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

Walgreen Co. (NYSE:WAG)

F2Q 2014 Earnings Conference Call

March 25, 2014 08:30 AM ET

Executives

Rick Hans - DVP of IR and Finance

Greg Wasson - President and CEO

Wade Miquelon - EVP, CFO and President, International

Kermit Crawford - President, Pharmacy

Alex Gourlay - EVP, President, Customer Experience and Daily Living

Analysts

Lisa Gill - JPMorgan

Robert Jones - Goldman Sachs

Ricky Goldwasser - Morgan Stanley

Eric Bosshard - Cleveland Research Company

Scott Mushkin - Wolfe Research

Charles Rhyee - Cowen & Company

John Heinbockel - Guggenheim Securities

Edward Kelly - Credit Suisse

Operator

Good day, ladies and gentlemen and welcome to the Walgreen Co. Second Quarter 2014 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. (Operator Instructions) As a reminder, this conference call is being recorded.

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

Rick Hans

Thank you, Nicole and good morning, everyone. Welcome to our second quarter conference call 2014. Today, Greg Wasson, President and CEO; and Wade Miquelon, Executive Vice President, CFO and President International, will discuss the results for the quarter. Also joining us on the call, and available for questions are Kermit Crawford, President of Pharmacy; and Mark Wagner, President of Store Operations; and Alex Gourlay, President of Customer Experience and Daily Living.

As a reminder, today's presentation includes certain non-GAAP financial measures, and I would direct you to our website at investor.walgreens.com for reconciliations to the most directly comparable GAAP measures and related information. You can also find a link to our webcast on our Investor Relations website. After this call, this presentation and a podcast will be archived there for 12 months.

Certain statements and projections of future results made in this presentation constitute forward-looking statements that are based on current market, competitive and regulatory expectations that involve risk and uncertainty.

Except to the extent required by law, we undertake no obligation to update publicly any forward-looking statement after this presentation, whether as a result of new information, future events, changes in assumptions or otherwise. Please see our latest Forms 10-K and 10-Q and subsequent filings for a discussion of risk factors as they relate to forward-looking statements.

Now, I will turn the call over to Greg.

Greg Wasson

Thank you, Rick. Good morning, everyone and thank you for joining us on our call. Today, I will begin with a review of our financial performance. Next, I'll discuss our performance against our three strategic growth drivers and finally I'll look ahead to how we’re preparing our company as we head towards fiscal 2015.

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

This quarter was marked by a solid top line growth in performance. We achieved record quarterly sales and record second-quarter prescriptions filled in spite of continued headwinds from slower generic drug introductions and severe weather.

For the quarter, sales were $19.6 billion, up 5.1% from $18.6 billion a year ago, driven in part by 4.3% increase in comp store sales. GAAP operating income for the quarter was $1.3 billion, up 4.9% from $1.2 billion last year. Adjusted operating income for the quarter was $1.3 billion, down 4.3% from $1.4 billion in second-quarter 2013. GAAP earnings per diluted share were $0.78 in the second quarter compared to $0.79 last year, down 1.3%. Second quarter adjusted earnings per diluted share were $0.91, down 5.2% from $0.96 in the same quarter last year. And finally we generated operating cash flow of $1.1 billion in the second quarter and free cash flow of $877 million.

Turning to trends in gross profit dollars and SG&A dollars. In the second quarter on a GAAP basis, our gross profit dollars increased 0.8% or $43 million from a year ago. SG&A dollars increased 1.6% or $72 million compared to a year ago. Adjusted gross profit dollars increased 0.4% or $22 million compared to a 4% increase in the same quarter last year. This difference resulted from several key factors. The shift in the generic wave from a peak in introductions in the first quarter last year to a trough this year, continued to have a negative impact, the impact which moderated somewhat from the first quarter is expected to continue to moderate in the third quarter and turn positive in the fourth quarter.

A weak flu season compared to last year resulted in fewer cough, cold and flu related prescriptions, and lower sales of over-the-counter products compared to the same period last year. And we also maintained meaningful promotional investments in our daily living business in the quarter.

While we did see some pressure on our gross profit dollar growth, we were able to balance that with on-going cost discipline. In a quarter with a record sales and an increase in comp store sales, our adjusted SG&A dollars increased by only 1.7% or $76 million compared to the same quarter last year.

Want to give credit to our leadership team in the stores who are using their resources efficiently to serve our customers. In our estimation adjusted gross profit dollar growth would have been about the same as our adjusted SG&A dollar growth if we had not had the impact from severe winter weather.

In the quarter, we also made progress on our three strategic growth drivers, creating a Well Experience, advancing the role of community pharmacy, and establishing an efficient global platform. Today I will provide more details on that progress.

In our Well Experience growth driver, we saw the on-going impact of a value conscious consumer, while unseasonably cold temperatures which I mentioned earlier further affected our sales. In response, we continued to invest in promotions, increasing front-end comp sales by 2%. We also continued to roll out our Well Experience stores reaching a total of 628 across the country. We realized market share gains across the majority of Nielsen tracked categories in our daily living business. And in addition, average basket size increased 3.4% in the quarter as customers continued to consolidate trips.

This quarter we successfully reached a milestone for enrolment in our Balance Rewards program topping 100 million in enrolees. With almost 80 million active members we now have the largest retail loyalty program in the industry.

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

On our Well Experience rollout we're pleased with our progress to date. We continue to refine or store formats to integrate healthcare, provide an elevated beauty experience, and also deliver exceptional seasonal and consumable convenience to meet customers’ needs.

Also this quarter, we expanded and enhanced our beauty offering, introducing Boots No7 in New York City. We completed the rollout to 10 stores in February and plan to reach 150 stores in the city. Our New York City expansion follows or successful launch of Boots No 7 and other boots brands in our Arizona market and our flagship stores across the country.

Finally we continue to bring together our world class digital capabilities to complement our convenient store locations and leverage our omni-channel context to delight customers. Today nine million customers touch the Walgreens' brand every day at our stores over the web or through mobile channels making Walgreens a true omni-channel provider.

In our Pharmacy, Health and Wellness business, our script comp was up 2.2% in the quarter. Our retail pharmacy market share increased to 19% for the quarter, up 20 basis points year over year and we filled a record 214 million prescriptions, up 2.8% from the same period last year. We also continue to grow our 90 day retail program. According to IMS in the second quarter, the 90 day retail market grew 15% year over year while the mail market declined 10%. Also our 90 day at retail volumes in the second quarter increased by 17% over the prior year, from perspective our 90 day at retail business alone is as large as one third of the total mail industry and mail market industry.

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

In addition, we had a strong season for immunizations with a total of 8.6 million vaccines administered through the first half of the fiscal year. That’s an increase of 11% over the same period last year. While that increase was mainly on the strength of a strong flu shot season, we also continued to build our non-flu immunization business. For example, today we are the number one retail provider of Zostavax, a vaccine for shingles.

And finally, we continue to see some impact to margin from the on-going negative effect related to generics and the volume drop-off of controlled pain medications which we referenced last quarter.

Looking ahead, our Medicare Part D program is accelerating our momentum in pharmacy. In the quarter, our Med D volume was up year over year with significant growth in new customers on top of strong performance in fiscal ’13. Our Part D market share for the quarter increased 80 basis points compared to the same period last year.

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

Also as you know, we are tightly integrated in our healthcare clinics with our pharmacies in hundreds of locations. We are experiencing growing interest from customers in value convenient affordable high quality healthcare services and from payers who view Walgreens as an emerging health alternative care model and an important part of the patients care daily regime. To help meet this growing demand, we have a goal to add nearly 100 new healthcare clinic locations in calendar 2014 on top of our 400 current retail clinics. And we will continue to expand our network to develop a comprehensive national footprint.

Our strategic partnership with Alliance Boots contributed $0.08 per diluted share to Walgreens' second quarter 2014 adjusted results. Combined synergies for the first half of fiscal 2014 were approximately $236 million. We now expect to exceed our second year combined synergy target and are now estimating $375 million to $425 million in the second quarter combined synergies.

We estimate that the accretion from Alliance Boots in the third quarter of fiscal 2014 will be an adjusted $0.13 to $0.14 per diluted share. And we purchased approximately 10.5 million shares of AmerisourceBergen stock as of February 28th and we own approximately 4.5% of the company.

We continue to make good progress on our global initiatives. We are pleased with the performance of our global procurement organization. With the introduction of AmerisourceBergen, we believe we will be the largest purchaser of pharmaceuticals worldwide. More importantly we are working with manufacturers transparently and collaboratively to help drive sustainable growth in the U.S. and Europe.

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

In addition, after successfully transitioning our branded drugs to AmerisourceBergen last fall, we began our generic transition this January and are making excellent progress. We're on track to complete the work by September 1st.

At part of the company’s efforts to optimize our cost structure and assets, we’re also taking a closer look at our store network. As we mentioned in our press release this morning, between now and August, we intent to close 76 stores spread across the country importantly, overall this year including store closings, we expect to expand our store base by approximately 55 to 75 locations in fiscal 2014.

We looked at several factors in deciding which stores to close. We address the impact of increased density from our own stores, the impact of real estate positioning within the market and material changes to a store’s trade area. In total, this represents a very small portion less than 1% of our 8,200 plus store base. As we position for future growth and markets and communities continue to change, we want to optimize our store footprint and make sure our stores remain on the best corners in America.

I also want to note that because most of these stores are located near another Walgreens, we will be reassigning a majority of our team members. The store optimization is expected to result in more than $40 million to $50 million and additional annual EBIT beginning at fiscal 2015, representing an estimated $0.02 to $0.03 in adjusted diluted earnings per share as well as estimated charges of $240 million to $280 million, substantially all of which is expected to be recognized in the third and fourth quarters of fiscal ‘14. Keep in mind that we plan to exclude these charges from our adjusted EPS calculation.

As we head into the second half of the fiscal year, we are well positioned to create value and accelerate long-term growth. We expect to continue to make meaningful investments in our frontend to drive the right balance in sales and margins. We're also focused on our important programs in pharmacy, health and wellness such as Medicare Part D, immunizations and healthcare clinics that will continue to improve volume and expand access to convenient high quality affordable healthcare services. With these areas of focus, we will capitalize on the convergence of our two dynamic industries, retail and healthcare and continue to meet the changing demands of our customers, partners and payers. That coupled with the commitment to excellence and execution that has always defined Walgreens, I am excited about the future of our company.

And finally, I'd like to thank our team members who did such a great job serving our customers through a very difficult winter. Across the country, they ensured our customers had convenient access to the essential products, emergency supplies and the necessary prescriptions they needed through this harsh winter.

And now I'll turn the call over to Wade.

Wade Miquelon

Thank you, Greg. Good morning everyone and thank you for joining us on the call. This morning I will take you through our quarterly results as well as update you on our Alliance Boots strategic partnership and our AmerisourceBergen relationship. As Greg noted earlier, for the quarter, we reported a GAAP EPS of $0.78 per diluted share based on nearly 964 million shares. GAAP EPS walks to an adjusted EPS of $0.91 for the quarter as illustrated by this chart. A LIFO provision of $0.04, acquisition related items were $0.12 per share consisting of $0.06 of acquisition related amortization costs, $0.01 of acquisition related cost and $0.05 from Alliance Boots related tax.

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

Let me now review our comparable store sales for the quarter. Comp prescription sales increased 5.8%. Comp frontend sales increased 2% and total comp store sales increased 4.3%. Comp prescription sales increased 2.2% versus a script comp of 4.3% in the year ago period.

In the second quarter, the frontend comp increased 2%, complement to this comp are traffic which decreased by 1.4% and basket size which increased by 3.4%. As Greg touched upon earlier, our frontend was impacted by the tough cough cold flu compare and a severe weather versus the prior year. Looking forward, please keep in mind that the March frontend comp sales will begin to be negatively impacted by the Easter shift this year versus last year. And recall Easter fell on March 31st last year and falls on April 20th this year. As always, we will provide the combined March-April comp on May 5th to give you a better understanding of our underlying sales for these two months.

Looking at comparable store script numbers, our retail scripts were up 2.2%. In spite of the tough cough cold flu compare; this performance reflects the fundamentals of our underlying business, the return of Express Scripts customers and our on-going progress in winning new Medicare Part D customers. It's also worth noting that the two-year stack on script comps has risen back to levels last reached prior to the Express Scripts dispute.

With respect to margin, our adjusted gross margin reflects our FIFO inventory was 29.1% in the current quarter compared to 30.5% last year, a 140 basis point decline. While we always experience some level of reimbursement pressure, the most significant factor affecting the pharmacy margin was dramatically slower rate of new generic introductions year-over-year.

The frontend margin was negatively impacted by increased promotional investment designed to drive traffic and sales, partially offsetting these margin headwinds is the fact that purchasing synergies positively impacted both the frontend and the pharmacy margins.

Taking a look at our adjusted gross margin trends, this quarter’s 140 basis point decrease was versus a 120 basis point increase a year ago. In essence, the benefit of the generic wave last year [reversed itself] [ph] this year. We expect this impact to continue to moderate in the third and fourth quarter and become a tailwind to some degree in the fourth quarter of fiscal ‘14. Now keep in mind that the timing of the introduction of some generic drugs remains a question mark. For instance, as most of you know the launch of generic diversions of Diovan and Nexium may be delayed, which would result in their benefit being pushed out from our second half of fiscal 2014 into fiscal year ‘15.

Moving forward the front end margin will continue to be impacted by our promotional investments until we cycle these changes beginning this summer. As we demonstrated and discussed the last two quarters, this graph illustrates the impact that new generic drug introductions have had on our monthly prescription sales comps. The highlighted quarters illustrate that the number of new generic drug introductions have slowed dramatically versus a year ago. And you can see that the generic impact on comp prescription sales was about a negative 6% in the second quarter of fiscal year 2013, versus the generic impact of negative 1.3% in the most recent quarter.

In our experience the margin change resulted from generics is inversely correlated and slightly lag to the impact of generic sales changes. That is, the strongest positive effect on margins typically occurs shortly after the generic impact on prescription sales is the most deflationary. That period occurred in the year ago quarter. As you can see, the tough year-over-year generic impact margin comparisons dissipate in the later half fiscal 2014 given the generic impact on pharmacy sales comps is expected to increase in that period.

Transitioning now to gross profit, this slide illustrates our quarterly gross profit dollar growth trends for the past 10 quarters on a GAAP basis. And the next slide shows the trends on an adjusted basis. Adjusted gross profit dollar growth slowed to 0.4% from 4% in the year ago period as a result of the headwinds we described for you in the first quarter including generic wave shift, the front end investment and the impact of weaker cough cold flu.

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

Shown here are the SG&A dollar growth trends for the past 10 quarters on a GAAP basis and the following slide shows a similar trend on adjusted basis. The adjusted SG&A dollar growth for the quarter was 1.7% year-over-year increase versus the 4.2% increase in the second quarter of fiscal 2013. Included in this SG&A dollar growth rate was approximately 50 basis points or $23 million of incremental weather related expenses mostly snow removal.

This next chart illustrates our two year stacked SG&A dollar growth trends on a GAAP basis for the last nine quarters.

Now let’s review the two year stacked trends on adjusted basis. Two year stack adjusted SG&A trends improved versus a year ago by 200 basis points. With a two year stack of 5.9% growth in the second quarter of 2014 down from 7.9% last year and about half the rate of growth of 11.6% two years ago.

During the quarter, the rate of growth and adjusted gross profit dollars trailed to adjusted SG&A dollar growth by 130 basis points. As you can see gross profit dollar growth decelerated year-over-year, which reflects the incremental headwinds we encountered.

Turning to a few other components of our income statement, this quarter included LIFO provision of $51 million versus a provision or charge of $72 million a year ago. Our effective LIFO rate for the quarter was 2.5% down slightly from 2.75% a year ago. Net interest expense for the quarter was $37 million versus $23 million from a year ago. Now recall that the quarter a year ago benefited from the receipt of $19 million of interest income generated by late pharmacy reimbursement payments.

We expect interest expense of approximately $40 million in the third quarter. Average diluted shares outstanding were 964 million shares versus 953 million shares last year. And the change is primarily due to the impact of a higher stock price on a number of in the money options which are counted as diluted shares.

In third quarter, we expect a diluted share count of approximately 965 million shares subject to changes in the current share price. Our blended effective tax rate for the quarter was 34.9% versus 36.6% last year. The difference is primarily attributed to foreign sourced income taxed at lower rate partially offset by increases to estimated permit differences between booked and tax income.

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

Accounts receivable increased by 11.8% primarily due to increased business including the return of Express Scripts network prescriptions and while accounts payable increased 2.3%. LIFO inventories were down 0.6% and FIFO inventories were up 2% year-over-year versus sales growth of approximately 5.1%. We expect inventory levels to come down in the back half of the year as we realized greater efficiencies due to daily delivery and complete the full generic distribution transition to AmerisourceBergen. Overall, net working capital increased by 2.9% versus a year ago.

During the second quarter we generated approximately $1.1 billion in cash from operations versus $1.2 billion in the year ago period. The free cash flow in the quarter was $877 million versus $953 million a year ago.

The next slide shows our correlated accretion from Alliance Boots which was as Greg said, $0.08 per share for the quarter versus our forecast of $0.07 to $0.08 per share. And you can you find a more detailed walk included in the appendix to this presentation on our investor relations website.

Combined net synergies for the quarter totalled $129 million and for the first half of the year have totalled $236 million. As Greg noted, because we’re running ahead of our original estimate of $350 million to $400 million of combined synergies for the year, we are now raising the range of our estimate to $375 million to $425 million.

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

Similar to last quarter, we have reviewed our fiscal year 2016 goals internally and performance to date with respect to four of our five goals remains on track with or slightly ahead of our expectations and these four goals are sales of $130 billion including Alliance Boots share of associates and joint venture sales, synergies of $1 billion, operating cash flow of $8 billion and net debt of $11 billion.

As stated in our last call, our adjusted operating income goal of $99.5 billion is currently tracking below the CAGR required to meet this goal and below our initial exceptions. We continue to recognize that there are risks to achieving this goal, however we remain focused on delivering it and as I also stated we have identified a range of further opportunities including benefits from our AmerisourceBergen relationship, incremental Alliance Boots synergies, business expansion and new initiatives and cost savings, which can all help mitigate these risks.

The asset optimization program that Greg described highlights our focus on efficiencies while the increase in our fiscal year ’14 synergy estimate demonstrates that we’re driving additional synergies with Alliance Boots and AmerisourceBergen.

In closing, we believe our strategies for long term are sound and should further differentiate us versus competition and create value for our stakeholders. When recapping the current state of our business, there are many indicators that give us confidence in our future. As Greg said, we’ve been growing share of the competitive U.S. daily living and retail pharmacy businesses. And we continue on our Well Experience journey and we are focused on continuing this front end momentum and also focused on possibly impacting margin overtime fee and mix and promotional and supply chain efficiencies.

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

We also have a significant opportunity to participate in and influence the healthcare market more broadly, via our asset in healthcare professional breadth. Through our various healthcare partnerships and initiatives, we’re in a path to do exactly that.

Now lastly, we continue to be very pleased with our Alliance Boots partnership and AmerisourceBergen relationship. On the Alliance Boots sides, their business remains resilient in a European environment that remain challenging. The continued strong cash flow and deleveraging focus has also been very positive. Our combined synergies have continued to track it behind of our estimates and we’re learning from each other every day and our step to join operational and financial planning is going well. Our AmerisourceBergen relationship thus far has also met our expectations with the distribution in our joint synergy efforts progressing right on plan. We also continue to identify additional ways that all three partners can work together to create value and change the paradigm in various areas of our business.

In short, we believe we’re just scratching the surface in what we can ultimately create as a global pharmacy lead health and wellbeing enterprise. But in my humble opinion we are off to a terrific start.

And with that I’ll turn the call back over to Rick.

Rick Hans

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

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Lisa Gill of JPMorgan. Your line is now open.

Lisa Gill - JPMorgan

Thanks very much and good morning and thanks for all the details. I guess just a couple of quick follow up questions. The first would just be around the global procurement impact in timing. Greg, you talked about the number being better as far as synergies going up to 375 to 425. But you didn’t necessarily update the billion dollars overall. Should we be thinking about that billion dollar number as like being more of a contributor to the overall 16 number?

Greg Wasson

Yes. Good morning Lisa. We feel confident upping the number for this year to 375 to 425 based on what we’re seeing. We still feel confident a billion dollars and aren’t ready to make any comments on that. We -- longer term we still feel confident that there are opportunities that we are identifying but at this point in time we feel confident that we’d get to that billion dollars in 16.

Lisa Gill - JPMorgan

And you made some comments about the Affordable Care Act. Yesterday there was some comments that perhaps now Florida is looking at expanding Medicaid. Can you just update us on anything you’ve seeing thus far around the ACA volume and then maybe any expectations for an increase in the back half of the year?

Greg Wasson

Yes. We saw that announcement and we think obviously as we’ve said, as enrolment grows, it’s going to be a positive for the businesses as you would expect with prescription business and people getting coverage they have not had coverage. Some of those maybe cash customers that we’re getting prescriptions that may not be a complete new prescription customer but we think there will be an additive benefit to more and more people getting coverage.

Yes, it’s still early to tell, as far as the number of people that are coming on board, I think there is some positive signs over the last month or so that more and more people are getting coverage. I may turn it over it over to Kermit. Kermit if you got any additional colours if you’re seeing?

Kermit Crawford

Yes, I think, Lisa I think the other thing to add is that we continue to work with many of the new customers, new patients during the transition period. We’ve announced that we will continue to do that through April. We’re also working with many of our health plan partners on educating many of the new potential enrolees. So we think the bulk of the volume will continue to be in the open networks and as we see more and more of the open network business, we think that will be good for us.

Lisa Gill - JPMorgan

And so is it fair to say that you would expect maybe -- hopefully you'll see that in the back half, in the next couple of quarters in your fiscal year or do you think that’s going to be more of a fiscal ’15 event?

Kermit Crawford

I think as we’ve seen a slow enrolment period, but I think we’ll see that gradually increase over the next couple of quarters and into next year.

Operator

Thank you. Our next question comes from Robert Jones of Goldman Sachs. Your line is now open.

Robert Jones - Goldman Sachs

Great. Thanks for the questions. I want to start on the gross margin trend. I know you guys mentioned that you expected negative generic comp experienced in the front half to ease as we move into the back half. And I understand you guys don’t give specific guidance but, can you maybe just help us think about the components of the gross margin trend in the back half, maybe for instance relative to the year-over-year declines that we’ve seen in 1Q and 2Q? Any sense you can give us on what we should be looking for on the year-over-year trend into the back half?

Wade Miquelon

Yes, I mean, I would just say just there is a couple of factors, the big one obviously is the timing of new generic introductions and so we start to move in a phase for those comps now. Again, the exact date of these can never be perfectly predicted so you have in general the information that we have but that makes a very substantive difference.

Again, we’re starting to cycle the front investments that we made that were quite substantial to get back to more of a normalized rebalancing mix and so over the next quarter or two we’ll move into that cycling. And then even things like flu [I think too is] [ph] going to have some mix effect and so we’ll start to both cycle that and get into more of a normalized period. So these things will kind of all come when then come, but directionally especially when you also look to stacks for compare, they tend to even out over time, and I think we’re moving into that phase.

Robert Jones - Goldman Sachs

Great and then just going back to the synergies, I know originally you guys were calling for this to be a little bit less than what we saw last quarter clearly not the case, realized more synergies in 2Q than 1Q. And then looking at the full year even though you did increase it, it does look like the back half would actually be on track to produce less than what we saw in the front half, so just any more specifics or commentary you can give us around the drivers of synergies and maybe what’s causing some of the cadence in this fiscal year at least?

Wade Miquelon

Yes, I think we feel very good where we are but I would also say that for the people they are in the trenches working, these people like Jeff and John, these - some of the deals that we work, you never can predict exactly when they’re going to hit and for what period they will accrue to, but separately I would say that every day we have multiple streams working very hard to identify new synergies to work - negotiate new synergies. And so again while we feel very good on the glide path and even a long term as Greg suggested these things are going to require hard work each and every quarter, every quarter going forward and we just don’t want to get ahead of ourselves there.

Robert Jones - Goldman Sachs

So then it’s not something that’s necessarily linear clearly based on the guidance that you guys put out for the back half?

Wade Miquelon

Well, I don’t know if it’s linear or not but I'll say they can be choppy along the way, because sometimes you get a step up for something that we do, but other times we identify a new source of synergies and start working there. It’s just there is a lot to moving parts underneath the hood, but directionally we feel we have the right momentum towards our goal.

Operator

Thank you. Our next question comes from the line of Ricky Goldwasser of Morgan Stanley. Your line is now open.

Ricky Goldwasser - Morgan Stanley

A couple of questions, first on the SG&A spend, I mean, this is the second quarter where you’ve grown SG&A at well below your 3.5 to 4.5 organic target. So if you can talk a little bit more in detail about the cost control, is this kind of like a new level going forward? And also how much of it is being driven by distribution efficiencies from the ABC relationships? And when does that normalize if it does?

Greg Wasson

Yes, Ricky maybe I’ll take the high level and then let Wade get in a little more detail. I think -- as I said, I think we’re feeling good with what the stores are doing and efficiency that Mark and team have really driven through the stores. I think we’ll continue to see the stores doing a nice job in balancing payroll according to volume. I think a lot of the corporate initiatives that we’ve had in place regarding really looking at core initiatives and core programs and projects, we feel good that we’re making a progress there and that should continue. I don’t think frankly that you should be -- in fact a lot of efficiencies yet from the AmerisourceBergen transition although we will -- we do expect to see that going forward, but we’re still in the process of transitioning the generic distribution from our distribution centres to theirs that’s early on, so there is not a lot of that built in. We certainly do expect there would be opportunities going forward with it. Wade anything to add?

Wade Miquelon

Yes, I think we’re just aggressively attacking all costs, so we have had a couple of very, I think, strong quarters versus to what we had prior in our sustainable growth model. We’ll continue to attack all costs and make sure that we focus all resources on the core strategies that will drive values. So I hesitate to lay into any kind of guidance on that, but as Greg said also that the big distribution benefit for us really comes at the end of this fiscal and into next fiscal, when we have all of our generic volume which is just smaller dollar piece about 80% of the unit volume fully consolidated in their systems. And I think that’s also when they see the benefit too, as once we get the full integration of branded generics so that will be a next year event by and large.

Ricky Goldwasser - Morgan Stanley

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

Wade Miquelon

We haven’t given that number, Ricky, although making good progress and we intend to be completed by the end of the fiscal year and we are on track to meet that date for sure.

Ricky Goldwasser - Morgan Stanley

Okay, and then secondly on the tax rate, I know the tax rate in the quarter was below historical levels and Wade you touched upon that, but just to clarify, should we expect in the next quarter then, a higher tax to go up, or is there any change on how you account for the AB equity earnings, how you are accounting taxes for that?

Wade Miquelon

No, I think you can expect probably going forward a rate similar to what you saw in this quarter. It’s again if I think it’s really complex to kind of track the rate through this based upon our joint venture, their business and our business. But I think that you will see something markedly different from what you saw in this period.

Operator

Our next question comes from the line of Mark Wildermuth of Jefferies, your line is now open.

Mark Wildermuth - Jefferies

I wanted to get some insights on the Alliance Boots number. The reported income from Alliance Boots of 194 million was much higher than a lot of us were expecting. What was in that number? Was there anything unusual in that? And what do you think the core operating earnings growth for Alliance Boots is running at right now?

Wade Miquelon

Yes, the big thing in the number for IFRS purposes is the warrant income from ABC, and they have a lag, so it was actually gain in this period for them. And without the lag for us, the stock pulled back a little bit. It was a slight loss. But that was the big thing in the IFRS number, and again for our purposes, for GAAP we reversed that out. There is always some nuances back and forth. With respect to the overall business, I’m not going to provide any kind of guidance on it going forward, but they are going to be reporting their numbers for the full-year in May. And so closing at the end of March, in the next week or two, so I think we’ll be able to get a lot more color on their business probably. And that should probably be very helpful.

Mark Wildermuth - Jefferies

Okay, and the difference between that 194, that was in the reported numbers, and the 100 million that you had in the slides that were kind of tax affected. Is that just a ticking up that gain that you were talking about?

Wade Miquelon

It was primarily the warrants, I don’t have the full rec, but that will be the main event. But we can get you the specific details on that.

Mark Wildermuth - Jefferies

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

Wade Miquelon

As Greg has said, our gross profit SG&A spread would have been basically equal, having not had it. So you can deduct about 20 couple million, 22 million for snow removal, 25 million and then a balance up to 60 million, so 35 million or so for gross profit impact. I mean that was built through historic closures where we had substantial store closure days and a little bit of traffic too.

Mark Wildermuth - Jefferies

Okay, so 22 million plus a 35 million.

Wade Miquelon

Yes, about that, say 60 in total.

Operator

Our next question comes from Eric Bosshard of Cleveland. Your line is now open.

Eric Bosshard - Cleveland Research Company

Good morning. Two things, first one, in terms of merchandising changes with Alex involved in with Beauty; I am curious if you can give us an update of where that is going in terms of an opportunity to further expand Beauty? What you are doing in terms of adding product, adding space, adding labor and then also the opportunity to expand brands to further drive share opportunities from that area?

Greg Wasson

Yes, good morning Eric. I have got Alec here, so I'll lead off, and maybe I will let Alec weigh in a little bit, but you know as I said, we do think we have an opportunity to build bigger in Beauty. We feel good with our pilot rollout of the Boots brands in Arizona as I said. I think we've been in that since last fall. We're seeing some pretty good results, not only in with the brands specifically, but in the total category itself, which is encouraging. We intend as I said the rollout, in New York City next, we think that’s a good metropolitan market to introduce the brand in a very special way. And we're going to do it right. So, we’re feeling pretty good there. I guess maybe I will -- Alec, I will let you kind of weigh in there with your thoughts.

Alex Gourlay

Hi Eric, thanks Greg. As Greg said, we are pleased with our progress so far. I have seen really positive response from some of our customers who are already shopping for Beauty in Walgreens and doing more shopping for Beauty in Walgreens particularly developing some categories. The bed is absolutely right, [indiscernible] it’s not just the way the product, it's about the customer care that runs a product. And if we are not consistently both in Phoenix and in the 10 stores that we have upgraded in New York. So I might [indiscernible] if you want to have look out and you square example in New York City, Empire State Building in New York City. They are both on the ground and we'll have a 150 growing by the end of this fiscal year, and I am feeling good. That’s certainly encouraging Walgreen shoppers to shop a bit more in Beauty already and it is not just Number 7, it’s the Boots brands and beyond that.

Eric Bosshard - Cleveland Research Company

Just a follow on, as you think about the future opportunity to gain share perhaps never getting to where Boots is in the UK but moving in that direction, how important is the ability to gain access to brands that you don’t have today national brands or prestige brands, how critical is that or how far can you get without those?

Alex Gourlay

We believe we can go quite a long way without them. Again the history in Boots, the premiums brands have only been in Boots for about 15-20 years and Boots have a very beauty business and mask and we call it [indiscernible] which is mid-market brands before then. So we are feeling pretty good about being able to expand with both premium brands and obviously as we go forward into the future we attract customers to think more about the experience of beauty instead of Walgreens, we believe that some of the premium brands may be interested in joining us in Walgreens but I strongly don’t know at all, and we think we can get quite a long way on that road without the support of premium brands.

Eric Bosshard - Cleveland Research Company

Thanks and then just one other if I could, the store closings is a little bit different than what we’ve seen in the past, curious about the timing on that and thinking on that and then also if there is a larger opportunity to manage the SG&A or corporate opportunity within the business as you look at combining the organizations?

Alex Gourlay

Well, Eric, maybe I’ll lead off and get Wade and even Mark Wagner if he wants to weigh in. Keep in mind that when we talked earlier in the year about our enterprise optimization program to really set ourselves up for the global the international entity we’re about to become, we really want to make sure we’re positioned to ready roll for that and we’ve been doing some good stuff corporately as we talked about to position ourselves and then the next thing we want to look at some of the assets, we took a real hard look trade area by trade area at our store locations something to your point we really -- we’ve done in the past but not with a real focused effort. Good news is frankly we’ve got a lot of great locations out there and we've only really stumbled on about the 75 or so that we’re talking about. A lot of that is due to -- some of that is due to us. We put in may be an extra store in the trade area and probably what we should have and we’ve done step in so forth.

But with that may be I’ll turn it over to Mark a little bit as far as he went through -- he led that exercise to look at our store base and I think maybe he’ll add a little colour.

Mark Wagner

Yes, hello Eric. Yes, we looked at really with two lenses, one with a strategic lens, one with a financial lens and kind of loosen the Prado philosophy 80% of the closings are really and some of our denser markets, some of our big growth states that where we were the biggest competitor in these trade areas. Some of the other challenges we had in the trade areas where they changed over time due to pattern changes, overpasses, underpasses you name it, that really made our store real estate sights not as competitive or out-positioned in most cases.

Operator

Thank you. And next question comes from Scott Mushkin of Wolfe Research. Your line is now open.

Scott Mushkin - Wolfe Research

Hey guys, thanks for taking my questions. First one I want to talk about is free cash flow, looks like it’s running about half of last year’s levels and want to get your thoughts as we go forward and we get to next year when we’re going to close the acquisition and what impact does this trend continues that will have?

Greg Wasson

Yes, I would just say that this year both operating and free cash flow look a little bit lumpy just because we’ve got this major transition with AmerisourceBergen, the timing of the brand move, the timing of generic move, they are really selling us contract for how we think about inventory versus payables. But this is really going to work its way through the system because at the end of the year we anticipate that we’ll have what will be the targeted levels for this type of transition. So I guess what I would just say is I don’t think anything is unusual this year in operating or free cash versus prior year and that slight changes working capital slight changes and whatever.

So as we look forward, I guess 2016 we still are very -- remain very confident Eric, in our combined cash goal of $8 billion in operating and very strong free cash flow. And again I think what you saw last quarter was very low but it’s really just because of this transitional effect in this quarter was more normalized but the next couple of quarters we should be kind of even out for the entire year as we complete the full transition.

Scott Mushkin - Wolfe Research

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

Greg Wasson

Yes, well, I mean the real [indiscernible] it’s just for us operating less the capital but it’s not substantially different, you’ve got our guidance for what we planned on capital spending and you could do the math yourselves there, so.

Scott Mushkin - Wolfe Research

Then my second question goes, I think you guys said you had 628 well stores, I wonder if you can give us any and maybe you’ve done this before, but any kind of as you convert stores to the Well Experience, what the sales list looks like, what’s the profit list and then how many more are you expecting this year [indiscernible] and that would be great.

Greg Wasson

Scott we haven’t really given out colour on actual performance. I can say that as we’ve been working on this for the last three years, it’s gone to crawl walk run and we want to make sure that the investment we’re putting in, we’re getting the right return. We feel pretty good. There is still some areas that we’re tweaking to make sure that we can continue to put the pedal to the metal, one of the things we’ve done is the good thing is, is we now have a pretty good idea of the various components with the Well Experience format and what’s working, what still needs some work and the good thing is you will begin to see the various components within the Well Experience format show up throughout the chain in a much quicker way than we would have been if we just continued to roll-out the entire format or try to get the entire format right. So, bottom line, we feel good about it. There are still areas where we want to tweak and get the returns on that added content and product so forth, but there is lot of the areas that are modular that we can begin to roll-out throughout the chain. Alec you want to add any colour there?

Alex Gourlay

Yes, thanks Greg. The other thing I will say is that the success of the Balance Reward Card in terms of 180 million active customers and 100 million people signed up, has given us real-time data about how people are using our stores, and really that data is helping us to design as Greg has said even better assortments going forward. So, I think the design has been really appreciated by customers, the feedback in terms of the brand perception is good, in terms of moving on the brand perception to a more differentiated space than normal drugstore channel which exactly what the team is out to do a few years ago. And the data from the Balance Reward Card is now allowing us to build better assortments for our customers. So, I think we'll accelerate from this point based on that data and based on what the customers are telling us right now in terms of their perception of the Walgreens brand within it.

Operator

Thank you. Our next question comes from the line of Charles Rhyee of Cowen & Company. Your line is now open.

Charles Rhyee - Cowen & Company

Yes, thanks for taking the question. May be if I could just follow-up on that question Alec, in terms of the data for Balance Rewards, how much has that data been really analysed and how much is it already been acted upon or is this something you are still kind of calling the data and really kind of crunching it to really understand sort of the behaviour of your shoppers?

Alex Gourlay

Yes, I think it’s a bit of all three. I mean I think some of it is really well understood and we're using already to simplify some of the things we're doing particularly in the promotional strategy and some of it we'll understand in terms of building assortments as said already. And I know from experience of being with us that there is a lot more we can do with this data over time but a strong team they are really a good team and are working closely with our association partners across in Alliance Boots and I think this will give us a lot of momentum going forward. So, I think all three to be honest for very good reasons.

Greg Wasson

I would weigh in on that as well, I think -- I would say we're really kind of in the infancy of the insights that we are beginning to gather from, having launched nearly a 180 million active members a year ago. So, there is a lot of excitement from the merchants let me tell you about the data and the insights are beginning to have.

Charles Rhyee - Cowen & Company

Okay, that’s helpful. And then maybe a question for Wade, if I look at the cash flow statement, am I correct, I think you didn’t really repurchase any shares in the quarter? And how should we think about that maybe for the balance of the year? Thanks.

Wade Miquelon

No, we didn’t repurchase any shares. I think as we have said before, our allocation policy was to get us through step two very strong balance sheet position prior to reconsidering any buybacks. We have been buying, as you could call, to see some AmerisourceBergen stock and the number at the end of the quarter was 1.5%, 1.6%.

Charles Rhyee - Cowen & Company

Okay, great. And then maybe if I can just sneak one last question in, on the -- you touched on sort of the stores that are closing and so our net stores are what 55-75 for the year opening, how should we think about store expansions as we go forward? You might have touched on that, I am sorry if I missed it.

Wade Miquelon

We don’t think that our kind of rate of annualized growth that we've talked is going to be different. Again in the grand scheme of things, these seven, six stores are less than 1% of our total and many of them have, circumstances have changed over many years. But on a go forward basis, we will see the same kind of cadence we've had had in the past few years.

Greg Wasson

Yes, I'd say one of the things that we have, we do feel good about with the opening of at a slower rate, although still plenty of New York store growth year-over-year, we are really finding some great locations and that’s what we want to do. We want to A plus locations now and open at that same rate going forward. We still have several geographies out there that we can expand in, and fine great locations.

Operator

Thank you. I am showing we have time for few more analyst questions. Our next question comes from the line of John Heinbockel of Guggenheim Securities. Your line is now open.

John Heinbockel - Guggenheim Securities

Hey Greg. So, two things, how do you think about tobacco? How much of an opportunity is that near-term right as CVS exits, is it a liability long-term? And then to your partners HMOs, PBMs, customers, do they care whether you sell it or not?

Greg Wasson

Morning, John. Let me start with kind of where we're focused and what we're focused on is to help encourage our customers to make healthy choices and not only with just with cigarettes but with daily habits and that’s just kind of our walk with Well and some of the things we're doing are designed to do. That includes helping people quit. And I think that CVS, as said, that two most important factors that help someone quit smoking as a healthcare professional as well as nicotine replacement therapy and some stats that maybe you may have or may not have but back in the 60s, 70s we're better than half of this population smoked today it's down to about 18%, it's been 18% for a period of time. Those folks 60 some percent of them want to quit, 45% last year tried to quit. We think we are well positioned to help folks change their behaviour who want to quit. So our pharmacists are geared up and we really want to begin to help change behaviour. So that’s our area folks.

John Heinbockel - Guggenheim Securities

So I mean it sounds like you are going to stick with it unless it’s mandated like in San Fran, that you can’t sell it.

Greg Wasson

Well, as I said we’re going to help people change behaviour, we’re going to help them quit and I don’t think there is any one better than retail pharmacy where the pharmacists and smoking cessation products that can help people change your behaviour and help them quit.

John Heinbockel - Guggenheim Securities

And then for Alex while we have him -- obviously Beauty Number 7, that’s pretty obvious how that can help Walgreen. What are some of the less obvious things you can bring from Boots? Like one of the things that’s always intrigued me is migrating Pink Friday to the U.S. What are some of the things you’ve looked at that can be impactful to Walgreen U.S. that may have flown below the radar screen?

Alex Gourlay

Yes John I think Pink Friday which as you know was a [indiscernible] in the UK, Walgreens already has a really seasonal business, and particularly it seemed a last minute I guess destination for many Americans and that’s exactly what Boots does as well. So we think we can really join together and improve certainly the Beauty ranges in Walgreens. And surly through brings supports across both Boots and Walgreens by Kmart but even better for customers. So seasonal is definitely one area. And I think also the second point would be the fantastic Walgreens brand. At our Walgreens healthcare brand is the number one healthcare brand from a consumer healthcare point of view. And again working closely together to being new innovative products both to the U.S. and to the UK market where Boots is primarily based is another big opportunity in this relationship on the consumer and the front end.

Greg Wasson

John may be I’ll add because Alex is humble, he won’t say this. But I think one of the things that we’re bringing as well and he is helping with is the understanding of how their Boots loyalty program was successful and help drive a lot of the success that they had moving into beauty and other areas within the UK, and I think the knowledge that we’ll bring in with our 80 million active members now to continue to improve our loyalty program is going to be a big opportunity for us.

Operator

Thank you. And our next question comes from the line of Edward Kelly of Credit Suisse. Your line is now open.

Edward Kelly - Credit Suisse

Good morning guys and thanks for squeezing me in. I was hoping we could maybe wrap up with two topics that have become more top of mind with investors recently. The first is around a longer term view of leverage at the company. You obviously historically have been operating with a lot of leverage at all. Alliance Boots has, right? And I think the question is as you go forward as a combined company generating a ton of free cash flow, would it make sense to operate possibly with a lot more leverage than where you are today to unlock cash through either share repo or additional deals. So your thought on that first would be helpful.

Alex Gourlay

Yes, I guess a couple of things as obviously I think when you look at our business you need to look through to the leases and the lease is back on the overall balance sheet which is significant. We like where we are in investment grade and I think it’s been important for us to stay investment grade, we’re in that investment grade zone. We should be over time I think, we've decided over time as we go. But I guess what I would say yes we are, we do believe we’ll generate a lot of free cash flow, have a lot of options. But at this point we’re really focused on getting through to step two with the structure, with the ratings, with the overall metrics that we’ve had, at that point I am sure that we’ll look broadly in for instance all of our options as a company to say what’s the best capital allocation process going forward, and where the best value creating ideas returning back to shareholders or is it investing back on the business. Glad to say it's a little bit premature to have that discussion right now.

Edward Kelly - Credit Suisse

The second question which, the answer is going to be similar but, it’s on the notion of tax inversion because there’s been a lot of speculation amongst investors about the opportunity here. Could you maybe just talk about what the issues may be for a company like Walgreens and potentially doing something like this and whether it’s something that you would be open to considering?

Greg Wasson

It’s Greg, maybe I’d start with just retreating what I said, I think not on last earnings call, the one before that we have no plans to do so to do so, to do an inversion or redomicile the company. I think what we are focused on frankly is spending the time with our Board and on diligent and so forth to make sure that we put our board and our shareholders into position to make the right decision on step two. And that’s what we’re focused on. But just to reiterate as I said on last call we have no plans to do an inversion.

Operator

Thank you. I am showing no further questions. At this time I’d like to hand the call back over to Mr. Rick Hans for any closing remarks.

Rick Hans

Folks, that was our final question, thank you for joining us today. As a reminder we will report March sales on April 3rd. And until then, thank you for listening.

Operator

Ladies and gentlemen thank you for participating in today’s conference. This does conclude today's program, you may all disconnect. Have a great day everyone.

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's CEO Discusses F2Q 2014 Results - Earnings Call Transcript
This Transcript
All Transcripts