Walgreens Boots Alliance, Inc.
Q1 2012 Earnings Call Transcript

Published: 21 Dec 2011

[Operator:]

Good day, everyone, and welcome to today's Walgreen Co. First Quarter 2012 Earnings Call. Today's call is being recorded. I'll turn things over to your host, Mr. Rick Hans. Please go ahead, sir.

[Rick J. Hans:]

Thank you, Jason. Good morning, everyone. Welcome to our first quarter conference call. Today, Greg Wasson, our President and CEO; and Wade Miquelon, our EVP and Chief Financial Officer, will discuss the quarter and update you on Express Scripts. Also joining us on the call and available for questions is Kermit Crawford, our President of Pharmacy, Health & Wellness Services; and Mark Wagner, President of Community Management. 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 reconciliation. You can find a link to our webcast under the IR 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 information that is based on current market, competitive and regulatory expectations that involve risk and uncertainty. Except to the extent required by law, we undertake no obligation to update publicly any forward-looking statement after this presentation, whether as a result of new information, future events, changes in assumptions or otherwise. Please see our latest Form 10-K for a discussion of risk factors as they relate to forward-looking statements. I'll now turn the call over to Greg.

[Gregory D. Wasson:]

Thank you, Rick. Good morning, everyone, and thank you for joining us on our call. Today, I'll begin with our quarterly results. Second, I'll discuss the progress we're making on our strategies. And finally, I'll provide a brief update on Express Scripts, and then Wade will give you more details on our performance and the considerations for the year ahead. Beginning with our results today. As you saw in our release this morning, we reported record first quarter sales of $18.2 billion, up 4.7% from $17.3 billion a year ago. First quarter net earnings were $554 million, and first quarter earnings per diluted share were $0.63. Compared to the prior year, the delay in cough/cold and flu season impacted net earnings per diluted share by $0.01, while the strategic decision to no longer be part of Express Scripts pharmacy network as of January 1, 2012, cost $0.01 per diluted share in comparable pharmacy sales and $0.01 per diluted share in related expenses. Cash flow from operations for the quarter was $809 million, and free cash flow was $309 million. We returned $803 million to shareholders in the quarter, including the largest dividend payment in the company's history, and $601 million in stock repurchases, up nearly 18% over the first quarter last year. Now I'd like to put this quarter's results into context. On our September call, we anticipated we would see challenging comparisons for gross profit dollar growth in the first quarter and we did. We were up against 2 strong prior year quarters. As we discussed, our first quarter is always impacted by volatility and the timing and the severity of the cough/cold and flu season, which this year is off to a slow start. We were also impacted by slower rate of generic introductions this quarter compared to the prior year quarter, and that impact will reverse and then accelerate through the fiscal year with the release of new generics, including generic Lipitor. Couple that with a step-down in pharmacy reimbursement, including July rate reductions from Express Scripts that were built into our current contract, and our year-over-year increase in gross profit dollars slowed to $159 million or 3.2%. Turning to SG&A dollar growth. We continued to invest in our strategies, focusing on our CCR store conversions, our health and daily living pilot stores and driving innovation in E-Commerce. While overall SG&A dollar growth came in at 5% excluding drugstore.com, our costs increased by 4.2%. The spread between gross profit dollar growth and SG&A dollar growth for the quarter was negative $41 million. Recall, we really think about this spread over a longer period of time, not quarter-by-quarter. As we look further into the results, we continue to see strength in our business fundamentals. We filled a first quarter record 208 million prescriptions, as our 90-day program continued to fuel growth. In fact, 90-day retail prescriptions grew by 37% year-over-year. Based on the most recent data from IMS, on a 30-day basis, our retail pharmacy market share was 19.9%, which is up 40 basis points from a year ago. We administered 5 million flu shots this flu season through November 30 compared to 5.6 million a year ago. We continue to deliver more flu shots than any other single entity outside of the U.S. government and to build a strong immunization program for adults and adolescents, which is an extension of our flu program. In addition to our work in pharmacy, we maintained momentum in our front end despite weak cough/cold and flu. We completed the successful rollout of CCR, contributing to our front-end sales growth. We're striking the right balance between sales and margins as our front-end margins held steady compared to the first quarter last year. We're outperforming our nearest competitors on comps. And reinforcing the success of CCR, we continue to grow our market share in our targeted signature and power categories compared to food, drug and mass merchandise competitors, measured by the Nielsen company. For the 12-week period ended November 26, Walgreens gained share in key health and wellness, beauty and personal care product categories. Today, I'm going to focus my attention on 2 of our 5 key strategies

[Wade D. Miquelon:]

Thank you, Greg, and good morning, everyone. This morning, I'll review the first quarter of fiscal 2012 in detail. I'll highlight the key considerations for upcoming quarters, and finally, update you on the financial impacts of our situation Express Scripts for the fiscal and calendar year. So let me begin by saying that this quarter's comparable store sales were impacted by several important factors, including the slow start of this year's flu season and the unusual timing and severity of the 2010 flu season. To better understand the underlying trends, we are showing the 2010 comparable sales numbers for reference. As you can see in the first quarter of fiscal 2012, prescription sales increased by 2.6%, front-end sales increased by 2.4%, total sales increased by 2.5% and prescription scripts increased by 1.8%, all versus a year ago. As our trends over the past 13 quarters highlight, the first quarter of fiscal 2010 was unusually strong, driven by the H1N1 flu pandemic and the launch of our flu shot program, and this quarter's prescription comp is still impacted by that echo effect. Remember that last year's 2% script comp was on top of a prior year comp of 9.2%. In addition to cycling strong 2-year trends, this quarter's 1.8% comparable script growth, shown in the green bars, was impacted by

[Rick J. Hans:]

Thank you, Wade. That concludes our prepared remarks. We're now ready to take your questions.

[Operator:]

[Operator Instructions] We'll go first to Mark Miller with William Blair.

[Mark R. Miller:]

In the white paper, you highlight that half of the employers have options to contract separately with Walgreens, and I think you talked about a number of those employers think there would be a resolution. But is that the main reason why you think that you've not gotten more of them to contract directly with you thus far? And for those that haven't yet, how many do you think may be able to do so in 2012?

[Gregory D. Wasson:]

Yes, Mark. I think that many, as we've said, were waiting toward the end to see if, indeed, we'd settle. And I think what's encouraging is the fact that they do have a clause to exit their PBM contract. And I think what we're hearing is that many are actually thinking about it and talking about doing that next year and going out to RFP.

[Wade D. Miquelon:]

Yes. Also remember that 2 clients for Express Scripts represent 50% of their business, right. But as we said, we've seen a very good traction. It's literally evolving by the day. So I think it's playing out in a very positive way.

[Mark R. Miller:]

The impact that you see if you can offset half of the gross profit loss, would that be proportional across the quarters or would that impact the -- more front weighted? How should we think about that flowing through the year?

[Wade D. Miquelon:]

You expect to have a little more impact in Q2, because as we said, we're making sure that we provide stellar level of service through January to help all of these patients, make sure they're taken care of and navigated properly.

[Gregory D. Wasson:]

I'd agree with that. We've spent a little extra money on purpose in this quarter, to make sure that we were allowing our pharmacist to have quality time with their patients, especially during the Med D enrollment period. And I think to Wade's point, we want to make sure we're taking care of patients in January. So it's most likely be back half weighted.

[Mark R. Miller:]

Then on my last question, can you give us some sense of what tolerance you have on debt to capital, given this more intense impact upfront and given your long-term beliefs? How aggressive can you be on share repurchases that are potentially you could do more during this period?

[Wade D. Miquelon:]

I guess, Mark, I'm only at liberty to talk about the fact that we're executing the plan we've got aligned. So as you know, we're halfway through the $2 billion plan. We continue to be aggressive and ahead of schedule on that, but that's really all I can say at this time.

[Operator:]

Next up, we have Matthew Fassler with Goldman Sachs.

[Matthew J. Fassler:]

I want to ask you a question about sort of looking down the road. And Medco has obviously been a part of the discussion here, that is the Medco merger with Express, from about a month after you made the decision to dissociate from Express. And it would seem as if the impact to sales would be similar and the impact to earnings would be greater from -- than initially walking away from Express. What would that do to your ability to return capital to shareholders? And how are you thinking about your capital plan, given the need to think about that contingency?

[Gregory D. Wasson:]

Matt, Greg. I'll take the first half, maybe let Wade comment on the capital plan. I think -- obviously, we think that if we -- that we deserve a fair and acceptable reimbursement compensation for the services we provide, and that's what this issue is about with Express Scripts so we wouldn't accept anything different from any PBM, including Medco. Can't comment on the proposed merger, but in addition, keep in mind that Medco's book of businesses is much less than it was a year ago. And we think with the uncertainty in the marketplace next year, that they're going to be -- they're going to have a challenged selling season as well. We're working with all of our partners out there right now to help them find a solution that would have Walgreens in it, so.

[Wade D. Miquelon:]

Yes. I mean, I would just say this, too, we hear the same thing from the Medco clients as we do from Express clients, which is they want Walgreens in the network, and they're going to want to have it. And the advantage they're going to have is they're going to have more window here of visibility to explore their options and probably more change of control provisions and other ways to direct their contracts. So we're very convinced that these clients are going to want Walgreens, and they'll have the luxury of time, hopefully, to find alternatives to do so.

[Matthew J. Fassler:]

And then one other question, actually, on the near term. The payables ratio came down a chunk year-over-year. How should we think about the driver of that? And what direction do you expect it to move in?

[Wade D. Miquelon:]

Yes. Little bit of an anomaly of just the WHI sale, but a lot of it is just payables can just really flow month-to-month on the month end. And so this will work its way out. So it’s just really just an anomaly.

[Operator:]

Next up with Crédit Suisse, we have Ed Kelly.

[Edward J. Kelly:]

Could you guys give us maybe your best update on how negotiations have progressed over the last 6 months with Express? And I guess what I mean by that is, has there been any movement whatsoever? And I've heard you kind of talking about a difference of maybe $4 to $5 per script, is that the delta that we're still looking at?

[Gregory D. Wasson:]

Yes. Ed, I'll start off with this. As I like to say all the time, we're in the business to fill scripts. And certainly, we need fair reimbursement, but we're always open. I will say that we made another serious attempt last week to get an agreement before January 1 to minimize patient disruption. Unfortunately, the response we got back was not very meaningful, and more importantly, the response was suggested to kick the can down the road past January 1, which, frankly, doesn't do anything to minimize the disruption for our patients, WellPoint's patients and Express Scripts' patients. So we're moving on, but we're always open. As I said, we're in the business to fill scripts at fair reimbursement, but -- that's the latest update I can give you.

[Edward J. Kelly:]

Greg, what do you mean by kick the can down the road as a response?

[Gregory D. Wasson:]

Past January 1. Our focus is to minimize the patient disruption, and there's going to be a lot of disruption in the marketplace beginning January 1. And we look to make one last attempt to try to prevent that, and the timeliness of that does not make sense for us.

[Edward J. Kelly:]

So we should consider that kind of like your last and best offer?

[Gregory D. Wasson:]

As I said, I'm always open. We're in the business to fill scripts, but that was our best attempt to try to prevent the disruptions. It's going to -- it's really going to happen in the marketplace January 1, and I hope the folks don't underestimate the disruption that this is going to cause.

[Edward J. Kelly:]

All right. So getting back to Medco, I mean, how should we begin to think about the Medco contract assuming obviously that Express does close on this deal? How has that weighed on your decision to not accept Express's offer?

[Gregory D. Wasson:]

I would say it hasn't changed our opinion one bit. Getting a bad deal with one party doesn't make you feel any better about getting a bad deal with 2. The reality is the people at Medco's network they value Walgreens network. They feel they're getting fair services for what we provide. And as long as we can keep compensated fairly for what we do, that's probably fine. But all the data suggests, those clients are going to want Walgreens in the network, and like I said, they'll have to look at all their options. And if it does happen with the luxury of time, we're very confident that we'll have that business one way or another as well. Ed, I think it's important to point out that, frankly, we're feeling more and more confident about this decision every day. We have plans, health plans, PBMs coming to us daily looking for the opportunity to differentiate themselves next year by having us in their network versus those that don't. And when you think about the fact that we absolutely are convinced that there is no significant cost savings, and in fact, by removing us, there may be increase in cost and the fact that you've got Walgreens in the network versus no without, we're encouraged by partnering with the folks that are out there looking to differentiate themselves and win in the marketplace next year.

[Edward J. Kelly:]

Then I guess what I don't understand is that you clearly make the case that it's not that much cost savings and a lot of disruption. And it doesn't really seem on the surface, if I just listen to this call, to make any sense that you're in this situation today, and yet you look at Express Scripts, right, and Express Scripts has shareholders to answer to as well. So I just -- I don't understand basically why we're seeing this today if all that is fair.

[Gregory D. Wasson:]

Well, clearly, their spread model obviously doesn't work if we don't pay them the rates that they want from us. But obviously, we just expected 2 principles of being compensated fairly for what we do and also not advantaging any one payer substantially versus others, unless there's a reason to warrant it. And as long as we stand by that principle, we're going to be just fine with or without them. And we would agree. We don't understand the fact. But frankly, Express Scripts’ desire to force narrow networks based on cost is only accelerating our ability to create deeper preferred partnerships with our partners based on both value and cost, and that's where we're headed.

[Edward J. Kelly:]

So just back to this Medco contract for a second. If you were to accept Express Scripts offer on that Medco contract, how big of a hit would that end up being? Because I -- I mean, I've heard from your peers that the Medco's reimbursements are actually better than Express Scripts' reimbursements. Is that right?

[Gregory D. Wasson:]

Well, we're not going to talk about any client obviously, but the fact that we have an issue right now with Express Scripts and not Medco tells you something. But we feel we get fair with all payers, including Medco, but we're not getting fair compensation with Express. And that's why we've done what we've done.

[Edward J. Kelly:]

All right. One last question for you. Just let’s take a step back for a minute and think about sort of longer-term strategy, right. Because it's kind of clear that drug retail seems to becoming a more challenging business. I mean, we hear your peers talking about reimbursement pressure. You've obviously got this dispute with what's potentially soon to be the biggest PBM out there. How has it changed the way you're thinking about corporate strategy? And what I mean by that is, do you view your business as maybe you need more scale and maybe M&A is a way to take care of that? Or do you look at the PBM retail model differently than maybe you have in the past?

[Gregory D. Wasson:]

Yes. Ed, good question. Frankly, I think what it does is get us more excited about our strategy and the need to even accelerate it and the opportunity to accelerate it. Frankly, as I said, this skirmish is moving the marketplace more toward us. The other hundreds of payers out there are looking to work more closely with us, and that's actually helping us. So we're excited about the strategic direction we're headed in. We're excited about the value the community pharmacy can and will play in the future, and frankly, we're accelerating.

[Wade D. Miquelon:]

Yes, I think Greg's completely right. I mean, in the bigger picture, we've got many, many tailwinds. We've got the generic wave coming on. We've got the aging population. But I think even more importantly, people are saying how can a valued community pharmacy and this 12% of spend help me and enable me to save on the other 88% of spend. And that's a huge opportunities for us to play, not only in pharmacy, but beyond that, into the health and daily living space that we're evolving to. So I'm optimistic on the space. I think we've got a great future ahead. We just have to play our game.

[Operator:]

We'll move next to John Heinbockel, excuse me, with Guggenheim Securities.

[John Heinbockel:]

Guys, couple of things. Have you heard anything at all from WellPoint or there's been radio silence there as it relates to you?

[Gregory D. Wasson:]

We've been in discussions with WellPoint as we are with all our payers over the last several months, but we can't comment specifically on what's going on with WellPoint.

[John Heinbockel:]

All right. Secondly, you would think if Medco-Express goes through, there would be -- to some degree, there would be a value in you having a closer, an even closer relationship with Caremark. And obviously, if CVS didn't own it, that might be easier. Does that -- does the fact that CVS is a competitor on the retail side complicate that ability to have a closer relationship with them strategically, on the PBM front?

[Gregory D. Wasson:]

John, I would say no. As I said earlier, we're in the business to fill scripts. We're looking to partner with anybody who wants to leverage having us in their network. And frankly, I think the opportunity to have a wider, broader network, including Walgreens in Caremark's network, is an opportunity and advantage for Caremark. So we're absolutely interested and willing to work with Caremark.

[Wade D. Miquelon:]

Yes. I think common ground we both have, is we both have and both value community pharmacy. It's part of who we are, and I think that's a common ground we can work from.

[John Heinbockel:]

If January 1 comes and goes -- I mean, people often ask, could you January 5 or 10 or whatever come to an agreement, obviously, you can come to an agreement at any point, but just practically, it almost doesn't make sense if we go past the 1st to do it until something is proven out right in theory. The white paper you guys have laid out, that has to get proven out. So it almost seems like if January 1 comes and goes, it's going to take a while for the 2 sides to get back together and work together again. It's not an overnight thing. Is that fair?

[Wade D. Miquelon:]

I think that's right.

[Gregory D. Wasson:]

Yes. John, as I said, we made our last attempt last week. So that we'd minimize the disruption January 1. I think once it crosses January 1, there's going to be a lot of disruption in the marketplace. And frankly, that's why we're locked and loaded, and we're moving on.

[Wade D. Miquelon:]

Plus, as we partner with others who are very eager to win new business, we need to picture that tactic if we cross that January 1 line and make sure that we work with them and help them continue these partnerships.

[John Heinbockel:]

Do you -- have you done any work to see if you lose a script to somebody and it's gone for -- let's say, the PBM contract changes hands next year, but it's gone for 6 months or it's gone for a year, what's the -- maybe this has -- it has never happened before, but what's the percentage likelihood of getting that script back? Is it 50-50 after 3 months? Is it 25-75 after 6? Have you done any work on that?

[Gregory D. Wasson:]

Yes. John, let's put it this way, when we have -- had been forced out of plans in the past, what we have seen is that patients return much more sooner than they do if they choose on their own to go elsewhere. So there -- if the patient is forced to go somewhere and then we are back in that plan, they return to us much sooner than they do if they just chose that -- they made that decision on their own.

[John Heinbockel:]

Yes. But what did you find in terms of timing though? How quickly -- what was the time lapse there for them -- for you to be back in that plan?

[Gregory D. Wasson:]

It varies by plan, by market and by market share.

[John Heinbockel:]

All right. Then one final, just housekeeping thing. If you look at -- your pharmacy gross looks like down about as much as it's been in 2 years. How much of that was the Express reset? Was that half of it, or was that not that big?

[Gregory D. Wasson:]

I’ll just say it was material, but I won’t say more than that.

[John Heinbockel:]

So there's reimbursement broadly?

[Wade D. Miquelon:]

It was a meaningful step-down in the number.

[Operator:]

Next up with Cleveland Research, we have Eric Bosshard.

[Eric Bosshard:]

I'm just curious if you can provide a little bit of color on the retention number, the retention expectation in these next couple of months, specifically -- I know you've outlined where retention might be. But in January, February, March, what would you expect the retention number to be?

[Gregory D. Wasson:]

Eric, let me start, and then Wade can fill in a little more. What's encouraging is, as I said, I think, in my prepared remarks, the activity that we've seen in December with our partners is excessive compared to what a normal season is. That's encouraging. People that are now beginning to realize this could be major disruption for their employees are moving. We think that, that will continue on through January, February and March, as people begin to really realize what this will do. So we -- it's hard to put a number on it, but we think the -- typically, when there is almost no activity in January, February and March, there will be activity this January, February and March.

[Wade D. Miquelon:]

Yes. I would just say, you can see that we've got the 11.4% basically. They're kind of in the bank. Again, we feel pretty good about winning back a meaningful part of Med D. What is it exactly? We won't know. But it will be meaningful, we believe. This all other -- there's just a lot of plans. We don't even know what they are. And every day, we're getting notification of one more that we didn't know, so we don't know in that bucket what we don't know until we get there. And then of course, these other big blocks, what remains to be seen with DOD or WellPoint is -- I know but -- I think we feel pretty good about the progress we're making, and we'll keep making it.

[Eric Bosshard:]

Within sort of -- and I appreciate that the Part D you don't know until you get, I guess, into January and some of these other plans you don't know. But is it reasonable or logical, just trying to get a sense, that the January number is going to be at the lower end of whatever it's going to be? I mean, how -- I guess I'm just trying to figure out how it might step up from month-to-month, and if January could be this 11% number and then it would work its way higher from then. That's what I'm trying to better understand, but...

[Wade D. Miquelon:]

Well, I think it will continue. I mean, I've always said that whatever happens on January 1, in that period, we've always viewed that as that's going to be our toughest period, because we know, we’ll disproportionally get business back with other parties that value having us in their network. So whatever that is, it will continue to grow. The rate at which it grows, I think, remains to be seen, but all the market indications, everything we're seeing and hearing, everything our survey validates basically says that it's really a matter of time before people find an option to get what they want.

[Eric Bosshard:]

And then secondly, with these plans that you're negotiating directly with to get back into the plan, are you making any concessions to them? Is there any pricing change or reimbursement change that you're offering as an inducement for them, or is that part of the deal?

[Gregory D. Wasson:]

No, Eric. In most cases, once they realize what the rates are that we're offering, they realize those are pretty darn good rates.

[Wade D. Miquelon:]

Yes. I think exactly that's right, and I think it also affect those principle, too, of being fair with all the people that we deal with.

[Gregory D. Wasson:]

And, Eric, I'd just like to add the fact that in addition to our belief and the research we've done, that our baseline costs are extremely competitive. The opportunity for a client to take advantage of not only our generic utilization, but also our 90-Day at Retail offering, there are significant savings opportunity out there for clients. That if they were indeed given the opportunity to add a 90-Day Retail benefit on top of an existing mail benefit, there is -- there are ample savings for clients, and that's what we're pushing.

[Wade D. Miquelon:]

Eric, I'll say one more thing, too. I think what this thing has done is -- recall in the past, we haven't been able to talk or work with a lot of these clients directly. So they've never -- many of them have never known what our actual rates are. Now as many are coming and able to look at our direct rate, I would say the general feeling is a bit of surprise that our rates were much more competitive than they thought. And I think the thing is that now they're starting to understand the spread in the middle versus the actual rates, and I think that that's a good development. And I think we want people to know that we're very competitive with other pharmacies.

[Gregory D. Wasson:]

Unfortunately, a 1,000-employer shop -- Joe's garage shop has no idea what rate that Walgreens is giving to their PBM.

[Operator:]

Next up, we'll take a question from Meredith Adler with Barclays Capital.

[Brian Wang:]

This is actually Brian Wang on for Meredith. Just to change things up a little bit. Our question is actually around the front end. How long do you expect the benefits of the CCR initiative to last? And are you seeing above-average comps in year 2 of the CCR stores that were first converted?

[Gregory D. Wasson:]

Yes. Brian, we feel confident with CCR. You keep in mind, CCR wasn't just a static initiative. We're continuing to improve and add content, enhance product assortment, so forth. So we call it -- internally, we call it CCR 1.0, 2.0 and whatever, but -- so CCR was just a much-needed refresh, few reduction and some improvement of systems to help us manage our business better. That's been accomplished in 6,400 stores, and now we're moving on to the next big opportunities, which is content addition and marketing opportunities.

[Wade D. Miquelon:]

So exactly, I think Greg's completely right. I mean, we continue to raise our game in food, raise our game in beauty, raise our game in private label, et cetera and so forth. And so this is really just an evolutionary path, but we're very focused, and I think there's a lot of opportunity beyond 1.0.

[Brian Wang:]

Okay. So you expect it to -- as you make additional improvements, you expect it to continue to benefit results going forward, I would assume.

[Gregory D. Wasson:]

We expect to win in our front end.

[Operator:]

That is all the time we have for questions. I'll turn the conference back over to our speakers for any final comments they may have.

[Rick J. Hans:]

Ladies and gentlemen, that's our final question. Thank you for joining us today. As a reminder, the company will report December sales on January 5. Our next investor event will be the Annual Shareholder Meeting in Chicago on January 11, and we report second quarter earnings on Tuesday, March 27. Until then, thank you for listening. Happy holidays to everyone, and we look forward to talking to you soon.

[Operator:]

This will conclude this Walgreen Co. First Quarter 2012 Earnings Call. Thank you for joining us. Please enjoy the rest of your day.