Walgreens Company (WAG)
Q3 2009 Earnings Call Transcript
June 22, 2009 8:30 a.m. ET

Executives

Rick J. Hans - Divisional Vice President, Investor Relations and Finance
Gregory D. Wasson - President, Chief Executive Officer, Director
Wade D. Miquelon - Chief Financial Officer, Senior Vice President

Analysts

Mark Miller - William Blair & Co
Simeon Gutman - Canaccord Adams
Mark Wiltamuth - Morgan Stanley
Eric Bosshard - Cleveland Research
Scott Mushkin – Jefferies & Co
Meredith Adler - Barclays Capital
Lisa Gill - JP Morgan
Debra Weinswig - Citigroup
John Heinbockel - Goldman Sachs
Edward Kelly - Credit Suisse

Presentation

Operator

Good day, everyone and welcome to the Walgreens Company third quarter 2009 earnings conference call. As a reminder, today’s call is being recorded. And now I would like to turn the call over to Mr. Rick Hans, Divisional Vice President of Investor Relations and Finance. Please go ahead, sir.

Rick J. Hans – Divisional Vice President of Investor Relations

Thank you Cecilia and good morning everyone. Welcome to our third quarter conference call. Today, Greg Wasson, our President and CEO, will discuss the quarter’s highlights, including updates on our three key growth strategies. Wade Miquelon, Senior Vice President and Chief Financial Officer will detail the second quarter financial results before we begin taking your calls. John Spina, our Vice President and Treasurer, also is joining us on the call today. When we get to your questions, please limit yourself to one question and a follow-up so that we can give an opportunity to as many investors as possible during our limited time.

Today’s call is being simulcast on our investor relations website located at investor.walgreens.com. After the call, this presentation will be archived on our website for 12 months.

Certain statements and projections of future results made in this presentation constitute forward-looking information that is based on current market, competitive, and regulatory expectations that involve risk and uncertainty. Please see our latest forms 10-K and 10-Q for a discussion of factors as they related to forward-looking statements.

Now I’ll turn the call over to Greg.

Gregory D. Wasson – Chief Executive Officer

Thank you, Rick and thank you, everyone for listening to our call. We certainly appreciate your continued interest in Walgreens. Today I am going to review the quarter, update you on our three strategies, and share some thoughts on today’s consumer and healthcare reform. In the third quarter, 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 consumes 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. Net earnings were $522 million, or $0.53 per share diluted, compared with $572 million or $0.58 per share diluted a year ago. Earnings per share this quarter include $0.06 of rewiring for growth costs and $0.06 in rewire benefits.

I am pleased with our ability to generate cash flow from operations of $1.5 billion in the third quarter, a 54% increase over a year ago. For the nine months, our cash flow from operations was $3.3 billion, up 31% 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. We are often asked to clarify our cash priorities so let me do that now. Our first priority is to ensure a sound balance sheet and ample liquidity to weather any storm during these tough economic times. Second is to ensure that we continue to invest in our winning strategies for the future, such as CCR; and third is to make sound decisions that reward shareholders. As a reminder, our board will review dividend and share repurchase options at its July meeting.

Most of you are familiar with our three strategies that are intended to help us return to double-digit earnings growth. Those are leveraging the best store network in America, enhancing the customer experience, and implementing major cost reductions and productivity gains. 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. That’s because we’ll lessen the financial drag of a large number of new store openings each year. As you see from this chart, new stores don’t turn profitable until their second or third year and as those stores continue to mature, their profitability grows. I think we just got the slide up. With our past store growth, we’ve put down the tracks for significant ROIC improvement.

Now our store growth hasn’t slowed yet but SG&A already has dropped significantly. That reflects our rewiring for growth efforts and the fact that we’ve done a good job managing store operating expenses. Beginning in the fourth quarter, we’ll see a sequential decline in new store openings toward our 2.5% to 3% growth target. As that slowing of new stores begins, it will contribute to SG&A control going forward. I’ll pause a few minutes so you can view the slide. Looking at our second strategy, we hit new milestones in the third quarter 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. The four big wins of CCR are improving the customer experience, thereby driving higher sales, lowering costs, and reducing capital employed.

In the quarter, we rolled out the new CCR format to 35 pilot stores and here’s a before and after look at one of those locations. You see our CCR format on the lower right is more open less cluttered, and provides better sight lines to help locate products, also posted a short video on YouTube showing a store’s CCR transformation. You can find that video by clicking the link to it on the homepage of our investor relations website after our presentation. It’s too early to extrapolate any results but these 35 stores are performing ahead of plan on all metrics, so we are encouraged that achieving all four wins is possible. Each of these 35 stores was converted in about a week and with minimal disruption to sales. Our plan is to roll CCR out to about 400 stores this fall. And after a break for the holidays, we plan a nationwide rollout through calendar 2010.

Besides the 35 store pilot program, we’ve completed, optimized assortment resets for 36 of our first 40 product categories nationwide. Through that optimization process, about 4,500 SKUs were eliminated for about 18% of our total. That’s one of the contributing factors to this quarter’s tight inventory control. Please note we are not reducing SKUs for reduction’s sake. We are developing a preferred assortment that our shoppers are telling us they want. Meanwhile, gross profit dollars increased 6.6% on an adjusted basis. We’re encouraged that gross profit dollar growth has stabilized over the past two quarters. We continue to focus on cost reductions and productivity gains around our business. One way we are 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.