沃博聯公司 (WBA) 2008 Q3 法說會逐字稿

Good day, everyone.

Welcome to the Walgreen Company third quarter 2008 earnings conference call.

As a reminder, today's call is being recorded.

And now I'd like to turn the call over to Mr.

Rick Hans, Director and Vice President of Investor Relations and Finance.

Please go ahead.

Thank you, Nikki, and good morning, everyone.

Welcome to our third quarter conference call.

We'll start today's call with Jeff Rein, our Chairman and CEO, discussing the quarter's results.

We'll then introduce Wade Miquelon, Senior Vice President and Chief Financial Officer, who just joined us last week.

Bill Rudolphsen, who has moved from the CFO to the new position of Senior Vice President and Chief Risk Officer, will provide additional details on the third quarter financial results.

And Greg Wasson, our President, will give an overview of our growth strategies.

Following that, Jeff will give a brief summary, and then be ready to take your questions.

For the Q & A, we will also be joined by John Spina, our Vice President and Treasurer.

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.

I'd like to point out that today's call is being simulcast on our Investor Relations website, located at Investor.Walgreen's.com.

After the call, this presentation will be archived on our website for 12 months.

Before we get started I'll read our Safe Harbor language.

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 Form 10-K for the fiscal year ended August 31, 2007, for a discussion of factors as they relate to forward-looking statements.

Now here is Jeff Rein.

Thank you, Rick and good morning, everyone.

Today we report a solid third quarter performance in a challenging economy.

We continue to successfully execute our strategies for growth while effectively managing costs.

We reported record quarterly sales of $15 billion, an increase of 9.6%, despite the impact of tight consumer spending.

We had a tough comparison to a net earnings increase of nearly 20% in last year's third quarter, which was aided by blockbuster generic drug introductions.

This year's net earnings grew 2% to $572 million.

That amounts to $0.58 per share, up 3.6% from last year's $0.56 per share.

One of the sales components that stood out in the quarter was our strong front end comparable store sales, which increased 4.6%.

Competitors simply can't match our convenient locations.

They'rethe best in the business with 144 million Americans living within two miles of a Walgreen's.

Combined convenience with more promotional activity and we are positioned very well to win in today's environment, both the number of customers in our stores and the average dollars per transaction increased this quarter.

On the pharmacy side, the number of prescriptions we filled in comparable stores in the quarter increased 1.1% over a year ago, compared to industry wide decrease excluding Walgreen's of 0.9%.

Industry-wide prescriptions continue to be impacted by a number of factors, according to IMS Health, including the switch of Zyrtec from prescription to over-the-counter status, fewer new drug introductions, safety concerns over newer medications, and the weaker economy.

Despite these near term challenges, nothing will slow the impact of nearly 80 million baby boomers moving into their peak prescription use years.

This is a very good business to be in for the long term.

That's why our growth will increase approximately 9% this year, and to attract more patients to our pharmacy services, we're offering our prescription savings club to the public.

The club goes well beyond generic discount programs by offering savings on more than 5,000 brand name and generic medications.

Greg Wasson will talk about this a little later.

We opened 138 new drug stores in the third quarter, 17 more than the year ago period.

So far, in fiscal 2008, we've opened a record 420 drug stores compared to 339 a year ago.

That resulted in a net gain of 370 drug stores after relocations and closings.

Even with all those openings in the third quarter, and investments in our Take Care Health Clinics, selling, general and administrative expense dollars increased only 10% over the year ago quarter.

To put that in perspective, it is only the second time since the fourth quarter of 1995 that SG&A expense dollars have been held to an increase of 10% or less.

We decreased the rate of store salary and expense growth and lowered advertising expenses.

At the same time, our pharmacy service remained high, as store level pharmacy satisfaction levels improved each month during the quarter.

As a percent to sales, SG&A expenses at 22.1% were essentially the same as last year.

Throughout this fiscal year, we've proven our ability to hold the line on expenses, SG&A expense dollars are up only 10.3% through the first nine months of fiscal 2008.

With that overview, I'd now like to welcome Wade Miquelon as our new CFO.

Wade officially joined us a week ago and is quickly getting up to speed with our people and the business.

Wade comes to us from Tyson Foods where he was Executive Vice President and CFO.

His excellent financial, strategic and operational experience at companies like Proctor and Gamble will be a great benefit to us.

As the financial community gets to know him, I'm sure you'll see why we're so impressed with his strategic thinking and communication skills.

In our press release announcing Wade's hiring, you saw that Bill Rudolphsen is moving from CFO to lead our Risk Management area as our Chief Risk Officer.

This new role is critical to Walgreen's given our size, and growing complexity of our business and the highly regulated industry in which we operate.

Earlier this month, we also announced the appointment of Sona Chala to the new position of Senior Vice President of eCommerce.

Sona will join us on July 1 from Dell, where she was Vice President of Global Online Business.

Her hiring represents the significant committment we're making to take our online marketing and sales to a higher level.

Even with the hiring of Wade and Sona, we continue to be primarily a promote from within company, but as the industry and environment in which we compete change, we will look outside for unique abilities that compliment the expertise we develop in-house.

And now, Wade, would you like to say a few words, please?

Thanks, Jeff and good morning everyone.

It's a pleasure to be able to join in on my first Walgreen's call today.

While I've only been on the job a few days and have an immense amount to learn, I can honestly say I'm very impressed with everyone I've met and am extremely excited about all of the opportunities that lay ahead of our Company.

Bill and his team are doing an excellent job of helping me to on board and I look forward to meeting and spending time with our shareholders and the financial community in the future.

I also look forward to partnering with Bill and his team as he takes on the new and critically important role of Chief Risk Officer, and with that I'll turn it over to Bill to review the financials in more detail.

Thank you, Wade.

Looking closer at our sales, total sales in comparable stores were up 3.4% in the quarter.

Prescription sales, which represented 65.5% of total sales, rose 8.9% for the quarter and 2.7% on a comparable store basis.

Total gross profit in the quarter was $4.2 billion, a 9.3% increase, compared to a 16% increase the prior year.

Gross profit margins in the quarter decreased 0.1 of one percentage point to 28.2.

The growth rates this quarter for gross margin dollars and overall profits were impacted by tough comparisons to an unusually strong period a year ago.

That's when we were aided by the introductions of blockbuster generic versions of name brand drugs Zocor and Zoloft.

Front end margins decreased because of more promotional activities, many in the digital photo category.

We also saw the sales mix shift to lower margin items.

We also lowered our LIFO rate this quarter by 25 basis points compared to a 50 basis point reduction in the year ago quarter.

That resulted in a LIFO provision of $16.1 million in this year's quarter versus a LIFO credit of $3.5 million last year.

In the pharmacy, margins increased with a growth in generic drug sales.

The effective tax rate was 37.3% compared to our rate of 35.2% in the year ago period.

Last year's quarter included a $13.5 million credit from the resolution of a multi-year state tax matter.

We anticipate a tax rate of 37.1% for the fiscal year.

Accounts receivable were up 19.5% in the quarter, driven primarily by the Option Care, Specialty Pharmacy and Home Infusion business we acquired last August.

The remainder of the increase resulted from the normal increase in third party sales.

Inventories in the third quarter climbed 9.4%, less than our 9.6% sales gain.

Total short-term debt stood at $1.1 billion at the end of the third quarter.

We will continue managing our balance sheet for maximum financial flexibility and to support our core growth strategy.

Cash flow from operations totaled $2.5 billion for the year-to-date, and now I'd like to turn the call over to our President, Greg Wasson, for an update on growth initiatives.

Thank you, Bill, and good morning, everyone.

First, I'd like to congratulation our employees across the Company for their sales efforts and expense management this quarter.

We received suggestions from nearly every department in every location and we found opportunities to reduce costs throughout the Company.

In particular, our store operations folks proved why they are the best.

They controlled costs and they took care of our customers.

Thank you.

Over the last several months, the competitive environment has clearly changed as the economy has slowed and $4 a gallon gas impacts customers.

The same time, discount retailers and grocery chains are picking up their pace of promotional pricing, especially in the pharmacy, which they're using to build traffic.

Our advantages are that in addition to being price competitive, we're better positioned with more convenient locations and enjoy a powerful brand reputation.

I'd like to put it this way.

While many of our competitors have a pharmacy department, Walgreen's is a pharmacy.

Patients, employers, and manage care groups look to us to be their low cost pharmacy provider.

And we're at the leading edge of healthcare cost management in retail pharmacy and beyond.

Our Specialty Pharmacy and home care business, independent of a major PBM, is attracting more and more interest throughout the industry.

We now have about 550 combined work site health centers and retail clinics to provide accessible, low cost healthcare.

In this time of soaring medical costs, we're helping Americans meet basic healthcare needs.

We're seeing strong momentum in the push toward electronic prescribing, which improves patient compliance and enhances safety.

We've been a strong advocate of this technology for more than 16 years, and during this calendar year, we expect to fill 15 million electronic prescriptions, more than double 2007.

As Jeff mentioned earlier, we're also expanding our prescription savings club, a cost savings solution for many people who need help paying for prescriptions.

The club provides discounts on not just a select list of generics, but also an additional 5,000 brand and generic medications.

Plus, members can get a 90 day supply of more than 400 generics for $12.99, and they also get a 10% rebate on the purchase of Walgreen brand products.

Though the most important aspects of our prescription savings club is that it encourages patients to have all of their prescriptions filled at Walgreen's.

Not only is that good for us but allows our pharmacists to screen completely for dangerous drug interactions.

Many patients don't realize that pharmacies can't access their prescription records at a different retailer.

They don't know the danger of going to generic at one retail pharmacy, an antibiotic at another, and a brand name drug at a third.

Our savings club is a great new product that's being well received by many patients, saving them money and we're very encouraged by patient reaction to it.

Meanwhile, our focus on expanding pharmacy services that are complementary to our retail pharmacies continues.

The suite of services allows us to work with payors on a broad solution to lower cost.

Our Specialty Pharmacy business, which is greatly expanded with last year's acquisition of Option Care, is well positioned to deliver the growing number of specialty medications approved the FDA and used by patients today.

And, of the new products awaiting FDA approval in 2008, 80% are specialty drugs according to IMS Health.

As you can see by this slide, the Prime Therapeutics contract for specialty drugs announced earlier this year has basically doubled our access to Blue Cross and Blue Shield plans nationwide.

We strongly believe that our independence from the major PBMs was a significant factor in winning this business, and our independence will help us consistently win contracts over the long term.

Clients are telling us they prefer to be aligned with a Company that isn't involved in services with which they may be competing in the future.

Many specialty drugs are infused or injected rather than taken orally.

That means more demand for home infusion services.

We took another step toward growing that business this month when we announced our acquisition of CuraScript Infusion pharmacy from Express Scripts.

The transaction will further expand our national coverage in home infusion services and give us close to 100 home infusion locations in more than 30 states.

This quarter, we also formed our Walgreen's Health and Wellness division, to incorporate the acquisition of I-Trax and Whole Health Management, operators of work site health centers.

We're on track with a solid plan that aggressively integrates these businesses.

I-Trax and Whole Health were the top providers in their industry wand we combine with the best people to create a powerful management team.

Together with our Take Care Health Clinics, we can offer large company, employees, healthcare and dependents access to health centers and pharmacies at their work site and at our drug stores, and we're already hearing a great deal of interest from clients for these services.

We currently have about 550 retail clinics and work site centers under our Health and Wellness division and we're ramping up that growth.

We also continue our expansion of pharmacies in hospitals and other Medical Centers to serve outpatient prescription needs.

By extending our definition of main and main locations to prestigious health systems, we're creating great value for the hospitals, patients and Walgreen's.

In closing, in the past 18 months we've acquired and assembled a terrific set of assets, including Specialty Pharmacy, home infusion and home care facilities, work site health centers, retail health clinics and pharmacies on location at major medical campuses.

The real value will come as we collect the dots for a complete low cost pharmacy and healthcare solution for payors.

This gives us a closer relationship with employers and health plans making us a more valuable healthcare provider.

Now I'll turn the call back to Jeff.

Thanks, Greg.

Not only are the adjacent pharmacy and healthcare services Greg just outlined an important part of our future growth, it will also center around our retail drug store business, which is proving its worth to American consumers during this tough economic period.

Above all, we're a drug store, and we're proud of the success we're showing, especially in our front end businesses as consumers turn to us for value and shopping that's close to home.

Very few retailers can match our strong front end comparable store sales.

At the same time, our comparable strong prescriptions are still outpacing the industry.

The opportunity for growing our business is as strong as ever, especially with the impact of the baby boom generation looming on the healthcare industry.

Our growth strategy entails first broadening our customer access through an expanding store base, second, leveraging the best retail corners in America to improve their productivity, and third, expanding our platform of adjacent healthcare services to be the provider of choice.

To insure the financial community has the complete picture of our value and growth strategies, and how they enhance shareholder value, we intend to hold an investors day conference later this year.

We'll keep you up-to-date on the event as the details are arranged.

I look forward to many of you joining us for the day when you'll have a chance to get better acquainted with our Senior Management Team.

Thank you.

Folks, that concludes our prepared remarks.

We're now ready for your questions.

Nikki, may I have our first question?

Thank you.

Today's question and answer session will be conducted electronically.

[OPERATOR INSTRUCTIONS].

We'll take our first question from Meredith Adler from Lehman Brothers.

Please go ahead.

Good morning, guys.

A couple quick questions.

I'd like to start by asking a question about the Infusion business you've got.

You obviously have the capability to do infusion either at locations or at people's homes.

Does your infusion business also give you exclusive rights to distribute or infuse those particular drugs or will you work with the drugs that are controlled by anybody?

A little of both.

This is Greg, Meredith, I'm sorry.

Our goal is to be able to offer services that will work to support any pharma company's drug, infused drug, so we're looking, we have access to just about all infusion products, looking to gain access to those that we don't, but it's not a restricted drug program, if that's what we're asking

Oh, well just in terms of the exclusive control, my second question is about kind of the connection between the Take Care facilities and I-Trax/Whole Health, the work site health facilities.

Do you anticipate that you will be able to provide the same kinds of services and range of services at the Take Care facilities that you offer on the work site facilities or will there be a difference in the offering?

Greg here again, this is a good question.

I think there will be a different portfolio of services.

I think the work site centers can provide everything from a range of physical therapy to acute care to primary care, worker's comp programs and so fourth.

I think the real value is connecting the dots for the employer for the members and employees that are able to use those services at the work site with our retail health clinics and retail pharmacies in the community which gives them a more complete network of care, so the Take Care healthcare clinics within the retail stores will probably be more acute, more HR type wellness programs.

We just recently launched Soft Backs to all of our Take Care clinics nationwide, so I think there will be probably more intense and more disease management focus in the centers and then combined with acute care wellness programs and retail stores.

Meredith this is Jeff.

One more thing to keep in mind also between the on site clinics and the Take Care clinics is that we'll also be able to take care of retirees and dependents because when you're dealing with the employer on site, you only have the employee.

This gets them very familiar with the Walgreen's name and gets them into our system and we'll be able to serve their whole family, once again the dependents and retirees.

We think the two will tie together very, very well, so wherever they need care, whether it's at home or work, we will be there and that's the main intent of trying to integrate all of these together.

I have one follow-up question with that is about technology.

To really make this effective, do you think you need to make significant investments in technology?

It's clear that there's probably a demand on the part of employers to have a repository of all kinds of healthcare information about their employees.

Is that something you anticipate being involved in?

Absolutely.

We're involved in that right now.

We're integrating all of them.

As you know we're working with outside companies, it could be Google for example, it could be Microsoft, so there's a demand that's filling an evolving business.

There will be some money and resources that we will put into technology to make it happen, but one of the most important points that we can do is to make sure there's one face for Walgreen's, and that the patient is able to integrate it across all the different companies, so basically what they see is one Company, and we take care of them no matter where they are.

Meredith this is Greg.

If I might add that's one of the reasons all three of these companies, Whole Health, I-Trax and Take Care really appealed to us is all three of them have state-of-the-art systems, Take Care has a great EMR, Whole Health and I-Trax have great operating systems which will help us leverage that technology.

Thank you very much.

Our next question comes from Eric Bosshard with Cleveland Research.

Please go ahead.

Good morning.

Good morning, Eric.

Two questions.

The progress on SG&A at the store level, it looks like SG&A per store is actually now running flat year-over-year and you commented the sort of historic or low level of SG&A growth.

Can you just talk a little bit more specifically about what's going on there that's different than what we've seen in prior years when that number was growing more like 15%?

Sure.

About 60% of the relative savings this time was from the payroll at store level.

There was some mixture in there of expenses and advertising control.

What we're really doing is making sure that we targeted our sales and targeted our budget on a weekly basis.

I think what happened before is that the payroll got away with us because we did not really follow our budgets.

If you get budgeted sales and of course you get budgeted hours.

If you're above sales you get more hours and conversely if you're down in sales then you get less hours.

So we've taken a more proactive approach.

We've gotten more Operations, Vice Presidents, District Managers and Store Managers to pay attention to what is going on in their stores on a weekly basis.

So once again it all comes down to discipline and focus, that's a big difference from before.

Also as Greg mentioned, we're getting more suggestions of how to really watch out for what we call duplication in terms of expenses.

Are we doing things that we really need to do, or just things we just want to do.

Big difference there, so we're really focusing on what we need to do.

We're focusing on investing the business where it makes sense for the long term and being very very careful on spending these expense dollars, keeping in mind we're only a $0.03 company, $0.03 net to sales.

You have to be very careful and very aware of that.

On a go forward basis I think you previously talked about SG&A growing 11 to 12%.

Is that what you think is the number or is it now 10%?

So what's the number and how long is that sustainable?

Yeah, we've put out there the 11 to 12%.

Of course part of it is related to the net store growth of course.

This year, we're going to be up a little over 9% so holding down those expense dollars artificially would not be wise to do because we don't want to hurt service levels.

We certainly don't want to hurt going after new businesses.

You know about all of the acquisitions we've done.

Not only in the business itself but obviously expertise and different people, so our goal right now is still out there at 11 to 12%.

We want to be smart about it, but we are absolutely focused on making sure we manage it properly, and if we need to be under the 11 to 12% we certainly will.

A lot of it is tied into the gross profit dollar increase and you have seen that chart over time where it's pretty well matched up, where the gross profit dollars are decreasing, we will absolutely decrease those gross profit expenses.

I guess within this, do you feel like you've got visibility into the service levels at the store to know that you're not cutting too much?

Absolutely.

Boy that is something we're really focused on.

We have what we call KPI, key performance indicators, we have the mystery shop, where we have an outside company shopping our Company, to give us feedback.

They talk to the employees, or they don't even identify themselves and make notes of what's going on, plus we use the receipt survey, where after a customer purchases something, there's an inducement, if you seen on the receipt, to actually have them call in or use the internet to give us feedback on how we're doing, and we know exactly what store that that is being measured against, so yes, we're extremely, extremely aware of what's going on.

Plus the other thing that we've done, really stepped up, is in terms of night checks and making sure supervision is in the field.

We absolutely have to do that.

Eric this is Greg.

Every morning at 6:00 a.m.

I can come in at my finger tips and read sales, read payroll and read customer satisfaction, so we have visibility.

Okay.

And then secondly, the comment made about the front end promotional environment, could you just characterize, I know the front end is always competitive, but you mentioned grocery and mass.

Can you just talk a little more about how competitive that front end promotional environment is and is getting, and sort of, is this as bad as it gets or does it get worse from here?

Well what we're seeing is that people are absolutely shopping for a value.

And with Walgreen's convenience, and our promotional pricing, we do get that value.

We are seeing a trending up of ad sales, so items that we run on promotion, or what we call mega savers, in store promotions, we are seeing an uptick in those particular sales.

People are a little bit more price-conscious.

They definitely are trading down.

However, that does help us when they trade down for the private label products, as you know, our private label products are just as good, if not better than the brand products so we give people a value, they shop us, it's working out very well.

I can't say if this is absolutely the worst.

I don't know that.

Hard to predict but I can tell you based on our convenience, being close to home, close to work, and people only thinking of 1.6 items coming into Walgreen's, they absolutely are using us more and more.

Great.

Thank you.

You're welcome.

Our next question comes from Mark Miller with William Blair.

Please go ahead.

Hi, good morning.

Can you talk about what has changed in the environment that has the Company exceeding its goal for store openings this year?

There's some thought that slowing down perhaps you could get better real estate terms and how are you thinking about balancing this pursuit of long term growth with nearer term performance, and then final part of this question is, how do you think about ROI on new stores versus buying back your own stock as an investment?

Sure.

On the first part of your question, as you know Mark, many of these sites were approved 24 to 36 months ago.

Typically takes anywhere from the time it's approved in real estate to the time it opens is about 24 to 30 months and there are some outliers of course that can take longer.

So in terms of what's going to open next year, the 9%, sometimes the authorities work with you, sometimes they work against you and in this particular case, many of the sites that we're opening actually went through the entitlement process a little bit quicker than we anticipated.

Going forward, it is is interesting that we are seeing some, we do see some weakening in terms of the occupancy coss, so where there's been a lot of emphasis on the home market we are seeing some emphasis now on the commercial market, where those prices are decreasing which is a really welcome sign.

In terms of construction, that has been going up for concrete and steel and so on, but we also have come up with different designs with our stores to take out costs out of the store, which actually works real well.

The percentage increase this year will be over 9%, but that was really not by design once again.

In future years, you will see that percentage going down.

We've always said organic growth to be around 8%, sometimes it's higher, sometimes it's lower, and you can track that over the years of course.

Going forward, I do see that percentage edging down though, because this is about as many stores as we're going to open a year this year and next, to be about our maximum absolute number of stores in any one year.

In terms of the ROI and in looking at the stores, our maturest stores do make over 15%, and that's what we're looking for.

It is true in the first few years that ROI is less obviously, because they're new stores and they lose money, but over time a mature store, we absolutely look for over 15%.

Bill do you want to have a little comment please on buying back stock?

I do want to comment on that.

We have been able to generate a consistent return on investment over time, even growing our store base at 8% so it has definitely worked out for us, and just to echo Jeff's comments, a mature store over three years old will generate a 15% return on investment, so our best investment is to continue growing our Company at an 8% clip in store growth.

We are looking to maintain a debt-to-cap ratio in the 50% range and we want to maintain our credit rating.

We're still growing our store base rapidly.

We are able to get 75 year flat term rents based on our credit rating and that's how we're going to continue.

Mark also in terms of new store growth, keep in mind that we're in an industry that the pie is expanding.

Many industries are cutting back or shrinking.

We are expanding, particularly with the baby boomers getting older.

I think you're going to see a great explosion of folks taking drugs, whether it's Obama or McCain coming in, both of them have talked about increasing utilization of drugs and they want more access to drugs by people to help control total healthcare costs, so there's a lot of opportunity for us, most people choose a pharmacy based on location, when it's closest to home or closest to their office so we want to make sure that we're positioned very well in the future.

Thank you.

My other question is on the SG&A growth.

Could you help us disaggregate what is the change in the growth rate of comp store expenses, you talk about lower rate, kind of for store salary and expense growth, how much would be coming from new stores, I recognize it's not one for one, in other words these stores have a lower expense rate to begin with and then how much would be if you could tell us the year on year change for the Take Care clinics?

Thanks.

So you want to answer the expense?

Yeah, on a comp store basis Mark, we're looking at SG&A growth in the range of 4%.

And also Mark, on the Take Care clinics, we have put out there $75 million as a drag on earnings.

We're still tending to hold on to that right now.

Obviously we'll be able to measure more properly as we go along but right now I would still have 75 million in your model.

Okay, thanks.

Our next question comes from Lisa Gill with JPMorgan.

Please go ahead.

Thanks and good morning, it's actually Mike Minchak in for Lisa, just a couple questions.

First off, in terms of your healthcare offering and how you're marketing the various pieces have you assembled to the payer community I'm trying to understand whether you have separate sales teams in place for each of the various components or if you united them under all one common banner?

Sure, Greg, could you handle that, please?

Yeah, good question.

We have what we call our Managed Care sales team which is more of a general organization where they've had the relationships over the years with the Managed Care and PBM payors with the pharmacy directors and so fourth.

That group leveraging those relationships to bring in the specialists that lie within the individual business groups.

For example, Mike Namath, who used to be with WellPoint is running PBM and specialty.

He has a group of experts helping to sell our specialty business.

Paul Mestropa, who now leads Option Care and our home care division has a great group of sales folks that understand that business, Take Care, Hal Rosenbluth, so we have a general team where we bring in the specialists as we get the opportunities.

Great and then just a follow-up to that.

Now that healthcare does make up a larger portion of your business, following some of the recent acquisitions do you have any plans or requirements to increase the disclosure around that segment in particular?

Yes.

We will do that as soon as it hits our 5% mark.

Right now it's all under our Walgreen's Health Services.

Thanks for the comments.

Our next question comes from Ed Kelly with Credit Suisse.

Please go ahead.

Hi, good morning.

Hi, Ed.

Question for you on your digital photo promotional strategy.

Can you maybe talk about how much of the overall front end gross margin pressure is from lower digital photo prices and then are you pleased with the return you're getting on this investment and how do you measure that?

Yeah, Ed, on the photo we have lowered the prices as you remember.

We did that last October.

It is definitely a drag right now because we wanted to make sure we are competitive.

We do see the photo volume moving up, but once again on the margin itself as you know, it's extremely high margin business but it does hurt the margins.

However, I can tell you that once again, it does bring people in, competition lowered their prices so we obviously match that, but we have one of the top rated photo websites around.

Keep in mind that really helps us is in terms convenience, once again, you can upload your scripts from anywhere in the Company and pick it up at any other location in the Company, so if your daughter wants to upload scripts to you and pay for it, which would be nice of her to do, you can actually pick it up at a pharmacy near you or a location near you.

It's a very very viable business.

We obviously measure the ROI on each of the components.

One of the things in that department that we're doing is expanding other services so if you look at the DHL services, if you look at printer cartridge refills, those are all high volume, high margin businesses and Greg I know you've got really good training programs going on to make sure we really increase those sales, you want to mention that?

Yes.

I think, Ed, I think I'll go back to when we talk about our strategy in that second bucket as leverage in the box, that's exactly what this is doing, with our photo customers that we're bringing in are attracted to a lot of the many additional services we're looking to expand, the DHL and ink jet and so fourth.

We're going to have a little over half of our employees trained this coming month on DHL, as we roll DHL out to all stores by the end of the year.

We've got some very good training programs now that drive incentives and opportunities for our photo folks to grow sales and earn commission so we're really excited about this area.

At some point here and I guess it's probably October or November that you'll start to cycle this.

Yes, right.

What I'm trying to figure out is how much pressure it's creating on the gross margin now.

It seems like it could be more than half of the decline in the gross margin.

Is that fair?

Bill?

Ed, it's less than that, but there is an impact on the margin and it's true that we would be cycling this in October and we are definitely seeing some softness due to less travel out there, and more promotional activity but it is less than half of the impact on the front end margin, I can say that.

Okay, that helps.

And then just one last question.

I just want to understand the questions earlier and your answers on expense control.

If we continue to see sales kind of at current levels and let's fast forward to next year, it sounds like you have the ability to grow SG&A less than the 11 to 12% in that type of situation.

Is is that what you were trying to imply earlier?

Yes, that is very true, yes.

It's not just an implication but it's something we are focused on doing absolutely.

We really watch the gross profit.

We are really focused on do we need the expense, do we have to have the expense?

Is it best to spend that money for the benefit of the Company so yes, the bottom line question and answer is yes.

Okay.

And just with the inflationary environment we have today, the fuel obviously that you've got the issue of price inflation as well and your cost of goods, does it make it more difficult to do what you're just talking about?

Only in the sense that you're looking at probably payroll, electricity and things of that nature, but in terms of cost of goods as you know, we would pass that along, because like other retailers are doing, we're very very competitive, we make sure we shop the competition, but if there's price increases and inflation coming down the pike, which I believe there will be, then we will pass those on to consumers.

Okay, great.

Thank you.

Our next question comes from Deborah Weinswig with Citi.

Please go ahead.

Good morning.

Can you talk and Wade, welcome very is much to the Walgreen's organization.

We look forward to working with you.

Thank you, Deborah.

And Jeff, in terms of the Take Care clinics, obviously there's a lot of competition out there right now.

Can you remind us what the competitive edge really is for Walgreen's and how you see that developing going forward as well?

The competitive edge for Walgreen's is we're very focused on having a quality experience in our Take Care clinic.

If you look at our clinics versus the others we've been rated one of the top ranked ones around.

That's because we have two exam looms, we have a table, we have hot water, we also have strict protocols for the nurse practitioner, and they're based back near the pharmacy, so if you look at the environment and the feedback that we've had from physicians, customers, patients and nurse practitioners, we have one of the highest quality experiences in all of retail.

Once again, based on our convenience and our attracting of quality people and being accessible to people, whether it's the nights, the weekends, I believe it differentiates us from the competition.

If you look at some of the competition are actually going back and redesigning, reformatting their clinics to bring them up to the standards that we have, we also have certain clinics within the industry that are owned by other folks, not Take Care, but that are actually going out of business.

They're pulling up shop because they cannot match the expertise and the quality we are offering our patients.

Great.

Thank you and then can you also elaborate a little bit on the Walgreen's prescription savings club?

How are you making sure that your customers in store are aware of the club and then also how are you reaching out to those customers who maybe aren't yet in your store network?

That's a very good question and Greg has been intimately involved in that.

Greg why don't you talk about that.

Yeah, Deborah, as far as in store that's where we're really accelerating right now.

We obviously have in store signage.

Our folks who know how to execute are talking to folks and explaining the value of the card so I think we've done very well with the in store segment.

As far as the external, we're launching a major campaign as we speak.

We absolutely do think we have a great product.

We want to get it out there.

We want the doctors to know of the card.

We think there's great value for them to be able to talk to patients who are struggling with prescription costs, to let them know about it.

So we really are looking forward to ramping up our Marketing efforts externally.

One interesting fact is that only 7.5% of the people that come into Walgreen's actually go back and get a prescription so there's a great, great opportunity to make sure people know about the prescription savings club card on the front end.

People who never make it back to the pharmacy that didn't even realize the savings that are involved, and I'm telling you this, 400 generics for $12.99 for a 90 day supply is a great value.

It's a little over $4 a month of course, and you talk about convenience that really plays into convenience and access and savings very very well.

And the potential as you know is it's huge, it's 47 million uninsured out there, there's many more millions that are under insured, we think we've got a great product to help them control their prescription costs.

And it also seems from looking on the website there's also coupons you'll be giving to customers even just for them inquiring about the club, so there is definite kind of aggressive marketing strategy behind this?

There is.

We're using the internet more and more.

We did find out for example, during Medicare Part D that was very very effective for us to give people coupons just for coming back to the pharmacy and talking to our pharmacists and staff about the savings they can do, and the services that we do have so you're right.

The on site works very very well.

The

Great.

Well congratulations and best of luck.

Thank you.

Our next question comes from John Heinbockel with Goldman Sachs.

Please go ahead.

Just a couple of things, Jeff.

Talked about the current, you mentioned competitive environment but you would think in light of pharmacy sales and this lull in generic activity there would be more competitive fall out, independents and small regional chains, and maybe supermarkets than we've seen.

Yeah.

Are we seeing that, are we going to see that?

Where is the market share opportunity for you there?

Well John you're darn right on that.

We're seeing fall out left and right.

It's interesting when Medicare Part D first started, a lot of the independents were on the fence so to speak, should they get out of the business or not and now they are definitely getting out of the business.

I also see smaller regional chains for example, that can't have the resources or don't have the resources to put into technology, updating their format and things of that nature so there's a great great opportunity and that comes back a little bit to our store growth.

That's why it's very dynamic and as people fall down and fall apart and are no longer with us and I can assure you they will be, that's where we will be to have a site in the trading area that will take care of people so you're exactly right.

The opportunities for us in the next three to five years, because of the fall out of people going out of business, is just tremendous for Walgreen's and we're going to take advantage of it

Is there enough market share opportunity to get you back to your long term profit growth rate in the interim here, or does that require a better economy and a better group of generic drugs coming on the market?

Well, I think this is a lull right now in prescriptions in general.

As you know, the prescription usage is down for various reasons, part of it is the economy of course.

Part of it in our numbers is Zyrtec by the way, that was a 70 basis point drag on the quarter.

Part of it is a scare of what Pharmaceuticals do.

For example, the Heparin, Vitorin, safety issues, people are a little bit more scared, but I do believe that IMS is saying that there's going to be a 4 to 6% increase over the next 3 to 5 years, and I think you will see once again our growth being spurred on by whichever administration is in power, both Obama and McCain have come out very strongly in saying drugs do help control healthcare costs and we want better access for the American public to these prescriptions.

That is going to happen.

It's absolutely going to happen so once again, this is a lull.

I do see us getting back to our normal growth rates and we're going to be well positioned to take advantage of it.

Finally what's going on with discussions with other PBMs with regard to the joint venture working together, to bring new programs to the market?

Is that fertile at this point or not going anywhere?

We are definitely talking to the other PBMs.

As you know, CVS/Care Mark manages about 15% of the prescriptions at Walgreen's.

That leaves 85% of the prescriptions managed by somebody else and we are definitely definitely talking with those folks.

Greg you had a few comments you wanted to add-on that?

Jeff, I'd echo just that.

I think we had several of the payors, PBMs out there that do not own mail or specialty that we work very closely.

We're expanding those relationships and we're also working with the Managed Care plans that are out there, as Jeff said, Prime is a great example of our special relationship, we're looking to work even closer with them, certainly as the remaining large PBMs have been more interested talking to this as we talked about in the past, since the merger, so we're really working closely.

We're really targeted on the blues as you you know and as Jeff said, the premise to our strategy is is that we absolutely believe that a large vertical integration between a PBM and a retailer creates competitive conflict between the rest of the payer community and their 85% of the lives out there being managed by many payors that we want to work with more closely.

Okay, thanks.

Our next question comes from Neil Currie with UBS.

Please go ahead.

Good morning and thank you for taking the question.

I just wanted to dig down a little bit more on new store productivity.

You talked about the 15% ROI on maturity but at any one-time you have a lot of your stores which are less than three years old and just looking at your pharmacy, volumes and same-stores, a lot of the stores that contribute to same-store volumes are the ones between 2, 3, 4 years old and it does seem that the gap between your sales and the rest of the market seems to have narrowed.

You're opening 8 to 9% square foot a year, your pharmacy volumes are just about positive, the rest of the industry is lightly negative but that gap, historically has been somewhat higher so I'm wondering whether a couple things happening here.

Whether Wal-Mart is having more of an impact than we think on overall volumes hence the introduction of the Savings Club or whether recent new stores that are in a two, three year age, whether they are continuing to drive a sort of comp growth that they have traditionally.

Can you just comment on that comment?

Yeah, a couple of points what you're talking about.

The first five years, under five years, the new stores are definitely a drag on earnings.

On average it takes stores three years to become, to hit that breakeven point and they start growing from there.

I think one interesting thing that you might want to consider in terms of narrowing of the spread and it has narrowed a little tiny bit is our competitors are consolidating so they're doing two-for-one location, putting two stores into one store and also we're going into Markets that are more difficult for us, that take a little bit longer to grow and we've talked about that in the past.

That's California, particularly Southern California and the Northeast.

Those stores once again take a little bit longer to hit their breakeven point and since we're not as well known, takes longer to build up the pharmacy business.

It is interesting though in looking at the numbers from IMS is that we are still having a significant spread between us and the competition and of course you can look at those numbers and see that our spread is still very significant on a month to month basis.

So there has been a little bit narrowing over the last I'd say three to four years, that's part of that is the competition, the stronger getting stronger, but once again our spread is still very significant compared to the industry.

And just on the Wal-Mart $4 generics, and $10 for 90 days it's not just Wal-Mart, it's a whole host of discounts and it seems that supermarkets are gradually starting to move towards that pricing.

Is this becoming more of an impact on the cash business?

Hence the introduction of your savings club card?

That's one of the reasons we came out with the prescription savings club card.

Keep in mind that the cash business at Walgreen's depending on the month in that 5-6% range so even though it's not part of our total business in terms of how big the impact is, it is still part of our business, but this prescription savings club card as Greg mentioned has been very very well received by our patients and our customers, and we'll make more end roads in the future.

We're having approximately thousands and thousands of sign ups a week that are absolutely taking advantage of this and will be good in the future so once again, people are getting more aware of the cost of medication but when you come back to our convenience and the stores that we have opened and the hours we have opened, we will definitely win out.

Yeah, and keep in mind, Neil, the majority of our business is in contracting with third party payors where members have co-pays and many generics at $5 or less in some cases, so as far as the third party business, we absolutely believe our convenience is a major factor.

And we think that the PSC card, prescription savings card will help us gain share in that cash customer.

Thank you very much.

Our next question comes from Mark Wiltamuth with Morgan Stanley.

Please go ahead.

Hi, thank you.

It's Mark Wiltamuth.

Just wanted to home in a little more on your comments that some of this IMS is data may be weak because of the economy.

Are you seeing different compliance trends in different parts of the market and have we seen any drop off in prescriptions more in the California or Florida regions or anything along those lines?

Yes.

A couple things that interest happening that we've heard and seen.

Number one, people are actually spreading out their medicine to make sure they go further.

They are scripting doses, in other words taking their dose every other day and in certain medications you wouldn't be able to tell the difference short-term.

For example, in high blood pressure medication if you skip a dose or a day, you probably won't feel a difference, same thing with statins.

California and Florida have been difficult.

They've been hurt terribly by the economy and we are seeing impact there but overall we are continuing to pick up market share across the nation.

Even with the introduction of the Wal-Mart $4 program, we have increased our market share since that time, so even though there's a lull in prescriptions right now I do believe it will come back and in many of these factors in my mind are temporary.

If you could just talk a little bit about how generics were for you in the quarter, is it helpful or how did it compare versus to last years?

The big difference this quarter in terms of the profitability is we lost oxycontin.

If you remember, oxycontin was a pain medication that went from generic to brand.

That was a significant hit in terms of earnings.

Otherwise everything else is pretty much normal.

Mark, we were also cycling the effect of Zocor and Zoloft going generic last year.

Right.

So just to repeat we had phenomenal increases in gross margins last year and they're a little bit soft compared to last year's introduction of those two blockbuster drugs.

Okay.

And just a general comment, I just get the impression that of all your adjacency acquisitions you're not really getting much credit from the investment community on those, and a lot of them have been smaller, individual deals but in total , there are several of them and I'm just curious, if you characterize what kind of accretion the group would have in terms of EPS impact over like maybe a three to five year

Yes, Mark, thanks very much for recognizing that.

We appreciate that comment because that's exactly what's happening.

Even though they look small in total, they are big, and keep in mind, the expertise that we're getting with this.

Healthcare in America is changing and it's evolving.

People are looking for a reason and a value to pay for services and they want to make sure that we can influence outcomes.

We're absolutely doing that.

Greg has been absolutely intimately involved working with WHS, Walgreen's Health Services and really leading up these efforts in terms of the integration of our Health and Wellness area.

Greg why don't you mention a few things on that.

Mark, thanks for the suggestion.

I don't think that we're getting the credit and the recognition we should.

I think over the past 12 months to 18 months, we've assembled a national infusion platform that's second to none, I believe out there with a big pipeline of infusion in specialty drugs coming at us.

The Med Mark acquisition with the expertise we got from Stan Blaylock and his group has provided us a scalable platform that we're linking to an infusion platform as we speak.

I think we picked up the best in store retail clinic provider of Take Care that was out there.

I think Hal and his group is bringing us a ton of experience.

The couple of the top providers in the wellness space with I-Trax and Whole Health coming together, we've assembled a strong Management team and a heck of a platform.

The real value comes between connecting the dots between the two as I talked about.

I think the way we look at these is not only do we see these businesses and these adjacencies providing huge growth opportunity for us as we go forward but they also accelerate the core of the drug store business for us as well.

So we're really bullish on this and thank you for the question.

One more thing to reiterate.

All the time we've been doing this over the last three quarters we have managed to keep our expenses in check.

We're very very focused on growing businesses that make sense and cutting back on items that do not make sense.

Do you have anyway of quantifying the total accretion we could be thinking about a couple years out?

Bill, do you want to --

Mark, we haven't laid out a lot of details there, but we have talked about some of the larger acquisitions and we would place accretion anywhere from $0.05 to $0.10 per share over the next three years.

Okay, thank you very much.

Our final question comes from David Magee with SunTrust Robinson Humphrey.

Please go ahead.

Yeah, hi, good morning.

Good morning, David.

Really a two part question.

One is you mentioned the fact that new stores in the aggregate will be kind of plateauing in the next couple years.

Is there any difference in terms of just the profile of new versus existing Markets that you're going into and then owning versus leasing?

That's my first question and then the second part is that thinking longer term, many years down the road and knowing that maybe that you guys would go international, are there any international markets that to you seem most similar to the U.S.

In terms of how it's constructed that look maybe most interesting to you?

Okay on your first question on in terms of profiling what the stores look like, we look at trade area, we look at the demographics and other things in that trade area with many different metrics we look at but in terms of profile of the store, I wouldn't say there's anything necessarily different about them except the selection of merchandise inside.

Sometimes there's a little difference in the way the stores look but that's based on community approval but we do have many projects going on, one of them basic department Management, one is optimization of the SKUs in that store, so you always want to have that local flavor that matches the demographics and matches the wants and needs of that particular clientele.

But once again there's opportunities across America in all the different trade areas.

It could be in markets that we're not heavily in right now or it could be in markets like Chicago, Memphis, St.

Louis and so on, Tucson that we're already in that we're doing very well we want to dense up even more.

In terms of owning or leasing, Bill, do you want to comment on that, please?

Right now our target roughly is 20% owned, 80% leased, David, and that will probably continue on for a while but we'll have to evaluate that if we do plateau our growth in the future.

We'll have to continually evaluate our capital structure but that's where we're settling in right now to protect our credit rating.

And Jeff on the market so you could expect the ratio between new and existing markets to be about the same as it is?

Well, no.

We've actually hit almost all of the new markets.

We're going into Washington D.C, We have over 200 approvals in the Northwest now, we're all over the country.

We recently announced Alaska right, so that will give us 50 states so we're okay there but where we have that opportunity is to dense up in many markets.

When you dense up you take advantage of costs, that supervision costs, advertising costs, distribution costs so you can spread those costs out of a wider base, and in any one market there's always a tipping point where you build, you build, you build, you hit that tipping point and then your profitability explodes, and there's many markets that are in that camp.

So once again, in terms of beachheads, we really are across all of the United States.

Getting back to your question also in terms of international , as Greg was talking about earlier in healthcare services there's are so many opportunities here for us in the United States that between the United States and Puerto Rico, there really isn't any need to go international at this point.

People are looking for value.

They're looking for help in how they control their healthcare costs and how they stay healthier and Walgreen's with Take Care clinics, with Option Care, our infusion business, our pharmacies, 6300 distribution points across America, we are extremely well positioned for the future so once again, international, we've looked at it but our opportunities in the United States here are just

Great.

Thanks a lot.

And that does conclude today's question and answer session.

I would like to turn the conference back over to Mr.

Rick Hans for additional or closing remarks.

Folks, that was our final question.

Thank you for joining us today.

We'll announce June sales on July 2.

Our next quarterly financial announcement will be September 29, when we announce fourth quarter and fiscal 2008 year-end results.

Until then, have a great day and remember, you're always welcome at Walgreen's.

Ladies and gentlemen, that does conclude today's conference.

Thank you for your participation.

You may now disconnect.