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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Good day, ladies and gentlemen, and welcome to Walgreens Boots Alliance Second Quarter 2018 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct and question-and-answer session and instructions will be given at that time. [Operator Instructions] As a reminder, this conference call maybe recorded.
I would now like to introduce your host for today's conference, Mr. Gerald Gradwell, Senior Vice President, Investor Relations and Special Projects. Please go ahead.
Good morning, ladies and gentlemen, and welcome to our 2018 second quarter earnings call. As usual, I'm here today with Stefano Pessina, our Executive Vice Chairman and Chief Executive Officer of Walgreens Boots Alliance; Alex Gourlay, Co-Chief Operating Officer of Walgreens Boots Alliance and President of Walgreens; and George Fairweather, our Global Chief Financial Officer.
We're presenting in a slightly different format today to try and give you a better overall picture of our thinking, where we are with the business and where we want to be. We would welcome any feedback you may have on the updated format to ensure we're addressing your needs. I will shortly hand you over to Stefano to make some opening comments and host the call. Before I do so, however, there are some things that never change; so I'd ask your indulgence and attention please while I take you through the legal Safe Harbor and cautionary declarations.
Certain statements and projections of future results made in this presentation constitute forward-looking statements that are based on our current market, competitive and regulatory expectations and are subject to risks and uncertainties that could cause actual results to vary materially. Except to the extent required by the law, we undertake no obligation to update publicly any forward-looking statement after this presentation, whether as a result of new information, future events, changes in assumptions or otherwise. Please see our latest Form 10-K and 10-Q for discussion of risk factors as they relate to forward-looking statements. In today's presentation we will use certain non-GAAP financial measures, we refer you to the appendix in the presentation materials available on our Investor Relations website for reconciliations to the most directly comparable GAAP financial measures and related information.
You'll find a link to the webcast on our Investor Relations website at investor.walgreensbootsalliance.com. After the call, this presentation and webcast will be archived on the website for 12 months.
I'll now hand you over to Stefano who I should say is slightly under the weather today with a bad cold; so if sounds a little cocky, that's why. Stefano?
Thank you, Gerald. If you would have seen from these mornings announcement, it has been a rather good financial quarter for the Company. We've re-run the progress in our key numbers. It is despite the what has widely been seen in the retail markets as rather mixed stuff to the year.
George will run you through the numbers, but before then, I would like to say a few words about our markets and strategy and ask Alex to give you some insights about how we are interpreting and implementing that strategy in our daily operations.
So I would like to start by reminding you why we believe that we are at the heart of an extraordinary dynamic sector despite it apparently being a little out of favor at the moment, and why we have such conviction about our future. Fundamentally, we see ourselves as being in very attractive markets, the pressure of pharmacy adjusted elements of the overall pressure in the healthcare system. In the U.S., this is mainly the reimbursement pressure from the payers, the PBMs and the health plans. Although as I have always predicted, these are now pretty much one and the same and the sign of the pressure, the payers are under from their customers. It is a sign that everyone recognizes the need to control the inevitable growth in demand.
Population continue to age; with increased life expectancy comes increased expectation for quality of life and increased demand for healthcare. In the U.S. alone over half of all prescription drugs are taken by the over 65 and this percentage is even higher in many of the entirely state funded healthcare systems in other countries. The cost of care continues to rise. The relative attractiveness or medication based treatments to keep people leading productive life in the community continues to increase as the cost of medication remains materially lower than the total cost of healthcare. The innovation in healthcare means demand is infinite and most markets manage cost by managing supply.
Against these backdrop, we see different approaches to managing healthcare spend. In most countries around the world, these have been achieved through government intervention either to limit reimbursement, limit availability of treatment or more usually, some combination of the two. The most sophisticated system combined these with some element of free market economics. The United States is one of the markets with the greatest element of such free market economics built into the system.
But with some 18% of U.S. GDP already spent on healthcare, significantly more than any other country in the world, everyone recognizes that the U.S. system can be more efficient. The greater the element of free market economics in the healthcare system, the greater the scope for us and the greater the number of ways in which we can add value through reducing overall cost of care and working with that to evolve the way in which healthcare is both delivered and funded.
We have outstanding experience and a strong track record of success in managing our business to play an active role in the management of our area of healthcare costs. We have shown that we can tie commercially while doing so, sharing the benefits and at times the growing pains of the market without partners in the relevant healthcare system. These has made us a trusted partner for patients, payers, governments and providers; most notably, the drug companies, and of course has been the foundation on which our team has delivered many, many years of excellent financial performance. In the market we are applying the strategies that have systematically delivered us a combination of cost control and commercial growth in other market.
I can summarize our approach really quite simply. The main points of our strategy are to drive growth and consolidate volume through organic growth partnership of acquisition and use these volume to buy best-in-class, and most importantly, significantly better than our competitors. Control cost optimizing financial efficiency and leveraging our financial strength. We rigorously apply financial discipline in everything we do from day to day operation to business development. Differentiate ourselves where we can through value, quality of service, exclusivity, or innovation; and our own trends form a strong point of differentiation. Build a portfolio of complementary business across a broad geography to provide protection from the unique cycles in any one area. Reinvest for both organic and external growth and foster a portfolio of opportunity to give us multiple levers for growth.
Naturally, we must adapt these approach specifically to the condition in each of our markets. And the U.S. it's not different, in fact, if anything -- these approaches are more relevant to the U.S. than to many other markets. I can honestly say that there is nothing that we have done in the U.S. indeed anywhere across the Company that cannot be traced directly back to one or more of these teams. And of course, underlying these are two basic principles; the need for dynamism ensuring that we move with indeed lead the market and the strength of leadership and management ensuring we have the right team with the right skills and experience. Our announcement of James Kehoe's appointment to join us as Chief Financial Officer from June 1 reinsures to add with [ph] business development after a carefully managed transition, demonstrate our ability to attract exceptional skills and experience. It also demonstrates the commitment of our current team to remain engaged in our future and prevail the team as much as the Company to keep it relevantly strong.
Don't take these as an indication that I am going anywhere, there is still a lot for me to do but it is an indication that we are committed as a team at every level in our organization. George has done outstanding work as CFO over many years which we all thank him for, and he has a lot more to contribute to the Company.
Thinking of other members of the team who have done great work but still have a lot more to do, this is probably an appropriate time for me to hand you over to Alex who will tell you about how we are implementing our strategic approach in the U.S.
Thank you, Stefano. I'm going to focus today on the U.S. as this represents so much of our activity. Stefano has defined a strategy succinctly, and the evidence of the strategy in action is clear from a recent earnings performance and in stores although of course a lot more goes on behind the scenes.
As I said, everything we do eventually comes back to the service we give to the patients and customers and how we deliver for our partners. Before I talk about the future, when we just review how we apply our strategy in the U.S. market today besides what we've had to do a lot of work to quite the data we needed and apply it in the way we needed. As you know, we are investing considerably in our systems and are spending a lot of time getting pointed in the right direction and working even better. Overall, we spent over $500 million to-date on building, testing and implementing new systems; we're on-track and in addition, in the next 3 years we anticipate investing more than $500 million on this area of transformation of our business which will in turn lead to further cost savings and efficiencies.
We're starting to get good data from our stores and we're making progress towards what we need. We're now running the balanced awards program as a data and customer insight tool as much as the marketing program as it was just designed and we have now 88.6 million active users who are so working to simplify the program but we now have available tool as nearly 3 years of excellent customer data. We're part way through updating other core retail systems which will give us a full suite of data enabling us to better mine the business and provide a platform for future growth, those are working in a number of other key systems.
We've been very open about the files that our pharmacy management system although state-of-the-art when we implemented some 25 years ago and still performing very well given this age has some constraints in it's ability to handle the future needs of the business and our markets. This is a big priority for us, the work is progressing on-track and we've been significantly helping this by recent experience of developing for assistance elsewhere in the Company. In addition, some of the work George and his team are doing within Walgreens to update the financial assistance and with the processes is already giving additional visibility on our financial performance on a much more timely basis which is helping us track and respond to changes much more quickly. As ever there is more to do but the combination of management data and customer insight has really begun to kick-in and they form a great deal of change in our business.
Turning now to pharmacy; as you know, one of our top priorities has been to grow volume and keeping with Stefano's forced strategic gain. It is pretty clear to us 3 years ago that our cost base was designed for a volume of prescriptions that have been lost but not fully replaced. We did some work to validate the information we have in the markets and compare that with our own internal information; it was clear with updates in our thinking and approach. The implication was a pretty big shift in our approach which we had to work hard to manage significantly cutting out places to bring us back into line with the market, but also focusing on improving our service standards, particularly availability of prescriptions and speed of service. In this we had to meet the judgment call on network, our position in the communities we serve and service levels would make us attractive at market prices. We made this judgment based on extensive consultation everywhere with peers on both a leg work and the consultation paid off. Once again this quarter you've seen prescription volumes grow and our market share increase to the highest level we ever reported, 21.4%.
Over the past few years, we have grown our market share by over 200 basis points. While volumes and market share come and go as contract shift, I'm confident that we are now back to a position where we are competing strongly. Despite any short-term shifts in the market, we are well positioned to see volume and market share growth overtime. This gives us a strong basis on which to review our pharmacy operations and improves them in areas where we can generate more value for both ourselves and our partners, and look at ways to improve costs and efficiency overtime to augment the growth we will see in volumes.
Of course, as you know, this team in Switzerland are using these volumes alongside those of our procurement partners to do a truly fantastic job in terms of getting us great buying terms but we do not and cannot rely solely on buying. The procurement work is there to support the pharmacies and volume counts in procurement. Especially growth can also be seen clearly in this quarter's performance as we continue to develop our Alliance RX partnership with Prime Therapeutics and extend the number of successful community specialty pharmacies. And the products here that we have recently added [indiscernible] in specialty pharmacy, a 23 Walgreens community based specialty pharmacy sites. Overall, I believe we are well positioned to grow specialty market share in the future.
In the retail side of the business, despite having been area of much discussion we are at an early stage. Over the last 3 years we have been focused on driving profitable growth, looking at the comparative quarter 3 years ago on our usual adjusted basis, we delivered higher retail gross profit through improving gross margin by over 300 basis points. This progress has been made through a combination of good solid retail management and focusing promotions and a plan with rigorous financial discipline which Stefano has already mentioned. Through changes in merchandising and product mix, we have followed our strategy of differentiation and increased penetration of own brands while significantly improving margins. This has been achieved in competitive markets by driving improvements in our health and good [ph] offerings, we made good progress but not perhaps as quickly as I would have hoped but the new store formats we're working on will provide a platform for us to accelerate this growth.
Of course there have been many areas we've been able to make progress within the comp store formats such as optimization of ranges and promotional activity, all of which have delivered improvements in performance. This can be clearly seen in our beauty differentiation roll outs within partnership with our suppliers, we have extended the rollout to our own 2,800 stores having more brands including our own brands. It's not just about improving the look and feel but making sure we have the skills and training and our own team to support this work. Since we concluded all out, beauty sales and beauty differentiation stores have outperformed our non-beauty differentiation stores in the quarter, as accounted for retail margin differential of around 2 percentage points. We intend to continue this and just to add more stores on more cashes on beauty.
In the new store format, we'll bring together such as optical, hearing care and lap [ph] along with further testing of value, royalty and supply chain initiatives. We plan to bring together all of this learning in the pilot stores which we will begin launching in the coming months as we mentioned in our first quarter updates. I was stressed that the new formats as much of bringing Walgreens upto date as themselves living the future but they will provide a platform from which we can deliver future services, retail offerings and accessible healthcare. The past stores would also provide a platform for the existing initiatives we've already introduced. Such strategic partnership with FedEx is already available in almost all of our Walgreens stores, all performing very well. Equally, there are areas unique to us that don't have the scale or expertise to optimize in our grid.
We've gone for some quick wins but known our position for more fundamental change. The development of the new store formats and [indiscernible] as we learned more from their performance in the market also provides us with the opportunity to develop a wider range of services at different value proposition. The acquisition of the ready stores which is now being completed at accelerated -- the development of our network during this transitional phase accepting as we have said there will be no material attrition from right at the fiscal year.
Another key initiative that's developing a digital presence which is not just a buzzword but increasingly of true relevance in the healthcare area, as well as obviously in retail and again, whilst as it is, we have not been sitting still in this area. Our app has been downloaded 50.6 million times, has a 5-star customer rating on the U.S. App Store. During the second quarter, around 21% of Walgreens retail resale scripts were initiated through digital channels, up almost 3 percentage points versus the comparable quarter last year. So with all these initiatives while there is a long way to go, we must not lose sight of the ships in the market while we are transforming the business. We have many great opportunities at stake and many paths that we can choose to follow as we drive our business forward to create a more differentiated customer proposition in the USA.
My job is to make sure that we are the right team, with the right tools, and the right focus; to make sure we have the dynamism that Stefano talked about reaching all parts of our operations. That's why in the U.S. we have paid to investor into $100 million per annum and increased wages beginning later this calendar year. Putting the systems in place as I said in my opening comments is an example of providing the right tools and the forthcoming appointment of Sebastian and James to head our booths is a good example of how we can broaden and renew the skill base of our team, how we execute our planned succession within our operations. I'm delighted I'm doing this, we've also been able to keep the experience of less [ph] within the business.
Now, over to George.
Thank you, Alex. We are pleased with our overall progress, both in the quarter, and through the first half of the fiscal year and we continue to expect to have a solid year. And today we have raised our guidance for fiscal 2018.
In the quarter, our key profit metrics were all up on the comparable quarter last year both on a reported and constant currency basis. As we announced this morning, on a reported basis, sales were up 12.1%, adjusted operating income was up 7.3%, and adjusted diluted net earnings were up 16.6%. Most importantly, adjusted diluted net earnings per share increased by 27.2%. This very strong growth was in part due to the U.S. tax law changes, our share buyback program and of course good growth in adjusted operating income. On a GAAP basis, diluted net earnings per share increased by 38.8%, the key difference between GAAP and adjusted growth being the cost transformation program in the same quarter last year, partially offset by the provisional net discrete tax expense. For completeness, here are the first half financial highlights showing adjusted diluted net earnings per share growth of 22.4%.
So, turning now to the performance of our divisions in the quarter, starting with retail pharmacy USA. Retail pharmacy USA total sales, comparable store sales and adjusted gross profit all increased versus the comparable quarter last year with adjusted gross profit being higher in both pharmacy and retail. At the same time adjusted SG&A as a percentage of sales has improved versus comparable quarters for 19 consecutive quarters; these together resulted in adjusted operating income increasing by 6.3%. So let's look in more detail at pharmacy where we've continued to make good progress.
U.S. pharmacy sales were up significantly, increasing by 18.7%. This was primarily due to higher prescription volume including central specialty and mail following the formation of Alliance RX Walgreens prime and from the acquired Rite Aid stores. On a comparable basis, pharmacy sales increased by 5.1%, partially due to higher volume. Reimbursement pressure on generics had a negative impact, partially offset by brand inflation. The number of retail prescriptions failed on a 30-day adjusted basis including immunizations increased by 9.1% leading to an increase in reported market share in the quarter to 21.4%, up 100 basis points. On a comparable basis, prescriptions filled increased 4%, this was primarily due to the positive impact of our strategic pharmacy partnerships and to Medicare Part D.
As in the first quarter, we delivered higher pharmacy gross profit despite ongoing reimbursement pressure and a higher proportion of specialty which adversely impacted gross margin by around 190 basis points.
So turning next to retail. Total retail sales were 0.7% lower. Comparable retail sales were down 2.7% as we continue to focus on delivering improved margins. This action resulted in higher retail gross profit than in the comparable quarter last year. As Alex has said, looking at the comparable quarter 3 years ago, we have improved adjusted retail gross margin by over 300 basis points.
Next, let's look at retail pharmacy international. Retail pharmacy international total and comparable store sales on a constant currency basis were lower this quarter, market conditions continuing to be tough, particularly in retail. Comparable pharmacy sales increased by 0.6% with UK being up 1%, mainly due to mix. Comparable retail sales decreased 2.8% with UK being 3.3% lower. As I indicated on our January earnings call, our trading has been challenging, we are managing our businesses well to address this. In particular, we are managing our cost base very tightly. As a result, we've been able to increase adjusted operating income on a constant currency basis by 6.6%.
So now let's look at our pharmaceutical wholesale division. Sales increased by 3.4% on a constant currency basis; this was behind our estimate of market growth weighted on the basis of our country wholesale sales due to challenging market conditions in certain continental European countries, partially offset by strong performance in emerging markets. Adjusted operating income was down 1.3% on a constant currency basis, generic procurement margin pressures being largely offset by higher adjusted earnings from AmerisourceBergen, primarily due to the U.S. tax law changes.
So turning next to cash flow. We continue to deliver strong cash generation. Operating cash flow in the quarter was $2.2 billion. During the quarter, our working capital inflow was $502 million reflecting our seasonal reduction in inventories. Cash capital expenditure was $288 million. We continue to invest in key areas to develop and differentiate our core customer proposition, as well as the upgrades to our IT systems which Alex has referred to. Overall, this resulted in free cash flow of $1.9 billion. This brings our free cash flow for the first half to $2.5 billion which is another strong performance.
So turning next to tax. Now that we have better clarity on the tax benefit for this year and beyond, I thought it would be useful to explain the impact. The adjusted effective tax rate for the quarter which we calculated excluding ABC was 16.5%; this was lower than in the same quarter last year, primarily due to the recent U.S. tax law changes. For the first half the tax rate on the same basis was 20.3%. The core tax rate in our half year income statement is a blended rate. As we have in August fiscal year end, this reflects 4/12th of the old U.S. tax rate and 8/12th of the new rate. Our GAAP effective tax rate in the second quarter was 27.4% compared with 19% for the comparable period last year. This was significantly impacted by a provisional net discrete tax expense of $184 million associated with the new U.S. tax law.
This net figure consist of current estimates of $794 million of transition taxes payable over the next 8 years, partially offset by $610 million reduction in deferred tax. In terms of the fiscal year 2018 cash tax benefit, we now expect this to be more than $350 million; this compares with our previously announced estimate of over $200 million. All these figures are current estimates which we will continue to refine.
Finally, turning to guidance for the full financial year. We now expect adjusted diluted net earnings per share to be in the range of $5.85 to $6.05. Our guidance now incorporates the U.S. tax law changes. The expected benefits are now marginally higher than the $0.35 per share upper end of our previously indicated range. As we said before, we do not expect Rite Aid to significantly impact this years adjusted diluted net earnings per share, and as usual, this guidance is based on current exchange rates remaining constant for the rest of the fiscal year.
I'll now hand you back to Stefano.
Thank you, George. So from what you have heard, I hope that you can see we remain very confident of the robustness of our business and our ability to drive growth in it. The results that we have delivered today demonstrate the real value we are creating, as we continue the transformation of our business and our updated guidance reflects the confidence we have in our ability to continue to deliver solid financial return.
The strength of the Company like Walgreens Boots Alliance does not lie entirely with the momentary placed any single business in the Company is in it's specific business cycle. It lies in our ability to bring multiple businesses and multiple opportunities to bear, to manage our portfolio business against our market position and our partnership to create opportunities, to deliver a consistent performance as a company, overall. We have a great deal of experience of doing this and despite the ever changing markets that we see much to give us confidence that we can continue to do that going forward.
So to conclude, as we look ahead, we are optimistic as we have always been. Thank you.
We will now take any questions you may have.
[Operator Instructions] And our first question comes from Ross Muken from Evercore. Your line is open.
Hi, this is Elizabeth [ph] in for Ross. Given the reasons be in industry consolidation, how has that changed your view if at all on any of your capital allocation priorities?
Well, it doesn't change it at all. We have our strategy and we follow our strategy trying to be consistent in what we believe. I have just announced which are our principle, and of course, we are always willing to do a deal if the deal is consistent with what we expect from a deal, if we have the right return, if we can see a way to have back indication that we used for the deal. So we are always open to the deal, we are open to joint ventures, to collaborate with other partners in order to extract synergies, to extract benefit that we can share, possibly investing capital but not enormous amount of capital. But if all these would not be possible inspite of our cost and attention to the market. We will return somehow the money today to shareholders, we are a good cash generative companies, of course we have to use the money that we create. We will try to do reserve M&A if possible, otherwise we will give back the money to the shareholders.
And in addition, your Alliance RX partnership seems to be going off great; what is it do you think is it about your offering that's really resonating with clients?
I mean it's really early stages, so we are pleased with where we are. I think there is a couple of things; I think that we're able to really work in a different way in terms of the visibility of the partnership and what the payers are seeing within that partnership. Clearly, there is more to do here but that's one part of it. Second part of it is, that we're able to connect some of the customers to our local specialty pharmacies, they are also handling the additional LDD drugs that we've been able to acquire as a result of that both in partnership with Alliance RX and expansion of our local community pharmacies within all these network. So we feel good about where we are, we think we have a more local model as more relevant along with the great partnership with Prime Therapeutics.
And our next question comes from Robert Jones from Goldman Sachs. Your line is open.
I guess just looking back scripts growth, up 4% on a same-store basis was maybe a little lighter than what we were expecting, given the residual benefit we thought you'd still have from the prime arrangement and obviously, a very strong flu season. Could you maybe just comment on what you saw as far as volumes on scripts in the quarter? And then I know earlier this year you had talked about the back half, seeing script growth in the 2% to 3% range; I wanted to see if that was still a valid target?
I think that remember as investors in Q2, they meet the wins of last year and it happened obviously January 1; so Q2 does contain an element of that. Secondly, the flu season was unusual in the sense, it was very strong in December and January but relatively we can feel [ph] overall, it was a pretty -- from our point of view, a pretty normal flu season. And remember, Q2 for us is these 3 months; so we saw the flu season pretty much to our level off to normal. So I wouldn't say there was much impact, I don't know volumes there. Going forward, as we said before, we still expect to grow in the back half of the year and also we expect to grow going forward. We have seen some additional marketing activities from some of our competition which again is impacting some of the volume, this is pretty much as we said and we're very confident -- we are in a really strong comparative position, not just for this year but the future as well.
And of course, last but not the least, very importantly, the smooth transfer of the rating businesses that we have purchased to ourselves, of course again is growing on volumes in the second part of this fiscal and calendar year.
I guess just one quick follow-up or clarification on the plan to increase wages, I think you mentioned by $100 million; that won't affect this fiscal year, is that correct? I think you said it would start in fiscal '19. And then I guess more importantly, any sense you can give us on where you think this puts you relative to others in the market where you're competing for our hourly wage earners?
Yes, we haven't given a date yet but we did say based on this calendar year; so you can assume that it will have little or no effect on this calendar -- this fiscal year. In terms of the marketplace, we review this all the time, there is quite a lot of announcements we've made from people in the marketplace and we're confident what we're doing later in this year will keep us in a very competitive situation and we continue to invest in our people in over the long-term. While this really has nothing to do with the tax benefits that George outlined in his prepared remarks, this was already something that we plan to do but obviously was helped by the fact that we had some release date as well.
And our next question comes from George Hill from RBC. Your line is open.
First, I start with George; if I look at the guidance change, kind of where you guys came into the quarter versus the updated guidance -- it looks like most of the benefit is coming from the tax change, I guess I would just ask are there any changes to any of your internal operating assumptions as it relates for the guidance where we should just think of most of the changes? And then I have a quick follow-up for Alex.
Yes, you've summarized it pretty well. Our updated guidance really reflects no change to our core growth assumptions which you can if you do the math from the midpoint to midpoint; you will see that it's really primarily from the expected tax reform benefit, so really no change. And just to add to that, I think as we said in the last two earnings call; we said that we expect fiscal '18 to be more balanced between the two halves and that was the case in fiscal '17.
And then -- I guess Alex, as we think about the payer environment, we've seen the Cigna-Express deal and the CVS-Aetna deal; I guess are you seeing anything from your end that makes you concerned about future reimbursement pressure on the commercial side of the buck from payer consolidation or does this -- do the alignment of these payer organizations not seem like they're going to impact future reimbursement?
No, too early in any case to work or to see it. But remember that for sure there will be some negative effect in these consolidation but there will be many positive effect because we are in a free market and so the people who have not taken part to the consolidation will be more willing to work a bit -- the people were independent on the market. It's too early to see the effect but overall, we would expect a slightly positive effect for us.
Thanks, George. I have nothing to add, just to those remarks, I see the same way.
And our next question comes from Ricky Goldwasser from Morgan Stanley. Your line is open.
My first question is on the new store format; just if you can kind of like help us quantify what type of capital investment do you envision as required per store and how should we think about the cadence of the rollout?
These really are tests, there are tests based on a lot of stuff we've learned in the last 3 years, both on the front and product mix, and also importantly, some tests that we've got in the markets separately with healthcare services along of course with our new platform with that X on a digital platform that we already have in place. So really putting all of that together to understand that this is the test, so we really haven't got any more information on rollouts. In terms of affordability I think we've been very clear that we are fiscally very disciplined, and we will work this within the normal rules that we have in the business about returns that we would expect to get from any initiative including one, rolling out a format. And our experience in the past has been that you can achieve with a reasonable spending capital in a small box like Walgreens, a good return as you would start to shift the mix and induce more services, and also improve the value proposition overall and that's exactly what we intend to in these formats, it's proved that case and then when we're ready, we'll come back and let you know how that looks in terms of plan.
This is what we're typically doing. We make a trial, spending a limited amount of money and after we refine the trail because before holding it over we work on the trial and if we know that these takes a little more time at the end of today but we believe that is worthwhile to spend sometimes and to be sure of what we want to do in order that when we hold over the clients to many stores, we have a model which is not perfect but it's quite robust. And of course, these times -- but at the end we save a lot of money because we don't under-risk to all over a trial format or any activity that after we have to adjust or probably to substitute, so we try not to waste money.
And then my follow-up; one is on -- United and Aetna are moving to point of service rebates where there are fully insured members. Does this have any impact on the pharmacy economics as it relates to the co-pay? That's one. And second of all, when we looked at your front end comps, of the door down 0.27 in the quarter, but how should we think about the impacts from your decision to rationalize SKUs? So how should we think about comms on the same SKU basis?
We actually believe that point of service is a good thing for the customer, so we actually think this is a good move forward, creates more visibility. And we don't expect that to be any more than normal reimbursement pressure that we've seen consistently over the years as a result of this. But we expect that pharmacy experiences to get better which should help us from an efficiency point of view and a customer care point of view, but clearly, we'll see what happens when our colleagues in the industry rollout these initiatives.
On the front end comps, we have been consistent in saying and I think the number we gave today about the 300 basis points is the one important data point that we are driving for profitable growth. Part of that was a significant SKU reduction in the bottom quarter over stores last year and I don't have any specific data to give you today but we are pleased with the performance of these stores and are moving that thinking on as an important part of simplifying our offer, both for people who serve as customers. But also importantly, for customers who wanted to actually have a really good experience some more gains as well.
So one of the things we have seen is good improvements in MPS as a result of that work. So there is more management to do, more work to do but remain confident in this approach and that's why we're accelerating it.
And our next question comes from Lisa Gill from JP Morgan. Your line is open.
George, I understand your comments around guidance and primarily being taxed but what did the quarter look like versus your internal expectations? Would it be nicely, I think first is a straight execution; so I'm just trying to understand the way that we had it modeled versus your internal expectations?
Overall the year-to-date is very much turning out as we had anticipated, hence really what we said today about the guidance for the full year.
And then just secondly, Stefano, I know you consistently get this question, the first question today was about capital allocation but if I go back to our discussion in January where we talked about vertical integration and you anticipated there would be even more opposed the CVS-Aetna deal. I want to better understand and I understand what you're talking about, whether you're talking about a deal that's consistent with returns when you think about things financially but is there something that you believe you need to strategically from where you sit today or is it just more of -- if something comes along that fits our financial criteria, that's the direction we're looking at. I just want to better understand how you're thinking about from a strategic standpoint?
From a strategic standpoint, I rarely believe that our market -- our pharmacies, our stores tomorrow would have to be very, very different and so for sure from a strategic standpoint we have to change a lot but I don't believe that the change is only possible if you merge with a health plan, this is one-way to rationalize the market. Of course, if you can extract a value from it, if the value that you can extract from it is justified price to pay but this is one model, but there are many other model because we will have to change today. The stores are quite substantially in the future and the way we will serve the consumers in a very radical way; so there is much to do with our without a merger with a health plan, with or without merger with other players in these market. And I see that the main transformation in future would not be just a merger with one of the main part we mentioned would be to adapt the stores, to what the future customer will require.
And if we go to Asia and you will see what is happening there, if you look at what the people like Feint [ph], Alibaba and others are doing or are talking of doing, you will see that at that end even we -- given us have to think in a different direction for the future and this is something that of course it's ineluctable. While a merger with an insurance company or with PBM or with whole sellers, if not ineluctable; the fight in future would not be on this basis.
And our next question comes from Steve Valiquette from Barclays. Your line is open.
Just curious here now that you completed the purchase of the 1,900 plus Rite Aid stores; just curious if there is anything that has surprised you on the upside or downside and now that you have all these assets under your ownership?
No, we're really pleased to have got to this point as you can imagine and the process has been good, nothing surprised us on the upside or downside and we remain confident that we will be able to execute what is still quite a big plan. I mean adopting an over 1,900 stores into your network is not actually forward; so we still have a lot to do but we remain confident it's on plan and will give us returns that we had expected.
And then just quickly, just to throw it out there since nobody else brought it up; are you able to comment at all on these broad news articles, a month or two ago suggesting there were talks going on between ABC and Walgreens on the potential buyout of the rest of ABC that you don't currently own? Just curious again, just to throw it out there. Thanks.
We don't comment on any market speculation.
Maybe people are curious about that.
Yes, now you're right about that.
People are so curious that we too -- we have become curious reading the press.
And our next question comes from Michael Cherny from Bank of America. Your line is open.
So I want to go back to Lisa's question little bit regarding the store of the future; I think Stefano you talked about some of the changes you're seeing globally. As you think about the positioning of where the stores are right now along some of the partnerships you're doing whether it's with Lab Corp [ph] but you know, is my expressed business. How do you think about the transition of that moving target in terms of staying ahead of whatever you think the consumer might demand in the future versus the investments that you're making now to make sure that you can react to those demands?
With an additional service you can offer apart from that these additional services represent an additional source of revenue and profit which of course is not irrelevant but apart from that, it's clear that most services we'd be able to offer, the easier would be to catch the customers, to keep the customers review. Just probably in future you will have to offer your services in much more sophisticated way and knowing more about your service or your customers being able to anticipate what the customers will need. All things that everybody says today but of course it is necessary to repay the company for this preparation or it's quite a complicated one.
This doesn't mean that we don't have to expand and to lead in the world of today and we have to do whatever we can to improve the efficiency, to improve the profitability of our company. The two things are not excluding; I was asking -- the way I was asked before, I would see that pharmacy in 5-10 years in future, I have seen pharmacy under stores and store -- quite different from now.
But of course if now we could do a good deal with someone at reasonable terms, where we could see a substantial return, not just in earnings per share but also in IRR-- also in ADA [ph], cash return, we would be delighted to do it.
And then George, one just quick clarification question on the tax savings; I'm not a CPA, so I won't admit that I'm an expert here. But if you think about the difference between the original $200 million cash tax benefit, it's led to about $0.30 to $0.35 based on your previous guidance. The guidance for the midpoint in terms of the official change was $0.37, you increased that tax benefit by $150 million, how do we think about the bridge in terms of those two numbers?
I mean they are essentially two quite different numbers because of the way the tax law is structured. The way I would try and think about, if you think about the rate then -- and what the rate is, I think the best way of looking at it is that the half year adjusted effective tax rate and that came in at 20.3%. And within that we had a discrete charge of about 0.5%, so that in effect says that for this year we anticipate -- because the half year is based on a forecast, for full year you should be thinking around the 20% mark, plus or minus for whatever discreet end up at being. In terms of the cash tax this year, when we first set the estimates, it was very quick after the law was enacted and some of the details on timing and other things have really only come out since that time, and we certainly were always very careful before we published numbers that we're absolutely sure that we're clear the numbers are really good estimates that we always feel comfortable before publishing, and so that's really what's driven the increases.
And then I also talked a little bit about the deferred tax and repatriation tax and again that's just taken us a little bit of time to work through to publish the estimates that we've put in our numbers today. I'm afraid it's really quite complex and of course, as I said in the prepared remarks, because of our fiscal year starting 4 months before the tax reform came into place, then when you're thinking about next year, you have to remember that we'll obviously have a full year of the numbers. But everything, all the numbers I'd stressed are provisional under the accounting we have 12 months to finalize this and of course we're overtime, increasingly seeing more clarification from authorities on exactly how to interpret the various changes that have come in at a very, very short period of time.
So the 20% -- I just apologize for this -- should be a good tax rate for the second half of the year or the annualized full rate? I just want to make sure we get this quick.
I mean, as a proxy, the way the accounting works; for the first half of the year you have to -- businesses have to forecast your full year rate before discreet and not based on your forecast and that is what you use for the half year. So the half year rate is a good indication but it can vary obviously depending on the mix. In the second half it's different versus what we forecasted internally this time and it can also change depending on the discreet which of course, vary quarter by quarter; some quarters they could be positive, some quarters it could be charged.
And our final question comes from Eric Percher from Nephron Research. Your line is open.
So as the discussion on consolidation brought to bear, it sounds like you would expect that there will be some pressure overtime on volume and reimbursement but that's a reasonable expectation, you would do the same. I wanted to get your thoughts on relative to the commentary on both, past 3 years what you've seen in share gain and reimbursement. How do you view the steady state of growth? What do you think the opportunities are for growth over the next 3 -- do they look similar given those headwinds on consolidation?
And then on reimbursement pressure, are we at a point where your relationships have evolved to a place where there may not be as much pressure as we've seen in the last couple of years?
I think it's always hard to have a crystal ball over 3 years but yes, we are assuming that we have the same opportunity to grow as we have done the last 3 years. So I think in terms of volume, that would be a reasonable assumption to take. In terms of margin pressure, it's harder to anticipate at the moment but we see the same trends right now, so as we build and think forward and think about how we are preparing the business for the future as Stefano mentioned earlier within the pharmacy, we're looking for similar reimbursement pressure as the past, will ebb and flow a bit year to year, but there is no indication there is going to be any materially different. What is going to be different we think is the ability to take care of customers better and link them better to a total offer.
Going forward, we mentioned quite a lot about our investments in data and technology and we're doing that for a reason which is to try include a more joined up experience for our customers and we see pharmacy as the area where we have got in the next 3 years probably more opportunity going forward. So I would be happy to see the future in pharmacy in the next 3 years.
On that investment I heard you speak to data and efficiency; I would think that your peers are also going to be looking at clinical capabilities to make these transactions impact cost. What is your view on investment today and the ability to impact the pharmacists enabled in this part of the care team?
We see it the same way. I'll go back to what Stefano said many times and I agree with this, which is you don't have to be vertically integrated to be able to provide the same services to the payers, as well as to the patients. So you can assume with the investments we're making that we are going down the same route and of course we're getting there as I said already in my prepared remarks, and we're in a pretty decent shape at the moment.
And I just wanted to squeeze in the $90 million legal benefit this quarter, could you just define that for us?
We really have nothing else to add to that Eric. I mean I know obviously we can't speak about it, it is what it is, so we have nothing else to add.
At some places as you can see, it's just -- it's an accrual related to ongoing U.S. regulatory models.
We have our ways to review carefully the potential risks that we have and we are account for consistently what we see.
Thank you. And I would now like to turn the conference back over to Mr. Gerald Gradwell for any closing remarks.
Thank you, thank you all for your questions. As I mentioned in the beginning, this was a new format in the presentation for us, so while we're talking to -- anyone who wishes to talk to us, afterwards the IR team are all here, Ashish, Debra, Jay, Patrick and myself to take your questions over the next few days and any feedback you have on the presentation format will be much appreciated as well. Thank you very much indeed.
Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, you may all disconnect. Everyone have a wonderful day.