Highlights From Walgreen's Q3 Conference Call: Solid Results in a Difficult Economy - But Shares Fall 6% Today

June 22, 2009 2:49 PM EDT

This morning, Walgreen (NYSE: WAG) reports Q3 EPS of $0.53, (including an impact of 6 cents in costs and 6 cents in savings associated with the company's Rewiring for Growth and Customer Centric Retailing initiatives) versus the analyst estimate of $0.56. Revenue for the quarter was $16.21 billion, versus the consensus of $16.16 billion. Shares are down 6% in afternoon trading.

Highlights From Q3 Conference Call Include:

• Same store sales rose 2.8% during the quarter.
  
• (CEO) In Q3, we posted solid results in a difficult economy while recording significant restructuring costs. Net sales for the quarter were a record $16.2 billion, up 8%.
  
• We continue to see consumers save more, use less credit and spend closer to payday. This is challenging to all retailers including us, but we are well positioned to continue to grow.
  
• I am pleased with our ability to generate cash flow from operations of $1.5 billion in Q3, a 54% increase over a year ago.
  
• Inventory control was one of the key drivers for our cash flow improvement. Implementing our strategic initiatives is improving our cash flow which in turn allows us to invest back into our key strategies and start the virtuous circle all over again.
  
• As part of our first strategy, late last year we announced that we would slow our pace of store openings from the current 9% to 2.5% to 3% in fiscal 2011. This slowing will have a positive impact on our operating profit and ROIC.
  
• Looking at our second strategy, we hit new milestones in Q3 with one of our key initiatives for enhancing the customer experience, Customer Centric Retailing. CCR is redefining our customer offering
  through enhanced store formats, fine tuning the role of various categories within the store, optimizing product assortment, pricing and promotions and enhancing our vendor relationships.
  
• Our plan is to roll CCR out to about 400 stores this fall and after a break for the holidays we plan a nationwide roll out through calendar 2010.
  
• We continue to focus on cost reductions and productivity gains around our business. One way we're doing that is by transforming community pharmacy and our POWER project is an enabler of that. We've nearly completed rollout of POWER in Florida and rollout in Arizona is underway.
  
• The latest AC Nielsen report for the 12 weeks ending in April shows our private brand dollar sales growing 12.8%. That compares with an increase of 7.6% for all drug stores excluding Walgreens and just a 1.2% increase for all other food, drug store and mass merchandize retailers.
  
• We also have nurse practitioners located in about 350 in-store clinics to handle routine family illnesses at a much lower cost than an emergency room visit.
  
• In addition, we're pioneering new approaches to achieve better healthcare outcomes. In coming quarters, we'll pilot a chronic care management service in four markets focused initially on Type II diabetes.
  
• (CFO) In the quarter net sales increased 8% while total comparable sales rose 2.8%. Prescription sales rose 8.2% and represented 65.6% of sales for the quarter. Prescription sales in comparable stores rose a solid 3.8%. The number of prescriptions filled in comparable stores increased 4.9%.
  
• We filled 187 million prescriptions during the quarter and our U.S. retail scripts increased 8.3% over last year's third quarter. That includes an impact of 1.4 percentage points from patients filling 90-day scripts rather than 30-day scripts.
  
• Net earnings in the third quarter were $522 million or a decline of 8.8% from last year's quarter. However, this year included a $99 million pre-tax impact from costs associated with Rewiring for Growth or $0.06 per share diluted.
  
• On a two-year stack basis SG&A dollar growth for Q3 declined from 24.9% to 17.6%, primarily due to store salary and expense control.
  
• Over the last four quarters, FIFO total inventory growth has ranged from plus 10% to flat in the most recent quarter. When adjusting for store growth, FIFO total inventories on a per store basis fell 9% in the most recent quarter.
  
• Our net cash position at the end of the quarter was $52 million with cash and cash equivalents of $2.4 billion and long-term debt of $2.35 billion. This cash position compares favorably with a net debt of $785 million at the end of Q2 and a net debt of over $1.5 billion at the end of Q1.
  
• In the first three quarters of fiscal year, we invested $1.5 billion on additions to property, plant and equipment versus $1.7 billion last year, mostly for the addition of new stores. We estimate capital spending for the full year to come in at about $1.8 billion or slightly higher about $400 million less than fiscal year 2008. For fiscal year 2010, slowing store growth will result in lower CapEx for new stores but we will increase our investments for systems and other improvements in existing stores.
  
• Our cash flow from operations in the quarter increased to $1.5 billion from $985 million a year ago, a 54% increase. Meanwhile free cash flow for the quarter stood at almost $1.1 billion compared with $375 million a year ago or nearly a three-fold increase.
  
• (Q&A) Hi, can you discuss what you think the impact to the P&L will be of the store remodels in 2010? So based on what you've learned so far from the upfront expense from converting the stores compared to the benefits as they accrue, do you think it's reasonable to think that this will be a drag on EPS going forward? (A) We are - obviously we are finalizing the modeling for it. I'll give you a rough range. The rough range is we are probably talking in the order of 30 to $50,000 per store, doing the bulk of stores. Obviously the new stores coming out won't need to be done. There's some inner-city stores that won't need to be done, so it's not overall a tremendously significant number. We are seeing lots of other benefits coming from CCR so, while there will be some cost and investment here mostly expense, we also believe as we continue to go forward we'll be getting, benefit coming from Rewire to help pay for that and from CCR, pardon me.
  
• So, net of it all, I mean it sounds like there might be more expense as you go into this until you get more of I guess accrual in the benefits which come a little bit later. (A) Well yeah, I mean, obviously the benefits from the store remodels come after we've remodeled but there's other benefits from CCR such as the more efficient pricing, promotion, supply chain work that we're already starting to see and we'll continue to see.
  
• On the path to achieving double-digit earnings growth and I don't know whether you think about it on just a one year or two year basis. Can you talk about structurally where the expense dollar growth, you think it's going to go? And then related to where it was this quarter I think on a two-year basis 17%, does it continue on a straight path downwards or are there some spikes along the way? (A) Yeah, I think if I interpret the question: kind of trying to understand where SG&A will go over time. You know obviously this quarter's SG&A I think we made very good progress when we look at the number of store opening which is a major driver. I guess what I would say is over this quarter and last quarter we've actually seen our established store base, our comp store base, SG&A negative. So we're making tremendous progress and then, over time we'll also overlay increased benefits that we get from the entire Rewire initiative. So without giving a number, it should help you kind of factor into your model just how much of the SG&A is driven not only by store growth but also as we see the benefits fully come through what we could potentially overlay on that.
  
• Hi; could you give us a little more detail on what we should be watching for in the healthcare reform in terms of generics, access for the public, margin compression that could come out of it? (A) Yeah. Mark, Greg, and I think that as I say internally a lot, is that certainly healthcare reform, there's certainly some threats and then there's opportunities. I think as the administration tries to provide more coverage for the 47 million uninsured, there's certainly going to be focus on cost and so we'll be focused on margin pressure and reimbursement pressure. But that's something that we deal with and have dealt with over the years. I do think the opportunities are great as well, certainly with coverage for more than 47 million Americans there'll be prescription volume, just like we saw with Part D. I also think that the administration - one of the key principles is prevention and wellness. And an understanding and realization that prescription drugs are a big part of that. So I think we have a great opportunity to play a part, as I said earlier, with access and affordability. Think this weekend you saw where pharma made some concessions to help with the doughnut hole in Part D. I think that's a positive that will help
  seniors that have had - have been challenged during that when they hit the doughnut hole.
  
• Is there any pressure on retail to make any concessions? (A)No, I think that probably no more than what we've experienced. Obviously I think that holding down costs both on the medical side and prescription side will be a focus. You know, we've had some challenges in a couple states as we - as
  is out there and you probably heard with Medicaid, but you know, we think we have solutions and we think rather than rates, there is ways to improve generic compliance for states and really help improve the quality of the benefit they offer.

Walgreen Co. operates a chain of drugstores in the United States. These drugstores sell prescription and non-prescription drugs, and general merchandise.

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