沃博聯公司 (WBA) 2013 Q2 法說會逐字稿

Good day, ladies and gentlemen.

Welcome to the Walgreens second-quarter 2013 earnings conference call.

At this time all participants are in a listen-only mode and later we will conduct a question-and-answer session and instructions will follow at that time.

(Operator Instructions) As a reminder, this conference is being recorded.

I would now like to introduce your host for today's conference, Rick Hans, Divisional Vice President of Investor Relations.

Thank you, Bethany, and good morning, everyone.

Today Greg Watson, President and CEO, and Wade Miquelon, Executive Vice President, CFO, and President International, will discuss the quarter and this morning's announcement about our strategic long-term relationship with Amerisource Bergen.

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

Certain statements in 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 Forms 10-K and 10-Q and subsequent 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.

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

Today I will begin with a review of the highlights of our results for the quarter.

Then I'll touch on our announcement earlier today on the Walgreens and Alliance Boots strategic long-term relationship with Amerisource Bergen and how that carries forward one of our three key strategic growth drivers to create an unprecedented global platform through our Alliance Boots partnership.

After that I will turn the call over to Wade for more information on our performance this quarter and details of the Walgreen's, Alliance Boots, and Amerisource Bergen announcement.

Turning to our overall financial results, we are pleased to report a solid quarter with adjusted earnings of $0.96 per diluted share and GAAP diluted EPS of $0.79.

With that performance were a number of highlights.

First, we had operating cash flow for the second quarter of $1.2 billion and free cash flow came in at $953 million.

Second, our Balance Rewards program continues to show a strong response from our customers with more than 60 million customers enrolled.

Third, the Alliance Boots business and synergies are on track with our expectations with accretion to our adjusted EPS of $0.05.

Finally, this morning's announcement of our strategic, long-term relationship with AmerisourceBergen demonstrates how we continue to move forward on our strategy to create a global network for pharmacy-led health and well-being with Alliance Boots.

With those highlights, let me recap our financial results for this quarter.

As we began doing in the fourth quarter of last year, we will present our results on both a GAAP and a non-GAAP basis.

We reported first-quarter sales of $18.6 billion, virtually identical to the same quarter a year ago.

Remember that this quarter includes one less day due to last year's Leap Day, and sales also continued to be impacted by the growth in lower-cost generic drugs which help our bottom line.

GAAP operating income, or EBIT, for the quarter was $1.2 billion, up 10% from $1.1 billion for the same period last year.

Non-GAAP adjusted operating income, or EBIT, for the quarter was nearly $1.4 billion, up 12.9% from just over $1.2 billion in the second quarter 2012.

GAAP net earnings for the quarter were up by 10.7% from $683 million, or $0.78 per diluted share, last year to $756 million, or $0.79 per diluted share, this year.

The non-GAAP adjusted net earnings for this quarter were $915 million, or $0.96 per diluted share, compared to adjusted net earnings of $776 million,(sic-see press release "$767 million") or $0.88 per diluted share, in the same quarter last year.

As I mentioned in January, we came into this year with a number of tailwinds and we capitalized on these positive trends in the second quarter.

That is especially true in pharmacy which continues to be on the upswing.

I would like to quickly review some of these tailwinds.

With our multiyear contract with Express Scripts we saw an increasing percentage of those patients returning to us this quarter.

Walgreens is now a preferred drugstore in four Medicare Part D plans, giving these members a financial benefit when they choose Walgreens over our competitors.

Our reinvigorated private brands led by Nice!, Delish, and Well at Walgreens are driving margin and receiving great feedback from our store managers while they continue to build momentum with customers.

And this month we are cycling last year's change in our promotional strategy that moved us away from predominantly print promotions.

Instead we are leveraging digital media and our new Balance Rewards loyalty program launched last September.

From a global viewpoint, our Alliance Boots strategic partnership is now firmly in place and we are already realizing benefits from our procurement joint venture.

Now, with this morning's earlier announcement with Alliance Boots and AmerisourceBergen, we are taking another step forward in establishing an unprecedented and efficient global pharmacy-lead health and well-being network and achieving our vision of becoming the first choice in health and daily living for everyone in America and beyond.

Turning to trends in gross profit dollars and SG&A.

In the second quarter on a GAAP basis our gross profit dollar growth increased 4%, or $218 million, from a year ago.

SG&A dollar growth increased $213 million, or 5%, compared to a year ago.

On a non-GAAP basis gross profit dollar growth, after adjusting for the LIFO provision, increased $218 million, or 4%, year over year driven primarily by growth in generic prescriptions while front-end margins also increased slightly.

SG&A dollar growth was up $178 million, or 4.2%, after adjusting for the Alliance Boots transaction costs, other acquisition-related amortization, and the USA Drug acquisition related costs.

Through the quarter we continued to make steady progress in executing on the three major strategic growth drivers we put in place in 2012 to position our company for long-term growth and value creation.

On creating a Well Experience, this week we are opening our newest flagship store in Washington, DC, followed by a flagship in the Empire State building later this month and one in Boston next month.

These locations are raising the Walgreens brand in important markets as we continue to drive innovation across our store network.

On transforming community pharmacy, among other steps, we recently formed accountable care organizations, part of a national healthcare reform, with three leading physician teams in Texas, Florida, and New Jersey.

And this morning's announcement with Alliance Boots and AmerisourceBergen was a significant step forward on our third growth driver, establishing an efficient global platform.

Our new strategic long-term relationship with AmerisourceBergen has three main components -- a distribution agreement, strategic collaboration, and equity alignment.

Let me touch on each and then Wade will provide more details.

First, our distribution agreement is a long-term 10-year contract.

It offers expanded service levels and more frequent deliveries and it offers improved economics through a number of operational efficiencies and better rates.

The second component, the strategic collaboration, gives us supply chain and procurement benefits, new opportunities for customer and supplier collaboration, and for domestic and international growth.

Finally, the equity piece of the agreement is designed to align our common interests and allow us to participate in the joint value creation.

Let me sum up by saying we are very pleased with the way customers, patients, and partners are responding to our efforts to help people get, stay, and live well.

We see this in their response to Balance Rewards, our vaccination and immunization program, our health and wellness initiatives, our innovations and partnerships, and the excitement we continue to generate in our Well Experience format.

With our partnership with Alliance Boots performing well and producing the expected synergies and a new strategic long-term relationship with AmerisourceBergen, we announced today we believe Walgreens is truly on its way to be the first choice and health and daily living for everyone in America and beyond.

Thank you.

Now let me turn the call over to Wade.

Thank you, Greg.

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

This morning I will take you through our quarterly results, as well as build on Greg's comments regarding today's announced strategic relationship between Walgreens, Alliance Boots, and AmerisourceBergen.

I'll also provide greater detail on the 10-year agreement as well as further perspective on why we are confident this relationship will unlock significant opportunities for our companies and provide value to our shareholders.

Starting with the quarterly results, as Greg noted earlier, for the quarter we reported a GAAP EPS of $0.79 per diluted share based on 953 million shares.

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

The LIFO provision was $0.05 per share, the acquisition-related amortization was $0.08, and the Alliance Boots adjusted earnings tax add-back was $0.04 for a total of $0.12 per share.

And, finally, the special items column had a net zero impact on adjusted earnings per share because of the $0.01 of acquisition-related costs and they were offset by a $0.01 gain related to client retention escrow proceeds from the sale of our PBM in 2011.

The sum of these yields in adjusted EPS was $0.96 per diluted share for the quarter.

It is also worth noting that the quarter this year had one less day than the quarter last year which included Leap Day, February 29.

Adjusting for Leap Day, the adjusted earnings per share increased over 10% in the quarter rather than the 9.1% that Greg noted.

Let me now provide more detail on our comparable store sales for the quarter, and keep in mind that all comps are reported on a 28-day basis.

Comparable prescription sales decreased 1.2%.

Comparable front-end sales decreased 1.6%.

Total comp sales decreased 1.4%.

Comp prescriptions filled increased 5.7% versus a negative 6.1% script comp a year ago.

Also note that comparable prescription sales were negative versus the positive script comps, primarily due to the increased introductions of new generics year over year.

This slide illustrates the trend in prescription comps for the last 14 quarters and clearly shows the impact on comp store script numbers for the prior fourth quarters we were not part of the Express Scripts network.

As you know, Express Scripts customers started returning to our pharmacies in the first quarter.

The comp stores scripts increased 5.7% in the second quarter.

Please note that the script comp also included a 1.9% positive impact from a higher incidence of flu this quarter versus a year ago.

The next slide shows a trend in front-end comps for the last 14 quarters.

The primary drivers behind the trend the last four quarters were the impact of the move to rebalance our overall ad and promotional spending strategy and the impact of Express Scripts.

Our goal is to strike the right optimal balance between sales and profitable growth using our promotional strategy, as well as our unique Balance Rewards loyalty program, which gives us an additional lever to help find this balance between loyal customer sales and margins.

We are pleased to achieve stable margins in the front end despite a very promotional environment.

On a 28-day basis traffic in the quarter decreased by 4.4%, basket size increased by 2.8%, and the front-end comp decreased by 1.6%.

Keep in mind we will lap the change in overall promotional spend strategy this month which should help improve the recent comp trend.

March comps will also be positively impacted by the shift in Easter from April 8 last year to March 31 this year.

Turning to margin, our FIFO gross margin was 30.5% in the current quarter compared to 29.3% last year, a 120 basis point improvement.

The overall margin was primarily helped by pharmacy, but the front end also contributed.

Pharmacy margins were positively impacted by generics.

Front-end margins were positively impacted by OTC drugs, personal care, and household products, but these benefits were partially offset by the increase in points accruing as we ramp up our loyalty programs.

Front-end margins were also negatively impacted by the e-commerce mix effect.

Taking a look at our longer term gross margin trends, it's important to note that this quarter's 120 basis point improvement builds on a 20 basis point increase a year ago and the improvement this quarter is similar to last quarter.

Both quarters a testament to the benefit of generic introductions this fiscal year.

Front-end benefit to margin did move from neutral to positive sequentially.

Also note the 4% improvement in FIFO gross profit dollar growth, which is much better than the 0.1% growth last quarter and the 1.5% growth in the quarter a year ago.

This illustrates our two-year stacked SG&A dollar growth trend on a GAAP basis the last nine quarters and the next slide shows the trend on an adjusted basis.

Two-year stack adjusted SG&A trends improved versus a year ago to 7.9% growth in the second quarter of 2013, down from 11.6% last year.

To get to adjusted SG&A dollar growth you can see that our reported SG&A dollar growth of 5% included 30 basis points of Walgreens amortization and 50 basis points of acquisition-related costs.

This resulted in adjusted SG&A dollar growth of 4.2%.

This illustrates our quarterly gross profit dollar growth trend of the past 10 quarters on a GAAP basis and the next slide shows the trend on an adjusted basis.

Adjusted gross profit dollar growth increased from positive 0.1% in the first quarter to a positive 4% in the second quarter.

The trend in adjusted gross profit dollar growth data shows the benefit for members of Express Scripts plans returning to our stores combined with an increase in the mix of generic drugs.

Following this same construct, this slide shows the SG&A dollar growth trends for the past 10 quarters on a GAAP basis and the next slide shows them on an adjusted basis.

As I discussed in the SG&A walk earlier, the adjusted SG&A dollar growth for the quarter was 4.2%, an increase from the 2.5% adjusted SG&A dollar growth reported in the first quarter.

Keep in mind that the adjusted SG&A dollar growth rate of 4.2% also includes a few other noncomparable expenses, like the operating expense related to the USA Drug acquisition and further expenses to sign up Balance Rewards members, among other items as well.

Focusing on our income statement for a moment, this quarter included a LIFO provision of $72 million, the same amount as a year ago.

Our effective LIFO rate for the year was 2.75%, up from 2.5% a year ago.

Net interest expense was $23 million including the impact of the Alliance Boots acquisition and interest income associated with the delayed payments by a state Medicaid payer.

Our effective tax rate was 36.6% versus 37.3% last year.

Average diluted shares outstanding were 953 million shares versus 875 million shares last year.

Again, this increase is primarily due to shares issued for the Alliance Boots investment.

Cash and cash equivalents were $2.4 billion at February 28 versus $1.1 billion a year ago.

Overall working capital decreased by 5.4% versus a year ago.

Accounts receivable decreased by 1.1% while accounts payable increased by 4.4% and inventories decreased 1.3%.

Total FIFO inventory increased by 2.5% in the quarter versus a negligible percent increase in total sales.

FIFO inventories on a per-store basis were flat.

During the second quarter we generated $1.2 billion in cash from operations versus $1 billion a year ago.

Cash flow in the quarter benefited from the timing of a $300 million employee profit sharing contribution, which occurred in February last year, that occurred in March this year.

Free cash flow in the quarter was $953 million versus $703 million a year ago.

Keep in mind we also raised the dividend over 22% this year, $0.275 per share per quarter.

Let me now transition to our accretion for the quarter as a result of our partnership with the Alliance Boots.

Second-quarter accretion was $0.05 per share, in line with the $0.04 to $0.06 range we forecasted last quarter.

We are reconfirming our estimate of $0.12 to $0.13 per share for the third quarter and $0.09 to $0.10 for the fourth quarter.

The next slide illustrates the synergy dollars, the amortization adjustments, and the equity earnings that comprised $0.05 of accretion.

As shown we realized $25 million before tax of synergies during the second quarter and $15 million after tax.

We expect synergies to ramp during the second half of our fiscal year, but we remain comfortable with our $100 million to $150 million combined synergy goal for fiscal 2013.

Amortization adjustments amounted to $23(sic-see presentation slides "$23 million") for the deal amortization and $12 million for the brand amortization.

After tax Alliance Boots equity earnings were $85 million for the second quarter on a GAAP basis.

On an adjusted basis the income from affiliates was $120 million as noted here and the incremental after-tax interest expense to Walgreens was $13 million.

After the cost of share dilution the accretion equaled $0.05 in the second quarter.

Now let me take a few minutes to speak about our announcement this morning regarding the strategic long-term relationship with AmerisourceBergen.

I would like to fully express my enthusiasm for this agreement and what it means with respect to the various opportunities that it brings us.

As Greg outlined earlier, this relationship has three components -- distribution agreement, strategic collaboration, and equity alignment.

First, let me first describe the detailed structure of the agreement.

First and foremost, Walgreens is committing to a 10-year comprehensive pharmacy distribution agreement with AmerisourceBergen.

The strategic collaboration will allow broad international reach and significant knowledge-sharing opportunities to create efficiencies and design programs to improve access to pharmaceuticals for healthcare providers worldwide.

To align interest and strengthen the long-term relationship, Walgreens and Alliance Boots together have been granted the right to purchase a minority equity position in AmerisourceBergen beginning with the right, but not the obligation, to purchase up to 7% of the fully diluted equity of AmerisourceBergen in the open market.

We have established a joint venture with Alliance Boots that we intend to fund over time that will be an efficient vehicle to purchase and hold these shares.

In addition, AmerisourceBergen has granted to Walgreens and Alliance Boots equity warrants exercisable for 16% in the aggregate of the fully diluted equity of AmerisourceBergen.

First warrants representing 8% of the fully diluted equity of AmerisourceBergen and strike price of $51.50 and will be exercisable for a six-month period beginning in March 2016.

The second warrants have a strike price of $52.50 and will be exercisable for a six-month period beginning in March 2017.

Walgreens and Alliance Boots have agreed not to acquire additional equity of AmerisourceBergen under the terms of the standstill agreement.

A Walgreens executive will be appointed to AmerisourceBergen's Board upon Walgreens and Alliance Boots together acquiring a 5% equity stake and an Alliance Boots executive will be appointed upon exercising full of the first warrants.

These new board seats will add to AmerisourceBergen's current nine-member Board.

The 10-year comprehensive distribution agreement will be positive to earnings and cash flow from operations.

The agreement is market based and is expected to be modestly accretive to fiscal year 2014 adjusted earnings.

The working capital was negotiated in essentially have a neutral impact to both parties, specifically the reduction in inventory days at Walgreens will largely be offset by the decrease in accounts payable days over time.

The operational benefits for Walgreens will include an enhanced supply chain with daily deliveries.

Synergies will also contribute to earnings and cash flow from operations in fiscal 2014 and they are expected to build in subsequent years.

Likewise, the equity investment will drive dividend income in fiscal year 2014 and beyond.

To summarize, the financial benefits for both Walgreens and Alliance Boots that will begin in the first year are improved commercial agreement rates, synergies, and dividend income that arise from the investment.

Beginning in year three the Walgreens and Alliance Boots JV also expects an incremental financial benefit in the equity income.

As we stated in our announcement, this transaction is structured to enable all three organizations to work together on programs to improve service levels and efficiencies and benefit from available synergies.

To wrap up today I would like to revisit our fiscal year 2016 goals for the combined Walgreens Alliance Boots equity.

We are not changing our goals and want to clarify that the agreement we announced today will provide operating income synergies and operating cash flow benefits accretive to our prior plans.

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

The business performance objectives are meeting our expectations and are on track to meet our first year synergy target.

Now with the new strategic relationship with AmerisourceBergen we are well-positioned as leaders in the rapidly changing global healthcare environment.

In that context, we affirm our combined stated goals for fiscal 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 $100 million to $150 million in fiscal year 2013 combined synergy goals; $8 billion of operating cash flow.

And given the strong cash flow trends at both Walgreens and Alliance Boots, we believe that with a 7% investment in AmerisourceBergen we will still meet the combined net debt goal of $11 billion or less.

So in summary, we are on a journey, a journey to alter the global landscape in pharmacy-led health and well-being and create significant shareholder value along the way.

With our partners, Alliance Boots and AmerisourceBergen, the opportunities before us are limitless and combined capabilities are unmatched.

Thank you and we appreciate your interest in our company.

And with that I will turn the microphone back over to Rick.

Thank you, Wade.

That concludes our prepared remarks.

We are now ready to take your questions.

(Operator Instructions) Steven Valiquette, United Bank of Switzerland.

Good morning.

Just a question on the gross margins.

Again, it looked pretty strong this quarter and obviously there is some seasonality as we kind of jump from the holiday-related quarters to the non-holiday.

So I am just curious -- I know you don't like to give guidance, but to the extent you have kind of shifted from LIFO to FIFO gross margins, should we assume the same sort of seasonal progression of gross margins on a FIFO basis that we kind of saw previously on LIFO?

Just any sort of general color along those lines would help, thanks.

Yes, a couple of things.

One is we are very focused on margin.

I think in the front end, even though we have had some volume softness, I think we have been able to do a very good job of improving profitable mix.

On pharmacy you are seeing some of the benefit of generics, but also I would say a real focus.

I think at the end of the day we will keep looking to improve margin opportunities, but really I would focus on our gross profit dollar growth versus our SG&A dollar growth and being able to continue to widen that spread.

I think you see now for the first time since the Express Scripts dispute we have actually crossed back over into positive territory and I would expect that momentum to build.

Okay.

And that previous guidance you gave along that is kind of unchanged on a FIFO basis versus what you gave on a LIFO basis previously.

Is that -- just to confirm that, is that correct?

Yes.

So obviously LIFO to FIFO, I mean you really never really know until you get various price increases and things that flow through.

I think FIFO is very indicative, though, of the way we do run our business.

Okay.

But, again, I think for all the things I mentioned we should be able to have nice, solid gross profit margins over SG&A dollar growth.

Okay.

Thanks and congrats on the ABC deal as well.

John Heinbockel, Guggenheim Securities.

Couple things on the Amerisource deal.

Your comment about working capital, is that neutral to the system or neutral to you?

It is relatively neutral to the system and to us, but over time working together we should both be able to get additional efficiencies and drive additional days of inventory out.

So I think there is probably upside for both of us as we work together.

But it is relatively neutral to the system and it is in balance, so it is relatively to both parties with some exceptions of some initial startup fees.

Okay.

The idea that it is modestly accretive in 2014 is that including some one-time costs?

And then how do you think that generally ramps up in 2015?

There should be very modest one-time costs so it is probably modestly accretive and modestly accretive including those.

But the key thing here is we are going to have -- today effectively we have three distributors when you think about it.

We have had AmerisourceBergen, we have had Cardinal, and we have had ourself.

We are streamlining all of that into one.

Generic volume is very, very significant and so that will be phased in over time.

As we phase that in and get that up to speed that is where there is additional opportunities, significant opportunities, for both parties.

All right.

Then lastly, if we look at the front end and script count as well, February looked like it was somewhat impacted by macro, both pharmacy and front end.

Maybe your take on that is we have kind of gotten to this year with payroll tax and what have you.

Do you still think, in terms of getting positive on traffic at the front end -- that is still likely to be a laggard relative to average ticket I assume.

Do you think we will see positive traffic by the end of the fiscal year?

John, Greg, I would I guess agree with your comments to begin with as far as macro trends in February and certainly in March.

As we have said, we have got an early Easter so we will probably know more by the time we come through April.

But as far as the front end, certainly, as Wade said, we focused on shifting that promotional strategy from [roto] to some of the new media opportunities and I think we are working to balance both traffic and basket size.

I think certainly we want to have both.

As I have said, we are lapping the change in that new strategy beginning actually last month.

But we are focused now on really reinvesting some of that margin that we are picking up from our private brands from our Balance Rewards program to focus on traffic.

So we want a little more balance going forward and we think we should be able to achieve that.

Whether it is by the end of the fiscal year or not, we don't want to give guidance but we think we are going to achieve that.

Okay, thank you.

Matthew Fassler, Goldman Sachs.

Thanks a lot and good morning.

Couple questions.

First of all, if you think about the cadence of Express reclamation, talk about how they are progressing relative to your plan.

Given that you are almost through the first 90-day cycle of the calendar year, what kind of build do you think you might see beyond the calendar first quarter?

Matt, again, we have kind of focused on comps versus just the Express Scripts, but I think we feel good about our comps and the win-back that we are seeing.

I think that certainly, to the earlier call, the macro environment in February tightened up a little bit post flu season, but I think we feel very good with where we are.

We are on track and we feel good about our pharmacy comps going forward.

I think we would also say that far from being able -- as we continue to win back that business, which we are, we also feel very good about the ability to keep growing disproportionately our share of Part D. (multiple speakers) Go ahead, I'm sorry, Matt.

Please go ahead, Wade.

I think we are just seeing very nice gains as we expect and we expect those to continue to grow throughout the year as people switch into a preferred plan with Walgreens.

Understood.

Just a quick follow-up question on the Amerisource deal.

If you think about the equity investments you might make down the road, what would the cash needs be to fund those and what is your expectation for how you pay for it?

Over the next immediate period we have the ability to purchase up to 7% and that will be at the market price, so that will be whatever it will be.

As I said before, though, the fact that both Walgreens and Alliance Boots have been exceeding our cash flow targets and we believe that we will over that period be able to continue to exceed and in fact still be on track with the $11 billion net debt or better, even with that investment.

The warrants will be a separate investment.

You have got the strike prices and you have got the time.

Again, we have the right to purchase those but not the obligation, so as we go down the road here we can reassess what makes sense at that time.

So most likely cash on hand and incremental free cash flow, or would you see going back to the debt markets or to the bank line to fund this at all?

No, I think we can do it internally, at least for the first 7%.

Got it, that is helpful.

Thank you so much.

Eric Bosshard, Cleveland Research.

Good morning.

Two questions for you.

First of all, Greg, you commented a little bit of the evolving front end and certainly understand what you've done over the last year, but curious how the front-end strategy is evolving as it regards to promotions.

Also curious in terms of the new store format what the strategy is in terms of rolling that out broadly.

Obviously you have had a change in merchandise leadership or are going through that right now, but give us an update of how all of those steps are evolving.

Eric, maybe I will start with your last one first.

As far as the change in leadership, certainly our strategy has not changed, will not change.

We feel very good with our well-experienced format as you referred to.

We are in over 400 stores.

We are certainly still in pilot and learn and enhance, but we feel good with how we are going forward with that.

The customer response, which is kind of the leading indicator, is very good which tells us that we are moving in the right direction.

There are a lot of things that we feel very good about that are working well.

There are some things that we want to continue to tweak, but I think you will see that continue to evolve and expand.

As far as our front end, I think we feel very good with the adjustments and the opportunities that we have.

You know, Eric, as I have said before, a shift from primarily print advertising and a lot of spend in that area to leverage and utilize more digital media and our Balance Rewards program that is a big strategic shift.

We actually feel good as far as how we have moved.

But there is opportunity to look at ways to reinvest some of that margin that we have to make sure that we continue to focus on driving traffic and that is what we are doing.

I think the luxury that we have is the fact that our private brand strategy is doing extremely well, which is obviously delivering margin that we generally reinvest.

Then, secondly, with the ABC deal this morning, obviously you have got a lot going on with Boots especially on the purchasing side.

I'm just curious how you are going to balance the effort with ABC along with combining those two businesses.

It seems you have put a lot on your plate, especially within purchasing, before we think of these other things.

Can you talk a little bit about the bandwidth to execute on what becomes sort of a growing list of things to get accomplished?

Eric, I think it is a fair question and, frankly, we believe that actually it will become easier for us.

As Wade said we are actually moving from three distributors down to one.

But I think when we look at certainly our three key objectives I think we have a real focus in the organization in driving those three key objectives.

I think, secondly, with our partnership with Alliance Boots and where we are and being on track with that we feel good there.

I think when we began to explore our strategic opportunities for our US supply chain with our expiration of our contract we looked at a lot of different options and, frankly, this was the most compelling strategic and financial option that we had.

With AmerisourceBergen's expertise, Alliance Boots' expertise we think it can enhance our supply chain and, frankly, simplify and ease some of the work that we have been doing in the past with self-distributing.

And so we have also established our JVs and our collaborative efforts in bringing them into the fold as a partner that is really, I would argue, is not more work.

It is just going to complement and augment what we are already doing.

Thank you.

Mark Wiltamuth, Morgan Stanley.

Good morning.

Can you maybe go through the global nature of the transaction with AmerisourceBergen and how this works for the Boots side of things?

And then if you are shifting to more generic sourcing doesn't this kind of get entangled with that synergy target that you have laid out?

It sounds like your goals here are not incremental to -- or they are incremental to the synergy targets you have given us.

Maybe explain how that interaction works on the generics.

They are incremental and, with respect to the international collaboration, the efficiency work for example, our JV and our employees there will be working with the AmerisourceBergen people.

Again, we expect incremental benefits for both us and for them, and our benefits will be split with our partners, Alliance Boots.

Separately on the other global work, the Alliance Boots folks are working with them to identify various opportunities, whether it be expansion of specialty overseas, 3PL, pre-wholesaling, and others, and we feel there is a lot of opportunities over time.

As those get more firmed up I am sure we will share more details.

Okay.

Just on a separate topic, how do you expect the script gains from the preferred Part D networks to really start to build as the year progresses?

And how much were they on the quarter for script volume?

We haven't dissected the quarter, but we did see nice gains in January as people switched into plans where Walgreens is in in preferred.

What we usually see, what we saw the year prior, is that throughout the year as Part D people are made aware of the benefits they can get by going to a preferred pharmacy within that network we tend to see gains all year long as well.

Not to mention the 12,000 people a day which are entering into Part D and getting into a plan and, hopefully, disproportionately into a plan that has Walgreens and/or is preferred by us.

Okay, thank you.

Meredith Adler, Barclays.

Thanks for taking my question.

I was wondering -- I'm trying to understand sort of the mechanics of the relationship with AmerisourceBergen.

Are they going to take over operating your distribution centers?

Will does distribution centers ever support their independent or other customers?

Are you really merging the two supply chain networks, or is it not going to be like that?

Selectively they may utilize some of our generic distribution assets, but they will get the large benefits by integrating broadly into their supply chain.

Now a lot of our distribution centers have a generic distribution component and a front-end component, so we have got actually lots of volume still there and lots of opportunities to reallocate resources.

But, broadly, they will be taking this volume into their system to get the full scale and efficiencies and be able to deliver three lines of business to us versus just one prior, or three lines from three different distributors if you can include ourselves as one.

It sounds like they were very anxious to do this business.

Obviously there are many, many layers and pieces to the benefits of this.

It's all very interesting.

Just talking about the supply chain contract, it seems like because you have been shipping generic drugs on your own trucks where you are shipping front-end product isn't it just less efficient for them to be the ones that ships that product?

No, well, Meredith, Greg.

Keep in mind that they deliver daily, which is -- obviously it improves the service level that we have in our stores as we go direct in most cases once a week.

I think that the opportunity -- think about it this way, Alliance Boots and AmerisourceBergen are experts in pharmaceutical supply chain distribution.

We are very good at it, but the combination of what they both do to improve our supply chain, take that off of our hands, and improve our service levels is really the opportunity that we are excited about.

So they can -- rather than do brand deliveries as separate from our generic deliveries, they can consolidate brand, generic, and all specialty into one shipment, which has lots of positive implications for us and lots of efficiencies in aggregate for everyone.

Right.

Well, congratulations; it is really very interesting transaction.

I will turn it over to somebody else.

(Operator Instructions) Edward Kelley, Credit Suisse.

Good morning, guys.

Congratulations on your deal.

I have a question for you related to this along with the original synergy target with Alliance Boots.

I think it was kind of asked maybe a couple of different ways; it is still kind of unclear to me.

Practically how does this impact the capture of the generic procurement synergy that you initially talked about?

I ask that question because you had control I guess in the past over your own generic purchasing.

You were going to combine that with Alliance Boots and it is clear as to how you benefit from that scale.

But I think you are transferring that control AmerisourceBergen.

It is just unclear to me how all this is going to work and how it flows through into the income statement of the companies.

We are not transferring control.

In fact, our JV, which is set up and working, will continue to work and it will work on the behalf of our partner effectively as well.

We do see that these benefits are going to be incremental, the component for us, but also incremental for them.

And so, again, we will maintain control on this.

A lot of those benefits on our side will flow through our JV structure, which then gets split and then cycles a little bit because of the 45% ownership that we have in Alliance Boots.

But at the end of the day we see that this will bring incremental value for us and clearly incremental value to AmerisourceBergen as well.

In essence, we are bringing a new pool of buying volume from AmerisourceBergen into the Alliance Boots/Walgreens venture that we have set -- we have established.

Is there upside to that initial synergy target, or is that upside captured in the better pricing of this deal?

There is upside to the synergy targets and the commercial agreement is very separate.

The commercial agreement stands on its own with respect to our distribution agreement, and we feel that it is a good agreement and better than we have today for lots of reasons.

Not only cost, but what would be service levels, the deliveries.

It is also a market fair and good deal for AmerisourceBergen.

And, again, by having gone from effectively three distributors to one it provides opportunities for both parties to gain.

But this agreement is really separate from that.

Okay.

Then just one other question for you.

On SG&A this quarter a little bit higher than we thought it was going to be.

And you have been talking in the past, Wade, about looking into your stacks.

So if we think about to your stack today and we carry that forward to the second half, it looks like you could see SG&A dollars up 9%-plus.

So I guess the first question is that right, the right way to think about it?

And then, secondly, if that is right, can you still grow gross profit dollars faster than that in the back half?

A couple things.

One is our SG&A this quarter has, outside of what we even call adjusted, had some anomalies.

We had some further investments in loyalty.

We had some M&A which adds SG&A on top of it from a growth point of view, but you get gross profit as well.

Then there was actually some other one-time items in there we didn't call out.

So we actually felt pretty good about our SG&A this quarter.

I think the thing to look at is the SG&A versus gross profit dollar growth, which gross profit dollar becomes easier in the back end too, so it is that spread.

Separately our sustainable model has always been to have organic SG&A growth of 3.5% to 4.5% of any period 1.5% to 2% of that driven by new stores.

But I think on a two-year stack basis over time that model should still be as relevant as ever it was before.

Okay.

Thank you.

Andrew Wolf, BB&T Capital Markets.

Thanks and good morning.

To kind of piggyback on Meredith's question, just logistically over time with the AmerisourceBergen contract is there still going to be some cross-docking of branded drugs?

Or are they going to basically over time be going to Walgreens stores directly on a daily basis?

Yes, Andy, they will be going to the stores on a daily basis.

That is a big part of the opportunity is the improved service levels, frankly, over time.

I think also, as Wade mentioned, certainly if there is opportunity to leverage some of the space that we have in our DCs that is committed to pharmacy warehousing that also frees up capacity within our existing distribution centers for our front-end product as well.

But, yes, we will be leveraging their ability to come to the stores on a daily basis.

Okay.

The second part of that question is daily delivery, from my view, can really increase your in-stock rates, particularly around specialty drugs.

So can you discuss what the long term -- as more of the pharmaceutical market and the value of the pharmaceutical market moves to specialty drugs is that sort of the underlying or part of the underlying reason for this agreement long-term strategically?

Love that question, Andy.

Yes, I think that the opportunity to leverage that daily delivery, for all medications but even in particular high-cost specialty medication, so the patients can access their trusted community pharmacist that they have know for years to pick up their special meds is a huge opportunity.

One of the things that really excites me and intrigues me is obviously, of the wholesalers in the US, AmerisourceBergen absolutely leads in the specialty sector.

So we think there is a lot of opportunity to work together to provide new and innovative solutions for specialty.

The other thing that is intriguing with AmerisourceBergen is their focus on health systems and in-patient meds and the fact that as you know we are working a lot of major health systems with outpatient pharmacies as well.

So there is a lot of opportunities along those lines, Andy.

Just lastly, shifting to the Balance Reward program and the membership strong numbers.

Why can't you talk about usage rates and how they are trending versus expectations?

Just some color around that.

It's a very ambitious program, not just for Walgreens, but I think from what we have seen in the country.

I think I guess I would say we have been in a heavy ramp up basis.

More than 60 million members in a very large, let's say, a majority of our sales now on the card.

It is really that investment phase.

As I said, [along the magic], now comes [the redemption].

Now that we have a critical mass of people signed up, a critical mass of purchases people are getting a significant number of points that they can use.

It becomes about redemption and turning that into delight.

And that is where I think, Greg said, we are rounding the horn on promotion but to some extent too we are also exiting the build phase on loyalty.

And that is why we see that as a win going forward.

Andy, way in there.

Think of this as obviously a new currency.

It takes a while for people to understand the value of that.

As they build points and then begin to redeem them they begin to understand the value of that currency, especially in an economic climate like we have today.

And that is what we are beginning to see gaining momentum and we feel will really help us with the traffic in the front end as we go forward.

Because a lot of the behavior you are trying to get is to allow [folks] to accumulate the points is to get people to buy a certain product.

That is a different kind of modality, I think, than a typical loyalty card and so that is what I was asking.

Is that on trend; are the CPG partners getting what they want out of that, whether it is trial of a new product?

That is what I was asking you to maybe shed some light.

Obviously there is some learning in start-ups, but what I would say is that loyalty card holders the feedback is very, very positive in terms of the program and increasingly the ability to understand it.

So I think we feel that we are in a very good spot there.

As we continue to tweak and refine in terms of what will motivate people, how do we make the CPG dollars and others money go as far as possible, there have probably been some refining and tweaks.

But I think that directionally we are on a good track and we know where we are going to take this over time.

Specifically to your question, Andy, we are encouraged by the basket size lift that we are seeing with loyalty members.

Thank you.

Lisa Gill, JPMorgan.

Thanks very much and good morning.

I just had two quick questions.

First, just wondering, Wade, was there any benefit in the quarter to gross margin from your purchasing synergies now that you have the purchasing alliance with AB, with Alliance Boots?

Well, there is about $25 million in total combined synergies of which the purchasing piece was a big piece.

Of course, without all the nuanced detail on the phone because of our JV and because of our percent ownership, whatever, it is a little complex in terms of how it flows right back to the Company.

So, yes, there was.

Again, we have the $100 million to $150 million run rate.

This quarter, again like I said, was circa 25 but that is building very quickly.

So we expect a very nice tick up here in the back half, in part because there is the P&L timing.

When we get the cash benefit is different from when some of this actually flows through our inventory and through our accounting.

Great.

Then my second question had to do with ACA as we start thinking about exchanges and calendar 2014 and we think that about relationships with exchanges.

Can you talk about how you anticipate those will be set up?

Will the rates be the same as we see in commercial markets?

So, therefore, if you have a relationship with a large managed care today you will just get the increase in that volume would be my first question.

Then, secondly, what are your thoughts and anticipation around Medicaid, whether it is fee for service Medicaid or direct Medicaid increases, and what that will do for reimbursement as we start thinking about 2014?

Lisa, I think a lot of that certainly is unknown at this time although we are beginning to see things take shape.

I believe that the first opportunity a community pharmacy has, and we are certainly looking forward to do, is to help people understand, educate, and navigate, to help the government locate folks who are eligible.

I think secondly, as far as participation in networks, I think you will see all of the above.

I think you'll see some preferred networks like you are with Medicare Part D that certainly we want to leverage our existing relationships with to participate.

Medicaid, I think with the expansion of Medicaid it will be interesting to see how states respond.

I think you will probably see maybe -- potentially may see more move into managed plans.

But there again I think we intend to work with them in whatever way or form or fashion they are looking to go forward with, whether it is a preferred opportunity or not.

Lisa, one thing I would say about the ACA is even though a lot of it is unknown it's kind of unfolding before our eyes.

I think there is two positive dynamics embedded in it for us as a community pharmacy.

Number one is the fact that, similar to Medicare Part D, individuals want to go where they want to go and so when there is a dynamic that allows people to choose what they want we typically more times than not are able to be a provider to people that want to go to Walgreens.

That is a good dynamic.

I think the second thing is by the nature of these over time we will be looking to reduce the overall cost of healthcare for the patients and community pharmacy will be a more generics utilization, be preventative things that we can do on the front lines -- screenings, consultations, a variety of things.

We hold a lever for that so we can -- we would expect to be fairly compensated for what we do because the levers that we can pull to reduce the overall cost of that are significant well beyond just the cost of the drug.

Lisa, I think both the plans and the government understand that finding, educating this population to help them find plans that work for them is going to be even more difficult than with seniors.

Am I also correct though, Wade and Greg, in thinking about this that you have a leverageable fixed cost today, that you probably have excess capacity in most of your stores that this should be -- all of this increase in volume there shouldn't be a lot of incremental cost on your side to bring these on?

And, therefore, if the pharmacy of choice is Walgreens that you're going to see this increase in volume without a lot of increase in costs of finding those patients and bringing them in the door?

Is that the right way to think about it?

I think to some degree that is true.

I thought you were going to say are we looking into variable pricing and the answer is no.

But, for sure, some will be incremental, but there will be some shifts I suppose from mid and small to large, maybe others that choose to go a different way and push people into exchanges.

And from that vantage point it is probably a zero-sum game.

Okay, great.

I appreciate the comments.

That does conclude the question-and-answer portion of today's call.

I would like to turn it back to Rick Hans for any closing statements.

Ladies and gentlemen that was our final question.

Thank you for joining us today.

As a reminder, the Company will report March sales on Wednesday, April 3, and we will report our third-quarter 2013 results on June 25.

Again, thank you for your time today and please feel free to follow up if you have any further questions.

Goodbye for now.

Ladies and gentlemen, this does conclude your conference.

You all may disconnect and have a good day.