the quarter was $317 million. As I have said on previous calls, we continue to invest in key areas that develop our customer proposition including IT. This resulted in free cash for the quarter of $2.0 billion. As we have stated previously, we're very focused on cash flow and are very disciplined in making capital allocation decisions and we remain committed to a solid investment grade rating.
As you have seen from our press release, we have narrowed our fiscal 2016 guidance range to between $4.35 and $4.55 by raising the bottom end of the range by a further $0.05. This assumes AmerisourceBergen equity income on a two-month lag no material accretion from agreement to acquire Rite Aid, the previously announced suspension of the balance of our $3 billion share buyback program, the continuation of our normal anti-dilutive buyback program relating to equity incentives, and no significant changes in current currency exchange rates.
Please remember that we have currency translational exposure. Not only does this impact our adjusted operating income and EPS, but it can also cause quarterly volatility in the sales gross margin and SG&A line items. We estimate that 1% move in Pound Sterling and the euro versus the dollar impacts full year sales by approximately $150 million and $125 million respectively. On an adjusted earnings level a 1% move in Pound Sterling impacts full year adjusted EPS by approximately $0.01 per share of the impact of the euro is somewhat less significant.
Note that other currencies can also impact reported results, particularly on the sales line as they did this quarter. Our guidance reflects current currency rates and so factors in headwind of $0.06 since we provided our initial fiscal year 2016 guidance back in October 2015.
Since Walgreens provided its fiscal 2016 adjusted earnings per share goal way back in August 2014 that was a $4.25 to $4.60 we've encountered a currency headwind of around $0.19 per share.
And lastly, when considering the outlook for the balance of this fiscal year, please keep in mind that during the third quarter of our last fiscal year that we had a temporary pause in certain investments within our U.S. business as we evaluated the returns being generated on certain projects.
By the time we entered the fourth quarter of last fiscal year we had finished this exercise and resumed our more normalized SG&A spend. This led to SG&A last year being a little lower in Q3 and a little higher in Q4 than you would expect on a more normalized basis. So with that, I will hand you back to Stefano.
Thank you, George. So, if you’ve heard of all our companies therefore being pretty much in line with our expectation. [Indiscernible] we are now past the main year of the exceptional items that impacted us during the last few quarters as we began to work of bringing our management information system together and started work as with most of our projects is now complete after such a short time as a unified company we are making good progress.
As our business begins to normalize and embrace a new approach to important gain control both at the business and operational level we are beginning to see far more cleanly the impact and implications of the levers we have to influence our operations and the areas where we have the greatest opportunities and the areas where we have the most work to do. I have to say that this is very much what we expected.
It is an important and necessary exercise to help ensure our priorities are correct and our assumptions are not flawed. I believe that one of our greatest things as a managing team is that where we can, we base our decision on provable facts and where we can't, we always and I mean always question our own assumptions.
Then we go back and check whether we were right or not so that we can learn and do better next time. In our U.S. division you can see some examples of how slightly you focus on the way we work is impacting the company already in a very real way, beyond the impact that our cost saving and synergy programs are bringing. In the more innovative approach is we are taking in terms of partnership and strategic relationship such as that we have entered into Valeant Pharmaceutical, why Valeant is as a company is clearly still working its way through some challenges.
The collaboration that we have with them, though still in its early stages is showing some very promising results in terms of improved access and affordability of their product. Since the close of the quarter, we have announced a partnership with OptumRx to create a new 90-day at Retail Pharmacy collaboration giving eligible OptumRx member choice of how to receive their medication and providing them with 24/7 pharmacists availability.
Although I cannot disclose the terms of this contract, it is fair to say that it has been structured so that there is a shift in mutual benefit to us working together to increase the utilization and volumes in a more collaborative manner that I understand to have been the case in the past.
Of course, now let me [indiscernible] is continuing as we expect with the regulatory approval process progressing in line with the timetable we had expected. All these actions not only contribute to the development of the company, but also provide us with opportunities and the flexibility to continue the process of reviewing and rejuvenating our existing operation, both in retail and pharmacy, further differentiating us in the marketplace.
These actions also validate that in seeking to lead improved efficiency in the healthcare value chain we not only target highly selective M&A activities, but also new partnership and relationship driven on equity alignment like AmerisourceBergen.
Innovative commercial relationships such as the Valeant supply contract as well as improvement in long-standing arrangements with our critical business partners. As we have always said, this is much longer term, but it’s essential to the sustainable future of our company.
We have to find new innovative and valuable offering to continue to bring people to our stores. In pharmacy, the contracts can help us to do these to an extent, but we need to announce our patient offering and then ensure we maximize the value of that interaction both to the patients and to ourselves as a company through enhanced services and a richer relationship between the patients, the pharmacies team and our company overall.
In the front of our stores, we need to focus our offering, be clear what we stand for and define our two areas of expertise and differentiation and we need to offer these through whatever medium or interface the customer wants. We have done well in controlling cost and improving efficiency, but we understand that these have limited life span, if the growing [indiscernible] cannot be altered.
Alex and his team know this and are very focused on their very strategies to address the recent trend. If these all sound very U.S. focused it is perhaps not surprising as today the U.S. is the market where we have the most immediate opportunities. This does not mean we are neglecting our other markets. Far from it. In the UK, the team is working hard on strategies to keep Boots stores and our brand portfolio not just ahead of the market but most relevant to its customers.
While working on plan to manage and mitigate the next round of what is ever present government pressure on pharmacy prices and across our businesses owned and in partnership to our equity investment, the work on [indiscernible] constant daily to renew the structure of payment, to be the best they can be and to always be ready to address the challenges, but more importantly to take the opportunities where we see them.
However, we must do this with a strict vigilance and vigor so that we achieve it without disrupting the extraordinary level of service our customers that they’ve come to they were right to expect from us and without failing to deliver for you as the owners of our company. Now let’s open up for questions.
Thank you. [Operator Instructions] Our first question is from Alvin Concepcion with Citi. You may begin.
Hi good morning. Thanks for taking my question and great performance in the quarter. I just had a question on the U.S. retail pharmacy operating margins. On an adjusted basis, it looks to be flat relative to last year, so I’m wondering to what extent did the soft flu season hurt your margin this quarter and as a follow-up to that based on what you’re seeing out there, what is your level of confidence that the operating margin in the U.S. retail business will continue to improve both this year and longer-term?
Hi good morning, Alvin, it’s Alex here. Yes the cough, cold season, I mean the mix particularly in the front of store does have an impact. We have already noticed that we actually might increase the margin from the store despite that impact.
On the other side, which is still the bigger impact on the operating margin in the U.S. is pharmacy reimbursement and we continue to see the pressures we've spoken about in the past on today and also going forward as George mentioned on the call, we might be seeing additional volume point of view on plan and have the expected impact on margins and reimbursement pressure as results.
So I will say that there is really no change overall in the margin. We continue to work hard to improve the front end store margin with some successes and we continue to see constant reimbursement pressure which we’re dealing with as we are planning to do going forward.
Thank you. And on the guidance, it does appear to include the ABC equity income now, I’m just curious, what you’re building in for the EPS contribution from that?
Yes it does include ABC, we’ve obviously, this is no change to where we’ve always internally looked at this because obviously the economics of the warrants were such that it was the right thing to do to exercise the warrants, the first set of warrants at the earliest opportunity, which is what we’ve done.
Got it and last one from me, I’m just curious about the beauty rollout. You know I know New York and Phoenix are some of the most matured markets, I’m curious if you could give us a little bit more color on what you’re seeing there, have you seen an uplift I’m sure to the beauty section but I’m curious if you’ve seen one at the overall front end?
Hi Alvin, it is Al again. Yes, we’re really pleased with the performance both particularly in Phoenix which is more normal for the - in the state. I’m taking the best model we saw in Phoenix and we're now rolling that out as George said to 1600 more stores this autumn. I’m very confident about the return we will get from that.
It’s certainly impacting the beauty basket in a positive way and in particular No7 continues to be the brand on skin in particular which is driving more frequency and driving a bigger basket. So we [indiscernible] the execution plan is on track and the team are really excited about this. And if I don’t think it’s not just about the products, it’s also important about the customer care model and slight and important enhancement, overall look and feel in a standard drug store.
So it’s not just about the products, it’s about the overall experience the customer would start to get in beauty and it lays a really good foundation for the future where we have potentially more opportunity and more brands and more opportunity over time to satisfy more customers in the front end in beauty.
Yes, thank you very much.
Thank you. Our next question is from Robert Willoughby with Credit Suisse. You may begin.
Just a quick one, do you have any opportunities to expand the generic purchasing power of your consortium? I guess what we’re asking is, do you have a role, any role whatsoever in the Amerisource discussions with Express Scripts about renewing their distribution agreement this year?
No we, of course, of course Amerisource is a separate company and they have to manage their contract independently on us. For the generics, the situation is quite complex because it’s not obvious that if you buy more, you buy better, it depends on what you buy and where are you buy.
It is an analysis which has to be done very carefully and we have also to think that if you want to really be preferred customers, we have also to abide by certain rule. One of those rules being the fact that you must have the right quantity of products because if you need more products then the manufacturer can manufacture, you have to go and have meet the manufacturers at the certain time and at that point, your bargaining powers of course is less because instead of them needing us, we need them.
So the situation is complicated and of course, we analyze any opportunity on the market. We are open to discuss everything which can improve our efficiency, but we don’t have to believe that every contract or every addition at the end is really profitable.
Thank you. Our next question is from Eric Kutcher with Barclays. You may begin.
Thank you. Alex you mentioned that in Part D, you’ve seen the type of volumes you expected but obviously rate pressure, could you speak to your overall strategy on rate versus volume and what you have seen in commercial plans, I know there is some major contract renewals this year, what you've seen in January and February in terms of volume delivered and how this fits in with the broader Optum strategy?
Thanks Eric. Yes I think it is finally the results, we have been pretty clear that we want to try more volume into pharmacies and we have been encourage by what we have been in that D and again this season has gone well and therefore you should expect us to continue to drive our strategy in Optum. [Indiscernible] is an example of that where we have an opportunity to work with the team Optum and to really take care of customers 24/7 and provide more services where they want to get a mail order or where they want to pick up in their local pharmacy.
I’m pleased with that partnership to of course that starts and join in 2017. In terms of our overall strategy to drive more volume into our pharmacies we know that we have to continue to build good relationships and strong relationships with every single payer including PBMs and health systems and insurance companies.
And that we intend to do, has been a real focus of a Brad and Richard and their teams and we are happy with the progress they are making. The one thing I would say is that, as we always say – we said this in the start is that we know that reimbursement pressure will continue and therefore we think this is going to be an effective strategy and we believe this will be true at tomorrow as it has been for us in the last 12 months. And of course finally we don’t make any comment about the major contracts. As you know, that's not something we talk about in the open until we have completed.
Fair enough and may be a follow up is, have you seen uptake as a result of programs, clinical programs you are putting into place, have you seen any willingness to adapt narrow networks and a more aggressive stance I am thinking back to the Caterpillar type strategy that we saw several years ago?
Yes, I think we are seeing now in the networks, I think that’s been a feature of the market family for the last couple of years. But more importantly and we’re seeing people pushing for more of a healthcare comments particularly in the Med D space we have, there is more payment available now for delivering against the SARS on generic utilization. So, I think these features of the market are continuing and we continue to recognize them and do what we can to make sure that we are part of that, not these networks and delivering good care and good quality to our customers.
Thank you. Our next question comes from Ricky Goldwasser with Morgan Stanley. You may begin.
Yes, hi good morning and congrats on a very good quarter. Stefano in your prepared comments you talked about really how you are challenging the norm in looking for new ways to partner with the different players and continuing. So when we think about the Optum relationship, can you may be share with us any kind of like thoughts about do you have opportunities to expand that beyond Optum and also to include kind of like the united population? Are you having these conversations or is this something that would depend on the success of your relationship with Optum?
Well, this a first step of course so as you have said. We are very keen to create new partnerships and to have good relationship with as many companies and many people as possible and I don’t exclude that we could do similar things with other partners. Whether this is the first step for further integration, well it seems to me that we go too far if we say this. It is obvious that any, any kind of additional relationship, any collaborations its helping to understand better each other and to find other ways to collaborate. But this agreement is what it is, it’s a commercial agreement which makes a lot of sense, which can create value for both parties, it could be followed by other agreement. Of course we are open, but we could also have similar or different agreements without a partner.
Ricky, it is Alex, I just want to add one thing, our biggest Med D partnership remains with United that they are very important player in our space and we’ve been with them for some time and Walgreens and continue to work closely with them.
Okay, so I guess the question was right, it seems that there is kind of like opportunities once you kind of like tie in the health plan data to kind of like take a more holistic view of the patient and really kind of like empower the pharmacy which I think are things that you have been talking about in the past. So, kind of like for us kind of like when we step back and we think about the longer term this is kind of like part of the bigger vision from Optum-United tie?
I wouldn’t give too much weight to this agreement, but I can also say that this agreement for sure is not an impairment problem that relates to the future.
Okay and then I noted obviously you can say a lot about Rite Aid, but obviously the divestures are top of my investors will get a lot of questions about it. So I guess has anything changed in the comparative landscape since you announced the deal that could impact the potential divestures?
No, nothing has changed, except the fact that we are collaborating and as the time is passing probably the solution will be closer because at the end of the day we knew from the very beginning that this would have been a very long process that we would have been of many, many documents and information. We are going through the process, the process is developing in an absolute normal way and so we hope that sooner or later we will have an indication on where we are, but of course we cannot put a day or within a month for this indication because it depends very much on how deeply the FDC wants to analyze all of the documents that we have given, but is nothing a typical exactly on line with what we were expecting.
Okay, great and last question for George. I know, I think you said that no comment on Express, but just in terms of may be timing clarification given your fiscal year, should we think about just an Express contract is it relevant to fiscal year 2016 or is it more a fiscal year 2017 type of an impact?
We obviously, don’t comment on individual terms of contracts with any of our peers is just Alex had said earlier, so really I can’t, I’m afraid I can’t really answer that question.
Okay, thank you very much.
Thank you. Our next question is from Robert Jones from Goldman Sachs. You may begin.
Great, thanks for the questions, sorry if I missed this, but could you share what the generic headwind and price inflation impact were on the U.S. pharmacy same-store sales? It seems to us like price inflation meaningfully decelerated, so I guess first is that correct and then if that is correct did the weakness come more from the branded or the generic side?
Yes, hi, hi, Robert it is Alex here, yes there was a shift towards more of the inflationary and in part particularly in generic switches that always the bulk of our volume, our value so again that is true, but again it’s a – obviously it’s a trend that’s being – we were more or less flat last quarter and this quarter we're going straight with the inflationary. And I think the other thing that’s this what [indiscernible] bring really in terms of sales is importance of the specialty business within that as well and again we are driving that pretty well overall, but again as that was an impact in terms of sales year-on-year again in terms of some less inflation in specialty which is a quite a big value number overall.
So, I think that was, the two key things. We're pretty pleased with volume. You know the volume was, I think as George says it was up 3.9%. We gained some market share according to IMS and that’s pretty much on the trend that's been going out for some time now and we continued to drive that quite hard. So, that's where we are so a slight deflation in generics, slight slowdown in specialty. I’m pleased with volume.
Got it. And then I guess George, just wanted to ask a question on the proposed treasury rules from last night, I know it just came out, but is there anything specific around the proposal specifically around intercompany lending that would affect your tax strategy? Just curious if that or either of the proposals as you see them at kind of first glance would limit your ability to generate more efficient tax rate?
Rob we continue to obviously closely watch those all those developments, at this stage it’s too early to comment. We continue to look to ways to optimize our arrangements in terms of funding, but at this point really I’m not envisaging any change from what you’re seeing in our current numbers, but we will keep you posted.
Fair enough. Thanks so much.
Thank you. Our next question is from Lisa Gill with JPMorgan. You may begin.
Thanks very much. I just want to go back to a couple of comments. First, Stefano, you talked about patient offerings and announcing services related to your pharmacists, can you give us any indication as to some of the things you’re thinking about there and does that tie into specialty or I was trying to hear more in the market that we’re seeing more and more specialty drugs actually comes through the retail pharmacy, is that a trend that you’re seeing and is it more that you’ll have pharmacists helping to manage some of those trends, if you could just give us an indication as to what your thoughts are there?
And then as it relates to Optum, I know you don’t want to give specifics, but is there any way that you can maybe give us parameters, you or George around how to think about, how many incremental prescriptions we could see come with this relationships based on other narrow network type relationships that you’ve had with United?
No I don’t believe that we can give [indiscernible] we cannot give indication about the contract and about the specialty, what you want to know exactly?
So are you seeing more specialty drugs coming through your retail pharmacy than in the past or perhaps in the past it’s gone through a specialty pharmacy rather than coming through the retail network? So are you starting to see programs for example where your pharmacist is interacting on behalf and doing more services around specialty and just any thoughts that you have around specialty contracting and the impact to your business right now?
I believe that these should be an important development in our company in the future. We have started. We are focusing our attention on specialty. The specialty side is important and it will continue to be important even though the margin will probably shrink and so they would be important because they would be a big part of the market, but there will not be probably in future, so profitable as they are today. All the same of course, we have to play our part and so we are focused on that. But it’s true that we could offer for the specialty service to the customers that as pharmacist that not many other people could offer, maybe Alex?
Yes it’s Alex here. Again, I think it’s really insightful question for sure. For sure there is more interest from manufacturers in mixed model or central specialty on distribution to retail pharmacy and that’s because the patients and customers do like having care closer to where they live, when they are on certain medications so the carers do as well.
We’ve seen that trend and I will say going for a while. There has been more interest and more contacts particularly since we started to speak about new model and relationship with Valeant, but at this stage we are really working out through in terms of what does that mean for what we do today.
So we know we got some great assets and communities beyond the [indiscernible] in terms of excellence that we have within our normal drug stores, we have community pharmacies well over 100 now close to where some of these specialist doctors look after patients and we have again plans for well over couple of hundred in hospital pharmacies as well again doing with outpatient specialty.
So we think we got a fantastic network to be honest to deal with this trend as it comes through, but we’re still working, so the interest is high. We’re building our assets and we’re working on other partnerships we need with both manufacturers and others to try and take advantage of this trend.
And then just my last question would be, your comment Stefano around the relationship with Optum and the fact that it doesn’t preclude you from working with others, you could see some closer relationships in the marketplace. Back to that, the comments around the Express Scripts contracts being up, I know a few years ago there was a Smart 90 contract that was signed. I’m just curious, do you see incremental opportunities to work with Express specifically, are there ways to enhance what you’ve learnt from that Smart 90 relationship and perhaps to increase the offering and have a tighter relationship between Walgreens and Express Scripts?
We have been very clear that we can see the partnership as one above the most important value that we have and we want to put these in practice. So, we will try to create partnership with as many players as possible and of course I see the opportunity to have a great relationship with Express Scripts. I don’t see an impediment. After you have to do what is possible if there are certain relationships which could be good on the paper, but difficult to achieve because after you have to interact with other players, the manufactures, they also have company, may be certain partnerships cannot be achieved, practically achieved, but everything that can be achieved and everything that can be in the interest of the two parties has to be explored and if possible has to be done. So, for sure I see the possibility of having very, very, very good relationship with Express Scripts.
Okay, great. Thank you.
Thank you. Our next question is from George Hill with Deutsche Bank. You may begin.
Yes, good morning guys and thanks for taken the question and this one is either for George or may be Alex. I guess as we think about the moving pieces that drove the improvement in retail pharmacy gross margins in the quarter, I’m just trying to get a sense for understanding the severity between the generic drug price deflation and the changes in reimbursement rates that impacted at the start of the year and I guess was it a big positive from the changes in drug pricing and a big negative from reimbursement or should we think of a small positive from the changes in drug pricing and a small negative from reimbursement changes, I just want to understand severity of the mix?
Yes and again the first thing I would say is, it is Alex here, [indiscernible] accent, it is Alex here, the impact happened definitely in each quarter. To be honest I wouldn’t look at any quarter in isolation, as George I think has said, we’ve only had two of the three months this quarter actually have the Med D impact. So, I think is able to look for one quarter in isolation and what I would also say is that we are constantly working hard at procurement not just because deflation, as Stefano said because of the good capability we harbored in Europe. And therefore we are working hard to try to deliver more synergies.
The cost space also that they would working on its balance – but all of that is a balanced out by the ongoing reimbursement pressure beyond simply the Med D contracts. There are commerce reimbursement pressures and when the impact is we'll let you know, but they are definitely there and also we are working them hard as well. So, I was say on balance the opening margin in this quarter were slightly more positive because of the impacts of when some things hit the overall trend is really the same trend that is seen and may be seeing for some time’s and with management trend.
Okay, all right. Thank you.
Thank you. Our next question is from Eric Caldwell with Robert W. Baird. You may begin.
Thanks. I have just a couple here, first going back to Optum quickly without going into contract specific details, could you explain in more detail how the economics of a deal like this might work in terms of revenue and profit to Walgreens and will you be booking full Scripts revenue on 90 – day fills just a service fee, some combination of both and realizing this might be overly meaningful to revenue for some time, would a deal like this generally be seen as margin accretive or margin dilutive to the Retail Pharmacy segment.
Hi a load of detail questions there Eric and so I can’t answer anything as part of the contract. What I can say is our objective is to get more prescriptions into our pharmacies not lowers our overall operating margin by making better use of our fixed assets. That's a really important component in this particular program. It also allows us to take better care of Optum members when in the pharmacy particularly making sure they are taking their medication properly and making sure that as they are as in chronic conditions that they get direct to back into a probably health system a bit more fast as well as saving costs elsewhere.
That’s really into this program. We are comfortable with the deal that we’re – is a fair deal both ways and we had a great conversation that went through with the team from Optum and we are in good shape. Obviously the certain assumption is gone in from both sides and we will wait and see what happens over the length of the contract. Remember this does not really start until January 17, so it will be some time before any impact of this new contract is seen in our P&L.
Okay, that’s fair. If I could just do a quick follow up on Bob Jones question, I’m not sure if I caught it, but did you specifically quantify the year-over-year revenue impact from generic shifting from inflationary to deflationary?
No, we didn’t and we can’t.
Okay, thank you very much.
Thank you. Our next question is from David Larsen with Leerink Partners. You may begin.
Hi, congratulations on a good quarter. I just want to talk a little bit more about the USA retail gross margin. It looks like the first year-over-year expansion in a couple of quarters so, congrats there. I mean with your Part D rates and those Part D contracts do they all now have price protection built into them, so we have generic inflation comes back you have protection on the reimbursement side?
Again David, I can’t be specific, but what we can say is, we’ve been working hard to put that in so, the majority do have some price protection yes.
Okay, and then in terms of the gross margin expansion that we did see, I mean was it due to generic deflation like George was asking earlier for the most part?
It was a combination and that was part of it. I think also as we said before, we still got another month of the real impact of Med D to come. We’re not fully protected on deflation. We are mainly protected not fully protected and finally we are making good progress on the front end, you saw that front end margin improved in the quarter as well despite a slight change in mix.
Okay and then just last one, it looks like for the wholesale piece of the business, there was a sequential decline in operating income and revenue was slightly below our model, what drove that and can you remind me what impact FX had on the quarter? Thanks.
[Indiscernible] that you have to take into account the fact that most of it is - almost all of it is in UK, in Europe, in other countries whether the currencies has played big role in and the mix of the different currencies.
So it’s difficult really to judge what is happening and after you have also to appreciate that in the last year, we have divested some more businesses which are irrelevant of course, but of course represented some fees because we have tried to streamline and we are still trying to streamline our business more generally, not just our selling business eliminating all those businesses which are not profitable or which are requiring a big attention, a big absorption of energies.
Now we have a big program, we have big opportunities to create value and each time to and we have started this last year to let’s say start to sell all those small businesses which are not adding much, but can reduce the overall efficiency of the company of the group. I could say that independently on the number, if you look at as we do of course they countries specifically overall most of the countries are doing quite well, even well.
Surprisingly a country like Turkey and Egypt are doing very well. Romania and other countries are suffering, particularly France I would say and particularly Russia and also Germany is not particularly brilliant. So it’s a mix and a combination of these portfolios with the combination of the different currency because we don’t have just the Pound Sterling and the Euro, but we have the Turkish Lira, we have the ruble, we have many other currencies, the combination of these two things that can give strange effect. But overall, you see that the results are not bad, the margin is still there and which is important of course in interfering business.
Thanks very much.
Thank you. Our next question is from John Heinbockel with Guggenheim Securities. You may begin.
I certainly have a strategic question and one is more tactical, when you look at the partnership with Optum and maybe other PBM partnerships, how does that, how do you think that fits in with your potential ownership of Envision, is Envision too small to matter or do you think, are you committed assuming Rite Aid goes through committed to owning Envision or maybe you divest that, how would that work with the partnerships?
First of all we will decide to do with them Envision one, so we will have completed the deal. With Rite Aid we cannot anticipate what we will do on something that is not here today. Secondly, even if we decide to develop it, I don’t see any difficulty because of course, we would not be a major competitor on the market and so we could find a niche, where we could collaborate and we could have a big collaboration as pharmacy, pharmacy chain and maybe some niche or more limited collaboration on the PBM business.
So it’s not, we cannot be considered a true competitor, a competitor at the point that we cannot collaborate in the most important element of the business, which is to allow the PBM to give to us a very good service to the customers.
And then more tactically, I mean a lot of the improvement in gross this quarter in the U.S. look to be front end, you know maybe for Alex, if you think about and I know you’re probably more focused on driving top line than margin per se, but if you think about where the Walgreens frontend margin is today, maybe benchmarking that against Boots or others, do you think there is a significant amount of frontend margin opportunity left from mix and maybe promotional cadence or not so much from where we are right now?
Hi, yes, I still think there is a lot to go, it will just take us a number of years to get there. So the focus has been on operating margins. So we’re really focusing on removing unprofitable activity, unprofitable items and try to simplify the offer and focusing on the key destination countries for us which really is primarily help beauty and convenience and we feel good the way we are, but those are, long opportunity ahead of us and our opportunity is to get customers to reevaluate the offer inside of Walgreens and to see it is more unique and more differentiated.
And we started that journey really with a few differentiation projects, we spoke about earlier in the call, earlier on this [indiscernible].
So I think the opportunity is still a lot to come, particularly on the expansion of differentiation and higher margin products. It will just take us longer to get that done as customers one by one reevaluate what they’re seeing inside of Walgreens.
I think finally I will say is that we've had a one size fits all approach to Walgreens frontend for quite some time and as we have all been thinking on omni channel in four months, again we believe there will be more opportunity there in two years, but the first thing I think people should reevaluate their current Walgreens which is almost right now and then we will figure out how do we use this space differently in over the medium to long-term.
Okay. Thank you.
Thank you. Our next question is from Eric Bosshard with Cleveland Research. You may begin.
Good morning. From a pharmacy margin environment you talked a couple of quarters ago about some of the challenges and ongoing challenges, I'm just curious as you reposition the company to some degree with some of these relationships if you feel on more stable footing about the future of pharmacy margins in the U.S. or give a different view of how that is going to play out?
No, I think that, again this is Alex here, I think we've said this already, but it is an important point. We see the volume mix are very important for both our partners and peers, customers and also for ourselves. So we will work within the market, which means that we believe will be ongoing reimbursement pressure and then we work hard within that to drive our volumes through offering better volume, better care to customers. That really is our strategy. I know it sounds very simplistic, what we are trying to do.
If we do these things we think we can stabilize the operating margin over time and we can grow the business. That is what we are doing right now and we believe that is the future going forward. So that's how we see it. But we accept and as I said is I think Stefano said this obviously Eastern Europe, reimbursement pressure is a constant factor and we believe this it will be a constant factor here in America going forward and our strategy is as I described it.
Within that it sounds like the strategy is therefore more volume in order to leverage the expenses and that ought to stable or beneficial operating margin, Rite Aid is a piece of that, Optum is a piece of that is, am I correct in the perception that that is the strategy is more volume and therefore are there more alliances that you will evaluate or pursue to drive more volume through the business?
It is part of the strategy. You see when you have to accept that the margin or the gross margin ineluctably decline will decline over time, you have to find ways to compensate the void. So additional services like Valeant can help better, a better organization of the work not just synergies but a different structure of the work, a rethinking of the organization of the flow of the medicine, of the flow of the work, the use of the pharmacies can help.
Are there an increase, better relationship with your suppliers can help of course because it contributes to the margin a better relationship with the clients, with the PBM with all the people who are at the end of the day the source for the script. And clear the way of collaborating with them can help because it can increase the number of scripts and of course the volume is very, very important, because if you can compensate at least partially the volume, by the volume the actually margin of course these can help substantially.
So there are many, many different actions that you can take and we are taking. And these actions can stabilize the results, the final results as Alex was saying for years and years to come and in 10 years time or whatever we will have probably another organization of the business and we will see what will happen at that time. And for the next year we see enough ways to compensate the margin reduction. We accept that the margin reduction will be there and we are trying to find and we are finding different ways to compensate for it.
Okay, thank you.
Thank you. Our last question is from Charles Rhyee with Cowen. You may begin.
Yes, thanks for squeezing me in here. Just actually, just one of the random question I guess may be, I think there is a vote coming up in the UK regarding I think the European Union, I guess they refer to it as the Brexit, if that referendum were to actually happen, how would that affect the Boots business here and I guess Walgreens in general? Thanks.
To be honest, I don’t believe that it will be impacted directly because there in the retail business is a let's say a local business and the brand business, well even now, we don't manufacture drugs in UK so there and we will find a way to continue to manufacture at the lowest possible cost, so the brand will not be impacted.
The retail business is local so it will not be impacted. It could be impacted by a change of the whole economy if we had recession or if we had difficult consequences from the Brexit this could impact more generally our business as all the other businesses. And the same is too for Europe because our business is in Europe, again our local businesses, our retail and wholesale businesses, our local businesses depend more on the consumption of the medicines of the products that are on the political and economical situation.
So they could be just impacted by a general trend, but not specifically. We have totaled it and we don’t - we have decided that we don’t need an emergency plan for it. When there are big changes we try to think at least potentially of an emergency plan, but in this case we don’t see the need for it.
Great, thank you.
You are welcome.
Thank you and now I would like to turn the call back over to Gerald Gradwell for closing remarks.
Thank you. Thank you everyone for joining us on the call today. We look forward to speaking to you again on our next earnings call at the beginning of July and in the meantime I will try and find something that keeps definitely more entertained with these comments. So then, if you need, if you have any other queries or need to speak to us, the IR team here, myself, Ashish, Debra [ph] and Jay [ph] are around and available to answer your calls. And with that, we'll draw the call to a close. Thank you very indeed for joining us tonight.
Thank you, ladies and gentlemen, this concludes today's conference. Thank you for your participation and have a wonderful day.
Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.
THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.
If you have any additional questions about our online transcripts, please contact us at: firstname.lastname@example.org. Thank you!