Q3 2020 Walgreens Boots Alliance Inc Earnings Call
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Ladies and gentlemen, thank you for standing by and welcome to Walgreens Boots Alliance Inc. third quarter 2020 earnings Conference call. At this time all participants are in a listen only mode. After the speakers presentation. There will be a question and answer session to ask a question during the session you when each press star one on your telephone.
If you require any further assistance. Please press star zero I would now like the hand the conference over to your Speaker today, Gerald Gradwell Senior Vice President of Investor Relations and Special project. Thank you. Please go ahead Sir.
Good morning, ladies and gentlemen, and welcome to offload Court running school.
On the goal with me today, I'll Stefano Pessina, our executive Vice Chairman and Chief Executive Officer, Walgreens Boots Alliance.
<unk> key Oh Global Chief Financial Officer, erotic Girly co Chief operating Officer, Walgreens Boots Alliance.
Before I agree with the step mother to make some opening comments I will as usual take you through the legal safe Harbor importantly decorations <unk>.
Certain statements and projections of future results made in this presentation constitute forward looking statements that are based on current market competitive unregulated expectations are subject to risks and uncertainties, but could cause actual results to vary materially we undertake no obligation to update publicly any forward looking state.
And after this presentation, whether as a result of new information future events changes in assumptions or otherwise. Please see our latest forms 10-K, and 10-Q for discussion of risk factors as they relate to forward looking statements. A note in particular that these forward looking statements may be affected by risks relating to.
The spread an impact of the Corona virus cobot pandemic in todays 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.
We'll find a link to the webcast on our Investor Relations website at Investor thought Walgreens Boots Alliance Dot com.
After the cold this presentation and web cost will be archived on the website for 12 months.
Ill now hand over to Stefano.
Thank you Jay I'd done and good morning, everyone.
This quarter once again.
In Maine team, that's all I'll call. It has to lead the global economy printing.
And now you test impacted I'll be there.
So I want to style to ask again by thanking go people from Dallas tending F. authentication.
In the Saturday so they are local communities despite facing challenging situation.
Our teams have continued to walk tires.
They must painting extend play dedication and commitment.
To help ensure continued later availability of medicine and advice to our patients.
And to maintain as efficient they supply chain as possible to our own pharmacies.
And now or the same customer.
Okay. All the team used to protect the health and wellbeing of our customers and out people as we walk to serve our communities playing getting a same shallow holder in the healthcare systems in many countries around the world.
We made clear on our last earnings call that we had only began to see the impact of the call. It five.
In deepwater.
The full extent of that impact he said Oh, two up probably.
Kabi.
As impacted all of our market.
But.
The impact has been most significantly in the U.S. and especially in the UK markets.
Let me get Mancos set to address this paid over the virus have fundamentally change the way our customers have had to approach of managing their head.
And then daily shopping needs.
Has looked down center has taken swearing produced.
We saw significant decline seen foot fully know too.
At times, because I do think to a fraction of they play coffee to that.
At the same time.
We needed to keep the majority of our locations open to help ensure the timely for ply your medication and to continue the vital for both we often people you know local communities.
We have leveraging all the other two seats available to us in order to maintain our services.
While ensuring adequate safeguard has in place.
To protect our deep and customers.
If you would expect.
We have seen unprecedented demand for home delivery.
And for online services.
Then if element of these services you say colas topic you for us.
During the crisis, so we have significantly increasing our capacity to serve these demand.
We believe it.
And the situation oversold.
The process of lifting the speech on so we'd be progressive.
And we expect no return to our normalized state we take some time.
Furthermore, we also believe that it is highly likely that certain aspects of customer behavior.
May change apparently.
Obviously, we have taken have look to our key strategic priorities and validated that they are still very relevant.
As you know how digitalization of program. It was one of our four key strategic priorities.
And do we see an acceleration of these over the coming month.
Together with a major expansion or bio mass personalization in customer engagement platform that our recently announced agreement with Adobe Microsoft We Delever.
We're also accelerating our transformational cost management program.
Strong focus on controlling and reducing costs.
Even more important now.
Besting the savings to derive a future growth is one of our top priorities.
Of course, we remain absolutely committed to developing our health care offering a cost out of network.
And making Gulf to.
Naval has destination.
We have taken a key strategic step forward here by expanding our patent issue, but we see village MD.
This brings physicians and pharmacies together, both in physical location and toll evidenced toward telephone.
It will also hello, both companies to accelerate the how via trailer healthcare solutions.
And fits well with our own digital strategy.
We believe the capability to accept physicians and unsigned pharmacies in a close at a more card in 18 manner.
He is the future community headcount.
I have already taken at the first steps to ensure that as a management team, we accelerate our strategy with appropriate focus and clarity.
I have asked Alex and on and like our co chief operating officers.
To become a more geographically focused rather than dividing that possibility for by your operational discipline.
Recognizing the significant from Walgreens as our largest single business.
Alex will now focus entirely on our U.S. operation.
Boots, we now reporting tore NOLA.
Along with the rest of our international operation.
Our business is aware broadly on truck prior to the copied crazy.
Both Alex Internet very clear on the need for half to move quickly to ensure we imagine from the carbon situation in a position of strength.
I'm prepared to return to sustainable long term growth.
I will now ask James entirely to take you to our earnings presentation James.
Thank you Stefano and good morning.
As you have seen from our earnings release.
Our third quarter results were significantly impacted by covert.
Firstly, the boots impairment charge led to a third quarter EPS loss of $1.95 cents.
And constant currency adjusted EPS was 43.4% lower than prior year.
This decline was mostly due to an estimated negative covert impact of 61 to 65 cents.
Retail pharmacy, USA delivered sequential improvement and total comp sales with continued improvement in retail performance.
Offsetting a slowdown in scripts.
We were faced with significant footfall declines across most of our markets in retail pharmacy International.
Especially in the UK.
This was only partly compensated by much faster growth from our online businesses.
And finally pharmaceutical wholesale delivered yet another strong performance.
The other two bright spots in the quarter were cost management and cash flow.
A little later I'll talk you through the great progress, we're making on our transformational cost management program. In summary, we are increasing our annual cost savings target two in excess of $2 billion by 2022.
I do want to highlight that we remain in a solid financial position.
Year to date free cash flow was $2.4 billion up 24% versus prior year.
During the quarter, we moved quickly to increase or financial flexibility by over $5 billion.
And today, we announced a 2.2% increase in our dividend.
First let's look at the estimated impact of covert on the third quarter results.
Overall, we estimate a negative adjusted operating income impact of $700 million to $750 million.
However.
Over the impact at each of our divisions very differently.
In Walgreens solid comp retail sales performance, partly offset lower gross margins on a falloff in scripts versus pre covert levels.
Comps script growth decelerated due to a drop in doctors' visits and hospital admissions.
Comp scripts slowed from 4.9% in the pre covert second quarter.
Two 0.4% in the current corker.
Consistent with the market as a whole.
By contrast, us retail grew faster in the third quarter, what comp store sales up 1.9%.
Compared to 0.6% in the second quarter.
Although foot traffic was down around 20%.
This was more than offset by a bigger basket.
While retail comp sales improved gross margin was under pressure.
As consumers spending shifted from higher margin discretionary categories for lower margin essential categories and more customers shop online.
Adjusted retail gross margin declined by 85 basis points versus prior year, whereas in the second quarter gross margin was 65 basis points higher than the prior year period.
We manage this gionee quite well.
Covert related operational costs were a little over $100 million in the quarter, including onetime bonus payments for certain employees on fire cleaning and say for the costs.
Our UK retail businesses were sharply impacted on accounted for around 46% of the overall impact on adjusted operating income.
And ultimately our review led to $2 billion of impairment charges in the quarter.
Strict lockdown conditions led to a sharp reduction in high Street football.
And boots, UK retail comps declined 48% in the quarter.
We did much better on our online business.
Food stock home delivered very strong growth with sales up 78% in the quarter.
Orders exploded and we quickly added new capacity to meet demand.
And boots dot com exited the quarter in much stronger shape.
However, this came at a cost.
Retail gross margin declined 440 basis points in the quarter as a result of higher fulfillment costs, reflecting increased online orders and a significant shift from in store pickup to home delivery.
Boots UK was also hit by higher operational costs.
But these were largely offset by UK government programs.
Including temporary abatement of property taxes.
Let's now look in more detail at the results.
Third quarter sales were up cereal, 0.1% and up 1.2% on a constant currency basis.
With the performance held back by an estimated covert impact of around 2%.
Adjusted operating income declined 46.4% on a constant currency basis.
Almost entirely due to covert which accounted for over 40 percentage points of the year on year decline.
Let's turn now to the financial performance for the first nine months of the year.
Constant currency sales increased 2.5% on a constant currency basis, adjusted EPS declined 18.3% with around 13 to 14 percentage points of the decline coming from the covert impacts we encountered in the third quarter.
Let's now look at the performance of our divisions.
Starting with retail pharmacy USA.
Sales increased 3.2% in the quarter.
Total comp sales increased 3% slightly faster than the second quarter growth rate.
Adjusted gross profit was down 8.7% with declines in both pharmacy and retail.
Retail gross margin declined versus pre covert levels due to higher fulfillment costs and adverse product mix.
Adjusted SGN, they spend decreased 0.4% versus prior year, despite over $100 million of covert related costs in the third quarter.
Adjusted operating income declined 38.4%.
Off which we estimate the covert impact accounted for around 26 percentage points of the year on year decline.
Now, let's look in more detail at our pharmacy business, which encountered a slowdown in comp script growth compared to the previous quarter.
Total pharmacy sales increased 4.6% versus prior year due to higher brand inflation and specialty sales.
Central specialty sales continued to grow nicely up 15.9% versus prior year.
Confirmed to see sales were up 3.5% and this was pretty much in line with the second quarter, but with a different composition.
As mentioned earlier comp script growth slowed to 0.4% growth in the quarter on this was quite a bit lower than the pre covert second quarter growth of 4.9%.
This was partly offset by higher brand inflation.
While comp scripts declined 5% in both April and May we are encouraged to see improved script growth in June of around 8%.
Note that this includes some benefit from phasing and the day fall adjusted figure is closer to 3%.
Turning next to our us retail business, which delivered improved revenue growth, although with a lower gross margin.
Retail sales decline, 0.7% in the quarter, including the impact of store closures comp sales increased 1.9% a sequential improvement from the second quarter.
Excluding tobacco and the cigarettes comps were up 3.5%.
Although consumers were shopping less frequently they were buying lower per visit.
Our flagship health and wellness category performed particularly well up around 9%.
Led by demand for veterans and new PE products.
Personal care grew 5% and grocery was up 8% despite a weaker Easter.
Discretionary categories remained under pressure with beauty down, 9% and photo down 34%.
Geographically, we are seeing buoyant sales in rural areas with the overall result held back by sizable declines in urban locations.
Turning now to store gross margin and I should point out that as a slightly different definition than the adjusted gross margin numbers used on slide number five.
Store gross margin represent scan gross margin and it is a good measure of core margin movements as it is less impacted by timing or phasing.
In the third quarter store gross margin declined to 80 basis points versus prior year. Now. This compares unfavorably to the 95 basis point increase we delivered in the second quarter.
This negative impact was due to a shifting consumer spend from higher margin discretionary categories, such as photo and beauty to lower margin everyday essentials.
Hi. Good example, here is the 34% decline in photo sales.
Which led to a 90 basis points negative impact on gross margin.
While store gross margin improved somewhat in June.
We are still tracking around 50 basis points below prior year levels.
In May and June we saw improved retail sales trends as stay at home orders were relaxed.
But footfall remains very weak and it was only partly compensated by strong dotcom sales.
Turning next to the retail pharmacy International Division.
Which was most heavily impacted by covert.
As usual I'll talk to constant currency numbers.
Sales declined 26.2% as the global covert pandemic caused severe disruption across all of our international markets.
The UK had a more stringent locked down than the use which stay at home orders imposed nationwide on the 23rd of March.
As an essential retailer most boots UK stores were required to remain open However high Street footfall ground to a halt and fell by as much as 85% at its peak.
Additionally.
Our premium beauty and fragrance counters were closed for almost 10 weeks and given boots position as a leading beauty retailer. This had a significant impact on comp sales.
Additionally on official advice.
Most of our 600 opticians stores were closed.
The impact was sizeable as this business has annual sales of almost $500 million and comp sales declined by over 70% in the quarter.
The combination of high fixed cost stores.
And sharp sales declines led to an adjusted operating loss of $143 million in the third quarter.
Compared to adjusted operating income of $165 million in the third quarter of last year.
Overall, the estimated covert impact on adjusted operating income was $365 million to $390 million.
On a brighter note our retail JV in China is performing very strongly.
Third quarter percentage sales growth in the mid thirties as of the end of May.
The JV you had more than 5700 stores.
Let's take a look now at some of the UK trends.
Boots, UK pharmacy comps sales declined 1%.
We saw a pull forward of demand ahead of the locked down for the decline in April and May as you would expect as the pull forward corrected and we saw fewer news prescriptions.
Retail comp sales declined 48% in the quarter note that retail comps do not include boots dot com direct to home sales.
Again, we saw some increased demand prior to the lockdown, but a very significant reduction after to stay at home orders were imposed.
As I've said.
Although the majority of our stores are in remain low.
Footfall virtually ground to a halt.
And boots was not a destination for consumers, making a single weekly grocery shopping trip.
By contrast, we saw very strong growth in our online business and we moved quickly to increase capacity.
Turning to the end of the quarter.
Volumes reached Black Friday levels on a daily basis and May sales increased almost 120% with June sales growth even higher.
The success of our online business has been encouraging but it did have an adverse impact on retail gross margin.
Which fell 440 basis points year on year, mostly due to higher fulfillment costs.
Since quarter end comp retail sales have shown a gradual improvement almost all of our boots UK stores and the majority of opticians are now open.
Okay.
While we have seen a slow return of consumers for the high Street footfall remains significantly down on last year.
And we estimate Tom retail sales declined by around 40% in June.
Turning now to the pharmaceutical wholesale division, which I'll also discuss in constant currency.
Pharmaceutical wholesale delivered another strong performance with sales up 5.3% versus prior year led by the UK and Germany.
Adjusted operating income increased 5.1%, reflecting sales growth and a higher contribution from amerisourcebergen, partially offset by lower gross margin.
Turning next to free cash flow, which on a year to date basis increased 24% versus prior year.
Free cash flow was strong in the year to date period with $2.4 billion delivered in the first nine months of the year up $467 million on the same period last year.
We estimate a covert related inventory build of around $500 million at quarter end.
And this was mostly offset by reductions in capital expenditures on cash inflows from government support initiatives.
We took proactive action in the quarter to increase short term financial flexibility by $5.1 billion, including a $1.5 billion bond offering and $3.6 billion of credit capacity.
We are increasing our dividend for the 40 fiveth consecutive year.
We have decided to suspend activity under our share repurchase program for the time being.
Year to date, we repurchased $1.3 billion of shares, whereas we previously targeted $1.75 billion for fiscal year Twentytwenty.
Please note that our anti dilutive program is unaffected by this decision and we will continue with our anti dilutive share repurchases.
Next let's go to the transformational cost management program, where we continue to over delivered.
We are increasing our savings target two in excess of $2 billion in annual cost savings by fiscal 2022.
Reflecting continued momentum and better line of sight to savings.
Our store closure program is broadly on track and we're actually slightly ahead of target on the transition of our ITC run and operational services to Tcs by the end of the calendar year.
Last week, we selected Genpact as our long term partner for finance for the future program.
Multiyear program will lead to improved costs capability and controls and help drive improved business outcomes.
Given the severity of the covert impact in the UK and the uncertain outlook, we're celebrating the transformation of our boots, UK and opticians businesses.
This reorganization will impact more than 4000 positions are around 7% of the workforce.
Now I'll give you some more detail on guidance last quarter, given the money variable surrounding covert we decided to temporarily suspend guidance.
Although there are still monies uncertainties, we now have a clear understanding of the full year impact on our business.
We are now introducing guidance for fiscal year Twentytwenty.
And expect adjusted EPS in a range of $4.65 to $4.75.
Furthermore, we estimate the full year impact of covert to be in the region of one dollar tree sense to $1.14 cents with the most significant impacts in the UK.
While we do expect to see some improvement in sales trends UK comp sales are expected to remain very weak.
Gross margins will remain under pressure in short term, mainly due to adverse category mix and higher fulfillment costs.
In the fourth quarter, we expect us script growth of around three to tree in half percent.
And this remains below the 4.9% pre covert run rate.
In us retail sales are off to a strong start in June and suggest our fourth quarter comp sales growth of around 2% to 3%.
However, the US retail result will be held back by continued adverse category mix.
June margin is around 50 basis points below prior year, and a slightly to be in that kind of range for the rest of the quarter.
In the UK, we expect boots, UK retail comps to decline by around 40% with retail gross margins down around 400 to 500 basis points.
As I said earlier, the UK margin declines are mostly due to increased fulfillment costs, reflecting a significant increase in online sales and home delivery.
These assumptions lead to an adverse covert operating income impact of around $500 million to $575 million for the fourth quarter would around 60% from international.
Our word of caution here.
This guidance is based on the trends we are seen in the month of June and does not factor in a potential reversal of these trends.
In summary covered had a significant impact on our third quarter results with an estimated 61 to 65 cents heads to adjusted EPS.
We are seeing some improvement in sales and gross margin trends.
But the nature and duration of the recovery is uncertain.
However, we are introducing full year adjusted EPS guidance in a range of four daughters, and 65 cents the $4.75 as our best estimate of the likely full year outcome.
This assumes covert related adverse impacts of one dollar tree sense.
To $1.14 cents per share.
While covert as presented a huge challenge we remain on a good financial position led by excellent free cash flow delivery.
We've increased our financial flexibility.
We suspended our share repurchase program for time being.
And we're raising our dividend for 40 50 consecutive year.
What's important now is that we're taking swift action.
Both operationally and financially.
We've raised our savings target for transformational cost management program and more quickly scaling up our omnichannel and healthcare investments to spur future growth.
I'll now hand over to Alex.
Who will bring you true our plans for investing in future growth.
Thank you James.
As you've heard the Qubic pandemic has impacted all areas of our business.
First and foremost I would like to send my sincere. Thanks to the incredible teams, we have working in our stores and behind the scenes.
Our teams are face many challenges to help ensure communities continue to receive medications and services.
Through this dedication on a daily basis to serving our patients and their customers has been outstanding and what's been a very different time for many both our walk on the home.
Now I'll update you on the significant progress we've made against a key strategic priorities starting with health care.
You know treating neighborhood destinations across the country is one of our core objectives.
So I am delighted.
Agreed a significant expansion of our partnership with village Andy a major step forward for both of us.
Our goal is to provide an integrated primary care and pharmacy model now will drive better health outcomes reduce costs and provide a differentiated patient experience to the communities we serve.
We'll be opening between 500 700 co located fill surface abilities medical's in more than 30 U.S. markets within the next five years.
Destock collect clinics for Keytruda, Walgreens pharmacies, who provide comprehensive primary care services and we'll focus on developing relationships with patients to manage their long term conditions.
Once we've completed this initial rulings we intend to bill several hundred more clinics and at least 20 additional U.S. markets.
Very importantly, beyond the physical locations, we will be developing whom based munching until the Mets incentive fees.
Leadership abilities end, these integrated data and technology under own find care platform.
We are investing $1 billion of debt and equity in the partnership over the next three years, including a $250 million equity investment and anxious study.
On completion of this investment we expect our ownership interest of approximately 30% in village Andy.
And then of course strategic priority is it digitalization of our business.
We were taken significant steps in the corner.
We're now accelerating our plans and will be further increasing investment in digital initiatives in the coming months.
The pandemic has of course significantly increased the mine for omni channel products on more computing services.
We've extended reach to customers in store and online acting swiftly to provide new products and significantly expand fulfillment services for example, extending and try and three service to include retail products, such as health and wellness and household essentials.
Customers can now order online in advance and our products razor claims at around 7300 try through windows without leaving the safety of their car, but also ruling out topside collection for online orders on other delivery alternatives.
Omnichannel performance in the quarter was very strong as you'd expect driven in part by changing customer behavior during the pandemic.
We have increased capacity and our online operations threefold to improve service to our customers.
Sales on mortgages dot com were up 20% versus prior year.
Talk to digitally initiated sales were also operating 23% and mobile app traffic was up over 200%.
Finding alternative ways to receive care, while staying safe has become parliament with many turning to tele health offerings.
Our find care platform traffic was up 48% divest the second quarter two over 3 million visits and up 14 fold faceted last year demand for one to two D. Walgreens Express farms delivery service with Fedex increased significantly.
With the volume of prescriptions delivered up 78 fold since the last quarter a program through at mass personalization facilitated by new technologies is already well advanced.
For the second straight quarter. This boosted retail performance increasing sales in the third quarter by 95 basis points.
Last week, we announced the strategic partnership with Microsoft and Adobe to launch a world class marketing technology, and customer data resource, which will form the basis of a new customer engagement platform.
This will further transform already successful retail mass personalization activities, our maintenance to Korea passionately speeds for each individual customer and pharmacy health care wellness and Judy.
Turning next to our third Suzy priority to transform and restructure our retail offering.
We've expanded our rule in the community during the pandemic to offer a vital healthcare services.
We're working to solve as a comprehensive testing solution across our U.S. store network to provide self testing in store testing and large based testing solution I will provide every patient with biology, and serology test as appropriate and away that best suit their needs.
To do this we're working with a number of partners, including expanding our partnership with Labcorp alongside other solutions to provide the range in capacity of testing we need.
Looking forward, we of course, all hoping for a vaccine to develop soon.
Once this happens we believe we will have a key role to play protecting patients.
But administering the vaccine quickly to those who need it among the 8 million customers, we interact with daily.
Also in retail we've agreed or electronic ancestry offering to focus on the high quality brands that customers are seeking including an agreement with Apple to sell their branded accessories and finally, the benefits from the Kruger partnership Hubbing, even greater during the course pandemic and we're continuing to explore how we might be able to respond this.
Ownership and expense UK. This of course has been a very difficult quarter and as you've heard the coupon Miami has a far greater impact on our UK operations and it's hard in the us.
Today, we announced a program to restructure boots accelerated to adopt the changing operating environment and reduced fixed costs in the week of corporate.
This would be not very tough decision, but we are taking this auction to ensure a sustainable future at the time of economic uncertainty on a shifting customer behavior towards online and digital channels.
We're proposing a reduction of over 4000 rules in total across be cheeky and piece of tissues, representing around 7% of the current workforce.
This includes a proportional action of approximately 20% of employees in our head office around 7% of a store colleagues and the closure of 48 boots opticians.
As you've heard.
Over this quarter dramatic and radical shift in our business, but our teams have responded rapidly to the challenges.
Ben Pharmacy, we're putting a key role in supporting the NHS, we quickly developed and implemented try to testing in the quarter under took more than 330000 cubic tests.
We try to boost pharmacists team to support the NHS medical Helpline, we've increased the capacity of our online pharmacy to meet demand for home delivery.
And again working with NHS, we have step up deliveries for fungible patients.
Turning to retail operations as James mentioned this online business has grown significantly since the start of the pandemic increasing 120% in the month of me.
To me this increased demand and make it easy as possible for our customers to get the products. They need we have moved swiftly to reconfigure.
Our online operations and significantly increase capacity.
In beauty, we built online advice and materials, which accounted momentum in recent weeks and building on our online presence. We recently under two car force global digital skincare product launch.
Number seven and fund strengthened all.
The part has over 100000 customers on the waiting list ahead of launch has been well received.
My sense the most popular cash squeeze on line continue to reflect the core offering up boots is so well known for health and wellness beauty and personal care.
Let me now pass it back to Stefano for his closing comments.
Thank you Alex.
And the company.
We are facing some significant challenges and are moving faster to other come them.
Many of our businesses have been operating very successfully for mania.
And they're faced.
Extra ordinary challenges and descriptions.
In value from markets in the time.
We have always been able to survive.
Yup.
And tie.
And I am convinced that we will come out of these categories as competition.
With a clear path to sustainable lump them CLO.
I am encouraged by the tangible progress we have made there in the quarter in developing our strategic priorities.
Our agreement with Microsoft and Adobe.
Usually significantly and will deliver a significant step forward in our ability to offer that personalized service to our customer.
The increase saving goal for our car Formational cost management program.
If SASSA, even more capacity to react quickly to the new market environment.
As we implemented manpower all the saving to invest to grow.
And most importantly, I'm very excited.
About the huge step four wall Doug.
We have taken in our healthcare strategy.
Less than that partnership with village MD.
Which will transform our community healthcare offerings.
Despite the challenges of card.
We continue to be a white position at company with above and defendable cash flow.
And a solid balance sheet.
This will allow us to invest with confidence in our business.
At the time when many other companies that do not have at the same capability.
If you have heard.
2021 that we'd be a here will increase investments to pave the way from a return to sustainable predictable growth.
The strength of our company.
And then indication of our people.
And then as part of our customer.
And now recognize our commitment.
Selling dam in supporting their communities.
Gives me great confidence in the future of our business.
And if anything.
Further strengthen my own of this whole to deliver the changes so we need to drive sustainable.
Thank you now we'll take your question.
Thank you as a reminder to ask a question you want me to press Star one on your telephone to withdraw your question press the pound or hash key please standby only come pilots una roster.
And our first question today comes from the line as Eric Percher from Nephron Research. Your line is open.
Thank you and thank you for your efforts on behalf of consumers in patients during this time.
Given the strong U.S. comp I think the impact on gross margin is quite striking I understand the front end shift, which you outlined.
To what extent is air pressure on the pharmacy.
Beyond reimbursement pressure you would expect our their pressures from movement from 30 to 90 or some commercial to cashing in Medicaid could you help us on that.
I had a solid here are a good morning.
The pharmacy trend in margin was really as we had expected.
So were we saw some decline or you see die Q via data.
This is the pandemic come through on commercial.
The last recovered as people have come back into employment to some extent.
It really it was as expected.
There was really no other change and as we've come through node to June again, the waters as you can imagine very carefully.
And there's nothing within that trend that when beyond what we had expected to see what is very different.
Is the new therapy.
I was hoping James is covered in his comments, where again, we're seeing a reduction of just the bank of 20%. According to Cuba data and UTI therapy. So the volume through this quarter was substantially less than we had expected.
Having said that we were quite worried as I think we as we saw the mail order numbers shift, particularly in the early weeks of the pandemic, but again were more relaxed node to see that the meal order on the retail businesses stabilize particularly in the last six weeks.
So that really has been the story of the pharmacy margin is more of a volume story than it is of any shift in the margin from our perspective, yes.
Confirm exactly what Alex said, if you look at the US business with an impact of around three to 350 million two thirds of the impact was due to gross profit and one third was due to higher SGN a as a result of the bonuses for select employees plus cleaning them. So.
Operating expenses when you go back to the gross profit, which is around 225 to 50.
All of that is due to raise and it's all in the retail business.
So essentially we didnt have a volume impact because the negative trend that we saw on pharmacy scripts and that was entirely due to medical visits and the impact on new prescriptions was entirely offset by continued buoyancy on our retail business. So it was actually just downstream summarize everything on the gross.
<unk> was raised on the Best example is the one I gave in the split as we have a fairly large photo business with quite attractive margins.
On a decline in that business in the quarter essentially costs as 90 basis points of margin just Q2 home profitability is compared to the average of the of the business.
Hope that's very helpful.
Thank you.
And our next question comes from the line of Charles Ray from Cowen. Your line is open.
Charles <unk> your line is open.
Yeah, sorry, I think I was on your yeah. Thanks for taking the question maybe just a follow up quickly on Eric's question, which is on when we look at a June trends or 3% have we started to see within that new scripts.
Accelerating as people kind of come back to the physicians and then secondly.
The village MD.
Partnership sounds great Alec what does that say too. The other pilots you had been doing with partners and primary care with Humana Medexpress with United.
And even with Labcorps, how did those kind of fit in with the new strategy. It looks like your your embarking on thanks.
Charles you I know, we are seeing a recovery new therapy, but EBITDA is I still I would see unpredictable and for all the obvious reasons as a C for the spread of the virus in many states across USA. So we are seen return and James is giving you. The number I would see we saw engine a four.
For scripts.
So encouraging but still not completely integrated predictable and sign off by to the note. The number was had before and the pandemic.
In terms the second question.
We just had a really successful trial in Houston.
With village Andy.
We show we have accelerated a with a very good management team a they are agnostic to peers. The work within every appear in the marketplace and every health care system.
They do they do both fixed and they do fee for service they do of course to taking risk.
I am most important evolve <unk> point of view the take care of people with long term conditions, we know the $40 million spend in the U.S.C., 85% advise longtime conditions. So they come towards the who failed doctors.
The new move our final through their very strong technology to more from fees and service on taking risk on the model just works really well for isn't really very quickly and therefore very keen to accelerate it we still have very good relationships with United Health and we're working with them as you know a in Las Vegas area, both going on both.
Our incentives for enrollments, but also importantly centers for primary care and of course, we continue to expand their partners in primary care model with open feed the more of them as well. So we continue to believe strongly in the neighborhood destination concept.
We believe we'll have to have Ah you more partners in just one.
The movement the partner, who really has performed the best for rose.
Has been village Andy I'm, we're very committed to accelerating in the we we described.
You know stiffener here and you remember probably that Oh, we have tied to me a little different aframax of clinics and there is always.
So we tie we are patients and ER, we want to see where we have no return.
And with billing indeed, we found demand Delaware, we could see a reality to the not in that.
Relatively.
Sure a medium term there and there we feel really and complement the Lisa out or how much is leased award we normally do in a pharmacy.
After many tie answer.
We ended the founder Dave there these smaller than that he said probably do when a week or fit best that we know pharmacies and when we have.
CND. So we didn't there if you take the to invest heavily in these models.
And just finally, so it's all of them Islam call people love cooperate a really important partners to us.
We look at 100 1000 12 of the goes exactly a slight related continues I'm a developing a cost new models with them for testing and I know obviously, we're continuing to work very closely with our team. So again, we feel very good about partnership glaucoma.
Great. Thank you.
And our next question comes from the line as Kevin Colleen go from you, Yes, you are liner companies.
Thank you thanks for taking my call.
I just wanted to get a little bit more detail on the impact the delta between your online sales and your your inside store sales certain.
What the what they were what's the difference in gross margin on that.
And sort of what are your expectations on board is this the new normal or do you expect.
Foot traffic to increase in online sale to sort of stay where they are I'd love to sort of get it take on on the impact now and sort of what you expect the mix to be going forward.
Yeah, I'll I'll take a bit of a shot at that in our biggest online business is actually in the UK, that's a $500 million plus business.
As a very strong position in beauty.
And what we're looking at right now and I said in the prepared remarks foot traffic in our stores was down 85%.
So it was a tremendous impact in the UK so effectively it was at a standstill.
I will at the beginning of the crisis, we didn't have enough capacity in our online business and we've exited the quarter with sufficient capacity for the future. So what are we seeing right. Now we are seen in the UK that there is a slow recovery on the high street or transactions are still down 46% again, it's a huge.
But our online business over the last weeks and months is running up in excess of 120% growth.
We would expect them to continue at least for the next quarter and I think with the job. We have now is how do we move this business from being a half a billion dollar business to a billion dollar business. So we're studying different goals and we actually don't want the market to define what we want to do we want to define a much stronger E commerce.
So in the UK, where we actually have a very strong set of assets. We have a very powerful loyalty program would I think it's 17 18 million members. The second thing is strong starting position and we clearly want the stake out a number one position then as a beauty retailer online regarding the permanently.
I think as you as you build models into next year I think you have to assume that we will have transaction declines for the first half of next year and I think you will see that as well in the U.S., but it's less exaggerated in the U.S.
But you will also see a very strong online business and to get back to your margin question. This this is.
Quite unusual so in the quarter, we had a 78% increase in online sales and that's you know wheatstone through the quarter on the running a 120% than me.
The biggest issue on margin does not necessarily the absolute increasingly online margins because we actually have a very emerge attractive margin profile in the UK on our ecommerce business.
The issue is prior to the covert pandemic, 70% of the orders were picked up in store and right now it's less than 20%.
On the biggest incremental cost we have is the fact that it's it does a zero cost if somebody is picking that up in store and it's probably cost in three to $4 more to actually ship because somebody's house. So are we believe that will reverse but it's probably six months away so as consumers get much more comfortable.
Going back to the high Street, there will also become much more comfortable or pick up in store, which will reduce the headwind on margin as we move forward, but you know this will be a month by month kind of thing. We're we're actively managing the situation.
Secondly, we did put in place some short term distribution centers that obviously have a higher cost right now.
As we put in place more permanent omni channel delivery methods and the cost will come down in the U.S. market is a little different the margins are not attractive in the U.S. market. It's a three to 400 million dollar business. So we're quite behind the competition and maybe I'll pass it over to Alec because we have a very aggressive strategy.
Do you mind.
Really build and strong omnichannel presence in the U.S., we do recognize we're behind the market and we're scaling up the investments as we speak so let me I'll pass it to other than they can bring through some of the vision for the next six to 18 month.
Thanks, James Yeah, Hi, Kevin Yeah, I think that we really see in one of the key numbers. We quoted was at 200% increase in our mobile app usage, which is very encouraging.
On a and therefore as we see you know a whole decline in physical stores and its customs adult two new omni channel methodologies from headed to the shopping we're very committed to accelerating the use of the up on the convention or be up into sales, both retail and healthcare sales, particularly moldings.
You saw and I spent a few days ago. The Adobe Max of partnership that's really a bit on you approach to marketing, which we tested for about 12 months I'm. We're really excited by the performance being significant increases in sales and not performance. So as we go forwards we believe.
The ability to personalize our marketing.
On the doors, we spend today into different types of dollars that personalized marketing for customers. We believe it will be able to convert more people immobile up drive as James said in the UK, we should be banks have supporters buy online pick up in store.
Also trying to windows and convert more them more people into this idea of omni channel and ultimately our platform strategy as I mentioned I think in prepared comments. This idea of a customer engagement platform is one we're investing in very heavily focused on our pharmacy folks in health care books, all the partnership's, who created including the village and the partnership.
Stephen affair to a few minutes ago.
So we remain convinced that our stores or beautifully placed as forward distribution hubs in communities.
No no investing to make sure as people more to more moved to omichannel ways of getting their goods and services, including health care.
We are absolutely convinced or investment strategy will come through strongly in the years ahead now and maybe the part we didnt cover was what's happening in the U.S. front of store.
Right now the transactions are down somewhere between 10, and 12% yeah, what the basket sizes up considerably. So we're doing a lot of work on retention of cost mclagan on but we expect we've seen a dramatic improvement over the last weeks.
As the Lockdowns relaxed.
So currently the transactions or 11% the drug channel is a channel that was losing transactions over a multiyear period call it 3% to 4% well. The GAAP is starting to close on transactions, but were were quite surprised pleasantly surprised by our ability to retain basket size.
This there is a shift happening than the market were convenient locations other not an advantage here that we're becoming a destination, it's less frequent right now, but the destination when they come to what are picking up a higher selection products and just one of the number that's important to understand.
And is that we do have a a lot more open stores and some of a direct competition, which I think is an advantage in the long term, but the more money urban areas are most affected.
By the risks can feed off the pandemic. So for example, and New York City in Manhattan, We have Oh.
Almost 100 stores in Manhattan alone and you can imagine the fifth fall onto sales under transactions or have we done in these markets.
It's it's for quite interesting because it's as Alex said, it's very geographically dispersed. So we have a large proportion of stores, our rural and they're up about 8% in the quarter and you've got a small number of urban stores, maybe three to 400, <unk> urban stores and they were down 18%.
So as you move out of the big cities, which have been disproportionately impacted our performance is much much better.
Thank you so much.
Thank you.
Our next question comes from the line of Steven Valiquette from Barclays. Your line is Anthony.
Okay. Great. Thanks, Good morning, everyone. So my question and actually kind of picks up right, where you left off.
Some of the geographic discussion in the U.S. I'm not sure if you're able to comment on this or not but to see some investors are wondering whether you're seeing any dichotomy in the most recent trends and sunbelt states like Florida, and Texas universes trends in the upper Midwest and northeast, where things are more stable now to separate from their rule versus urban.
I think just people are focused on the sunbelt just any comments you made geographically given some of the investor concerns around rising Kobe cases in some key states you might also be helpful. Thanks.
Thanks, Steve It sounds like here that the reality. The is there are hot spots, where we're seeing some fine tuning and then some quite in done.
But really broadly a it's pretty consistent apart from the urban areas to be the sort of it suburban areas, which I just mentioned.
So again the new is a is that the patterns are there when you look when you quick there in a level too. So for example, we take Houston is maybe an example that we did see evidence of some pantry loading a couple of weeks ago, but they are they aren't very specific areas on the trend is not really like clear from from the numbers that we've seen really clear.
Trying to go back toward James Coty before is a very clear trend.
And we're watching this every single day on of course, you know, we're continuing to take all the actions we have to take to keep of stores or pharmacies Queen err on the island and applying all the rules, which is so important.
And of course, making sure the number one priority is keeping people safe and secure unaccustomed to safe and secure in our premises.
So there's no real trends beyond the one a gene decided that we really picked up you know you know we did see slide.
Outperformance in May in Texas in the southwest on the transaction basis, because they relaxed sooner.
But you know these things are moving around it it's not 15 points of growth. It's more like two to tree as a difference, it's really metropolitan compared to rural and suburban that's where you see the big issues.
Okay I appreciate extra color. Thanks, I mean, I mean, one thing I would say and again, it's been well comments on is the local smaller stores.
Our doing reasonably well again, so again, we feel confident but the position over pharmacies and the size or over pharmacy in their boxes.
Again I just another call nothing that's coming through in a lot of market research that I've seen for sure.
Okay, great. Thank you.
Our next question comes from the line of Lisa Gill from JP Morgan Your line is open.
Thanks, very much good morning.
Alex I just want to go back to that comment that you need around affiliates empty and how well the pilot had gone in Houston and that's the reason that you've chosen them as here Big partnership going forward like what did you measure that on what did you see I left in pharmacy comps like like what's going to be the best metric for us.
Well look at well when we think about the success that partnership it again, it's it that pharmacy Comping can you share with us potentially the left that you saw.
Yeah, So absolutely farms comp is a big one for throw the obvious reasons and I think as we said already Elisa and there's that they bring in a few file of Apple of patience with them. So these doctors come into the fuel file. So from day one they are writing prescriptions for all the patients who follow them into the surgery and we love this idea.
Oh the farm, we talked is really clear from market research. The farm, we talk to the PCP is the person that people really trust. The the other quarterback of health care SAP system. I mean, you put them in partnership in physical stores and digital assets with that pharmacists and Nazis then you get coordinated care.
In a way they really did uses costs improved care and particularly helps people to manage longtime conditions and that we were described so that is definitely one driver along with other health care products, we should associated with that at that time without a doctor's practice and what that the doctors I recommend and more to of course people pay compensate the.
Pharmacy into Tc [noise].
The other thing that's important to two to understand and in the in the short time, it's been the NPS score in the NPS scores over 90%. So this is a a really fantastic feedback and the way that these particular village and these are designed.
Is really strong from the point of view cool surgery quite different and I hope you seem to pictures to water. Many local surgeries look like today.
And last but at least of course, the they are very good others as a as a practice and as a company.
With the software they have a they're able to really use our software to help doctors to support gaps in care.
And make the best next step so closing, causing a improving star ratings and all the things that really draw even though the more risk based models.
Which is very strong and their software and again, we expect as we go forward.
This will become mood or more of a indicate acute immortal it'll be more opportunities for ourselves and other partners to provide the solutions, but the tail long term and patients with chronic conditions needs.
Going forward.
And I understand how that it is there a number that you can quantify like Phil if you think about that specific market and again were not looking to extrapolated across that five to 700, but just any kind of.
Attain embraer together [noise].
Well why can describe as the you know you're working against 20% or with an average market share.
You can expect us to be well above 50%.
When these a with all of market share when these settle then.
Okay. That's helpful. Thank you.
And our final question today will come from the line of Atlanta that Anderson from Evercore ISI. Your line is open.
Hi, Good morning, guys thing I'm, just getting back up or any other questions that were asked on the cost side can you talk in other like inquire about where that I learnt how our transformation costs are colors I live in Nicole.
Can you comment on how you should have no cap that's right they've asked us not see had hired a balance that need for caught a capex spending or says that some of the transformational cost. Thanks.
Yeah sure you know as well as we looked at why did we raised the guidance on the transformational cost management program is it's the savings were seen year to date and then too is we just have greater visibility to the future programs on the degree of certainty is gone up dramatically.
And I think we alluded to that under prior call. So it's not a specific program. It's a combination of programs over over a multiyear period.
We did see some delays as a result of coal that and you know we heard that we have the move quite a lot of supply chain on operations people away from transformational cost management programs.
We estimate that probably cost the program in the year about $45 million, but we were easily able to absorb that with other actions ought to to contain costs. So we think of you know if you look against the peer set out there in one month of the incremental overhead some of them have incurred we believed that our 100 million and.
The quarter is quite low number compared to the peer set and we try to manage that as closely as we could so we think we've done quite well on that on your cash flow question is a good want them. This is kind of interesting because there was a lot of moving pieces. Here. One is we do estimate that at the end of the quarter, we had approximately half a billion.
$1 of higher inventory.
So the actual volatility in demand and whether that's across pharmacy or across retail we took a conscious decision that we were privilege and you know I'm, having the availability in store 'em, we exited the quarter would very very strong availability. So that 500 million will work itself. So.
All of the out of the <unk> cash flow by the end of the year, but we actually believe.
With the risk of a potential second wave, we will probably retain somewhere between two and 300 million of excess inventory at the end of the year and when I say excess that's the cover volatility that's increased significantly.
Some of that is offset by a good question on capital programs and a really good probe example, here is we have the whole for a period of time R.S.A.P. rolled out in the U.S., which is a huge program because we couldn't go into a store when they were struggling to fulfill demand on them in a very complex involved.
Women.
So we will have a deferral of capital expenditure is probably 150 to 250 and I give a deliberately round range because I'm not sure how much of that will impact next year. So there will be inventory will probably go down next year compared to this year, but capital expenditure will go up because of.
Deferrals this year.
And then they they lost partners there have been some some assistance from the U.S. government in terms of the deferral of cash contributions on payroll taxes and other items and there's been some in the UK as well that probably benefit or cash flow to the June 300 million and as you look forward that will work itself out.
The the system going forward. So it's it's in summary, you know we added a lot of inventory half a billion.
That was offset by government contributions and.
On the.
The government contributions on the capital expenditure phasing.
So we effectively exited the quarter with a zero impact on cash flow as a result of older.
We we do think it's probably a good idea that we keep excess inventory.
As we exit the year and that will have some impact on the profile next year.
I hope that's helpful as you're thinking through the.
The impacts.
Yeah, that's great. Thank you very much.
I would now like to turn the call back to Gerald Gradwell for closing remarks.
Thank you Lisa and just to say I know that there were a number either didn't get draws questions today as I have a we we run out of time, but the IR team are here unavailable to ER to take your questions.
Over the coming days or weeks. So please feel free to really try to us. Thank you much indeed, and we'll look forward speaking to you in on the next quarter.
Ladies and gentlemen, this concludes today's conference call. Thank you for participating you may now disconnect.
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