Walgreen Company Earnings Call Insights: FIFO Gross Margin and Investments

Walgreen Company (NYSE:WAG) recently reported its fourth quarter earnings and discussed the following topics in its earnings conference call.

FIFO Gross Margin

Edward Kelly – Credit Suisse: Could we start with the gross margin? I am a little confused on the FIFO gross margin down 20 basis points, pharmacy up, front-end down slightly, but I guess I don’t really understand how the front-end margin maybe is not down more or pharmacy not down given the total Company down 20 basis points? Because front-end just not – is only 35% of sales or so, right, and its only down slightly. If you could maybe just help us reconcile exactly what’s going on there?

Gregory D. Wasson – President and CEO: Yes. I will start and maybe Rick or Wade can give some actual dollars. But as far as, as we said directionally pharmacy was up obviously with the help of the generics that we had for this past quarter, offset obviously by ongoing reimbursement pressure but also with our 90-day drive that we have. One of the focuses we have is to continue to give customers what they are looking for and as for chronic medications and 90-day (colonies of) retail. So that’s an impact that’s working the other direction certainly in pharmacy but we think it’s the right thing to do long term. So is the front-end, as we have said, we think we are making good intelligent investments in price and promotion. I feel like we are getting steady momentum back into the front-end of the business and we are continuing to make sure that we do that going forward. But as we have said we were going to – we always plan to make some investment in the front-end, that’s exactly what we are doing.

Edward Kelly – Credit Suisse: Are you happy with the comparable gross profit dollar growth in the front-end, how does that look and how has that changed as you started investing into promotions?

Wade D. Miquelon – CFO: Yes. I think we had solid gross profit dollar increase and then when you compare to the SG&A dollar growth and we have said all along there, goal is to have 100 basis point spread between the two, over the long haul and I think with the performance that we have turned in this quarter we are pleased with the way both of those worked in unison…

Gregory D. Wasson – President and CEO: Yes. Just to kind of restate, I really think that, we really look at it from a gross profit dollar basis as you know and I think we’re really finding it a good balance with – seeing good momentum we have in growth right now with also managing the margin wisely, so.

Edward Kelly – Credit Suisse: Wade, you gave some color on 2014, which has definitely helped, but I just had a couple of follow-ups on that. Given the fact that you have some tougher comparisons next year with the flu early on less of a generic benefit, does gross profit dollar growth slow from here over the next few quarters?

Wade D. Miquelon – CFO: Well, we don’t give obviously specifics on that kind of detail, but I think that fundamentally we feel very good about our business going forward. I think we just want to provide some color that quarter-to-quarter, there can be somewhat some up, some down, but in aggregate, we feel good about how we drive gross profit dollars and to manage SG&A as well.

Edward Kelly – Credit Suisse: On the SG&A side, you’ve done a lot of good stuff from a cost control perspective. How much of that do you think you can carry forward into 2014, is there still opportunity there?

Wade D. Miquelon – CFO: Well, I think, we can always be better every day forever and that’s one of the things we’re working hard at, is to really put continuous improvement and continuous focus on driving efficiencies and effectiveness in every aspect of our business. So, I’d say, yes.

Edward Kelly – Credit Suisse: Alliance Boots equity income, first quarter you didn’t have it, seasonally how does that business look in the first quarter?

Wade D. Miquelon – CFO: The first quarter is by far the toughest quarter of the year seasonally. So, it’s again – we guided it to roughly $0.05 accretion for the first quarter. It’s summer period, not holiday period, so both in the wholesale and the retail business, it’s a low seasonal point.

Edward Kelly – Credit Suisse: Then just one last question for you all sort of modeling rate but there has been a lot of talk sort of like I think amongst investors about what the real tax rate is that we should be using on the synergies? Any color there?

Wade D. Miquelon – CFO: I guess, what I’d say is we’ll do some work to try to figure out how we can provide more clarity in guidance as we go forward. I mean obviously, the rate that I gave today looking forward was kind of the Walgreens stand-alone rate. Alliance Boots has a different rate, so we have to use a blend for that and then of course you know the work we’re doing together in synergies and other things is a bit more complex, but we’ll do some work to see how we can provide better understanding as we move ahead.

Investments

Meredith Adler – Barclays Capital: I was wondering, as long as we were talking a little bit about the investments you are making in the front-end comp, are you making the investments that you expected to make and are you getting the response that you expected to get? Can you talk a little bit about how you think that plays out in full year ’14? You only started this I think in May, this increased promotion, so do you think it will last till May of ’14 or do you think that it’s something you will be doing for longer until the frequent shopper program really gets huge traction?

Gregory D. Wasson – President and CEO: Meredith, I feel good about the investments we have made and are making. And as I said, that’s a balance between the right amount of investments and to drive the right amount of performance, but I think the team has done a very good job in being surgical, using the data that we’re getting from a Balance Rewards program to help us understand how to strengthen the Sunday circular as well begin to use individual programs through Balance Rewards to drive traffic in basket. So, I think I would say, yes, that we are seeing the expectations that we had with the investment we made. Going forward, I think we will continue to try to drive improved performance, and I think what we feel good about that we’re going to be able to have that are – to be able to use will be the increasing information we get the Balance Rewards and the data that we have on the program. Not only to make even better decisions on what we promote and at what pricing, but also more and more individual marketing programs through the Balance Rewards program itself. As I said, the other thing that’s needed is for Alex here, now is working with our team would be able to begin to bring some of the best practices from their program into our Balance Rewards program. So, I think it would be – I think it’s going to be, as I have said before, like a locomotive. This isn’t a jet aircraft. We’re going to continue to just gain steam and try to continue to gain momentum and feel confident about it.

Meredith Adler – Barclays Capital: Then I have a much more technical question maybe for Wade, and maybe you’ve answered this in the slides, although I went through those slides quickly. You have other income and is that the warrants with the fair market value of the warrants and there is a number in one of your schedules at the end of the press release that has $62 million as opposed to whatever $43 million, $44 million for the other income. I don’t understand what the difference is.

Wade D. Miquelon – CFO: That is the fair market value of the warrants.

Meredith Adler – Barclays Capital: Why is it a different number than what you had in that schedule?

Wade D. Miquelon – CFO: That’s an AB share as well. That’s the difference. We call the warrants a split. I mean, effectively Walgreens has 50% of those warrants and AB effectively has 50% of those warrants.

Meredith Adler – Barclays Capital: Could you just explain how that shows up in the numbers here? Is that because it goes into your share of AB?

Wade D. Miquelon – CFO: Yeah, we can work it offline, but that’s effectively right. So, these have basically been – for the purpose of adjusted earnings they have been net redacted out.

Meredith Adler – Barclays Capital: Then I guess I just have one more question about the gross margin. Trying it, could you talk again – I know Greg you talked about sort of the expectation for generics next year, but are we saying that most of the benefit of generics for next year comes really towards the tail end of fiscal ’14?

Wade D. Miquelon – CFO: That’s right.

Gregory D. Wasson – President and CEO: Yeah, it is, Meredith. In fact, if you think – the graph that we showed, showed the volume, certainly last year it shows what we’re up against. But then as far as first and second quarter, they’re light quarters and in the second half, we’ll see a lift again. But we’re also against an easier compare in the back half, but we’re up against a tougher compare in the first half…

Meredith Adler – Barclays Capital: Then sorry, one more question about SG&A. You have done a pretty good job of managing expenses. Could you just talk about whether there is any one initiative or a group of initiatives that you would point to that have been helpful in slowing the growth of SG&A?

Wade D. Miquelon – CFO: I think our folks in the field Mark Wagner and Kermit and team have done a tremendous job in really making sure that they are – ensuring that our SG&A and our labor in the stores and our expense match the volume as we bring it back. I think our store people have done a tremendous job in becoming more efficient. We’re really focused, Meredith, on trying to take more and more tasks out of the stores, so that we can free our folks that are in the stores up more to spend time with customers. So I would give probably 80%, 90% of the credit to our folks in the field. With that, for our folks and corporate, we have really this year, I think, done a tremendous job in getting focused on the key projects and initiatives that will move the needle for us going forward in a big way and stop doing a lot of things that will not. Combine those and I think we feel very good with the focus we have and the ongoing focus we will keep.

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