Walgreen's Management Presents at 38th Annual dbAccess Healthcare Conference (Transcript)

May.30.13 | About: Walgreens Boots (WBA)

Walgreen Co. (WAG) 38th Annual dbAccess Healthcare Conference May 30, 2013 10:00 AM ET

Executives

Rick Hans – Vice President, Investor Relations and Finance

Analysts

Kristen Stewart – Deutsche Bank

Question and Answer Session

Kristen Stewart – Deutsche Bank

Thank you all for joining us. I am Kristen Stewart, the medical device analyst at Deutsche Bank but I’m moonlighting as a consumer drug retail analyst for the purposes of this fireside chat. I do want to give a special extra thanks to Rick Hans for joining, Vice President of Investor Relations and Finance at Walgreen. Certainly I think it’s been an interesting evolution of the company just to kind of watch from the sidelines, so I was wondering if you could just maybe take a step back and just kind of talk a little bit more about the bigger picture strategy that you guys have had over the last couple years. I know that you guys have entered into the arrangement or agreement with Alliance Boots, and then more recently have announced with ABC that equity investment and the pie agreement.

So maybe just talk about how you think really big picture, very strategically about Walgreen and the evolution of the company, because it struck me, just kind of looking at all the different transactions that you guys have and equity investments and whatnot. So maybe just start off real big picture.

Rick Hans

Sure. Okay, will do. Good morning everyone, thanks. It’s interesting – this all probably started back in 2008. That’s when we first announced our slowing of our store growth domestically, so there were a few obviously tougher years just getting through the downturn in the economy and then kind of cycling through that slowdown in store growth. So we managed our way through that, and of course with a slowdown in growth domestically we are a company that does look for growth, so we did look for growth around the globe. And without getting into too much of the minutiae, we struck a deal with Alliance Boots, who happens to be the biggest drugstore/wholesaler in Europe, and announced that deal last July. Now I think most of you recall that wasn’t particularly well received, and I think in part due to the fact that we were still at odds with Express Scripts at that time.

So we did patch things up with Express Scripts, as you know, and I think we hosted an analyst day in London in February of this year and I think people got a lot more familiar with the AB folks and what they’re trying to accomplish in Europe. In spite of their very tough economic environment there, I think, as you know, they are actually performing very well.

Then as you also know, in March we announced a strategic deal with AmerisourceBergen, and oddly enough the announcement of that deal actually made it a lot easier for people to look back and say, hey, I like the Alliance Boots deal a lot better. So as you know, we’ve now enjoyed the fruits of people getting more familiar with that and happier with the deal in general.

And that brings us to today. Now it’s about execution. We’ve put out some fairly, I think achievable but something worth shooting for goals for 2016. I think if people can wrap their heads around our ability to get to those numbers, and I’ll tick them off for you. We have a goal of a combined adjusted EBIT of 9 to 9.5 billion. We believe we can generate a billion in synergies just from the Walgreen’s-Alliance Boots agreement, and we have a cash from operations goal of around $8 billion, so if you plug in some 2 to 2.5 billion in CAPEX, you’re looking at fairly good free cash flow and then 11 billion in net debt. So if we can hit those goals, I think people can probably wrap their heads around the fact that this could continue to be a good company to invest in.

Kristen Stewart – Deutsche Bank

How does the ABC deal kind of help further—or allow you to better achieve the longer term plans, because it seems like that, you’ll have some savings associated with that, and maybe just to step a back, why did you choose ABC rather than staying with Cardinal, who I think you previously had an arrangement with.

Rick Hans

Sure, and I’ll back up just a bit before I answer that. The Alliance Boots-Walgreen deal is in part predicated on the idea that we can generate substantial cost of goods synergies from the buying of generic drugs, and today combined a Walgreen’s and Alliance Boots probably buys around 7 billion in generics. By 2016, that number should be around 10 billion, and so we think we can get roughly 500 million in generic buying synergies.

The ABC deal brings another probably $3.5 billion in generic buying to the table, so we’ve actually created a JV in Berne, Switzerland for the buying of these generic drugs, and so ABC will bring their generic buying to that pool of buying and it will be significantly bigger than even our combined buying, so by far, the largest buyer of generic drugs in the world. But the ABC deal, it’s more complicated than that. It’s really a three-part. It’s a distribution agreement, it’s a strategic collaboration both domestically and in Europe, and both on pharmacy and specialty and lots of other areas where they have expertise; and then Alliance Boots obviously is wrapped into that too. So it’s a large agreement, it’s a 10-year deal. We think it’s very beneficial to both parties, and really to all parties involved.

The reason—one of the reasons that we did it is that first of all we had a contract that was maturing with Cardinal, so we had the ability then to shift our business to any player and we investigated all the players, as you might expect we would. We even looked at the idea of actually going direct with all of our distribution. Most people don’t realize or didn’t realize that today we actually self-distribute all of our generics, which is 80% of our units, so we self-distribute another probably 8% of our units vis-à-vis branded drugs, so they to our warehouse and we self-distribute. So we’re a fairly big distributor in our own right.

All that business is actually going to be now moved to ABC over time. The branded business will move on September 1 and then we’ll be methodical about transitioning the generic business over the next 12 months, probably market by market because the volumes are fairly large.

Kristen Stewart – Deutsche Bank

Are there any risks that you would see—what generally do you think might happen across the competitive landscape and is there anything you’re seeing that maybe some of the competitors in Europe or wholesalers start to go down the same path and team up with others?

Rick Hans

Yeah, that’s typical of retail, though. There is no stopping people from copying or making other moves to try to offset your move, and that’s just the way the world works. So I’m not too concerned about that. We’ve lived in a very competitive world for 100 years and we’ll continue to do so. It’s the old adage that I always say—the beauty of the deal is that our cost structure will likely be lower than any other player, and in most cases if you’re being chased by a bear, all you’ve got to do is outrun the other guy, and that’s the plan.

Kristen Stewart – Deutsche Bank

Can you just remind us about the logistics or the mechanisms with the deal? I think there was an initial opportunity to buy something like 7% of the company on the open market and then additional percentage ownership? Do you have a number (inaudible) and whatnot? Just go through that dynamic.

Rick Hans

Yeah, sure. So what Kristen is referring to is really the equity alignment component of the deal that we made with ABC, and there’s a couple of parts to it. One is that we and Alliance Boots have the right to buy up to 7% of ABC stock on the open market, and that really can happen at any time now because we have received clearance from HSR in Germany, was the other regulatory approval we needed. Once we have that, and really once we get to 5%, we actually will have a board member on ABC board, and then we have the further equity components in 2016 and 2017. There are warrants for us to—if we exercise, we get in each tranche 8% of outstanding equity for ABC.

So if you just do the math on that, we’d end up with 23% investment in ABC stock, and if they continue to buy back stock, in fact our ownership could really move up to 30%; but 30% is our maximum per our agreement.

Kristen Stewart – Deutsche Bank

Okay. So I guess if they continue to buy back stock, then at some point it might trigger a sale that you would have to do. That’d be easy enough—

Rick Hans

That’s correct. If they did share repurchases beyond that, we’d have to sell into their share repurchases.

Kristen Stewart – Deutsche Bank

Okay. Can you maybe just talk about the current trends you guys are seeing with the front end traffic?

Rick Hans

Yeah, okay. By the way, there’s a hand up over here, but we’ll come back to that. Let me get this real quickly. It’s a bit of a complicated story and I’d like to walk you through from the start, just so people here get a feel for it, because there has been some confusion about the impact of Express on our front end. I’d just like to remind people that if you go back to last January, a year ago January, we were first on to the Express network. Our scripts were down 10% but our front end comp was still up 1.6. In February, scripts were down 10, the front end comp was up 2. It was really at the end of February when we changed significantly our ad strategy and some of our other pricing and promotions in the store, and really even changed our outlook on seasonal sales, that you then saw really a pretty dramatic step down in our front end comp and traffic.

So like I said, we went from a 2% comp in February to, if you look at the combined March-April comp last year, it was minus 0.5. And then basically as the year proceeded, we were down about minus-2 on the front end. The traffic, frankly, was down on average about minus-4%, so we were getting a better basket.

The other thing that we were getting is actually better margin, so even though the comp was falling off, the margin was actually flat to up slightly, and that is something strategically that they were hoping to achieve. Now, I think that there were some things that happened that didn’t play out the way we had hoped. I think the competitive environment got a little more drastic than we thought it would be, and I personally think that we sort of handed a gift to some of our competitors and they fired some of that ammo back at us. So I think it got a little tougher for us, and certainly the company is not happy with negative script comps, or negative traffic comps.

But you have your first glimpse of the lapping of that event really in March-April of this year, so the comp which had been running minus-1.5 to minus-2, was really minus-0.2 in March-April. You’ll get a better view of that – next week we’ll announce May comps, and I think you’ll get a better picture of where we’re headed with regards to our focus on the front end. Obviously it will take a while to get that traffic back.

Kristen Stewart – Deutsche Bank

Maybe we’ll take a question here.

Unidentified Analyst

Sure, thanks. Just two quick follow-ups on the ABC deal. I’m just curious why you all thought the equity portion of the deal was necessary, and do you feel that reduces your flexibility somewhat going forward? You mentioned for example, as the Cardinal deal rolled off, you all were able to kind of survey the landscape.

And then a second question, in terms of—you mentioned about COGS synergies, and ABC has had a fairly significant position on the distribution space for independent pharmacies. Given now that they’ve got this Walgreen’s partnership, I’m curious whether some of those synergies from a buying power standpoint, there may be a mitigant if they were to lose some of that independent pharmacy buying power as well.

Rick Hans

Yeah, okay. Just from the equity standpoint, because it is a really long-term deal, I suppose there’s always pluses and minuses to long term deals, but obviously we felt the pluses outweighed the minuses. So because it is a 10-year deal, getting everyone aligned on the equity side we thought was important. That way, people are rolling in the same direction. But you could make the argument that we don’t have the chance of making another decision every three years – I’ll grant you that. But we just think that this is such a positive deal long-term for us, not only on the distribution side but we’ve been getting specialty distribution from ABC for many years, so we’re not totally new to this company. We know these people and we know what they can do. So we have maybe benefits that we haven’t articulated yet that we find are very positive that will help us on this deal.

With regards to their independent, Walgreen’s has obviously been aligned with retail pharmacy forever so we’re not a stranger to the needs of independent pharmacies, and certainly we don’t have adverse or adversarial relationships with independent pharmacists. We’re believers in the retail model, both chain and independents, so we think it’s good for medicine, it’s good for society to have both. Basically, they do operate in a lot of areas today that chain drug really doesn’t operate and will probably continue to do so.

So I think that obviously the benefits that ABC gets in procurement will also be a benefit to their customers and clients which are independent pharmacists. So it’s service and price, and I think there is no getting around it that they can be a good provider under those scenarios.

Unidentified Analyst

Can you give me a sense of the working capital you’ve freed up by switching to Cardinal to ABC, now not distributing and also having one truck a day as opposed to every other day, and what will you do with that capital?

Rick Hans

Yeah, it’s a bit of a mixed story there, by the way, so I’m glad you asked that. In any negotiation on procurement, it’s a function of both the terms and the price. In the negotiations that Walgreen’s, ABC and AB had on this deal, they basically held working capital neutral, so even though our inventory will drop, our AP is going to drop also so there is really not a working capital element to it. When you take this out of the equation, then you can just more easily focus on price, and that’s really the way the deal was structured.

Did you have another part to your question that I missed, or is that good?

Unidentified Analyst

(Inaudible)

Rick Hans

Oh, yeah. Okay.

Kristen Stewart – Deutsche Bank

Can you maybe just update kind of where you stand now just in terms of getting back with Express Scripts, and then also how would you look at pharmacy utilization trends if you were to (inaudible)?

Rick Hans

Yeah. With regards to Express Scripts, our position has always been that in the end, we believe that we’ll get most of these customers back, and we have in fact found that the percent of customers that we’re winning back goes up every month. It just makes logical sense, in my opinion, that the main reason someone chooses a drugstore today actually is because it’s really close and convenient to where they live, and if we were someone’s original choice for that reason but then for nine months they had to go to another drugstore, it’s really hard for me to believe that at some point they wouldn’t switch back to the place that’s close and convenient to where they live. So I think over time.

My suggestion to you is get 100 moms in a room and ask that question. I think you’ll get your answer.

Kristen Stewart – Deutsche Bank

Okay. I guess just moving on to—you guys launched your Balance Rewards program. How much of that is based off of the Alliance Boots program and what has been the reception to that so far?

Rick Hans

Yeah, the Balance Rewards card was initiated mid-last September. We’ve now signed up about 70 million of our customers to the program. We’re still fairly early in the process. I mean, there are people who are generating points and now getting rewards, and I think as you cycle through that and you get word of mouth on the benefits of these rewards, there will be more excitement about this.

Certainly it has a lot of aspects similar to the Advantage card that Boots has, because their card is really directed to mom. Mom is in charge of the family budget in many cases but doesn’t want to spend the family money on certain beauty items but can generate points over time through the family budget and then reward herself from time to time with a nice beauty item. So I think in the end that’s going to play out very similar. In the U.S., I think that’s just the way people are wired. I think a lot of dads are just give me the discount, but I think moms are going to really look forward to using this card.

Kristen Stewart – Deutsche Bank

Okay, and then there is another question.

Unidentified Analyst

I just wanted to check on your purchasing synergies in generics. You mentioned the 500 million. Do you have pacing for that? Is it more gradual and overall—I mean, some of us have heard you could have different molecules in Europe versus U.S. maybe on a similar generic and then you can only squeeze, say, these global players. How do you exploit that? If that works, could you transport that maybe even into OTC products and get some added purchasing (inaudible) as well?

Rick Hans

Sure. Correct – I mean, the synergies that we expect to get on generics are really based over—you know, the $1 billion goal is a really a 2016 goal, so for FY13 what we said is we believe we can between 100 to 150 million in combined synergies. And it’s not all generics – we really have six different work streams for all the synergies that total up to a billion, and that’s including goods not for resale, the buying of other commodity goods which you suggested, some branded OTC, branded pharma, and then we do expect to get some revenue synergies just related to the fact that we believe we can sell some of these very good Boots products in our stores, and perhaps they could actually sell some of our products also.

So to your point, it’s probably every permutation will exist with regards to how we generate the synergies on the generic drugs, but I think it’s a fact – in the world of commodity buying, the bigger the buyer you are, you probably get the better price. So our logic is really just based on that simple fact.

Kristen Stewart – Deutsche Bank

Can you just further expand on—you mentioned selling some of the AB brands within stores, just higher looking at that opportunity. And then also to the extent that you guys have shared some best practices, what are the some of the different things from a more operational perspective that you guys have learned over the past year or so?

Rick Hans

Sure. We’re being very methodical in the roll-out of No. 7 and botanicals and some of the other Boots products. Currently, you can get No. 7 in about five of our stores and basically in our flagships that we’ve opened in the last few months. You can see one of them over here on school and summer, and you’ll see the No. 7 when you walk in the store. So I think we’re going to be very careful about that. We are selling the products online, drugstore.com, beauty.com, which are our URLs, and on Walgreens.com we’ve actually had a big promotion in the past week. So I think as the name gets to be more known, we will obviously test market by market broader roll-outs. You won’t see the product in every store, but I think most stores will get some of the Boots products one way or another over time.

Kristen Stewart – Deutsche Bank

Okay, and then you just bring up, I guess, the online and the ecommerce area. What percentage of your sales do you expect ecommerce to represent? I think CVS launched a new app and that’s been driving this a little bit for them. How do you think about the ecommerce opportunity or threat?

Rick Hans

Yeah, I think we’ve been a leader. I think Walgreen.com app has been very much a leader in the drugstore app world. We bought drugstore.com three or four years ago, and that’s been a very good investment for us. You know, you can look back and see what their sales were, and it’s grown since then; but we haven’t really broken out ecommerce sales. Part of it is that we’re really not trying to silo our business – how much is ecommerce, how much is retail – because they really work hand-in-glove. A very high percentage of our scripts everyday are reordered through mobile and online, and mobile is just going through the roof. So I’m assuming some people in the room have our mobile app, and the Balance Reward card dovetails there. You can see the ads, you can take a picture of your pill bottle and reorder. You can transfer your prescriptions by doing the same thing. It’s a very robust application, and I really believe that people will run a high percentage of all their life activities on probably 10 apps at some point, and we certainly are hell-bent on being your drugstore app, and I think we deserve it.

Kristen Stewart – Deutsche Bank

Okay. We had talked at the outset about your 2016 goals, and I believe you guys actually set out kind of more near-term goals. How do you feel that you’re tracking more recently in the level of confidence you guys have in terms of just getting to the 2016 number? What aspects of those goals do you feel less confident? Is it more on the level of sales? Is it more on the margin, or perhaps some of the working capital or cash?

Rick Hans

Again, candidly on the sales goal, I really don’t talk much about even though we do have a sales goal out there. With the influence of generics on the top line, that’s a little bit more of guesswork anyway. We’re still very confident on our ability to generate 9 to 9.5 billion adjusted EBIT to generate the cash flow to get our debt levels down and to get the synergies, so we haven’t changed any of our confidence levels.

I’ll remind you that the arrangement that we struck with ABC and AB, that really is even baked into those numbers, so that I think gives us even more confidence.

Kristen Stewart – Deutsche Bank

So would just ABC and all the savings you expect there, I guess would we interpret that to mean that there’s potential upside to 2016? I mean, if that helps you get there—

Rick Hans

Yeah, I think that’s the takeaway. We’ve been—we didn’t up the goals with the ABC deal. What we did say publicly is that this would be modestly accretive to us, so we just left it at that. But it is above and beyond the 2016 goals.

Kristen Stewart – Deutsche Bank

Okay. Any other questions from the audience? All right, I think we will take any other questions offline. Are there any closing remarks you want to make?

Rick Hans

No, I appreciate everyone showing up today. Thank you.

Kristen Stewart – Deutsche Bank

Okay, thank you all for your time.

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