沃博聯公司 (WBA) 2013 Q4 法說會逐字稿

Good day, ladies and gentlemen.

Welcome to the Walgreen Co.

fourth-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, today's call is being recorded.

I would now like to turn the conference over to your host, Rick Hans.

Sir, you may begin.

Thank you, Shannon, and good morning, everyone.

Welcome to our fourth quarter 2013 conference call.

Today, Greg Wasson, our President and CEO, and Wade Miquelon, Executive Vice President, CFO and President - International, will discuss the quarter.

Also joining us on the call is Kermit Crawford, President of Pharmacy.

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 website 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 and 10-Q and subsequent 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 highlights of our fourth quarter and fiscal year.

Next I'll discuss the substantial progress we made in advancing our three key strategic growth drivers.

And finally I'll take a look ahead to fiscal 2014.

Then I'll turn the call over to Wade for a more detailed financial review of the quarter, and our full-year performance and the coming year.

We are pleased with our solid performance, as we posted record adjusted earnings per share for the quarter of $0.73, generated $1.1 billion in operating cash flow, and a record $785 million in free cash flow.

We paid off $1.3 billion of senior notes upon maturity, consistent with our debt reduction plan.

In addition to our strong financial performance we also made significant strategic gains in the quarter.

We introduced Smart90 Walgreens, our 90-day prescription drug program with Express Scripts.

The program gives customers the option to receive their maintenance medications through Walgreens retail pharmacy or Express Scripts home delivery.

We also announced our agreement to acquire certain assets of Kerr Drug in early September, including their 76 retail drug stores and specialty pharmacy business.

Kerr and its associates will be a great addition to our family of companies.

Also in September, we launched another innovation in pharmacy healthcare as we announced our long-term partnership with Theranos to provide new, less invasive lab testing services to customers at Walgreens.

This service is currently available at our Palo Alto, California store, and we have plans to expand later this year.

And, finally, we successfully transitioned on September 1 the distribution of our branded pharmaceuticals to AmerisourceBergen, executing seamlessly to begin our 10-year strategic relationship.

Fiscal 2013 was a year of major strategic progress as we advanced the transformation of our Company for long-term sustainable growth and value creation.

As you know, we worked hard throughout the year to improve our performance in our Daily Living business.

And we continued to see growth and strong results in Pharmacy and Health and Wellness.

That performance across our business resulted in record annual sales of $72.2 billion and record annual adjusted earnings per share of $3.12.

We continued to make progress in our strategic partnership with Alliance Boots, achieving $154 million in combined net synergies, exceeding our previous estimate for the year of $125 million to $150 million.

We generated $4.3 billion in operating cash flow and a record $3.1 billion in free cash flow.

We distributed more than $1 billion in dividends this year to our shareholders, increasing the dividend for the 38th consecutive year.

We filled a record 821 million prescriptions for fiscal 2013, representing a retail prescription market share of 19.1% for the year.

In addition, we made substantial progress on a number of our key initiatives.

We launched our Balance Rewards program last September.

The program has now become the fastest growing loyalty program in the world with more than 85 million people enrolled to date.

Alliance Boots has nearly 20 years experience running the leading UK loyalty program.

And our partnership with them gives us the benefit of their experience which we will leverage as we continue to enhance our program.

And, finally, with our strategic partnership with Alliance Boots and our long-term relationship with AmerisourceBergen, our three companies are best positioned to create a pharmaceutical supply chain unmatched in the world.

Now I'll take you through the high-level results for the quarter.

As always we'll be presenting numbers on both a GAAP and a non-GAAP basis.

As you saw in our release this morning we reported fourth-quarter sales of $17.9 billion, up 5.1% from $17.1 billion a year ago.

GAAP operating income for the quarter was $1 billion, up 75.3% from $586 million last year.

Adjusted operating income for the quarter was $1.1 billion, up 31.6% from $838 million in the fourth quarter of 2012.

GAAP earnings per diluted share were $0.69 in the fourth quarter compared to $0.39 last year, up 75.9%.

Fourth-quarter adjusted earnings per diluted share were $0.73, up 15.9% from $0.63 in the same quarter last year.

GAAP and adjusted earnings per diluted share both include a positive $0.03 per share net impact from certain litigation matters.

Turning to our performance for the fiscal year, sales were $72.2 billion compared to $71.6 billion last year, up 0.8%.

GAAP operating income was $3.9 billion, up 13.7% from $3.5 billion in fiscal 2012.

Adjusted operating income for the year was $4.7 billion compared to $4.1 billion in 2012, up 14.1%.

Our full-year GAAP earnings per diluted share were $2.56, up 5.7% from $2.42 last year.

And on an adjusted basis, earnings per diluted share were $3.12, up 6.5% compared to $2.93 last year.

Looking at our gross profit dollar growth and SG&A dollar growth on a GAAP basis, this quarter the spread was $319 million.

On an adjusted basis the spread was $156 million.

Adjusted gross profit dollar growth increased in the quarter by $216 million or 4.3%.

We also continued our strong focus on cost control as adjusted SG&A dollar growth rose $60 million or 1.5% in the quarter, which included a 1.1 percentage point net benefit from certain litigation matters.

Our continued focus on our strategic growth drivers through the quarter and the fiscal year generated results across our business.

We continued to create a Well Experience, introducing new products and formats, and making other investments in our Daily Living business.

The ongoing innovation in Pharmacy and Health and Wellness continued to change the relationship we have with customers, patients and payers, and helped lift our market share.

And we strengthened ties with our partners Alliance Boots and AmerisourceBergen, bringing us closer to becoming the first global pharmacy-led health and wellbeing enterprise.

As we create a Well Experience we are transforming the customer experience across all of our touch points, channels and formats.

As we discussed with you at our Analyst Day, we continue to focus in four areas -- improving customer value, providing innovative products and services, developing a systematic localized offering, and designing the most relevant network and formats.

Today I'll discuss some of the progress we've made this year.

We finished the fiscal year with more than 500 Well Experience stores across the nation, breaking out of the traditional drug store format with cutting-edge design, new assortments and an integrated healthcare offering.

We also now have 12 flagships, the ultimate Well Experience store.

We opened six new flags in fiscal 2017, including in Washington DC, Boston, and San Francisco.

In beauty we launched the Boots No7 women's skin care line at the grand opening of our 8,000th store, our Los Angeles flagship.

No7 products and Boots Botanics skin care line are now available online and in select flagship locations.

In addition, we're rolling out both lines to the Phoenix market by the end of the year.

We also introduced the Boots No7 men's product line in stores across the country this summer, as well as two other high-profile UK beauty lines, Indeed Laboratories skin care and Mark Hill hair care.

Our private brands are also giving customers a reason to come to Walgreens.

We invested significantly this year in our product lines, like Well at Walgreens, Delish, Nice!

and Well Beginnings, introducing 400 new items in the fourth quarter, and increasing our private brand penetration in our front-end sales by 90 basis points year over year to 22.3% this quarter.

In addition to these strategic initiatives last quarter, we implemented a 3-point plan to balance our investment in sales and margin in our Daily Living business to drive profitable growth.

First, we made adjustments to our promotional investments, with particular focus on our weekly ad.

Second, we worked to maximize the value of our Balance Rewards program, highlighting redemption, rewards and dollar value of points earned in both our stores and our circular.

And third, we began enhancing our store segmentation to ensure we meet the local needs and preferences of our communities.

The result of that plan was our front-end comp increased 1.6% in the fourth quarter compared to the same period last year, showing growth in every month beginning in May.

Traffic also improved through the past two quarters compared to last year.

And in addition, while final numbers for the month are not available, we have seen further improvement in our comp sales and traffic data in September.

Final numbers for the month will be available in our normal monthly sales release on Thursday.

Turning to our strategy to transform the role of community pharmacy, we're making good progress across our business in core pharmacy, enterprise specialty pharmacy, and health and wellness.

We're advancing our work across these three businesses by providing even more comprehensive care to our customers and patients, developing a differentiated experience that our competitors can't easily match, and we're becoming a strategic partner of choice.

We've made significant progress in our Pharmacy and Health and Wellness businesses.

And I'll take you through a few of the highlights.

With the win back of Express Scripts patients beginning last September, and the successful extension of other major pharmacy relationships, we now have greater predictability on rates in our commercial book of business, meeting our principle for fair value for the services we provide.

Through our preferred relationship with top Medicare Part D plans, we improved our market share with an important customer segment, older Americans.

Our Medicare Part D share grew by 120 basis points this fiscal year, outpacing the industry.

As a result, we've also increased overall retail pharmacy market share to 19.1% for the year.

We rebranded our nearly 400 Take Care clinics as Healthcare Clinics at Walgreens and expanded the services we offer.

We added chronic care assessment, treatment management to our preventive and acute offering.

We also continued to build on our successful immunization program, a foundation of our effort to transform community pharmacy.

We administered more than 8.5 million total vaccines in fiscal 2013 compared to 6.7 million in the prior year.

We remain the only chain pharmacy providing all 17 CDC recommended vaccines in every state where we can provide them, and the largest retail provider of flu vaccines in the country.

And to improve the experience we offer specialty customers, we launched an alliance this year with the Cystic Fibrosis Foundation to offer industry leading pharmacy services to patients through CF services, especially pharmacy, that provides medication and treatment support to the cystic fibrosis community.

We're also improving support to specialty patients by providing more access to limited distribution drugs for cancer, rheumatoid arthritis and other conditions treated by specialty drugs.

The specialty pipeline is robust.

And this year we gained access to 21 new limited distribution drugs.

We're making them available across our unique collection of enterprise specialty assets, which includes central, retail, health system, and community pharmacies.

And, finally, our WellTransitions program, which provides medication therapy management support to patients in the hospital and through their discharge, was recently endorsed by the American Hospital Association for improving medication adherence and reducing hospital readmissions.

Script comp for pharmacy shows the momentum in our performance throughout the year.

In the fourth quarter prescriptions filled in comparable stores grew by 7.1% over the same period last year.

Looking at the results over two years, which Wade will show you in his section, our script comp improved from the third to the fourth quarter.

We also saw solid progress this year on our work to establish a global platform.

With this growth driver we're focused on designing a winning global organization, optimizing the global supply chain, expanding our own brand portfolio, leveraging the best practices, capabilities and innovations, and pursuing new market opportunities.

We launched our joint venture in Bern, Switzerland this year.

And thanks to the work of our joint teams, achieved $154 million in combined net synergies for the fiscal year.

Our strategic relationship with AmerisourceBergen is also making an impact.

They began daily deliveries of our branded drugs to our stores chain-wide as of September 1. In addition, we purchased $224 million of AmerisourceBergen stock as of August 31.

Finally, we announced that Alex Gourlay, the Chief Executive of the Health and Beauty Division for Alliance Boots, is joining our Company.

He will serve as Executive Vice President and President of Customer Experience and Daily Living beginning today.

It's great to have Alex come to Walgreens.

He brings tremendous depth and experience from Boots in their health and beauty business.

And we are looking forward to his leadership of our Daily Living division.

Fiscal 2013 was a year of solid progress.

Looking ahead to fiscal 2014, we have real momentum, yet more work to do.

While we're still operating in a challenging environment, we will continue to focus on execution in our core Daily Living and Pharmacy and Health and Wellness businesses.

We're comfortable with the adjustments we're making in our promotional investments in Daily Living, driving both sales and margin to advance profitable growth.

With our momentum we're now turning our attention to flu season and the holidays, our busiest season.

In Pharmacy, Health and Wellness, we continue to be a preferred provider for Medicare Part D. And we're working closely with our key partners to ensure our customers can take advantage of lower co-pays and more access to services this season.

With both our Smart90 Walgreens offering and our Theranos launch of lab testing, we have new products in the marketplace that will help lower costs for our customers and improve their health outcomes, supporting our purpose to help people get, stay and live well.

On our global platform we expect to accelerate the contributions from our strategic partnerships with Alliance Boots and AmerisourceBergen through fiscal 2014.

Wade will update you on the financial contributions we expect from both relationships.

In closing, we are confident we have the right strategic growth drivers in place to continue to transform today's challenges into opportunities, to deliver exceptional value, and build toward our future as a global pharmacy-led health and well-being enterprise.

In addition to executing on our three key strategic growth drivers, we also remain steadfast in managing ongoing reimbursement pressure and are constantly looking for ways to streamline our cost structure to prepare our Company for our global future.

We're setting our priorities against our strategies to ensure we can continue to grow in an increasingly competitive marketplace.

And finally today, I want to thank our 248,000 employees for their commitment and dedication.

They are the driving force behind so much of what we talk about on these calls, the experience we offer our customers and the services we deliver.

And they deserve much of the credit for our results.

Thank you.

And with that, I'll turn the call over to Wade.

Thank you, Greg.

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

This morning I'll take you through our quarterly results as well as update you on our investments and partnerships with Alliance Boots and AmerisourceBergen.

As Greg noted earlier, for the quarter we reported a GAAP EPS of $0.69 per diluted share based on 957 million shares.

GAAP EPS translates to an adjusted EPS of $0.73 for the quarter, as illustrated by this chart.

In most quarters we add back the LIFO charge, but in this quarter the LIFO benefit of $0.01 per share is negative in the GAAP-adjusted walk, which I'll explain shortly.

Acquisition related items were $0.10 per share consisting of $0.04 of acquisition related amortization costs, $0.01 of acquisition related costs, $0.04 from Alliance Boots related tax, and $0.01 of Alliance Boots related amortization.

Finally, special items were a net reduction of $0.05 per share.

As noted, there was a $0.01 per share in cost associated with the Company's charge in prescription drug wholesalers, which was more than offset by the positive impact of $0.06 related to the warrants issued by AmerisourceBergen.

In the quarter GAAP and adjusted EPS both included a positive $0.03 per share net impact from certain litigation matters.

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

Comp prescription sales increased 6.4%.

Comp front-end sales increased 1.6%.

And total comparable store sales increased 4.6%.

Comp prescriptions filled increased 7.1% versus a script comp of negative 8% in the year-ago period.

Recall the year-ago quarter was negatively impacted by our exit from the Express Scripts network.

In the fourth quarter the front-end comp increased 1.6% and traffic decreased by 1.9%, while basket size increased by 3.6%.

As Greg discussed, our front end is now term positive on both a one- and two-year stack basis, primarily due to the momentum of our strategies in our new promotional decisions designed to balance traffic, basket and profitability.

Looking at comparable store script numbers, our retail scripts were up 7.1%.

This continues to reflect the fundamentals of our underlying business, the return of Express Scripts customers, and our continued progress in winning new Medicare Part D customers.

With respect to margin, our FIFO gross margin was 28.9% in the current quarter, compared to 29.1% last year, a 20 basis point decline.

Pharmacy margins increased as a result of the ongoing margin benefit from generics that was partially offset by market reimbursement pressure and continued growth of our 90-day retail program.

The front-end margin was negatively impacted by increased promotional investment.

But we are pleased with the results we are seeing in improved traffic and front-end comp in a challenging consumer environment.

Taking a look at our longer-term FIFO gross margin trends this quarter's 20 basis point decline was up against a 60 basis point increase a year ago.

The pharmacy margin was positive in the quarter but was more than offset by the negative change in the front end margin.

Moving forward, front-end margin will continue to be impacted by our new promotional adjustments until we cycle these changes in the latter half of fiscal 2014.

This next chart illustrates the impact that new generic drug introductions have on our monthly prescription sales comps.

You can see that the generic impact on comp prescription sales was greatest in the first quarter of the fiscal year, reaching a negative 9% versus the generic impact in the most recent quarter of approximately negative 2%.

The highlighted quarter showed the number of new generic drug introductions have slowed versus a year ago.

In our experience, the margin change resulting from generics is inversely correlated, and slightly lagged to the impact of generic sales changes.

That is, the strongest positive effects on margin typically occur shortly after generic impact on prescription sales when it's most inflationary.

And, conversely, the weakest positive effect on margin typically occurs shortly after the generic impact on prescription sales is the least deflationary.

Transitioning now to gross profit, this slide illustrates our quarterly gross profit dollar growth trends for the past eight quarters on a GAAP basis.

The next slide shows the trends on an adjusted basis.

Adjusted gross profit dollar growth slowed slightly from a positive 5.3% in the third quarter of 2013 to a positive 4.3% in the fourth quarter.

Likewise, on a two-year stack basis, gross profit dollar growth stepped down sequentially as we lapped a 3.2% decrease from the prior year's fourth quarter when we were out of Express Scripts network.

Some of the slowing in the one- and two-year gross profit dollar growth stacks can also be attributed to the slowing generic impact I just described, as well as the continued strong adoption of our various 90-day at retail programs.

As Greg said, we made solid SG&A progress in the quarter.

To get to adjusted SG&A dollar growth, you can see that our GAAP SG&A dollar growth was 0.9%, which included 0.1% for Walgreens acquisition related amortization, and a 0.3 percentage point related to the Company's change in prescription drug wholesalers, as well as a benefit of 1 percentage point from lower SG&A expense for the acquisition related costs.

Netting these items resulted in an adjusted SG&A dollar growth of 1.5% in the quarter.

GAAP and adjusted SG&A dollar growth both included a benefit of 1.1 percentage points from the net impact of certain litigation matters.

Shown here are the SG&A dollar growth trends for the past eight quarters on a GAAP basis.

And the follow-on slide shows a similar trend on an adjusted basis.

As I mentioned earlier, the adjusted SG&A dollar growth for the quarter was 1.5% year-over-year increase versus the 1% in the fourth quarter of fiscal year 2012.

Looking at adjusted SG&A dollar growth on a two-year stack basis, as you can see, there was a 180 basis point sequential step down from the third quarter of 2013.

We are very pleased with the SG&A dollar growth in the quarter.

And we continue to be very focused on continuing to drive efficiencies across all aspects of our business.

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

Now let's review the two-year stack trends on an adjusted basis.

Two-year stack adjusted SG&A trends improved versus a year ago with 0.5% growth in the fourth quarter of 2013, down from 3.4% last year.

During the quarter, the rate of growth in adjusted FIFO gross profit dollars exceeded adjusted SG&A dollar growth by 280 basis points.

As you can see, this is the second consecutive quarter with a positive spread, and we're very pleased this is moving in the right direction.

Excluding the impact of net litigation, our spread was 170 basis points, meaningfully above our ongoing fiscal year objective of 100 basis points.

Turning to other aspects of our income statement, this quarter included a LIFO benefit of $8 million versus the provision or charge of $132 million a year ago.

The significant change in LIFO was primarily driven by unusually high branded drug inflation in the year-ago quarter, and lower than anticipated prescription branded drug level inventory as we initiated our transition to AmerisourceBergen.

Our LIFO rate for the year was 2.67%, down from 3.3% a year ago.

Net interest expense for the quarter was $55 million, up $18 million from a year ago.

The increase in interest expense was primarily attributable to the $4 billion note issuance associated with Alliance Boots transaction and also includes a $16 million negative impact from a non-cash fair market value adjustment to our interest rate swaps associated with our $1.3 billion notes that were repaid in August.

Our effective tax rate was 35.4% versus 35.8% last year.

Average diluted shares outstanding were 957 million shares versus 895 million shares last year.

And as a reminder, the change is primarily due to the rolling impact of the 83.4 million shares issued for the Alliance Boots investment, and to a lesser extent the impact of a higher stock price on the in-the-money options which are counted in diluted shares.

In Q1 '14, you can expect a diluted share count of approximately 960 million shares, subject to changes in the current share price.

And you can also expect interest expense of approximately $35 million.

On a go-forward basis, Walgreens' tax rate expects to be about 37.5%, excluding the various impacts associated with Alliance Boots partnership.

Cash and cash equivalents were $2.1 billion in the fourth quarter versus $1.3 billion a year ago.

Accounts receivable increased by 21.5%, primarily due to the return of Express Scripts prescriptions, while accounts payable increased 5.7%.

LIFO inventories were down 2.6%, and FIFO inventories were up 0.6% year over year versus a sales growth of 0.8%.

Overall, net working capital decreased by 0.6% versus a year ago, and we are pleased given our strong focus in this area.

During the fourth quarter we generated $1.1 billion in cash from operations versus $768 million a year ago.

And free cash flow in the quarter was a record $785 million versus $320 million a year ago.

As a company, we remain very focused on cash flow.

Returning cash to shareholders remains a key initiative for Walgreens as evidenced by the 22.2% year-over-year increase in dividends per share, distributed to shareholders in fiscal year 2013.

As previously announced, in fiscal 2014 shareholders will receive a 14.5% increase in their dividends per share.

Our goal remains a dividend payout ratio in the range of 30% to 35%.

Our capital allocation policy has four primary components, beginning with continued investment in our key strategies.

In addition to returning cash to shareholders via dividends, we are also focused on delivering our 2016 goals, which includes a combined net debt level of $11 billion grounded on the basis of very solid cash flow generation.

During the past year, Walgreens repaid $1.3 billion of debt, while Alliance Boots reduced their net borrowings by $1.8 billion.

We also invested $224 million to purchase AmerisourceBergen stock in the quarter at an average cost of $56.55 per share.

As a reminder, we are not currently repurchasing Walgreens shares.

As we've stated on previous occasions, we deal with a fair amount of quarterly variability in our business, including seasonality, reimbursement rate changes, generic wave trends, flu trends, and changes in macroeconomic conditions, among others.

Looking forward let me give you some general thoughts on fiscal 2014 by quarter.

We expect Q1 '14 will face the headwind of a relatively slowdown in the introduction of new generic drugs.

But will be helped by an easier compare to a year ago because Q1 '13 adjusted EPS was negatively impacted by the diluted effect of issued shares and interest associated with the Alliance Boots transaction without any meaningful synergy or equity income benefit due to the three-month reporting lag.

Q2 '14 faces a challenging comparison as Q2 '13 benefited from one of the strongest flu seasons in the last 12 years and also benefited from our peak in the pharmacy margin during the recent generic wave.

In addition, keep in mind that plan changes with great adjustments typically occur in January.

And last year the high rate of introduction of new generics moderated the impact of those adjustments.

This year, however, we anticipate a very low rate of introduction of new generics in the second quarter.

Generic waves should begin to help us in the latter half of fiscal 2014, and our synergies should ramp throughout the year.

Lastly, our strategic relationship with AmerisourceBergen is expected to be modestly accretive from a distribution perspective in fiscal '14 as the full generic distribution cut-over benefits are expected to be realized in a more meaningful way in fiscal year '15.

Shifting to our quarterly Alliance Boots accretion walk, as shown, we realized $56 million before tax in synergies during the fourth quarter and $33 million after tax.

Amortization adjustments amounted to $8 million for deal amortization and $11 million for brand amortization.

After tax, Alliance Boots' equity earnings were $90 million for the fourth quarter on an adjusted basis.

And on an adjusted basis the income from our Alliance Boots investment was $109 million and the incremental after-tax interest expense to Walgreens was $14 million.

After the impact of share dilution, the accretion equaled $0.08 in the fourth quarter.

Looking forward, we estimate the adjusted EPS accretion from Alliance Boots for the first quarter of the fiscal year 2014 to be approximately $0.05 based on our current estimates of IFRS to GAAP conversions and foreign exchange rates.

And moving forward we will provide our accretion estimates on the call for each quarter in advance.

We estimate the combined synergies for fiscal year 2014 to be in the $350 million to $400 million range.

We are very pleased with both the operational performance of Alliance Boots and the combined synergies we are achieving.

And we feel we are just scratching the surface of things that we can do together in the coming years.

I'd like to close now by reminding you of our fiscal 2016 goals.

$130 billion of combined revenue, $8.5 billion to $9 billion of combined operating income, $9 billion to $9.5 billion of combined adjusted FIFO operating income, $8 billion of combined operating cash flow, total synergy goal of $1 billion.

And, as I mentioned earlier, $11 billion of combined net debt, again by the end of fiscal 2016.

Later this fiscal we will review the components of the relevant measures with respect to our progress, risks and opportunities across each of these measures.

So now, in closing, let me just share a few final thoughts.

This quarter reflects progress against many of our key focus metrics, such as accelerated top-line growth, solid cost management, and record free cash flow.

We also had many other meaningful proof points with respect to our long-term strategies, such as strong Alliance Boots' results and above-goal synergy delivery, a successful start to our AmerisourceBergen partnership, and a continued evolution of our healthcare strategy, which at its core leverages our best-in-class nationwide retail footprint and more than 70,000 healthcare professionals.

I feel strongly that we are only at the very beginning of the next leg of our Company's journey, a journey that started over 110 years ago.

A journey that can put us at the epicenter of delivering better healthcare outcomes in the US and abroad, make everyday living a little bit better, and change the paradigm of how we work with large global suppliers in an ever-increasingly changing world to create value for them, for Walgreens and, most importantly, for the customers that we serve.

I'm sure that there will always be challenges along the way and we're very appreciative of stakeholders who have taken the long view.

In that vein, I believe the megatrends we face lend themselves to our unique assets and capabilities.

Related, our strategies are differentiated and sound, and, executed well, should create significant value for shareholders.

In short, it's ours to win.

Thank you again for your kind attention and support.

And now I'll turn the call back over to Rick.

Thank you, Wade.

That concludes our prepared remarks.

We are now ready to take questions.

(Operator Instructions)

Edward Kelly of Credit Suisse.

Hi, good morning guys.

Can we start with the gross margin?

I'm a little confused.

The FIFO gross margin down 20 basis points, pharmacy up, front-end down slightly.

But I don't really understand how the front-end margin maybe is not down more, or pharmacy not down, given the total Company down 20 basis points.

Because front end is only 35% of sales or so, right?

And it's only down slightly.

So, if you could maybe just help us reconcile exactly what's going on there.

Yes, Ed, I'll start and then maybe Wade can give some actual dollars.

But as far as, as we said, directionally, pharmacy was up, obviously, with the help of the generics that we had for this past quarter, offset, obviously, by ongoing reimbursement pressure but also with our 90-day drive that we have.

One of the focuses we have is to continue to give customers what they're looking for, and that's their chronic medications in 90-day quantities at retail.

So that's an impact that's working the other direction, certainly, in pharmacy, but we think it's the right thing to do long term.

As far as the front end, as we've said, we think we are making good intelligent investments in price and promotion.

Feel like we are getting steady momentum back into the front end of the business.

And we'll continue to make sure that we do that going forward.

But, as we said, we always planned to make some investment in the front end, and that's exactly what we're doing.

Are you happy with the comparable gross profit dollar growth in the front end?

How does that look and how has that changed since you started investing in the promotions?

Yes, I think we had solid gross profit dollar increase.

And then when you compare it to the SG&A dollar growth, and we've said all along that our goal was to have 100 basis points spread between the two over the long haul.

And I think with the performance that we've turned in this quarter we're pleased with the way both of those worked in unison.

Yes, just to restate, I really think that we really look at it from a gross profit dollar basis, as you know.

And I think we're really finding a good balance with some good momentum we have in growth right now, with also managing the margin wisely.

Okay.

And, Wade, you gave some color on 2014, which is definitely helpful.

I just had a couple follow-ups on that.

Given the fact that you have some tougher comparisons to next year with the flu early on, less of a generic benefit, does gross profit dollar growth slow from here over the next few quarters?

We don't give, obviously, specifics on that kind of detail.

But I think that fundamentally we feel very good about our business going forward.

I think we just want to provide some color that quarter to quarter there can be some lumps, some ups, some downs.

But in aggregate we feel good about our ability to drive gross profit dollars and to manage SG&A, as well.

Okay.

And on the SG&A side, you've done a lot of good stuff from a cost control perspective.

How much of that do you think you can carry forward into 2014?

Is there still opportunity there?

I think we can always be better every day, forever.

And that's one of the things we're working hard at, is to really put continuous improvement and continuous focus on driving efficiencies and effectiveness at every aspect of our business.

So I'd say yes.

Okay.

And Alliance Boots equity income, first quarter you didn't have it.

Seasonally how did that business look in the first quarter?

The first quarter is by far their toughest quarter of the year seasonally.

So, again, we guided to roughly $0.05 accretion for the first quarter.

It's summer period, not holiday period.

So, both in the wholesale and retail business, it's a low seasonal point.

Okay.

And then just one last question for you, modeling.

There's been a lot of talk, think, amongst investors about what the real tax rate is that we should be using on the synergies.

Any color there?

What I'd say is we'll do some work to try to figure out how we can provide more clarity and guidance as we go forward.

Obviously the rate that I gave today looking forward was a Walgreens standalone rate.

Alliance Boots has a different rate so you have to do the blend for that.

And then, of course, the work we're doing together in synergies and other things is a bit more complex.

But we'll do some work to see how we can provide better understanding as we move ahead.

Okay, thank you.

Meredith Adler of Barclays.

Yes, thanks for taking my question.

I was wondering, as long as we were talking a little bit about the investment you're making in the front-end comp, are you making the investments that you expected to make?

And are you getting the response that you expected to get?

And can you talk a little bit about how you think that plays out in full-year '14?

You only started this, I think, in May, this increased promotion.

So, do you think it lasts through May of '14 or do you think that it's something you'll be doing for longer until the frequent shopper program really gets huge traction?

Meredith, I feel good about the investments that we have made and are making.

And, as I've said, that's a balance between the right amount of investment and to drive the right amount of performance.

But I think the team's done a very good job in being in surgical, using the data that we're getting from our Balance Rewards program to help us understand how to strengthen the Sunday circular, as well as begin to use individual programs through Balance Rewards to drive traffic and basket.

So I think I would say yes, that we are seeing the expectations that we had with the investment we made.

Going forward, I think we will continue to try to drive improved performance.

And I think what we feel good about, that we're going to be able to use, will be the increase in information we get from Balance Reward and the data that we have from the program.

Not only to make even better decisions on what we promote and at what pricing, but also more and more individual marketing programs through the Balance Reward program itself.

As I said, the other thing that's needed is, with Alex here now working with our team, we'll be able to bring some of the best practices from their program into our Balance Rewards program.

So I think it's going to be, as I've said before, like a locomotive.

This isn't a jet aircraft.

We're going to continue to just gain steam and try to continue to gain momentum, and feel confident about it.

Okay.

And then I have a much more technical question, maybe for Wade.

And maybe you answered this in the slides, although you went through the slides quickly.

You have other income.

And is that the warrants, with the fair market value of the warrants?

And there's a number in one of your schedules at the end of the press release that has $62 million as opposed to, whatever -- $43 million, $44 million -- for the other income.

I don't understand what the difference is.

It is the fair market value of the warrants.

And why is it a different number than what you had in that schedule?

Yes, and it's an AB share, as well.

That's the difference.

Recall the warrants are split.

Effectively, Walgreens has 50% of those warrants and AB effectively has 50% of those warrants.

Could you just explain how that shows up in the numbers?

Is that because it goes into your share of AB?

We can work it offline, but that's effectively right.

And so these have basically been for purpose of adjusted earnings, they've been net redacted out.

Okay.

And then I just have just one more question about the gross margin.

Could you talk again -- I know, Greg, you talked about the expectation for generics next year.

But are we saying that most of the benefit of generics for next year comes really towards the tail end of fiscal '14?

That's right.

Yes, it is Meredith.

And, in fact, the graph that we showed, that showed the volume certainly last year shows what we're up against.

But then as far as first and second quarter, they're light quarters, and in the second half we'll see a lift again.

But we're also against an easier compare in the back half, but we're up against a tougher compare the first half.

Okay.

And then just one more question about SG&A.

You have done a pretty good job of managing expenses.

Could you just talk about whether there's any one initiative or a group of initiatives that you would point to that have been helpful in flowing the growth of SG&A?

I think our folks in the field, Mark Wagner and Kermit and team, have done a tremendous job in really insure that our SG&A and our labor in the stores, and our expense, matched the volume as we bring it back.

I think our store people have done a tremendous job in becoming more efficient.

We're really focused, Meredith on trying to take more and more tasks out of the stores so that we can free our folks that are in the stores up more to spend time with customers.

So, I would give probably 80%, 90% of the credit to our folks in the field.

With that, for our folks in corporate, we have really this year, I think, done a tremendous job in getting focus on the key projects and initiatives that will move the needle for us going forward in a big way, and stop doing a lot of things that will not.

And combine those, and I think we feel very good with the focus we have and the ongoing focus we will keep.

Great, thank you very much.

Robert Jones of Goldman Sachs.

Thanks for the questions.

I wanted to ask about the ramp of synergies.

I see you're calling for $350 million to $400 million in fiscal '14.

On the generic procurement side specifically, I was wondering if you guys could comment on whether or not the recontracting with your generic manufacturers, where you are in that process.

Is that close to complete?

And as it relates to that, how should we be thinking about the ramp on the generic procurement side specifically?

Is that something you expect within the overall bucket of synergies to come in a little bit faster?

Or is that pacing along with the other areas of synergies?

Yes, a couple things there.

One, obviously, since we exceeded our goal this year and hit $154 million, and we effectively started at zero, that means by the end of the year you have to be close to $300 million.

So as we continue to ramp that, that's why we gives the objectives and goals for the next year, that we have pretty good visibility on.

With respect to generics, our team whose leading it -- Jeff Berkowitz and John Donovan in Bern -- have made a tremendous amount of progress.

I think we're not going to give too much detail on it because it's work, it's obviously making this happening as we speak.

But I would say that I think they're working with the likely suspects to find really win-win relationships where we can bring a lot more business and volume to the players, and help them and they can help us.

So we're very confident that we're going to create a lot of value there over time.

But I'll just leave it at that.

And then just to clarify, Wade, the $350 million to $400 million in synergies, that does not include any additional generic procurement benefits from AmerisourceBergen purchasing?

Or does it?

This is really primarily, this is just us and Alliance Boots.

Again, there's six work streams of which generics, we've always said, is the biggest one.

But all the work streams are now creating value.

Any sense you can give us just as far as timing?

I know it's still a little bit earlier on in the process than where you are with AB.

But any sense you can give us on when you might be in a position to share an additional synergy number related to AmerisourceBergen?

Perhaps maybe in future calls we'll talk a little bit more.

Really right now the core focus of AmerisourceBergen, as Greg has said, we've now basically moved all the branded drugs into the AmerisourceBergen distribution network, and that's going fantastic.

And now, over the next 9 to 12 months, we'll be moving all of the generics.

And the view of that will come farther out.

But perhaps we'll guide on that later.

Bob, I will say that I happened to be in Bern last week or two weeks ago with the Stefano Pessino and Steve Collis and the team.

And I tell you, there is a lot of confidence, a lot of energy with that team.

So, we feel good going forward with what that team is going to be able to deliver.

Got it, that's great.

And if I could just sneak one more in.

On the front end, obviously promotional activity seemed to be a big focus currently.

I know you talked about the more targeted promotional programs.

And it sounds like these, obviously, have had a negative impact in this quarter and you're expecting that to continue in the front half of fiscal '14, if I heard you correctly.

I was just wondering if you could give us any order of magnitude as we think about the cadence into Q1 and Q2.

Is it more or less negative than what we saw on the gross profit margins in this quarter?

Anything directionally there would be really helpful, thanks.

I don't know if we give actual numbers, Bob, but I will say I think the investment the team's making over the past several months is beginning to drive the momentum.

I would say that we're pretty much right on as far as the order of magnitude that we need to continue to invest to drive that steady momentum.

So, I wouldn't see any probably more aggressive investment.

I think we'll just continue to take it quarter by quarter and make the right investments.

But I feel good with the level of investment we're making now, and I think that can continue to drive the momentum we're looking for in the front end of the business.

I also think balancing the promotional strategies is one small component of what the teams are doing -- driving the well experience, improving our own brand portfolio, more relevant localized tailored formats.

There's a lot of great work going on that's very structural and long term in nature.

Our customer satisfaction keeps growing.

I think this is the bigger story of why we feel confident as we move forward here.

Makes sense.

Thanks so much.

Robert Willoughby of Bank of America Merrill Lynch.

Wade, what is the inventory run rate we could expect with ABC now controlling more of the flow here?

Should it drop meaningfully?

The run rate of what?

-- I'm sorry, Bob?

Your inventory.

With our inventory, effectively we've reduced substantial inventory, all of our branded, effectively, in the cutover.

But as part of the agreement we've also increased our days payable.

So the working capital balances out to a fair degree.

It just ends up on different lines.

Okay.

Net-net continued current run rates then overall for working capital?

Yes, I would say that's a pretty good assumption.

And just another question, in terms of the real estate that you own for your stores, that metric was always 19%, 20%.

Where does that stand now?

It's still about that.

Historically that was both for how we wanted to balance our balance sheet as well as there are just some areas where it's more advantageous to own than it is to do a structured lease agreement.

But I think we'll probably be about that zone moving forward.

That's great, thank you.

Ricky Goldwasser of Morgan Stanley.

Yes, hi.

Good morning.

You mentioned that you were at about $300 million of a run rate at the end of fiscal year '13.

So, when you think about your synergy guidance for '14, the $350 million to $400 million, what is the exit run rate that you're expecting to achieve?

The exit run rate?

Yes, the exit run rate for '14.

It would be obviously higher than the higher end of that limit.

But we haven't given exact guidance because we give rise to the following year.

It would be higher than $400 million.

Right, but should we think about it as $500 million to $600 million range?

I guess it all depends on the magnitude of the ramp up?

Yes, there's moving parts.

So if I gave you an exact number it would probably be plus or minus wrong.

But I think we feel confident that year by year by year we can keep delivering incremental synergies on these fixed streams.

And we're also increasingly finding new areas that we can focus on, not only drive cost efficiencies but just take the capabilities and drive top-line benefit, as well.

Okay.

And can you share with us, when you think about Alliance Boots for fiscal year '14, any color on what's the top line and EBIT growth that we should expect from AB?

And understanding that there is some seasonality as we've seen in fiscal year '13 but just overall for the year.

We're not going to comment on their business any more than we feel they are obviously performing very strong in a challenging environment.

I think you saw obviously the last year delivered strong numbers.

I think that they feel that the wholesale business continues to do well in a challenging environment, as well as the retail business and being able to drive profitable meaningful growth.

And then just a follow-up on the SG&A.

Obviously, I think, in response to an earlier question, you said that you think that you can continue to improve SG&A spend going forward.

But the growth initiative on SG&A on an adjusted basis was about 2.6%.

So really significantly below your long-term steady state guidance of 3.5% to 4.5%.

So, as we think about our model for fiscal year '14, should we stick with the 3.5% to 4.5% or are you now at a new baseline of growth?

What I'd say is that I'd just revert you back to that objective we have, that 100 basis point or more spread over time on SG&A to gross profit dollar growth.

There are also in SG&A, there's lots of lumps that happen quarter to quarter, and even fiscal to fiscal.

The key takeaway is we are very focused, as Greg said, on really prioritizing the organization around the things that really matter.

We're really looking at everything to see does it create value.

Things like indirect spend, things that we buy that we don't resell, do we need it, is it cost optimized, is it efficient.

So, again, I think it's really more of that ratio that's important.

Because even that number that you alluded to, the 2.6%, also includes things like USA Drug.

So it's not really even a true organic number, which would have been better than that.

And these things can change that metric over time, as well.

Okay.

So we should obviously include Kerr, as we think about your SG&A growth for next year.

Yes, right, for sure.

And can you give us a ballpark of what that dollar number would be?

In terms of year-on-year growth?

Yes.

Again, I'd just say that that objective for us is to make that spread or beat it consistently most of the time.

And Kerr is 76 stores so that alone isn't going to really change materially our base SG&A.

Okay.

And lastly on preferred party network, it contributed to your growth last year.

Are you looking to add new partnership, new network partnership on Part D this coming year?

Kermit, do you want to address that?

Ricky, this year, as we were last year in January, we started to have relationships that are preferred with our Medicare Part D providers.

We're excited about the opportunity as we saw our market share grow in this, as Greg said, very valuable older American.

So, next year you'll see us with the same partnerships that we've looked at in the past.

It's a part of our -- if you think about our overall strategy as being a better strategic partner, there's a number of examples out there where we're beginning to see this, not only with the Medicare Part D plan but also with our SmartD90 plan with Express Scripts, where we see that customers will have a choice to get their 90 day at retail at a Walgreens or through Express Scripts home delivery.

So, this strategic partnership is a part of our overall corporate initiative to continue to work with partners.

Okay.

And then, finally, on October 1, open enrollment is starting today.

Can you just share with us your thoughts of how you think ACA is going to impact your business over the next 12 months?

The enrollment period starts today.

We certainly have our pharmacists and all of our people prepared to ask questions as members or those who are affected or impacted come into our stores.

From an ACA perspective, we certainly know there's going to be an increase in the number of people that get insurance.

We are not speculating on what that number is but overall we would anticipate benefiting from that in a number of ways.

Not only from our script volume but when you think about our healthcare clinics, we have over 300 healthcare clinics that provide not only preventive but minor acute as well as chronic care.

We've also been involved in partnership around the ACOs, where people are looking to manage their entire benefit.

And under this exchange benefit design it's a benefit design of both medical and drug.

So we think we're going to play a key role in that as people take advantage of the pharmacy benefit and drive their overall lower medical costs.

Ricky, it's Greg.

I would just add, I think we're looking at it, certainly, for all those reasons, as more of a long-term benefit for us, for all the reasons that have been expressed.

It's a tougher audience, a diverse audience to bring into the program and make aware of.

So, next year is going to be hard to tell.

But certainly from a long term we think it will be a benefit for us for all of the reasons Kermit explained.

Thank you very much.

Steven Valiquette of UBS.

Thanks, good morning, Greg and Wade.

First, in relation to all that discussion on the adjusted gross profit dollar growth.

Is there any preliminary view on the change in LIFO provision and what that might be for FY '14?

In terms of the rate?

Yes, just thinking about it, if you're going to have fewer generic launches, and brand inflation remaining strong, I would think you could have a fairly good-sized LIFO charge overall in FY '14.

So I just want to make sure I'm thinking about that the right way.

And also does the ABC shifting change the way that your LIFO inventory might flow?

The ABC thing absolutely does change, obviously, because it's a different arrangement now and they are managing the bulk of the inventory.

I would say I don't think that we see the rate being materially different than it has been over the past couple years on average.

But there are a lot of moving parts with that, especially when you move from $60 branded to just having generics.

And then as we transition generics over time that will change yet again.

I think maybe as we go forward here next quarter we can provide some clarity, but I don't think it's going to be anything material versus history.

Okay.

And then, also, we've been getting a lot of questions recently on what your tax rate may go down to once you get into your FY '16.

You obviously have a lot of guidance for that year, but tax rate not being one of them.

But if we do assume that step two with Alliance Boots is completed, the question is, could there be a material step down in the tax rate on your income statement once we get into FY '16 versus where that tax rate is currently.

Very simplistically you could blend our rate and their rate on the relative businesses.

Although there are things line sub Part S and other things which can move it off of that number, depending upon how the business is structured.

But I think that if you wanted to model it simply you could probably use the blended rate and be close.

Okay.

I think there's been some discussion that even some of your US operations, if it gets offshored in some way, that even your overall tax rate could go down even lower than what that blended rate would be.

So maybe we can just discuss that more offline, if you want, but that's been something that's been coming up a lot recently, just FYI.

We have no plans for that.

Really, it's managing our businesses as effectively as we can the way they are.

Yes, Steve, none at all.

Okay, great, thanks.

Thank you.

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

Ladies and gentlemen, that was our final question.

Thank you for joining us today.

As a reminder, we will report September sales this Thursday.

And until then thank you for listening.

Bye-bye.

Ladies and gentlemen, this concludes today's conference.

Thank you for your participation and have a wonderful day.