沃博聯公司 (WBA) 2008 Q4 法說會逐字稿

Good day, everyone.

Welcome to the Walgreen Company fourth 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, Divisional Vice President of Investor Relations and Finance.

Please go ahead, sir.

Thank you.

Good morning everyone.

Welcome to our fourth quarter conference call.

We will start today's call with Jeff Rein, our Chairman and CEO, discussing the quarters highlights; Wade Miquelon, Senior Vice President and Chief Financial Officer will provide details on the fourth quarter financial results; Then Greg Wasson, our President will give an overview of progress on implementing our growth strategy.

Following that Jeff will give a brief summary and then we will 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 will 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 uncertainties.

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.

Good morning, everyone.

Today we announced our fourth quarter in which we once again grew sales and earnings, controlled costs, gained market share and strengthened our management team.

We also turned in our 34th consecutive year of record sales and earnings.

That's a track record matched by only one other Fortune 500 Company.

For the fiscal year sales increased 9.8% to a record $59 billion, net earnings grew 5.7% to a record $2.2 billion or $2.17 per share diluted.

Fourth quarter sales were a record $14.6 billion, that's an increase of 8.8%, net earnings rose 11.7% to $443 million.

That's $0.45 per share diluted, up 12.5% from last year's $0.40.

The quarter included several unusual items both positive and negative that Wade will discuss in detail.

Fourth quarter front end comp store sales grew 3.7% while total comps grew 2.6%.

It is obvious that customers are finding value in our product, services and convenient close to home locations, especially as gas prices skyrocket.

On the pharmacy side, comparable prescription sales rose 2.8% in the quarter after adjustment for calendar shifts.

The number of prescriptions filled in comp stores was up 0.6% over a year ago.

That compares favorably to an industry-wide decrease of 1.9% excluding Walgreens.

As you see we are consistently beating the industry.

As many of you know we are facing a continuation of the slowest growing prescription drug market in 47 years according to IMS Health.

Several things are driving this.

First is a switch of the allergy drug ZYRTEC from prescription to over-the-counter status earlier this year.

We've also seen fewer new drug interactions as well as some safety concerns over new medications.

We believe the biggest impact has been a very tough economy.

According to a July survey by the National Association of Insurance Commissioners, 22% of Americans are reducing their doctor visits and 11% are scaling back on medication use.

The good news is that we continue to gain prescription market share and now fill 17.6% of all retail prescriptions in the country.

That's up from 16.8% last fiscal year.

Before turning the call over to Wade for more details on our financials, I'd like to give a quick recap of our competitive position.

In fiscal 2008 we implemented our growth strategy through a number of short term and long term initiatives designed to deliver significant value to shareholders.

First, we are moderating Walgreen's organic growth rate.

This decision will give us greater operational and financial flexibility.

And it will also drive earnings growth in coming years.

Wade will offer more color in a few minutes but it is important to note that even while organic expansion slows, Walgreen's will remain one of the fastest growing retailers in the country.

Second, our work site health care acquisitions in our health and wellness division are integrating well.

With them, we have established a foundation to provide compelling future growth across all platforms.

Third, we have a relentless focus on reducing costs through disciplined control today and over the long term.

You can see the evidence of that throughout the past fiscal year and especially in the fourth quarter.

Fourth, we've expanded our leadership team to drive bold, creative and innovative responses to a rapidly changing retail and healthcare environment.

This past summer, we added Wade Miquelon as our CFO, and our Sona Chawla as our Senior VP of E-commerce.

Our latest edition is Kim Feil, the new Chief Marketing Officer we announced last week.

Kim, previously CMO at Sara Lee will need a new marketing organization to more effectively meet the needs of Walgreens customers and and pharmacy patients particularly for health and wellness.

Before moving on I'd like to note that we will not be discussing our previously announced proposal to acquire Long's Drugstores.

We remain committed to our proposal which we believe is a superior one but we won't take any questions regarding it during the Q&A.

With that overview I will turn the call over to our CFO.

Wade.

Thank you, Jeff.

First, I'd like to reiterate and thank our people for the strong sales and cost discipline that continued throughout our Company in the fourth quarter.

We continue to position ourselves as a leading retailer in a very tough economy.

Recapping sales we were up 9.8% for the fiscal year and 8.8% for the fourth quarter.

We posted a total comparable store sales increase of 2.6% for the fourth quarter and a front end comp store sales increase of 3.7%.

Prescription sales which represented 56% of total sales rose 7.9% for the quarter and 2% on a comparable store basis.

Net earnings per diluted share grew 6.9% in fiscal 2008 to $2.17.

For the fourth quarter net earnings per diluted share increased 12.5% to $0.45.

In the fourth quarter we had a $79 million positive adjustment for employee vacation accrual.

During our year end controls process, we discovered we had been historically over occurring for vacation versus our long standing policies.

If this was not material to the year nor to one historical period prior it was appropriate for us to true it up in this quarter.

To the negative we had heavier promotional spending than originally planned, several smaller adjustments, a higher than year ago tax rate and a fairly significant provision LIFO provision.

The fourth quarter had a LIFO provision of $24.9 million which compares to a provision of $32 million a year ago.

The total LIFO provision in fiscal 2008 was roughly $98.5 million versus the provision of $69.3 million in the previous year.

We expect the LIFO provision to become a much larger item in fiscal 2009 as inflation continues.

We will work to offset that to the extent possible through our pricing strategy but we believe that LIFO could be as much as twice our current rate in the upcoming year.

One thing that we are very proud of this quarter was our ability to control costs.

SG&A expense dollars increased 5.5%, benefiting from the vacation accrual credit.

Net of this adjustment SG&A expense dollars increased only 8% which is less than our 8.8% sales gain in the quarter.

SG&A benefited from excellent payroll control, our store operations people from coast to coast did a terrific job of controlling expenses.

Looking at cost on a two year stack basis, you will see that the fourth quarter SG&A dollar costs were 23.3% of sales or an improvement of more than 4 percentage points since the first quarter of fiscal '08.

And that is excluding the benefit from this quarters vacation accrual adjustments.

Comparing our fourth quarter SG&A costs over the last three fiscal years you will see we've reduced the growth rate by 5 percentage points.

Now, turning to gross profit, total gross profit dollars in the quarter were just over $4 billion, a 7.4% increase, reflecting the slow growth rate in prescriptions filled, and as mentioned, the heavier promotional activity on the front end.

Gross profit margins decreased 34 basis points to 27.64.

Retail and pharmacy margins increased due to a greater use of generics but total pharmacy margins were impacted negatively from the higher growth rate of specialty pharmacy which has the high dollar range but a lower margin as a percent of sales.

Front end markets were essentially flat helping the front end was a shift to higher margin products which is our private label brand but hurting front end margins were heavier than normal promotions as I just mentioned.

Now let's look at our tax rates, our working capital and our CapEx.

The effective tax rate in the fourth quarter was 37% compared to a rate of 35% in the year ago period, when we had some favorable adjustments.

Accounts receivable were up 13% in the quarter driven primarily by third party sales and slower Medicaid payments by states such as California and Illinois.

We showed continued progress and focus on inventories in the fourth quarter which were up only 6.8% or less than our 8.8% sales gain.

Accounts payable increased 14.9% and this is primarily due to timing of a few major payments.

Our net debt at the end of fiscal year -- at the end of the fiscal year was $977 million compared to a net debt of $651 million a year ago.

Our net debt included $82.7 million of short term debt, $1.34 billion of long term debt and this was offset by cash and cash equivalents of $443 million at the end of the year.

You will recall that in July we restructured our debt portfolio, when we issued $1.3 billion in five year senior notes at 4.875%.

With our strong financial footing, we have the flexibility to ensure that we drive our core strategies and evaluate opportunities as they may arise.

We will continue to be disciplined however with our capital allocations, our focus on working capital and our continued sharp cost control.

Capital expenditures including new stores, distribution centers and IT development reached $2.2 billion in 2008.

Since our last conference call, we announced the slow down in our drugstore organic growth rate.

That will lead to lower capital expenditures going forward.

We expect to reduce organic net drugstore growth rate from the current 9% growth to a long term rate of approximately 5%.

Let me give you a year by schedule for how we will take that down.

We will open 495 net new stores in fiscal 2009, 425 in fiscal 2010 and 365 in 2011.

As Jeff said, that still makes us one of the nation's fastest growing retailers.

Many of you have asked why we decided to slow our growth rate at this time.

I want to reiterate that our focused ROIC from new stores continues to be as robust as it was in the past.

But there are good reasons why we decided to moderate our growth.

First and foremost, it allows us more time to develop our management ranks and focus on improving the shopper experience.

Improving the shopper experience to drive fierce loyalty with our shoppers and ultimately a larger basket size is one of the single biggest levers of value creation that we have and we are going free up resources to do this.

Secondly, we want the flexibility to continue to invest across our core strategies and be opportunistic if appropriate especially in this time of a very uncertain and very challenging economy.

And lastly, for the reasons I outlined above and as a result of the increased earnings power over time, we believe it will also help us increase our shareholder value.

And now I would like to close my section with some thoughts related to the overall economic situation.

It is our long standing policy not to give guidance, but I do believe that it is important that we continue to provide perspective to our stake holders on the overall market dynamics and related factors that impact our business.

While we continue to grow our business and outcomp the industry in both the pharmacy and the front end, and while we firmly believe our strategies are absolutely the right ones to drive our business and shareholder value, the market fundamentals pose significant challenges in these uncertain times.

As we have talked before IMS data shows the slowest script growth rate in many decades, and we continue to see our front end consumers under significant economic pressure from higher inflation and a growing unemployment trend.

While historically our business has been more recession resistant that most, there is no question that at least as we move forward there will be some challenging times for retailers, especially to the extent that the macro economic variables such as inflation and unemployment continue to move negatively.

Having said that I am absolutely convinced that we have the right strategies which are the enablers to win in even the toughest markets which we have had historically done.

We will look to turn market challenges into opportunities so we will come out of this difficult economy an even stronger Company than when we went into it.

We will talk more to you about all of the things we are doing in this regard at our analyst day conference next month.

With that I would like to turn the call over to our President Greg Wasson for an update on implementing our strategies.

Thank you, Wade.

Good morning.

First, I want to thank all of our employees throughout the Company for their sales and cost control efforts this quarter.

As Wade said we are operating in a very tough economy.

But we are taking care of our customers, and doing everything we can to meet their needs.

As I travel across the country I am overwhelmed by the support of our people.

I believe they're the best in the business.

I also want to commend our employee in the aftermath of hurricane Ike, they were there to serve their communities and to help people when they needed us the most.

Within five days of the storm we had over 200 of our 235 stores open in southeast Texas taking care of customers and pharmacy patients.

We were also one of the fist retailers to reopen in Galveston to help out residents who didn't evacuate.

Having spent the early part of my Walgreen career in Houston, I'm not surprised by the response and efforts of our folks to overcome a disaster like this.

Now I will spend a few minutes talking about the progress we have made on each plank of our strategy to grow earnings and create shareholder value.

Our first plank is broadening access to our products and services for organic expansion and acquisitions.

We are building an impressive network of healthcare access that combines our mail and retail pharmacies, our in-store health clinics, and work site health centers with our specialty pharmacy facilities, our home care centers and our long term care facilities.

Let me be clear on this point.

We intend to be the most complete and convenient provider of pharmacy and healthcare services in the nation.

Today, we offer most or all of these services in markets across the country.

The next step is tying them together into a single unmatched offering to meed the needs of employer groups and managed care organizations.

Payers are looking for accessible low cost, convenient health care during times of soaring medical costs.

Simply put we are helping American health care needs with an affordable solution.

Our second plank involves reinventing the customer and patient experience.

We are in the early stages of a process of trying to create a very convenient shopping experience in our stores.

With this customer sensory mindset we are working across the Company to offer an efficient assortment of products, price points, and promotions.

We are really looking forward to our new CMO Kim Feil to help us identify and meet the needs of our shoppers.

One early example which is available in our stores today, is Walgreen's prescription savings club.

This club is making medications more affordable for more than 45 million uninsured Americans.

We've proven the power of this program and our brand over the last two months as we kicked off an agressive marketing campaign.

As a result, our membership has soared over the 1 million mark.

In this economy people aren't just looking for low cost alternatives, they're looking for -- they're searching for the best overall value.

That's where our brand reputation comes into play.

Patients a way to spend their dollars without sacrificing safety, service, or convenience.

Furthermore, the prescription savings club goes well beyond the discount generic programs at other retailers.

We offer savings on more than 5,000 name brands and generic medications, plus you can get any of more than 400 generic medications for less than $1 a week.

To top it off, Club members receive a 10% reward on all Walgreens branded products and they can be used on future watering purchases.

We are very excited about the early success of this program.

Our third strategic plank expands the pharmacy related health care services that we offer.

One part of this effort is our new health and wellness division announced last spring.

Today we are the largest provider of work site health centers in the country through our take care employer solutions group.

Division also includes the take care consumer solutions group which manages convenient care clinics at our select Walgreen drugstores.

Between the two groups our health and wellness division manages nearly 600 health centers.

Our goal is to have 800 retail clinics and employer wellness centers in operation at end of fiscal '09.

Another area where acquisitions have helped us build our health care offering is specialty pharmacy.

We are experiencing strong growth in this business as we become the provider for more and more payers.

Today, we are the largest independent specialty provider in the country.

Earlier this month, we were named one of two specialty providers for Premera, a health plan serving more than 1.7 million members in four western states.

One of the big factors of winning this business was our ability to integrate specialty pharmacy services with our retail pharmacies, and with our infusion services for our home care branches.

Specialty pharmacy is increasingly important to us because it is the fastest growing sector of pharmacy expanding at about 15% a year.

Then to the new product awaiting FDA approval in 2008, 80% are specialty drug according to IMSO.

And fourth, finally, our fourth plank supports the three I just discussed by developing the systems and capabilities necessary to carry them out.

We are conducting an across the board review of our support and cost structure to place the right resource in the right spots.

We want to ensure that our costs, culture, and capabilities support and enable our strategy.

With that, I will turn the call back to Jeff to wrap things up.

Thank, Greg for providing some examples of our strategy execution.

I'm proud of the progress we are making.

We are becoming a sharper, faster moving Company that is more focused on customers.

And we put the people and the strategy in place for future growth.

We are working hard to ensure we are successful in a tough economy.

Over the long term, the impact of the baby boom generation on health care is too strong for prescription sales to continue their current trend.

That means demand for our retail healthcare offering will be strong for years to come.

As an affordable, and accessible provider of high quality healthcare, we are positioned very well to take advantage of this long term opportunity.

As Wade briefly mentioned we will hold an analyst day conference on October 30.

That's when we will provide financial analysts with details on our plans for pharmacy operations, the front end customer experience and other new insights that we haven't offered before.

while you can listen online to the webcast of the presentation, analysts who attend in person also will have a chance to meet our management team including the new members we have added over the past year.

As we close out another record year of Walgreen's, I would like to thank all our supporters for backing us and we look forward to our prospects for successful fiscal 2009.

Thank you.

Ladies and gentlemen, that concludes our prepared remarks.

We are now ready for your questions.

May I have our first question?

Thank you.

(OPERATOR INSTRUCTIONS) We will take our first question from Andrew Wolf with BB&T Capital Markets.

Good morning.

Just wanted to ask about the promotional activity during the quarter which you called out more in your press release and your remarks, in the press release essentially indicates you overinvested.

You did mention that, but then it spoke to that you're going to ratchet back investments.

I guess one way to look at it is what would the quarter have looked like if the promotional activity you are going to ratchet back to had been in place during the entire quarter so that we can get a sense of how much overinvestment you think you might have put into the quarter.

I think, Andy, what happened during the quarter, when I talk about overinvestment is we drove too many promotions to get folks into our stores.

We want to be more targeted, we want to create value and make sure from the customers point of view it's a value.

What I was talking about in the press release and even at the conference before, was we made this investment but people did not buy the impulse items that we thought they would in the past.

Typically when people come in they buy the coupon items, they buy the promotional items and then the market basket typically goes up in a good way in terms of profitability because they're buying extra items.

That did not really happen this time.

Let me, I would just, Andy, it's Wade, I would just pile on here and say you are probably looking in the range of $0.01 to $0.02 per share in terms of heavier promotional activity versus what we would have normally hoped for.

Okay.

And if I can sneak in a follow-up, not exactly related but on the million members that you have in the prescription savings club, is what kind of multiple of that might you -- are in your plans?

And as you look at those million members do you have a way of figuring out, maybe through your files which ones are net new pick ups or return customers who might have gone elsewhere?

And which ones are just sort of customers who are joining the club to create savings for themselves?

Yes, and that's an excellent question.

It has actually been a very, very popular card right now.

Our goal is actually several million.

We haven't given out a specific goal yet but I can assure you it is going to be several million.

I know Greg has been intimately involved in that.

Greg, you had a few comments on that?

Yes, Andy, I do think there is a tremendous upside, there's 40 million uninsured Americans out there so we have got a long way to go now that we have a million, as far as new patients, I think what we are really excited about is we just kicked off that marketing campaign August 1, and which was targeted to go, to bring in, new patients, we're seeing nearly 25%, 30% of the patients coming in since they're new patients of Walgreen's we think that will continue to grow.

That's of the 1 million, it is 25 to 30%?

Make sure I understand that.

Yes.

Okay.

And of the rest that are just current customers, does the economics of the plan including the membership fee and other things, how does that, when you look at that, let's say the lifetime, over a years worth of business with that customer, is that net neutral or dilutive or accretive for that customer in terms of earnings for the stores?

Andy, Greg, certainly a net positive.

What we are seeing with even existing customers who choose to use our prescription savings cards.

One is obviously you've got to consider the retention factor and two there's absolutely an increase in compliance with our prescription members and we think that's a good thing for health care.

Got it.

Thank you.

We will take our next question from Robert Willoughby with Banc of America.

Thank you.

As it relates to the health care strategy that seems to be a bit more dependent on acquisitions, are you finding there are enough attractively priced platforms big enough to make a difference in the consolidated companies numbers or do you anticipate a lot of smaller deals over the next couple of years?

No, there are more opportunities.

As you know, health care is evolving very, very quickly right now.

It is consolidating a bit.

There are more opportunities.

We typically don't comment on current and future acquisitions but I can tell you, by putting all of this together we are becoming the affordable, low cost, accessible provider.

Whether it is the take care clinics, the on site clinics at employees, the hospital clinics, the Walgreen stores themselves, it all ties together, once again, to bring folks easy into the system and save them money.

So there are more opportunities.

Whether it is big or small that is debatable at this point, of course, but I can assure you it is all coming together.

It has been well received not only by the public but the payers and also the employees.

.

And Jeff, you were quite clear a couple years ago, I think in the annual report whee your areas of interest were.

There's o change to those listed areas?

Let me put it this way, Bob, we are always looking at acquisitions, we are always looking at health care and we are always looking at our business model to make sure that we are going down the correct path.

So something might have been going on two years ago.

As you know, the whole world has just changed in the last couple weeks.

So we are certainly open, we're flexible, we're adaptable.

And that's one of the reasons I actually brought new people into the Company like Wade and Sona, Kim, Stan Blaylock, Hal Rosenblum.

This brings a different perspective and gives us different ideas.

So I would say that we're still marching forward.

Wade?

Bob, I would just say there's really no change in the standpoint that we continue to put it through the same filter which is -- number one is we're only looking at things that are on strategy.

That means it really has to link to our assets and our capabilities.

It has to be strong to the core of that.

It has got to have strong financial payout.

Finally, we have to believe that we're highly capable of executing with excellence.

So we'll continue to use that filter as we go forward.

You will definitely not see us get off track in terms of acquisitions or how it relates to health care.

That's great.

Thank you.

We'll take our next question from John Heinbockel with Goldman Sachs.

Couple of things.

Jeff, about a month ago you talked about the consumer and that they had really gone into a shell mid-July and beyond in terms of the cherry picking.

We have heard from other retailers.

Things got a little bit tougher after Labor Day.

What is the update on where your consumer sits.

Are they still as cautious, did they get more cautious or what?

Yes, John, in terms of the consumer they are still being very cautious, they're still very promotionally oriented.

They are looking for value all the time.

They are still buying products obviously.

It is a good thing that we are in a recession resistant type business.

They still need their Medications, they still need their toothpaste, toiletries, and so on.

So I think people are being cautious but actually for us, that is not so bad because the products we sell, once again, they need them on a daily basis, or they're the small things in life like $5 toys or $10 gifts that make people happy.

It's not all doom and gloom for example, let's say Christmas sales, we expect to have a decent Christmas, don't think it's going to be spectacular but I think it is going to be decent.

People are not going to give up on Christmas, they're not going to give up on Halloween.

They still want to take care of themselves and their families, have some fun.

It usually what happens for Walgreen's is a poor economy is actually better for us, particularly around the seasonal events, because people are trading down.

Once again, most of the products that we sell are not that expensive.

So it is about the same as I mentioned a couple, three weeks ago but still I think we are in a very good position going forward.

John this is Greg.

We are certainly seeing in this environment an uptip in private label sales, also helped us overcome some of the margin pressures and the additional promotional pricing.

So it's definitely an economy that's helping us with private label.

Secondly, have you guys rethought or will you rethink with your new marketing actually, the idea of a loyalty card and whether that can direct promotional dollars better or not.

Yes, John, good question, that is one of the things under consideration.

As you know Kim has a lot of experience in that area and that is she came from IRI.

So she's not only a great marketing person but she's very, very analytical.

We believe over the years our best loyalty card has actually been our sites, we have class A sites, we've put a lot of money into being in the right location, the best location, but a loyalty card may be in the cards and we will certainly look at that when Kim comes in.

And finally, basically in the quarter retail gross margin would have been -- was up pharmacy was up, front end was flat.

So gross margin was up.

What would the retail EBIT margin have done, because I am not sure what your retail, SG&A dollars grew at but would retail margin have been down for the quarter or not?

I don't think we usually give that out.

I think you can probably follow the math a bit across the line but in generally we don't give that out.

And I guess going forward, you think that we will see, it is highly likely we will see front end margins up going forward -- overall margins up and front end up because of your pull back in promotional spend?

No, it depends on the buy, also, as you know, we're being very careful on the inventory we are putting into the stores.

As you know we grew inventory less than sales this time.

If the sell through is pretty good then our margins will come out pretty good too.

That's a little bit of a wild card.

We are trying to be very, very careful on our promotion, we want to make sure they make sense.

Keep in mind that when you're looking at our margins overall we are selling more specialty products and the margin is flat in the front end.

It was up a little bit in the pharmacy, the retail stores but the margin was squeezed by the specialty products that we are selling.

As you know they do have a lower margin but high gross profit dollars.

John, I would just add that on the front end, there is a balancing factor between promotional activity and then finding the sweet spot of good everyday pricing.

So in these challenging economic times we have to continue to make sure that we drive good loyal traffic through the front door.

Again, I think we are going to fine tune our approach to it in terms of using just promotions, per se, but here's no question that we can't be uncompetitive either.

All right.

Then finally do you think we are, is this a new level of SG&A growth if you back out the Medication accrual 8% give or take, is that sustainable?

We are committed to the cost discipline that makes sense to growing our Company, John, and we are very, very strict on this.

There's opportunity not only at the store level but there's more opportunities at the corporate level.

So, believe me, going forward we are going to be very, very strong on this, very disciplined and make sure we do the right thing to grow our business.

I would just add, as we've talked, John, this is Wade, it is -- we are doing a lot of work to really understand a sustainable growth model.

Both in kind of best of times and more challenging and then working backward from there to say how do we make all of our costs fit in that model, how do we stay agile, and how do we make it something that's accretive consistently overtime?

Okay.

Thanks, guys.

We will take your next question from Deborah Weinswig with Citi.

With regards to the front end, can you maybe discuss where you saw strength in various categories and also on the lines of private label, can you update us in terms of your current penetration and what your goals are?

Yes, Deborah, what was the first part of the question, please?

I didn't hear that.

Where are you seeing strength in the front end?

Oh.

Where we see strength?

Yes.

From a category perspective?

In the health and you beauty aids very very strong particularly in the allergy departments and also in food, just been phenomenal.

People are looking for a bargain.

As you know, we carry a wide selection of food, people can use it, obviously, on the way home, or any time during the day, carry a full line of milk, refrigerated groceries, canned goods and so on.

It has just been phenomenal.

Once again, on the drug side, we're seeing a lot more people self medicate themselves.

As you know, doctor visits are down, they're not generating the prescriptions as much as in the past, however people are still getting sick and they do go in and see the take care clinic, nurse practitioner, they do come in and buy the drug wall themselves.

We are seeing our drug sales be very, very strong in that respective.

The other -- this is Wade again, the other changing pattern we are seeing too, Deborah is we are seeing, as Jeff mentioned, a heavier shift towards private label as consumers are seeking good value.

We are also seeing a shift, just in terms of overall traffic pattern, we tend to see a bit of more frequent visits during the weekdays with slightly less on the weekends.

I think this speaks to both consumers loading up on the weekends, maybe some of the larger stores but also, seeing that we are a good value on the weekdays with respect to the cost of gas and the cost of time.

And Deborah, Greg, as far as your question we've seen about 100 basis point improvement year after year in private label and expect to see tat continue to grow.

It's been phenomenal, private label has just been phenomenal.

Then on the specialty pharmacy side, Wade, you discussed that there was a negative gross margin impact as a result, can you talk about what percentage of your business specialty pharmacy represents right now?

I don't know if you can give any additional color in terms of the gross margin impact?

I'm sure I can tell you.

Specialty is kind of in that 6 to 7% range of the total business, but again it is very high dollar range.

So it is very high gross profit dollar per se.

But again those margins in that business are much smaller as a percent of sales.

So I don't know if we have given a specific mix factor, but you could probably do some back of the envelope math and get a feel for it.

But the growth rates are very high and nefarious, so again that's providing the mix effect.

Keep in mind, Deborah, that specialty patients bring a lot of traditional prescriptions along with them.

So definitely a good customer to have.

Great.

Well, thanks so much.

I look forward to seeing you in a few weeks.

We will take your next question from Ed Kelly with Credit Suisse.

Hi, good morning.

Good morning.

I'm sorry to harp on the gross margin question here but I'm not sure I quite understand it yet.

If I look at your gross margin and the year-over-year increase or decrease and if we ex out LIFO, so if you look at last quarter your FIFO gross margin was up 6 basis points and the pharmacy was up and the front end was down.

This quarter your FIFO gross margin was down about 40 basis points and the pharmacy is up and the front end is flat.

So the specialty pharmacy issue, I think from a mix standpoint would have been there last quarter I'm just not really sure what would have changed and does any of it have to do with the acquisition of CuraScript?

I was just hoping you'd give us some more color on that.

If I fully understand, Ed, your question, part of it on a year on year basis is the acquisition of option care being folded in plus overall growth.

So that might be something you are not picking up there because that was a substantive mix effect.

Well, option care was there last quarter or no.

It was last quarter but not year ago.

I'm not sure what you're reconciling to.

We had two weeks of option care in this quarter only versus 12 prior.

All right.

Okay.

Second question--.

Vice versa, sorry.

Right, right.

From an acquisition standpoint I think historically you have looked at organic growth as sort of a core competency, and now it seems like acquisitions are becoming what you feel is more of your core competency, in fact even bigger retail acquisition.

So can you just help us understand what has changed over this time period?

I really wouldn't classify it as a change.

Our whole strategy in terms of growth is to broaden access and connect all these points of care.

So we are still growing very strongly in an organic way.

However, the industry in terms of retail in particular is consolidating broad time and to have these broadening the access and have the point of care we want to make sure that we participate in this consolidation.

Similar to what we did with Happy Harry's a couple of years ago.

If there's an opportunity we are open to it.

I think before is that we basically said we are just going to do organic growth only and that was that.

But as you know, over the last couple of years we said we are more open to these acquisitions that make sense from a strategic point of view.

So we are still going along the same path, once in a while, there might be opportunities that are good for us and good for the shareholders.

And Ed, remember, as I said before, that our potentially single biggest value creation lever is to make our good stores out there even better.

So being able to have the energy to take our core and do more from our core is really a great place for value accretion too.

And an example of that maybe the file buys that Wade was talking about in terms of our core stores.

These file buys, in terms of small chains or independents going out of business, it's a great, great opportunity for us and once again, it's all -- that's part of an acquisition, but at the same time you're growing your core business.

And that $76 million, Wade, is that after tax or pre tax?

$76 million is pretax.

$79 million.

$79 million.

Sorry.

Okay.

Who is next?

We will take your next question from Scott Mushkin with Jefferies.

Hey, guys.

Kind of want to poke at something Wade was talking about.

Just trying to understand '09, I think Wade kind of, I took it as being somewhat cautious in 2009.

From a gross margin, we had a pretty nice hurt from specialty on gross margin, is that something we should expect as we move forward into '09?

And then the second question on SG&A, we did have a lot of one-time items that flowed through '08 on a positive basis.

When we look at '09 what should our expectations be for SG&A?

And then the final question would be do we -- is it possible to have flat earnings next year?

What are you guy really saying about next year, it seems like you are being cautious.

I am just trying to understand how cautious we should be as we look at the--?

Just in order of your questions, this is Wade again.

On specialty you are certainly going to see a little bit of dilution over time because the specialty business is growing faster than the core but again, remember that things like the acquisitions we have done have made that disproportionate to this particular quarter.

So I think you will see a little bit of effect there but I think from a gross profit dollar basis it is actually a very good thing.

And it's a good ROIC business and it's a good growth vehicle for us.

On SG&A, in terms of SG&A, I think that the key thing is what I mentioned earlier is that we are really looking at what our sales would be over time and working backwards and saying what is the right SG&A structure, I think we've done a lot of good work in the last few quarters, to get some low hanging fruit But we will continue to be very aggressive to make sure they are weeding out all of the costs that don't add value and having a model, which is flexible and works with anything.

I think in terms of flat earnings I don't want to go there.

I think what I am foreshadowing is just that it is very challenging economic environment.

I don't think anybody here can predict with the events of the last few weeks, where unemployment will go over the next quarter or two or three, and I think we will just have to keep watching it.

I think right now I think we have done a very good job in this environment, we're outcomping the industry front end and back end.

We do have a good cost control.

We are effectively keeping our margins in general intact.

But I also think it is important for all of us in retail and across all sectors to make sure we keep a watchful eye on consumers because I think the consumer is under quite a bit of pressure right now.

Scott, this is Jeff here, I am hoping you'll be able to come to our analyst day conference at the end of October where we are going to talk specifically about SG&A and programs and projects, shall we say initiatives that we have in place and going forward what we are going to do about that.

I definitely look forward to it.

And then getting back, I think Bob Willoughby, and was also talking about your acquisition strategy, and just to clarify a couple of things, is a PBM still off the table, or is that something you now think is a little bit better?

I wasn't clear with the answer there?

And then as far as on the retail side, Happy Harry's and the one that we don't want to talk about are very different as far as your market share in those areas, has something changed in that aspect that you are more open to things with a lot more overlap?

In terms of the PBM we haven't changed our position on that.

We think our transparent model has been well accepted in the marketplace.

It is the right path to go.

The most profitable path to go.

In terms of the retail acquisitions, if it makes strategic sense then we will go forward.

As long as it meets our hurdle rate and we're giving value to shareholders then it is something we'll go after.

Okay.

Thanks.

That's it for me.

Thank you, sir.

We will take your next question from Meredith Adler with Barclays Capital.

Thanks very much.

Can we talk a little bit about, you mentioned shelf pricing and that you think you need to make some adjustments.

Have you done any consumer research that gives you some sense of what consumers perception is about your shelf pricing?

We have done that because we do launch that all the time, we do competitive shops obviously.

We have a consumer research department where we do look at what folks think about our pricing.

What I was talking about earlier, was the amount of promotional spend that we had to get people into the store, particularly when we look at our what we call rotos, or the circulars that come out every Sunday, in Sunday papers.

In some cases we gave away more than we had to.

It's always good, of course, to draw them into the store but then you have to be very careful of how you mark down products in the stores on a promotional basis.

We just went a little bit overboard on that.

So our shelf pricing, our everyday shelf pricing is good.

We obviously look at the major competitors whether it is Target, Wal-Mart, CVS, RIte Aid and so on so make sure that we were right for that particular market.

Meredith, this is Greg.

We certainly want to understand that to the fullest.

That's one of the values we're really looking for Kim Feil to help bring us to really get out there and understand the consumer more and more and what they see as value and what they don't.

So certainly have a lot of focus in that area.

And I presume part of Kim's task will be to figure out if you are less aggressive on your promotions, what that is going to do with sales?

Is that part of commission?

It is working all together, whether it is market planning and research, advertising, purchasing, it is a effort that gets together from everybody.

Yes, we want to be very correct in what we are doing.

One of the things that Kim will help us do also, is to present one pace of Walgreen's to the consumer, to the customer.

Right now, when folks come in sometimes, it's difficult when you go on line or you shop in the stores or you shop Walgreen health services, we want to make sure that we are really working on that patient, that shopper experience that is very very pleasing to them and as Wade mentioned earlier that creates that sense of fierce loyalty.

Okay.

Great.

And then, I would like to go back to talk about expense.

I understand that this is a moving process that you are working very hard on it.

But Wade was kind enough to talk about the two year which is how I look alt it and you had a very very easy comparison this past year especially in the fourth quarter but the comparisons start to get easier, and if you do a two year it looks like you are running 11.5% dollar growth.

Is that something that we should see as to the near term is sustainable.

Obviously you got opportunity to do things in future but I think that's a lot higher than the 8% that happened in the fourth quarter.

Yes.

The two year stack I think is a good longer term metric but I think the key thing is when it comes to SG&A sometimes you are only as good as your last quarter.

It's because, Again, of all the things that go into it.

So I feel very good about the 8% number that we effectively hit.

I think it says that we are making real progress in the short term.

I think that we have got other things that we are working aggressively.

So I think the trend there is very good, and we'll continue to challenge all things and say do they add value or not, are we best utilizing our resources but again we have got to start with where we think our overall sales and gross profit are going and make sure that we engineer backwards to be efficient and accretive over the long haul.

Yes, the last two years, if you look at '06, fourth quarter '06, and show it on the slides we were at 28.3% growth, for a two year stack and now we are down to 23.3.

That's excluding that vacation accrual.

So we are making progress and yes, there is more to go.

We absolutely believe there is more to go, not only in the stores but in Corporate and the way we do things.

Okay.

Got a question about this vacation accrual.

I am surprised nobody asked that but the most conservative way to look at it is to say that all of it is one time.

It wasn't clear from your commentary what time frame that was multiyear or if that was just this year.

So if we wanted to add it back to come up with a run rate, how much of it should we add back?

I would say, effectively, as you know, it's a very large amount, that's why we called it out, it is a multiyear it goes over many, many years.

And what's not material in aggregate to this year, nor any single year, and that's why it was appropriate to disclose to put it in this quarter, but I think you could pretty much call the vast majority of it one time.

You are always going to have -- in that regard, as you know, at year end you're always going to have a lot of puts and calls.

So this is obviously a large unusual health item.

We had several smaller hurt items that added up to a fairly large number too.

But I think for the sake of transparency, for the most, far, vast majority of this is all one time.

Okay.

Then my final question is back to Ed Kelly's question.

If I am understanding what you are saying right, option care was not in third quarter numbers and was only partially in the fourth quarter numbers for last year.

Yest.

It was only two weeks of last year in the fourth quarter.

Right.

So, you would have expected that specialty would have had a similar impact on the two quarters because there really wasn't that much different.

And yet that isn't what happened.

Is it because there was very big growth in specialties between fourth and third quarters?

Yes.

We have had very, very good success once again being the largest independent provider, in the services we provide, the quality we provide led by [Paul Nestropha] and Company.

They are doing a fabulous job and we are winning more business.

Okay.

My final, it is really a request, very excited about you having an analyst meeting but next year could you maybe not do it the same day that CVS and Medco report earnings?

It's going to force all of us to multi-task hugely.

Thank you.

We are deeply apologetic for that.

We will have, A, we will delay our day and start a little bit later and B, we are going to provide rooms, phones, lines for everyone so that they can dial in and do that early morning work if need be.

We will make sure we try to as best accommodate everyone so that you can serve all that.

Good suggestion Meredith.

Thank you for saying that.

Thank you.

We will take your next question from David Magee with SunTrust Robinson Humphrey.

Yes, hi.

Good morning, guys.

Morning, David.

Just a couple of clarifying questions at this point.

On the specialty side, obviously the gross margins are less there, is there still a positive contribution on the EBIT line from that business?

Absolutely.

Absolutely.

And again, from a ROIC point of view as well, it is also, despite the market percent compression it's also one of the best businesses we can invest in.

So in the fourth quarter on a year to year basis that business helped the EBIT line?

It was accretive to the EBIT line year to year?

That's right.

Secondly, Wade, you talked about this a lot.

So reserve being twice in 2009, if I heard you correctly, were you speaking in dollars or as percent of sales and is that a, is that something that would also help your top at the same time?

I am just trying to get a sense for how much of a negative that might be, inflation being higher in the coming year?

Yes, it's dollars and it really depends on your ability to get out and price in front of it.

It could be a hurt or it could be a help.

If you think about it it's sort of an accounting term, so you don't necessarily want to be pricing too aggressively just to recoup that when maybe you should be looking at it from a FICO basis.

Okay.

But a a general rule of thumb I would say we've historically been pretty good at offsetting it.

But again it is really a timing issue of how fast you can price in front of it.

Okay.

Great.

Thanks a lot.

We will take your next question from Neil Currie with UBS.

Good morning.

Thanks for taking my question.

Morning, Neil.

Just one question about the real estate market with some of the problems we are seeing in the banks.

I know traditionally one of your biggest competitors for retail space has been the high street banks.

Are you seeing any signs yet of that competition easing or maybe even some sites being available?

That's a very good question.

We have seen easing of the competition for good sites, the banks started pulling back around I would say six months ago approximately.

You are right, they were actually one of your top competitors and really drove the costs up.

They are pulling back big time and freeing up some sites that we may not have ordinarily been able to obtain.

So the impact of that is, is it just, more sights available to look at or, gee, will those sights that you are looking at become somewhat cheaper?

It is lower sites, there's also more negotiating power on our end.

But no chance to take advantage of that and maybe rescind some of the slower growth that you are expecting?

We are doing what we can.

I am not quite sure what you are saying there.

You have talked about putting back the expansion program it might be some opportunities to accelerate a little bit.

Not at this point we are pretty much committed for the next two years.

We will down in that 5% range for 2011.

It does allow us though, to make sure that we go after the very best of the best sites and once again sometimes these banks pull away from an excellent location that we couldn't get otherwise.

So obviously we will put our priorities towards those areas that free up.

Thank you.

I don't know if you saw the press release from Caterpillar to their employees where they are allowing employees to go to Wal-Mart to get tier 1 generics at 0 copay whereas they have to pay $5 to go to other drugstores.

Do you have any comments on that and would you consider pulling out of that network?

Yes, we do, actually did see that press release and what it really gets into is what I talked about earlier in terms of transparency, and the way our model is and evolving even more into the future.

I know Greg has been involved in that extremely intimately.

Greg, can you talk about that please?

Yes, Neil.

This is obviously a pilot, sounds like from Wal-Mart but I think what it really shows and I think Wal-Mart obviously is trying to go directly to employers, and I think of offer a solution for the employer but I think they are really going to cut out the middleman in the process.

I believe they believe that the middleman traps cost as we do.

As you know, we've made two acquisitions in the owner wellness center space.

We're looking to get on campus with large employers, small employers throughout the country to do much the same thing, to really provide value and help MO their own healthcare costs directly.

So I really think that it is really focused on the intermediate area within health care and pharmacy benefits--.

These trial costs, as you know, wherever there's a middleman there's a lot of profit and Wal-Mart is attacking that and rightly so and that's our philosophy also, we are in line with them on this particular issue.

Okay.

And then finally, we see the fact that you spent a bit more than you wanted to on promotional expense and people cherry picking the promotions and maybe not spending on other things in the store.

Would having a loyalty card help some of these issues because clearly you get information on what the customer is spending and you can talk at that spending somewhat more effectively.

In retrospect, do you think this is something you should have considered before now?

I think we have lots of vehicles per loyalty, right?

So loyalty is a multidimensional thing.

As Jeff Alluded to, great real estate and great service in a great environment is job number one.

Subscription savings club is another vehicle, you have other ones as well.

I am not saying a loyalty card is good or not good but for it to work here's really two key criteria and number one is how do you differentiate it so it is meaningful to people, and provides real loyalty among things that they want versus just save price alone.

And then number two as you alluded to over time, how do you really make sure that you mine the data in a way which is relevant to them.

So again as Kim Feil comes in we will continue to look at it, and say are all the things we're doing, whether it is Megasavers, our real estate platform, our PCS card, are all those things right for loyalty or some other proposition but you have to go for the filter, being differentiated, being meaningful, and being able to be leveraged beyond the discounts to make sense.

Obviously from practical points of view, how can you get the data without having a loyalty card?

And to analyze the effectiveness of your promotions and enable yourself to be less wasteful?

The promotion effectiveness can be done.

There's lots of tools to do that.

I think it is the segmenting that we obviously have a lot of data on a lot of our shoppers not as broad as maybe a broader loyalty card but the benefit therein lies in being able to do better segmentation.

There's a lot of point of sales tools we utilize in terms of market back.

But also in terms of the spend what I would like to mention is we did spend in terms of marking down products that we didn't have to.

As you know, the average customer comes into our store for 1.6 items, they usually leave with 3.2.

Where we went a little bit too far in the fourth quarter is we marked down items in the store that we didn't necessarily have to once we already got them in, So I think that's a differential there.

Okay.

Thanks very much.

Thanks, Neil.

We will take your next question from Mark Wiltamuth with Morgan Stanley.

Hi.

Good morning.

Wanted to get Wade's views on share buyback and dividends.

If you look at other companies that kind of slowed their unit growth model, McDonald's and others we have seen them increase share buybacks and increase dividends to focus more on return on invested capital.

If you could just talk about your approach on buyback and dividends and then also the single A credit rating has kind of been sacrosanct for some time for you and as you are continuing to put acquisitions out there I am wondering if you are willing to let the single A credit rating go and does that change your approach to the sale lease back market?

I guess I'll flip and start with the last part of your question first.

We still remain committed as ever to keeping a very strong rating.

I believe that's very important to us for lots of reasons.

Least not the credibility it gives us and the flexibility in the real estate markets nd people will be working.

So we are committed to that.

In terms of share buyback we have done some in the past.

We've frozen that program for a while.

I am not saying that we would never relook at it but I think we need to look at all of our different choices in terms of organic growth, some of the opportunistic stuff.

We also want to monitor this economy as we go forward.

I think that there is some good scenarios and some tough scenarios out there.

I think that we want to make sure that we have enough flexibility, enough liquidity, and a rating that's very, very strong and we'll put it through the filter of that.

Okay.

It sounds like at this point acquisitions are still winning out over buybacks and dividends.

Is that fair to say?

Only if they make good financial sense, good strategic sense, and they are within our capabilities.

Okay.

And on the credit rating, the reason I am asking that is the -- I know you don't want to talk about the Longs transaction but that one seems to put you in a position where maybe a credit rating would come to question.

Any comments there?

On the agency, it is obviously written that an acquisition would certainly put some downward pressure on their point of view and we would still be very highly rated I suppose at the end of the day.

I don't know what more I can say versus that, but over the long term here we are very committed to keeping very strong credit ratings.

Okay.

Thank you.

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

I would like to turn the call back to our speaker for any additional or closing remarks.

Since that's our final question, thanks for joining us today.

Remember, we will announce September sales this Thursday, October 2, and we will also be delighted to host an analysts day on October 30.

Our next quarterly financial announcement will be December 22, when we announce fiscal 2009 first quarter results.

Until then have a great day.

Thank you for joining us.

Once again that does conclude today's call.

We do appreciate your participation.

You may disconnect at this time.