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Walgreen Co. (NYSE:WAG)

November 16, 2011 8:40 am ET

Executives

Wade D. Miquelon - Chief Financial Officer and Executive Vice President

Analysts

Unknown Analyst

Mark Wiltamuth - Morgan Stanley, Research Division

Mark Wiltamuth - Morgan Stanley, Research Division

Okay. Welcome, my name is Mark Wiltamuth. I'm the drug retail analyst for Morgan Stanley. I'm here to introduce Walgreens. Walgreens is one of the leading U.S. drug retailers with 7,800 stores and roughly a 20% market share. The company was in the third year of a big 3-year turnaround campaign, driving for slower growth but higher return on invested capital. They've cut about $1 billion of expenses. They've slowed their store growth from 8% down to 2% to 3%, taken out working capital, and now they're returning a lot more cash to shareholders. In June, Walgreens announced that they had plans to exit the Express Scripts retail network that put about $5.3 billion of sales at risk. Walgreens has put out an 8-K addressing some of the Express Scripts concerns. So I'm sure we're going to hear a lot about that this money. Let me introduce Wade Miquelon, Chief Financial Officer.

Wade D. Miquelon

I've been asked to go fairly quickly here because you may have a lot of questions. So I will hit the highlight points, and away we go. So good morning, just take a moment to read the Safe Harbor. Great. What I want to do is I want to basically talk about a couple of things. First, I want to just talk about the assets and strengths of our company, which I think are formidable and growing all the time. I want to talk about our financial results, capital priorities, where we've been from the last 2 years, where we're going, strategies overall, and I'll home in on a few of those. And then finally, we'll have ample time for Q&A.

As Mark said we have -- actually have 7,700 drugstores here, but he said 7,800. I think they might have built 100 since last night, since we put the slide together. But nevertheless, we have the most drugstores of any chain in the United States, a strong financial foundation, balance sheet, history of, I think, a very prudent financial management on both not only the P&L side but the balance sheet as well. 40 million people a week come to Walgreens. When you think about that physical touch point and what we can do with that over time, it really is, I would say, probably our most remarkable asset on top of our footprint. 75,000 healthcare professionals, unmatched, unrivaled by anyone else in this country or almost anyone in the world. That's pharmacists, pharmacy techs, nurse practitioners, doctors and the like. We've crossed over the 20% retail share, so we're #1 in retail and just slightly over 20%. And it's the most trusted brand in pharmacy. And we have a lot of other assets too. I'll touch on it later, but things like 24-hour stores. We have 1,600 24-hour stores, more than anyone. And 560 of those are in MSAs where the closest 24-hour store apart from us is more than 5 miles away from a person's home. So these are these embedded assets that really make a difference when you think about who you are to your customers.

We're closest to people. So close means proximity, but it also means other things I'll touch on. But with respect to proximity, you can see that about 2/3 of Americans live within 3 miles, and when you get within 5 miles, this number is up around the 80s. And that's more than any other retailer in America. And importantly, I think, is that this is an average, but when you look at communities that we serve, some of the underserved in food, the food deserts and medically underserved, which tend to heavier in Hispanic and African-American, these numbers are much higher. So we're close. And we're even closer to customers, where close is even more important.

About 3 years ago, we started what was called the "plan to win," and with all the things changing in the world, we really set out on a journey to basically get back to industry-leading sales growth. I know Mark said that we were slowing our sales growth. We didn't. We actually slowed our store openings, but our plan is to keep our sales growth accelerated. So it was to get back industry-leading sales growth, to that strong double-digit earnings, EPS that we've seen over time, and to drive cash flow efficiencies, both for things like return on invested capital -- to keep rising that metric, but also to reward shareholders. And the reality is that 3 years later, we've done everything we said we'd do. We've been leading the industry in sales growth. You can see that last year, we're up 7% overall. And when you strip out the divestiture of WHI PBM, earnings last year were about 14% adjusted for that. They were higher if you include the gain. And on an EPS basis, they're about 24% or 25%. Cash flow is at record level. So I'll touch on that a bit as well. And as I said before, our return on invested capital is now starting to grow again nicely.

A few other highlights. We filled 820 million prescriptions last year, up 5% from the prior year. Flu shots, we administered 6 million, which is more than anyone in the country by far except for the U.S. government. Various new health and wellness partnerships with folks like Johns Hopkins, Northwestern, Ochsner and several others. Opened 200 drugstores basically, which is more than anyone else and almost, I think, as much everyone else combined. We dramatically enhanced the front-end experience, but we're just getting started. We'll touch on that. We did the drugstore.com acquisition to extend our multichannel capability. And again, have strong financial results. And I think Mark touched on the fact that 3 years ago, we also said that we would strip $1 billion of cost out of our company and take that to both fuel the business and to the bottom line, and we have completed that program ahead of schedule and ahead of the $1 billion dollars.

With respect to our sales trends, here's a look at our 1-year and 2-year stack sales trends for the front end, what we're now basically calling Daily Living. And you can see that like everyone, we had a bit of a rocky period in '09 and '10. But as we've basically done several interventions to improve our stores, with something we call CCR and through various other initiatives, our 1-year changes are now nicely in the 4-ish percentage, and our 2-year stacks are moving back towards more in historical averages.

And I think this is probably the more important chart, which is when you look at our comps versus our 3 closest, most relevant competitors, we've been out-comping them significantly. And this is the last quarter where you can see we've out-comped all 3 competitors. But the story is the same -- even more markedly so over the last 4 or 5 quarters. So I think we're doing a lot of right things right. And I think, economy aside, which as we all know is a bit probably flattish and dragging along the bottom, I think we've done a good job to get back to that kind of growth that we expect to have in the front of our business.

On the scripts. You can see that if you look at our 1-year change in the green and the 2-year stack in the blue, effectively, we've been in that 6% to 8% 2-year stack basis for quite some time. So about 3% to 4% comp growth is kind of the -- on 1-year basis. And the spikes here really are just the effect of H1N1 in 2010 and then the effect of cycling that. So I think that the chart basically says that our prescriptions are pretty healthy and pretty steady despite the economy. And again, a lot of that comes back to how the model works, as you know.

So this has also enabled us to return record cash to shareholders and you can see that over the past couple of years, over $2 billion. In this past year, we raised our dividend about 29% and took up our buybacks as well to a total of $2.4 billion. We also have recently announced $2 billion buyback that we're executing on as we speak, and so we'll continue to drive good cash back to shareholders.

We really have -- if you stayed with us the past few years, you know that part of this "plan to win," we've kind of had this 3 by 8 strategies and priorities. As we keep refining and honing and putting all the wood behind the arrow, it's really now morphed into really 5 key strategies to create value for our shareholders as we go forward. I'm going to -- I'm not going to read the whole wheel to you and I'm going to really talk today to the first 2. But the first thing is we are really doing a lot of work to really transform what is the traditional community pharmacy. And we say we're transforming it into a retail Health and Daily Living store or really, a destination. And I think if you've been to some of our new, refurbished -- whether it's 40 Wall or if you were on the tour this morning, or even what we're doing in Chicago and many other pilots across the country, I think what you're seeing is, we have a wonderful opportunity to really step out of the drugstore channel and step into a space which is much more relevant. Again, this health and daily living, and we're seeing tremendous results as we go. And it's really -- it comes down to fact that we have a great footprint by any respect: the best corners; the pull-in parking; the right-sized box. And as we make our offerings more and more relevant, we can really play much deeper in people's lives. The second strategy I'll talk to today is really advancing community pharmacy to play a much greater role in healthcare, and we're doing a lot of work there. And we have a tremendous opportunity ahead of us, and I'll touch on that as we go as well.

So again, 3 years ago, as part of this transformation, one of the things we did was really our initial refresh. That was really what we call CCR, or Customer Centric Retailing, and it was really getting our stores kind of up to snuff to where they should have probably been, but getting the sight lines right, getting the assortment right, the right adjacencies, the right systems to support it, overall decor refresh, et cetera. And basically now we're completing that program, 5,500 stores, I believe, as of this month that will have been refreshed. And we're done with that journey. And we've seen not only good lifts, as I showed you, versus our competitors, from this, we also paid for the several times over in the first few days alone through major inventory reductions. And the point of the assortment was not to reduce assortment for assortment's sake. The point of the assortment was really get focused on what people want to buy and leverage that for better shopping experience. And again, we've seen nice lifts across the board. We've seen lower cost as a result. We have seen substantial inventory come out of the system. But really, what it also does, it provides the foundation for us from which to continue to evolve and dramatically enhance our experience for our customers. It's really foundational work.

We've done a lot of other things too. We're making tremendous progress in our private brand. Here's a few of them. Obviously, we've had the leading drugstore private brand for many years at around 20% share, but it's really been more of a compare-and-save strategy, so similar to national brand at a discount. And while that's a good business to be in, we're doing a lot of work to actually come, I call it "top down," with differentiated offerings. So we've launched our Nice! business with many items out and many more to come. If you think about, good, better, best, it's definitely our better label for many different brands. We had the Delish brand, which started at Duane Reade in New York and is being expanded across the country. You can see we have other brands. We've launched Pet Shoppe. We're strengthening the Walgreen brand dramatically. We have many other private brands to come and literally hundreds, if not thousands, of SKUs on the way out. But really having a tremendous private brand presence is not only a way that we drive much better profitability for our stores, it also helps differentiate Walgreens, so there is a reason to come to us versus someone across the street. And again, we're putting tremendous focus behind this. The results are all good, and we have a long journey ahead to create value on this one.

Our front-end initiative also includes fresh, where we have many, many fresh pilots. And as you probably read, in many cities across the country, there are literally many, many pockets and areas that are food deserts, where there's really -- the closest grocery can be 3 miles from people that don't have transportation. And we're in those communities. We're right there. We're on the front line. We're expanding our fresh food offerings: fruits, vegetables, good foods, prepared foods, on-the-go, et cetera, and the results are really remarkable. Over the next few years, we'll have more than 1,000 Food Oasis, and we will be enhancing our food lineup, really at every Walgreens in the country. But in terms of really getting heavier in fresh food for those people that need us in their neighborhoods and don't have access to fresh food, we're there and we've got great results and a lot more that can be done.

On the front end, we're also revitalizing our beauty, and here's just a few snapshots. But if you've been to 40 Wall, you've probably seen the best of the best, where our LOOK Boutique, Duane Reade -- literally, the atmosphere, the ambience and over time, the assortment will rival anyone. You can see the LOOK Boutique down below, which is now being piloted and expanded into the most relevant Walgreens stores. And up on the top right, you can see that over time in every Walgreens, we're going to make beauty look and feel a little bit more like beauty. And we'll do it in a way that's relevant to that consumer. But there is a tremendous opportunity here for us to drive this business. It's a big market. We can be a lot bigger, very good margin market, and we're really -- we have all the work streams in sync to make sure we raise our game on the assortment, raise our game on the environment, raise our game on the service and again, tremendous opportunity to increase value.

We've gotten more, I would say flexible or creative in recent years with respect to new stores. It's no longer just "one size fits all" and then build a new store. Here's one example in Hoboken, where we've taken the old bank and trust, kept the travertine marble, the old roof, et cetera and made it not only more contemporary but also fit very nicely into that community. And we have many, many other stores like this. But again, I think we're really -- the big -- I guess the big picture here is that we're really doing a lot of work to become much more relevant in everything we do to our constituents, because the size of the prize is dramatic. You've heard me say the average consumer buys 3 items. We do 3 million in the front end per store per year on average, getting that to 4 million, 4.5 million over time. We've doubled the earnings of the whole company. And from the results that we see in terms of becoming more relevant and the different pockets of how we play it, I really believe that, that journey is very much possible. And again, it's really putting all the wood behind the arrow. We know who we are, we know who we are not, and we're really focused on taking our core assets and making them much more productive to drive value for shareholders.

Drugstore.com. As you know, we bought drugstore.com, which includes Beauty and various other properties last year. It's been a terrific asset for us because it really not only enhances our current capabilities, 3 more million unique users that we have access to that are heavy buyers online. They expand our lines and allows us to do what I call long tail, short tail. So for example, we carry about 17,000, 20,000 SKUs in our store. Online, we carry 4 or 5x that. We don't want to be adding SKUs to our stores, but we never want to give our customers a reason to say no. So a beauty customer may come into a store for Olay or whatever but -- and that may be fine, but they might want one of the long-tail prestige items delivered to their home the next day. And we have the operability to play this without driving waste. It's been, like I said, a very great acquisition for us, and it's really part of this overall drive to become not only the leader in the Health and Daily Living retail space, but in a way that's ubiquitous. So we want to lead that multichannel and be able to connect all these dots for people so they can always get whatever they want, wherever they want, whenever they want it, and this is a key part enabler to that.

Another one related to that is our Web Pickup, which we have now expanded in Chicago and in San Jose, where people can order online and have it picked up in store, delivered to curb, et cetera. And again, this is all part of it when it comes to health and daily living. We want to be able to give our consumers what they want, where they want it, when they want it. We want to do that in an economical way. And so when you put these pieces together, the online experience of the e-commerce things we're doing, of the web-enabled pickup, et cetera, it allows us to play much more broadly, much more intimately, much more expansively in people's lives.

Now to healthcare strategy. We're on the front line of healthcare. As you know, pharmacy is not only the most used benefit in healthcare. When you think about it, I always like to say that a pharmacist maybe the only person in healthcare in the U.S. that will talk to you for free without an appointment. And leveraging that infrastructure in our pharmacy technician, et cetera, is going to be a critical piece and component of helping to participate in healthcare in a much bigger way. You can see the list, but we're #1 in a lot of things. And it's really not just our retail stores, it's also our other assets. It's our very large presence in growing dramatically in our work site, in our retail clinics. It's our large presence in hospital pharmacies, out-patient. It's our home infusion business, and it's our growing multichannel specialty business. All of these assets combine to support and reinforce the core and allow us to work with payers in a much broader way to help the managed overall healthcare spend on top of pharmacy spend.

With respect to health and well-being and where we're going, we're not only reinventing the front of the store, we're really reinventing the pharmacy and all the other assets that I spoke to. This is just one snapshot of the shape of things to come in many of our pilot stores, where we have a health concierge that's helping people understand what solution is right for them. Off to the left, we have a clinic, which is either a nurse practitioner or doctor clinic. It depends on where we are in the market. You can see that we have automatic express pickup and refill. We also have the pharmacist out in front, who's an adviser and able to talk to people versus being back behind the glass, an overall different experience. We have community rooms for diabetes training for MTM and a variety of things. So it's entirely different infrastructure, which starts to bring together an entire different Walgreens experience, and the results are very, very good. And this is a journey that is going to be well worth taking. Like I said before, these other assets that we have, stitching them together, which is our retail clinic, expanding that footprint broader is our work site clinic. We're #1 on 400 work sites, doing everything from not only pharmacy to medical to other health and well-being services like occupational therapy or fitness centers, et cetera, stitching together what we do at hospitals, what we do in the home as with the home leader infusion, and again, the multichannel specialty play. It's all coming together in a way which creates value in a way, not only for Walgreens, that I think is unique, but also for the payers because of the opportunity to control the whole dollar health spend versus just the $0.12 at pharmacy.

Update on the flu season. This flu season has been light with respect to getting the flu. You can see that in 2010, we did a record 7 million flu shots, and that was of course on the back of the H1N1 season. Last year, we did about 6.4 million. To-date, we're at about 4.6 million. The flu has not really come yet. February is typically when we start to see it hit, so we will see. But with respect to flu shots, you can see where we are season to-date, which is pretty much on track, and again remains to be seen what the actual underlying flu is going to do.

ESI, I'll touch on very quickly. Then we'll do Q&A. You probably know about the dispute, obviously. It's very simple. There's 2 principles that we have to have to be successful in the long term as a company. We have to work -- we have to make sure that we get reimbursed fairly for what we do, not below our cost, not below what we get with others, not below what we deserve. And principle #2 is we have to treat all the payers fairly. So we have no reason to give one payer a dramatically better price versus all the others unless they've done something to warrant it. And those are 2 principles which are never going to change because those are 2 principles which have made us successful and will make us successful in the future regardless of who we partner with.

Express Scripts business is about 7% of our total business. Book of business, you can see it is broken down, about 45% as managed care organizations, 26% our employer groups, 18% Department of Defense, and about 11% Part D. We are winning business across the board with these customers in various ways. We'll talk about it. I can tell you with great certainty that everybody who has the right to get out of their contract or contractually go direct we've either signed or they're talking to us. So we'll get to narrow networks, but we see no evidence and there's no mathematical basis or scientific basis for any value to be created by one as well. So with that, we're very confident.

I think on the last earnings call, 3 scenarios. I said depending on what happens, you can run kind of a chess game. And assuming that we never ever, ever come together again, we could, in the short term, retain 25%, 50% or 75%, depending on a couple of moving parts of the business. We have cost austerity both in SG&A and COGS in place ready to go, to cover half of whatever the hit us. And you can see that from an EPS point of view, this 25% retention is $0.21 and the 75% is about $0.07. And so the way I look at this is to take a principled stand to keep this company strong and deliver the long-term goals that we have. Is it worth the scenario in the short term not to compromise on what we do? And the answer is, "absolutely." And the reality is, whether it's $0.07 or $0.21 or $0.02, whatever it is when we flip over to January 1, that will be the hardest period that we'll ever see because we know for certain -- we're already seeing them line up for next season, that we'll keep basically signing on more and more of the customers with other PBMs and payers that value us at better rates. And so this just gets better as we go, and so it's a very easy decision to make in that context.

Apart from the fact that we believe we're competitive on a rate basis in networks -- and we've had many other PBMs run with and without Walgreens, just to make sure that we're not drinking our own Kool-Aid. We know our base rates are competitive. But we also know that -- for example, versus Express Scripts' own published data of their generic dispensing rate that we actually save $2 more versus average from that alone. And as you can see here by offering 90 days, they can save the clients another 7% if they wish to. They won't actively sell this. But again, apart from the fact that our base rates are competitive, you could see that clients could be missing out on $200 million better generic rates or $180 million specifically and significant savings from driving 90-day penetration as well.

So look, at the end of the day, we've had a long history of growth. We've been through a lot of things, discount store, $4 drugs, mail order, et cetera. I think at the end of the day, we're highly confident we're going to be in a much better place moving forward by not violating our principles. And if we do violate our principles, we're still committed to our goals, and I think we've got a great future ahead. And with that, I'll go to Q&A.

Question-and-Answer Session

Mark Wiltamuth - Morgan Stanley, Research Division

Thank you, Wade. Why don't we start with -- at this point, are you still talking to Express? And do think it's likely we're going into head to January 1 with no...

Wade D. Miquelon

I've been -- no. I have been telling people all along from Day 1 that I think you should be modeling our company as if this is not resolved. And I think we've laid out what those scenarios are. Whether it's 25% or 75% remains to be seen, because there's a lot of moving parts. But we are miles and miles apart, and we are philosophically miles and miles apart. And I just want to make that crystal clear.

Mark Wiltamuth - Morgan Stanley, Research Division

And at this point, if you look at the 25% scenario, like how much of the Express volume do think you've retained given some of the side deals you've done and some of the conversations you're having?

Wade D. Miquelon

I mean, it comes through a lot of pockets. We've already seen a lot of -- every day, we're getting more and more clients that we're finding out have moved. So we know what their base volume was and we know -- and every day, we're finding out more and more that have moved. So you factor that over, right? We're also -- as you know, we've also signed several deals directly. And to my knowledge, almost everyone who can sign direct has reached out to us, trying to. Many others have tried to and they're being told that, against all their legal rights, they'll be fought. But nobody wants to have a narrower network for no savings, because they haven't offered anybody the material savings. And the reason is they can't, because we're not more expensive. And then we're also seeing Med D right now. Early signs look very, very good, but we won't know for a while. But the open enrollment is signing up too. So it's the business they've lost, it's the business we're signing directly or through them to adjudicate, and it's also the Med D. And we're also finding out -- I mean, I've been on the road here for the last couple of weeks talking to many managed care and PBMs and we're seeing a lot of managed care that are customer getting them the med or the -- they're getting pharmacy benefit carved out. So even if a managed care stays with them, it doesn't mean that we can't win that business through carve-outs. And that's been happening as well. So there's a lot of trickle-down theorems, but I wouldn't obviously put those 3 scenarios out there if I didn't think all 3 were likely outcomes.

Mark Wiltamuth - Morgan Stanley, Research Division

And how do you feel about right now, how much do you think you've actually secured at this point?

Wade D. Miquelon

I mean, if I said that, I'd be saying something that hasn't been said, but I would tell you that I think that all 3 of those are likely. I know you've seen statements like, "Oh, we'll keep less than 3% or 5%." It's just -- that's a bunch of bunk, right? We're way beyond those numbers. And I think the other thing we put out publicly was that -- sorry, we're way beyond those numbers. And I would tell you that we've also put out that we see next year, that this is never resolved. Keeping 97% to 99% of our business is kind of the likely range for pharmacy volume, right? So that it would include not only what we retained with them, it includes our normal comp growth and our store expansion of 200. So you can run the math, and the answer is that we've retained a lot more than that. I mean, again, I think all of the 3 scenarios are very, very likely. It's entirely possible next year that our script count growth is actually positive. And think about it, whatever that period is next year, when we go into this, it's our worst period ever, because we'll win that business back disproportionately fast with others who value us. And so it's kind of we take the hit one time and we move on much better. And so again, 97% to 99% is the range we put out there, and you can get to that plausibly, or better.

Mark Wiltamuth - Morgan Stanley, Research Division

Okay. Why don't we get some questions from the crowd then I'll fire some more.

Unknown Analyst

Wade, can you tell us when your Medco contract expires?

Wade D. Miquelon

Yes. We never talk about any customer contract and we don't for a lot of reasons. Number one is it wouldn't be appropriate to them as a customer; and number two, it wouldn't be smart. But I can tell you, like anybody, we're not stupid. These things are staged with all of our customers, right? All of our contracts. But the reality is that we have a good relationship with Medco right now. So it'll be what it'll be.

Unknown Analyst

But under the regime change scenario, aren't we going to see similar dynamics and you're going to have similar slides and you're going to be down a similar path?

Wade D. Miquelon

No. I mean, first off, there's a big question mark on that. And I'm not going to say whether, will or won't because it's not for me to decide. But there is a big question mark, and not only an if and a when. But remember -- I mean, I'm sure we'll be happy to serve all those Medco clients as long as they keep compensating us fairly, right? And we've reached out to many of those big clients, and you've seen many surveys. But those big clients have all said they will not have a restricted network, right? And unlike the Express situation, they're going to have, most of them, change of control agreements which allow them an out. You'll be hard pressed to find a large Express customer that doesn't want to contract directly or get out. But right now, they're basically having their legal options forced at them, but this is a very different scenario. So we'll happily serve those customers as long as they don't -- as long as they keep paying us what they're paying us. And if not, they're going to have a lot more flexibility in terms of time, in terms of legal options to pursue a different course. And the surveys I've seen, the people I've talked to, and everything says that no large customer is going to accept the narrow network for inconsequential or 0 savings. And so I'm not really worried about that at this point. We'll just have to see whether it comes or not and deal with it then. But that doesn't change our position at all. I mean, it's still the same principle, and the principle is even important, times 2 more, if that's the principle.

Unknown Analyst

But I guess, if Express acquires Medco, wouldn't you think that they would -- I mean, why would you think it would be any different with that part of the book?

Wade D. Miquelon

Because they're going to lose all their customers. If they try -- if they lose Walgreens and that would -- they'll lose their customers and the customers will have more options. I'm sorry, but you just cannot be a network -- the only PBM in America that doesn't have a #1 pharmacy and doesn't offer any savings and is anchored on your biggest competitor's pharmacies for survival. It's highly illogical. Narrow networks have never taken off, okay? They never have. ESI has been pushing an EN40 and 30 network for almost a decade that doesn't include Walgreens. And I believe right now, it's less than 1% of their customers. If narrow networks were so great, they would have taken off. And the reason they're not great in pharmacy, unlike other parts of healthcare, is on a $60 item, you're talking about the pharmacy being plus or minus $1. Even if you were the $1 more expensive, if you carve out 20% of the network, you're going to save 0.3% of your cost to disrupt people, right? No one wants to save $0.20 on a $60 item for their people, to make them drive an extra 10 miles or be inconvenienced. It doesn't make any sense. So narrow networks have never taken off. The evidence has said that. Everybody I talk to in the markets says that they're not taking off now. And the answer is you can't provide any savings in a pharmacy in a narrow network because the band, the Pareto Curve of pharmacies is all in that range, and that's different. Hostile networks can be between 30% and 100% difference in cost. So that's where you've seen them take off, and not aggressively as where you have differentials that make sense. But for 0.3% savings, I've not heard of any customer ever who has considered narrowing the network by choice, only by force. So I mean, again, you can do your own surveys. You can talk to Medco customers and talk to consultants, but you'll be hard pressed to find anybody, I think, that has knowledge or integrity on the issue who's going to say that the Medco customers are going to be happy with a restricted network for no savings.

Unknown Analyst

Wade, 2 questions for you. First, can you explain the difference between what Express Scripts is doing versus explicit -- where they're explicitly trying to cut your rates -- or at least that's my perception of what's going on -- versus what the other PBMs are doing in terms of the arrangement with like branded Lipitor in terms of moving the formulary around when that goes generic and the 180-day exclusivity period? I mean, I'm just trying to reconcile which is sort of worse for you. And then second, on your 8-K, when you guys talked about amoxicillin -- I can never pronounce the drug -- but can you just offer some -- put some meat on the bones in terms of how the -- where the numbers are shifting there in that specific drug, since you did bring it up in your 8-K?

Wade D. Miquelon

For which specific drug?

Unknown Analyst

You're going to make me -- amoxicillin.

Wade D. Miquelon

Yes, I mean -- first off, I don't want to drag others into this battle, right? So what other PBMs are doing with respect to generics, et cetera, I mean, that's for them to do or not do. I think that Express is very, very simple. As we said publicly, we're getting well below rates we get with all others. Below market, and I'm not just making up "below market." We buy hundreds of pharmacies all the time, and lo and behold, they're almost always getting better reimbursement. Duane Reade was getting $4 more with ESI than we were getting and after the deal closed, they cut our rates. I don't know if they passed any of that through. So the reality is, Express is very, very simple. Right now, they're paying us below other payers. They're paying us below market, and they want to pay us a lot more below that, because they want to take it out of our pocket and put it into their pocket. This is not about passing it to the end consumer. I mean, the DOD is a classic example, right? With the Department of Defense, we said that not only we believe our rates are competitive, but because it's a pass-through model, we will actually guarantee -- we guaranteed in writing, as you've seen -- that we will match the rates of all of their balance pharmacies no matter what. And if our rates, in fact, are cheaper than all others, the DOD can keep those savings, right? And Express Scripts is denying that right now. They have not taken that offer. Now if it doesn't cost the government anything, it doesn't cost military personnel anything, it doesn't cost Express anything, then why would they disrupt millions of people -- especially when we have petitions signed by, I think, 250,000 people now? And the answer is it's because they would like to get better rates on a commercial book, to take it from our pocket and put it in their pocket. And that's not just going to happen because it's not fair to all other payers. How do we work with a Medco or MedImpact or Catalyst or even a Caremark and say, "For whatever reason, we decided that one PBM deserves dramatically better rates than you"? I mean, how do you work with hundreds of payers if you don't hold the principle that we're going to treat all of them fairly? It's very, very difficult. So I think that's the nature of that agreement. It's not just about rates, it's about terms, quite frankly. I mean, they -- apart from what they've said, that they didn't make any change to the existing contract, they sent us a 40-page addendum with changes like they want to be able to solely determine what is a brand and what is generic. Well, if you don't even know what's a brand or generic, and that can change anytime at their sole determination, the reality is that rates are really just -- they're irrelevant. You'll never get to the rate discussion because you don't know what you're really signing onto. Not a person in this room would sign a contract like that. And that's the real heart of the dispute, right? And the waterline has to be we have to get fairly compensated for what we do and we have to treat all payers fairly. And that principle can't change. Doesn't change for Express, and it can't change if Medco happens too.

Unknown Analyst

In terms of what other payers are doing with -- in terms of branded Lipitor, did you: a, anticipate that and proactively change your contractual rates so that you'd be whole on a average gross profit per script basis? Or b, are you going to...

Wade D. Miquelon

I tell you, that's kind of -- in the grand scheme of all the wheels moving, it's a very small issue for us, and there's a lot of assumptions. Would there be one supplier or 2 suppliers? How will that work? There's a lot of people now kind of looking at that, but I'm just not going to get into that. I mean, because I'm not -- I think it's for others to worry about and not me and I'm not going to drag them into it.

Mark Wiltamuth - Morgan Stanley, Research Division

There's time for one more in the room.

Unknown Analyst

Could you share any of the history of your relationship with Express Scripts that predated this spat?

Wade D. Miquelon

Yes. I mean, I've said it publicly so I'll say it again. I mean, 3 years ago, we negotiated our 3-year contract. As they've said, it was a 9-month negotiation. And it was. If you know these negotiations, they really can be done in a day. It's not rocket science. It's pharmacy pricing. But we thought we were negotiating in good faith for 9 months, but after lots of missed meetings, lack of returned phone calls, canceled meetings, et cetera, we got down to the end of November or maybe early December -- I forget the exact date, and they basically told us that, "If you don't accept our terms, conditions and rates that's starting January 1, we're going to stop reimbursing you and it's going to be your problem. You'll have to tell the payers and the patients that you cut them off." If you think about the context then, we'd been through Lehman, we'd been through a CEO change, the world was changing. And I can only describe it as we kind of looked at ourselves and said, "We've been rope-a-doped." We thought we're negotiating but what we didn't realize, we were negotiating against ourselves. And because there was a month left that we had before the turnover, we said, "You know what? We're going to just have to take this and live to fight another day." And that's why we told them in February that we want to start negotiating now for next year's season. It needs to be wrapped up by April because we're not going to go into December again. If we can't agree by April, May or June, then let's just agree that we can't agree. They said they were shocked, that we're out the network. I'm shocked they were shocked, because we told them exactly what we're going to do. And we did it. And the reason is we don't want our patients and payers to not have notice, and also because we did it in sales season. And we've seen the consequences of that with many accounts as well. So that's what it goes back to, right? And we just said we lived to fight another day. But we made it clear 3 years ago that over time, we expect to be compensated fairly from them as well as everybody else. And there's no reason to substantially advantage any one payer versus all others unless they've done something to warrant it.

Unknown Analyst

And was narrower networks part of the discussion 3 years ago? Or is that something...

Wade D. Miquelon

Yes. They have narrow networks. They have the EN30 and 40, which we don't participate in. They provide minor savings to clients. They've been selling that for, again, I think 7, 8 years. You could ask them. I think everything I've ever heard is less than 1% of their business. But yes -- so we didn't like the rates to begin with. So liking rates in a narrow network is even worse, because -- the reason we're not in those networks is because people will cherry pick. They'll say, "Hey, will you be in my 30,000 pharmacy network?" and they'll go to a market where half the chains don't exist, and you do, and they'll give you a lower rate. If it was used broadly -- consistently across the country, maybe we can sort of participating in it. But when it's only a mechanism to reduce your rates because in any one market some players don't exist, it's not really the kind of partnership that you want to have. And again, to me, that's proof positive that narrow networks don't sell because they've been trying to sell it for a very long time.

Mark Wiltamuth - Morgan Stanley, Research Division

Okay. We'll continue questions off in the breakout session. Thank you.

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Source: Walgreen Co. Presents at Morgan Stanley Global Consumer Conference, Nov-16-2011 08:40 AM
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