Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Walgreen Company (NYSE:WAG)

F1Q09 Earnings Call

December 22, 2008 8:30 am ET

Executives

Rick Hans - Divisional Vice President of Inventor Relations and Finance

Greg Wasson – President and Chief Operating Officer

Wade Miquelon - Senior Vice President and Chief Financial Officer

John Spina - Vice President and Treasurer

Analysts

Lisa Gill – JP Morgan

Mark Miller – William Blair

Eric Bosshard – Cleveland Research Company

Nathan Reich – Citigroup

John Heinbockel – Goldman Sachs

Ed Kelly – Credit Suisse

Mark Wiltamuth – Morgan Stanley

Meredith Adler – Barclays Capital

Steven Halper – Thomas Weisel Partners

David Magee – Suntrust Robinson Humphrey

Bakley Smith – Jefferies & Company

Operator

(Operator Instructions) Welcome to the Walgreen Company First Quarter 2009 Earnings Conference Call. Now at this time I’d like to turn the conference over to Mr. Rick Hans, Divisional Vice President of Inventor Relations and Finance.

Rick Hans

Welcome to our First Quarter Conference Call. We’ll start today’s call with Greg Wasson our President and Chief Operating Officer, discussing the quarter’s highlights and the progress we have made on our strategic initiatives. Wade Miquelon, Senior Vice President and Chief Financial Officer will provide details on the first quarter financial results before turning it back over to Greg.

John Spina our Vice President and Treasurer is also joining us on the call today. In addition, I’d like to introduce the newest member of our Investor Relations team, Lisa Mears; Lisa just joined us this month as manager of Investor Relations.

We have allowed plenty of time for your questions on the call today but please limit yourself to one question and a follow up so that we can give an opportunity to as many investors as possible during our limited time. I’d like to point out that today’s call is being simulcast on our Investor Relations website located at investor.Walgreens.com. After this call the presentation 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. Please see our latest Form 10-K for a discussion of factors as they relate to forward looking statements. Now here’s Greg Wasson.

Greg Wasson

Let me begin by thanking everyone who came to Chicago for our Analyst day in late October. We greatly appreciate your interest in Walgreens and enjoyed having the opportunity to meet you. We also appreciated the breadth of questions posed during the day and your comments and suggestions for our next analyst day. For any of you who missed our meeting the audio presentation and slides are archived on our website.

Before discussing the financial results and strategic initiatives we put in place during the first quarter I would like to emphasize that the CEO search process has not slowed down the implementation of our strategic growth initiatives in any way. I can assure you we haven’t missed a beat. We are progressing rapidly on the key initiatives which drive our three strategies.

As our Board, Chair and Acting CEO, Alan McNally outlined at the analyst day meeting, the Board determined that the search process would consider both internal and external candidates and take about three and a half to four plus months. At this point we would expect an announcement sometime in early 2009.

To get started, today we announced that we are slowing our new store openings to 2.5% to 3% by fiscal 2011; this will reduce our CapEx by an additional $500 million. Both Wade and I will have more to say about this later. Net sales for the first quarter were a record $14.9 billion, up 6.6%. Comp sales rose 1.7%, net earnings were $408 million or $0.41 per share diluted compared to $456 million or $0.46 per share diluted a year ago. Our customer traffic strengthened as the quarter progressed, although basket ring was down as customers were buying essentials rather than discretionary items.

Comparable prescription sales rose 2.6% in the quarter, the number of prescriptions filled in comp stores was virtually flat compared with a year ago but on an adjusted 90 versus 30 day basis we would have increased 150 basis points. For the quarter we filled 156 million prescriptions. Total retail prescriptions increased 3.7% over last years first quarter. That compares favorably to an industry wide decline of 0.5% as reported by IMS, excluding Walgreens.

We’ve talked previously about some of the factors affecting prescription sales despite these near term challenges we have seen benefits in December from a recent up tick in the flu and the later than usual Thanksgiving. We continue to gain prescription market share, we now fill 18% of all retail prescriptions in the country.

We’ve seen a big increase in a number of flu vaccines administered this season, delivering over 1.1 million shots which are more than twice what we did all last year. Special thanks to all the hard work of our pharmacists and nurse practitioners who are successfully building this business. As I said during the quarter we made great progress on the three growth strategies which you may remember are:

Leveraging the best store network in America

Enhancing the customer experience

Major cost reduction and productivity gains

I’ll bring you up to date on our progress. As you can see on this slide over the last six months we have substantially reduced our plans for new store openings. In July we announced the reduction of the long term growth rate from 8% to just 5% in 2011. Today, we announced that we are reducing new store openings further to about 4% to 4.5% in fiscal 2010 and about 2.5% to 3% in fiscal 2011. This decision was made after evaluating the current economic conditions and concluding that we have substantial upside to drive greater value creation by enhancing the best community based store network in America.

As a result, we believe that for the long term slowing in new store openings is an important strategic step. Because this is an increasingly dynamic process going forward we will be providing guidance regarding planned store opening data as a range rather than providing the exact number of openings as we’ve done previously.

Let me be clear, we will continue to open new stores on the best corners and end markets that deliver the highest return on invested capital. Our new Times Square store is a great example, we opened it in November and it has already become one of our top performers.

In summary, moderating new store openings will one, support our customer centric retailing initiative, two, increase flexibility to invest opportunistically, three, save an additional $500 million over the next three years over and above the $500 million we previously announced, and four, drive greater value creation by strengthening the best community based store network in America.

We continue to enhance the customer experience through new customer centric programs and improvements to store operations. These include efficient assortment, efficient promotion and refreshing our existing store base. We’re also responding to the current consumer need for increased value by broadening our offering of what we call affordable essentials, basic staples such as food items, paper products and other consumables.

We’re positioning our stores to take advantage of the new consumer reality for retailers which means customers are making more purchases using cash and timing those purchases closely to the beginning or the middle of the month when they receive their employer or government checks.

We’re also meeting the needs of our cost conscious customers with money saving initiatives such as our Prescription Savings Club. This loyalty program serves the needs of the 46 million Americans who are uninsured as well as the millions who are under insured. We now have more than 1.4 million Prescription Savings Club members an increase of more than 400,000 in just three months and more than 30% of the PSC members are new Walgreen patients.

As we’ve said before, our private brand business is one of the strongest in retailing and continues to grow as consumers look for value. We’ve also had tremendous momentum in our online business which reported a 45% increase in traffic to Walgreens.com during the month of November. Another component of consumer centric retailing is testing and evaluating new store formats. We are underway and as we make progress we will update you.

Now let’s talk about another major initiative which we are making good progress, POWER. POWER will transform community pharmacy as we know it today and it is currently being rolled out across Florida. As you may recall, POWER focuses on one, eliminating a significant amount of administrative tasks from the community pharmacy which will free up pharmacists to play a greater role as trusted clinicians, two reduce overall pharmacy costs, and three enable us to increase the breadth and dept of pharmacy services such as flu shots and vaccinations.

In October we told you that POWER was in 152 Florida locations, today POWER is in 280 stores in Florida. The Orlando metropolitan market has been completed and we’re well on our way to completing South Florida. By the end of the fiscal year we will have implemented POWER in all Florida stores, that’s more than 760 locations and more than 10% of our total drugstores. We’ve begun providing centralized fill in services 30 stores in Arizona from our Tempe mail service facility as you can see we are well on our way.

We continue to leverage and enhance the core business through our growing pharmacy and health and wellness services and locations. We opened four new worksites and 76 new retail clinics in the quarter giving us a total of 661 retail and worksite clinics nationwide. We expect to be operating in about 800 locations by the end of the fiscal year.

As Americans seek to control the cost of their healthcare services, our retail clinics provide cost effective, quality care that’s extremely convenient to customers. In combination with our worksite clinics and health centers we help corporate clients control healthcare costs while encouraging healthy lifestyles for their employees.

Interest continues to build; recently we opened locations for the 70,000 eligible employees and their families at the Disney properties in Orlando and a new health center in Las Vegas, serving 11,000 eligible members. We continue to expand our specialty pharmacy business which represents one of the fastest growing areas of healthcare today. On December 1, we completed the acquisition of a specialty pharmacy business from McKesson Corporation. The acquisition will further strengthen our position as the fourth largest specialty pharmacy in the country.

I’ll let Wade update you on the specifics of the quarter, the rewiring for growth initiatives and the financial impact to date of our new strategic initiatives.

Wade Miquelon

Given the context of a challenging economy our team worked hard in the quarter to deliver higher sales and control costs. As Greg said previously net sales increased 6.6% while total comparable sales were up 1.7%. This compares favorably with many other retailers for the past quarter. Net earnings were $408 million a 10.4% decline from last year.

Prescription sales rose 6.2% and represent 66% of sales for the quarter. Prescription sales in comparable stores rose 2.6%. The number of prescriptions filled in comparable stores was virtually flat although, as Greg pointed out, prescriptions were up 1.5% when adjusting for more patients filling 90 day scripts versus 30 day prescriptions.

During the quarter we had approximately $0.045 per diluted share cost impact from a variety of items which includes first, an incremental $0.01 charge for LIFO reserve versus a year ago, second, a $0.01 cost, one time charge for rewiring for growth, third, $0.01 of interest expense above the year prior, lastly about $0.015 of year on year incremental investment for our retail clinic expansion.

Gross profit in the quarter was $4.2 billion a 5.9% increase reflecting a challenging business environment. Gross margin was down 20 basis points in the quarter compared with the prior year. The overall margin was negatively impacted by lower margins of a non-retail businesses and a higher LIFO provision. This was partially offset by a higher retail margin as a result of the impact of generic drug sales. Front end margins were essentially flat year over year.

SG&A expense increased 9.1% in the first quarter compared with an increase of 10% last year. While our base cost control was very robust this level of SG&A growth above sales growth can be attributed to three causes. First, we opened a record number, 212 new stores in the quarter and that is a very large driver of SG&A. Second, as I mentioned earlier we continue investing in our retail healthcare clinics. Finally, we incurred some one time costs associated with rewiring for growth and these are essentially all in SG&A.

We have made significant progress in controlling the growth of SG&A in recent quarters. As you can see from this chart SG&A dollar growth in the quarter on a two year stacked basis has steadily declined from 28% to 19.1% despite very aggressive store openings. The same three issues I highlighted a moment ago and on the previous slide as negatively impacting our business near term will actually begin to benefit SG&A in the future.

For example, slowing new store openings will allow for significant slowing of SG&A. We are likely to have our highest loss quarter and highest loss fiscal for retail clinics this year and we will receive significant ongoing cost benefits from rewire for growth beginning the end of this fiscal and on into 2011.

Now let’s look at a few other financial drivers in the quarter. The effective tax rate was 37.6% compared to a rate of 37.4% in the year ago period. Net interest expense was $15 million compared to zero last year due to the issuance of $1.3 billion in long term debt. The LIFO provision was $43 million versus $27 million in the first quarter of 2008.

In the quarter, we invested $638 million on additions to plant, property and equipment versus $490 million last year due largely to the addition of 212 new stores versus 166 last year. In fiscal 2009 we plan on opening a total of 540 new stores, yielding 475 net new stores yet our capital spending has been a bit front end loaded this year and we continue to estimate that capital spending for the full year will come in at around $1.8 billion.

Accounts receivable were up 23.6% in the quarter and this was driven primarily by reimbursement timing, non-retail sales mix which has a higher normalized DSO and also the end of the quarter falling on a Sunday. Inventories grew by 9.9% driven primarily by record new store sales growth, slower comps and the effect of seasonal goods.

Accounts payable increased 22.4% due primarily to timing of disbursement give the Sunday quarter end and the increase of inventories. Our net debt at the end of the quarter was $1.5 billion reflecting short term borrowings of $1.1 billion, long term debt of $1.3 billion and offsets by cash and cash equivalents of $886 billion.

As we discussed at analyst day, we are targeting $1 billion in annual cost reductions by fiscal 2011. Three primarily areas of opportunity include strategic sourcing of indirect spend, corporate overhead and store labor reductions, and POWER, which also includes workload balancing. We are making significant progress in all three areas.

This next chart shows a schedule of timing of costs and benefits associated with rewire for growth. As you can see, during 2009 and 2010 we will incur one time costs of $300 to $400 million to achieve our long term objective of $1 billion of net cost reductions by fiscal 2011. We also expect to achieve working capital benefits of an additional $500 million through our customer centric retailing initiatives.

In short, we are confident that our three strategies will enable Walgreens to get back to a path of strong EPS growth performance. The last thing I’d like to focus on before I close, our exceptional balance sheet and strong cash flows are enabling and will enable significant financial flexibility as we move forward. Our Commercial Paper ratings of A1P1 and our long term debt ratings of A+A2 give us the ability to drive our strategies and do right things right at a time when many other corporations are struggling with liquidity.

We’re proud of our credit ratings and we are committed to maintaining our high investment grade position grade position. Further, our decision to slow the pace of store openings to strengthen and enhance our core and to reduce unnecessary costs will only further strengthen our balance sheet and ensure that we have ample financial flexibility for a very strong future.

Now I want to turn the call back over to Greg Wasson.

Greg Wasson

I’ll finish with saying how extremely proud I am of the superb leadership team that we continue to build at Walgreens. To that end, today we’re announcing the addition of three new Vice Presidents who are experienced leaders with track records of growth and success in their respective industries. Their contributions will strength our Walgreen management team and give us an even stronger blend of external talent and internal expertise.

Bryan Pugh, most recently with Tesco’s Fresh and Easy Neighborhood Markets joins us as Vice President responsible for the development of new store formats. He’ll be focusing on affordable and essential merchandise. He helped design the fresh and easy store operations model and launched the retail grocery chain on the West coast as it grew to 90 locations in less than a year.

Colin Watts, formerly with Campbell Soup Company and McNeil Consumer Healthcare Worldwide becomes President of Walgreens Health and Wellness Disease Management. Colin brings significant healthcare industry expertise to Walgreens and has a proven track record of growing consumer and healthcare companies in the US and globally.

Jeffrey Zavada, formerly National Vice President Key accounts for United Healthcare, joins Walgreens as Vice President and Chief Sales Officer. We look forward to his expertise in helping Walgreens build a world class sales organization in order to continue to broaden and deepen our payer relationships.

In summary, Walgreens has a winning strategy, an exceptional leadership team and a strong focus on execution to grow our business and create long term significant value for shareholders. I’ve never been more confident about our future.

Rick Hans

That concludes our prepared remarks. We’re now ready for your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Lisa Gill – JP Morgan

Lisa Gill – JP Morgan

Is there any way you can break out for us the SG&A as it pertains today to the new stores so that we can get an understanding of what your run rate looks like as we start to think about the slowing down of the stores and we start thinking about modeling for that? Secondly, I’m wondering what you’re seeing, where you’re taking customers from your RX savings club plan? As we start thinking about things like electronic prescribing, etc. how will that also impact some of the programs that you have in place around your generic programs?

Wade Miquelon

On SG&A either way I would frame it if you look at our same store SG&A year on year and the direct costs, hourly labor, etc. effectively that’s kind of been 0% to 1% range or actually below our rate of comp sales. The balance of it isn’t all new real estate, there is obviously other items in there some of which I mentioned like rewire investment. That gives you a general feel for the relative level of SG&A that we put into new stores and the fact that on a base level we have a pretty good sustainable model now in cost control.

On the PSC or RX card I’ll start there, I would say I think we are seeing a lot of traction and from a financial point of view I think it’s a good thing because there is a fair amount of turn over, churn normally in prescriptions and really this is capturing a lot of that so net, net, net its financial accretive and also a great driver of loyalty.

Lisa Gill – JP Morgan

Where are you taking those customers from, are they coming from the other retailers, are they coming from the supermarkets, from Wal-Mart, where do you think you’re taking them from today.

Greg Wasson

We don’t know truly where we’re taking them from. The opportunity of 46 million uninsured folks that didn’t have cash and maybe some folks that weren’t really taking medication or seeking compliance medication. The two biggies that we’re seeing, we’re seeing 30% of the patients that are on the PSC card are new adds and we’re also seeing increased compliance once their on. I think the opportunity is huge for the 46 million out there that are uninsured.

Wade Miquelon

We can’t prove exactly where the share is coming from but we do know is we track, for instance, the $4 scripts, the generics that fall into that bucket that we have actually gained share in that now year on year after a year ago being tougher. I think it is a lot of the cash customers and again I think that’s the validation that it’s hitting those particular scripts.

Greg Wasson

To your e-scribe comment I think two things; we’re certainly seeing increased compliance of prescriptions. We see more people picking prescriptions up that are on e-scribe once the doctor has written the order and I think you’re certainly seeing increased formulary compliance which will increase generic utilization as well because the doctor will be able to see the formulary much easier.

Operator

Your next question comes from Mark Miller – William Blair

Mark Miller – William Blair

I was looking for more color on the gross margins, how were pharmacy margins up and then when you give the breakdown is the higher LIFO charge netted in those qualitative descriptions on pharmacy and front end? In the non-retail margin decline how much was that and what was the decline in the recurring businesses, ex. the growth in clinics?

Wade Miquelon

I don’t know if we can give all the specific detail but effectively pharmacy margins were up slightly front end were close to flat year on year and yes LIFO for both is embedded in both. As you’ll recall we have about $200 million for the year in LIFO or an increase of roughly $100 million planned. In terms of specialty, specialty does have lower margins and that has grown faster than the business so they’re not declining versus where they were its simply just a mix effect of faster growing versus slower growing.

In the retail clinics that I called out is about a $0.015 year on year drain to overall profitability and that also has a disproportionately low gross profit just because the nature of work costs were allocated for that business. I hope that gives you directional feel but essentially front end and back end were basically stable to up slightly. All other factors bring it down back to neutral and the other businesses pulling down as I said.

Greg Wasson

I’m sure, just as a reminder, specialty margins may be tighter but the gross profit dollars, as you know for script are huge.

Mark Miller – William Blair

Can you give us any qualitative comments on December thus far in the holiday selling season? If you could elaborate on your comment about inventory, I think you said the higher increase was reflective of some effect of seasonal goods, in what type of markdown risk might we be looking at in this environment?

Greg Wasson

We’ll certainly be giving more information on December sales the first of January. Certainly, as you know, we lost a week of holiday sales in the quarter. We’re certainly continuing to see a concerned consumer. However, the thing I’m really glad of is that we’re selling things that people need. As more people are leaning toward affordable essentials and staying closer to home I think we’re well positioned. We’ll give you more color in January.

Wade Miquelon

On the inventory we did see a little bit of a bump just because of a few things. Number one, we always see both this time of year seasonally but also over the last few quarters we’ve had slightly lower comps so a lot of these items are bought well in advance. As we sit here today we’re working through that inventory level. I don’t see anything above and beyond what we normally do in terms of write downs here.

Again, as we talked at the analyst day related to rewire for growth in terms of total efficient assortment they’re making some charges but that would be well covered within what we’ve outlined before related to that project. It’s a bit seasonal, it’s a bit adjusting to the new realities of the economy but we’re working through that and working that out. I don’t see that as an issue.

Greg Wasson

The two big drivers of inventory were the Thanksgiving shift in our new stores. The encouraging thing is that front end margins were flat and traffic was up so I think we’ve really been surgically using promotions to drive inventory movement when needed.

Mark Miller – William Blair

I was surprised your front end margins were up so that looked good.

Operator

Your next question comes from Eric Bosshard – Cleveland Research Company

Eric Bosshard – Cleveland Research Company

The change which is material in the store growth today versus 90 days ago I know strategically 90 days ago you made the decision that you made and now you’ve taken another step down. Is there something that you’ve observed in results or analysis that you’ve done other than just seeing the economy as soft to make the decision to further reduce the store growth as much as you have?

Wade Miquelon

Perhaps the biggest material change is just the economy continues to shift and change. It becomes more uncertain all the time. I think that’s probably part of the factor. Related to that, I think that there will be opportunities for more file buys and we may see more consolidation in the industry and I think it behooves us to make sure we have financial flexibility to do that.

Lastly, I think we do believe that our strategies especially around the customer centric work at getting more from the core making stores better is the single biggest value creation lever we can pull. Everything we can do on that is worth that if its going to pay dividends.

Greg Wasson

As we get further along the lines of our consumer centric retailing initiative, to Wade’s point, I think we’re seeing more and more opportunities to use the existing 6,500 stores that we have with more efficient assortments, adjacencies, refreshes, re-paintings, remodeling. I think that’s where we’re really excited.

Eric Bosshard – Cleveland Research Company

Is 9% SG&A growth which is what it was in the first quarter, is that about as low as it can go considering the store growth investment that’s embedded in the business at least for this year or can you do better than that?

Wade Miquelon

I wouldn’t say it’s as low as it can go but I’d say it’s pretty darn good if you look again the huge driver of the new stores. If you look at it just on a no new store basis it’s pretty good. I’d say the structural systemic things that we’re doing in rewire to get that $1 billion going over the next three years are going to provide further step downs if you will. It’s as good as it can be without the structural interventions that we’re putting in place but those interventions will be significant.

Greg Wasson

I think the SG&A control we’re seeing in the core business, of course drugstores has been pretty robust. As we see a couple of these major initiatives come on we’ll see benefit.

Eric Bosshard – Cleveland Research Company

On page 20 you have a chart that talks about returning to double digit earnings growth and the arrow seems to point up as we look at 2009, do you want to give some guidance on how we should think about 2009 earnings from the company?

Wade Miquelon

Here’s how I frame it, if we look at the last quarter and this quarter, recall last quarter I think we were up 10%, 11% but we had an accrual adjustment in there so effectively apples to apples we were kind of flat year on year. This quarter, with our 1.7% or 2% comp we had some other negative things that went the other way. Effectively we were again flat year on year. In this 1%, 2% comp range that’s where we are before interventions.

I think the kinds of things that are going to help us moving to the back end of the year and into the future will be again the customer centricity, big opportunities there, rewiring a big step up there, slowing of stores is definitely going to help over time but its going to take some time to get that benefit. The other wildcard out there is the overall economy which is challenging for everyone now. I do think that given that we’re more destination in nature, more essentials and given that we’re probably going to see some industry consolidation over time that will probably be in that as we go along.

Without giving guidance for the year I just want to give perspective on really where were the last quarters have netted down and ensuing that the out periods what kind of things we’re doing to bring that up.

Operator

Your next question comes from Nathan Reich – Citigroup

Nathan Reich – Citigroup

My question is around the rewiring for growth initiative how does slower square footage growth change the cost savings that can be achieved with the rewire for growth if it does at all?

Wade Miquelon

It really doesn’t at all. The things we’re looking at are not really, obviously we’ll get one benefit over time from slowing store growth just because there’s so much front loaded costs to bring new stores on and we’re diverting attention from making the core even stronger. With respect to how we factored in the savings and what we’re looking at that’s not really part of the equation.

Nathan Reich – Citigroup

If you could give a little more color on what front end categories are performing the best?

Greg Wasson

As we said, we’re seeing strong increases in consumables, affordable essentials we’re talking about groceries, snacks, paper products, basic needs that people are looking for. The discretionary categories are tight, the non-discretionary are up. We’re also seeing good increases in over the counter items and our private label brand as people trade down and look for value we’re seeing good increases.

Operator

Your next question comes from John Heinbockel – Goldman Sachs

John Heinbockel – Goldman Sachs

Is there any sign yet with unemployment rising that there is some further impact on consumer behavior in terms of pill splitting and script volumes in general. Secondly, as a corollary to that are you seeing any incremental pressure in reimbursement from companies whose budgets are under pressure?

Greg Wasson

As far as impact on scripts with unemployment it’s hard to say. Certainly we’ve all heard where folks are busy doctors less and picking up less prescriptions and that may be affecting the industry number. The good thing is we’re seeing strong increases for prescription sales the numbers are up. We saw strong increases in the amount of flu shots we administered; our PSC card is showing strength so we’re pretty encouraged with the trends we’re seeing in pharmacy right now.

Wade Miquelon

We’ve seen a bottoming or strengthening on the prescription side so there’s really no short term evidence of worsening. Where we’re seeing different behavior patterns is really more on the front end. Again, it’s more towards discretionary items as Greg talked about. It’s more towards private label, more towards paycheck time, more towards weekday buys versus weekend buys. You’re really seeing the effects of the economy there much more than you’re seeing it right now in the prescription side.

John Heinbockel – Goldman Sachs

If you look at WHS as a whole and think about its P&L impact could you just discuss that a little bit. Obviously it sounded like it was a little bit of an impact on margin maybe even on expenses. Do you think WHS was dilutive to the growth rate for the quarter or additive, what would the impact have been more from a bottom line standpoint?

Wade Miquelon

WHS wasn’t dilutive from an earnings point of view because of the specialty businesses have lower gross margins and because they were growing faster than the balance it hits the gross margin impact a little bit on OCS. It was really the hit that I talked about at one point $0.06 it was on the health and wellness division side that was plan but that’s really from the ramping up. We’re going to start leveling that off and then we’ll start cycling this.

This is really our biggest investment here that we see on the clinic side I’ll just leverage on that too is that they’re still on track in terms of that 2 to 3 year ramp up to profitability. Because it’s negative doesn’t mean that we have any less confidence that these things over time make sense.

John Heinbockel – Goldman Sachs

WHS in total you put everything together operating income, up or down versus year ago it sounds like you might have been down.

Wade Miquelon

No, I didn’t say that.

John Heinbockel – Goldman Sachs

It did not detract from the EBIT growth rate of the whole company?

Wade Miquelon

The health and wellness division had a $0.015 but WHS did not.

Operator

Your next question comes from Ed Kelly – Credit Suisse

Ed Kelly – Credit Suisse

Back to your decision to cut the growth again, I certainly applaud the decision although you don’t currently have a new CEO in place as of yet I was just wondering it does sound like you’re very close. With a new CEO on board with all this I would imagine that’s yes. Secondly, I think the fear from investors will be that you are moving pretty quickly to do this. I think their fear is going to be that it’s driven by deteriorating fundamentals as opposed to other opportunities. Could you address that?

Greg Wasson

As Wade said, we’re certainly looking at the economy and making a prudent decision to where we’re headed and how we want to use our capital going forward. I think that’s a big part of it. More importantly, as I said it’s certainly very strategic as we see it. I think that we’ve got 6,500 of the best locations out there to date. We talked a lot about leveraging and enhancing that core business and core drugstores. As I said, with what we’re seeing with our customer centric retailing there’s just incredible opportunity to really choose and bring those stores on as we go forward.

I wouldn’t read much more into it than the fact that it makes sense in this economy and the fact that we think there’s a lot of opportunity.

Wade Miquelon

There is not deteriorating in the fundamentals. It’s just a matter of being smart about our capital allocations choices and the value we can create by putting more into some of these levers refreshing stores and from the experience potentially more file buys or whatever may come is greater than the value of opening stores at the prior rate. That will be our beacon as we go forward.

Greg Wasson

It’s what you lose to our balance sheet. It gives us the flexibility as we go forward, a strong balance sheet to take advantage of opportunities. We feel that’s good.

Ed Kelly – Credit Suisse

The FIFO gross margin even if I ex. out the LIFO charge has bounced around quite a bit the last few quarters. It looks like it’s up about two basis points this quarter, is down 41 last quarter. How should we think about this going forward? If we’re in a current, steady state where we are today are we looking at flattish to maybe a little bit better excluding the LIFO charge?

Wade Miquelon

You mean with respect to overall earnings or with respect to?

Ed Kelly – Credit Suisse

Gross margins, the FIFO gross margin.

Wade Miquelon

I’d hate to try to forecast completely. I think we’re kind of in a bouncing around the flat range. There has been a little bit of promotional pick up for everyone as we go into December and the holiday season. We’re not doing silly things but we’re making sure we are competitive in that regard in providing value. I’d say it’s difficult to fully predict. We’re seeing some pickups from more private label that helps. We’re seeing some more essentials that hurts a little bit. In general we’re doing a pretty good job of holding our own.

Ed Kelly – Credit Suisse

Are you seeing any change from your chain drugstore competitors from a promotional standpoint more recently?

Wade Miquelon

I think the whole industry is up. I just saw the other day that for many retailers its double year on year so there is some increase. I don’t think we’re not doing anything crazy; we’re just making sure that we’re competitive.

Greg Wasson

We are seeing, we had some early markdowns out there across the industry both in the drug channel and throughout retail. We’re happy and glad that we had purchased and bought down last year our seasonal merchandise. We’re making some good intelligent decisions as we go forward. We’re watching items; we’re watching them daily making necessary adjustments where possible. We’re certainly seeing the industry react in probably a more aggressive way and we’re trying to be extremely surgical as we go forward.

Operator

Your next question comes from Mark Wiltamuth – Morgan Stanley

Mark Wiltamuth – Morgan Stanley

When we previously heard from you on slowing your store growth down to 5% the slowdown to 5% was really driven by just what was in the pipeline and just the natural phase down of that growth. Are there any lease charges or termination costs associated with the slowing down to 2.5% to 3%?

Greg Wasson

We’re certainly not looking at any signed leases or signed deals. We’re looking at unsigned deals, deal by deal. Some of those may be further out, a little less difficult. Some of those are a little closer in to maybe some costs to it.

Wade Miquelon

I don’t think we’re looking at anything significant if there is any it will be certainly covered by our overall rewire effort. I’d also say that we have pretty intensive process we continue to look at all our stores and make sure they’re performing and they make sense. I could sit here and tell you that there’s the number of stores that we maybe should shut down because they’re not productive they won’t be less than a handful so there’s nothing material there either.

We’ll look at these case by case and we’ll deal with them. As Greg said, none of these are signed deals but it’s just a matter of working them through one by one.

Mark Wiltamuth – Morgan Stanley

Now that you’ve got up to $1 billion in CapEx savings, any thoughts on where to deploy that?

Wade Miquelon

We’re still looking at that, it would obviously be smart about it, be flexible, make sure we can reinvest in our strategies, and make sure that if the right value creating opportunities come along ROIC that we look at those. What I would say is right now we’re sort of in an analyze mode and also making sure that this economy that we have stellar liquidity and a stellar balance sheet because I think right now that’s just gold.

Mark Wiltamuth – Morgan Stanley

Previously you had kind of hinted that you might put that towards acquisitions on the new strategies, do you think it’s still heading in that direction or more towards shoring up the balance sheet?

Greg Wasson

We’ll put it where it makes the most sense to give us the greatest return. We’re definitely going to use it to drive our strategies. As we said earlier there’s a lot of opportunity that we’re learning through customer centric retailing that we can put back into our stores there so that would probably be a top priority. Obviously we’ll look at opportunities as they exist out there and consider those as they come about.

Operator

Your next question comes from Meredith Adler – Barclays Capital

Meredith Adler – Barclays Capital

If you could talk about how competitive it is to buy files right now. You guys for many years weren’t really in that market I know that it’s mostly who’s closest is willing to pay the most but are you seeing it become more competitive?

Greg Wasson

Not really, we’ve been buying files for years. I think with the economy and the challenge and struggles a lot of the independent and small chains are having today it’s probably a little more opportunity over the last couple years. We certainly look at these just like we look at any acquisition or any opportunity to make sure they give us the return on investment that we need. We’ve got a group out there that is aggressively talking with independents. I wouldn’t say it’s heated up as far competition.

Meredith Adler – Barclays Capital

My other question comes back to some things that were said at the analyst meeting and that you talked about a little bit today about your POWER program and workload balancing. There was a time a few years ago where workload balancing was really highlighted as being an opportunity and I mean using stores and excess capacity at existing stores and then the shift to a more central fulfillment is kind of change. Could you talk about it, I don’t really understand why you went in that direction?

Greg Wasson

With workload balance as described a couple years ago we have seen benefit and that really helped us move work between stores and really help existing stores continue to grow volume. If you have a store out there that may be averaging 300, 350 a day and a store down the road is going to help them you see that it increased lift. I think what we’re beginning to see now with POWER is a huge opportunity to leverage the entire enterprise our mail service operations as well as our central processing utilities to work around.

We see the opportunity to fill as many as 30% to maybe 40% of our chronic prescription centrally but a big part of POWER is not just a central fulfilling of prescriptions its shifting the order entry work and the insurance processing to a more efficient platform to become more efficient and allow the store pharmacist to spend more time with patients.

Wade Miquelon

I think of it as they’re not at all different directions, in fact, they’re evolutionary and complimentary because the workload balancing is the first step of being able to do that virtual paperwork, we’ll call it and central fill goes beyond that to be able to the physical work as well. As Greg said, it’s not just about the cost it’s about freeing up those resources. Dynamic workload balancing will always play a role as it did in some of the hurricanes being able to on the spot shift the paperwork and be fluid there is also a nice tool in the arsenal to help reduce costs.

Meredith Adler – Barclays Capital

The difference is you’ve said that you have a lot of immature stores and that fixed cost is already in place at those stores to build the capacity you need in POWER you actually have to add more capital and essentially more fixed costs. I guess I’m still a little confused why not lever what you already have is there a regulatory constraint?

Wade Miquelon

From a paper flow point of view that’s true, we can leverage that in place but over time that’s not going to be the best systemic solution. We’re going to have to have a central scale; you’re going to get in a central facility visa vie the paperwork or the physical flow by leveraging that network. We are taking advantage of those new stores in that way. That’s more of an evolutionary short term fix versus and end game where you have true scale.

Greg Wasson

I wouldn’t look at it as its one or the other, we’re leveraging both. Workload balancing is allowing us to continue to leverage those new stores now as we speak. POWER allows us to really move a lot of work into a more efficient manner on top of that.

Meredith Adler – Barclays Capital

Back to a discussion about the front end and seasonal merchandise, is it your expectation, did you go into the holiday with very low level of inventories or do you believe that you’ll end up having markdowns that might be noticeable in the front end gross margin?

Greg Wasson

We did go in with less inventory than last year. We did anticipate tougher economy. Going into next year we’ll probably even be looking even further reductions as we buy for holidays and seasons. Right now I think we feel pretty good. As I said, we’re watching inventory daily, making adjustments, moving merchandise around from store to store, market to market. As we move toward the end of the season we’ll see more. I think we’re managing it pretty effectively at this point in time.

Wade Miquelon

The wildcard still is the recent weather, snow and cold snap we’ll see how that plays out here the next few days. I don’t think that we’re talking anything above and beyond the usual that we always have.

Operator

Your next question comes from Steven Halper – Thomas Weisel Partners

Steven Halper – Thomas Weisel Partners

Could you go through your thoughts on the sku rationalization efforts and is there something there that prevents you from going even quicker than you have been?

Greg Wasson

We have gone through about a little more than 30% of our total categories already. As far as looking at the efficient assortment, the adjacencies and moving pretty quickly there we’ll begin to see rollout of those categories as early as May. We intend to move pretty quickly. We’re really encouraged, I think the team is moving pretty quickly to move through the categories.

Wade Miquelon

The speed at which we’re doing it, it might be long to you but it is really extraordinarily rapid for the number of categories we’ll be changing. Its very important move so it has to be done right, it has to be bedded with research, with shoppers, qualified and has to be executed flawlessly in the stores. As Greg said, by May we’re going to have a big wave and we’re working our way through almost half of all categories now in terms of doing the work. I don’t think we could be going any faster and doing it a quality way at this time.

Operator

Your next question comes from David Magee – Suntrust Robinson Humphrey

David Magee – Suntrust Robinson Humphrey

A question on the LIFO charge, did I hear you say that the expectation is for $200 million this year?

Wade Miquelon

It’s about $185 million I forget the exact number but that’s almost double the year prior.

David Magee – Suntrust Robinson Humphrey

Could you talk about that a little bit given the fact some retailers are talking about potentially deflationary environment next year?

Wade Miquelon

If you think about the year being broken into four quarters we’re actually ahead of pace a bit for that annualized rate but that’s because we saw last fall a lot of price increases coming through and the step up when all the commodity prices were up. Now I think what we’re not going to see necessarily is we’re not going to see either a lot more increases on top of that or a lot of these front end suppliers aren’t going to probably be dropping their price directly either. They might promote more but you seldom see list price declines. That’s the front end.

On the Pharmacy end we’ll have to see how it goes the next month or two but we have seen some price increases and especially on the branded side there may be some more before the next administration is fully in place. I would say it’s too early to tell at this point but we think overall for the year that’s a pretty good number.

David Magee – Suntrust Robinson Humphrey

On the one time costs associated with some of the cost initiatives like POWER can you give a little more color as to what constitutes those costs on the one time part?

Wade Miquelon

Over time it’s obviously going to be things like consultants that are helping us, it’s going to be things like potential with the skus elimination. We’re going to see some potential write downs associated with that and there could be obviously some people costs, transition costs, those are the big buckets. In this first period the bulk of it would be people costs associated with helping do the work. Things like consultants and other ancillary charges.

Operator

Your next question comes from Bakley Smith – Jefferies & Company

Bakley Smith – Jefferies & Company

I wanted to get at the reduction in square footage growth a little bit. We you growing too fast before and now you feel like you’ve right sized or do you feel like your view on the industry and the opportunity out there has changed significantly in the last six months or a year?

Greg Wasson

I wouldn’t say we’re growing too fast. I think what we did in the past is organically we found some of the best corners in America. I think now we realize we have 6,500 of the best locations and there is opportunity to take that capital that’s freeing up and invest back into those stores to drive some incredible value. We’re going to continue to invest and find those best corners. We’re still going to look for the best corners across the country. We’re going to look for markets that make sense strategically to continue to grow share in and certain make sure that it gives us the return on investment we’re looking for.

Bakley Smith – Jefferies & Company

Could we call this a planned remodel, do you have a new remodel in mind or is it in process? It sounds like you’re going to step up the remodel effort a little bit and is there a program that’s going to be associated with that or is it adhoc at this point?

Greg Wasson

Its work in progress. If you think about our consumer centric retail initiative first you’ll see new category planograms rolled out through all stores that we talk about coming out in May with more efficient assortments, the adjacencies, departments moved closer together that make sense. At the same time, we’re looking at a new design, new format and that’s what you will hear more about. Certainly we’ve got to understand more as far as where we’re headed and put the cost to it so we understand how much capital will be required.

Rick Hans

That’s our final question. I want to thank you all for joining us today. A couple of quick reminders, we’ll announce December sales on January 5th so we’ll host our annual shareholders meeting on Wednesday, January 14th at Navy Pier in Chicago, remember it begins earlier this year at 10am Central Standard Time. As usual, we’ll host an analyst Q&A session immediately afterwards. Our next quarterly financial announcement will be Monday, March 23, when we announce fiscal 2009 second quarter results. Until then have a happy holiday and a great new year.

Operator

That does conclude today’s call we do appreciate your participation you may disconnect at this time.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Walgreen Company F1Q09 (Qtr End 11/30/08) Earnings Call Transcript
This Transcript
All Transcripts