Walgreen Co. Presents at Lazard Capital Markets 8th Annual Healthcare Conference, Nov-16-2011 01:00 PM

| About: Walgreens Boots (WBA)

Walgreen Co. (WAG)

November 16, 2011 1:00 pm ET


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


Unknown Analyst

Thomas Gallucci - Lazard Capital Markets LLC, Research Division

Thomas Gallucci - Lazard Capital Markets LLC, Research Division

All right. Great. I hope everybody enjoyed lunch, and it's my pleasure to have Walgreens here with us today to kick off the second half of the second day of the program.

As you already know, Walgreens is the largest drugstore chain in the U.S. today, offering compelling brand and footprint among the retailers, especially in the pharmacy space. The company has refreshed the look of its stores in recent years and successfully executed a substantial cost savings initiative that has left Walgreens more efficient and not to mention the launch of various new product lines like beer and wine, vaccinations, et cetera, continue to drive incremental growth.

With that I'd like to turn things over to Wade Miquelon, the company's CFO, to tell you more about their story and answer your questions. And of course, we've also got Lisa Meers here as well.

Wade D. Miquelon

All right. Great. Thank you for having me here today. It's a real pleasure. I'm going to go fairly quick through my presentation. I think we have half an hour -- 25 minutes. I want to make sure we have some room for Q&A at the end, so please bear with me. Safe Harbor, take a second to read it. Away we go.

All right. Today, I want to talk a little bit about our company, our assets and our strengths. You probably know us to some degree, but maybe expound and build on that a little bit. I want to give you a little bit of update on our financial results. Most recently, some of our thoughts and policy moving forward relatedly, moving to some strategies and the core we're going. In particular, I'm going to zoom on 2 of our top 5 strategies. And finally, again, leave some room for Q&A.

I think you know our company. We're about 7,700 drugstores. We feel we're on the best corners in America, we got the right-sized box, the most freestanding, best parking, and this is a real asset that has served us very, very well, but there's just so much more we can do. We got a great financial foundation, very strong balance sheet, but apart from that, one of the strongest assets we have is we have 40 million people a week literally that come into a Walgreens, whether it's for the pharmacy or the front end, and that is a phenomenal asset that we can tap into as become -- as we become much more relevant in their daily lives, and that's really part of the big value-creation journey I'm going to expound on later.

75,000 healthcare professionals, unmatched for any company that I know of in the U.S. or the world between nurse practitioners, doctors, pharmacists, pharmacy techs and others, a huge network. Again, the #1 share, just over 20% and the most trusted brand in pharmacy.

Also other embedded assets too. So for example, we have more 24-hour stores than anyone; we have about 1,600. And I believe in about 560 MSAs, we're the only 24-hour store within 5 miles of the people that live there. So again it's not just about the location, the real estate, it's also about all the other things that we wrap around that.

America lives closest to Walgreens, and we're trying to redefine "close" in many other ways, not just the physical locations, but also ubiquity in terms of multi-channel play, online experience, whatever, but the reality is that we're closest to population. And today it's almost 2/3 within 3 miles, and I believe over 80 within 5 miles. Importantly, too, is with respect to the African-Hispanic community, where we serve people in underserved communities both from a food point of view and medically, we are far closer and for the most part, we are in the 80s of those populations. Again, where convenience and proximity counts the most, we are disproportionally stronger in those areas.

Looking back 3 years ago, we created a "plan to win", which was the plan to get our company back to consistent best in industry, top line growth, back to strong double-digit earnings per share growth and back to very strong cash metrics, both in terms of things like return on invested capital, but also in terms of how we reward our shareholders. How have we done? We've met every commitment we've made. And you can see in the most recent 12 months, our sales were up 7%. Comps had outpaced all of our competitors, and our earnings, when you take out the gain at the PBM sale that we had, we're up about 14% on an EBIT basis and 24.5% on an EPS. So we've done what we said we would do in year 3 of "plan to win", and now we're moving forward into new strategies to create value for the future.

A few highlights this fiscal '11, I don't want to read at you but again, we are 820 million scripts, the most in the industry; 6 million flu shots, which is more than anyone by far with exception of the U.S government, so a very robust pipeline there; several partnerships, we have a partnership now with Johns Hopkins, deepened with Northwestern, Ochsner and many, many others, but we're creating deep partnerships with the health systems that you want to partner with across the country; opened more drugstores than anybody at 199. We probably should have done one more but we didn't; and we've also done a lot to enhance the front-end experience. This thing I'll talk about briefly called CCR. 5,500 stores refreshed while at the same time, we pulled out $1 billion in costs to basically help fuel that, but also fuel the bottom line. So we feel pretty good as we close out our 3-year plan. I think the highlights point to that.

With respect to our sales trends, you can see there our front-end comp trends, like everybody, dipped in the midst of the toughest part of the financial crisis, but they're coming back nicely over the past -- if you look over the past few periods here, we've been in the 4% range, so our 2-year stack is getting back in that kind of 6% to 8% range, which has been again, I think, a lot of a -- basically, I think the causal effect is a lot of things that we have done as a company to improve our customer experience and become more relevant.

And as proof point of that, here's our latest comps versus our top 3 competitors, and so you can see that we have out-comped them, and this has been the same story for about 4 or 5 quarters now. And I think the economy is very tough; it's not getting much better. It's kind of dragging along the bottom, so I think kind of a flattish comp is kind of where the world really is, but I think this time we're becoming more relevant, we're improving our experience, we're driving more relevant assortment. At a better refresh, we believe we should be able to do better than the market.

With respect to the scripts, the script trends have been reasonably strong. You can see over the past several periods, both on a 1-year and 2-year stack that we've been in that kind of 6% to 8%-ish range for the 2-year stack. The spikes here are really the effect of the H1N1 in 2010 and knock-on effect of that later.

For the lowest part, our business has been fairly stable, and we've been outpacing IMS dramatically too, and I think in October, even widened more considerably than it had in previous periods. So again the market, I'd say, is fairly flattish, but our ability to out-comp the market has been strong for several periods.

Again, returning cash to shareholders, like I said, we've been able to reward our shareholders for their support as we've revamped the company. You can see here that we had a record cash return in fiscal '10, over $2 billion, and in fiscal '11, $2.4 billion return to shareholders, with about a 29% dividend increase and a large buyback. And we have just announced another $2 billion buyback, which is work in progress as we go.

We -- if you followed us for a while, you'd know that we've had a kind of this 3 by 5, 3 strategies by 5 core priorities. We have refined our strategies moving forward as we keep, I would say, putting all the wood behind the arrow and keep stacking the weights on where we can create value. These are the 5 strategies without reading them at you. I'm going to talk more about the first 2.

So we are transforming really the traditional drugstore experience into something very different and what that is, is to really be the leader in health and daily living, to be the most relevant player in that space. It's a tremendous opportunity for us to make our box more relevant by doing better things, doing more in food, doing more in beauty, better healthcare solutions integrated, et cetera, and we're well on our way.

And the second strategy, which is really a big broad frontier but has tremendous implications of how we create value for the long haul is we're really advancing the role of community pharmacy with respect to how it plays in healthcare and how we integrate with partners. And we've been moving the needle over time from not only prescriptions to adherence programs to MTM to vaccinations, whatever, but there's a lot more we can do, and this is as we help not only go after the $0.12 of the dollar for the pharmacy spend, but more specifically as we help people manage the other $0.88 by things that we can do more conveniently and more cost-effective than many, many other providers. And again, it's a partnership, and integrating is where the big wins come versus a direct competition here.

CCR, over the last 2, 3 years we've rolled out 5,500 new formats. It's our basic upgrade, where we were able to improve the assortment, the sight line, refreshed the décor, et cetera, and so forth, and this really was a -- almost a no-brainer. We were able to get nice comp lifts and dramatic improvements in inventory. At the same time we're able to improve the customer satisfaction. So really, we pay for the thing in the first couple months of inventory. We're able again to reduce our costs, improve our profit, improve our list but more important, it's a beginning of the journey to improve the experience of our customers, and it's really very foundational, I would say, to where we're going, which is raising the weights even more to become even more relevant, even more contemporary and get a much bigger basket both front of shop and back of shop with our customers.

We've also done a tremendous amount to refresh our private label. Our private brand has been about 20% best in drugstore for the last couple of years. But really it's been more of a, I call, a "compare and save" strategy, where you can get a Walgreens brand, for example, on OTC at 30% less than national brand and leveraging the trust that way. It was a huge frontier for us as a company by going what I call top-down. Right? And top-down really means differentiated offerings, so good, better, best. Unique products that aren't available to the branded companies, and we've expanded our Delish launch that came from Duane Reade to across the Walgreen franchise, and we have many, many more initiatives coming behind that that's going very, very well. We've launched our Nice!, which is really our mid-tier broader brand, which is providing great value and very innovative offerings. And we have several other brands, Pet Shoppe, et cetera, that are coming behind it. So over time, we are going to dramatically expand and enhance the private label business and as you know, it's much more profitable for us. But to the extent that they're differentiated offerings versus just compare and save, it puts us in a great position to differentiate our box over time and give people a reason to keep coming to Walgreens.

On the fresh initiative, we've launched fresh and enhanced our game across the country, and there's a lot more that can be done. In the next couple of years, we'll be over 1,000 food deserts as the food oasis making tremendous tractions. It's a wonderful opportunity. We are in these communities where oftentimes people don't have transportation, they're 3 miles from the closest grocery store, and we can provide a much broader array of relevant food offerings. That can be pre-packed fresh fruits and vegetables, it can be more prepared on-the-go fresh items, so we've got a lot of success and traction there.

And across the entire chain, all the 8,000 stores, we're also raising our game in terms of the kind of food offerings. And if you've been to any of the Walgreens refurbs or the Duane Reades in New York and you've seen what we're doing with Delish and other food offerings, I think you know exactly what I mean.

We have tremendous opportunities to raise our game in beauty, and we're doing so. And you can see all the way from 40 Wall, if you haven't been down there, I suggest that you go there. That top-left picture is a picture of beauty, again a tremendous opportunity to play in the higher end prestige. And I think that, that atmosphere, ambiance, service level rivals anyone in beauty today. Down to the LOOK boutiques in the broader Duane Reade that we're now expanding in the Walgreens and having much success with. And the upper right, just a general refresh of the overall chain, but the key here is that there's tremendous opportunity to be had in terms of top line sales and value creation in beauty for Walgreens. And the key is making beauty feel like beauty, both in terms of ambient service, but also assortment that's relative to that local demographic. And so a long way that we can run here, and I'm very excited about the progress.

Moving to strategy 2, we're on the front line of healthcare. We're #1 in retail pharmacy share, #1 in flu shots, #1 in other vaccinations, #1 in generic conversion utilization, #1 in work site and retail clinics, #1 in hospitals sites, blah, blah, blah. The reality is we are in the front lines and we do touch 40 million people a week, and we're going to keep touching them deeper and deeper and deeper as it relates to all their healthcare needs and not just filling prescription bottles. We've reinvented the CCR experience for the overall store and made some improvements in pharmacy, but we're radically changing our pharmacy. And here's one picture of one example, which was many pilots in place and improves, but you can see that we have a concierge who greets people, providing great lift in the pharmacy, great lifts in customer satisfaction, great lifts in the retail clinic because people now understand what the clinic is, what it's about, what their insurance carrier will do, et cetera. We've got the pharmacist out in front talking with patients, giving advice, doing what they were meant to do, what they wanted to do from pharmacy school onward. We've got automated kiosks where they can do automated pickup, quick refill. We've got consultation rooms for various therapies, adherence, compliance, trainings. And the reality is the whole magic is coming together to create a pharmacy and health and wellness experience that does not exist today because we are stepping out of traditional drugstore channel into something else, which is really about being on the front line of managing people's health and well-being, and the results are great. Like I said, you'll see a lot more of this as we move forward to the next phase of our evolution.

Update on flu season. There's not a lot of flu out there. Flu usually hits around February, but most states are green, if not all, so it's lower than last year and a lot lower than 2 years ago. But with respect to flu shots, you can see we've done about 4.6 million to date. Still quite convinced we're probably on pace as a leader there. And what it will ultimately be, will it be greater than last year or not remains to be seen but again, I'd say at this point with respect to flu, we're also kind of still waiting to see what happens.

ESI, coming very quickly as we close in. Basically, the dispute with them is very, very simple. Two principles: we believe we have to be compensated fairly for what we do, we know the market, we know when others would have a PBM, we buy pharmacies all the time; and principle number two is we don't see any reason to advantage any one payer versus the other payers without having them do something to warrant it. So it's really that simple, right? We have to keep an ecosystem that's fair to all, and we're not going to compromise on those principles no matter what it takes.

Express business, you can see they do just under 90 million scripts a year with us. That book, it's about 7% of our total business, maybe just over 10% of our pharmacy business. That book is broken down to 45% Managed Care, 11% Part D, 18% DOD and 20% employer groups.

We've had -- basically, we will get to Q&A, but I can tell you, every large group we've talked to, every single one is saying that over time, they must have Walgreens in their network.

There's no cost savings, not for doing so. They want broad access pharmacies, the most used benefit. There's really no savings to be had by restricting it, that's why they don't take off. We'll talk about that further. But we're seeing lots of traction across the board, and I think we're pretty confident that over time we're going to get most of this business back.

I'd laid out on the last earnings call 3 scenarios, whether we retain 25% on Day 1, 50% or 75%, we believe we have cost austerity in place for half of any scenario. Here's the EPS impact. And the reality is, is whatever that January 1 number is, it's going to be the worst number that we ever face because we know that as contracts expire, is Part D keeps coming up for enrollment, if managed care plans are trying to carve in or carve out the PBM space, that we're going to keep winning that business disproportionately fast on top of the base with other payers that pay us fairly. And so again we take a bit of a dip, but we end up in a much better place down the road than we would by working with them.

You've seen a couple of different white papers. Basically what we do, we believe our base rates are competitive and what we do on top of that with respect to generic rates and our rate of conversion, you can see that we believe in ESI's book versus their own published data that we are actually about $2 a script beyond that, better for payers, about $180 million. That means payers are actually going to pay more for not having Walgreens in the network, not less, and that's why ESI has not offered any substantive savings to any of their clients. But it's important to understand that's the overall spend and how you get through the generics, generic utilization, night and day discount, et cetera. We've also -- PBM has also published a white paper out there saying that in their network, when they run it with or without Walgreens, they're between $2 and $9 cheaper. We are versus the balance of the network, and they've had that, I believe, independently audited and verified, so the reality is, is despite what you hear, we are not more expensive than others and there aren't savings to be had, and that's why networks have never taken off.

ESI has been selling EN30 and EN40 for almost a decade without us in it for very little savings, and I think it's less than 1% of their book because people don't want to save 0.1% or 0.2% or 0% to dramatically restrict the options of the people. So unlike other networks, hospital networks can be 30%, 40%, 80% different. We're talking about 1% or 2%. So when you take 20% out, you save 0.3%. It's not really driving any value, especially the disruption of the relationship.

So at the end of the day, we've had a long ride at Walgreens. We've come through a lot of different challenges. I've never been more bullish in the business than I am now, and so we will be a stronger company for the stand. I think at the end of the day, if you sit where I sit, it's one of the biggest decisions the company has ever made to go forward without Express Scripts, but actually if you look at the math, it's the easiest. So we're better off moving on than we are taking the deal, and that's what it is. So we have a good business, and I think we have a great future, and I thank you for your support.

I guess we have about maybe 8 minutes for Q&A, 5 minutes.

Question-and-Answer Session

Thomas Gallucci - Lazard Capital Markets LLC, Research Division

Yes, we got a few minutes here. What is the status of talking to Express, not talking to them, and at what point do you sort of reached the point of no return in your mind?

Wade D. Miquelon

I tell you, for those of you that follow us, support us, whatever, I mean, I've been saying all along, you need to plan that we're not going to be in their network starting January 1. And the reality is, is we are miles apart, miles and miles, and there's philosophical differences. And we know what the worst case is, but we also think that the worst case is not that bad and only gets better and better and better over time. But we're not going to substantially advantage any partner versus all the others only to put the money into their spread model and then create lack of trust with all the other partners. We're just not going to do that. Our offer is very fair. Our offer is very industry standard. We know what we get with other payers. We had a PBM. We buy pharmacies all the time, so we know the market. And I would say that if you ask me, the gap is so wide, I think you should model that this will not be resolved.

Thomas Gallucci - Lazard Capital Markets LLC, Research Division

And the point of no return, is there a time where you just say you never can go back?

Wade D. Miquelon

It's very close when I cut over that we have 75% of the business. And if we have 75% of the business without working with them directly and quite frankly, getting fair rates with others, you have to scratch your head and say, "What's the point of coming back together?" So I'd never say never. I'm very pragmatic, but I'll also tell you that this company is not going to compromise on its principle of holding the line on fair reimbursement. What we've offered is fair by any standards, terms, rates, agreement, whatever, and we're not going to compromise, but I think we'll see where it goes. But I think if in next year one of those better scenarios pans out, we can be honed very, very quickly, and I would rather have -- create a better relationship with 99 of our payers and not have a relationship with one that doesn't value us than to have mediocre with 99 and terrible with 1 because the other 99 don't trust that we're treating them fairly. So for the health of our business, right, if we can't look everyone in the eye and say, "We're holding the line for what's fair versus others and versus the market, then we really have nothing." [indiscernible] right there?

Unknown Analyst

[Question Inaudible]

Wade D. Miquelon

Well I can't speak for all the others, but I've not heard anybody who says they love the deal they get with them, so I can't speak for them, but I can tell you I don't know why Express doesn't want to pay what's market fair, but maybe they can't. Maybe for their model to work, for their spread model to work, maybe they're not able to afford what's fair. So I always knew this day of reckoning was coming, but most of us thought the day of reckoning was coming after the generics. The fact that we're at this point today tells me something about the overall market dynamics, right? Leave it to yourself, right? And I would say, I'm not going to speculate on -- I mean first off, the question mark is will it happen? And if it does, when? And there's a lot of question marks. And I can tell you, from what the other PBMs have told us, from what I've seen in surveys and what -- from their clients who've reached out to us have told us, there's no way that those big clients, and the book is mostly big, are going to live in a network without Walgreens, especially when there's no savings to be had. So those clients will have visibility. Those clients, a lot of them will have more time to change, those clients may have changed their control, but I'll tell you -- I mean, we'll happily say to Medco clients, "We'll happily keep serving you under any agreement as long as we keep getting compensated fair like we are today." But for whatever reason that were to happen and they said, "Oh, you're going to have to take this deal, whatever," we would say the same thing. This is our principle and we're leaving. And as soon as you can get out, if you want to get out and come to us, we'll be here with somebody -- other partner, but it doesn't change it. But I think the dynamics, I mean you have to believe that when every PBM basically in America has Walgreens and they can match the price of a network either Express and Express and Medco without Walgreens, to think that without Walgreens the same price is going to be compelling, then you're not talking to the big payers, right? I'm telling you, they can't -- pharmacy is very simple, right? The average script that gets charged from a pharmacy is about $60, and the bell curve is between $59 and $61. Even if we were $61, if you took that assertion, and even if you -- if we weren't and you took away my generic utilization conversion right, you can save the payer $1 on a $60 item. Over 20% network, that means they save 0.3%. Go for yourself and ask anybody in the country who pays a pharmacy benefit and say, "Will you narrow your network with the #1 pharmacy for a 0.3% savings?" I've not heard a single one answer that. Some of the ones that are locked into contracts might say their rhetoric right now but I can tell you, our phones are ringing off the hook with people who are telling us as soon as they can switch over they're switching over, and the reality is that they will because it's Adam Smith's invisible hand. These other PBMs are hungry for the business the other Managed Care companies are hungry for the business. If I can give you an apple and a banana for the same price as an apple, I know which one you'll take. You'll take the apple and the banana, even if you hate a banana. You'll give the banana to somebody who likes them.

Thomas Gallucci - Lazard Capital Markets LLC, Research Division

Next question. Right here.

Unknown Analyst

[Question Inaudible]

Thomas Gallucci - Lazard Capital Markets LLC, Research Division

Just comparing CVS's dispute and Express.

Wade D. Miquelon

I think the source of the dispute is identical. We didn't feel at the time we were getting compensated fairly, and we felt the rates were trying to take us to were even more unfair than that. I think within 11 days we were able to work it out, and I think sitting here a year later CVS Caremark is probably going "Yes, it was a good move." Because they're sitting probably very nicely as the -- as a -- not only as the second pharmacy in America, but one that can offer Walgreens in their network, right, like the other PBMs, so I think at the end of the day, we worked it out. But we have to draw a line and it's unfortunate we have to go public with these things, but the last negotiation went 9 months down to the end of November, December when they basically said, "If you don't take our terms, contract, conditions, then we're going to stop reimbursing you Jan. 1." So we had 30 days to decide whether or not we were going to tell the patients and payers that sorry, but you can't come into the network or not. And between the economic crisis and transition of CEOs and having 4 weeks, we said, "Hey, you know what, we were over-doped, but shame on us." So we said we took the deal. We lived to fight another day. But we learned from that, with CVS Caremark and with this is that these deals can be inked in a day. So we told Express in February we've got 3 months to work on it. If we don't resolve it, then we're going to be out of your network and we'll announce it very early. It doesn't take 9 months, but we're not going to wait till December to harm our customers, our payers and our shareholders by being the one at the very last minute giving the notice. We've given 6 months notice to everyone. People have either made other options, moved PBMs or are preparing to do whatever they want to do, and that's what we learned, right, is that we we're being -- we weren't negotiating, we we're being stalled down to the wire only to have a "take it or leave it" deal only to potentially embarrass ourselves in front of all of our patients and clients. So we took the deal, but we learned from it, and I think we've moved on.

Thomas Gallucci - Lazard Capital Markets LLC, Research Division

Great. I think we're actually past our time right now, so I'd like to thank Wade and Lisa for being here. Up next in this room is Covidien in the services space. Vanguard is across the hall next. Thank you.

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