沃博聯公司 (WBA) 2012 Q2 法說會逐字稿

Good day and welcome to the Walgreen Company second-quarter 2012 earnings conference call.

At this time I would like to turn the conference over to your host, Divisional Vice President of Investor Relations, Rick Hans.

You may begin.

Thank you.

Good morning, everyone.

Welcome to our second-quarter conference call.

Today Greg Wasson, President and CEO, and Wade Miquelon, Executive Vice President and CFO, will update you on the quarter.

Also joining us on the call and available for questions is Kermit Crawford, President of Pharmacy, and Mark Wagner, President of Community Management.

As a reminder, today's presentation includes certain non-GAAP financial measures and I would direct you to our website at investor.walgreens.com, for reconciliations.

After the call, this presentation and a podcast will be archived on our website for 12 months.

Certain statements and projections of future results made in this presentation constitute forward-looking information that is based on current market competitive and regulatory expectations that involve risk and uncertainty.

Except to the extent required by 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 filing for a discussion of risk factors as they relate to forward-looking statements.

Now I will turn the call over to Greg.

Thank you, Rick.

Good morning, everyone, and thank you for joining us on our call.

Today I will begin with our quarterly results.

Second, I will discuss highlights for the quarter and update our progress on our Well at Walgreens strategy to become America's first choice for health and daily living.

And then finally, I will provide insight into the second half of the year.

Then I will turn the call over to Wade for a more detailed analysis.

Beginning with our results today, as you saw in our release this morning, we posted record second-quarter sales of $18.7 billion, up 0.8% from $18.5 billion a year ago.

Second-quarter earnings per diluted share were $0.78, down 2.5% compared to $0.80 in the year ago quarter.

Despite our lower earnings, cash generation continued to be strong as cash flow from operations for the quarter exceeded $1 billion and free cash flow was $703 million.

We returned $570 million to shareholders in the quarter, up 23% over the same quarter last year including $374 million in stock repurchases.

Compared to the prior year, the effect of no longer being part of Express Scripts Pharmacy network as of January 1, 2012 impacted our results by $0.07 in the quarter and the mild cough, cold, flu season impacted net earnings per diluted share by $0.03.

This year's results benefited from one extra day versus last year because of leap year.

As we look further into the results even with the impact from Express Scripts, the strength in our business fundamentals comes through in our financial highlights.

First, our front-end comp was up 1.2% this quarter compared to the same quarter last year and excludes the effect of the leap day.

We continued to see momentum in our daily living business as a balanced promotional approach during the holiday seasons led to profitable sales growth.

And as we expected, our convenience and our product and services led to higher comp store front-end sales in the quarter despite our reduced pharmacy volume.

Secondly, we saw a 31% increase in our volume for our 90-day prescription program.

This demonstrates that the true value of our 90-day retail offering is becoming clear.

Customers are getting what they want, the convenience to pick up a 90-day supply of the chronic medications at their trusted community pharmacy.

At the same time, we are reducing cost to payers and helping to improve medication adherence and compliance, which is good for both patients and payers.

And finally as we discussed, cash flow and cash returned to shareholders continued to be strong.

As you can see on this slide, our gross profit dollar growth was up $65 million or 1.2%, driven by our strong front-end and solid underlying pharmacy performance and despite the exit from Express Scripts Pharmacy Network and a weak flu season.

Importantly, the pharmacy gross profit impact was as we anticipated.

As we detailed in last quarter's call, we expect more significant gross profit dollar growth from new generics including generic Lipitor in the back half of the year.

Turning to costs, SG&A dollar growth was $167 million or 4% increase for the quarter.

We also discussed on our last call that we were holding off on our cost reductions in pharmacy in order to retain as many patients as possible and help ensure a smooth transition for those patients on Express Scripts plans who were forced to transition to new pharmacies.

Because of that, our planned SG&A savings from labor reductions will be back-end loaded.

SG&A dollar growth also reflects new store growth, continued investment in our strategies, and the integration of drugstore.com.

Taking it all together, the spread between gross profit dollar growth and SG&A dollar growth for the quarter was a negative $102 million and recall we think about the spread over a longer period of time not quarter-to-quarter.

To generate these solid results, we continued to focus on our five key strategies to become America's first choice for health and daily living.

I will begin today with an update on our first strategy to transform today's traditional drugstore to a health and daily living destination.

To date we have transformed nearly 200 drugstores across the chain to our new Well Experience format.

These include stores in Chicago and Indianapolis, and Duane Reade stores in New York.

Add to that our new Well Experience flagships in Chicago, Las Vegas, and New York City and it is clear we are stepping out of the traditional drugstore format to create something completely new and unique.

We're combining cutting-edge design with an improved product assortment and developing the right mix of healthcare, beauty, fresh food, and private brand solutions to more closely meet the needs of our communities.

Our goal is to create an experience unmatched in the industry and one that is flexible enough to accommodate every community from a store in an urban food desert, to suburban stores, to a flagship location on Wall Street and all types in between.

The response we are getting from customers, payers, government officials, and employees is extremely encouraging.

Our most impressive leading indicator is customer delight, the metric we use to measure customer reactions.

We have seen a significant jump in the last six months in both pharmacy and front-end that reflects our enhanced in-store experience and the commitment of our employees.

And because we are still in the test and learn phase, we continue to refine and enhance this Well Experience format to meet the needs of our different markets and demographics.

Just as we are transforming the front-end of our stores, we are equally focused on advancing the role community pharmacy plays in healthcare.

As part of that commitment, we are excited to be part of the launch of our RxAlly, a network of 20,000 pharmacies that aims to improve patient health and reduce overall healthcare costs through enhanced pharmacist care.

The launch is the first step toward a performance-based network of pharmacies that is designed to differentiate itself through improvements in health outcomes and other services.

Last month we cemented our relationship with AARP as they selected Walgreens for a three-year contract to deliver drugstore benefits to their members.

We remained the first choice that community pharmacies turn to as we acquired the prescription files and inventory for more than 100 pharmacies in the quarter including more than 30 Kmart pharmacies.

We announced an agreement to acquire BioScrip's 30 community specialty pharmacies and the assets of their centralized specialty and mail service pharmacy business.

This acquisition will accelerate our strategy to become -- to bring specialty pharmacy products and services closer to patients at their community pharmacy.

We expect to close the transaction in May.

Our team members also continued to do great work this quarter, signing up more than 700,000 people to our prescription savings club card during our January promotion, which is used by both underinsured patients and those who don't have access to Walgreens.

With all this exciting work, we were pleased to be named once again to Fast Company's list of most innovative healthcare companies.

This was the second time in three years we have received the honor and it's a credit to everyone in the Company.

As we advance our efforts in healthcare, we are also working to deliver an outstanding customer experience by enhancing our employees' engagement.

By strengthening our focus on employee training and leadership development, we are seeing dramatic improvements in service levels in both our pharmacy and daily living business.

In fact our customer service data has shown a 440 basis point improvement in overall store customer satisfaction from February 2011 to February 2012, which we believe is having a significant positive impact on our comp growth.

As we continue to refine and enhance the experience we provide, we are also expanding the scope and reach of Walgreens.

One way we are doing that is through our multichannel approach.

This quarter we continued to make progress in our integration of drugstore.com and our holiday execution across all of our online shops was extremely promising.

As part of that integration we opened a new e-commerce distribution facility in Edwardsville, Illinois.

This 500,000 square-foot facility started shipping orders on February 22 and is expected to improve customer order delivery time by 50%.

In addition, in keeping with our commitment to diversity and inclusion, 30% of our Edwardsville team members have a cognitive and physical disability.

We expanded Web pick up beyond Chicago and San Jose with our launch in Indianapolis this quarter.

We also made additional improvements to our industry-leading mobile and social media technologies.

In mobile, we added new functionality for customers to help them stay on top of their medications and transfer prescriptions in a few easy steps.

Finally, we just added a new application on Facebook called Answers, which is the first of its kind interactive portal that gives our two million friends access to valuable health information and resources including prescription drugs, disease symptoms, at home remedies, and over-the-counter recommendations.

We are also consistently looking for new and more efficient innovative ways to run our business.

A great example is our next-generation point-of-sale system.

The system is designed to be intuitive and easy to use and is powered by the latest technology and wireless capability.

We will complete the rollout by the end of calendar year 2012.

As we continue to focus on the strategic work that is core to our progress, we are also managing important external factors, particularly the upcoming FTC decision and this year's PBM selling season.

On the potential Express Scripts-Medco merger, like all of you, we are waiting for the decision.

However, we have a good relationship with Medco and an ongoing contract in place that we intend to honor.

We've been talking in recent months with many of Medco's clients, a number of whom are Fortune 500 employers in managed care companies.

Those conversations have been very productive and their clients appreciate the convenience and value we bring.

In addition, we are looking forward to this year's selling season.

We already know from our survey that even the most price-sensitive payers want 5% savings or more and most want 10% to consider a restricted network without Walgreens.

We do not believe those savings are truly attainable.

We feel good about the value we are offering as more and more PBMs, health plans, and others approach us to develop unique member services and benefits that can be offered to clients.

We have never been this busy this early in a season and every indication is that this would be the most active selling season in recent memory.

In conclusion, our business performance in light of Express Scripts has been as we expected and we remain steadfast in our belief that this decision was in the long-term interest of our customers, employees, and shareholders.

And as our early results support, we expect the short-term impact to lessen over time.

I want to thank all of our employees for their hard work this quarter.

Based on their efforts and these results, we are confident in our continued progress and focused on executing our strategy to become America's first choice for health and daily living.

Now I will turn the call over to Wade.

Thanks, Greg.

Good morning to everyone.

We are pleased with our performance in the quarter, reporting record quarterly sales, strong cash flow progress, and managing the business through our transition out of Express Scripts Pharmacy Network, consistent with what we have outlined in prior calls.

This morning I will take you through our quarterly results in more detail, update how we frame the second half of fiscal 2012, and provide some thoughts around the potential impact from the proposed merger between Express Scripts and Medco.

Let me begin with a review of our comparable store sales trends.

Both our front-end and our pharmacy trends in the quarter were in line with our expectations and please note that all comparable store numbers discussed on today's call exclude the benefit of this year's leap day.

In our second quarter, total sales were up 0.8% as comp prescription sales decreased 5%, comp front-end sales increased 1.2% over a strong prior-year period.

Total comp sales decreased 2.6% and comp prescriptions filled decreased 6.1%.

Finally for the second quarter of fiscal 2012, we achieved 18.7% retail pharmacy share versus 20.1% share a year ago, reflecting the decision to exit the Express Scripts network, partially offset by a gain in share from the balance of the industry.

Second-quarter 2012 comp prescriptions filled decreased by 6.1%, which included a 750 basis point impact related to Express Scripts as well as a 130 basis point impact from a weaker cough, cold, and flu season.

On a two-year stack basis, comps scripts decreased 1.6% versus a 7.9% increase a year ago.

To better understand our prescription trends, we have isolated the impact of Express Scripts and cough, cold, flu.

Adding back the 750 basis point impact from Express Scripts gives us an adjusted 1.4% prescription growth rate, which compares favorably to the industry including Walgreens, which grew at 0.9% over the same period.

Also adding back the 130 basis point impact from a weaker cough, cold, and flu season yields an underlying prescription comp trend or comp of 2.7%.

Moving to our front end, we are very pleased with our daily living comp of 1.2%, driven by core strategic categories including strong progress on beauty, beer and wine, and convenience and fresh, and illustrating a point that we have consistently made, which is that our retail pharmacy business is not a direct driver of the front of our stores.

Traffic in the quarter decreased by 0.1% while basket increased by 1.3%, reflecting a good balance between our promotional strategy and our pricing discipline.

We enjoyed a strong Christmas and Valentine's Day, with Valentine's Day performance helped by customers seeking convenience, given the midweek holiday.

While the weak flu season had a negative 0.5% impact on our daily living comp, overall we were pleased with the results especially in strategic health and wellness categories.

Finally, our two-year stack represented by the blue line continues to be in the mid-single digits.

Compared to our industry, our front-end sales continued to perform well.

After adjusting our daily living comp to the next three largest retail pharmacy competitors, we outperformed two of the three in the quarter and on a two-year basis, we have outperformed all three by at least 200 basis points.

Like everyone, we continue to see a cautious consumer and a competitive retail environment so we believe this outperformance is a reflection of our differentiated strategies, our focus on the customer experience, and excellent execution in the stores.

Turning to margin, our gross margin as a percent of sales was 28.9% in the current quarter compared to 28.8% last year.

Overall margins increased due to stronger front-end margins.

Pharmacy margins declined slightly, impacted by reimbursement, specialty pharmacy mix, and a higher LIFO provision, partially offset by the introduction of new generics.

Taking a look at our longer-term gross margin trends, this quarter's 10 basis point improvement was against the second quarter a year ago with flat margins.

I would also like to remind you that we believe the better way to look at our business model over time in both daily living and in pharmacy and health and wellness services is to focus on our gross profit dollar growth.

This quarter and for the remainder of the calendar year, please keep in mind that the comparability of gross profit dollar growth will be impacted by the loss of prescriptions related to the exiting of the Express Scripts network.

Two year stacked SG&A trends improved versus a year ago with 12% growth in the second quarter of 2012, down from 13.1% last year.

Our SG&A growth in the quarter was impacted by new stores, investments in strategic initiatives and capabilities, and non-comparable drugstore.com costs.

After adjusting for costs related to the drugstore.com operations and integration, our two-year stacked SG&A growth improved to 7.4% in the second quarter versus 11.1% a year ago.

To get to our core SG&A dollar growth, you can see that our reported 4% SG&A growth included 80 basis points of integration and operational costs related to the drugstore.com acquisition.

The remaining base SG&A dollar growth was a combination of new store openings, inflation and investments in strategic initiatives and capabilities.

This slide shows our quarterly gross profit dollar growth trends for the past six quarters.

Recall the primary driver of our higher gross profit dollar growth in the first three quarters of 2011 was the acquisition of Duane Reade.

When we cycled the acquisition in the fourth quarter of 2011, you can see the slower gross profit dollar growth.

In the second quarter in addition to strong front-end performance, we benefited from the recent launch of generic Lipitor.

As you look at the upcoming third and fourth quarters, you should consider the following points.

First, we will be impacted by the loss of Express Scripts prescription volume for the balance of the year as well as by the continuing reimbursement pressure, and particularly the uncertainty with respect to AMP.

Second, gross profit comparisons get easier in the second half of the year particularly in the fourth quarter.

Last, we expect to benefit from a higher level of new generic introductions in the second half including expected launches of generic versions of the brands Lexapro, Seroquel, and Plavix.

Following this similar construct, you can see that SG&A dollar growth was 4% in the second quarter of fiscal 2012 versus 8% a year ago.

Recall that last year includes 430 basis points from the impact of the Duane Reade acquisition.

Overall in the second quarter, we were able to offset over 50% of the gross profit dollar impact of our exit from Express Scripts Network through our cost initiatives, which have been heavily focused on SG&A and COGS.

As we have stated previously, our highest priority in January and February was to serve our patients and minimize disruption at the store level and we have just recently adjusted store labor to reflect the changes in prescription volumes.

Our confidence remains that with all of our interventions we can offset half or more of the gross profit dollar loss due to Express Scripts at current retention levels, which were about 15% as of the end of the quarter.

Taking into account our planned cost savings and growth initiatives assisted with the Express Scripts situation, we currently expect the impact for the fiscal year to be about $0.21 per diluted share.

Finally as we stated in our press release, the second-quarter impact of Express Scripts was $0.07, which included two full months of the impact as well as some transitions in December.

Now taking you through our income statement, this quarter included LIFO provision of $72 million versus $56 million a year ago.

Our effective LIFO rate for the year was 2.5%, up from 2.25% a year ago.

We had a $0.01 per diluted share benefit from this year's leap day.

Net interest expense was $17 million, down from $18 million a year ago.

Our effective tax rate was 37.3% versus 37.8% last year and average diluted shares outstanding were 875 million versus 928 million a year ago due primarily to our share repurchase program which I will touch on in a bit.

Cash and cash equivalents were $1.1 billion at February 29 versus $2.2 billion a year ago with the reduction largely driven by our commitment to return cash to shareholders and invest in strategic opportunities.

Overall working capital increased by 8.4% versus a year ago, primarily driven by lower accounts payable, which was a function of the timing of our payments largely as a result of significant inventory progress which will work its way through the balance sheet over time.

Accounts receivable increased by 0.5% and improvements in inventory management primarily in our supply chain led to a 3.4% decrease in total inventories.

Looking more deeply at inventory, total FIFO inventory decreased by 0.4% in the quarter versus a 0.8% increase in total sales.

And FIFO inventories decreased by 2.3% on a per store basis, again reflecting strong inventory management and a reversing of three quarters of increasing in per store inventory.

For the quarter, we invested $304 million in capital projects bringing our year-to-date capital expenditures to $723 million.

For the year, we now expect capital expenditures of $1.4 billion, reflecting our commitment to continue to invest meaningfully in game changing technology such as the new POS system and e-commerce distribution center that Greg described as well as to continue to invest in our existing store base.

In the quarter ended February 29, 2012, we generated $1 billion in cash from operations, up 13.7% from $886 million a year ago and continuing our strong cash flow trends.

Year to date, we have generated $1.8 billion in cash from operations and that was despite a significant negative associated with the payable timing as just mentioned.

Free cash flow in the quarter was $703 million, up 1.9% and year-to-date totals of $1.1 billion.

As one of our core capital allocation priorities, we continue to return surplus cash to shareholders.

In the second quarter, we returned $570 million including $196 million in dividends and $374 million through share repurchases.

For the first six months of fiscal 2012, we returned $1.4 billion including $398 million in dividends and $975 million through share repurchases.

Currently we have approximately $600 million remaining against our current $2 billion share repurchase authorization.

Let me now turn to a few thoughts regarding our perspective on Express Scripts and Medco merger, should the transaction be consummated.

Before addressing this potential scenario, I will start by saying that we respect and have a good relationship with Medco and today we feel we have an ongoing contract with Medco that we feel is fair for both parties.

It's good for Medco clients and good for our patients and we intend to honor our contract under existing terms which we believe is to the benefit of all parties.

As a result, we plan to continue serving all of our patients currently covered under their contract with Medco and unless the new company takes an extraordinary action effectively terminating the existing contract or materially changing the terms or financial arrangements, which we have no indication they would do.

And while we believe it serves all parties to honor this existing agreement, our principle of being compensated fairly for the value we provide does not change, merger or no merger.

Now it might be helpful if I sized our book of business with Medco.

As shown on this slide, in calendar 2011, we filled approximately 125 million scripts for Medco members.

In calendar 2012 as a result of Medco's net change in clients, we are on a pace that would result in our filling about 108 million scripts.

Taking into account known client migration to other PBMs including UnitedHealthcare, we estimate that our book of business with Medco will be approximately 74 million prescriptions as of January 1, 2013.

Now this roughly breaks down as follows -- 30% managed care organizations; 29% large employers including 18 of the Fortune 50; 17% state and local governments; 15% small employers, and 9% Medicare Part D plans.

Medco's client composition is different from the Express book, which is highly concentrated specifically with two contracts that account for approximately 50% of the business.

Please note that our actual 2013 business with Medco could have further adjustments up or down following the 2012 selling season.

Having described our business activity with Medco, let me also share that we have had many conversations with existing Medco clients, assuring them that first and foremost we have been happy to serve them and would like to continue to do so.

Additionally, we are communicating that if the merger ultimately consummates, we intend to continue to honor the terms of the current agreement we have with Medco and therefore in theory, there should be no impact to them unless the new company were to take an extraordinary action which again we have no indication at this time that they will do.

And in this context if the merger does occur and the new company were to terminate the agreement or materially change the terms or financial arrangements relating to our network participation, we would work with them to find alternative ways to serve them in accordance with their interests and their contractual rights.

With respect to this point, we believe that a substantial portion of Medco clients measured by prescription volume have contractual options, meaning the contracts either have change of control provisions, provisions requiring certain named pharmacies versus just the number of access points, the right to direct contracts if necessary, and/or are expiring in the relatively near term.

This appears very different than Express Scripts, where Express Scripts by their own public statement said that only a small handful of customers had the contractual right to include Walgreens in the network and to our knowledge, we've contracted directly with or created other arrangements to continue to serve nearly all of them.

Finally, we are hearing clearly from large employers' managed care and early selling season feedback that a network without Walgreens is not gaining traction because there is no compelling value proposition to support it.

There are little to no meaningful savings that accrue to the client and in some cases it may actually be more costly for patients and payers not to have Walgreens or Duane Reade in their network.

Furthermore, the convenience and quality of our stores and the professionalism of our employees is of real importance.

Employers and patients get it.

This is not about 50,000 dots on a map, it is about real people who have real health and wellness concerns and real relationships with the pharmacies and pharmacy employees that they choose.

I would like to build on that more by speaking to the value of Walgreens.

Similarly think about value just in terms of cost and while cost as important, the other side of what delivers value is the benefit.

But let's start with costs.

We believe that in addition to offering competitive unit rates, Walgreens also drives costs down in many other ways including but not limited to our industry-leading generic dispensing and conversion rates and our discounted 90-day at retail offering.

To highlight the lack of potential savings, let me again review the math.

Even if Walgreens charged $1 more than an average pharmacy on what is an industry average of about $60 per prescription, excluding our 20% market share to restrict a network would only save a payer $0.20 per prescription or roughly 0.3% if all of the savings were passed on to the clients.

Moreover, this math does not factor in the significant savings to payers from our industry-leading generic dispensing and conversion rates and our 90-day at retail program.

Our recent survey findings, which are consistent with other industry surveys, affirm that even the most price-sensitive customers are looking for significant savings, again typically at least 5%, to narrow a network substantially.

In my mind narrow doesn't necessarily mean without the nation's number one retail pharmacy.

We drive additional value through the benefits of a direct relationship with the pharmacist and the quality and convenience of our stores which includes best in industry locations, the highest number of 24-hour stores, the face-to-face relations with our people and the broad range of additional clinical services and advice that we offer.

The big idea here is that managed care companies and employers alike understand that the future of healthcare is not about looking just at cost per transaction or even at total pharmacy costs in isolation, it's about prevention and improving patient health and doing it in a way that saves on total healthcare costs.

The fact is, community pharmacists remain one of the few healthcare professionals in America who will counsel a patient free of charge without an appointment.

We are transforming our customer experience in pharmacy to provide convenient, affordable, and quality access to health care.

That's what this country needs.

That is what our customers are asking for.

That is where we are headed.

In closing, we anticipated this would be a challenging quarter and in spite of everything, we were pleased.

The quarter included record sales, positive front-end comps, good cost management, strong cash flow, and significant cash returned to our shareholders.

As I have frequently said with respect to our decision to exit the Express Scripts Network, January 1 would be our toughest day and then we only move forward from there.

Our strategies are sound and our value proposition is compelling.

We remain confident in our future ability to build our business and create shareholder value.

We thank all of you for your support and now I will turn it back over to Rick.

Thank you, Wade.

That concludes our prepared remarks.

We are now ready to take your questions.

(Operator Instructions).

Andrew Wolf, BB&T Capital Markets.

Thank you and good morning, everybody.

I just wanted to ask you about the $0.07 from Express Scripts.

Did that include any of the costs to service clients either to help them stay with Walgreens or smooth their transition to a new pharmacy or is that just sort of a pure gross margin number?

No, that is the net all in including those specific costs.

But effectively as we said, we offset 50% of the gross margin this quarter primarily through SG&A and COGS, but it is an all in number.

You achieved it this quarter or you are expecting to achieve it going forward?

I thought this quarter you actually -- the costs were up because that was my next question.

What is the swing in SG&A that you anticipate by managing down pharmacy hours and other hours and other costs versus sequentially, if you will?

Look at it this way.

We had about two months and a third of a month and when you think about the volume impact, part of December, right, and then two months that we had an impact from the gross profit point of view but we had 50% of that offset through COGS and SG&A.

In the future we are going to have three months but we're going to have a step up in some of our cost efforts and measures accordingly.

So it will be really a balanced impact of Express Scripts through these three quarters, $0.07 in each quarter, basically.

Andy, just to reiterate, I think the key point is the fact that we still feel the $0.21 impact based on that lower scenario is what we will see for the year.

Got you, okay, that clarifies that.

I wanted to ask about Medco in the event of the Express Scripts-Medco merger being consummated.

In your contract with them, does it allow an out with a change of control?

If not, what is the term?

I think we would all benefit if you could tell us how long the contract is for and so that's the contract part.

Secondly, you talked about the book of business going down to 74 million scripts in next year, next calendar year.

Do you have a -- could you size what percent -- you talked -- it sounds like it is a large number much higher than Express but what percent of those contracts or prescriptions you believe are under contracts or will be under contracts that are flexible enough that would keep Walgreens in the network if the merger is consummated and Express changes how they do business with Walgreens, with Medco?

Andy, maybe Wade and I'll both tag team on this one to make sure we get all of it.

I think certainly on the first part as far as what's in their specific clauses and contracts, we certainly don't have visibility into those.

We do believe from what we have heard in the industry that some do have change of control clauses and everything that Wade went through, so that's just based on intelligence, what we're hearing from the field.

As far as the terms of the contract, we said, as we've said, we've got an ongoing contract with Medco that we intend to honor and we don't see any indication that that would change.

As far as the percentage of the business, maybe I'll let Wade kind of key in on that one.

Yes, it's impossible to predict but I would say clearly these customers have -- it's a very different situation.

They have much more rights at large than did Express customers and they also have had the benefit of time watching this unfold as they look forward when their contracts end and potentially renew.

So again without speculating a number, I would just say that for all the reasons I outlined the situation is very different and they have a lot more flexibility and rights in aggregate than did the Express customers.

Again back to the contract we have with Medco, it's been in place for many years.

It continues to move forward I suppose until the parties decide at some point that it doesn't.

So essentially an evergreen contract that either side can walk away from at their whim?

We're never going to talk to any specific contracts with any specific customer or supplier, but I would just say that, like I said before, it has been in place for a long time and we both obviously have felt it's fair, good for patients, payers, and everyone, and we continue to honor that.

Thank you.

Ann Hynes, Mizuho Securities.

Good morning.

I just want to focus on the Medco slide.

When I look at the scripts from calendar 2011 to 2012, you have a decline of 17 million scripts.

And when I look at the book of business that Medco is losing for 2012, it seems a little high to me just taking your national percentage of market share.

So can you maybe go into a little more detail about what -- which contracts are really driving that decline?

You mean the decline from 2011 to 2012?

Yes, I understand t that 2012 and 2013 (multiple speakers) and your market share.

But I'm a little confused about the 2011 to 2012, the drop of 17 million scripts.

Well, there's been obviously many public accounts, CalPERS and others out there.

I don't want to go into the list of the different clients but quite frankly 2012 is pretty easy because now that we are already in March we can see our actually monthly rent rate and reconcile back to those accounts.

So 2011 was an actual.

2012 is kind of a current actual rolling forward and then 2013 is just doing the other puts and calls we know like United.

Ann, I guess the main point is we've got a lot of confidence in that number because we have done the internal analysis and based on the book of book of business and the plans that have been publicly announced that that is the number (multiple speakers)

And what we see every day on our book.

Perfect.

And then the $0.21 impact for fiscal 2012, I just want to confirm that is current retention rate in the mid teens that you experienced in January and February?

Correct, yes.

As Wade said, Ann, we hit about 15% at the end of the second quarter and I think it's important to say that we expect that to build and as plans begin to take action, State of Nebraska has publicly reported its changing July 1, so we expect that to build.

All right.

And will you give any details on the gross profit differential between an Express Scripts and Medco scripts so we can just --?

I guess we could basically say that there is no Express contract, so there's really no differential to give.

But no, we never talk about any one customer to another and our objective here is to be fair with all customers and try to treat them all fairly in the same genre, anyway.

All right, thanks.

Mark Miller, William Blair.

Good morning.

You talked about the restricted networks not gaining traction and I was wondering how do you know that's not about to happen through the rest of the selling seasons or later in the year?

What visibility do you actually have on that?

I think, Mark, good question.

We feel pretty confident as far as the intelligence we're getting from the field.

We've got people out talking to the benefit consultants.

We've got people out talking to clients as well as the other partners that we work with out there and we just don't see it.

What we are more encouraged by frankly is the fact that as I said on the last call, that the other payers that we are working with whether it's PBMs or health plans are more and more interested in working closely with us and differentiating themselves in the marketplace this selling season because they have Walgreen in versus Walgreen out.

The survey that we did that we published last quarter also I think is a strong indicator that says that employers would need a 5% to 10% greater savings to even consider restricted networks, so all intelligence that we see, the folks that we are working with, we do not (inaudible) trends.

I think especially, again, this word restricted gets used loosely.

Someone might have a restricted network that doesn't include a pharmacy that doesn't have a share in that market anyway, right?

When it comes to excluding the nation's leading pharmacy for little to no savings, there's really no evidence that that is ever taken up, nor is it this season as well.

Okay, my next question is given there's more than a $0.50 spread in the consensus estimates high to low for fiscal '12, given there appears to be decent predictability to the business based on the constraints of what the lawyers will let you talk about, can you give some general commentary on the second-half outlook?

The Street is looking for nearly flat EPS down a little bit.

Is that a reasonable framework?

Same scenario for fiscal '13, there's like a $0.60 spread in the analyst projections.

Look, obviously since we don't give guidance, I can't point to any specific number.

I would just come back to our overall framework.

Prior to the Express Scripts -- prior to exiting their network we had financial goals and targets, financial goals that we've stated we wanted to hit over time.

We have talked about what the impact of Express Scripts will be to us on a fiscal year basis.

We've even laid out by quarter basis, so you kind of have to model backwards from there.

Okay, last question from me is you had talked about the EPS benefit growing from generics.

Roughly what kind of an EPS lift did that give to the Company in the fiscal second quarter?

Was that in the range of a nickel?

Could you help us out on sizing the benefit?

And then how much greater should we think of that lift in the coming quarters?

Thanks.

We aren't going to outline exactly what it was in Q2 but I will actually defer to Rick's Heisenberg Uncertainty Principle of Generics, which is the more you try to measure and estimate what they are going to be in the future, the more the number keeps changing all the time because there's lots of variables -- first supplier, second supplier etc.

So clearly we get a lift in the back half.

We said that, but I think it'll be premature to try to put a number around it until we get there.

Okay, thanks.

Tom Gallucci, Lazard Capital Markets.

Good morning, thank you very much.

Just one clarification and one sort of follow up almost on that last set of questions.

I guess just on the clarification, the $0.07 Express hit, what rate is that based off of?

Is that your old contract or the terms that you proposed?

How would you put that in context?

That would have been our exiting rate.

Okay, then maybe following up on what you were talking about a second ago in terms of your long-term goals, I guess if you add the Express impact and the flu and you take away a penny from leap day, maybe your EPS grew 7% or 8% in the quarter on a year-over-year basis.

How does that sort of compare to what your expectations are over the long-term ex some of the noise that we've got in terms of Express and whatnot?

You could certainly do the math that way.

We don't adjust that way.

We just keep it raw as it is.

But what I guess I would say is over the long term, we are still operating over that systemic framework.

We believe that we can have industry-leading growth.

We can have that robust EPS growth.

We can have steadily improving cash flow and ROIC and a good, strong balance sheet.

So this is -- I would call this a blip in the road on the path to keep focusing on that.

Right, but in terms of robust EPS growth, I don't know -- is high single digits the goal?

Is it sort of low double digits or how do you think about the business ex a lot of the noise in the long run?

This is Greg.

Our goals haven't changed.

We set out the plan to win three years ago.

We want to get back to double-digit EPS, strong return on invested capital and top-tier shareholder return and that's what we think our strategies will allow us to do.

You know, there two ways to look at frankly the lost business from Express Scripts and frankly we anticipate that we will continue to be -- to work with Medco and their clients.

But you know, there's the opportunity to continue to grow share with those plans that are out there that are wanting to work with us and we are very encouraged as I said earlier with those that are coming to us and trying to win business this selling season against those that don't have us.

Secondly is the austerity and the cost-cutting measures that Wade talked about.

We feel confident we are going to be able to do both of them and we are very confident on our strategies and the ability to return back to those goals.

Okay, last one.

Wade, you mentioned AMP.

How are you thinking about that?

What is the latest that you've got there?

Thank you.

I will let Kermit to answer this.

Obviously there's not a lot to update but, Kermit, why don't you --?

As you know, Tom, right now we are in the comment period on the FUL.

There has been some questions around the FUL that they should have been fixed drafts out there.

So as an industry, we are still continuing to work with CMS to get an AMP that reflects the actual retail, community pharmacy purchasing price, and that is our continued goal.

So as we continue to work with CMS, it's all about getting AMP right and doing what's right for the community and community pharmacies.

Is there an expectation for a timeframe when we will have maybe some resolution or is it pretty uncertain still?

I think it's still uncertain as to the time of AMP implementation.

Okay, thank you.

Matthew Fassler, Goldman Sachs.

Thanks a lot and good morning.

A couple questions, a couple follow-ups.

First of all, you alluded in your press release to strategic projects impacting SG&A.

Any clarity as to what that relates to and what you're working on?

Yes, Matt, we continue to invest obviously on our multichannel business.

We think that's a big opportunity for us and some of the things I've mentioned on the call would be indicative of that.

We continue to invest in our stores.

As we said three years ago, the reason we decided -- one of the reasons we decided to slow our new store opening growth was to be able to reinvest in our existing store base.

We think we've got a heck of a footprint.

A lot of the things that we have done with CCR this past year is a good foundation for us to build upon.

So we are continuing to invest in those new in those new formats (technical difficulty) pilots and we will continue to measure to make sure that's a good use of our capital.

We'll also continue to invest in our front-end offering, private brand.

We are really feeling good about where we are going there so it's basically our five key strategies that we are pretty consistent with as to where we are investing.

Got it and sort of related to that, I know there's been some discussion of ultimately launching a loyalty program.

Is the cost embedded in current SG&A in any way and any update as to the timing of that kind of effort, please?

Yes, as far as -- I will take the loyalty launch itself, we feel good with where we are headed.

We're still planning for a mid to late September launch with a loyalty program.

As far as the SG&A impact, I will let Wade address that.

Yes, we certainly have some costs that we're doing to get -- obviously we are not going to launch in the timing Greg said without having some upfront investment to get it right.

We haven't disclosed that amount, but that's a part of those strategic investments to really set us up for the future here.

Got it.

Finally at some point, the focus will likely shift back to the core business and to retail.

You spoke about the well format stores.

You have over 200 of them now.

I know some are Walgreens, some are Duane Reade, but can you talk about the economics of conversion, the kind of investment that you need to generate, how those stores are comping and what their margins look like versus the rest of the chain?

All I would say is this.

What we are seeing in those stores from lifts and from profitability and returns is very promising and we're still measuring and analyzing.

We look at unit economics, so every store is slightly different.

Every model is slightly different.

It's all contextual to what we're trying to achieve and so obviously we wouldn't be going down this path if we didn't think that it was financially accretive and good for the customer as well.

And again, early results across the board are promising but we continue to refine and look at it to really fine-tune our unit economics moving forward.

Got it.

Thank you.

Scott Mushkin, Jefferies & Co.

Thanks for taking my questions.

So let's assume the Medco and Express merger goes through and I'm just trying to understand what you would think is a material change.

If Express slowly tries to move people, the Medco accounts over to their network, how do we view that and how would you view that?

How would you respond?

Scott, Greg.

Certainly a good question.

I'm not going to speculate on what they may or may not do.

I think as we said in the call, we've got a good relationship with Medco.

We think we've got a great relationship with their clients.

We've got an ongoing contract that we think makes sense for all to honor and we intend to do that.

As far as what they may do or might do I think that probably is not worth speculating on.

I will say that as Wade said, like all business once we see and have an indication of what is actually happening and the terms and conditions and so forth, then we make the adjustments necessary.

So bottom line is we look for fair reimbursement for the value we provide and that is what we would expect.

I'm sure -- I'm not even sure of the exact question.

When you say move over to their network I guess what you're saying is a network without being able to access Walgreens, because we have no arrangement now with Express Scripts.

Correct, what I am saying is if they offer the Medco customers the ability to switch over, how do you guys deal with that and how would you respond?

A customer could always choose that.

Today Express Scripts for 10 years has been trying to sell EN30 and EN40 without Walgreens.

It is less than 1% of the business but they have the right to do that.

Customers clearly don't like thinking they've got bacon and eggs and show up and have cold oatmeal, so the real issue I think is whether or not customers want Walgreens and value Walgreens and we believe from what we are hearing that they do.

Scott, as I have said several times, and we want to remind you, we are in the business to fill scripts and that's what we do, so certainly that's why we would want to honor that contract and continue to work with those clients.

But it has to make good business sense for us and we just decide and determine at the time based on what we see as to how we would go forward.

So just to summarize, if they had a lot of success you might have to deal with it, but you don't think necessarily they will have a lot of success.

Is that a good summary?

Customers want to get what they pay for, right?

And what we are hearing loud and clear from the customers is they want a broad network and they know there's no material savings and so in this case they are obviously quite a lot more rights in Express.

What they are by customer will remain to be seen but at the end of the day, customers want to pay for what they want to get.

Scott, here's what we are seeing and do believe, that although we are not an Express Scripts Network, unfortunately, at the same time we are building deeper relationships with all the payers that are out there wanting to work more closely with us.

So we can focus on the lack of access to Express Scripts but the positive is the gain in share and the deeper relationships we're building as a result with every other payer that's out there.

And that's where we are focused.

And we feel good with what we are seeing in the early selling season, as I said in my early opening remarks.

This is one heck of a busy selling season already.

So I wanted to -- thank you for all that clarity by the way.

I wanted to switch gears to SG&A just to understand when the store level cuts I think you said they are kicking in maybe March 1 and I think you've outlined lower store hours, reduced staffing and salary cuts.

And so I guess what I want to know is when will they be fully implemented and then kind of a corollary here is the SG&A dollar growth rate this quarter if I adjust -- some of the adjustments Wade put up there but also thinking about the store growth, it looks like the core business ex the store growth was kind of flat.

And I wondered if that is something you can replicate, so the two-part SG&A question, and then I will yield.

Thank you.

I will hit it first and then I'll kick it over to Kermit and Mark.

I think our SG&A growth, you're right when you exclude things like drug stores as well as our new stores.

We did have very good progress there and I think a lot of what we're doing across the board not just in stores but at corporate is continuing to find ways to become more efficient, effective all the time, Express or not Express.

What I would say is that -- before I turn over here too is the efforts we're doing in stores, we are trying to match up to do it smart to where the biggest volume impacts have been.

This is not peanut butter and we still intend on having the best service in the business.

We still intend on improving our customer satisfaction as we go, but this is really about making sure that we do it smart, again in concert with the volume (inaudible) we've seen.

Scott, I would just add, we balance our stores' labor payrolls all the time depending on volume, so as our volume fluctuates, so does the way that we balance our store labor.

Scott, I will weigh in.

I want to commend.

I want to commend frankly, I take this opportunity that we probably have employees that are listening, Mark and Kermit, the job they have done, I think our employees have done an incredible job reacting intelligently to the reductions that we are beginning to put in place.

As I said, the good thing about this is there is a good -- it's market by market, store by store in specific markets and we have got the ability to laser in and dial down store by store.

But our store employees, our store managers out there have just done a terrific job in managing through this.

Frankly they support the long-term decision that we have made and where we are headed.

Thanks very much.

John Heinbockel, Guggenheim Securities.

A couple of things.

If you -- if we look at $0.21 earnings impact with 15% retention, so that looks like maybe an incremental $100 million or so of cost reductions somewhere, cost of goods, SG&A.

Generally speaking, where is that coming from?

Those are two of the buckets, obviously, but the other piece of it is even though almost all of it is cost, we are also seeing while it might not be ESI retention, we might be building scripts or getting topline volume from other customers.

So for example, we have seen -- I'll give you a couple of examples here.

We've seen other pharmacies that were so overloaded with Express customers they couldn't handle the volume.

They had out of stocks, they didn't have supply.

So customers that we could have served in the past that were going to other pharmacies have now come to Walgreens and we are kind of seeing that by the day right here as we also link it with conversion programs.

We also see Medicare Part D.

Every day I think it is something like 11,000 people are turning -- being able to go Medicare Part D and some of those were with Walgreens before, then they found out -- they woke up and they couldn't go to Walgreens and now they turn to the age where they can get Medicare Part D and they're looking for plans that have Walgreens.

So there's lots of different buckets like that but the vast majority is incremental cost efforts but we are seeing outside of the retention bucket, we are seeing other volume upticks in lots of different areas.

It happens slowly but surely.

John, as we said, we held off on store labor and store reductions to make sure we give the good service.

But we have been focused corporately and we are certainly looking at projects and making sure that we are focused on those that really move the needle.

I think frankly the positive of this is we are laser focused on those five key strategies and driving what -- and really focused on the projects that are going to move the needle.

So we have been looking at corporate over the last couple of months so there is some real progress there.

All right.

Secondly, are you doing anything differently with other PBM partners this selling season in terms of how you are working with them, what you are offering them aside from them just selling Walgreen being in the network?

Anything else that's different than past years to accentuate that?

I guess if you are, it sounds like you are getting good early feedback that that's working.

Yes, John, I think several things.

First of all, a lot of them are coming to us, as I said earlier.

They're looking at this being one of the few selling seasons where there is true differentiation in the marketplace with the PBM offering and that being frankly that they have the largest retailer in the country in their network or out of their network.

That's number one.

Frankly what we are hearing is that's a pretty easy sell and they're looking forward to that.

Then we begin to talk about the fact that we drive high generic utilization.

They're looking to work with us on how we can drive that even higher and bring them greater value.

Many of them are now really beginning to see the benefit of 90-day at retail being added to an existing mail plan.

So as we've said several times, that when a payer or a client adds a 90-day retail benefit to an existing mail plan, there is anywhere from 7% to 9%, maybe more percent in savings available.

So I think they are really beginning to work with us in ways and look for some of the ways that we can help them reduce costs and drive real value.

All right.

And then finally, if you take a long-term view do you think -- I mean clearly reimbursement rates are going to go down secularly but if you think about a Medco Express, so I'm assuming that goes through, which it looks like it is -- if you look at that concentration on the PBM side, does that drive quicker reimbursement rate pressure on the retailer over the next year or two and do you think then that leads mostly to consolidation, mostly I guess the smaller guys falling out more quickly?

Is that where we are headed?

I guess you could -- I don't know if it's going through or not, right?

So who knows what it will.

But I would say that from our point of view, our principle is our principle.

We expect to be compensated fairly not just versus our own thinking but versus the market and versus others and that doesn't change, Medco or no Medco.

I think you could make the argument that it could put tremendous pricing pressure on the little guys as they need to pay for the premium of the merger, etc.

and quite frankly, I think you can see it from our battle as large as we are as the number one retailer, that a small player is going to have a very difficult time probably holding the line in that scenario.

Yes, but even for the big guys you would say the pressure gets ratcheted up a little bit or no?

I'm pretty convinced of our value proposition.

We are seeing it now in the sales piece and we are seeing people just not having Walgreens as a nonstarter.

There are no material savings and I think people don't want to go within their own network just to spread an intermediary.

I think the reality is, though, is that a small player is going to have a very difficult time in that environment.

John, I think we have had -- we've been in this industry.

There has been ongoing reimbursement pressure for years in this industry and still will be.

And I think therefore as we are focused obviously on costs and making sure that we continue to take costs out, we are also looking -- that's the reason we are driving our strategies, to make -- to be able to work with payers and create value in ways other than just a focus on reducing pharmacy costs specifically.

Okay, thanks.

David Magee, SunTrust Robinson Humphrey.

Good morning, guys.

In the event that Express and Medco does happen, would you care to hazard a guess as to what the retention rate might be given your greater conversations with those clients?

I don't think we'll get into that.

I will say if you go back to Wade's chart, we tried to show what we see the book of business being with us January 1, 2013.

Frankly I'll tell you, I believe it would be difficult for Express Scripts and others to continue to sell without Walgreens in their network.

We have had, as I said, we've had several conversations with many of key clients and those clients indicate to us that they really value having Walgreens in their network.

And that they've got the ability and the means to do that, and that's their intention, so I think we remain pretty confident that it's a very different scenario.

My second question is looking at the impact on Express being $0.21 this fiscal year, is it fair to assume that that maybe gets cut in half in 2013, so maybe $0.07 in the first quarter and maybe $0.03 in the second quarter?

I think either way just to model it is you've got eight months this year and then four months next year so you lap it, right?

So you could build your own models and figure out the sequence and timing on how you lap it.

It's not that hard to do.

Great.

Thank you.

Ladies and gentlemen, that was our final question.

Thank you for joining us today.

As a reminder, the Company will report March sales on April 4 and we'll report third-quarter 2012 earnings on June 26.

Until then, thank you for listening and we look forward to talking with you soon.

That does conclude today's conference.

We thank you for your participation.