沃博聯公司 (WBA) 2012 Q4 法說會逐字稿

Good morning and welcome to the Walgreen Co.

fourth-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, Alli.

Good morning, everyone, and thank you for joining us.

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

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

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 to the most directly comparable GAAP measures and related information.

You can find a link to our webcast on our Investor Relations website.

After the call, the presentation and the 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 and subsequent Exchange Act filings 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, and good morning, everyone.

Thank you for joining us on our call.

Today I'll begin with some perspective on the year and a review of our results for the quarter and the fiscal year.

Second, I'll discuss the overall strength and performance of our business.

And, finally, I will take a strategic look ahead to fiscal 2013.

Then I'll turn the call over to Wade for a more detailed review of our quarter and full-year performance and key considerations for fiscal 2013.

I want to begin today by putting fiscal 2012 into perspective.

This was certainly a challenging year capped off by a tough fourth quarter, but a very important and strategic year for Walgreens.

As you know, we started the year with a critical decision to exit the Express Scripts network.

This decision, despite the short term ramifications to our business, was absolutely the right one for our shareholders long-term.

That said, as you are aware, we were ultimately able to reach an agreement with Express Scripts last July that met our core principles.

With this now behind us we are focused on the many opportunities ahead, starting with our truly game-changing relationship, the relationship with Alliance Boots, to create the first global pharmacy-lead health and well-being enterprise.

As we have said before, this relationship will accelerate our five core strategies.

It creates an unmatched supply chain.

Together we will have the largest retail pharmacy distribution network in the world and be the world's single-largest purchaser of prescription drugs and many other health and well-being products.

And, finally, it provides us with a platform for global expansion beyond the US and Europe into new markets around the world.

We believe replicating this combination will be difficult, if not impossible, given its tremendous first-mover advantage.

We also recently launched our innovative new loyalty program, Balance Rewards, which is our next step in making Walgreens the first choice for health and daily living.

This required replacing our decades old point-of-sale system with new state-of-the-art technology across the entire chain.

And we continue to expand our Well Experience stores, reaching 350 across the chain.

As you know, we're combining cutting edge design with an improved product assortment, including an enhanced mix of healthcare, beauty, fresh food, and private brand solutions to meet more closely the needs of our communities and create an experience unmatched in the industry.

Finally, we continue to participate in the consolidation of both the traditional pharmacy and specialty pharmacy markets with our recent acquisitions of USA Drug, Crescent Infusion, and the assets of BioScrip.

These were key strategic opportunities with top-notch talent and we welcome their team members into the Walgreen Co.

As I said at the open, it has been a very important and strategic year for Walgreens.

We now have the structure, strategies, and talent in place to drive both short-term and long-term performance.

With that, let's get into the numbers for the quarter.

I'll dig in today with our quarterly results.

We'll be presenting numbers on both a GAAP and non-GAAP basis and Wade will walk you through the details and the specific adjustments later in the call.

As you saw in our release this morning, we reported fourth-quarter sales of $17.1 billion, down 5% from $18 billion a year ago.

GAAP operating income, or EBIT, for the quarter was $586 million, down 53.7% compared to $1.3 billion at the same time last year.

Recall that GAAP figures from last year's quarter include the gains on the sale of Walgreens Health Initiatives, our pharmacy benefit manager.

Adjusted operating income, or EBIT, for the quarter was $838 million, down 12.6% from $950 million in the fourth quarter of 2011.

GAAP earnings per diluted share were $0.39 in the fourth quarter, compared to $0.87 last year, down 55.4%.

Fourth-quarter adjusted earnings per diluted share were $0.63, down 4.5% from $0.66 in the same quarter last year.

Turning to our performance for the fiscal year, sales were essentially flat for the year even with our strategic decision with regard to Express Scripts, which represented about 11% of our prescription business the prior year.

This performance illustrates the strength and diversity of our business.

For the full year, we posted $71.6 billion in sales compared to $72.2 billion last year, down just 0.8%.

It's important to note that overall sales would have increased by 1.2% without the impact of generic drug conversions throughout the fiscal year, which affected sales by $1.4 billion.

GAAP operating income was $3.5 billion, down 20.6% from $4.4 billion in fiscal 2011.

Adjusted operating income for the year was $4.1 billion compared to $4.4 billion in 2011, down 6%.

Our full-year GAAP earnings per diluted share were $2.42, down 17.7% from $2.94 last year.

Again, including the gain from the sale of WHI.

On an adjusted basis earnings per diluted share were $2.93, flat compared to $2.93 in the same period the previous year.

Finally, cash flow from operations for fiscal 2012 was a record $4.4 billion compared to $3.6 billion in fiscal 2011 and free cash flow was also a record at $2.9 billion.

And we continue to return significant cash to shareholders throughout the year with $1.2 billion in share repurchases and $787 million in dividends.

In the fourth quarter our gross profit dollar growth was down 4.6%, or $234 million.

Gross profit dollar growth was down year over year as a result of the continuing impact of Express Scripts.

SG&A dollar growth was up only slightly in the quarter, increasing $12 million, or 0.2%.

After adjusting for the impact of Alliance Boots, SG&A dollar growth was down $41 million, or 1%.

After adjusting for the LIFO provision, gross profit dollar growth declined $162 million year over year.

Although the adjusted gross profit dollars grew less than adjusted SG&A dollars, I would like to underscore that we were able to offset more than half of the gross profit dollar loss from Express Scripts with good SG&A control.

In fact, as you recall, we said that the impact of Express Scripts after adjusting our costs would be $0.21 for this fiscal year.

And we delivered on that.

Now our multiyear agreement with Express Scripts signed in July means we are once again participating in their broadest retail pharmacy network.

On September 15 many of our valued customers started coming back to Walgreens.

As always, they will have the benefit of convenient access to the pharmacist they have known and trusted.

We are pleased to be back with plans and employers we have been partners with in the past, such as WellPoint and many others.

Although we are still very early in the process, with only 12 days of welcoming customers back to Walgreens, we are encouraged by the early results.

I look at the patient return process like this; to me there are really three buckets.

First, there are people who will come back right away.

They are our most loyal patients who value our convenience and who have had long relationships with us.

And that is who we have been seeing in the first couple weeks.

The second bucket includes the people who will need a little convincing.

And that is what we have our marketing plans in place for, including our $25 gift cards, to transfer their prescriptions that as well as our Balance Rewards program.

The third bucket is a little tougher and we will see how the return works there over time.

We'll certainly have a much better read on customers returning to Walgreens over the next three to four months as more employers and health plans are able to communicate the changes to their people and as new plan changes take effect at the first of the year.

Now I know some of you may want specific numbers on returning customers.

However, as I am sure you can understand, these numbers are competitively sensitive.

Therefore, we think the best and most accurate way to track this and our underlying business in the months ahead is through our monthly sales and prescription comps.

This is because our comps reflect not only returning customers, but customers who have switched from one plan to another as well as new business.

And that is how we will be tracking our progress as we focus on growing our prescription market share overall.

Moving forward, we think we are very well-positioned to gain market share not only through Express Scripts members returning to Walgreens, but also through many other partners who have been -- we have been quite successful with in broadening and deepening our relationship throughout the past year.

In addition, we have probably never been better positioned heading into the Med Part D season this fall.

Now let me turn to our innovative loyalty program, Balance Rewards, as we continue to enhance our customer experience.

We launched the program online in early September and nationally on September 16.

We have seen great response since the launch, signing up nearly 12 million customers in stores, online, and by mobile, and we are significantly ahead of our forecast.

As the initial couple of weeks show, we took the time to do loyalty right and we have launched a program that provides real value for Walgreens and our customers.

Balance Rewards is unlike any other program on the market.

It is linked to our well-brand strategy and designed to foster long-term loyalty among our customers rather than simply providing cash back for purchases.

It is designed to be more engaging, more aspirational, and more explicitly anchored to health and wellness.

Compared to other programs, Balance Rewards provides more value for our customers.

Our points are valid for three years, they gain more value the more a member earns, and they can be used instantly at the cash register as soon as a member reaches 5,000 points.

Balance Rewards points can be earned and redeemed at all Walgreens and Duane Reade stores and online at Walgreens.com, while in other retail programs customers can only earn benefits in the stores.

And, finally, Balance Rewards members receive points for healthy habits like Walk with Walgreens.

To develop a program that would lead the industry, we depended on a talented team with deep expertise and loyalty and learned from Duane Reade's highly successful program.

We'll continue to enhance our program exchanging best practices with our new partner, Alliance Boots, which has the leading loyalty program in Europe.

Overall, we believe this will be the largest, most powerful, and most successful loyalty program in retail.

In the quarter, we also made progress on our strategy to expand into new channels and markets, closing on the first phase of our transactions with Alliance Boots.

With a 45% stake in the Company, we've begun the real work of the transaction with the goal of becoming the leader in global pharmacy-led health and well-being.

We closed a very successful $4 billion public debt offering, replacing our bridge facility.

We capitalized on strong demand in the market to get attractive rates across our maturities and upsized the deal a bit to lock in additional long-term capital.

We also established our shared Board governance structure, placing representatives from each company on the others' Board of Directors.

In addition, we have recently realigned our organization to accelerate our strategies and to support our partnership with Alliance Boots.

As part of that reorganization, Wade takes on an expanded leadership role at Walgreens, a global role, as Executive Vice President, Chief Financial Officer, and President, International.

In this broader role, Wade will lead the development of our strategic partnership with Alliance Boots and other potential international partnerships.

As I have said before, this partnership gives us a platform to accelerate our key growth strategies.

We have cross-functional teams from both companies who are looking for ways to bring together these two iconic brands.

We are already sharing best practices in areas such as loyalty and eCommerce.

We're also exploring opportunities to capitalize on Alliance Boots' expertise in owned-brands and beauty, while at the same time sharing our knowledge in pharmacy operations.

Working together, we also have the opportunity to create an unmatched supply chain with a scope and scale no competitor can equal.

We've begun setting up joint ventures to realize $100 million to $150 million in combined synergies from the partnership in the first year and more than $1 billion in combined synergies by 2016.

To support the joint ventures, we have set up six new global synergy teams in coordination with our partners at Alliance Boots and both companies have committed a number of key leaders to these teams.

And, finally, we have the opportunity for global expansion beyond the US and Europe.

You may have seen most recently that Alliance Boots announced their intent to acquire a 12% stake in Nanjing Pharmaceutical Company, the fifth-largest pharmaceutical wholesaler in China.

We also see tremendous opportunity in Asia and other parts of the world as we move forward with this strategic partnership.

In closing, fiscal 2012 was a reflection of the hard work, tough decisions, and strategic investments that have established a foundation for future growth and value creation for our customers, our shareholders, and all of our stakeholders.

As we turn the page on this year we have tremendous opportunities to continue to accelerate our strategies and expand our purpose to help customers get, stay, and live well around the world.

As a result of the decisions and actions made this year, we now have the structure, strategy, and talent in place to drive our operating performance forward into the future for some time to come.

Thank you, and with that I will turn the call over to Wade.

Thanks, Greg.

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

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

As you can see with our results today, we have begun reporting our performance in both a GAAP basis and an adjusted basis and we plan to continue to do that as we go forward.

Why are we doing this?

A few reasons.

First, we believe our adjusted numbers provide good additional perspective of our normalized underlying business performance.

Second, these adjustments are very consistent with how many of our key competitors and peers report their business, so it provides for a better comparison in that regard.

And, third, with our recent and large Alliance Boots transaction, we feel that now is a good time and helpful time to initiate this change.

Lastly, many in the investment community have commented to us that this additional perspective would be value-added.

Our non-GAAP adjustments include the LIFO provision, hence converting earnings to FIFO; special charges or gains, such as costs, associated with large acquisitions or divestitures; and finally, amortization related to acquisitions and divestitures.

For the quarter, we reported a GAAP EPS of $0.39 based on 895 shares million shares diluted.

To get to the adjusted EPS for the quarter you need to add to back the LIFO provision, which was $0.10 per share; the special charges related to the closing of Alliance Boots investment, and this $0.09 charge includes transaction expenses, interest expense, and the effects of share issuance and nondeductible expenses for tax related to the transaction; and, finally, $0.05 for existing acquisition-related amortization in the quarter.

The sum of these yield an adjusted EPS of $0.63 for the quarter and, as Greg stated earlier, this result is versus an adjusted EPS of $0.66 in the year-ago quarter.

Also, keep in mind that since we will be rewarding Alliance Boots using equity method accounting on a one-month lag, no Alliance Boots income is included in our reported net income on a GAAP or adjusted basis this fiscal year or fiscal quarter.

Compared to the prior year's quarter, the strategic decision to not be part of 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 $0.21 per diluted share for the fiscal year, consistent with our previously stated estimate.

For historical perspective, we are providing both GAAP and adjusted EPS data for the last 12 quarters and three fiscal years.

Note that GAAP EPS for fiscal 2012 is $2.42 versus $2.94 in fiscal 2011, while the adjusted EPS of $2.93 in fiscal 2012 was equal to the adjusted EPS of $2.93 in fiscal 2011.

And as you can see, the adjusted data is helpful in understanding the normalized business performance.

Now let me provide more detail on our comparable store sales for the quarter.

As you may already know, comparable scripts in the quarter were impacted by the loss of Express Scripts business.

Comparable prescription sales decreased by 12.8%.

Comparable front-end sales decreased by 1.3% over a strong prior-year period and total comp sales decreased 8.7%.

Comparable prescriptions filled decreased 8% and comparable prescription sales were down to a much greater degree, primarily due to the increased introductions of new generics.

Now this slide clearly illustrates the impact on comparable store script numbers for the latest three quarters we were not part of the Express Scripts network versus the prior year.

The comp store script trends were down 8% in the fourth quarter, which was a sequential improvement over the third quarter which was down 9.1%, while the two-year stack was essentially flat.

Moving to our front end, traffic in the quarter decrease by 3.2% and basket size increase by 1.9% and the front-end comp decreased by 1.3%.

The primary drivers behind these decreases were the impact of Express Scripts and the move to rebalance our overall promotional spending, which we believe is directionally right.

While we achieved a solid margin benefit, we will continue to work to strike the best balance between sales and profitable growth.

Here also, the two-year stack was essentially flat.

Turning to margin, our FIFO gross margin was 29.1% in the current quarter compared to 28.5% last year, a 60 basis point improvement.

Pharmacy margins increased as a result of new generics and were partially offset by a reimbursement in specialty pharma mix.

The front-end was positively impacted by OTC drugs, household and personal care categories, offset by eCommerce mix, which has solidly contributed gross profit dollars but at a lower margin than our balance of business.

We are pleased with the performance of Walgreens.com as well as the drugstore.com acquisition, which continues to exceed our baseline expectations.

Taking a look at our longer-term gross margin trends, it's important to note that this quarter's 60 basis point improvement was against a 20 basis point decrease a year ago.

The margin trend is reflective of the impact of our new promotional and pricing strategy in health and daily living and the impact of generics on the pharmacy.

On a GAAP basis, two-year stacked SG&A dollar growth trends continued to improve, in part driven by cost interventions we took to help offset the loss of Express Scripts business in the quarter.

Net of the special charges related to Alliance Boots and the acquisition-related amortization, SG&A in the quarter was down $41 million behind excellent cost control.

Two-year stacked adjusted SG&A trends dramatically improved versus a year ago with 3.4% growth in the fourth quarter of 2012, down from 15.2% last year.

The current quarter's decrease was primarily a result of lower comparable-store expenses and lower headquarter expenses, which were partially offset by SG&A related to investments in the business.

Respect to managing our store labor expenses, I want to personally extend a thank you to all of our team members for again pulling together this quarter and the entire fiscal year.

Get your adjusted SG&A dollar growth, you can see that our reported SG&A dollar growth of 0.2% included 120 basis points of Alliance Boots transaction-related costs resulting in an adjusted SG&A dollar growth of negative 1%.

These costs are primarily related to legal and advisory fees.

This slide illustrates our quarterly gross profit dollar trends for the past eight quarters on a GAAP basis and the next slide will show the same information on an adjusted basis.

The trend in the adjusted gross profit dollar growth data shows the impact of the loss of Express Scripts customers.

Gross profit dollar growth slowed from a positive 3.2% in the first quarter versus a negative 3.2% in the fourth quarter.

Now please bear in mind this wide range of gross profit dollar growth as you think about our quarterly performance in fiscal year 2013.

Even though we are winning back Express Scripts customers, this quarter comparison will be difficult until we cycle the first of the calendar year.

Following this same construct, this slide shows SG&A dollar growth trends for the past eight quarters on a GAAP basis and the next slide shows the same information on an adjusted basis.

The adjusted SG&A dollar growth trends again highlights the effort made by the Company to offset the loss of the gross profit dollars related to Express Scripts.

Adjusted SG&A dollar growth slowed from roughly 4% to 5% in the first half of the year to a negative approximately 1% to 2% in second half of the fiscal year.

The fourth quarter showed slightly higher adjusted SG&A dollar growth versus the third quarter, but this was primarily due to added expenses for new investments in the business that I referred to earlier.

Focusing on our income statement, this quarter included a LIFO provision of $132 million versus $60 million a year ago.

The key driver behind the higher LIFO reserve was overall brand pharmacy inflation, which accelerated significantly in the quarter to almost 2 times the rate a year ago.

Our effective LIFO rate for the year was 3.3%, up from 2.4% a year ago.

Net interest expense was $37 million, including the impact of the Alliance Boots acquisition, up from $15 million a year ago.

Our effective tax rate was 35.8% versus 36.7% last year.

Average diluted shares outstanding were 895 million shares.

The change in shares are primarily due to the impact of share repurchases, partially offset by the one-month impact of the 83.4 million shares issued due to the Alliance Boots investments versus 911 million shares a year ago.

And shares outstanding at the end of the fiscal were 944 million shares.

Cash and cash equivalents were $1.3 billion versus $1.6 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 15.9% versus a year ago, heavily benefited by lower inventory levels.

Accounts receivable decreased by 13.2% while accounts payable decreased by 8.9%.

Improvements in inventory management, both in underlying performance and adjustments to manage Express Scripts situation, led to a 12.5% decrease in total inventories.

On inventory, total FIFO inventory decreased by 7.3% in the quarter versus 0.8% decrease in total sales, and FIFO inventories decreased by 9.3% on a per store basis.

Now also remember that some inventory will build back as Express Scripts customers return to Walgreens.

During the fourth quarter, we generated $768 million in cash from operations, up 112% from $362 million a year ago, and we continued our strong cash flow trends.

Free cash flow in the quarter was $320 million.

For the fiscal year, we generated a record $4.4 billion in cash from operations, up 22% from fiscal 2011, largely driven by a solid operating performance and strong working capital management.

For the fiscal year, free cash flow was also a record at $2.9 billion and up 19% from the prior year.

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

In the fourth quarter we returned $194 million in dividends.

For the fiscal year 2012 we returned $1.9 billion, including approximately $787 million in dividends and $1.2 billion through share repurchases.

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

This fiscal year we also increased the quarterly dividend rate by 22.2% to $0.275 per share, consistent with our previously stated goal of returning cash to shareholders through dividends with a targeted dividend payout ratio of 30% to 35%.

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

For 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%.

Let me transition now to Alliance Boots and our fiscal year 2016 goals.

We continue to believe that the strategic fit, financial returns, and stepwise execution of this partnership is going to be a great thing for our stakeholders.

As Greg said, our efforts to deliver real synergies, enhance capabilities, and change the strategic landscape in the US, Europe, and other geographies around the world are off to a very solid start.

We shared our Walgreens Alliance Boots 2016 goals with you on the day of our strategic partnership announcement and I would like to briefly revisit those with you now.

At that time we showed you a LIFO operating income goal of $8.5 billion to $9 billion.

To stay in sync with our go-forward adjusted reporting framework we are also providing an adjusted operating income goal of $9 billion to $9.5 billion for fiscal year 2016.

In addition, we provided a fiscal year 2016 goal of approximately $7 billion of operating cash flow.

With further financial model refinement we are changing our fiscal year 2016 goal to be approximately $8 billion.

All other stated goals remain the same, such as our $0.23 to $0.27 fiscal year 2013 accretion goal, excluding special items; our $100 million to $150 million fiscal year 2013 combined synergy goal, leading to a combined synergy goal of $1 billion or more by fiscal 2016; and at the end of fiscal 2016 a combined net debt of $11 billion or less.

While we realize this accounting period is complex given items such as the transaction-related charges and the one-month reporting lag, our pro forma financial information filed with our debt offering and our next quarter earnings release should help to provide more clarity.

We are anticipating that in fiscal year 2013 will have approximately $0.05 of special items associated with the transaction, such as advisory fees associated with legal entity establishment, ex-patriot moves, and key dedicated resources.

Also, during the first quarter in fiscal 2013 we will recognize approximately $25 million of expense related to the inventory step-up component of our Alliance Boots investment, which is amortized over the first inventory turn in addition to other transaction-related amortization.

This slide illustrates the rate of maturity schedule for our recent $4 billion debt offering.

The offering was extremely well executed and well received by the market.

The weighted average rate for the $4 billion was just over 2.2% with a weighted average maturity of 8.7 years.

Our current balance sheet debt portfolio is $6.4 billion, which has a weighted average maturity of 6.8 years with an average rate of approximate 2.75% including our interest rate swaps and assuming current LIBOR rates.

Our capital allocation policy has changed only modestly.

We intend to continue to invest in our core strategies, such as our new stores, Well Experience journey, loyalty, and the multichannel experience.

And we will continue to invest in strategic opportunities that support and reinforce our core.

We will continue to return cash to shareholders in the form of dividends.

And finally, our intent is to continue to maintain a strong investment-grade balance sheet.

In closing, while we've had some challenges in the quarter, we've had many significant milestones which set us up very well for the future.

Overall, we were pleased with our year.

Given these challenges, we still have solid margins, exceptional expense management, record cash flow, and returned significant cash to shareholders.

But importantly, we continue to move our business forward against our key strategies, including our continued investment in our Well Experience pilot stores which hold strong promise moving forward.

We invested in successfully deployed, best-in-class technologies, such as our new POS system, and we expanded our omnichannel leadership in health and well-being.

We launched our new Balance Rewards program, which is off to a strong start, and we have dramatically accelerated and enhanced our private brand portfolio.

We continue to expand in community pharmacy services through new and enhanced offerings, such as our 90-day launch, broadened vaccination and immunizations, and we have formed deeper partnerships with many key players, including managed care, pharma, PBMs, hospital systems, physician networks, and employers.

And we also embarked on a truly watershed journey for our country as Walgreens and Alliance Boots work together to create what we believe will become the global leader in the pharmacy-led health and well-being space.

With combined retail stores and distribution touch points of more than 180,000 in 26 countries, I believe that we are well-positioned to change the paradigm in our industry as the world's largest, most relevant, and importantly, most innovative player in our space.

Together, we are well positioned for growth, uniquely positioned to leverage our mutual capabilities and assets for our customers and suppliers, and confidently positioned for delivering synergies and creating value.

No doubt this year has been one with many ups and downs, given the stance that we took for the long-term shareholder value, and for all of you who stood by us I want to thank you for all of your support.

We will continue to work hard to deliver on our commitment to you.

And with that, I turn the call 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.

Good morning.

Wade, on your exposition on the net number for the impact from Express Scripts, I think you've talked about -- there is a lot of labor taken out in other costs, but I assume mainly labor.

I think you've talked about as that business can come back that that can be leveraged at a rate where the variable costs, the labor doesn't have to come back at the same rate.

Could you just give us an update on your thinking in that regard?

Yes, I mean that is absolutely true.

Most of the cost we took out will not come back.

What we will do is we will do things -- where we see higher volumes of Express we will put the proper labor back in adjustments like that.

But for the most part, I would say that we have very strong leverage on it and most of the costs will not come back.

Okay.

So it's just going to be -- I mean because we are trying to model things sort of mechanically, would it be -- if we came up to an estimate of how much cost was taken out, would it be fair to say maybe half of it would be come back once -- you know, a year from now or so once (multiple speakers)?

With respect to store labor, we took for a 9%, 10% loss, whatever, in pharmacy sales.

We took out, I think, 2% or so of our labor, so you have a ratio there a 4 or 5 to 1.

So we will make the right interventions to make sure that we have the right service levels and take care of our patients.

But really a lot of the other efforts that we did to be more focused on with respect to projects corporately, efforts we made across COGS and other things, those are sustainable interventions.

Okay.

And the other question I would like to ask before moving onto the next is if you do the adjusted EPS and add back the Express Scripts impact, you get about a 5% growth this quarter, 7% for the year.

I wonder if you could expand upon -- are there any kind of opportunity costs, let's say lost front-end sales, for example, that are not necessarily quantified but that you either can expand upon or perhaps even quantify.

Thank you.

Yes, I think your math is probably fairly close.

I think -- I guess one thing is obviously -- there have been some challenges in the overall economy, but I think as we go forward, I guess what I would say from this point forward I see that we have no good tailwinds.

I think we have the Express Scripts situation behind us and so whatever we win back, we will win back.

But that will be a tailwind.

We have got, as Greg said, we are very well situated with many of the other players and we feel that we are going to be well versed to gain share.

We have got the loyalty program, which has been invested in heavily upfront and now is off and running very successfully.

And we have the Alliance Boots close and the initiation and all the work behind us as well.

And so now we move forward with them into our forecast for growth and accretion.

So I think you probably have a pretty good framework there, and I think moving forward I would just put that on top of it.

Andy, I would add, a lot of the work that we have done over the past year, such as our effort to really accelerate private brand, the completion of CCR last spring, the enhanced products we are putting with fresh food and meal consumption and so forth, all that we feel very good about being delivering strong tailwinds for us.

The way you calculate the $0.06 and the $0.21 that is a pharmacy-only or is that trying to include the front-end?

That includes the front-end as well.

Okay.

And just lastly, it's a technical question.

The LIFO charge was way higher than I think I expected and probably everyone else, and inventories were down a lot for the year.

Does this happen to be something to do with the layers you got into are more inflationary?

That is just sort of a much bigger swing than I would have thought.

If you could just give us an explanation of that, thanks.

Yes, I mean it's pretty simple as what I said.

Even though there is a lot of different moving parts that happen in the calculation.

The reality is that the brand inflation in the fourth quarter, and particularly in July and August, I believe we had last year around 2.5%.

In the quarter it was about 5%, so almost doubling.

So when you consider the size of our brands and brands in inventory, those kind of movements have a huge impact.

That doesn't mean that we will sustain back and forth.

I think part of the point of going adjusted, especially the FIFO, is that is a much clearer picture of how our operations and our business and our profitability comes in than the LIFO.

So it's an additional perspective that will allow people to see our business both on maybe more of a normalized perspective, or at least an additional perspective, but also how others view it.

So that's branded pharma, or the front-end?

That was branded pharma.

It was -- not the generic piece, but the branded pharma piece in particular, the inflation was again basically double of what we saw year prior.

And it really kicked up in July and August with three or four brands in particular.

Got it.

All right, thank you.

David Magee, SunTrust Robinson.

Good morning, guys.

Greg, I wanted to ask you, you mentioned the three buckets as far as you look at the customer recovery process.

Could you comment, I guess based on your past experience, what maybe the relative size of those buckets are thought to be?

David, it's kind of hard to say.

I think certainly bucket one typically is the easiest and most quickly to come back, and that is what I said on the call.

We are seeing that.

You know, it really comes down to three things -- convenience, the relationship, and service that these folks were forced away from.

We think we win in all three of those.

We think we are extremely convenient.

We think that we've had folks who, in that first bucket especially, who have had relationships over the years and who we give great service.

I think we will find out more and more as we get into this.

There is a lot of things that come into that.

As we have seen clients sending communication to their members, they come back quickly.

That is the reason I said as more plans notify their members I think we will see probably bucket two become even easier for us.

So it's hard to dimensionalize, but I try to put it in those three buckets just so you can also understand kind of our spend , because I think there is also some concerns or thoughts out there that we are going to get into a price war for these patients.

We are certainly going to spend our marketing dollars strategically across those three buckets and get the ROI that we need or we expect to get from that.

Thank you, Greg.

Then just secondly, can you talk a little bit about what you are seeing with reimbursements in the UK for Boots and what the prospects are there over the next 12 months?

Yes, I think there was some noise along the lines of the reimbursement cuts that the UK or England put into place last week.

I think the main thing is that was absolutely budgeted and anticipated by Alliance Boots.

They have been in this -- doing this for years and obviously that is an annual adjustment so it was expected.

So it won't impact their budget or their performance, and, therefore, also won't impact our accretion numbers as well.

Okay, great.

Thank you.

Ed Kelly, Credit Suisse.

Good morning.

Can I just ask a quick follow-up on the UK reimbursement cuts before I get into another question?

Sure.

Could you quantify what the impact is going to be on Alliance Boots there?

I will say what Greg said is that basically versus their budget and versus our accretion number there is no impact.

There has basically been austerity measures every year, at least for the last three years, in England.

And with respect to the formula and the clawback and the provision and how they budgeted it, it was pretty much expected.

And, Wade, as we think about this business going forward, is this -- we're obviously not all familiar with the UK, but is this something that we need to really focus on pretty strongly around this time of the year?

Because it does seem like it was a decent size cut.

I can tell you that the Alliance Boots folks are far more expert than myself, but after deep discussions with them and getting to understand it is this is something that continues to go forward year after year after year.

But basically inherent in the overall -- it is much more complex than on the surface, the inherent model mix, the move towards generic, the other pay-for-service fees.

They believe that they have got the forecast budgeted in their model and they are very well predicting.

So that is something I would not concern yourself with.

I would say that in our next year estimate and it is also inherent in our 2016 goals with respect to their best knowledge.

Okay.

Now that you've closed on the deal and you're almost a couple months in -- thinking more about synergies, that type of stuff -- how do you feel relative to the accretion estimate that you gave initially?

Is there a potential for upside?

Well, we're certainly, Ed -- we're certainly confident in the number we gave.

For a variety of reasons, the majority of that is cost opportunities and we've got the synergy teams in place that have been working on this, frankly, even months before we closed, to give us some real insight as to what is available.

The more we work together and the more they spend time together the more confident we get in the number.

Do we think there is additional opportunity out there?

I think typically, when you bring two organizations like this together, certainly you find additional opportunities you didn't even anticipate to begin with.

But we want to make sure we deliver the number we gave and we feel very confident we can do that.

Okay.

Then on Express Scripts, I know you guys have been optimistic about the amount of customers you're going to win back.

Do you have some expectation there that you could share with us in terms of what you think you'll get back in 2013?

Well, you know, we don't want to get in the game of predicting the future because it's impossible to fully predict.

We've got a lot of history of being out of networks in the past.

We've had some Express customers come back over the past few months.

We have a variety of data points.

I think that as Greg said we are pretty confident that a significant number of them came to us in the first place because they preferred our format, our location, our service, our relationships.

So that is the reason I think that we are going to see a significant number of them come back.

Initially, you have seen, obviously, a lot of players doing very aggressive promotional things to try to maintain them, but we are still seeing good customer flowback.

But at the end of the day the reality is you can't promote forever, too.

People will ultimately choose the pharmacy that is the best choice for them broadly.

I think it's great he talked about the three buckets and sort of a time flow through that of as the ones that come first, but that others over time also chose you for a reason.

I think that we are going to continue to win back customers not only in the short term, but over many long periods of time.

[This] is a very long tail wind, quite frankly.

Ed, that's the reason we think it's important to really focus on the comps, as I said, because not only obviously is the ESI customers returns going to impact our comp but there is a lot of moving parts.

Folks are moving from one plan to another and certainly we will be picking up the business there.

But also, and I really want to emphasize this, in addition to trying to work through it and reach an acceptable agreement with Express Scripts, which we are glad we did and met our core principles, we were out working all year long with all of our other partners to build relationships to grow our share there.

And, frankly, we feel very good without how we are positioned in the total marketplace to grow our total comp.

And I assume that the more scripts you get the higher the incremental margin on those scripts are going to be?

Obviously there is some upfront spending on advertising and I've seen some other stuff you are doing in the marketplace.

So can you give us some sense as to what percentage of that business you have to win back before you breakeven to start, and then start moving into the black?

Well, I would say this.

I would just say that some of the estimates on the upside I have seen are wildly and grossly exaggerated when you give the actual math of what it costs in promotional spend.

And I think the reality is that, for the most part, it is incremental profit almost from the get-go.

Yes, there is some marketing spend, but the reality is when you understand how it's executed and how the mix works, each script brings incremental value.

So again, I think there are some numbers out there which maybe don't fully contemplate how the spending actually works.

Okay.

And just last question for you on gross margin.

I actually thought that it would have been a little better this quarter because generics did ramp and you mentioned your comparison being easier.

I guess my question is what are we learning about the generic wave so far?

Then how should we think abound the [FIFO] gross margin over the next couple of quarters as the waves continues to grow?

Is there still upside to do better from here over the next couple of quarters?

Yes, good question.

I would say that kind of year on year our gross profit dollars per (inaudible) is what we really look at; we are basically roughly similar.

We had some benefit from generics.

We had a little offset from some overall -- we had very high 90-day growth, which is overall net gross profit dollar to the positive and a good payout, but a little bit lower there for the benefit we provide.

And then some other general compression and a little bit of year-on-year vendor mix.

But I think we feel that our rates are fundamentally very solid.

I don't think we have ever felt that we have had a commercial book that is stable across the players and has good, solid, long-term relationships.

With respect to the generic wave, we will continue to benefit throughout fiscal 2013.

But one thing we have also done through many of our contracts is we have really worked hard to, I guess, I would say put in kind of constructs that allow us to get good rates.

Not just through generic waves, but beyond thereafter.

So versus having a very volatile and riding the ups and downs as heavily, I think that we have put in what I would call good sustainability into our rate structure.

And that is what I think you're going to see for a long period to come.

And that, Ed, we think makes sense for the long term.

So to re-emphasize what Wade is saying, we think that setting ourselves up so that we have predictable, sustainable reimbursements with our generics over the life of relationship versus the high volatility we may get the first six months and then not having control of predictability throughout the life of the contract absolutely makes sense for us long-term.

We also -- I would add as well that we also worked with a few of our key partners and made some minor market adjustments to help them be competitive in the marketplace.

And, therefore, also put us in a preferred position with them to help win business.

Thank you.

Mark Wiltamuth, Morgan Stanley.

So the question on the generic drug, maybe for Kermit, do we still have the peak of the profit period ahead of us on generics?

And when do you think we start to roll off of the very strong margin period from this wave of generics we're in right now?

Well, Mark, we are certainly at the peak of the generic wave in 2013 as we look at our fiscal year, and we will begin to roll off as we get more into 2014.

But certainly with the Lipitor, Plavix, Seroquel, Lexapro, we are right in the peak of that generic wave right now and 2013 will be one of our better years.

Okay.

And for Wade, just a little more follow-up on the UK cuts there on reimbursement rates.

Is there some concern that this could filter across to the wholesale business for Alliance as well as time progresses?

With all the governments under fiscal pressure, wouldn't there be some risk of those reimbursement rates coming down kind of across Europe?

Well, look, the austerity in Europe in healthcare and single-payer system is nothing that is new.

I think that the dynamics there and the reason the business performs very solidly there and we believe will continue to do so are many.

One is they run a very good business, very differentiated in terms of how they work with not only their customers but also with their suppliers.

And so you see that in various agreements that are exclusive or preferred.

But separately, what you have seen across Europe and will continue to see is more and more governments pushing for more generics versus brands as a key lever to save money.

In southern Europe, script -- generic [representation] is only 30%; in Northern Europe it's at 50%.

So they can make, as a wholesaler as well as retailer, as a wholesaler can make better penny profit on generics which can save governments money and is good for them.

It is only -- the wholesale chain, because there is so many independents, is a vital part of the ecosystem of healthcare in Europe.

You have to have wholesalers and pharmacies are very valued, but they play a very vital role in distributing and serving them.

Secondly, you are going to see that apart from that, continue to see more pharma companies to save money as they get pressure from the governments.

They are actually outsourcing more and more activities to the healthcare distributors like Alliance, and that is allowing them to really ladder up and value up, because they can do things that are more cost effectively for Big Pharma.

And so that is another win.

Then, finally, the European wholesale market is not as consolidated as it is in North America.

There is lots of smaller players; [it's also some] of the tougher economies.

They are just having a harder time funding, keeping standards up and service levels, whatever, and that gives Alliances an opportunity to continue to grow and continue to capture share.

So I think the dynamics, again, this is not new to Europe, but the dynamics actually in the wholesale business being a vital part of the ecosystem and being such a low-margin business, actually has a lot of good momentum from this as well.

Okay.

And, Greg, just a little more color on that third bucket.

It sounds like it's going to be a little harder to get those people to switch back.

You had alluded to some plan changes and some other factors there.

What other things could we look for to kind of win back that third group that is difficult to transfer back?

Well, it's, Mark, I think probably time, but also as far as the plans, there will be some plans that have changed and are going to another plan that will pick up after the first of the year.

Absolutely we think that is the smallest bucket of the three, and that is where you have to balance -- we have to balance what makes sense from a return on investment on the marketing dollars that we want to spend and how big that bucket is.

So we think obviously bucket one is the largest.

We have had people -- we have had patients out there that have been coming back to our stores almost weekly to ask have we settled?

We had -- they were the ones that have come in the first couple weeks and will continue to come in.

Bucket two, we think, is probably where we should spend our money intelligently.

And then that third bucket, as I said, I think it is the smallest of the three and then we just have to really decide how much we want to spend there.

Sort of the way I see bucket three is those people may have gone to another pharmacy where, for whatever reason, it was more convenient for them or a better format or a better relationship, and so they may make that choice.

But there is a huge universe out there of 80% of the population that may be going somewhere else, be it the Express Scripts that are other places, that may find that we are a better choice for them.

So I think what we need to do is be pragmatic about which of these customers are the right return to get.

But I think that where we are going with all the other initiatives that we would be myopic to only focus on that versus the larger universe of patients that we can go after.

Mark, let me add.

We have a good communication plan in place to make these patients aware.

We have direct mail, direct communication within our stores, our $25 transfer program.

It is on our reader boards within our stores, and through both our mobile and our regular process transferring a prescription back is a very easy process.

Patients -- this is really easy for patients to transfer their prescriptions back, either through our mobile app or to come in our stores and talk to their trusted pharmacist.

Okay, thank you.

Scott Mushkin, Jefferies & Company.

Hey, guys.

Thanks for taking my questions.

So I wanted to get into the working capital, Wade, a little bit.

Just it looks like it was a pretty big benefit to your cash flows and just trying to understand will some of this reverse next year?

Looks like it was, for the fiscal year, over $700 million in the plus column for cash flow from ops.

You normally would use a little there.

Not every year, but you do tend to use, and I was wondering if you could kind of give us some flavor on how repeatable that is.

Well, some of the inventory will come back, but I would say the bulk of our inventory was actually real sustainable progress that we put into our business.

So some inventory will certainly come back as the customers come back.

But we are, I guess the 30,000 (inaudible) that we are very focused on not only on earnings that also on cash.

And that is one of the reasons that we wanted to give supplemental information on adjusted earnings because we really, in some regard, are a very strong cash, cash EPS type company.

And so, again, I think that you are going to see us continue to be very focused on cash, receivables, and payables over time.

Tend to more follow the business in sales, without major adjustment in terms.

But I think with respect to inventory, not only from a cash perspective, but just as the team really works on providing the rise in stocks, so call it service and better quality with lower cost of capital employed, we believe that we're doing things structurally that over time will help us continue that journey.

Scott, I would add that we have very efficient systems and you saw the efficiency when we took this product out.

We don't expect excess inventory coming back as we begin to replenish based on volume.

We know specifically where this volume is and we will be able to replenish accordingly.

So you think you'll be a user of working cap next year?

Well, what I would say is -- we're not going to give guidance on it per se, but I would say that improvements like inventory and things, when you adjust out the additional customers from Express Scripts, etc., we would assume that we will continue to make improvements.

Perfect, thank you.

Second question has to do with Express.

I'm just trying to understand a little bit about how many of the 90 million scripts you actually think you have an opportunity to get back at.

In other words, we have seen TRICARE go one way.

We have seen WellPoint go another, which is helpful to you.

Do you have an idea of those 90 million scripts how many you actually will have an opportunity to bring back?

Yes, I would say that outside the DOD, without giving exact percentage, almost all, right, percentagewise.

So we believe there is a big opportunity ahead of us and, again, we will see at what pace and frequency we go.

So I think $65 million is a good -- almost all that would -- DOD is there, maybe there was a few tag ins.

Do you think $65 million is a decent estimate?

Look, I'm not going to give an exact number, but your math is probably not too far off.

Okay, perfect.

Then the second -- the third question I have -- well, I've lots of questions, but the third one I guess I will ask is just regarding guidance.

There is none.

Also, visibility into Alliance Boots.

Clearly we have, as analysts, just a tremendous amount to try to take a look at here and this UK thing I think, obviously, took some people by surprise.

Are you guys going to get the Alliance Boots team to talk every quarter?

How do we look at this as analysts where we own 45% of this business, but there is really almost no visibility into what is going on with that business?

Then vis-a-vis guidance, is there any thought process of providing at least a little direction here?

It sounds like you think people are off quite a bit in how they are thinking about the incremental scripts.

I didn't exactly understand exactly what you said, Wade.

But how do you view this and what are you going to do for the investment community to provide a little clarity as the Company has gotten, obviously, very big, very dispersed and there is a lot of moving parts?

And then I'm done, thanks.

First off, we have to keep in mind that Alliance Boots is a private Company and it is an equity investment, so we don't have a controlling position and we need to respect that.

I think that next quarter you will be getting a lot more information.

You will be able to see their numbers.

We will certainly have some history for you and we will have some meaningful commentary, I am sure, on the state of the business.

But I also do want to also just -- again, it is not a controlling entity and it is private.

But I think as you see the numbers flow through next quarter, again, the history of the commentary, things we have that will help to provide perspective.

We certainly have their last annual report, which I think is very comprehensive and detailed, and the world hasn't changed dramatically from that time.

You also have our most recent pro forma with our debt offering which I think gives additional financial color.

Scott, we certainly understand the complexity of it, and I think it's one of the reasons we tried to give both a GAAP and a little more clarity with an adjusted number on this call.

We'll continue to do that, as we said.

I also think our monthly comps and everything that we are trying to provide.

We understand the complexity of it and we will try to give as much at week as we can, but at the same time, as Wade said, they are a private company and we have to respect that as well.

With respect to the -- with respect to your question on the ESI winback, again I think it's going to be what it's going to be.

We are off to a good start, but it's just the beginning, so we will see how time goes by.

I think it is probably even impossible for us to perfectly predict, because there is lots of moving parts.

And I think another big important part of the question is the preferred partnerships.

We work with many others; what happens in that dynamic.

And at the end of the day it's all going to funnel into one overall comp number, regardless of where it comes from.

All right, guys.

Thanks very much.

What it's worth I think it would probably help your P/E a little bit if you gave a little bit more, so numbers weren't all over the place.

Anyway, thank you.

John Heinbockel, Guggenheim Securities.

Hey, guys, couple things.

I assume in the monthly releases we get here for the next year you will disclose the Express impact on script count; that that will continue.

John, that is what I meant in the call.

We are not going to disclose that.

That is highly -- that is competitively sensitive information, as I am sure you understand.

And, frankly, in addition to that, which is, frankly, the most important reason -- in addition to that it doesn't really show the entire picture with all the moving parts and plan changes and so forth, as well as the opportunity to grow total share across the entire book of business.

That is what we're focused on.

That is what this team is challenged to do is grow our total share.

But the main reason is that is just information that we don't think we want to give for competitive reasons.

So it will be difficult for us to really track the recovery rate, right?

Well, what we would rather -- John, what I would really rather you focus on, everybody focus on, exactly what we're focused on, is our total comp growth.

Because for us to just focus on one plan versus the entire market you wouldn't want us doing that.

I think the comp actually gives a cleaner -- leaping back into a cleaner estimate of the progress we are making with them and others.

So on that, if I look at the buckets you talked about -- tell me if this is wrong.

So you would think that -- and I recognize September is a partial month -- that October we would see a step up in script count sequentially, obviously get less negative?

Would we then see, do you think we then see another one in January?

When you think about that second bucket that takes time and maybe people need to get literature for their new plan year.

Do you think that's the way it plays out, or it's more gradual than that?

I think you are going to see -- I think personally, and you never know, but my opinion is that you are going to see us kind of increase our comp, obviously, for at least two weeks.

Then you have the full October and it's going to kind of -- if there was going to be some slope of a line.

When you get to January you will have a step up and then you will have a slope and a step up.

Okay.

In that second bucket, when do you think -- based on what you just said, do you think it is then, I don't know, early next year where you can truly gauge how much of that you are getting back?

And if you are not getting back what you want make an adjustment, or are you think you get a read on that sooner than early next year?

Yes, as I said, I think three to four months we're going to have a pretty good gauge as to what is in all three of those buckets.

Certainly we are not going to wait for three to four months to begin to contact and go after whoever may be in each of those three.

Again, we will just make sure that we go at it intelligently.

The great thing is the timing of our Balance Rewards loyalty launch allows us to even more strategically approach and talk to these folks.

So we are going to -- we are no more than three or four months, but certainly we are not going to wait for three or four months to determine what our next step is.

All right, and then just on Balance Rewards, so two things.

Do you think that -- is that likely to impact front-end more than script count, or the other way around?

And what do you think the trajectory on that is in terms of the education process?

Is that a more -- I would think that is going to be a more gradual -- even though have you signed 12 million people up, they got to figure out the program.

A more gradual trajectory or no?

We think -- first of all, the first question.

We think it impacts both pharmacy and the front-end, and that is the way we designed it.

But not one more than the other?

Pardon?

Not one more than the other?

I think we really want to kind of focus on both.

Okay.

And then as far as the gradual, we feel very good getting out of the gate early, in 12 days being ahead of our forecast with a really nearly 12 million signed up.

I think we are going to see a pretty vertical line here.

We feel pretty good with the momentum we have right now.

Yes, John, I would say -- just to capitalize on what Greg said -- in the pilots we did we saw that we were able to basically move the needle in both.

Again, it is a balanced program which is linked to well, and it is hopefully a motive beyond just discounts.

But we did see that.

I do think if you look by any other benchmark of enrollment what we have been able to do in a short period of time is multiples beyond any other program enrollment I have seen.

And I think that speaks to the enthusiasm people have for what we have deployed.

Okay, thanks.

I would now like to turn the conference back over to Mr. Rick Hans for any closing remarks.

Ladies and gentlemen, that was our final question.

Thank you for joining us today.

As a reminder, the Company will report September sales on October 3 and we will report first-quarter 2013 results on Friday, December 21.

Also pleased to announce we will host our next investor day in London on February 13 followed by a field trip to Alliance Boots headquarters and other facilities in Nottingham on February 14.

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

Ladies and gentlemen, that does conclude today's conference.

You may all disconnect and have a wonderful day.