Walgreens Boots Alliance, Inc.
Q2 2012 Earnings Call Transcript

Published: 27 Mar 2012

[Operator:]

Good day, and welcome to the Walgreen Co. Second Quarter 2012 Earnings Conference Call. At this time, I would like to turn the conference over to your host, Divisional Vice President of Investor Relations, Rick Hans. You may begin.

[Rick J. Hans:]

Thank you. Good morning, everyone. Welcome to our second quarter conference call. Today, Greg Wasson, President and CEO; and Wade Miquelon, Executive Vice President and CFO, will update you on the quarter. Also joining us on the call and available for questions is Kermit Crawford, President of Pharmacy, 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 web website at investor.walgreens.com for reconciliation. 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 filing for a discussion of risk factors as they relate to forward-looking statements. Now I'll 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 highlights for the quarter and update our progress on our Well at Walgreens strategy to become America's first choice for health and daily living. And then finally, I'll provide insight into the second half of the year, and I'll turn the call over to Wade for a more detailed analysis. Beginning with our results today. As you saw in our release this morning, we posted record second quarter sales of $18.7 billion, up 0.8% from $18.5 billion a year ago. Second quarter earnings per diluted share were $0.78, down 2.5% compared to $0.80 in the year-ago quarter. Despite our lower earnings, cash generation continued to be strong as cash flow from operations for the quarter exceeded $1 billion and free cash flow was $703 million. We returned $570 million to shareholders in the quarter, up 23% over the same quarter last year, including $374 million in stock repurchases. Compared to the prior year, the effect of no longer being part of Express Scripts pharmacy network as of January 1, 2012 impacted our results by $0.07 in the quarter and the mild cough cold/flu season impacted net earnings per diluted share by $0.03. This year's results benefited from one extra day versus last year because of leap year. As we look further into the results, even with the impact from Express Scripts, the strength in our business fundamentals comes through in our financial highlights. First, our front-end comp was up 1.2% this quarter compared to the same quarter last year and excludes the effect of the leap day. We continued to see momentum in our Daily Living business as a balance promotional approach during the holiday seasons led to profitable sales growth. And as we expected, our convenience and our products and services led to higher comp store front-end sales in the quarter despite our reduced pharmacy volume. Secondly, we saw a 31% increase in our volume for our 90-day prescription program. This demonstrates that the true value of our 90-day retail offering is becoming clear

[Wade D. Miquelon:]

Thanks, Greg, and good morning to everyone. We are pleased with our performance in the quarter reporting record quarterly sales, strong cash flow progress and managing the business through our transition out of Express Scripts pharmacy network, consistent with what we have outlined in prior calls. This morning I'll take you through our quarterly results in more detail, update how we frame the second half of fiscal 2012 and provide some thoughts around the potential impact from the proposed merger between Express Scripts and Medco. Let me begin with a review of our comparable store sales trends. Both our front end and our pharmacy trends in the quarter were in line with our expectations, and please note that all comparable store numbers discussed in today's call exclude the benefit of this year's leap day. In our second quarter, total sales were up 0.8% as comp prescription sales decreased 5%. Comp front-end sales increased 1.2% over a strong prior year period. Total comp sales decreased 2.6% and comp prescriptions filled decreased 6.1%. Finally, for the second quarter of fiscal 2012, we achieved 18.7% retail pharmacy share versus 20.1% share a year ago, reflecting the decision to exit the Express Scripts network, partially offset by a gain in share from the balance of the industry. Second quarter 2012 comp prescriptions filled decreased by 6.1%, which included a 750 basis point impact related to Express Scripts as well as a 130 basis point impact from a weaker cough/cold and flu season. On a 2-year stacked basis, comp scripts decreased 1.6% versus a 7.9% increase a year ago. To better understand the prescription trends, we have isolated the impact of Express Scripts and cough/cold flu. Adding back the 750 basis point impact from Express Scripts give us an adjusted 1.4% prescription growth rate, which compares favorably to the industry including Walgreens, which grew at 0.9% over the same period. Also adding back the 130 basis point impact from a weaker cough/cold and flu season yields an underlying prescription comp trend or a comp of 2.7%. Moving to our front end. We're very pleased with our daily living comp of 1.2%, driven by core strategic categories including strong progress on beauty, beer and wine and convenience and fresh and illustrating a point that we have consistently made, which is that our retail pharmacy business is not a direct driver of the front of our stores. Traffic in the quarter decreased by 0.1% while basket increased by 1.3%, reflecting a good balance between our promotional strategy and our pricing discipline. We enjoyed a strong Christmas and Valentine's Day, with Valentine's Day performance helped by customers seeking convenience given the midweek holiday. While the weak flu season had a negative 0.5% impact on our daily living comp, overall we were pleased with the results, especially in strategic health and wellness categories. Finally our 2-year stack, represented by the blue line, continues to be in the mid-single digits. Compared to our industry, our front-end sales continue to perform well. After adjusting our daily living comp to the next 3 largest retail pharmacy competitors, we outperformed 2 of the 3 in the quarter. And on a 2-year basis, we have outperformed all 3 by at least 200 basis points. Like everyone, we continue to see a cautious consumer and a competitive retail environment, but we believe this out performance is a reflection of our differentiated strategies, our focus on the customer experience and excellent execution in the stores. Turning to margin. Our gross margin as a percent of sales was 28.9% in the current quarter compared to 28.8% last year. The overall margins increased due to stronger front-end margins. Pharmacy margins declined slightly, impacted by reimbursement, Specialty Pharmacy mix and a higher LIFO provision, partially offset by the introduction of new generics. Taking a look at our longer-term gross margin trends, this quarter's 10 basis point improvement was against the second quarter a year ago with flat margin. I'd also like to remind you that we believe the better way to look at our business model over time in both Daily living and in pharmacy and health and wellness services is to focus on our gross profit dollar growth. This quarter and for the remainder of calendar year, please keep in mind that the comparability of gross profit dollar growth will be impacted by the loss of prescriptions related to the exiting of Express Scripts network. Two-year stacked SG&A trends improved versus a year ago with 12% growth in the second quarter of 2012, down from 13.1% last year. Our SG&A growth in the quarter was impacted by new stores, investments in strategic initiatives and capabilities and noncomparable drugstore.com costs. After adjusting for costs related to the drugstore.com operations and integration, our 2-year stacked SG&A growth improved to 7.4% in the second quarter versus 11.1% a year ago. If you get to our core SG&A dollar growth, you can see that our reported 4% SG&A growth included 80 basis points of integration and operational costs related to the drugstore.com acquisition. The remaining base SG&A dollar growth was a combination of new store openings, inflation and investments in strategic initiatives and capabilities. This slide shows our quarterly gross profit dollar growth trends for the past 6 quarters. Recall the primary driver of our higher gross profit dollar growth in the first 3 quarters of 2011 was the acquisition of Duane Reade. When we cycled the acquisition in the fourth quarter of 2011, you can see the slower gross profit dollar growth. In the second quarter, in addition to strong front-end performance, we benefited from the recent launch of generic Lipitor. As you look at the upcoming third and fourth quarters, you should consider the following points

[Rick J. Hans:]

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

[Operator:]

[Operator Instructions] We'll go first to Andrew Wolf from BB&T Capital Markets.

[Andrew P. Wolf:]

I just wanted to ask you about the $0.07 on -- from Express Scripts. Did that include any of the costs to service clients, either to help them stay with Walgreens or smooth their transition to a new pharmacy or is that just sort of a pure gross margin number?

[Wade D. Miquelon:]

No, that's a net all-in, including those specific costs. But effectively, as we said, we offset 50% of gross margin this quarter, primarily through SG&A and COGS, but it's an all-in number.

[Andrew P. Wolf:]

You achieved it this quarter or you're expecting to achieve it going forward? I thought this quarter you actually -- the costs were up because -- that's my next question. What is the swing in SG&A that you anticipate by managing down pharmacy hours and other hours and other costs versus sequentially, if you will?

[Wade D. Miquelon:]

We're looking at it this way; we had about 2 months and 1/3 of a month when we think about the volume impact as part of this number, right, and then 2 months that we had an impact from the gross profit point of view. But we had 50% of that offset through COGS and SG&A. In the future, we're going to have 3 months, but we're going to have a step-up in some of our cost efforts and measures accordingly. So it will be really a balanced impact of Express Scripts through these 3 quarters, $0.07 in each quarter basically.

[Gregory D. Wasson:]

Andy, just to reiterate, I think the key point is the fact that we still feel the $0.21 impact based on that lower scenario is what we'll see for the year.

[Andrew P. Wolf:]

Got you, okay. It clarifies that. I wanted to ask about Medco in the event of the Express Scripts/Medco merger being consummated. I mean in your contract with them, does it allow an out with the change of control? If not, what is the term -- I think we'd all benefit if you could tell us how long your contract is for and -- so that's the contract part. And then secondly, you talked about the book of business going down to 74 million scripts in next year, next calendar year, and do you have -- could you size what percent? I mean it sounds like it's a large number, much higher than Express. But what percent of those contracts or prescriptions do you believe are under contracts or will be under contracts that are flexible enough that would keep Walgreens in the network if the merger is consummated and Express changes how they do business with Walgreens with Medco?

[Gregory D. Wasson:]

Well, Andy, maybe Wade and I both tag team on this just to make sure we get all of that. I think certainly on the first part, as far as what's in their specific clauses and contracts, we certainly don't have visibility into those. We do believe from what we've heard in the industry that some do have change in control clauses and everything that Wade went through himself. So that's just based on intelligence, what we're hearing from the field. As far as the terms of the contract, as we said, we got an ongoing contract with Medco that we intend to honor and we don't see any indication that, that would change. As far as the percentage of the business, I'm going to let Wade kind of key in on that one.

[Wade D. Miquelon:]

Yes, I mean it's impossible to predict and I would say clearly, these customers have -- it's a very different situation. They have much more rights at large than the Express customers and they also have had the benefit of time watching this unfold as they look forward when their contracts end and potentially renew. So again, without speculating a number, I would just say that for all the reasons I outlined, the situation is very different and they have a lot more flexibility in rights in aggregate than the Express customers. Again, back to the contract we have with Medco, it's been in place for many years. It continues to move forward, I suppose, until the parties decide at some point that it doesn't.

[Andrew P. Wolf:]

So essentially, an evergreen contract that either side can walk away from at their whim?

[Wade D. Miquelon:]

We're never going to talk to any specific contracts with any specific customer or supplier. But I would just say that like I said before, it's been in place for a long time and we both obviously have felt it's fair, good for patients, payers and everyone, and we continue to honor that.

[Operator:]

We'll go next to Ann Hynes from Mizuho Securities.

[Ann K. Hynes:]

I just want to focus on the Medco slide. When I look at the scripts from calendar 2011 to 2012, you have a decline of 17 million scripts. And when I look at the book of business that Medco is losing for 2012, it seems a little high to me, just taking your national percentage of market share. So can you maybe go into a little more detail about what -- which contracts are really driving that decline?

[Wade D. Miquelon:]

You mean the decline from 2011 to 2012?

[Ann K. Hynes:]

Yes. I understand that 2012, 2013 [indiscernible] your market share, but I'm a little confused about the 2011 to 2012, the drop of 17 million scripts?

[Wade D. Miquelon:]

Well there's been, obviously, many public accounts, scalpers and others out there. I don't want to go into the list of the different clients. But quite frankly, 2012 is pretty easy because now that we're already in March, we can see our actual monthly run rate and reconcile back to those accounts. So 2011 was an actual, 2012 is kind of a current actual rolling forward and then 2013 is just doing the other puts and calls we know like United.

[Gregory D. Wasson:]

Ann, I guess the main point is we've got a lot of confidence in that number because we've done the internal analysis and based on the book of business and the plans that have been publicly announced, that's the number.

[Wade D. Miquelon:]

We see every day in our book.

[Ann K. Hynes:]

Perfect. And then the $0.21 impact for fiscal 2012, I just want to confirm that's current retention rate in the mid-teens that you've experienced in January and February?

[Wade D. Miquelon:]

Correct.

[Gregory D. Wasson:]

Yes. As Wade said, Ann, we hit about 15% at the end of the second quarter and I think it's important to say that we expect that to build. And as plans begin to take action, state of Nebraska as a public reported is changing July 1, so we expect that to build.

[Ann K. Hynes:]

All right. And will you give you any details on the gross profit differential between an Express Scripts and Medco scripts, so we can just...

[Wade D. Miquelon:]

Well, I guess we could basically say that there is no Express contract, so there's really no differential to give. But no, we never talk about any one customer to another. And our objective here is to be fair with all customers and try to treat them all fairly, in the same genre anyway.

[Operator:]

We'll go next to Mark Miller with William Blair.

[Mark R. Miller:]

You talked about the restricted networks not gaining traction, and I was wondering how do you know that's not about to happen through the rest of the selling season or later in the year and what visibility do you actually have on that?

[Gregory D. Wasson:]

Yes, I think -- Mark, good question. We feel pretty confident as far as the intelligence we're getting from the field. I mean we've got people out talking to the benefit consultants. We've got people out talking to clients as well as the other partners that we work with out there. And we just don't see it. What we're more encouraged by, frankly, is the fact that, as I said in the last call, that the other payers that we're working with, whether its PBMs or health plans, are more and more interested in working closely with us and differentiating themselves in the marketplace this selling season because they have Walgreens in versus Walgreens out. The survey that we did that we published last quarter also, I think, is a strong indicator that says that employers would need a 5% to 10% greater savings to even consider a restricted network. So all intelligence that we see, folks that we're working with, we do not any trend.

[Wade D. Miquelon:]

I think especially, again, it's where restricted gets used loosely. Someone might have a restricted network that doesn't include a pharmacy, that doesn't have a share in that market anyway, right? When it comes to excluding the nation's leading pharmacy, for a little or no savings, there's really no evidence that, that has ever taken up noise at this season as well.

[Mark R. Miller:]

Okay. My next question is given there's more than a $0.50 spread in the consensus estimates, high to low for fiscal '12, and given there appears to be decent predictability to the business, based on the constraints of what the lawyers will let you talk about, can you give some general commentary on the second half outlook? The Street's looking for nearly flat EPS, down a little bit. I mean is that a reasonable framework? And same scenario for fiscal '13 is like a $0.60 spread in the analysts' projections?

[Wade D. Miquelon:]

Look, I mean obviously since we don't give guidance, I can't point to any specific number. I would just come back to overall framework. Prior to the Express Scripts -- prior to exiting their network, we had financial goals and targets. The financial goals that we stated we want to hit over time, we've talked about what the impact of Express Scripts will be to us on a fiscal year basis. They've been laid out by quarter basis, so you kind have to model backwards from there.

[Mark R. Miller:]

Okay. Last question from me is you talked about the EPS benefit growing from generics. Wade, roughly what kind of an EPS lift did that give to the company in the fiscal second quarter? Was that in the range of a $0.05? Could you help us out on sizing the benefit? And then how much greater should we think of that lift in the coming quarters?

[Wade D. Miquelon:]

We aren't going to outline exactly what it was in Q2, but I'll actually defer to Rick's Heisenberg uncertainty principle of generics, which is the more you try to measure and estimate what they're going to be in the future, the more the number keeps changing all the time because there's lots of variables for suppliers -- like in suppliers, et cetera. So clearly we get a lift in the back half, we said that, but I think it'll be premature to try to put a number around it until we get there.

[Operator:]

We'll go next to Tom Gallucci from Lazard Capital Markets.

[Thomas Gallucci:]

Just one clarification and one sort of follow-up on that last set of questions. I guess just on the clarification, the $0.07 Express hit, what rate is that based off of? Is that your old contract or the terms that you proposed or how would you put that in context?

[Wade D. Miquelon:]

That would have been our exiting rate.

[Thomas Gallucci:]

Okay. And then maybe following up on what you were talking about a second ago in terms of your long-term goals. I guess if you add the Express impact and the flu and you take away $0.01 from leap day, maybe your EPS grew 7% or 8% in the quarter on a year-over-year basis. How does that sort of compare to what your expectations are over the long term x some of the noise that we've gotten in terms of Express and whatnot?

[Wade D. Miquelon:]

Well, I mean, you could certainly do the math that way. We don't adjust that way. We just keep it broad as it is. But what I guess I would say is over the long term, we're still operating over that systemic framework. We believe that we can have industry-leading growth. We can have that robust EPS growth. We can have steadily improving cash flow and ROIC and a good strong balance sheet. So this is -- I would call this a blip in the road on the path to keep focusing on that.

[Thomas Gallucci:]

Right. But in terms of robust EPS growth, I don't know, is high single digit the goal? Is it sort of low double digits? Or I guess how do you think about the business x a lot of the noise in the long run?

[Gregory D. Wasson:]

Tom, this is Greg. Our goals haven't changed. We set out -- there's a plan to win 3 years ago. We want to go back to double-digit EPS, strong return on invested capital and top 2 shareholder return. And that's what we think our strategies will allow us to do. There's 2 ways to look at frankly

[Thomas Gallucci:]

Okay, last one. Wade, you mentioned AMP. How are you thinking about that? And what's the latest that you've got there?

[Wade D. Miquelon:]

Yes, I mean, I'll let Kermit answer this. Obviously, there's not a lot to update, but Kermit why don't you...

[Kermit R. Crawford:]

Well as you know Tom, right now we're in the comment period on the FUL. There's been some questions around the FUL that basically have been fixed draft out there. So as a industry, I mean we are still continuing to work with CMS to get an AMP that reflects the actual retail community pharmacy purchasing price, and that is our continued goal. So as we continue to work with CMS, it's all about getting AMP right and doing what's right for the community and community pharmacy.

[Thomas Gallucci:]

Is there an expectation for a time frame and we'll have maybe some resolution or is it pretty uncertain still?

[Kermit R. Crawford:]

No, I think it's still uncertain as to the time of AMP implementation.

[Operator:]

We'll go next to Matthew Fassler from Goldman Sachs.

[Matthew J. Fassler:]

A couple of questions, a couple of follow-ups. First of all, you alluded in your press release to strategic projects impacting SG&A. Any clarity as to what that relates to and what you're working on?

[Gregory D. Wasson:]

Well, yes, Matt, we continue to invest, obviously, in a multichannel business. We think that's a big opportunity for us, and some of the things I mentioned on the call would be indicative of that. We continue to invest in our stores. As we said 3 years ago, the reason we decided -- one of the reasons we decided to slow our new store opening growth was to be able to reinvest in our existing store base. We think we've got a heck of a footprint. There's a lot of things that we've done with CCR this past year as a good foundation for us to build upon. So we're continuing to invest in those new stores, those pilots and we'll continue to measure to make sure that's a good use of our capital. I think we're also continuing to invest in our front-end offering, private brand. We're really feeling good about where we're going there. So it's basically our 5 key strategies that we're pretty consistently with -- consistent with is where we're investing.

[Matthew J. Fassler:]

Got it. And sort of related to that, I know there's been some discussion of ultimately launching a loyalty program. Is the cost embedded in current SG&A in any way and any update as to the timing of that kind of effort, please.

[Gregory D. Wasson:]

Yes, as far as -- I'll take the loyalty launch itself. We feel good with where we're headed. We're still planning for a mid- to late September launch of our loyalty program. As far as the SG&A impact, I'll let Wade kind of address that.

[Wade D. Miquelon:]

Yes, we've certainly had some costs now we're doing to get obviously like a launch in the timing Greg said without having some upfront investment to get it right. And we haven't that disclosed amount, but that's part of those strategic investments to really set us up for the future.

[Matthew J. Fassler:]

Got it. And then finally at some point, the focus will likely shift back to the core business and to retail. You spoke about the Well format stores; you have over 200 of them now. I know some are Walgreens, some are Duane Reade. But can you talk about the economics of conversion, the kind of investment they need to generate, how those stores are comping and what their margins look like versus the rest of the chain?

[Wade D. Miquelon:]

I think all I would say is this is that what we're seeing in those stores from lifts and from profitability and returns is very promising and we're still measuring and analyzing. We look at unit economics. So every store is slightly different, every model slightly different. It's all contextual to what we're trying to achieve. And so obviously, we wouldn't be going down this path if we didn't think that it was financially accretive and good for the customer as well. And again, early results across-the-board are promising, but we continue to refine and look at it to really fine tune our unit economics moving forward.

[Operator:]

We'll go next to Scott Mushkin from Jefferies & Company.

[Scott Andrew Mushkin:]

So let's assume the Medco and Express merger goes through and I'm just trying to understand what you would think as a material change. I mean if Express slowly tries to move people -- the Medco accounts over to their network, how do we view that and how would you view that and how would you respond?

[Gregory D. Wasson:]

Well, Scott, Greg. Certainly, a good question. I'm not going to speculate on what they may or may not do. I think as we said in the call, we've got a good relationship with Medco. We think we have got a great relationship with their clients. We got an ongoing contract that we think makes sense for all to honor, and we intend to do that. As far as what they may do or might do, I think that probably is not worth speculating on. I will say that, as Wade said, like all business, once we see and have an indication of what has actually happened and the terms and conditions and so forth, then we make the adjustments necessary. So bottom line, we look for fair reimbursement for the value we provide and that's what we would expect.

[Wade D. Miquelon:]

I'm not sure of the exact question. When you say move over their network, I guess what you're saying is the network without being able to access Walgreens because we have no arrangement now with Express Scripts.

[Scott Andrew Mushkin:]

Correct. I mean what I'm saying is if they offer the Medco customers the ability to switch over, how do you guys deal with that and how would you respond?

[Wade D. Miquelon:]

Our customers could always choose that. I mean today, Express Scripts for 10 years, has been trying to sell EN30 and 40 without Walgreens. It's less than 1% of the business, but they have the right to do that. Customers clearly don't like thinking they got bacon and eggs and show up and have cold oatmeal. So the real issue, I think, is whether or not customers want Walgreens and value Walgreens and we believe from what we're hearing, they do.

[Gregory D. Wasson:]

Scott, as I've said several times, I'm going to remind you, we are in the business of filling scripts and that's what we do. So certainly, that's why we would want to honor that contract and continue to work with those clients. But it has to make good business sense for us and we just decide and determine at the time based on what we see as to how we'd go forward.

[Scott Andrew Mushkin:]

Okay. So just to summarize, if they had a lot of success, you might have to deal with it, but you don't think necessarily they'll have a lot of success. Is that a good summary?

[Wade D. Miquelon:]

Customers want to get what they pay for, right? And what we're hearing loud and clear from the customers is they want a broad network and they know there's no material savings. And so in those cases, they're obviously going to have a lot of more rights in Express. What they are by customer remain to be seen. But at the end of the day, customers want to pay for what they want to get.

[Gregory D. Wasson:]

Scott, here's what we are seeing and do believe that although we are not an Express Scripts network unfortunately, at the same time we are building deeper relationships with all the payers that are out there wanting to work more closely with us. So we can focus on the lack of access to Express Scripts, but the positive is to gain share and the deeper relationships we're building as a result with every other payer that's out there, and that's where we're focused. And we feel good with what we're seeing in the early selling season. And as I said in my early opening remarks, this is one heck of a busy selling season already.

[Scott Andrew Mushkin:]

So I want switch gears to SG&A, just to understand when the store level cuts, I think you said they're kicking in maybe March 1. And I think you've outlined lower store hours, reduced staffing and salary cuts. And so I guess what I wanted to know is when will they be fully implemented? And then kind of a corollary here is the SG&A dollar growth rate this quarter, if I adjust some adjustments Wade put up there, but also thinking about the store growth, it looks like the core business x the store growth was kind of flat. And I wondered if that is something you can replicate, so the 2-part SG&A question then I'll yield.

[Wade D. Miquelon:]

I'll hit it first and I'll kick it over to Kermit and Mark. I think our SG&A growth, you're right, when you exclude the things like drugstores, Walgreens stores, we did have very good progress there and I think a lot of what we're doing across-the-board, not just in stores, but at corporate is continue to find ways to become more efficient and effective all the time, Express or not Express. But I'd say is that before I turn it over here, too, is the efforts we're doing at stores we're trying to match up to do it smart to where the biggest volume impacts have been. This is not peanut butter, and we still intend on having the best service in the business. We still intend on improving our customer satisfaction as we go. But this is really about making sure that we do it smart, again in concert with the volume losses we've seen.

[Kermit R. Crawford:]

And Scott, I'd just add we balance our store labor payroll all the time depending on volume. So as our volume fluctuates, so does the way that we balance our store labor.

[Gregory D. Wasson:]

Yes, maybe, Scott, I'll weigh in. I want to come in and frankly take this opportunity. We probably have employees that are listening in, Mark and Kermit the job they've done, I think our employees have done an incredible job reacting intelligently to the reductions that we are beginning to put in place. And as I've said, the good thing about this is that there is good -- its market-by-market, store-by-store in specific markets and we've got the ability to laser in and dial down store-by-store. But our store employees and store managers out there have just done a terrific job in managing through this. And frankly, they support the long-term decision that we've made and where we're headed.

[Operator:]

We'll go next to John Heinbockel from Guggenheim Securities.

[John Heinbockel:]

Couple of things. If you -- if we look at $0.21 earnings impact with 15% retention, so that looks like maybe an incremental $100 million or so of cost-reduction somewhere, cost of goods, SG&A. Generally speaking, where is that coming from?

[Wade D. Miquelon:]

Well, those are 2 of the buckets obviously, but the other piece of it is even though almost all of it is costs, we're also seeing -- well, it might not be ESI retention, we might be building scripts or getting top line volume from other customers. So for example, we've seen -- give you a couple of examples here. We've seen other pharmacies that were so overloaded with Express customers, they couldn't handle the volume, they had out of stock, they didn't have supply. So customers that we could have served in the past were going to other pharmacies have now come to Walgreens. And we're kind of seeing that by the day right here as we also link with conversion programs. We also see Medicare Part D. Every day I think it's something like 11,000 people are turning -- go Medicare Part D. And some of those were with Walgreens before then they found out or woke up and they couldn't go to Walgreens and now they turn to the age where they can get Medicare Part D and they're looking for plans that have Walgreens. So there's lots of different buckets like that. But the vast majority is incremental cost efforts, but we are seeing outside of the retention bucket, we're seeing other volume upticks in lots of different areas. It happened slowly, but surely.

[Gregory D. Wasson:]

And John, as we said, we held off on store labor, store reduction to make sure we did a good service. But we have been focused corporately and we're certainly looking at projects and making sure that we're focused on those that really move the needle. I think frankly, the positive is we are laser focused on those 5 key strategies and driving what -- and really focused on the projects that would move the needle. So we've been looking at corporate over the last couple of months, so there's been real progress there.

[John Heinbockel:]

All right. Secondly, are you doing anything differently with other PBM partners this selling season in terms of how you're working with them, what you're offering them aside from them just selling Walgreen being in the network, anything else that's different than past years to accentuate that? And I guess if you are, it sounds like you're getting good early feedback that that's working?

[Gregory D. Wasson:]

Yes, John. I think several things. First of all, a lot of them are coming to us, as I said earlier. They're looking at this being one of the few selling seasons where there is true differentiation in the marketplace with a PBM offering. And that being, frankly, that they have the largest retailer in the country in their network or out of their network. That's #1. That's a pretty -- frankly, what we're hearing is that's a pretty easy sell and they're looking forward to that. Then we begin to talk about the fact that we drive high generic utilization. They're looking to work with us on how we can drive that even higher and bring them greater value. Many of them are now really beginning to see the benefit of 90-Day at Retail being added to an existing mail plan. As we've said several times, when a payer or client adds a 90-Day at Retail benefit through existing mail plan, there is anywhere from 7% to 9%, maybe more percent in savings available. So I think they're really beginning to work with us in ways and look for some of the ways that we can help them reduce costs and drive real value.

[John Heinbockel:]

All right. And then finally, if you take a long-term view, do you think -- I mean, clearly reimbursement rates are going to go down secularly. But if you think about a Medco, Express -- so I'm assuming that goes through, which it looks like it is, if you look at that concentration on the PBM side, does that drive quicker reimbursement rate pressure on the retailer over the next year or 2? And do you think that, that leads mostly to consolidation, mostly I guess the smaller guys falling out more quickly. Is that where we're headed?

[Gregory D. Wasson:]

Well, I mean, I guess you could -- I don't know if it's going through or not, right, so I hope it will. But I would say that from our point of view, our principle is our principle. We expect to be compensated fairly. Fairly, not just versus our own thinking but versus the market and versus others. And that doesn't change, Medco or no Medco. I think you could make the argument that it could put tremendous pricing pressure on the little guys as they need to pay for the premium of the merger, et cetera. And quite frankly, I think you can see it from our battle. There's large -- we are #1 retailer that a small player is going to have a very difficult time probably holding the line in that scenario.

[John Heinbockel:]

Yes, but even for the big guys, you would say the pressure gets ratcheted up a little bit or no?

[Wade D. Miquelon:]

I'm pretty convinced of our value proposition. We're seeing it now in the sales season, we're seeing people just not having Walgreens as a non-starter. There are no material savings and I think people don't want to go through their own network just to spread an intermediary. I think the reality is, though, is that small players are going to have a very difficult time in that environment.

[Gregory D. Wasson:]

John, I think we've been in this industry, there's been an ongoing reimbursement pressure for years in this industry and still will be. And I think therefore, as we're focused obviously on costs and making sure that we continue to take costs out, we're also looking -- that's the reason we're driving our strategies

[Operator:]

We'll go next to David McGee from SunTrust Robinson Humphrey.

[David G. Magee:]

In the event that Express, Medco does happen, would you care to hazard a guess as to what the retention rate might be given your greater conversations with those clients?

[Gregory D. Wasson:]

Yes, I think -- I don't think we'll get into that David. I will say if you go back to Wade's chart, we tried to show what we see the book of business being with us January 1, 2013. Hey, frankly, I tell you I believe it would be difficult for Express Scripts and others to continue to sell without Walgreens in their network. We've had, as I said, we've had several conversations with many of the key clients and those clients indicate to us that they really valued having Walgreens in their network.

[Wade D. Miquelon:]

And they've got the ability and the means to do that and that's their intention. So I think we remain pretty confident that it's a very different scenario.

[David G. Magee:]

My second question is looking at the impact of Express being $0.21 this fiscal year, is it fair to assume that, that maybe gets cut in half in 2013, so maybe $0.07 in the first quarter and maybe $0.03 in the second quarter?

[Wade D. Miquelon:]

I think either way just to model it is you've got 8 months this year and then 4 months next year, so you lap it, right? So you could build your own models and figure out the sequence and timing on how you lap it. It's not that hard to do.

[Rick J. Hans:]

Ladies and gentlemen, that was our final question. Thank you for joining us today. As a reminder, the company will report March sales on April 4, and we'll report third quarter 2012 earnings on June 26. Until then, thank you for listening and we look forward to talking with you soon.

[Operator:]

That does conclude today's conference. We thank you for your participation.