沃博聯公司 (WBA) 2014 Q2 法說會逐字稿

Good day ladies and gentlemen and welcome to the Walgreen Co.

second-quarter 2014 earnings conference call.

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

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

(Operator Instructions).

As a reminder this conference call is being recorded.

I would now like to introduce your host for today's conference, Rick Hans.

You may begin.

Thank you, Nicole, and good morning everyone.

Welcome to our second-quarter conference call, 2014.

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

Also joining us on the call and available for questions are Kermit Crawford, President of Pharmacy; Mark Wagner, President of Store Operations, and Alex Gourlay, President of Customer Experience and Daily Living.

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 also find a link to our webcast on our Investor Relations website.

After this call this presentation and a podcast will be archived there 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 Forms 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 will begin with a review of our financial performance.

Next I will discuss our performance against our three strategic growth drivers and finally I will look ahead to how we are preparing our Company as we head toward fiscal 2015.

Then I will turn the call over to Wade for a more detailed financial review of the quarter and the fiscal year.

This quarter was marked by solid topline growth and performance.

We achieved record quarterly sales and record second-quarter prescriptions filled in spite of continued headwinds from slower generic drug introductions and severe weather.

For the quarter sales were $19.6 billion, up 5.1% from $18.6 billion a year ago driven in part by a 4.3% increase in comp store sales.

GAAP operating income for the quarter was $1.3 billion, up 4.9% from $1.2 billion last year.

Adjusted operating income for the quarter was $1.3 billion, down 4.3% from $1.4 billion in second-quarter 2013.

GAAP earnings per diluted share were $0.78 in the second quarter compared to $0.79 last year, down 1.3%.

Second-quarter adjusted earnings per diluted share were $0.91, down 5.2% from $0.96 in the same quarter last year.

And finally we generated operating cash flow of $1.1 billion in the second quarter and free cash flow of $877 million.

Turning to trends in gross profit dollars and SG&A dollars, in the second quarter on a GAAP basis our gross profit dollars increased 0.8%, or $43 million from a year ago.

SG&A dollars increased 1.6%, or $72 million compared to a year ago.

Adjusted gross profit dollars increased 0.4%, or $22 million compared to a 4% increase in the same quarter last year.

This difference resulted from several key factors -- the shift in the generic wave from a peak in introductions in the first quarter last year to a trough this year, continued to have a negative impact.

The impact which moderated somewhat from the first quarter is expected to continue to moderate in the third quarter and turn positive in the fourth quarter.

A weak flu season compared to last year resulted in fewer cough, cold and flu related prescriptions and lower sales of over-the-counter products compared to the same period last year.

And we also maintained meaningful promotional investments in our daily living business in the quarter.

While we did see some pressure on our gross profit dollar growth we were able to balance that with ongoing cost discipline.

In a quarter with record sales and an increase in comp store sales our adjusted SG&A dollars increased by only 1.7%, or $76 million compared to the same quarter last year.

I want to give credit to our leadership team in the stores who are using their resources efficiently to serve our customers.

In our estimation adjusted gross profit dollar growth would have been about the same as our adjusted SG&A dollar growth if we had not had the impact from severe winter weather.

In the quarter we also made progress on our three strategic growth drivers -- creating a Well Experience, advancing the role of community pharmacy and establishing an efficient global platform.

Today I will provide more details on that progress.

In our Well Experience growth driver we saw the ongoing impact of a value conscious consumer while unseasonably cold temperatures, which I mentioned earlier, further affected our sales.

In response we continued to invest in promotions, increasing front end comp sales by 2%.

We also continued to roll out our Well Experience stores reaching a total of 628 across the country.

We realized market share gains across a majority of Nielsen-tracked categories in our daily living business and in addition average basket size increased 3.4% in the quarter as customers continued to consolidate trips.

This quarter we successfully reached a milestone for enrollment in our Balance Rewards program topping 100 million enrollees.

With almost 80 million active members we now have the largest retail loyalty program in the industry.

We also are leveraging our customer insights from Balance Rewards to evolve our value proposition and simplify promotions to help both our stores and our customers.

On our Well Experience roll out we are pleased with our progress to date.

We continue to refine our store formats to integrate healthcare, provide an elevated beauty experience and also deliver exceptional seasonal and consumable convenience to meet customers' needs.

Also this quarter we expanded and enhanced our beauty offering in introducing Boots No7 in New York City.

We completed the rollout to 10 stores in February and plan to reach 150 stores in the city.

Our New York City expansion follows our successful launch of Boots No7 and other boots brands in our Arizona market in our flagship stores across the country.

Finally, we continue to bring together our world-class digital capabilities to compliment our convenient store locations and leverage our omnichannel contacts to delight customers.

Today, 9 million customers touch the Walgreens' brand everyday at our stores, over the web or through mobile channels making Walgreens a true omnichannel provider.

In our pharmacy, health and wellness business, our script comp was up 2.2% in the quarter.

Our retail pharmacy market share increased to 19% for the quarter, up 20 basis points year-over-year and we filled a record 214 million prescriptions, up 2.8% from the same period last year.

We also continued to grow our 90-Day at Retail program.

According to IMS, in the second quarter the 90-Day at Retail market grew 15% year-over-year while the mail market declined 10%.

Also our 90-Day at Retail volume in the second quarter increased by 17% over the prior year.

From perspective our 90-Day at Retail business alone is as large as one-third of the total mail market industry.

We believe this validates the consumer's value, the ability to receive a 90-day supply at retail from their trusted community pharmacist and that payers are increasingly seeing the value in adding a retail benefit to their mail offering.

In addition, we had a strong season for immunizations with a total of 8.6 million vaccines administered through the first half of the fiscal year.

That's an increase of 11% over the same period last year.

While that increase was mainly on the strength of a strong flu shot season we also continue to build our non-flu immunization business.

For example today we are the number one retail provider of Zostavax, a vaccine for shingles.

Finally we continue to see some impact to margin from the ongoing negative effect related to generics and the volume drop off of controlled pain medications, which we referenced last quarter.

Looking ahead our Medicare Part D program is accelerating our momentum in pharmacy.

In the quarter our Med D volume was up year-over-year with significant growth in new customers on top of strong performance in fiscal 2013.

Our Part D market share for the quarter increased 80 basis points compared to the same period last year.

As we move forward we are well positioned to win with senior customers as a preferred provider in four of the top national plans, giving older Americans more plan choices, which offer them lower co-pays for their prescriptions.

Also as you know we are tightly integrating our healthcare clinics with our pharmacies in hundreds of locations.

We are experiencing growing interest from customers who value convenient, affordable high quality healthcare services and from payers who view Walgreens as an emerging health alternative care model and an important part of the patient's care delivery team.

To help meet this growing demand we have a goal to add nearly 100 new healthcare clinic locations in calendar 2014 on top of our 400 current retail clinics.

And we will continue to expand our network to develop a comprehensive national footprint.

Our strategic partnership with Alliance Boots contributed $0.08 per diluted share to Walgreens' second-quarter 2014 adjusted results.

Combined synergies for the first half of fiscal 2014 were approximately $236 million.

We now expect to exceed our second year combined synergy target and are now estimating $375 million to $425 million in the second-quarter combined synergies.

We estimate that the accretion from Alliance Boots in the third quarter of fiscal 2014 will be an adjusted $0.13 to $0.14 per diluted share.

And we purchased approximately 10.5 million shares of AmerisourceBergen stock as of February 28 and we own approximately 4.5% of the Company.

We continue to make good progress on our global initiatives.

We are pleased with the performance of our global procurement organization.

With the introduction of AmerisourceBergen we believe we will be the largest purchaser of pharmaceuticals worldwide.

More importantly, we are working with manufacturers transparently and collaboratively to help drive sustainable growth in the US and Europe.

Manufacturers have told us they appreciate our approach.

We think this sets us apart from others in the market, benefits our organizations over the long haul and positions us and our pharmaceutical manufacturer partners extremely well for both short-term and long-term sustainable value creation.

In addition, after successfully transitioning our branded drugs to AmerisourceBergen last fall, we began our generic transition this January and are making excellent progress.

We are on track to complete the work by September 1.

As part of the Company's efforts to optimize our cost structure and assets we are also taking a closer look at our store network.

As we mentioned in our press release this morning, between now and August we intend to close 76 stores spread across the country.

Importantly overall this year, including store closings we expect to expand our store base by approximately 55 to 75 locations in fiscal 2014.

We looked at several factors in deciding which stores to close.

We addressed the impact of increased density from our own stores, the impact of real estate positioning within the market and material changes to a store's trade area.

In total this represents a very small portion, less than 1%, of our 8,200-plus store base.

As we position for future growth and markets and communities continue to change we want to optimize our store footprint and make sure our stores remain on the best corners in America.

I also want to note that because most of these stores are located near another Walgreens we will be reassigning a majority of our team members.

The store optimization is expected to result in more than $40 million to $50 million in additional annual EBIT beginning in fiscal 2015 representing an estimated $0.02 to $0.03 in adjusted diluted earnings per share as well as estimated charges of $240 million to $280 million, substantially all of which is expected to be recognized in the third and fourth quarters of fiscal 2014.

Keep in mind that we plan to exclude these charges from our adjusted EPS calculation.

As we head into the second half of the fiscal year we are well positioned to create value and accelerate long-term growth.

We expect to continue to make meaningful investments in our front end to drive the right balance in sales and margins.

We are also focused on our important programs in pharmacy, health and wellness such as Medicare Part D, immunizations and healthcare clinics that will continue to improve volume and expand access to convenient, high quality affordable health care services.

With these areas of focus we will capitalize on the convergence of our two dynamic industries, retail and healthcare, and continue to meet the changing demands of our customers, partners and payers.

That coupled with the commitment to excellence and execution that has always defined Walgreens I'm excited about the future of our Company.

Finally, I would like to thank our team members who did such a great job serving our customers through a very difficult winter.

Across the country they ensured our customers had convenient access to the essential products, emergency supplies and the necessary prescriptions they needed through this harsh winter.

And now I will 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 update you on our Alliance Boots strategic partnership and our AmerisourceBergen relationship.

As Greg noted earlier, for the quarter we reported a GAAP EPS of $0.78 per diluted share based on nearly 964 million shares.

GAAP EPS walks to an adjusted EPS of $0.91 for the quarter as illustrated by this chart, the LIFO provision of $0.04, acquisition related items were $0.12 per share consisting of $0.06 of acquisition related amortization costs, $0.01 of acquisition related cost and $0.05 from Alliance Boots related tax.

Finally, the special items were a net $0.03 per share due to the combined impact of the warrants issued by AmerisourceBergen to Walgreens and Alliance Boots, with the Alliance Boots impact reported on a three-month lag basis.

Let me now review our comparable store sales for the quarter.

Comp prescription sales increased 5.8%, comp front end sales increased 2%, and total comp store sales increased at 4.3%.

Comp prescription sales increased 2.2% versus a script comp of 4.3% in the year-ago period.

In the second quarter the front end comp increased 2%.

Components of this comp are traffic, which decreased by 1.4% and basket size, which increased by 3.4%.

As Greg touched upon earlier, our front end was impacted by the tough cough, cold, flu compare and the severe weather versus the prior year.

Looking forward please keep in mind that the March front end comp sales will begin to be negatively impacted by the Easter shift this year versus last year and recall Easter fell on March 31 last year and falls on April 20 this year.

As always, we will provide the combined March/April comp on May 5 to give you a better understanding of our underlying sales for these two months.

Looking at comparable store script numbers our retail scripts were up 2.2%.

In spite of a tough cough, cold, flu compare this performance reflects the fundamentals of our underlying business, the return of Express Scripts customers and our ongoing progress in winning new Medicare Part D customers.

It is also worth nothing that the two year stack on script comps has risen back to the levels last reached prior to Express Scripts' dispute.

With respect to margin our adjusted gross margin reflects our FIFO inventory was 29.1% in the current quarter compared to 30.5% last year, a 140 basis point decline.

While we always experience some level of reimbursement pressure the most significant factor affecting the pharmacy margin was dramatically slower rate of new generic introductions year over year.

The front end margin was negatively impacted by increased promotional investment designed to drive traffic and sales.

Partially offsetting these margin headwinds is the fact that purchasing synergies positively impacted both the front end and the pharmacy margins.

Taking a look at our adjusted gross margin trends this quarter's 140 basis point decrease was versus 120 basis point increase a year ago.

In essence, the benefit of the generic wave last year reversed itself this year.

We expect this impact to continue to moderate in the third and fourth quarter and become a tailwind to some degree in the fourth quarter of fiscal 2014.

Keep in mind that the timing of the introduction of some generic drugs remains a question mark.

For instance, as most of you know the launch of generic versions of Diovan and Nexium may be delayed, which would result in their benefit being pushed out from our second half of fiscal 2014 into fiscal year 2015.

Moving forward the front end margin will continue to be impacted by our promotional investments until we cycle these changes beginning this summer.

As we demonstrated and discussed the last two quarters, this graph illustrates the impact that new generic drug introduction have had on our monthly prescription sales comps.

The highlighted quarters illustrate that the number of new generic drug introductions have slowed dramatically versus a year ago.

And you can see that the generic impact on comp prescription sales was about a negative 6% in the second quarter of fiscal 2013 versus the generic impact of negative 1.3% in the most recent quarter.

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 effect on margin typically occurs shortly after the generic impact on prescription sales is the most deflationary.

That period occurred in the year-ago quarter.

As you can see, the tough year-over-year generic impact margin comparisons dissipate in the latter half of fiscal 2014 given that the generic impact on pharmacy sales comps is expected to increase in that period.

Transitioning now to gross profit, this slide illustrates our quarterly gross profit dollar growth trends for the past 10 quarters on a GAAP basis.

And the next slide shows the trends on an adjusted basis.

Adjusted gross profit dollar growth slowed to 0.4% from 4% in the year-ago period as a result of the headwinds we described for you in the first quarter including generic wave shift, the front end investment and the impact of weaker cough, cold, flu.

For the quarter GAAP SG&A dollar growth was 1.6% to which we add back 0.1 percentage point for the acquisition related costs resulting in adjusted SG&A dollar growth of 1.7%.

Shown here are the SG&A dollar growth trends for the past 10 quarters on a GAAP basis and the following slide shows a similar trend on adjusted basis.

The adjusted SG&A dollar growth for the quarter was 1.7% year-over-year increase versus the 4.2% increase in the second quarter of fiscal 2013.

Included in this SG&A dollar growth rate was approximately 50 basis points, or $23 million of incremental weather related expenses, mostly snow removal.

This next chart illustrates our two-year stacked SG&A dollar growth trends on a GAAP basis for the last 9 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 by 200 basis points with a two-year stack of 5.9% growth in the second quarter of 2014, down from 7.9% last year and about half the rate of growth of 11.6% two years ago.

During the quarter the rate of growth in adjusted gross profit dollars trailed adjusted SG&A dollar growth by 130 basis points.

As you can see gross profit dollar growth accelerated year over year, which reflects the incremental headwinds we encountered.

Turning to a few other components of our income statement, this quarter included LIFO provision of $51 million versus a provision or charge of $72 million a year ago.

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

Net interest expense for the quarter was $37 million versus $23 million from a year ago.

Now recall the quarter a year ago benefited from the receipt of $19 million of interest income generated by late pharmacy reimbursement payments.

We expect interest expense of approximately $40 million in the third quarter.

Average diluted shares outstanding were 964 million shares versus 953 million shares last year.

The change is primarily due to the impact of a higher stock price on the number of in-the-money options, which are counted as diluted shares.

In the third quarter we expect a diluted share count of approximately 965 million shares subject to changes in the current share price.

Our blunted effective tax rate for the quarter was 34.9% versus 36.6% last year.

The difference is primarily attributed to foreign sourced income taxed at a lower rate partially offset by increases to estimated permanent differences between book and tax income.

On a go-forward basis Walgreens' tax rate is expected to be about 37.5% and Alliance Boots' tax rate is expected to be approximately 20%.

Accounts receivable increased by 11.8% primarily due to the increased business including the return of Express Scripts networks prescriptions while accounts increased 2.3%.

LIFO inventories were down 0.6% and FIFO inventories were up 2% year-over-year versus sales growth of approximately 5.1%.

We expect inventory levels to come down in the back half of the year as we realize greater efficiencies due to daily delivery and complete the full generic distribution transition to AmerisourceBergen.

Overall, net working capital increased by 2.9% versus a year ago.

During the second quarter we generated approximately $1.1 billion in cash from operations versus $1.2 billion in the year-ago period.

The free cash flow in the quarter was $877 million versus $953 million a year ago.

The next slide shows our quarterly accretion from Alliance Boots, which was, as Greg said, $0.08 per share for the quarter versus our forecast of $0.07 to $0.08.

You can find a more detailed walk included in the appendix to this presentation on our Investor Relations website.

Combined net synergies for the quarter totaled $129 million and for the first half of the year have totaled $236 million.

As Greg noted, because we are running ahead of our original estimate of $350 million to $400 million of combined synergies for the year, we are now raising the range of our estimate to $375 million to $425 million.

Looking forward we estimate the adjusted EPS accretion from Alliance Boots for the third quarter of fiscal year 2014 to be $0.13 to $0.14 per share based on our current estimates of IFRS to GAAP conversion in foreign exchange rates and moving forward we plan to continue to provide our accretion estimate one quarter in advance.

Similar to last quarter, we have reviewed our fiscal-year 2016 goals internally and performance to date with respect to four of our five goals remains on track with or slightly ahead of our expectations.

And these four goals are -- sales of $130 billion including Alliance Boots share of associates' and joint venture sales, synergies of $1 billion, operating cash flow of $8 billion and net debt of $11 billion.

As stated on our last call our adjusted operating income goal of $9 billion to $9.5 billion is currently tracking below the CAGR required to meet this goal and below our initial expectations.

We continue to recognize that there are risks to achieving this goal; however, we remain focused on delivering it.

And as I also stated we have identified a range of further opportunities including benefits from our AmerisourceBergen relationship, incremental Alliance Boots synergies, business expansion and new initiatives and cost savings which can all help mitigate these risks.

The asset optimization program that Greg described highlights our focus on efficiencies while the increase in our fiscal-year 2014 synergy estimate demonstrates that we are driving additional synergies with Alliance Boots and AmerisourceBergen.

In closing, we believe our strategies for the long term are sound and should further differentiate us versus competition and create value for our stakeholders.

When recapping the current state of our business there are many indicators that give us confidence in our future.

As Greg said we have been growing shares in competitive US daily living and retail pharmacy businesses and we continue on our Well Experience journey and we are focused on continuing this front end momentum and also focused on positively impacting margin over time via mix and promotional and supply chain efficiencies.

Our pharmacy business is well positioned in patient segments which is acute needs, Part D customers and key chronic conditions and we continue to drive real efficiencies in both our pharmacy operations and in procurement.

We also have a significant opportunity to participate in and influence the healthcare market more broadly via our asset and healthcare professional breadth.

Through our various healthcare partnerships and initiatives we are on a path to do exactly that.

Now lastly, we continue be very pleased with our Alliance Boots partnership and AmerisourceBergen relationship.

On the Alliance Boots side their business remains resilient in a European environment that remains challenging.

The continued strong cash flow and deleveraging focus has also been very positive.

Our combined synergies have continued to track at the high end of our estimates and we're learning from each other every day.

And our Step 2 joint operational and financial planning is going well.

Our AmerisourceBergen relationship thus far has also met our expectations with the distribution and our joint synergy efforts progressing right on plan.

We also continue to identify additional ways that all three partners can work together to create value and change the paradigm in various areas of our business.

In short, we believe we are just scratching the surface in what we can ultimately create as a global pharmacy led health and well-being enterprise.

In my humble opinion we are off to a terrific start.

With that I'll turn the call back over to Rick.

Thank you, Wade.

That concludes our prepared remarks.

We are now ready to take your questions.

(Operator Instructions).

Lisa Gill, JPMorgan.

Good morning, and thanks for all the detail.

I guess just a couple of quick follow-up questions.

The first would just be around the global procurement impact and timing.

Greg, you talked about the number being better as far as synergies going up to $375 million to $425 million, but you didn't necessarily update that the billion dollars overall.

Should we be thinking about that $1 billion number as more of a contributor to the overall 2016 number?

We feel comfortable upping the number for this year to $375 million to $425 million based on what we are seeing.

We still feel confident at $1 billion and aren't ready to make any comments on it.

Longer term we still feel confident that there are opportunities that we are identifying but at this point in time we feel confident that we'll get that $1 billion in 2016.

Okay.

And then you didn't really make any comments today about the Affordable Care Act.

Yesterday there were some comments that perhaps now Florida looking at extending Medicaid.

Can you just update us on anything you have seen thus far around ACA volume and then maybe any expectations for an increase in the back half of the year?

I saw that announcement and we think obviously as we've said as enrollment grows it's going to be a positive for the business.

And as you would expect with the prescription business and people getting coverage that have not had coverage, some of those may be cash customers that we are getting prescriptions that may not be a complete new prescription customer but we think there will be an additive benefit to more and more people getting coverage.

It's too early, it's still early to tell as far as the number of people that are coming on board.

I think there's some positive signs over the last month or so that more and more people are getting coverage.

I may turn it over to Kermit.

Kermit, if you've got any additional color that you are seeing?

Lisa, I think the other thing you can add is that we continue to work with many of the new customers, new patients during the transition period.

We've announced that we will continue to do that through April.

We are also working with many of our health plan partners on educating many of the new potential enrollees.

So we think the bulk of the volume will continue to be in the open networks and as we see more and more of the open network business we think that will be good for us.

And so is it fair to say that you would expect maybe hopefully you would you see that in the back half the next couple quarters in your fiscal year or do you think that's going to be more of a fiscal 2015 event?

I think we've seen a slow enrollment period.

But I think we will see that gradually increase over the next couple of quarters and into next year.

Okay, great.

Thank you.

Robert Jones, Goldman Sachs.

Let me start on the gross margin trend.

I know you guys mentioned that you expect a negative generic comp experience in the front half to ease as we move into the back half and I understand you guys don't give specific guidance but can you maybe just help us think about the components of the gross margin trend in the back half, maybe for instance relative to the year-over-year declines that we've seen in 1Q and 2Q?

Any sense you can give us on what we should be looking for on the year-over-year trend into the back half?

Yes, I would just say there's a couple of factors.

The big one obviously is the timing of new generic introductions and so we start to move into a phase where those come now.

Again, the exact date of these can never be perfectly predicted so you have in general the information that we have, but that makes a very substantive difference.

Again, we are starting to cycle the front investments that we made that were quite substantial to get back to more of a normalized rebalancing mix and so the next quarter or two we will move into that cycling.

And then even things like flu and C2s can have some mix effect and so we will start to cycle that and get into more of a normalized period.

So these things will all come when they come but directionally especially when you also look at the stacks for compare they tend to even out over time.

I think we are moving into that phase.

Great.

Just going back to the synergies.

I know originally you guys were calling for this to be a little bit less than what we saw last quarter.

Clearly not the case, you realized more synergies in Q2 than 1Q.

And then looking at the full year even though you did increase it, it does look like the back half would actually be on track to produce less than what we saw in the front half.

Is there just any more specifics or commentary you can give us around the drivers of synergies and maybe what's causing some of the cadence in this fiscal year at least?

Yes, I think we feel very good where we are but I would also say that for the people that are in the trenches working, these people like Jeff and John, some of the deals that we work you never can predict exactly when they are going to hit and for what period they will accrue to.

Separately I would say that every day we have multiple streams working very hard to identify new synergies to work with (inaudible) and negotiate new synergies.

And so again while we feel very good on the glide path and even the long term, as Greg suggested, these things are going to require hard work each and every quarter, every quarter going forward.

And we just don't want to get ahead of ourselves there.

Then it's not something that's necessary linear, clearly, based on the guidance that you guys put out for the back half?

I don't know if it's linear or not but I would say it can be choppy along the way because sometimes you get a step up for something that we do but other times we identify a new source of synergies and start working that.

There's lots of moving parts underneath the hood but directionally we feel we have the right momentum towards our goal.

Got it.

Thanks so much.

Ricky Goldwasser, Morgan Stanley.

A couple of questions.

First on the SG&A spend, this is the second quarter where you have grown SG&A at well below your 3.5% to 4.5% organic targets.

So if you can talk a little bit more in detail about the cost control.

Is this kind of like a new level going forward and also how much of it is being driven by distribution efficiencies from the ABC relationships and when does that normalize, if it does?

Yes, Ricky, maybe I will take it at eye level and then let Wade get in a little more detail.

I think, as I have said, I think we feel good with what the stores are doing and the efficiency that Mark and team have really driven through the stores.

I think we will continue to see the stores do a nice job of balancing payroll according to some volume.

I think a lot of the corporate initiatives that we've had in place regarding really looking at core initiatives and core programs and projects, we feel good that we are making progress there and that should continue.

I don't think, frankly, that you should be backing a lot of efficiencies yet from the AmerisourceBergen transition although we do expect to see that going forward.

But we are still in the process of transitioning the generic distribution from our distribution centers to theirs, that's early on so there's not a lot of that built in.

We certainly do expect there to be opportunities going forward with it.

Wade, anything to add?

Yes.

I think we're just aggressively attacking all costs so we have had a couple of very strong quarters versus to what we had had prior in our sustainable growth model.

We will continue to attack all costs and make sure that we focus our resources on the core strategies that will drive values.

So I hesitate leaning into any kind of guidance on that, but as Greg said also the big distribution benefit for us really comes at the end of this fiscal and into next fiscal when we have all of our generic volume, which is the smaller dollar piece, but 80% of the unit volume fully consolidated in their systems.

And I think that is also when they see the benefit too is once we get the full integration of branded generics.

So that will be a next year event by and large.

And what, if you can share with us, what percent of your generic volumes is now distributed via ABC?

We haven't given that number, Ricky.

They are making good progress and we intend to be completed by the end of the fiscal year and we are on track to meet that date for sure.

Okay.

And then secondly on the tax rate, I know the tax rate in the quarter was below historical levels and Wade you touched upon the.

But just to clarify, should we expect in the next quarter then a higher tax to go up or is there any change in how you account for the AB equity earnings, how you are accounting of taxes for that?

I think you can expect probably going forward a rate similar to what you saw in this quarter.

Again, I think it's fairly complex to track the rate through this based upon our joint venture, their business and our business but I think that you will see something markedly different from what we saw this period.

Okay, great.

That's helpful.

Thank you very much.

Mark Wiltamuth, Jefferies.

Good morning.

I wanted to get some insights on the Alliance Boots number.

The reported income from Alliance Boots of $194 million was much higher than a lot of us were expecting.

What was in that number, was there anything unusual in that and what do you think the core operating earnings growth for Alliance Boots is running at right now?

The big thing in their number for IFRS purposes is the warrant income from ABC and they have a lag, so it was actually a gain in this period for them and without the lag for us because the stock pulled back a little bit, it was a slight loss.

That was the big thing in the IFRS number and again for our purposes, for GAAP we reversed that out.

There's always some nuances back and forth.

With respect to their overall business I'm not going to provide any kind of guidance on it going forward but they are going to be reporting their numbers for the full year in May.

And so closing at the end of March here in the next week or two, so I think you'll be able to get a lot more color on their business broadly and that should probably be very helpful.

Okay.

The difference between that $194 million that was in the reported numbers and the $100 million that you had in the slides that were kind of tax affected, is that just taking out that gain that you were talking about?

It was primarily the warrants.

I don't have the full rec but that would be the main event.

But we can get you the specific details on that.

Okay and then, on the weather impact I guess there was some commentary on the SG&A impact from removing snow and so forth, but what do you think the total weather impact was in the quarter?

As Greg has said our gross profit SG&A spread would have been basically equal, had we not had it.

So you can deduct about $20 million, couple million, $22 million for snow removal, $25 million, and then the balance up to $60 million, so $35 million or so for gross profit impact.

That was both through store closures where we had substantial store closure days and a little bit of traffic too.

Okay, so $22 million plus the $35 million?

Yes, it was about that.

Say $60 million in total.

Okay.

Thank you very much.

Eric Bosshard, Cleveland.

Two things.

First of all in terms of merchandising changes with Alex involved and with beauty, I'm curious if you can give us an update of where that is going terms of an opportunity to further expand beauty, what you're doing in terms of adding product, adding space, adding labor and then also the opportunity to expand brands to further drive share opportunities from that area.

I've got Alex here so I'll leadoff and maybe I'll let Alex weigh in a little bit.

But as I said we do think we have an opportunity to build bigger in beauty.

We feel good with our pilot rollout of the boots brands in Arizona, as I said.

I think we've been in that since last fall.

We are seeing some pretty good results not only with the brands specifically but in the total category itself, which is encouraging.

We intend, as I said, to roll out in New York City next.

We think that's a good metropolitan market to introduce the brand in a very special way and we're going to do it right.

So we are feeling pretty good there.

I guess maybe, Alex, I'll let you kind of weigh in there with your thoughts.

As Greg has said, we are pleased with progress so far.

We have we seen a really positive response from some of our customers who already are shopping for beauty in Walgreens, and doing more shopping for beauty in Walgreens particularly developing some categories.

The bit is absolutely right.

It's about the whole experience.

It's not just about the product, it's about the customer care that surrounds the product.

And we've seen that consistently both in Phoenix and in the 10 stores that we have upgraded in New York.

So my advice would be if you are interested go and have a look at the Union Square for example in New York City, Empire State Building New York City, they're both on the ground and we will have 150 in the ground by the end of this fiscal year.

And we're feeling good.

They're certainly encouraging Walgreens shoppers to shop a bit more in beauty already.

And it's not just No7, it's the boots brands and beyond that.

Just a follow on as you think about the future opportunity to gain share, that's never getting to where Boots is in the UK but moving in that direction.

How important is the ability to gain access to brands that you don't have today, national brands or prestige brands?

How critical is that or how far can you get without those?

We believe we can go quite a long way without them.

Again the history in Boots, the premium brands have only been in Boots for about 16, 20 years and Boots have a very strong beauty business in mass, and we call it masstige, which is mid-market brands before then.

So we're feeling pretty good about being able to expand without premium brands.

And obviously as we go forward into the future we attract customers to think more about the experience of beauty inside of Walgreens.

We believe that some of the premium brands might be interested in joining us in Walgreens.

But that is somewhere down the road and we think we can get quite a long way down that road without the support of premium brands.

Great.

Thanks.

And just one other if I could, the store closings is a little bit different than what we've seen in the past.

Curious about the timing on that and thinking on that.

And also if there is a larger opportunity to manage down the SG&A or corporate opportunity within the business as you look at combining the organizations?

Well Eric, maybe I will leadoff and get Wade and even Mark Wagner if he wants to weigh in here.

Keep in mind that when we talked earlier in the year about our enterprise optimization program to really set ourselves up for the international entity we are about to become, we really want to make sure we are positioned and ready to roll for that.

And we've been doing some good stuff corporately as we talked about to position ourselves.

And then the next thing we wanted to look at some of the assets, we took a real hard look, trade area by trade area at our store locations.

Something to your point we really have done in the past but not with a real focused effort.

The good news is, frankly we have got a lot of great locations out there and we've only really stumbled on about the 75 or so that we are talking about.

A lot of that is just due to -- some of that is due to us, we put in maybe an extra store in the trade area than probably what we should have and we have densed up and so forth.

But with that maybe I will turn it over to Mark a little bit as far as he led that exercise to look at our store base and maybe that'd add a little color.

We looked at it really with two lenses.

One with a strategic lens, one with a financial lens.

And kind of losing the Pareto philosophy, 80% of the closings are really in some of our denser markets, some of our big growth states that we were the biggest competitor in these trade areas.

Some of the other challenges we had in the trade areas were they changed over time due to road pattern changes, overpasses, underpasses, you name it that really made our store real estate sites not as competitive or out positioned in most cases.

Great.

Thank you.

Scott Mushkin, Wolfe Research.

Thanks for taking my questions.

First one I wanted to talk about is free cash flow.

Looks like it is running about half of last year's levels and want to get your thoughts as we go forward and we get to next year when we're going to close the acquisition and what impact if this trend continues that will have.

Yes, I would just say that this year both operating and free cash flow look a little bit lumpy just because we've got this major transition with AmerisourceBergen, the timing of the brand move, the timing of the generic move, the resettling of contracts for how we think about inventory versus payables.

But this is really going to work its way through the system because at the end of the year we anticipate that we will have what will be in the targeted levels for this type of transition.

So I guess what I would just say is I don't think anything is unusual this year in operating or free cash versus prior year, net slight changes in working capital, slight changes working in whatever.

So as we look forward I guess 2016 we still remain very confident in our combined cash goal of $8 billion in operating in various trough free cash flow.

And again I think what you saw last quarter was very low but it's really just because of this transitional effect.

And this quarter was more normalized but the next couple of quarters we should kind of even it out for the entire year as we complete the full transition.

So we should think of free cash flow kind of similar to the levels we saw last year, is that how you would -- it's lumpy but it's going to be about the same?

Yes, the real -- just for us operating less to capital but it's not substantially different.

You've got our guidance for what we plan on capital spending and you can do the math yourself there.

My second question goes, I think you guys said you had 628 Well stores.

I'm wondering if you can give us any, and maybe you have done this before, any kind of -- as you convert stores to be Well Experience what the sales list looks like, what's the profit list and then how many more are you expecting this year?

So if you could give us a little insight into that that would be great.

Scott, we really haven't given out color on actual performance.

We will -- I can say that as we have been working on this for the last three years it's kind of a crawl, walk, run.

And we want to make sure that the investment we are putting in we're getting the right return.

We feel pretty good.

There are still some areas that we are tweaking to make sure that we can continue to put the pedal to the metal.

One of the things we have done, the good thing is we now have a pretty good idea of the various components within the Well Experience format and what's working, what still needs some work.

And the good thing is you are beginning to see the various components within the Well Experience format show up throughout the chain in a much quicker way than what we would have been if we had just continued to roll out the entire format or tried to get the entire format right.

So bottom line, we feel good about it.

There are still areas where we want to tweak and get the returns, some of that is added content and product, so forth, but there's a lot of the areas that are modular that we can begin to roll out throughout the chain.

Alex, you want to add any color there?

Yes, thanks, Greg.

The other thing I would say is that the success of the Balance Reward card in terms of having 80 million active customers and 100 million people signed up is giving us real-time data about how people are using our stores.

And really that data is helping us to design, as Greg has said, even better assortments going forward.

So I think the design is being really appreciated by customers.

Their feedback in terms of the brand perception is good, in terms of moving on the brand perception to a more differentiated experience from the normal drugstore channel, which is exactly what the team set out to do three years ago and the data from the Balance Reward card is now allowing us to build better assortments for our customers.

So I think we will accelerate from this point based on that data and based on what the customers are telling us right now in terms of their perception of the Walgreens brand within it.

Perfect.

Thank you.

Charles Rhyee, Cowen & Company.

Maybe if I could just follow up on that question, Alex.

In terms of the data for the Balance Rewards, how much has that data been really analyzed and how much has it already been acted upon, or is this something you are still kind of correlating the data and really kind of crunching it to really understand the behavior of your shoppers?

Yes, I think it's a bit of all three.

I think some of it is really well understood and we are using already to simplify some of the things we are doing particularly in the promotional strategy and some of it we are understanding in terms of building assortments, I said already.

And I know from the experience of being with Boots that there's a lot more we can do with this data over time.

But the team are a strong team, they are a really good team and they are working closely with their associates and partners across in Alliance Boots and I think this will give it a lot of momentum going forward.

So I think all three to be honest, for very good reasons.

I would weigh in on that as well.

I would say we are really kind of in the infancy of the insights that we are beginning to gather from having launched nearly 100 million and 80 million active members a year ago.

So there's a lot of excitement from the merchants, let me tell you, about the data and the insights they're beginning to have.

Okay, that's helpful.

And then maybe a question for Wade.

If I look at the cash flow statement, am I correct?

I think you didn't really repurchase any shares in the quarter?

And how should we think about that maybe for the balance of the year?

Thanks.

We didn't repurchase any shares.

I think as we have said before that allocation policy was to get us through Step 2, very strong balance sheet position prior to reconsidering any buybacks.

We have been buying if you can call it some AmerisourceBergen stock and I think that the number at the end of the quarter was 4.5, 4.6%.

Okay, great, and then maybe if I can just sneak one last question in.

You touched on sort of the stores that you are closing, so our net stores are what, 55/75 for the year opening.

How should we think about store expansions as we go forward?

You may have touched on that, I'm sorry if I missed it.

We don't think that our rate of annualized growth that we've talked is going to be different.

Again, in the grand scheme of things these 76 stores are less than 1% of our total and many of them have -- circumstances have changed over many years.

But on a go-forward basis we would see the same kind of cadence we have had in the past two years.

Yes, I would say one of the things that we do feel good about with the opening of -- at a slower rate although still plenty of new store growth year-over-year, we are really finding some great locations.

And that's what we want to do, is we want to find A-plus locations now and open at that same rate going forward.

We still have several geographies out there that we can expand in and find great locations.

Okay.

Thank you.

Thank you.

I'm showing we have time for two more analyst questions.

John Heinbockel, Guggenheim Securities.

So two things.

How do you think about tobacco?

How much of an opportunity is that near term right as CVS exits?

Is it a liability long term?

And then do your partners, HMOs, PBMs, customers -- do they care whether you sell it or not?

Let me start with kind of where we're focused.

And what we're focused on is to help encourage our customers to make healthy choices and not only just with cigarettes but with daily habits.

And that's kind of what our walk with Well and some of the things we are doing are designed to do.

That includes helping people quit.

I think that the CDC has said that the two most important factors to help someone quit smoking is a healthcare professional as well as nicotine replacement therapy.

And some stats that maybe you may have or may not have, but back in the 1960s, 1970s, better than half of this population smoked.

Today it is down to about 18%.

It's been 18% for a period of time.

Those folks, 60-some percent of them want to quit.

45% last year tried to quit.

We think we are well positioned to help folks change their behavior who want to quit.

So our pharmacists are geared up and we are -- really want to begin to help change behavior.

So that's our area of focus.

It sounds like you're going to stick with it unless it's mandated like in San Francisco that you can't sell it?

As I said, we're going to help people change behavior.

We're going to help them quit and I don't think there's anyone better than a retail pharmacy with a pharmacist and smoking cessation products that can help people change their behavior and help them quit.

All right.

Then for Alex while we have him, obviously beauty, No7, that's pretty obvious how that can help Walgreens.

What are some of the less obvious things you can bring from Boots?

One of the things that has always intrigued me is migrating Pink Friday to the US.

What are some of the things you have looked at that can be impactful to Walgreens US that may have flown below the radar screen?

I think, just starting with Pink Friday, which as you know is the Soap and Glory day in the UK, Walgreens already has a really really good seasonal business.

In particular it's seen as a last minute gift destination for many Americans, and that's exactly what Boots does as well.

So we think we can really join together and improve sharply the beauty ranges in Walgreens.

And I'm sure improve the range of growth across both Boots and Walgreens by saying that they are even better for customers.

So seasonal is definitely one area.

I think also the second area I would point to would be the fantastic Well at Walgreens brand.

The Walgreens health care brand is the number one health care brand from a consumer healthcare point of view in the US and again working closely together to bring new innovative products both to the US and to the UK market where Boots is primarily based is another big opportunity in this relationship on the consumer and the front end.

John, maybe I will add because Alex is probably humble and won't say this, but I think one of the things that we are bringing as well, and that he is helping us with is the understanding of how their Boots Loyalty program was successful and helped drive a lot of the success that they had moving into beauty and other areas within the UK.

And I think the knowledge that we are bringing with our 80 million active members now to continue to improve our Loyalty program is going to be a big opportunity for us.

Thanks.

Edward Kelly, Credit Suisse.

I was hoping we could maybe wrap up with two topics that have become more top of mind with investors recently.

And the first is around the longer-term view of leverage at the Company.

You obviously historically haven't operated with a lot of leverage at all.

Alliance Boots has.

I think the question is, as you go forward as a combined company generating a ton of free cash flow wouldn't it make sense to operate possibly with a lot more leverage than where you are today to unlock cash for either share repo or additional deals?

So your thought on that first would be helpful.

Yes, I guess a couple.

One thing is, obviously I think when you look at our business you need to look through to the leases and the lease effect on the overall balance sheet, which is significant.

We like where we are investment grade and I think it's been important philosophically for us to stay investment grade.

Where in that investment-grade zone we should be over time, I think, will get decided over time as we go.

But I guess what I would say is yes, we are -- we do believe we will generate a lot of free cash, we will have a lot of options.

But at this point we're really focused on getting through to Step 2 with the structure, with the ratings, with the overall metrics that we've had.

At that point I am sure that we will look broadly and reassess all of our options as a company to say what's the best capital allocation process going forward and where are the best value creating ideas, is it returning extra to shareholders, or is it investing back in the business?

Trying to say it's a little bit premature to have a discussion fully now.

Okay.

The second question, which the answer may be similar, but it's on the notion of tax inversion because there's been a lot of speculation in our place amongst investors about the opportunity here.

Could you maybe just talk about what the issues may be for a company like Walgreens in potentially doing something like this and whether it's something that you would be open to considering?

Maybe I would start with just reiterating what I said.

I think, not on the last earnings call but the one before, that we have no plans to do so to do, to do an inversion, or re-domicile the Company.

I think what we are focused on, frankly, is spending the time with our Board and on diligence and so forth to make sure that we put our Board and our shareholders in a position to make the right decision on Step 2.

And that is what we are focused on.

But just to reiterate, as I said on the last call, we have no plans to do an inversion.

Okay.

Great.

Thank you guys.

Thank you.

I am showing no further questions at this time.

I'd like to hand the call back over to Mr. Rick Hans for any closing remarks.

Folks, that was our final question.

Thank you for joining us today.

As a reminder we will report March sales on April 3 and until then thank you for listening.

Ladies and gentlemen, thank you for participating in today's conference.

This does conclude today's program.

You may all disconnect.

Have a great day, everyone.