沃博聯公司 (WBA) 2012 Q3 法說會逐字稿

Good morning and welcome to the Walgreens Co.

third-quarter 2012 earnings conference call.

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

Rick Hans, you may begin.

Thank you.

Good morning again.

Welcome to our third-quarter 2012 conference call.

Due to media commitments as a result of our earlier announcement regarding our investments in Alliance Boots, Greg will not be joining us on the call today.

Wade Miquelon, Executive Vice President and Chief Financial Officer, will update you on the quarter.

Following his prepared remarks we will be available to take your questions.

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

Statements in these materials and the accompanying presentation that are not historical are forward-looking statements are made based on current market, business, and regulatory expectations and involve risks, uncertainties, and assumptions that could cause actual results to vary materially.

Except to the extent required by law, we undertake no obligation to update publicly any forward-looking statement after this presentation.

Please see our latest Form 10-K and 10-Q filings and subsequent Exchange Act filings for a discussion of risk factors as they relate to forward-looking statements.

Today's presentation also includes certain non-GAAP financial measures and I would direct you to our website at investor.

Walgreens.com for reconciliation.

Now I will turn the call over to Wade.

Thank you, Rick.

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

This morning I will take you through our quarterly results and update key considerations for the final quarter of -- for the quarter of fiscal 2012.

Beginning with our results today, we posted third-quarter sales of $17.8 billion, down 3.4% from $18.4 billion a year ago.

Third-quarter earnings per diluted share were $0.62, down 4.9% compared to $0.65 in the year-ago quarter.

Despite lower earnings, cash generation continued to be strong as cash flow from operations in the quarter was an all-time record of $1.9 billion and free cash flow was $1.5 billion.

Through the first nine months of the fiscal year operating cash flow was also a record at $3.7 billion.

We returned $371 million to shareholders in the quarter, including $176 million in stock repurchases.

Compared to the prior year, the strategic decision to no longer be part of the Express Scripts pharmacy network as of January 1, 2012, impacted our quarterly results by a net $0.06 per diluted share including cost controls and a total of $0.15 per diluted share year-to-date.

This year's quarter was also negatively impacted by $0.01 per diluted share due to the cost related to our previously announced definitive agreement to enter into strategic transaction and partnership with Alliance Boots, the leading international, pharmacy-led health and beauty group, which we announced earlier today.

For the year we continue to expect the full year net impact from exiting the Express Scripts pharmacy network to be around $0.21 per diluted share.

In summary, we were pleased with our financial results and the quarter included good cost management, record cash flows, solid earnings per share, and significant cash returned to our shareholders.

As you can see, our gross profit dollar growth was down $140 million, or 2.7%, which was in line with our expectations, while SG&A dollar growth decreased by $62 million, or 1.6%, reflecting outstanding SG&A control during the quarter.

As discussed in our last call and as evidenced in our results this quarter, the benefits to our SG&A efforts weigh more heavily to the second half of our fiscal year.

Taking it all together, the spread between gross profit dollar growth and SG&A dollar growth for the quarter was negative $78 million.

Let me now give you more detail on our comparable store sales for the quarter.

As you already know, comparable prescription sales decreased 9.9%, comp front-end sales decreased 0.9% over a strong prior-year period, and total comp sales decreased 6.6% with comp prescriptions filled decreasing 9.1%.

Our third-quarter 2012 prescription comp of negative 9.1% and on a two-year stack basis comparable scripts decreased 4.5% versus a 7.2% increase a year ago.

To better understand our prescription trends, we have isolated the impacts of Express Scripts, [day fall], and cough/cold/flu adding back the [10.7] negative impact we experienced from exiting Express Scripts network it reconciles to an adjusted 1.6% prescription growth rate, which compares favorably to the industry, including Walgreens which decreased at 0.3% over the same period per IMF.

Adding back the 40 basis point impact from a weaker cough, cold, and flu season along with a 10 basis points impact for the day fall, adjustment calculates an underlying prescription comp of 2.1%.

Moving to our front end, traffic in the quarter decreased by 2.6% and basket size increased by 1.7%, and the front-end comp decreased by 0.9%.

The primary drivers behind these decreases were the impact of Express Scripts and the changes to our pricing and promotion strategy, which we continue to believe are directionally right.

While we achieved a solid margin benefit from this change, we will continue to balance and find the right trade-offs between sales and profitable growth.

Turning to margin, our gross margin as a percent of sales was 28.2% in the current quarter compared to 28.1% last year.

Pharmacy margins increased as a result of new generics and were partially offset by reimbursement, Specialty Pharmacy mix, and a higher LIFO provision.

The front end was positively impacted by convenience and fresh foods, household items, and nonprescription drug categories offset by e-commerce mix.

Taking a look at our longer-term gross margin trends, it's important to note that this quarter's 10 basis point improvement was against a 50 basis improvement a year ago with both front end and pharmacy cycling strong margins.

Finally 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 lost prescriptions relating to exiting the Express Scripts network.

SG&A in the quarter was down $62 million in absolute dollars as cost control this quarter was outstanding.

Two-year stacked SG&A trends dramatically improved versus a year ago with 5.6% growth in the third quarter of 2012, down from 15.8% last year.

Recall that last year's two-year stack included expenses related to the Duane Reade acquisition in 2010 whereas the current year's comparison includes expenses from our drugstore.com acquisition in 2011.

The current quarter's decrease was primarily a result of the lower comparable store expenses, which were partially offset by an investment and strategic initiatives and capabilities.

With respect to managing our store labor expenses, I want to personally extend a thank you to all of our team members for pulling together during this time of cost reduction.

After adjusting for costs related to the drugstore.com operations and integration, our two-year stack SG&A growth improved 4.2% in the third quarter versus 12.4% a year ago.

To get to our core SG&A dollar growth, you can see that our reported SG&A, a decrease of 1.6%, included 60 basis points of integration and operational costs related to the drugstore.com acquisition, resulting in an adjusted SG&A of negative 2.2%.

Recall that the drugstore.com transaction closed in June 2011 and that this will be the last quarter where it is a non-comparable event.

To help frame the fourth quarter it may be helpful to look at last year's trends.

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

You can see that our gross profit dollar growth comparisons become easier in the fourth quarter as we fully cycle out of the non-comparable impact of the Duane Reade acquisition with a slight year-on-year negative impact from our recent BioScrip specialty acquisition.

Following the same construct, you can see that SG&A dollar growth decreased 1.6% in the third quarter of fiscal 2012 versus an increase of 7.2% a year ago as the benefits of cost reduction efforts began to materialize.

Please note that in the fourth quarter we face the more challenging SG&A dollar growth comparison of 4.8% having cycled out of the impact from the drugstore.com acquisition.

As you estimate the upcoming fourth quarter you should consider the following points.

We expect the net impact of minus $0.06 related to our decision to exit the Express Scripts network.

Gross profit comparisons get easier during the last quarter of the year.

We expect to benefit from a higher level of new generic introductions in the fourth quarter versus year ago, including the third-quarter launches of generic versions of Lexapro, Seroquel, and Plavix.

We will have some cost associated with the Alliance Boots transaction, the magnitude of which in part will be determined by the actual closing date of the first step.

Taking you through our income statement, this quarter included a LIFO provision of $60 million versus $50 million a year ago.

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

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

Our effective tax rate was 37.2% versus 35.4% last year and average diluted shares outstanding were 865 million versus 922 million a year ago, due primarily to our share repurchase program.

Cash and cash equivalents were $2 billion versus $2.7 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 decreased by 3.9% versus a year ago, primarily due to lower inventory levels, and accounts receivable decreased by 11.7%.

And improvements in inventory management, both in underlying performance and in quick response to Express Scripts situation, led to a 7.3% decrease in total inventories.

Looking more deeply at inventory, total FIFO inventory decreased by 3.4% in the quarter versus a 3.4% decrease in total sales, and FIFO inventories decreased by 5.6% on a per-store basis, again, reflecting strong inventory management.

During the third quarter we generated an all-time record of $1.9 billion in cash from operations, up 50.2% from $1.2 billion a year ago and continuing our strong cash flow trends.

Year-to-date we have generated a record $3.7 billion in cash from operations, again helped largely by inventory management.

Free cash flow in the quarter was $1.5 billion, up 46.8%, and the year-to-date total of $2.6 billion.

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

The third quarter we returned $371 million, including $195 million in dividends and $176 million through the share repurchase program.

The first nine months of fiscal 2012 we returned $1.7 billion, including approximately $600 million in dividends and $1.2 billion through share repurchases.

Given our Alliance Boots transaction announced this morning, we do not anticipate additional share repurchases in the near term.

This morning we also announced the quarterly dividend rate will increase by 22.2% to $0.275 per share, consistent with our previously stated goal of returning cash to shareholders through dividends, with a target dividend payout ratio of 30% to 35%.

We are proud to have paid a dividend for 319 straight quarters, more than 79 years, and are now increasing our dividend for the 37th consecutive year.

Over the past five years Walgreens annual dividend rate has increased from $0.38 per share to $1.10 per share, resulting in a compound annual growth rate of nearly 24%.

Our focus in driving returns to shareholders was reiterated this quarter through our continuation of the share repurchase program and the increase we provided to our quarterly dividend.

In closing, we were pleased with our quarter.

We had solid margin, exceptional expense management, record cash flow, and returned significant cash to shareholders.

We continue to move our business forward against all of our key strategies, including our continued investment in our well-experienced pilot stores, expanding the role of community pharmacy services through expanding offerings and enhanced partnerships, driving significant improvements in our cost structure, and, most importantly, announcing a truly watershed moment for our company as Walgreens and Alliance Boots together create what will be unquestionably the global leader in the pharmacy-led health and well-being space.

This transaction offers compelling, strategic, and financial benefits that will provide significant value to all stakeholders and is being structured in a way which will maximize and ensure success.

So we thank all of you for your support and now I will turn the call over to Rick.

Thank you, Wade.

That concludes our prepared remarks.

We are now ready to take your questions.

(Operator Instructions) Dane Leone, Macquarie.

Thanks, guys.

Thank you for taking the questions; I know there is a lot to discuss this morning.

Maybe we can just start with the domestic strategy going forward in light of the transaction with Alliance Boots that you announced.

Maybe, Wade, you could touch on how much balance sheet flexibility you think you have going forward, the opportunity you see here domestically in light of kind of focus on BioScrip's and drugstore.com integration that seems to be going well.

Yes, along those lines; any color you can provide is appreciated.

Well, I would say that, regardless of this transaction, we are going to continue to drive our strategies.

We have got the flexibility and resources and capital to do that.

I think, as we said earlier on the call, we actually believe though that this partnership, this marriage is going to help us not only drive those but accelerate those.

It will allow us to really continue on this journey to become the most relevant retailer in our space, to really own the space of health and daily living.

So that doesn't change at all.

We continue to believe we have got the nation's largest, most trusted pharmacy.

We are on the best corners, and we are going to fully drive that experience and increasingly find ways to monetize it and to build deeper relationships with customers.

Okay.

And maybe more specifically on the domestic strategy, I think that you have done a great job of adjusting the cost structure for the lower volumes and the business as a result of the contract loss with Express Scripts.

But I am just curious, going forward the front-store traffic trends have looked like they have deteriorated over the last several months.

We have also seen kind of a revamp of the prescription savings club, I guess in the hopes of driving more volume through the door.

So how do you think about balancing cost structure, the promos that you are willing to provide for the volumes versus just managing the business to where it is?

Also, where do we actually see the front store traffic impact bottom out here?

Because, correct me if I am mistaken, but was that originally contemplated or is that included in the $0.21 EPS hit from the contract loss with Express Scripts?

Fully contemplated and fully included.

I think the step down you have seen -- which is not, by any means, a deterioration.

The step down you have seen is in part driven, because I think we are being much smarter in terms of how we manage our marketing and (inaudible).

So we are doing more items that are relevant with less items that aren't at very hot discounted prices, so that has changed traffic a bit, but I can tell you the profitability is better as a result.

When we look at our customer satisfaction metrics, when we look at our ability for stores to better deliver the items on promotion that people actually want without out of stocks, etc., by all metrics we are improving the customer experience.

So we are driving profitable volume and I think that is the right move.

We are also moving to a much more blended marketing mix so that we are not going to be completely dependent on our (inaudible) in the future.

We are going to touch consumers in multiple ways that are relevant to them and that are financially best for us.

Okay.

Then one final question for me, just in terms of the long-dated guidance that was given on the call with Alliance Boots, it did imply a decent organic growth rate between the two companies, somewhere in the order of 5% CAGR over the next several years.

Can you just kind of tease out for us what that means for an expectation for the Walgreens business here domestically versus the contribution from Alliance Boots?

Yes.

First, I mean when we put those goals out -- I am not sure what CAGR you are talking about.

Are you talking about top-line CAGR?

Top line, yes.

Well, I think what you have to do is to understand the model is make sure that you get into the generic versus branded mix.

So the sales, as you know, both domestically and overseas are a misnomer for value creation.

So, for example, as you know, our generics are much more profitable in the US; that would create some sales compression.

But we fully anticipate to drive robust volumes overseas in places like Europe where generics are underpenetrated.

They obviously are at a lower cost, too, but they are more profitable from a pennies per unit basis and the wholesaling, etc.

And so I think that it's very difficult for you probably to imply, or at least to back into, what the unit volume growth is we are anticipating.

Okay, thank you.

Steven Valiquette, UBS.

Thanks.

Good morning, everybody.

Just a quick question for me on the -- for 2013 there still seems to be a lot of feedback I am getting from investors on question marks around the Medco side of the business.

I guess my only question around that is would you plan an additional set of cost-cutting initiatives if there were some Medco-related volume that may fall off in 2013?

Or are you, as you alluded to more recently, assuming that that contract stays intact and then therefore have no other plans for cost cutting, etc.?

I can only tell you what we know and what we have said.

Basically we have said that we have had a contract in place for many, many years.

We are willing to honor it.

We want to keep serving those customers.

I think Express Scripts has said the same thing, so as of now we continue to serve those customers and I think we know overwhelmingly from those customers that they really want to have us in the network and intend to fully do that.

And so I think there is very little risk in that regard, but I think if there was something fully unanticipated that would happen I would say that as a company we would be fully prepared to do whatever was necessary in the best interest of our company and our shareholders.

Okay.

So then, I think some of the investor view is that the announcement today with Alliance Boots may be tied into some sort of Medco view.

But it sounds like what you are saying with the answer to that last question is there is really no tie in whatsoever to anything that you are looking at going forward in relation to Medco in particular, is that safe to say?

Yes, of course.

It would be very naive to assume that this is in some response to our dispute.

I mean the reality is we have been working together for almost a year-and-a-half and working on this for over a year.

A company our size is not going to do a transformational transaction of this magnitude unless you are thinking about the strategic fit, the overall financials, and the very long haul.

I just think -- I find it almost silly that people would think that this is reactive.

I can tell you, when you look at these two companies and our economic interest becoming entwined, all parties are really saying how big could the endgame be and is this the best and biggest alternative for the long haul.

We believe there is nothing even remotely close to this for us.

Okay, that is helpful.

Thanks.

Meredith Adler, Barclays.

Thank you very much.

I was wondering if you are in a position at all to talk about Boots, because I didn't get a chance to ask a question on the last call.

Sure, yes.

Okay.

Do you have any sense of what Boot's wholesale market share is in Europe?

[It's not just Alliance really].

That is a number that has never been stated, but I think, as we said, they are the clear leader in Europe and by unit volume the biggest in the world.

And I think, as George said earlier on the calls, number one or number two in all their key markets.

So I would just leave it at that.

Obviously there is probably ways for you to back into it and get close, but that is really all that is available at this time.

Okay, great.

Then I was wondering, when you were discussing the price that you were going to purchase Alliance Boots, did you take into account, and were they willing to take into account, the fact that Europe is struggling right now?

That is to say, do you think that you got a relative bargain because of the timing of the acquisition?

Well, a couple things.

Number one is, yes, Europe has some issues but so does a lot of the world.

What I would say is when you look at their business their business is performing very well, has been and still is.

So this is not a firesale.

This is a quality asset that is doing very well even in a tough environment.

Actually, in fairness to them, this challenging environment provides a lot of opportunities.

In the wholesale market, for example, there is a lot of small players who can get credit in easy times but if they are not good operators it's not so easy now and that provides wonderful growth opportunities.

Separately, generics in Europe range from 25% in the south to 50% in the north versus 75% in the US.

And as the governments come under pressure they are increasingly pushing more generics for big savings for the government, which is good for them and good for people, but it's also good for their business because they make more penny profit per generic than they do on branded.

But what I would say is that we have fully modeled the value of this company from both an intrinsic value, from a comparative multiple value, and also with respect to the gives and gets of both parties.

I think you will be hard-pressed to find a deal of this size where both parties believe they have the kind of value creation for their respective owners as this.

That segues into another question about what was said on the call.

Stefano used the word generics many times and I couldn't quite tell if he was talking about generic pharmaceuticals as we think of generics or was he talking about private brands or was he talking about both.

And do you have any sense of kind of the magnitude of those two different businesses -- generic pharmaceuticals and private brands?

Yes, I don't the specific comment, but I think he was probably -- if he used the word generics, he was most likely referring to generic drugs because they refer to their private brand as own-brand.

So the magnitude is obviously -- I gave perspective that the day we joined on generics by over $1 billion combined, which by volume is a huge volume because of the relative cost versus branded.

And that number is growing rapidly and will continue to grow rapidly.

Again, I think if you look around the world there is only one retailer in the world who has ever really been able to play the own-brand beauty game well and has a portfolio that has innovation and new products and that is Boots.

Just the fact that they have a relationship with P&G distributed in five countries ought to tell you everything you ought to know about their capabilities.

So there is huge opportunity and there will be.

One of the reasons I thought he was talking about own-brand as opposed to generic pharmaceuticals because he mentioned about procuring products globally.

Do you know whether they are able to source generic pharmaceuticals in places that you historically have not been able to procure them and what their regulatory issue is there?

Yes, of course.

It's different country by country but we procure a fair amount offshore in various countries; they procure a lot.

So generics are very different from brandeds where you maybe have a country price and then you have issues of cross-country and corridor pricing.

Generics are much more like other items where multiple suppliers can do it and regulations in most countries allow you, as long as you meet certain specs or regulations or FDA whatever, to take from anywhere to anywhere.

So you can think of that as more of a, I don't want to use the word, but more of how you would think about a typical commodity.

Okay, great.

Thank you very much.

Debra Weinswig, Citi.

Thanks so much.

Good morning, Wade.

Can you please provide some more color around gross margins this quarter in light of the growth in generics?

I think Specialty Pharmacy mix is cited as a drag.

I didn't know if you could elaborate on the change in mix year over year.

Yes, I think we had good gross profit margins as we listed.

I think the only thing on Specialty, and I think -- and actually e-commerce, it's not that those margins are eroding; it's that those gross profit margin percentage as are lower than others and those businesses are actually growing very fast.

So those are just only mix issues.

I would say if you look through our business we feel very good about the kind of gross margins and gross profit dollars that we are seeing on the pharmacy side.

We feel very good about the profitability we are building in the front end even though we might have sacrificed some traffic.

As we get our items which are more relevant, more meaningful to our equity, to consumers that gives fair value for us that is a trade-off that we will continue to balance but we don't feel is directionally wrong.

Right.

It just seems on the Specialty Pharmacy side that is a key focus for you.

I didn't know if you had a percentage in terms of where you are currently and maybe where you think you can go with that.

I don't know that we have given too much detail on margins, but as you know, these drugs can be $1,500 or $2,000.

So a big difference in gross margin might be better dollar profit, but, again, much lower on a percent basis.

But overall we feel very good about this business.

We continue to invest in it and I think the things that we are doing to create a real multichannel opportunity for people bundled with meaningful offers as a very good value over time are going to keep changing the landscape here as well.

Then during the quarter it also looks like you had extremely tight inventory management.

Was there anything new during the quarter in terms of supply chain or anything else that you implemented during the third quarter?

We had a lot of various supply chain initiatives.

I think we are just very focused on it.

What we are making sure is as we reduce inventory that our out-of-stocks don't go up and that our customer satisfaction goes up.

I think that for the past couple years we have been able to manage these because it's not about just having inventory.

It's about having the right inventory at the right time that people want.

Again, we are putting lots of efforts on our supply chain, on being more efficient and more effective, but it's all done from what I would call a consumer or a demand-driven perspective to make sure that the experience is better as a result of it.

And we will continue on that journey for a long time.

Okay.

Then one quick question on the Boots side.

What opportunity is there to bring the Boots opticians and some of the other services into Walgreens and Duane Reade here in the US?

I think that is one of the opportunities.

I can tell you I have got a list of many, many opportunities that could be hugely valuable and accretive as well.

We are going to work together and qualify these and pilot the right ones and expand, but that is one opportunity but there is many, many, many others as well.

Okay.

Then last question.

I know the loyalty card side of the equation seems like it's going to be changing and, obviously, Boots has an incredible one.

How should we think about the rollout there in light of the acquisition?

We are full speed ahead.

We have said we are going to launch loyalty sometime around September.

We believe it's going to be one of the biggest programs, ultimately, in the world of its kind.

I think even though we are a bit late in the game -- I always make the analogy to some developing markets with land lines and mobile.

Late in the game you can sometimes learn from others and jump to a better endpoint.

I think that you are going to see that it links very well with our equity of well and how we are trying to drive that for peoples' benefits versus just discounting.

One of the things I like about the Boots loyalty program is not only is it large and, as you heard, has two-thirds of the women in the UK signed up, is it's a financially smart program but it's also very emotive.

It's just not discounts and points.

It's really emotive and gets into gifting and many other things that really create a deep and real connection with consumers.

And that is where we can really learn as we draw the lines back to where we are going to own this territory of well.

Great.

Well, thanks so much and congratulations on the acquisition.

Thank you.

Appreciate that very much.

Eric Bosshard, Cleveland Research.

Good morning.

Curious on -- you have talked earlier in the year about your involvement in the selling season and this has been a very active selling season for you.

I am interested in an update on how you see things progressing and how we are performing relative to the 25% to 75% retention that you outlined at the beginning of year.

I will just say this.

One, is that I think you know where our attention started.

I can tell you we look at every single day, every single script versus comp whatever and we are building momentum every single day.

Every day we are getting back incremental scripts versus what would be a normalized comp, and that is going to continue to grow.

There will be some periods where maybe it steps up and others where it just slightly drifts up, but we feel very good about that.

I would say that everything you said before about the selling season that we believe is still what we believe.

The key thing is that we are working with lots of our customers, right, lots of our customers across the board.

In fact, almost all of them.

They are telling us that they really value us in their network; their customers value us in the network.

In many cases we are working very deep partnerships, but same as it ever was.

I think that we feel our value proposition is very sound.

We deliver a very cost effective and very high-quality solution with reach and penetration, other services, and hours that really no one else can deliver.

People want that and people value that, and so we stay the course.

Thank you.

Ladies and gentlemen, thank you for joining us today.

As a reminder, the Company will report June sales on July 5. Until then, thank you for listening and we look forward to talking to you soon.

Thanks, everyone.

Thank you, ladies and gentlemen.

That does conclude today's conference.

You may all disconnect and have a wonderful day.