沃博聯公司 (WBA) 2013 Q1 法說會逐字稿

Good day, ladies and gentlemen and welcome to the Walgreen first quarter 2013 earnings conference call.

At this time, all participants are in a listen-only mode.

Later, we'll conduct a question-and-answer session and instructions will follow at that time.

(Operator Instructions)

As a reminder, this conference is being recorded.

I will now turn the call over to your host, Rick Hans.

Please go ahead.

Thank you, Stephanie.

Good morning, everyone.

Welcome to our first quarter conference call.

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

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

As a reminder, today's presentation includes certain non-GAAP financial measures.

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

Certain statements and projections of future results made in this presentation constitute forward-looking statements that are 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 Acts filings for a discussion of risk factors as they relate to forward-looking statements.

Now I'll turn the call over to Greg.

Thank you, Rick.

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

Today, I'll begin with a review of our results for the quarter; second, I'll discuss key indicators that show strengthening in our underlying business.

Finally, I'll provide an update on our direction and progress on our three key strategic growth drivers -- delivering the Well Experience, transforming community pharmacy, and creating an unprecedented global platform through our Alliance Boots partnership.

After that, I'll turn the call over to Wade for a more detailed review of our performance this quarter and key considerations for the rest of fiscal 2013.

Turning to our overall financial results, in many respects, this quarter was a turning point for us.

To look at our business on an apples-to-apples basis, we have a number of non-operational items to discuss with you this quarter, the most significant of which is the reporting of results from our investment in Alliance Boots on a one-quarter reporting lag, rather than a one-month lag period.

While Wade will take you through these accounting impacts in detail later in the call, we want to underscore that we're seeing a strengthening of our core business.

First, the increasing pace of return of Express Scripts customers as reflected in the substantial upswing in our comp scripts.

Second, the improvement in our gross profit margins in the first quarter versus a year ago, primarily due to the impact of generics.

Third, the significant progress we're making on a number of key initiatives, including our Balance Rewards loyalty program, our flu shot program and other vaccinations, and the increased penetration of private brands.

Finally, we are pleased with the business performance of our strategic partner, Alliance Boots, and are also on track to meet our first-year synergy targets with them.

As we initiated last quarter, we'll present our results on both a GAAP and non-GAAP basis.

You saw in our release this morning, we reported first-quarter sales of $17.3 billion, down 4.6% from $18.2 billion a year ago.

GAAP operating income, or EBIT for the quarter, was $705 million, down 21.7% compared to $900 million at the same time last year.

Adjusted operating income, or EBIT for the quarter, was $924 million, down 8.1% from just over $1 billion in first quarter 2012.

GAAP net earnings for the quarter were $413 million, or $0.43 per diluted share, compared to $554 million, or $0.63 per diluted share last year.

Adjusted net earnings for the quarter were $553 million, or $0.58 per diluted share, compared to adjusted net earnings of $619 million, or $0.71 per diluted share, in the same quarter last year.

One final note, as you saw this morning, we are adopting a one-quarter reporting lag for investment in Alliance Boots, which resulted in dilution of $0.07 to adjusted EPS in the first quarter, compared with an estimated accretion of $0.03 to adjusted EPS had we used the previously announced one-month lag.

This is intended to align the audit requirements for the investment and more efficiently address regulatory and audit considerations.

This does not affect the underlying equity income and synergies we anticipate in the first 12 months since August 2, 2012, when we completed our initial 45% investment in Alliance Boots.

But it does impact the quarterly and fiscal year timing in which we report the equity income and a portion of the synergies.

In the first quarter, on a GAAP basis, our gross profit dollar growth was down a 0.10%, or $5 million from a year ago.

SG&A dollar growth increased $194 million, or 4.6%, compared to a year ago.

Gross profit dollar growth, after adjusting for the LIFO provision, increased $5 million year over year.

This was a $187 million improvement from the previous quarter.

SG&A dollar growth was up $104 million, or 2.5%, after adjusting for costs related to the USA Drug acquisition and Hurricane Sandy.

To give you a sense of the impact of the hurricane on our operations, at the peak of the storm, 750 of our drug stores in nearly 15 states experienced service interruptions.

As a result of the incredible efforts of our employees who worked non-stop, despite hardships of their own, within a week, the vast majority of those stores were open and serving our customers.

I want to thank all of our employees in the affected states for their tremendous dedication to our customers, Walgreens and to each other.

Now, because we are self-insured, we recorded $30 million of expense this quarter for charges related to Hurricane Sandy, which primarily included inventory write-downs and the closure of two stores.

Additionally, we made meaningful investments in staffing and marketing to support our Balance Rewards launch, Express Scripts win-back and Medicare Part D annual enrollment support.

As a result, we narrowed the gap in the quarter between our adjusted gross profit dollar growth and adjusted SG&A dollar growth by $22 million over the previous quarter.

With these results, we showed improvement in several key areas of our business during the quarter.

First, we saw an increase in comparable scripts of 320 basis points relative to the previous quarter and have continued to see meaningful progress so far in December.

Second, gross profit margins improved by 130 basis points compared to the year-ago quarter.

Third, front-end margins remained firm year over year, even as we invested in our Balance Rewards loyalty program.

Fourth, we saw a year over year increase in our gross profit dollar growth in our pharmacy business for the first time since leaving the Express Scripts network on January 1. Finally, as I mentioned, we saw the gap between gross profit dollar growth and SG&A dollar growth narrow in the quarter.

We believe all these indicators show the strength of underlying business as we begin the new calendar year.

In the past 3.5 years, as you know, we've undertaken one of the most significant strategic and operational transformations in our Company's history.

Today, we have in place three major strategic growth drivers that we believe position our Company for long-term growth and value creation.

First, we are delivering the complete Well Experience by transforming the customer experience across all of our touchpoints, channels and formats.

Our second growth driver is transforming the role a community pharmacy plays in healthcare, by offering unparalleled access to innovative, high-quality, affordable health and wellness services within our communities.

Third, we're creating an unprecedented global platform, becoming the first global pharmacy-led health and wellbeing enterprise through our strategic partnership with Alliance Boots.

Through the quarter, we continued to take meaningful steps to advance each of these strategic growth drivers.

Let me give you some of those highlights.

As we roll out Well Experience, we're stepping out of the traditional drugstore format, giving the customer a whole new experience from leading-edge design, enhanced assortment and multi-channel options all intended to maximize customer delight.

We're pleased with the performance in these stores and the response we're getting from customers.

In fact, in our Chicago and Indianapolis stores, customer delight, the metric we use to determine satisfaction, is running above our expectations and goals in the most recent monthly survey.

We now have more than 400 Well Experience stores in communities around the country as we brought the new format into Arizona and Florida.

In addition, we opened our newest flagship stores this quarter in the Bucktown neighborhood of Chicago and on Sunset and Vine in Hollywood, California, our 8,000th store.

We also build on the momentum of our loyalty program launch.

Through three months, we're extremely pleased with our progress.

We now have a new kind of currency in place that will help drive our front-end business.

To date, more than 45 million people have signed up for Balance Rewards and nearly 60% of daily living sales are on the card.

Millions of members have collected enough points to treat themselves for free rewards and more than 2.5 million people have already redeemed points.

Finally, nearly 80% of members surveyed have told us they're delighted with the simplicity of the program, how easy it is to sign up, and use in stores, online and with their mobile phones.

We also continue to expand our product offerings across all of our stores with expanded grocery items and fresh food selections.

We've enhanced our beauty departments with an array of niche and prestige brands, not found in traditional drug stores.

We continue to roll out upscale-look boutiques in specific markets across the country.

We're also seeing significant momentum in our private brands.

We've invested heavily in our own brands including Walgreens, Delish, Nice!, and many more and year over year, private brand penetration in our front-end sales improved 200 basis points to 22%.

In my 32 years, I've never seen our store managers as excited as they are now about our private brand offering.

Turning to our second growth driver, transforming the role a community pharmacy plays in healthcare, we continue to focus on bringing convenient, affordable healthcare solutions to our communities across the country.

As you know, a solid proof point that America values the additional services offered by a community pharmacy has been our industry-leading flu shot program.

Through the end of the quarter, we provided more than 5 million flu shots, exceeding last year's level with strong demand to date in December.

We are right in the midst of this year's cough and cold flu season and the Centers for Disease Control is projecting the worst flu season in 10 years.

We're moving beyond flu shots into adult, child and travel vaccinations and are very pleased with our performance, as we posted a year over year improvement in the first quarter of more than 100%.

While we participate in almost all Medicare Part D plans, we were better positioned for this year's open enrollment period, which ended last week because Walgreens has been chosen as a preferred provider for three of the top five Medicare Part D health plans -- UnitedHealth, Humana, and Coventry.

These preferred arrangements help seniors with, who are our existing Medicare patients, with lower co-pays, and give patients who transfer their prescriptions to Walgreens the same opportunities to lower their medication costs.

As we grow our core business, we also look for opportunities to participate in industry consolidation and file-bys to transform the role we play in healthcare.

In the quarter, we announced the purchase of a significant ownership stake in the parent Company of Cystic Fibrosis Services, a specialty pharmacy that provides medications and treatment support for the cystic fibrosis community.

We also continue to co-locate our Take Care Nurse Practitioners, together with our pharmacy teams in many of our stores, to expand our services even further to acute and primary care, healthcare screenings, and beyond.

As I've shown, our comparable prescriptions are up 320 basis points this quarter compared to the previous quarter.

This upswing continued a trend that began in mid-September when we, once again, began participating in Express Scripts retail pharmacy network.

We believe this chart validates that customers value our convenience, service and the pharmacists they've known and trusted as we've been gaining momentum on our script comp month after month.

As expected, customers are returning to Walgreens from every competitor.

We are winning customers back from different competitors at about the same ratio that they left last year.

That says to us that having a choice of pharmacy does matter.

When customers have a choice, many of them are selecting Walgreens.

That leads to our third strategic growth driver, creating an unprecedented global platform through our strategic partnership with Alliance Boots.

We're making steady progress in executing this partnership.

We realigned our organization to accelerate our strategies and support our partnership with Alliance Boots.

Both Companies were successful in completing the important financing transactions.

We closed a $4 billion public debt offering, getting attractive rates across all of our maturities.

Alliance Boots recently completed a highly successful amend-and-extend transaction of its current debt portfolio, which significantly increases future flexibility.

Both transactions reflect the strong support from public and private debt markets.

In this quarter, we also closed on the establishment of a new joint venture Company, Walgreens-Boots Alliance development, based in Berne, Switzerland, with key talent in place.

In addition, we've established the synergy streams and have begun to see results, putting us on track to meet our first-year synergy targets.

Currently, six teams of employees from both Companies are hard at work to capture the revenue and savings opportunities we've committed to, exploring opportunities in procurement, merchandising, and the sharing of best practices across our networks.

As part of that effort, our merchandising team added the popular Boots' No.

7 to our beauty product line, debuting it at our Hollywood flagship opening with very good, early results.

We look forward to sharing more details with all of you at our Analyst Day in mid-February in London.

In closing, as I said when I began this morning, 3.5 years ago, we launched an unprecedented strategic and operational transformation of Walgreens.

Today, we have the wind at our backs as we head into a new calendar year.

Customers from plans and Express Scripts network are returning to our pharmacies.

We have successfully launched our Balance Rewards program with 45 million people signed up.

We've executed our promotion strategy to balance our approach to driving sales and margin.

We now have more than 400 Well Experience stores, bringing a new experience to our customers with our flagships providing a halo effect in the major markets across the country.

Our reinvigorated private brands, led by Nice!

and Delish, are creating brand loyalty and increasing margins for our daily living business.

We continue to lead industry consolidation with strategic acquisitions from Duane Reade and Drugstore.com to USA Drug and the assets of BioScrip.

We are positioned to become the first global pharmacy-led health and wellbeing enterprise with a supply chain unmatched in the industry.

With Walgreens and Alliance Boots, we are bringing together two iconic brands to create something new and unique in the industry that will be difficult, if not impossible, to match.

So finally, I want to thank our 240,000 employees who worked hard this year and helped position us for a very exciting future.

Thank you.

Happy holidays.

Let me turn the call over to Wade.

Thank you, Greg.

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

This morning, I'll take you through our quarterly results, as well as update you on our investment in Alliance Boots.

As Greg noted earlier, for the quarter, we reported a GAAP EPS of $0.43 per diluted share, based on 951 million shares.

Recall last quarter, we began reporting results on adjusted basis in addition to a GAAP basis.

This chart illustrates the walk to adjusted EPS for the quarter.

The LIFO provision was $0.04 per share; acquisition-related amortization was $0.06 per share.

Finally, the special items totaling $0.05 per share, with $0.03 related to Hurricane Sandy and $0.02 related to the USA Drug acquisition and subsequent closure of some overlapping stores.

Some of these yield an adjusted EPS of $0.58 per diluted share for the quarter.

As Greg mentioned, we have decided to move to a one-quarter accounting lag for the Alliance Boots investment.

The adjusted EPS of $0.58 per share reflects $0.07 of dilution related to the Alliance Boots investment compared to what would have been an estimated adjusted EPS accretion of $0.03 in the quarter had we reported using our previously announced one-month lag.

The dilution, driven by the one-quarter lag versus a one-month lag occurs, because we incurred three months of interest expense and three months of share dilution.

But we only record equity income for the single month of August, which is also, typically, one of Alliance Boots' weakest months in what is a fairly seasonal business.

Before I get into full details of Walgreens' core business, let me take a minute to first give you a deeper explanation of why we adopted a one-quarter lag for Alliance Boots and review the reporting calendar to give you a clearer picture of the impact of the lag reporting and what you can expect going forward.

After much thoughtful consideration, the reason we made the decision to have a one-quarter lag is we believe that this is the most practical way to meet the various and complicated regulatory, audit and business concerns.

While this does delay some visibility into the Alliance Boots' business, and understandably, you are seeking that, one benefit would be that investors will ultimately have a comparable quarterly actual period with Alliance Boots on a lag basis.

I realize that, based upon our previous disclosure, you came into the meeting today, assuming we would report on a one-month lag basis.

Therefore, it is important that we give you more perspective on the change and its impact.

With a one-month lag, we would have reported equity income for the months of August, September and October in the quarter, whereas with the one-quarter lag, we only report equity income for August.

As mentioned, under both scenarios, the quarter reflects three months of a diluted effect of incremental shares and debt interest associated with the transaction.

This means that in our fiscal second quarter, we will report equity income from Alliance Boots for the months of September, October, and November.

It is important to note that this accounting change does not, in any way, alter the underlying performance of their business, which is performing in line with our expectations.

During our upcoming Analyst Day in London on February 13, we intend to go into much more detail on Alliance Boots, how to think about the strategies and performance of each of their businesses, and give you detail as to what you can expect with respect to ongoing reporting metrics.

Along that line of thinking, we have included in the Appendix a reconciliation of the $4 million of equity GAAP income we recognized in the quarter.

It's important to note that for the month of August, Alliance Boots had net income of $52 million in US Dollar terms under IFRS.

But multiple IFRS to US GAAP conversion items as well as intangible asset amortization and deal-related inventory step-up, which is transitionable by nature, take that to $4 million.

What this means, with respect to our revised accretion expectations, is outlined in this chart.

As discussed earlier, we had $0.07 of adjusted dilution during our first quarter.

In the second quarter, we expect to have adjusted accretion of $0.04 to $0.06 per diluted share.

In the third quarter, we expect adjusted accretion of $0.12 to $0.13 per diluted share.

The higher accretion in the third quarter is due to the fact that we will be reporting the expected equity income for the months of December, January and February for Alliance Boots, which are typically very strong months, given the holiday seasonality.

In the fourth quarter, we expect adjusted accretion of $0.09 to $0.10 per diluted share.

For the fiscal year, we expect the new adjusted accretion to be $0.18 to $0.22, which means we expect accretion of $0.25 to $0.29 over the balance of the fiscal year.

It may be helpful to reconcile these new adjusted accretion numbers with respect to our original fiscal year '13 accretion estimates of $0.23 to $0.27.

At the time of the announcement, we noted that the 45% periodic Alliance Boots income available to equity holders was subject to GAAP adjustments, foreign exchange translations, and basis difference amortization.

Our current estimate of the IFRS to GAAP adjustments for fiscal year 2013 are a negative $0.06, foreign exchange translations are zero, and the amortization add-back is $0.11.

As outlined, adopting a one-quarter lag had a negative $0.10 impact in the first quarter and the fiscal year relative to a one-month lag, yielding a new adjusted fiscal year '13 accretion range of $0.18 to $0.22.

Again, these estimates do not include amortization expense or one-time transaction costs and reflect the Company's current estimates of IFRS to GAAP conversion and foreign exchange translations.

All estimates assume no M&A or strategic transactions.

We are anticipating that in the remaining three quarters of fiscal year 2013, we will have approximately $0.04 of special items associated with the transaction, such as advisory fees, fees associated with legal entity establishment, expatriate moves and fee dedicated resources.

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

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

Comparable prescription sales decreased 11.3%, comparable front-end sales decreased 2%, and total comp sales decreased 8%.

Comparable prescriptions filled decreased 4.8%, noting that comp prescription sales were down to a much greater degree, primarily due to the increased introductions of new generics.

This slide illustrates the impact on comparable store script numbers for the previous three quarters when we were not part of Express Scripts network versus the prior year.

The comp store scripts were down 4.8% in the first quarter, which was a sequential improvement of 320 basis points over the fourth quarter of fiscal year 2012, which was down 8%.

This reflects our continued progress on winning back Express Scripts customers.

Moving to our front end, traffic in the quarter decreased by 4.2% while basket size increased by 2.2%, and the front-end comp decreased by 2%.

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

We achieved stable margins in a very promotional environment.

We will continue to work to strike the right optimal balance between sales and profitable growth, especially as our Balance Rewards loyalty program and membership starts to hit critical mass and creates a whole new lever to help find an optimal balance between loyal customer sales and margins.

Turning to margin, our FIFO gross margin was 29.8% in the current quarter compared to 28.4% last year, a 140 basis point improvement.

Pharmacy margins increased as a result of the introduction of new generics and the increase was partially offset by reimbursement in specialty pharmacy mix.

The front end was positively impacted by OTC drug, personal care, convenience and fresh food categories offset by loyalty investments and e-commerce mix which is a solid contributor to gross profit dollars but at a lower margin than the balance of the business.

Taking a look at our longer term gross margin trends, it's important to note that this quarter's 140 basis point improvement was against a 40 basis point decrease a year ago.

While the front end margin was flat, it also reflects the fact that the Company made meaningful investments in the Balance Rewards program.

This slide illustrates our two-year stacked SG&A dollar growth trends on a GAAP basis for the last nine quarters.

The next slide shows the trends on adjusted basis.

Two-year stacked adjusted SG&A trends improved versus a year ago, with 7.4% growth in the first quarter of 2013, down from 11.7% last year.

To get to adjusted SG&A dollar growth, you could see that our reported SG&A dollar growth of 4.6% included -- 30 basis points of Walgreens amortization; 30 basis points of Alliance Boots one-time costs; 90 basis points of Hurricane Sandy costs; and 60 basis points from the USA Drug transaction expense, primarily inventory and store write-offs.

This resulted in an adjusted SG&A dollar growth of 2.5%.

This SG&A dollar growth rate includes -- 60 basis points of non-comp operating expense for the USA Drug, and 90 basis points of expense related to staffing and marketing to win back Express Scripts customers, sign up new Balance Rewards members, and to help enroll seniors in Medicare Part D programs.

This next slide illustrates our quarterly gross profit dollar growth trends for the past nine quarters on a GAAP basis.

It shows the trends on adjusted basis.

Here, the adjusted gross profit dollar growth increased from a negative 3.2% in the fourth quarter of 2012 to a positive 0.1% in the first quarter of 2013.

The trend in adjusted gross profit dollar growth data shows the benefit of returning Express Scripts customers, combined with an increase in the mix of generic drugs, which we believe is a good indicator of the underlying momentum in our business.

Following the same construct, this slide shows the SG&A dollar growth trends for the past nine quarters on a GAAP basis.

The next slide shows this on an adjusted basis.

As I discussed in the SG&A walk earlier, the adjusted SG&A dollar growth for the quarter was 2.5%, an increase from the roughly negative 1% to negative 2% adjusted SG&A dollar growth in the second half of fiscal 2012, but still lower than our SG&A dollar growth in the first half of 2012.

Again, as I mentioned, we have several strategic initiatives and investments in SG&A in the quarter.

We believe that this will pay off nicely as we move forward.

Focusing on our income statement for a moment, this quarter included a LIFO provision of $55 million versus $45 million a year ago.

Our effective LIFO rate for the year was 2.5%, up from 2% a year ago.

Net interest expense was $37 million, including the impact of the Alliance Boots acquisition, up from $17 million a year ago.

Our effective tax rate was 38.2%, versus 37.2% last year, primarily due to discrete items and a one-time state rate true-up.

Average diluted shares outstanding were 951 million shares versus 885 million shares last year.

This change is due to a combination of share repurchases in the interim as well as the impact of the 83.4 million shares issued due to the Alliance Boots investment.

Going forward, we will expect our share count to be about 950 million shares on a diluted basis.

Cash and cash equivalents were $1.8 billion at November 30, versus $1.1 billion a year ago.

Overall working capital decreased by 12.8% versus a year ago.

Accounts receivable decreased by 12.5%, while accounts payable increased nearly 1%.

Inventories were down year over year but have increased sequentially as we added back pharmacy inventory due to returning customers.

Inventories were also impacted by USA Drug acquisition inventory and the inventory related to the timing of some front-end resets.

On inventory, total FIFO inventory decreased by 0.9% in the quarter versus a 4.6% decrease in total sales.

FIFO inventories decreased by 4% on a per store basis.

During the first quarter, we generated $601 million in cash from operations versus $809 million a year ago.

Free cash flow in the quarter was $265 million versus $390 million a year ago.

Changing cash is, in part, reflective of the inventory changes I mentioned which, again, were driven by many of the impacts outlined before.

Despite temporary working capital fluctuations, we are very focused on cash and feel that we will continue to show strong cash results over time.

Also keep in mind that we raised our dividend over 22% this year to $0.275 per share for the quarter.

Now let me transition to our fiscal year 2016 goals for the combined Walgreens-Alliance Boots business.

We continue to believe that this partnership will reward our stakeholders and as Greg said, will deliver significant synergies, enhance mutual capabilities, and change the strategic landscape in the US, Europe and other geographies around the world.

The business performance objectives are meeting our expectations and are on track to meet our first-year synergy targets as well.

Yet I remain highly confident in the strength of our two businesses as we set out to change the paradigm in our industry with a global pharmacy-led health and wellbeing platform that will meaningfully differentiate us and create significant value.

In that context, we affirm our combined set of goals for fiscal year 2016 of $130 billion of revenue; $9 billion to $9.5 billion of adjusted operating income, or $8.5 billion to $9 billion on a US GAAP basis; combined synergy goal of $1 billion with a fiscal year '13 target of $100 million to $150 million; $8 billion of operating cash flow; and a combined net debt of $11 billion or less.

In closing, we believe this quarter marks a key inflection point.

While it included some important reporting changes, the key takeaway is that our underlying business trends showed improvement.

We remain optimistic about our prospects for the rest of the fiscal year, aided by a significant tailwind as we begin cycling the anniversary of our Express Scripts network departure.

We are making progress across all of our key strategies and have embarked on a watershed journey with Alliance Boots.

With combined retail stores and distribution touchpoints in more than 180,000 in 26 countries, I believe we are well-positioned to lead our industry as the world's largest and the most innovative player in our space.

Together, we are well-positioned for growth and uniquely positioned to leverage our mutual capabilities and assets for our customers and suppliers.

We remain confident in our ability to execute with excellence and reward our stakeholders.

Now with that, I'll turn it back over to Rick.

Thank you, Wade.

That concludes our prepared remarks.

We are now ready to take your questions.

(Operator Instructions)

John Heinbockel from Guggenheim Securities.

So a couple of things.

Let me start.

Wade or Greg, is there any operational performance numbers you can share on Alliance Boots, whether it be topline growth, comps, EBIT growth, whatever for the last few months, just to get a sense of what the operational performance looks like?

Yes, John, I'll let Wade cover what he can with you.

Yes, what I would say is like I said, we're on track with respect to their business performance and also with respect to the synergies.

If I was to give some perspective on an IFRS basis, which is IFRS or non-audited, for the first four months August through November, their trading profit is exceeding 10% and underlying profit for the year is even better than that.

So that's, again, an IFRS basis but if you want color on those four months, in a tough European climate, they continue to perform very, very well.

Obviously, the southern countries are more challenging than Northern Europe but in aggregate, they're doing a very good job.

I think at Analyst Day, we'll be able to peel into their business to a much greater degree.

All right.

Then secondly, so help us put this into -- but it's really the same question.

If you think about Balance Rewards and then front-end traffic and ticket, do you think Balance Rewards, based on your pilot, that, that will move the dial on average basket size first?

Then when does it move the dial?

How many more months would you think before it moves the dial on basket size?

Then secondly, I assume you would think that's going to happen, so there is not a plan to become more promotional early in '13, if those numbers don't step up.

I guess you assume that they will, right?

John, good questions.

As I've said several times, the key to retail is trying to balance price and promotion in the right way.

We do think, obviously, with our strategic shift in promotional activity was due to having a Balance Rewards program that we knew we were going to be launching.

Certainly with our 45 million folks, we do believe, I would agree with you, I think we'll probably begin to see basket increase first.

I think with the way our program is designed, certainly as more and more people gain points as they are doing and then begin to redeem them on rewards, especially during this holiday season, I think we'll see momentum in that being recognized as a real currency.

That should indeed help drive sales next year as well as traffic.

Same time, the good thing as well as I pointed out, we're really driving our private brand penetration.

We're up 200 basis points, as I said.

The good thing there is that gives us some of the added margin that we can intelligently reinvest into the business if needed.

So we're going to continue to manage price and promotion intelligently and we think we have certainly the advantage of Balance Rewards as it catches on to help us.

Mark Miller from William Blair.

On the SG&A spend, can you provide a little more perspective about what has changed?

I think, with the trend down last year and then up 2% to 3%, excluding the one-time items you called out, I think you said around 90 basis points of investment, which would still have that up 1% to 2%.

So were there some expenses that kicked out of last year into this year or beyond those investments, what has changed here?

So I think if you look at longer trends, the one-year and then the two-year stacked trends, I think, actually, we feel pretty good.

Obviously, SG&A isn't something that you manage quarter to quarter.

You manage strategically.

Again, when you look at the -- not just adjusted but the comparable basis being up 1%, we felt pretty good about.

These investments we've made, in terms of loyalty sign-ups, in terms of Express Scripts win-back, and in terms of the Part D programs, in particular, where we are a preferred player, we believe are very, very good investments we can play off very nicely as we come into the new year.

On generics, in the past wave with Zocor and Zoloft.

I remember the Company had around 25% EPS growth and then past that exclusivity period, the earnings went flat.

Can you just tell us how the contracts have changed for you?

Are we going to see a similar type of step-down for Walgreens after this generic wave or how have you changed the contract structures?

We have obviously hundreds of contracts and they're all different.

But as a general rule of thumb, I think we've been very thoughtful about making sure that, in general, we're not going after feast or famine but sustainable profitability, which means on the front end, you might leave a little bit on the table.

But over a longer term, we think we have a very stable business with very strong margins.

So I think that's a general direction that we've had it.

Again, each contract is different but I think that we feel that not only through this generic wave but post the wave we're going to have a very solid business and very good margins we can work with.

Then related to that, Wade, the reimbursement you did indicate was down a little bit with reimbursement and specialty.

Was that negative impact in the quarter different materially than you had seen in prior quarters or should we (multiple speakers) in '13?

I would say reimbursement was negligible, really.

So in general, we had a good uptick from generics.

We do have some specialty mix.

Then we -- a little bit from 90-day but again, 90-day in aggregate is good incremental dollars for us and it's typically right on target.

With all these contracts that you've had and the negotiations, is there anything to call out in terms of potential changes going forward?

Thanks.

No, I think we feel like we're in a very good place.

I think we have as much stability in our commercial book as we've said that we felt for a long period of time.

We feel we're -- we have a good ecosystem.

We're being treated fairly by our payers and having them being treated fairly versus each other so I think we're in a good spot.

Okay, thanks.

Deborah Weinswig from Citi.

So you talked about it being the worst flu season in 10 years.

Can you talk about how you might be able to capitalize on that?

Yes, I guess we have to be careful how we [couch] that, Deborah.

But, yes, certainly, we think, as we've been seeing, I think our flu shots remain strong, probably, actually, the second burst that we typically maybe wouldn't have seen as -- but also cough and cold, we're seeing front-end categories that you would expect that are strong.

We're also obviously seeing some prescription lift.

So I think that when you're in the prescription business, certainly you can capitalize on that.

So I think we feel pretty good with this being, as the CDC said, the worst flu season in 10 years.

Then you talked about this being a very promotional environment.

Are you seeing that just from the drugstores or is it broader than that?

Well, I think we're seeing it probably throughout different channels by different players.

But certainly, we're focused on what we think is the right thing to do for our business.

But we're going to, as I said, I think we're well-positioned with the fact that we have 50 million -- we have about 45 million people on the Balance Rewards card, which is really just beginning to drive some momentum for us now that people understand the value of that currency.

But it's scattered by channel, by player.

Obviously, you have a very unique e-commerce approach with not only Walgreens.com but also Drugstore.com.

Can you talk about how you might be able to utilize that to get across, maybe a differentiated, let's just say, value message?

Yes.

We're really excited with what Sona and our team are doing in e-comm and mobile commerce with building an omni-channel solution.

As we've said, I think the value of our convenient brick-and-mortar locations, with a convenient omni-channel solution, positions us to do quite well going forward.

Our e-comm business continues to grow in line with the industry and we continue to add additional items.

The Drugstore.com acquisition gave us -- extended our long tail which gives us additional SKUs beyond what we carry in the store.

Some of the -- some, actually -- it's interesting, some of the Alliance Boots products that we carry on Beauty.com were some of our top items during the holiday season.

So we think we -- there's an opportunity to bring even more of Alliance Boots' expertise and product lines in our online offering.

Last question.

Would you say that the sign-ups on the Balance Rewards are exceeding your expectations?

How are you measuring ROI?

Wade.

We have a whole marketing mix model we look at and in part, this isn't necessarily incremental spend.

It's a different way of going to market.

So we've been shifting from what was typically, almost completely [roto] dependent to now, I'd say a much more balanced approach, of not [road] but also multi-channel efforts, what we're doing on the web, what we're doing with loyalty, what we're doing on our equity revision campaign.

So we think that, over time, that it's -- our use of funds, if you will, is much better in this new balanced approach.

Again, as Greg said, we build critical mass with loyalty, we now have [60%] of our sales coming through but where the real magic starts to happen is we start to build redemption where people can redeem and feel that there's real value in that redemption.

That becomes a powerful engine and we're just now starting to reach that point where those numbers are starting to grow.

Thanks so much and happy holidays.

Matthew Fassler from Goldman Sachs.

I would like to first try to delve a little bit deeper into Express recovery and the pace that you're seeing.

Obviously, some of your competitors have indicated that they're holding on.

Your November numbers did, in fact, show some improvement and you said some good things about December.

So what's your expectation of the pace of recovery and any numbers you'd be willing to share about what you think you're getting there or what you might ultimately recapture?

Well, Matt, first, as we said, we are pleased with the progress we're making.

We're on track with what our expectation was at this point in time.

You can see that as we said and suggested that you track our monthly comps and the progress we made this past month or this past quarter.

I think we're continuing to see and expect what we have forecasted throughout the next year.

We think we can retain a significant portion of these prescription -- customers over time.

Great.

Second question, if I could.

You spoke about some of the puts and takes on loyalty of 45 million members, saw some incremental SG&A and a little bit of hit to gross margin.

How do you think about the economics of the loyalty program?

At what point do you expect to see peak pressure from the roll-out of this program?

When do the economics start to become more attractive for you?

A couple of things.

In the short term, you have a bit of the accounting nuances.

As you get [point] it tends to impact gross margin as people redeem, it tends to impact sales.

Then over time, depending on how much breakage there is or there isn't.

That alters it.

But in general, we feel that even thus far with the investment, we've been able to maintain an overall strong profitability on the front end.

As I said, the real magic starts to come through as we start to move towards critical mass of redemption.

We're just getting to that point.

That's where we believe we can really move a bigger customer basket size and in a sense, the most loyal.

So I guess what I'd say is I think the team has done an outstanding job of not only executing and enrolling people.

But also really mitigating what in general, can be a tremendous upfront cost.

So for the most part, we've been able to glide through that and longer term, this, we believe, becomes a very accretive vehicle as well as something that differentiates us.

Yes, Matt, I would go back to something that Wade said earlier on an earlier question.

This -- I want to remind everyone, this is a strategic shift in our promotional strategy planned over a year ago when we knew we were going to launch the Balance Rewards program.

Certainly, with the advent of digital media, the decrease in print media, the now -- the fact that we now have 45 million people with a Balance Rewards program, that gives us the ability to more surgically and efficiently use marketing dollars.

We're really having a good reception from our vendors, our partners, who are looking at this as a more efficient way to spend their dollars.

Understanding that this was successful overall, in all the ways you just said, do the economics get better from here or does the pressure, such as it is, linger for a little while until this program matures a bit?

Year by year by year, economics get better.

So that doesn't mean necessarily in the next 30 days or whatever, there's a turning point but I think the important thing is that we've done the upfront investment in systems, we've been able to do the heavy investment in enrolling a significant amount of people.

I think the real magic starts to happen as you get enough people with enough points as they can really redeem for things that are meaningful and that's where we start to drive behavior.

But year by year by year, this gets better for us.

Got it.

Thank you so much.

Tom Gallucci from Lazard Capital Markets.

Thanks for all the color.

I just had a few quick ones hopefully.

On Part D, you mentioned that you're in the top few plans as preferred provider.

Can you give us any perspective on the market share that preferred providers typically would see or what your expectations are, as a result of being in those plans?

Tom, I can't really give color for the plans.

I think I can say, obviously, that three of those are, obviously, three of the bigger plans in the program.

I think we're just excited that they chose us as a preferred partner for all the value and the services we bring.

Certainly this enrollment period, we spent a lot of time trying to help seniors understand how Walgreens being preferred in a Part D plan was a benefit to them.

We think that these three plans will probably be some of the top winners in the program.

We're positioned well with them.

I think the data will come from the plans probably toward the end of January but we think they are three of the top plans and we think they will probably be highly successful.

We're delighted to be a preferred provider with them.

Okay.

Wade, just a follow-up on the generics.

Is it the right interpretation that you used to describe the exclusivity period to be exceptionally good?

It sounds like, over time, maybe the way you're contracting, the benefits won't be as skewed upfront?

Is that the idea?

If so, is there any way to think about fiscal or calendar '13 versus fiscal or calendar '12 in terms of the impact of generics?

I think others have said that the fiscal '13 is better than '12 and that's directionally true for us.

I think that the general idea that has -- we've been working, in general, to have more, what I would call, corridors so that, again, it's not a game of how much you can make in the first couple months.

But it's really about sustainability of the economics.

So we feel very good about that.

But I think as I said before, this is not a Company to invest in just because of a generic wave.

I think we're doing lots of things that, over time, are big and meaningful and much more sustainable than that as well.

I think that's -- that's, I think, good but I think that we've taken a very pragmatic approach on our contracting.

Okay, great.

Thanks a lot.

Edward Kelly from Credit Suisse.

Greg and Wade, could you maybe help us reconcile comments related to the ESI recapture versus what we're hearing from some of the other chain drug stores?

You seem to be happy with the way things are progressing.

They seem to be talking about very high retention rates.

The scripts that you're getting back so far, are -- is it the case that they may be coming from other channels other than chain drug?

Just trying to understand how we get two different stories.

Ed, maybe I'll start.

I know Wade's jumping to get in here as well.

But I guess I'll start with, we're certainly feeling good with where we are.

We're on track, as I said.

You can see it in our comp numbers.

So certainly, somebody is losing [their share].

With that said, that's one of the reasons we tried to fill the pie chart up, being that I think that pie chart shows that, frankly, they're coming from every player, doesn't matter who you are and at the rate of what we lost them at.

So bottom line is, we feel good with our comps, we feel good with our win-back and I can't help you with that disconnect, but other than the fact that we feel good with where we are.

We've certainly been on networks before so we have quite a bit of experience at the rate we win back and ramp it.

I think we continue to improve as we would expect quite nicely.

So there's nothing to suggest thus far that this is going to be any different.

I know people have maybe made predictions of what they think the end state of retention would be.

But I guess I would say that no one can really predict that.

It's impossible to predict but with respect to the trends that we're on now versus what we've seen historically, we're very optimistic.

And then--

(multiple speakers) percentages from the transferred [files] so it is what it is.

But I think that we know the percentages that were transferred out.

We've shown the percentages that are transferred back in.

It's -- In general, it seems to be pretty much the same percentages which, again, tells us that people want to come back, the ones that want to come back to their pharmacy want to come back and value it.

Okay.

Then on Alliance Boots, if I take the number that you, I guess, would have earned this quarter if you didn't have the issue with the lag versus what you're going to make the next three quarters, it seems like that maybe the accretion guidance went up, although I think there might be a timing issue in here.

So when we think about the accretion for the full year with Alliance Boots and what it would have been if we had the full year without the lag issue, did you raise it or is it the same?

I'm trying to understand.

It's pretty much the same, Ed.

Remember when we gave the original guidance, we didn't know what the amortization component would be or the IFRS to GAAP adjustments.

There's really no way to know that until you're very deep in the midst of it.

So what we tried to do was reconcile the $0.23, $0.27 to where we are today with those two adjustments in the lag.

Effectively, we would have been higher than $0.23, $0.27 but that would have been with other adjustments that were unknowable at the time.

But pretty much, we're exactly on track and again, the impact of the lag is effectively $0.10 and that's versus the one month.

It would be even greater if it was versus a zero month.

Okay.

Wade, could you maybe do us a favor, and as we think about when you report adjusted EPS going forward, what numbers are you going to be excluding from that?

Obviously, it's LIFO and stuff.

But what about the amortization step-up, the GAAP adjustments?

I don't know exactly what's going to be excluded and what's not.

From Alliance Boots, the numbers that will get adjusted will be as apples-to-apples to ours as we can possibly do.

So it will be FIFO to FIFO because that's our adjusted basis.

The amortization they have of things like brands and customer relationships, things that don't decay are added back, and then any truly special items.

But it will be on a GAAP basis.

So again, the numbers I quoted earlier in terms of their progress are IFRS.

But when we report it in our numbers, we'll make our IFRS to GAAP adjustments and the numbers you'll see for Alliance Boots will be as apples-to-apples as we can for our adjusted numbers on a US GAAP basis.

Okay.

Then just last question for you on tax rate of Alliance Boots impact.

Is the minority interest from Alliance Boots, is it pretax or after tax?

Then your tax rate this quarter, it seemed a little high.

Was there something impacting that and that and how is that tax rate going to look going forward?

Just [roughly] from the equity income I believe that you see there is the after-tax effect which is [circa] 20% tax rate.

There may be a little bit of a pick-up on things for Subpart F but in general, our rate will be fairly close to their rate on the equity income.

So it really depends, are there any items that would have Subpart F impact but in general, these should be fairly small.

So, call it, circa 20%, 21% is the effective tax rate you'll see coming through.

So the minority interest is already after tax and we should use your normal tax rate for below the line?

Is that right?

Yes.

Okay.

Okay.

Thank you.

Thank you, Ed.

You won't tax it again.

There will be a little bit of a true-up for Subpart F but it won't come in at an after-tax rate plus a US tax rate.

That concludes the Q&A session for today.

I will now turn the call back over to Rick Hans for further remarks.

Ladies and gentlemen, that was our final question.

As a reminder, the Company will report December sales on January 4, host our Annual Shareholders' meeting in Chicago on January 9 and we will report second quarter 2013 results on March 26.

Until then, thank you for listening and happy holidays.

Thank you, ladies and gentlemen.

That does conclude today's conference.

You may all disconnect and have a wonderful day.