© 2024 Alpha Spread Limited. All Rights Reserved.
www.alphaspread.com is not operated by a broker, a dealer, or a registered investment adviser. Under no circumstances does any information posted on www.alphaspread.com represent a recommendation to buy or sell a security. The information on this site, and in its related newsletters, is not intended to be, nor does it constitute, investment advice or recommendations. The information on this site is in no way guaranteed for completeness, accuracy or in any other way. In no event shall Alpha Spread Limited be liable to any member, guest or third party for any damages of any kind arising out of the use of any content or other material published or available on www.alphaspread.com, or relating to the use of, or inability to use, www.alphaspread.com or any content, including, without limitation, any investment losses, lost profits, lost opportunity, special, incidental, indirect, consequential or punitive damages. Past performance is a poor indicator of future performance.
You don't have any saved screeners yet
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 the Walgreens Boots Alliance Incorporated Fourth Quarter 2018 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, this conference call may be recorded.
I would now like to introduce your host for today’s conference, Mr. Gerald Gradwell, Senior Vice President of Investor Relations and Special Projects. Please go ahead.
Good morning, ladies and gentlemen, and welcome to our earnings call. I’m here today with Stefano Pessina, our Executive Vice Chairman and Chief Executive Officer of Walgreens Boots Alliance; James Kehoe, our Global Chief Financial Officer; and Alex Gourlay, Co-Chief Operating Officer of Walgreens Boots Alliance and President of Walgreens.
Before I hand you over to Stefano to make some opening comments, I will, as usual, 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 a discussion of risk factors as they relate to forward-looking statements.
In today’s presentation, we will be using 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 this call, this presentation and webcast will be archived on the website for 12 months.
I’ll now hand you over to Stefano.
Thank you, Gerald. Hello, everybody. Today, we are announcing another solid financial performance, both in the fourth quarter and for the full-year as a wholeI’m particularly pleased with the strong full-year adjusted earnings per share growth, up 18%, meaning that we have delivered mid-teens compound annual growth since WBA’s inception.
A significant feature of our growth has been our strong cash generation, which continued to develop well this year. These strong and resilient cash flows stem from the important role that our pharmacy businesses play in national health care systems and in the daily lives of our customers.
I believe true customer focus will be key to our future. Focusing on our customers and their needs will drive growth. And with that in mind, it is very encouraging to see the continued market share gain here in the USA, as we continue to deploy the benefits of scale in part to offset the inevitable pressures that occur as demand for healthcare continue to grow.
The team in the U.S. has continued to make good progress on a number of initiatives, notably with the work to integrate the stores that we acquired from Rite Aid, which the team are delivering on schedule and on budget. James will update you on that in a moment.
Of course, we have also made a significant progress in the formation and development of partnerships and alliances, as you have seen from our announcements in the past weeks, including the announcement of our expanded partnerships with LabCorp. This is all part of our strategic initiative to transform our offering, organization and infrastructure to be fit for the future.
We believe in true partnerships that share resources, skills and expertise and either accelerate our own work or bring us capabilities that we could not easily or economically develop ourselves. You will hear about these partnerships once James has taken us through the numbers.
So with that, I will hand over to James.
Thank you, Stefano, and good morning, everyone. Overall, we delivered a solid set of results in the fourth quarter and the full-year. GAAP EPS more than doubled in the quarter, with the full-year up 33.6%. Adjusted EPS increased 13% in the fourth quarter, both on a reported and constant currency basis, and for the year, adjusted EPS grew 18%, with 17.1% growth in constant currency.
We delivered full-year sales growth of 11.3% on a constant currency basis. And excluding the impact of acquisitions and divestitures, our organic sales growth was 3.2%. Encouragingly, our U.S. comp sales improved sequentially versus the third quarter, both in pharmacy and retail. Reimbursement pressure continued and we partially offset the impacts through good cost management and procurement savings.
Cash generation was strong, with free cash flow up 16.9% to $6.9 billion. And as we’ve said many times, if we don’t make any significant investments in the year, we will return excess cash to our shareholders and maintain an efficient balance sheet. In total, our strong cash generation allowed us to return $6.8 billion to shareholders this year, $5.2 billion in share repurchases and $1.6 billion in dividends.
Turning now to our full-year results on Slide 5. Full-year sales increased 11.3% and GAAP EPS was up 33.6% to $5.5. This performance reflects high single-digit growth in adjusted net earnings, the absence of the prior year of cost transformation program and a lower share count.
On an adjusted constant currency basis, our key metrics increased versus prior year. Sales advanced 10%, including the impact of the acquired Rite Aid stores and organic growth of 3.2%.
Adjusted operating income was up 2.9%, reflecting the solid performance in Retail Pharmacy USA. Adjusted net earnings were up 8% and adjusted EPS increased by 17.1% to $6.02 per share. Our ongoing share repurchase program contributed approximately 5.5 percentage points of EPS growth. The full-year adjusted effective tax rate was 18.8%, 4.4 percentage points lower than prior year, primarily due to U.S. tax reform.
Turning now to our fourth quarter highlights. Sales increased 10.9% and GAAP EPS more than doubled to $1.55, reflecting a lower effective tax rate and the gain on the sale of our interest in Premise Health in July of this year.
On an adjusted constant currency basis, our key metrics increased versus prior year. Sales advanced 11.3%, reflecting the acquisition of the Rite Aid stores and organic growth of 4%. Adjusted operating income was up 0.3% and adjusted EPS increased 13% to $1.48 per share, primarily reflecting a lower tax rate and the benefit from share repurchases.
Now let’s look at the performance of our divisions, starting with Retail Pharmacy USA. Sales were up 14.4% in the fourth quarter. Full-year sales advanced 12.7%, reflecting the acquired Rite Aid stores and organic sales growth of 3.4%. Adjusted gross profit was up 2.8% in the quarter and 5.2% for the year. The favorable impact of higher sales more than offset a lower gross margin.
SG&A spend increased 3.7% in the quarter, entirely due to the acquired Rite Aid stores. Excluding Rite Aid, SG&A spend declined 7.6%, primarily due to an amendment to certain employee postretirement benefits and continued cost reductions. Excluding Rite Aid, full-year SG&A declined 1.5% versus prior year, mainly driven by strong cost discipline. The amendment of certain employee postretirement benefits had no impact on the full-year comparisons, as there was a similar amount in the third quarter of 2017.
Adjusted SG&A was 17.1% of sales in the quarter, an improvement of 1.8 percentage points compared to the year ago quarter. On the same basis, adjusted SG&A as a percentage of sales has now improved for 21 consecutive quarters. Adjusted operating income increased 0.1% in the fourth quarter and 3.8% in the year. You will recall that we were lapping a very strong fourth quarter last year with double-digit growth in adjusted operating income.
Our full-year adjusted operating margin was 6%, 0.5 percentage points lower than prior year, almost entirely due to the dilutive impact of the acquired Rite Aid stores and the Prime strategic partnership. On an organic basis, lower pharmacy gross margins were offset by strong control of SG&A and higher retail margins.
Now let’s move to pharmacy. Total pharmacy sales advanced 16.7% in the fourth quarter and 17.2% for the year, mainly reflecting Rite Aid and organic growth of 6.5%. Our central specialty business led the way and delivered full-year growth of 80%. Fourth quarter market share was 22.3%, up 180 basis points compared to last year.
The number of retail prescriptions filled on a 30-day adjusted basis, including immunizations increased by 11.8 % in the quarter and 10.6% in the year. Comps were up 1.3% in the quarter and 3.5% in the year, with the second-half growth rate impacted by the Medicare Part D network changes.
Comparable pharmacy sales and prescriptions improved sequentially compared to the third quarter and included a benefit from the transfer of prescriptions from our Rite Aid stores. Pharmacy gross profit was slightly lower in the fourth quarter, entirely due to timing, and full-year gross profit increased mid single digits versus prior year.
The fourth quarter gross margin reflected the continued shift to specialty, which accounted for around 190 basis points and reimbursement pressure, which was in part due to unfavorable timing. These factors were partially offset by procurement savings.
Turning next to retail. Retail sales increased 8.3% in the quarter and 2.4% in the year, with the fourth quarter reflecting an increased sales contribution from the acquired Rite Aid stores.
Comp retail sales declined 1.9% in the quarter and 2.4% in the year. The fourth quarter comp improved sequentially compared to the third quarter decline of 3.8%. Full-year retail sales were held back by two factors. Firstly, promotional optimization had a negative impact of approximately 90 basis points. Secondly, we deemphasized cigarettes and seasonal products within our overall offering, and this led to a negative revenue impact of around 110 basis points.
So in total, these two programs explain around 200 basis points of the full-year sales decline and both of these have enabled improved retail margins. We grew comp sales in both the health and wellness and beauty categories in the fourth quarter and for the year, benefiting from investments in our top stores.
In fact, total retail sales in the beauty differentiation stores continue to outperform and resulted in an improved margin in these stores. Retail gross profit was higher in both the quarter and the year. Excluding Rite Aid, retail gross margin expanded 30 basis points in the quarter and an impressive 170 basis points in the fiscal year.
Next, let’s look at Retail Pharmacy International, which, as usual, is in constant currency. Sales decrease 2.7% in the quarter and 2.1% in the year. On an organic basis, sales decreased 1.5% in the quarter and 1.2% in the year. Comp pharmacy sales declined 3.4% in the quarter and 1.2% in the year, mainly due to lower UK prescription volume and continuing UK government reimbursement pressure.
Comparable retail sales were down 0.9% in the quarter and 1.5% in the full-year, as we saw improvement towards the end of the year. Excluding the UK, comp retail sales were up 0.9% in the year and 1.1% in the quarter, with good growth in the Republic of Ireland and Thailand.
Boots UK comp retail sales were down 1.4% in the quarter in a difficult retail market. While our beauty business declined in a changing category, we drove continued growth in our health and wellness and personal care businesses. We are taking actions to address our UK retail performance and we’ll be investing in new store and digital content. More to follow on this in future quarters.
Adjusted operating income declined 2.3% in the quarter. This was entirely due to lower revenue. Good cost management allowed us to hold our fourth quarter and full-year margins at the same level as last year.
Turning now to the Pharmaceutical Wholesale division, which we’ll also discuss in constant currency. Fourth quarter sales increased 4.7%, with continued strong growth in emerging markets. Adjusted operating income increased 2.7% in the quarter, reflecting relatively lower generic procurement pressure and higher contribution from AmerisourceBergen.
Before I move to cash flow, let me give you a quick update on Rite Aid. The integration of the Rite Aid stores is progressing well, and strong execution is leading to favorable results on prescription volume retention. The store optimization program is on track. And as of year-end, we have closed 458 stores in line with our plan. We aim to complete the store optimization program by the end of fiscal year 2019.
Integration and rebranding are also progressing, with pilots underway. We are now anticipating a total benefit from store optimization and synergies of more than $650 million per annum, ahead of the $600 million we had originally forecast. And we expect our overall integration and store optimization costs to be in line with our original estimate of approximately $1.2 billion.
Turning now to cash flow. Our cash generation was strong. Free cash flow for the year was up 16.9% to $6.9 billion, the highest level in the company’s history, reflecting higher operating income and cash tax benefits. Cash taxes were lower in fiscal 2018, partly due to non-recurring benefits of approximately $450 million.
We reduced working capital by $1.5 billion for the second year running. Around 25% of the reduction was as a result of the acquisition of the Rite Aid stores and good management of both receivables and inventory led to a reduction of our cash conversion cycle days.
Let’s turn now to our guidance for next year. We are projecting constant currency adjusted EPS growth of 7% to 12% in fiscal 2019. Our currency assumptions result in an adverse EPS impact of approximately $0.04. This leads to an adjusted EPS range of $6.40 to $6.70 in reported dollars, and we will tighten the range during the course of the year.
Now, let me share some of the assumptions embedded in our guidance. We estimate that next year’s adjusted effective tax rate will be broadly in line with 2018. We project a tax rate of between 18% to 19%, depending on the level of discrete items in the year. We will be making select incremental investments of around $150 million in fiscal 2019, mainly in store wages, but also the fuel our new community healthcare initiatives. And you can view these in light of the favorable tax reforms in the U.S.
In total, these investments represent a headwind of approximately $0.12 in the coming year, or 2 percentage points of EPS growth. In 2018, we returned $6.8 billion to shareholders, of which $5.2 billion was share repurchases. In 2019 and absent major M&A, we are planning share repurchases of around $3 billion under our current program.
In addition, since WBA’s inception, we have had a rigorous and continuous focus on cost reduction. Our guidance assumes significant strategic cost management programs and we will provide further updates over the coming quarters.
In summary, we are projecting adjusted constant currency EPS growth of 7% to 12%, and this guidance includes incremental investments of $0.12, or 2 percentage points of growth.
Thank you. And I’ll now hand you over to Alex.
Thank you, James, and hello, everyone. As you have heard from both Stefano and James, it’s been a busy year.
Before I come to some of the things we have just announced since the end of financial year, let me first give you a quick update on some of the initiatives within the U.S. business. You’ve heard that the growth in the U.S. pharmacy sales has been robust. And given the pricing pressures in the market, it will come as no surprise to you that this growth has been fueled mainly through the healthy growth in prescription numbers.
In the last year, we filled the highest number of prescriptions in Walgreens’ history. The shift in contract volumes do create an element of volatility from time to time, but the underlying trend in terms of prescription volumes and market share in the U.S. has been positive for a number of years now. And the fourth quarter reached 22.3% of the U.S. retail prescription market.
We also announced the acquisition of Scripts from DaVita Rx and since the year-end, the pending acquisition of the prescription files from Fred’s, and both are expected to contribute positively to next year’s script numbers. James mentioned the higher than forecast retention rate we’ve been achieving on Rite Aid script transfers, which gives us a high degree of confidence in these acquisitions.
We are very aware of these good retention rates are being achieved through the high service levels and customer-centric approach that our teams are demonstrating and bringing these new patients into our system.
Turning to specialty. We opened further 12 community-based specialty pharmacies in the quarter and totaled 31 in the year, taking our total to 306 at the year-end, up over 10% on last year. We also announced the implementation of a new cloud-based pharmacy platform, the Inovalon ONE platform for AllianceRx that will improve the efficiency of the business and allow the team to directly enhance oversight and management of the work they do.
We have continued to work on developing our online offering at Walgreens and driving the use of our app for patients who value online convenience as part of their daily healthcare regime. Our apps have now been downloaded around 53 million times and around 22.5% of Walgreens’ retail refill scripts were initiated through digital channels in the quarter, up 2.4 percentage points on the same quarter last year.
As you know, we’ve been using our stores in Gainesville, Florida to try a number of different ideas and we’re continuing to cycle programs through these stores to assess customer reaction to the offerings and to validate their commercial viability. We’ve always been clear that it will take time for these initiatives underway in Gainesville and elsewhere to be validated and potentially developed across our estate.
However, we are beginning to look at implementing the concepts in our wider network. In recent months, we’ve expanded trials of Express pickup points for pharmacy and store, and we’ll soon be expanding mobile self-checkouts beyond its current trial in Gainesville, allowing customers to scan merchandise and pay using an app in the store.
In the quarter, we also saw the first store outside of Gainesville refitted with our new health offering, inspired by some of our concept work. This stores is close to our head office in Deerfield, Illinois, and we’ve characterized it as a neighborhood health destination store. Although we’re still developing this concept, I’m really excited to see an enhanced healthcare offering beginning to be deployed in our U.S. stores.
Also across the network, we’re working to complete the roll out of the FedEx offering, which is known around 7,700 stores, and we’ve expanded the trial with Sprint to additional 80 locations planned to be opened by the end of this year in Illinois and Texas. There’s now a real energy and drive-in the business to make a step change in enhancing the customer experience, starting in our leading stores but over time, flowing down to every store in the network.
More recently, you’ve seen us announced an exciting new collaboration with Kroger to test the concept that brings together our pharmacy, health, beauty and personal care expertise with their extensive skills and resources in general retail and merchandising.
Kroger scale and expertise, combined with our own, can potentially create a truly unique concept in the marketplace. Clearly, this is a very early-stage trial, but this is a type of initiative that could drive a step change in the transformation of our customer offer and our stores overall.
I’m very excited by both the concept and the flexible approach and fresh thinking this initiative demonstrates in the Walgreens team. The success of such initiatives does, however, also rely on Walgreens continuing to develop its own expertise and resources in its areas of specific expertise.
The announcement of our collaboration with Birchbox to develop a store-in-store offering and provide integrated access to Birchbox online via walgreens.com under Walgreens app, clearly shows a drive to develop our beauty offering in the U.S. and internationally, alongside our pharmacy, healthcare and personal care offer.
Finally in the U.S., to complement the work we’re doing to improve the pharmacy experience for our patients and enhance the healthcare offering in our stores, we’re expanding our partnership with LabCorp. We’re planning to open, at least, 600 LabCorp patient data centers at Walgreens stores over the next four years, building on the 17 locations that opened since June 2017. So far, we have been delighted with the customer response to this partnership.
Outside the U.S., Boots in the UK has faced a challenging year. Sebastian James, a seasoned specialist retailer, has joined us to head up Boots from 1st September. And he’s already working with his team to take actions to address the opportunities of the UK business given the challenging market.
I should also highlight, our agreement with Alibaba to bring our beauty brands to Chinese consumers through our flagship store on Alibaba Tmall Global platform. We’ve had a long standing presence in China, and this is an exciting new step in building on that. It demonstrates that the growing digital environment, which is often characterized as a threat to traditional retail, we see as a great opportunity to work with forward-looking market leaders such as Alibaba.
In summary, we’re extremely excited by the opportunities created by the partnership we’ve announced recently, LabCorp, Birchbox, Kroger and Alibaba, which are all great examples of our partnership strategies.
I’m going to hand you back to Stefano for some closing comments.
Thank you. As you can see from our results, our businesses have mostly done a good job of growing or at least holding their own in a tough year in many of our markets. As a company, we have improved year-on-year on our headline financial measures.
We have, as usual, built on the respectable operating performance with further scale and financial efficiencies to maximize returns for our shareholder, while investing, as appropriate, for future growth. We have continued to improve the operational performance of our core businesses. And at the same time, we have done a great deal to advance the overall transformation of our company.
You have heard that we’re expanding our initiatives and partnerships, and there are a lot more to come. This work supports our focus on driving our business forward in three key areas.
First, we’re developing our omnichannel capabilities across pharmacy and retail to revolutionaize the customer experience. We’ve been producing a leading-edge thinking and infrastructure, as we move much of our business into the digital space. This will bring us closer to our customers in their daily lives beyond the physical presence of our stores. It will allow us to focus on our customers more closely and more individually than we have ever done before.
As we look forward, I believe this is easily one of the biggest transformations our business has ever seen. How we do this and the partners we choose to work with will have a major influence on the future shape of our company. It is of such importance that I’m leading it personally.
Second, it’s essential that we transform our retail business to create a modern retail offering that builds on our convenient locations and differentiates our stores in a crowded market. Most importantly, we must do this at a value proposition that is attractive to our customer and competitive against other comparable retailer.
Third, we intend to transform our pharmacies worldwide, expanding from our pure pharmacy focus to create healthcare destinations. Building on the current trusted role of the pharmacies, we will offer a wide range of health and well-being services supported with a strong and in many cases, unique, health, beauty and personal care retail offering.
We’re actively working to make our company the first choice in this sector for customers and partners alike. These partnerships bring us additional scale, knowledge, experience and resources beyond anything we could build by ourselves in areas that are very important for our future and they do so quickly.
Partnerships also create an agile, open and collaborative mindset that is vital for our growth as we look to the future. They enable us to quickly align our products, services and people to the needs of a rapidly changing and integrated omnichannel marketplace to meet the demands of a more dynamic and demanding customer base.
Of course, while we undergo the transformation, we must also continue to deliver good financial performance from our existing businesses, protect the strong market position we have today and meet the needs and expectations of our stakeholders. Our commitment is clear. We will return a capital to our shareholders when we do not have the opportunity to deploy it in the near-term for accretive value creation.
Our guidance for fiscal 2019 shows that we expect further robust growth in the year-end. And we will continue to deploy our strong cash flow for the benefit of the business and our shareholders. I’m confident in our company. I’m excited by the work we are doing to transform our businesses, and I’m looking forward with enthusiasm to the year ahead.
Thank you. Now, we will take your questions.
Thank you. [Operator Instructions] And our first question comes from Brian Tanquilut from Jefferies. Your line is open.
Hey, good morning, guys. Just the first question on the guidance. So as we think about, obviously, the EPS growth is being driven largely by the buybacks. But how are you thinking about EBIT growth on an organic basis if we consider Fred’s and Rite Aid as acquisitions, or I guess, how are you thinking about top line growth as well in terms of your ability to grow same-store and the front end of the store in the pharmacy in the U.S.?
Yes. Hi, James here. Hi Brian.
Hi, James.
I think, as you dissect the guidance, I’m inclined to take it from an EPS basis, but the only forward guidance we’re giving. So 7% is – approximately 5.5% is coming from, I’m sure repurchases. So I think, even at the low-end of the guidance, we’re looking for a core business growth of 1.5%. And we did call out quite significant investments in our stores of $150 million, that’s about two points of growth.
So we’re saying the low-end is 3.5 percentage point ex-buybacks and the high-end is 8.5%, and we think that’s a strong statement of confidence in the future. I think, as you look forward from next year, I think, Q1 will probably have similar trends to Q4, actually the average of this year. And then as we go further into the year, we’re going to see a distinct improvement in the gross margin trends as we move into the second-half.
So we have actually pretty good visibility on gross margin. We have a strong pipeline, we have investments, but we have strong pipeline of cost as well. And maybe, I will ask Alex to give you some perspective on the visibility on file buys and Rite Aid. The one thing I would say about Rite Aid is, if there are synergies next year, but we’re actually also incurring a significant increase in interest cost, so factor that into your model. So the contribution year-on-year is relatively marginal from Rite Aid. So maybe I’ll ask Alex to give us some perspective on how we think about the revenue line.
Thanks, James. Good morning, Brian. Yes, I think…
Good morning.
…revenue lines, we’ve seen first of all, a slight improvement in both underlying items growth and retail sales in the quarter. And we expect that improvement to continue into next year.
As James pointed out in his prepared remarks, for example, around about 90 basis points of the sales impact this year was promotional programs, which have now cycled out to the year as one example of the ongoing improvement. And we’re encouraged by our investments in the larger, more – larger stores and also by – in health and beauty as we continue to see a good return in sales and margin from these investments.
On the pharmacy side, we’ll cycle through the Med D networks from January 1. We expect to grow at the market next year. We know these contracts pretty well. And therefore, that is the fastest growing area of pharmacy underlying in the business, maybe the Rite Aid.
We’re encouraged by the retention, as we said in the prepared remarks of the scripts we’re now transferring from Rite Aid to Walgreens stores. They are higher than you’ve seen historically, and the team have done a really good job to drive that up, and we expect that to be sustained and the file buys are important. It’s important we continue to add customers into our stores from other pharmacies who are willing to sell their contracts at reasonable price. So all of these factors lead us to believe the underlying growth will be solid and we’ll continue to see progress through the year.
Just a quick follow-up for me. Alex. As I think about the $15 Amazon minimum wage increase, how are you thinking about that in terms of how it impacts your ability to hire and retain employees?
Well, we’ve announced already the investment of $150 million as – in James prepared remarks, which is primarily going into store labor. And we remain confident with the offer we have at local level and the way that we treat our people in stores, look after them in different ways that we will remain a very, very competitive employer.
And don’t also remember the fact that Amazon today primarily recruits people who walk in warehouses, and therefore, that is quite different in terms of market rates. So those who primarily walk in retail shops.
All right, got it. Thank you, guys.
Thank you. Our next question comes from Robert Jones from Goldman Sachs. Your line is open.
Great. Yes, thanks for the question. I guess, just taking your comments, James, on the 3.5% to 8.5% EPS growth, excluding the buyback. It seems like interest expense and tax, kind of offset each other for next year. So I guess, I was hoping maybe you could just give a little bit more context around a contribution you’re expecting relative to guidance from continued impressive SG&A control versus kind of core gross profit growth?
Yes. I think the – I think, it’s an ongoing challenge, the gross margin we have. It’s an industry with reimbursement pressure. And we have three valves for that for offsetting the pressure and it’s been quite successful over the last three years since the company was formed. I’d point that the average EPS growth was 16% over the last three years, last year was 17% constant currency, 18% reported.
So the model is there. And some quarters will be messy and other quarters will be much better. So the way we look forward is, we have first of all, volume. It’s a scale business. So the more prescriptions we put into our stores, the more we can offset any kind of reimbursement pressure. And honestly, the better the partner we are for all of the payers, which makes us just a more valuable commodity and less pressure.
The second one is how we purchase generics and the significant benefits we’ve gotten over multiple years. These are tailing off a little bit, but to compensate that, we will be significantly scaling up the SG&A efforts. And even on SG&A, there’s a track record 21 consecutive quarters of percentage reduction in SG&A. I actually think we can do better than that. I think we can start making better inroads on an absolute basis as well.
So we actually look forward quite encouraged that, whereas procurement goes down, we see the lever on back office optimization in general. I come from consumer goods, which is very ZBB oriented. So we will become a very lean and cost-efficient company, and that’s what’s required when you’ve got reimbursement pressure. So we’re extremely cognizant, and I’m very focused on the overhead side as Alex has been in the past. And I don’t know, Alex, do you want to add anything to that.
I think James said it really well. And I think the one thing I’ll just remind you of is, we’re also investing in technology. So we are replatforming both our retail supply chain, as well as our pharmacy supply chain, and we expect that investment will again give us opportunities for really simplifying the business in the future and give us data points and processes we’ve never had in the past before.
So we remain focused and confident that we can continue to take SG&A cost out of the business and important to improve the customer experience in our pharmacies and online.
Yes. Just maybe to add one thing. I mentioned in the guidance section, Q1 margins and gross margin will be probably similar to the trend in the latter part of 2018. Well, actually, we do see a significant improvement in the last three quarters and an improving trend, mainly because of the items we said, the procurement valve, the scripts in the store. And where we – our numbers have been very, very messy this year, because we’ve had this FEP contract in the specialties.
So our business is growing 80% in the quarter and just the mix because of lower-margin is driving 170 basis points of gross margin slippage. But actually, if you peel back, take out the FEP and take out some timing differences on reimbursement in the quarter, actually, there wasn’t that much change in the gross margin. So it’s a headline problem and it’s an explanation problem.
But the – once we lap FEP in Q2 of next year, the gross margins start looking more – they could more flatter in terms of trend, and still we’re going to start pushing up the SG&A engine much, much harder. So I just wanted to recognize that. Yes.
Great. That was actually my follow-up, James. So I’ll stop there. Thank you.
Thanks.
Thank you. And our next question comes from Lisa Gill from JPMorgan. Your line is open.
Thanks very much. Good morning. First, let me start with the gag order that’s being lifted on the pharmacists speaking to the individuals. Can you talk about the impact that, that will have on your pharmacy? Is that a positive for Walgreens, or is that a potential headwind?
Lisa, overall, it will have no impact. Our pharmacists have been allowed, encouraged to talk, to be honest, to make it – the cost as low as possible for the patients in every occasion. So this will have no impact. And obviously, we welcome that, of course, it’s a big step forward.
Okay, great. And then second, when we think about the LabCorp partnership, Alex, is there any metrics you can give us around what you’ve seen thus far? I know it’s only 17 stores. But as we think about that future relationship, whether it’s incremental buying when people come in, perhaps a correlation between giving a lab requisite and picking up a prescription, is there any data points that we can think about as we think about that relationship over the next several years?
Lisa, again, obviously this year, I can’t. But I can give you the big one this morning, which is you can imagine the team in LabCorp would not have agreed to expand by 600 stores not with Walgreens Boots Alliance had we not seen results that we’re very pleased with. And this is a platform, think of this as a platform for the industry and a platform for patients in terms of convenience.
So whether we can expand on helping customers take better care of their own health by getting information quicker in a convenient form from their pharmacy and LabCorp or was this about advancing medicine to the work they do with the manufacturers in clinical trials, et cetera, or whether this is about creating better health outcomes because of the convenience and the data, but just these are all things that we are looking to do with our partners in the future. And that’s why we also had a memorandum of understanding in place as well to develop the business further.
So we’re really excited by this partnership. We think it’s great for the industry. We think it’s great for patients, and the economics are good enough. So that’s where we are with that one.
Okay, great. And then just lastly, James, the conversation keeps coming back to the underlying organic growth, and I appreciate all of your previous comments to this. But as we think about the core business of Walgreens in the U.S., how do you think about that core underlying growth? So strip away Fred’s, strip away all the things that are kind of one-time, what are your thoughts around how you see that business growing just in the face of reimbursement and other issues? Just really want to understand what the baseline is that you think about this over the next several years?
Yes. I’ll just give you my thoughts, and then I’ll ask Alex to maybe add onto this. I think if you look at the full-year, our adjusted operating income growth on the corporation was 2.9% and the U.S. business over 3%. And for a business that size in a complicated industry with a lot of pressure on reimbursement, that’s pretty solid results. So – and the starting base is pretty strong here.
So I think as you look forward, we’ve got Rite Aid for an additional couple of periods next year. We got some new file buys coming in. We got a lot of operational excellence, and I don’t want to discount all of these partnerships and the benefit they’re going to bring generally in terms of a halo and our importance in general in the industry.
So that’s where we play up. It’s more a three-year horizon. And then in the short term, you’ve got reimbursement pressure, and I don’t want to start guiding to the pressures. But effectively last year, we offset about 70% of the pressure through generally procurement and others such as procurement activities.
So what’s left to offset is about 30% through overhead management. And I think, you’ve seen enough data points, and I’m repeating a little bit what I said at the start. I think, you’ve seen enough data points to show that neither of these tools is new to the company. I just see coming in with a fresh set of eyes. I look at things a little bit differently, and I’ve toured many countries.
I actually see that we could be a little bit more aggressive on the SG&A and procurement in general. I think, we’ve got good skill sets, but I think are they at world-class levels? No, they’re not. So I think the job that management has to do is make all of these world-class quickly. And that’s why I’m actually feeling quite good about the main business. It’s not an easy business, don’t get me wrong, because of the reimbursement. But I think the tool box we have is quite well-developed and we can scale it up even more. I don’t know, Alex.
Yes, Lisa, I think, the core driver for the underlying base business is prescriptions, as you know. And even this year, where we’ve had going from preferred to non-preferred for the Aetna book of business in one single year. We’ve been able to grow overall 3.5% items worth through the whole year, and you’ve seen a sequential improvement of 1.3% in this quarter.
So even in what was a more difficult year for the underlying business, we’ve been able to grow at or beyond the market underlying. And on top of that, there’s a lot of that dislocation in the market. There’s a lot of businesses who are looking to move away from pharmacy and we’re able to pick up the file transfers you’ve seen from different companies.
So we think that the core business is strong in the way that James has described. The volume is strong. We think we’ve done a good job in the front-end in terms of shifting the emphasis to become more of a health, beauty, wellness expert. And there’s a lot more to go, and it may be taking us longer than we had first anticipated. But the signs are very clear, where we’re heading to and the transition is well underway.
And in the U.S., that’s the core of the business along with SG&A. That’s the core of the business. So I think, we believe the core is strong. The market is challenging, but we’re very well-equipped to deal with it.
And Alex mentioned it a little bit earlier, don’t underestimate the positive impact on operational excellence from new systems investments, and we’re spending significant amounts of money in the U.S. business, both on the financial systems, store systems, stock availability. It’s just an enormous amount of positive momentum that will be brought online in the next couple of years, and this will all produce effectiveness in store and actually in the back office as well. So it’s a multi-year cycle unfortunately, and we have to go through it. But two years from now, it will be a very different animal in terms of the ability to execute.
Lisa, Stefano, Lisa. For years, we have been told, "Is your model sustainable? Will you be able to reduce cost for ever? Will you be able to buy better forever? And you see year-after-year, we are very, very delivering. Look at what we have done since the first day that we are here.
We have always given guidance. You can judge by yourselves whether our guidance were correct or not and where we ended up. At the end, we see guidance. So I’d say that we continue to deliver what we promise. And if we tell you that we believe that there’s still a long way to go in our – for our costs for our buying power. Well, at the end we have demonstrated that when we promise something, we do it so.
Okay, great. Thank you.
Thank you. Our next question comes from Eric Percher from Nephron Research. Your line is open.
Thank you. To start big picture, this quarter we saw the introduction of a authorized generic strategy at Gilead. And I’d be interested to hear your thoughts on how expansion of such a strategy might impact pharmacy and the opportunity with a generic and, of course, a little more limited with an authorized generic? How do you think about that?
Hi, Eric, it’s Alex here. Yes, I think, again, we are very open to anything that reduces the cost for the customer and provides access to care and very important molecules, because we are absolutely focused on the customer and what the customer wants. So we think overall, this is a good move for the industry. Economically, it’s a small impact on us and one that we can absolutely manage going forward. And I think, it will be interesting to see what happens with other molecules of similar types.
So this is the move to these generics has been happening in the U.S., as you know, for years and years and years. The penetration of generics overall is about 90%, and I think overall and it’s just a further example of our trend. So it’s good news for the customer. I believe it’s good news for Walgreens pharmacy overall, and we’ll remain very competitive as it shifts in the marketplace.
Okay. And then for James, I appreciate the commentary so far. Your comment on the first quarter was helpful. And maybe why I would ask is, with respect to gross margin, as you look at the headwinds you felt over the course of the year and gross margin this quarter was lower than we expected. What’s your take on how those have built? And I know that FEP played a large role and therefore, where that sets up in terms of the quarterly progression for next year?
Yes. The only one I would – the most significant one and significant one is about 170 basis points as a result of specialty, and it was somewhat higher in Q4 and the earlier part of the year was around 150 basis point. So not a big deal. So talking about 170, it will repeat in Q1 and then it will tail off in the rest of the year.
So if you build out your projections, the business will continue to grow really quickly. But the actual margin impact in Q2, Q3, Q4 just tails off, because we’re lapping the big FEP contract. So that’s the primary one in gross margin. I think, you won’t go wrong if you just adjust for that one.
And if you look at, I mentioned before in the comments, if you look at – you plot reimbursement at whatever your estimate is and you assume the majority of it is offset either through procurement of generics or on the SG&A side. So that’s kind of like the model as you might want to work through the quarters.
Just in general, our business is not that seasonal. So we have – we estimate we’ll have something like between 49% and 50% of the years in the first-half, and then somewhere around 21%, 22% is in Q1, and it’s always kind of like that. If you go back over three years, it’s got – it’s relatively predictable. So you won’t go too far wrong. If you look back on 2018 or 2017 and plot it out, you’ll get a good indication for the phasing.
Now, individual quarters will be lumpy and Q3 was a – Q4 was a lumpy quarter. We had phasing impacts on reimbursement contracts, which are enormously difficult to predict. And that, that gives you a 30 basis point impact in the quarter. It won’t repeat. So I think that we’ve given enough insights, probably a lot more than the past in terms of how to think about next year. So I really don’t want to go any further than that.
Okay. Thank you.
Yes. There’s only one commentary. We’ve lost a little bit is the 13% in Q4, you should look at it and the AOI growth, which was a little on the weakest side lower than the full-year trend. The Q4 of prior year, we grew adjusted operating income by 22%. So we’re lapping a really tough quarter. And as you think about what was the quality of the quarter, bear in mind that you do a three-year stack on this. And then you might come to a different impression on the quarter, which we think was stronger than maybe the headline would suggest.
Thank you. And our next question comes from George Hill from RBC. Your line is open.
Yes, good morning, James, and good morning, everybody. And we definitely appreciate all the color. I guess, thinking about the quarter and the go-forward guide, both in talking about the U.S. business at the AGP line and at, I guess, we’re calling it, the AOI line now. I guess, how do we think about the dollar growth and the margin impact? Because it seems like we saw, at the gross – adjusted gross profit line, like a big step down either in the contribution from Rite Aid or erosion in the core. And I guess what I’m trying to figure out is, how much of the negative impact would we think of as one-time versus how much is mix, because you talked about the change to the reimbursement contracts?
And then maybe, to the degree to which you can comment on the visibility as we go through the back three quarters of next year, it sounds like we’re calling for – we’re not calling for gross margin expansion, but just a much slower rate of erosion. Is that – am I – I want to make sure I’m hearing things correctly.
Hi, it’s Alex here. Yes, I think James explained it really well. So just repeat very briefly what James has said. The FEP contract was 190 basis points more or less of the impact, and that will be going by January 1, which is halfway through our second quarter. We’ve also mentioned that we have some timing issues in the quarter. This quarter that was lumpy in their own way, because some of the contracts paid us differently to what would they did the previous year. And I think James you mentioned that was about 30 basis points.
And then I always say that reimbursement pressure going forward is a bit normal. I don’t think it’s either was so better than what we’re seeing on our visual the last three or four years. And I remember, we have got good visibility into Med D at this time of the year, which is the annual contracts and, of course, the commercial contracts are longer by nature.
And I think also – I mean as already – so I think that also in terms of the front-end, as James has said, we saw 190 basis points improvement in the front-end margin in the full-year this year, and we continue to invest in our strategy. So, some of that was the 90 basis points of, I’ll say, a one-off effect of stabilizing our promotional programs.
We were overinvesting we believe in using new tools and techniques to make sure that we got adequate return, but the rest of that is really a shift in mix and focus in the business. So we expect to see ongoing improvement in the front-end margin. So I don’t know if that helps in anyway shape or form, but that’s just some additional color to what James has said already.
No, it does help square it all. And then, James, I guess, a real quick follow-up is the guidance for 18% to 19% tax rate would actually imply that tax is a headwind for fiscal 2019 as opposed a tailwind?
No, we actually – if I was to guide that, I think I would say flat and this kind of interesting that the tax rate reform benefit of 2.5 – it’s roughly 2.5 percentage points, is offset by the other elements of tax reform that people don’t talk about, which is the GILTI tax and there is a repeal of Section 199 relief and that 2.5 is offset by 1.6 points of the negative impacts of tax reform.
So tax reform is probably a net 1 percentage point. And then we have discrete items in the base year, that’s favorable tax judgments other stuffed in 2018 that right now, we project won’t repeat next year. And that’s why we made the comment, it’s a range of 2018 to 2019. In reality, it’s flat because, discrete and the not-talked about parts of tax reform will offset the rate improvement, because bear in mind, we still have one favorable quarter left of favorable rates and that’s roughly 2.5 points. And as I said, I will repeat 1.6 points are GILTI tax on Section 199 relief. So we’re kind of thinking of it as basically flat right now.
But you see, you have to remember that the tax reform has been mildly favorable for us, because we were very tax-efficient and as many international group of companies. Of course, we had a mixed rate or tax rate. And, of course, so when the reform came in, there were positive effects in the U.S. and negative effect on everything that was outside the U.S. So, of course, overall, it has been positive, but not as much as we could hope and not as much as other companies mainly based in the U.S. have enjoyed.
And bear in mind, the taxes based on current guidance – sorry, current regulations and our interpretation of them. The treasury department hasn’t finalized all of the regulations yet. So in Q1, when it gets clearer, we’ll give a further update on where we see tax evolving to.
Okay. I appreciate the call. Thank you.
Thank you.
Thank you. And our final question will come from Ross Muken from Evercore. Your line is open.
Hi, good morning, guys. So maybe just on sort of the PBM/reimbursement front, obviously, a number of mergers closing in the upcoming weeks. I guess, how are you thinking about sort of your positioning with the very players given, what those entities will look like and sort of how, maybe others may come to you given some of the natural conflicts in those businesses and just ultimately have to think through, whether that is a net positive or negative relative to either rate pressure or incremental kind of channel opportunity?
Let’s say that time will tell whether it will be net positive or net negative. We are quite positive on that. We believe that our position should improve. We believe that the network of partnerships that we are creating and we have just announced some of them will help us to improve overall our positions and to improve our profit. But the market is, let’s say, quite open and quite excited now.
And as you know, we have never excluded any M&A activity. We have just said that we are open to any kind of M&A provided, provided that it is really value creating for our shareholders. So we will see how the market evolves. For the time being, you have to see that what we can perceive today, it’s more favorable than negative. But we are, let’s say, very, very aware of these, let’s say, volatility of these effervescence of the market, and we are very willing to take advantage of any opportunities that we could have.
And maybe just on the SG&A side, I mean, obviously, it was a really strong performance in the quarter. But it sounds like, I think, you called out there was sort of a pension benefit give or take, and then it look like there were some legal reversals or accrual reversals.
I guess, just help us think about sort of the sequential cadence there, because I want to make sure, at least, in terms of the Q1 numbers folks kind of have the right base. I guess how should we think of kind of the underlying, I’m thinking more in the North American business SG&A base relative to the fourth quarter compared to those call outs? And then how do we think about the phasing in of that sort of $150 million of incremental investment?
Okay, I’ll take shot and Alex can help me out later. So I would say that you’re right. I think, the biggest item I would be concerned about or adjust in your model is the 110 in the quarter. So that was this curtailment benefit. I do want to point out on that we had a similar one last year in the third quarter.
So on a full year basis, it doesn’t really change the achievements, right? So that’s really important. So it has – it does impact the run rate. So we were at a 17.1% SG&A number in Q4. I would not plot that one forward, because it’s a little lower due to the 110 pickup in the quarter.
So – but I don’t want to start giving guidance on SG&A. So I would add back something and maybe project out, but we will have cost reductions. But I would describe the 17.1% as unusually low, and it wouldn’t be correct to project that forward. It would be somewhat higher.
But again, you don’t have to look at the business or judge the business on a single quarter. A quarter, by definition, are volatile. So in reality, we should judge a business and look at the business at least on a yearly basis and try to understand what is the trend year-over-year. And in this case, you have heard that on a yearly basis, part of these elements – one-off elements are practically neutral.
And also, as an operator, I can tell you having a good starting position in Q1 from a cost profile is a good place to start from and so we have. So as we manage the business, the team here led by Richard Ashworth and the operational team have done a great job to get to this position. So as we look forward, our starting position on SG&A is a good position to start from 2019 from a trend point of view.
Great. Thank you, guys.
Thank you. And that does conclude our question-and-answer session for today’s conference. I would now like to turn the conference back over to Gerald Gradwell for any closing remarks.
Thank you, Crystal, and thank you, everybody, for participating in our call. I know there were a number of you that had questions that we didn’t get to, but we do have to break the call up now. So the IR team are here on our usual numbers and contacts for any further questions that you have later on during the day. Thank you very much, indeed, and we’ll speak to you again in a quarter.
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.