沃博聯公司 (WBA) 2009 Q2 法說會逐字稿

Good day, everyone and welcome to the Walgreen Company's second quarter 2009 earnings conference call.

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

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, Angel and good morning, everyone.

Welcome to our second quarter conference call.

Today Greg Wasson, our President and CEO will discuss the quarter's highlights and how we're reinforcing our key strategies through changes in our corporate structure.

Wade Miquelon, Senior Vice President and Chief Financial Officer, will detail the second quarter financial results before we begin taking your calls.

John Spina, our Vice President and Treasurer, also is joining us on the call today.

When we get to your questions, please limit yourself to one question and a follow-up so that we can give an opportunity to as many investors as possible during our limited time.

Today's call is being simulcast on our Investor Relations website, located at investor.walgreens.com.

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

Certain statements and projections of future results made in this presentation constitute forward-looking information that is based on current market, competitive and regulatory expectations that involve risk and uncertainty.

Please see our latest Form 10-K for a discussion of factors as they relate to forward-looking statements.

Now I'll turn the call over to Greg.

Thank you, Rick and thank you everyone for listening to our call.

We appreciate your continued interest in Walgreens.

This is my first call as CEO, which makes it very exciting for me personally, but it's also an exciting time for Walgreens.

First, we're moving fast to execute our growth strategy and strengthen our position as America's most convenient provider of consumer goods and services as well as pharmacy and health and wellness services.

Second, in an economy more challenging than most of us have experienced in our professional lives, Walgreens is well positioned to win.

We're responding to the new consumer landscape with new merchandising efforts focused on value.

And third, we are aggressively reducing costs across the Company and maintain a healthy balance sheet, which gives us significant flexibility at a time when cash is king.

Now let's review the quarter's financial highlights.

Net sales for the quarter were a record $16.5 billion, up 7%.

Comparable store sales, adjusted for calendar shifts and last year's leap day, rose 2.1% in the quarter, while front end comparable sales decreased 0.2% on an adjusted basis.

We are continuing to see evidence of customers changing their buying habits.

Front end comps for discretionary items were down in the second quarter, but that was offset by positive comps for non-discretionary and other items.

Another good sign is that we are holding our own in terms of attracting customers into our stores.

Adjusted for last year's leap day, comparable store traffic was virtually flat in the quarter, when compared with a year ago.

That means we are keeping our doors swinging at a good pace, even while the retail industry as a whole is seeing more doors permanently closed.

Net earnings were $640 million, or $0.65 per share diluted, compared with $686 million, or $0.69 per share diluted a year ago.

Remember that last year's earnings benefited from an extra day due to leap year.

Earnings per share this quarter were reduced by a net $0.04 after costs and benefits for our Rewiring for Growth initiative, which I'll talk about more later.

As we noticed in recent quarters, consumer behavior has changed dramatically in recent months, beyond just the kinds of products they are purchasing.

Job losses and other financial pressures have led to fewer doctor visits, which mean fewer prescriptions being written and filled.

Despite that fact, we filled 164 million prescriptions during the quarter, an increase of 4% over last year's second quarter.

That compares favorably to the industry-wide decline of 1% as reported by IMS, excluding Walgreens.

The first half of fiscal 2009 saw us open or acquire 269 drug stores.

Even though that's 13 fewer openings than a year ago, the significant impact from our slowdown in new store openings will hit later in fiscal 2010 and 2011.

We also opened 117 Take Care Clinics in the first half of the year, including 41 in the second quarter.

During my first 60 days as CEO, one of my key priorities has been to build our management team, and it's structured in a way that fully supports our three key strategies.

Again, those strategies are, one, to leverage the best community store network in America.

Two, to enhance the customer experience inside our stores.

And three, to significantly reduce our costs and boost our productivity.

Now, let me recap the moves we made to our senior management team in the second quarter to put the right people in charge of the right processes.

First, Randy Lewis, who was in charge of logistics and distribution, is now our Senior Vice President for Supply Chain Management.

A pipeline with tremendous opportunity for inventory and cost reduction.

Now, George Real, is now leading the ongoing roll-out of our new Power Pharmacy program which I'll talk a little more about later.

George will also continue to manage pharmaceutical purchasing.

And Bryan Pugh is now leading our merchandising division for all front end categories in addition to developing new store formats.

Finally, Tom Connelly takes over our facilities division.

Tom is replacing Bill Shield, who retired after 38 years with us.

Bill had the hard work of turning our vision of 7,000 community stores into reality, and we certainly thank him for that.

In addition to securing the best store sites in America, Tom will take more of a portfolio management approach toward our slowing organic store growth rate.

Historically, that growth rate was in the 8% range and even reached 9% in fiscal 2008.

Now that we're stepping down that rate to between 2.5 and 3% by 2011, it's absolutely the right thing to do for three reasons.

First, it provides flexibility to invest in our core strategies and improve shareholder value.

Second, we'll have more time to develop management and focus on the shopper experience.

And third, it's a prudent step in the context of today's economic conditions.

We're seeing consolidation continue in the industry and our financial flexibility allows us to take advantage of these opportunities when they make sense.

Last week, we agreed to acquire prescription files from 11 Drug Fair pharmacies in New Jersey along with 32 other Drug Fair locations we would purchase and operate.

Also in February, we agreed to acquire 12 Rite-Aid locations in San Francisco and Eastern Idaho.

The next piece of our strategy I want to update you on is enhancing our customer experience.

One of the ways we're tackling this is through our Customer Centric Retailing project.

CCR is about streamlining assortments and reworking promotions.

It's not simply about SKU reduction but about prioritizing categories and items within categories.

As an example, we plan to give more space and add items to categories like skincare and cosmetics.

These are signature categories that build our brand and create loyal customers.

We're rolling out 40 categories with optimized assortments to all of our stores by this fall.

These categories account for more than half of our front end sales.

We'll do the roll-out at the same time we normally do resets in order to avoid disruption during peak sales periods.

New formats driven by CCR, will be piloted in 35 stores by summer.

These stores will represent various markets and demographics so that we get a good read on results.

Besides the new assortment of basic departments, these stores will include a lower store profiles and new layouts designed around customer solutions.

After analyzing this initial effort and confirming its success, we plan to fully convert several hundred stores to CCR before Halloween.

Then, after holding for the holiday sales period and making any needed adjustments, we plan a rollout of CCR formats at the beginning of calendar 2010.

Over the next 18 months, our goal is to touch every store in the chain.

That's what I mean when I say we're going to juice our stores.

Obviously, this will cost some money, and we'll pay for it by refocusing some dollars previously earmarked for new stores to taking care of the older ones.

One part of CCR that has moved forward very quickly is our affordable essentials program, launched chain wide in February.

This program includes basic staples such as food, paper products, toiletries and other consumables marketed together to move customers up to Walgreens, from traditional value retailers.

And the third piece of our strategy I want to highlight is cost reductions and productivity gains.

Over the past four quarters, we've made dramatic improvement with selling, general and administrative costs, which has allowed us to better leverage gross profit dollars.

That continued this quarter.

SG&A cost increased only 8.1% in the second quarter over the year-ago period.

The increase was only 5.7% when factoring out our net restructuring costs.

Meanwhile, gross profit dollars increased 5.1% on an adjusted basis.

We expect this momentum to continue as our corporate restructuring program, called Rewiring for Growth, moves forward.

We took our first steps under this plan in January, when about 400 corporate and field management employees took advantage of our voluntary separate program.

Many of them spent 25 years or more with Walgreens and are the ones who built the systems and executed the strategies that took this company to new levels of success.

We're certainly in their debt for all they accomplished, and now it's our job to build upon those accomplishments.

Earlier this month, nearly 200 additional jobs were eliminated from corporate and field management staff.

These moves, along with our voluntary separation program and other labor savings, are streamlining our corporate structure.

They also put us on target toward our goal by eliminating 1,000 corporate and field positions by the end of August which will contribute to $1 billion in annual cost savings in fiscal 2011.

Of the many structural changes we're making, one that really excites me is the decision to move our 29 store operations, Market Vice Presidents out of the corporate office.

Today, they reside in the market for which they are responsible.

They'll support all of our businesses in that area to drive growth and profitability.

This level of leadership, on the ground and living in the market, will move us from operating stores in communities, to serving communities across America.

We also expect to achieve cost savings, productivity gains, and improved pharmacy patient experience through the roll-out of Power.

Power moves the administrative tasks involved in filling prescriptions to central facilities.

Enables our store pharmacists to spend more time as a trusted clinician with our patients.

It also means our pharmacists can provide additional healthcare services such as wellness management and immunizations, and it makes us more competitive by improving the efficiency of our filling process.

Power also ties in closely with our slowing of organic store growth.

With Power's added capacity, we won't have to open new stores as quickly to relieve high pharmacy volumes at existing stores.

Power has already been implemented in nearly 400 of our approximately 780 Florida stores with 19% of prescriptions being filled at our central facility.

In addition, more than 30 Arizona stores are using key components of Power.

George Real will manage the roll-out to the remainder of the Florida stores by the end of August, converting pharmacies to this system is as much about change management as it is about technology.

And George, who is a pharmacist, and led the launch of our original online pharmacy in the late '90s, is the best person to help our pharmacists adapt to the changes that will transform how community pharmacy is practiced.

Now, I'd like to update you on our health and wellness division and what our folks there are doing to expand health services through our community store network.

In January, we connected our prescription drug offering, retail clinics and work site health and wellness centers under one umbrella called Complete Care and Well-being.

This program provides large employers with affordable, accessible and high quality care for their employees, dependents and retirees no matter where they work or live.

On the retail clinic front, we opened 41 Take Care clinics during the quarter, and openings will continue this year.

Beyond just increasing the number of clinics, we're also working to expand our service offerings to patients.

Some that we recently introduced or plan to in the future include health evaluations, an expanded vaccine suite, skin assessments and procedures, and disease management services for hypertension, diabetes and cardiovascular disease that will be integrated with the medical community.

In addition, in two Florida markets, we're piloting our Take Care clinics as administration sites for the injection infusion of specialty drugs.

Program's a preview of how we can integrate businesses like home care and Specialty Pharmacy with work site health centers, in store clinics and our retail pharmacies.

These services and others also will help reduce the seasonality inherent in the clinic business.

In addition to building strong relationships with employers, we're going direct to consumers.

For our Prescription Savings Club.

The Club has 1.7 million members, more than 30% of them are new to Walgreens.

Plus, PSC members like the convenience of picking up a 90 day supply at their local pharmacy.

As a result, they're bringing us their entire pharmacy business, and increasing their compliance with their medication.

Now, before turning the call over to Wade, I'd like to comment briefly on the economy and healthcare reform.

The new economy and its effect on consumers is dramatically changing the retail landscape.

Many people have commented about a once in a generation shift in consumer attitude.

We're adjusting immediately to this new consumer through programs like Affordable Essentials and stronger promotion of our private brands.

I'd like to point out that we're being extremely prudent in our capital allocation and protecting our balance sheet.

Believe our cash position and credit ratings are reassuring to investors during these turbulent times.

And finally, President Obama's plan for healthcare reform would certainly impact the retail pharmacy industry.

His plans call for affordable and accessible healthcare, and he understands that medication can lower overall health costs.

We are well positioned to respond with our convenient pharmacy and health and wellness services, and that's one of the reasons why I'm so optimistic about our future, even while we navigate some extremely difficult retail waters and align our Company with the new realities.

We also have the advantages of, one, selling basic necessities that people need.

Two, convenient locations in communities where people live and work.

And a winning strategy and good progress on key initiatives to move us forward.

Finally, a top management team that blends internal expertise, outside talent and new thinking.

So now Wade will update you on the specific financial results for the quarter.

Wade?

Thank you, Greg.

I would like to reiterate Greg's confidence in our three key strategies and their ability to.

Turning to the quarter, net sales increased 7% while total comparable sales rose 1.3%.

Total comp sales were negatively impacted by 0.8 percentage points for the calendar shift and last year's leap day.

This places us in good shape compared with other retailers, and we believe a good sign of health, given the amount of transformation that we are currently undertaking.

Prescription sales rose 7.8% and represent 63% of sales for the quarter.

Prescription sales in comparable stores rose a solid 2.9% and were negatively impacted by 0.7 percentage points by calendar shift and last year's leap day.

The number of prescriptions filled in comparable stores increased 0.3%.

That was negatively impacted by 1.6 percentage points, by more patients filling 90 day scripts versus 30 day scripts.

Also, calendar shifts and last year's leap day negatively impacted comparable scripts by 0.7 percentage points.

Net earnings in the second quarter were $640 million, a 6.7% decline from last year.

This year's quarter included a $93 million impact or $0.06 per share from costs associated with Rewiring for Growth.

We are now starting to see some Rewire benefits as well and this quarter had approximately $0.02 per share benefit from Rewire, giving us net costs from the program of approximately $0.04 per share.

In addition, the quarter included impacts of a negative $0.01 per share for the LIFO reserve versus a year ago.

And negative $0.01 per share for interest expense above the prior year.

Net these items, we had a total year on year quarterly cost of $0.08 per share or $0.06 per share after factoring in the rewire benefits.

Looking at our sales performance in recent quarters, you'll note the numbers have essentially stabilized in a very tough retail environment.

With the progress we're making on programs such as CCR, and the Affordable Essentials roll-out, I believe we're poised to grow sales in the front end despite the challenging economy.

Gross profit in the second quarter was $4.7 billion, or a 4.8% increase versus the year-ago quarter, reflecting the slowing economy.

Gross margin was down 60 basis points in the quarter compared with the prior year.

Negatively impacting margins were lower front end margins due to promotional pricing and product mix, non-retail businesses and a higher LIFO provision.

Helping overall margins was an increase in pharmacy margins as a result of the impact of generic drug sales.

Before addressing SG&A expenses and the impacts of the slowdown in store openings, I'd like to revisit a couple of slides that we first introduced in the first quarter of 2008, and we are updating today.

This slide shows the front end performance by store class for each of the past seven years.

You'll see that despite a weak retail environment, our newest class of stores is performing close to the long-term average.

Simply put, our store front ends are as productive as always.

On the pharmacy side, our newest class of stores is a little below average which can be attributed to several factors.

First, we're opening more stores recently in markets that tend to build script counts at a slower initial rate.

Second, we're operating fewer 24 hour pharmacies as a percentage of overall pharmacies.

Third, the economy is affecting the number of scripts patients are filling.

And finally, we're seeing a market impact from 30 day scripts converting to 90 days.

Still, our new store ramp-up curve remains fairly robust, and although scripts have slowed slightly in the 2007 class, we expect them to return to their historical growth rate as the economy improves, and as initiatives such as Power and Prescription Savings Club continue to separate our pharmacy from the pack.

Cost control has been a central focus for the past 18 months, and our significant progress in cutting SG&A growth continued this quarter.

Our increase in SG&A dollars in the second quarter was only 8.1%, and just 5.7% if you take out the cost for Rewiring for Growth.

On a two year stacked basis, SG&A dollar growth for the second quarter has declined from 25.5% to 16.9%, primarily due to salary and store expense control.

Going forward, slowing new store openings, opening fewer retail clinics, and realizing significant cost benefits for Rewiring for Growth will all reduce growth in future SG&A.

Let me show you where we are in the cost reduction progress.

Three primary areas of opportunity include Strategic Sourcing of indirect spend, corporate, field, and store overhead and Power.

This chart shows the schedule of costs and benefits associated with Rewire on an EPS basis.

We reported $93 million in restructuring costs in the second quarter.

That included $59 million for voluntary and involuntary employee separations, $11 million for inventory write-downs associated with CCR, and $23 million for consulting and other costs.

Overall, we are still on track for $300 million to $400 million in costs through fiscal 2010.

Now, originally we had thought that 2009 costs and benefits would offset each other in this fiscal year.

Now we expect a few cents per share net negative impact as we have accelerated some of our Rewire cost efforts.

But again, we are on track with respect to our total costs as well as on track to record more than $500 million in net benefits in fiscal 2010 and we are also on target to achieve our long-term objective of $1 billion in annual cost reductions by fiscal 2011.

Now, let's look at some of our other financial drivers in the quarter.

The LIFO provision was $49 million versus $31 million in the second quarter of 2008.

Primarily reflecting higher than anticipated price increases for non-prescription drugs and other front end merchandise.

Next are the $93 million in restructuring costs that I have summarized previously.

Net interest expense was $20 million compared with $2 million last year, due to the issuance of $2.3 billion in long-term debt.

The effective tax rate was 36.7% compared with a rate of 36.8% in the year-ago period.

Accounts receivable were up 21.2% in the quarter, driven primarily by growth in third party retail prescription sales and the impact of the quarter ending on a Saturday.

Thanks to excellent supply chain management by everyone, inventories grew only 3.5% despite a sales gain of 7%.

Accounts payable increased 17.9%, again, due primarily to normal business growth and the quarter ending on a Saturday.

As part of our focus on liquidity we held a successful bond offering in the quarter of $1 billion 5.25% 10 year Treasury bonds, that was a spread of 2.875% to benchmark Treasury notes, an exceptional result in these times by any standard.

Our net debt at the end of the quarter was $785 million compared with $1.5 billion at the end of the first quarter.

And that reflects long-term debt of $2.3 billion, offset by cash and cash equivalents of $1.6 billion.

Net, we finished the quarter with more than $2.8 billion in cash and credit lines available, more than sufficient to operate in the toughest retail environments and to drive our winning strategies.

Hence, we feel great about our financial strength and liquidity and our balance sheet should only strengthen as we slow store growth, improve inventory, drive cost savings and work our way back to target double-digit earnings growth over the next few years.

Depreciation and amortization for the quarter was $242 million, up 19.3% over year-ago.

A big driver was amortization for prescription file buys, which continue to be robust.

For the first half of the fiscal year, we invested $1.1 billion in additions to property, plant and equipment versus $1.0 billion last year.

And mostly for the addition of 245 new stores versus 275 last year.

We continue to estimate the capital spending for the full year will come in at around $1.8 billion, or about $400 million less than fiscal 2008.

Free cash flow amounted to $647 million for the first half of the fiscal year, up 40% from year ago.

Disciplined operations, inventory control, and a slight slowdown in store openings was a driving factors here.

Many of you have asked about forecasting capital expenditures in future years and in particular, cost per store remodels and refreshes.

Much of that will be expense dollars included in our Rewiring for Growth costs that we have outlined.

If there are remodels that require capital expenditures, we'll outline those for you in the future.

As a general rule we would expect our capital investment to continue to decline over time.

But we're just not prepared yet to put a dollar amount on that.

So, wrapping things up, I believe we are off to a great start with our three key strategies and that they will take us to an entirely new level over time.

The strategies are in motion and we're starting to see the fruits of that labor and we remain committed to return to double-digit earnings growth as part of our overall shareholder plan to create long-term value for our shareholders.

And now, I'd like to turn the call back over to Rick.

Thank you, Wade.

Angel, that concludes our prepared remarks, we're now ready to take questions.

Okay.

Thank you.

And the question-and-answer session will be conducted electronically.

(Operator Instructions).

And we'll take our first caller, Mr.

Andrew Wolf of BB&T Capital.

Ask you a few questions on the sales.

On just I guess Greg, do you see a permanent shift towards staples from discretionary in Walgreen stores?

You know, requiring fairly fundamental change in your mix, your merchandising, your pricing and is this signaled by your hiring a new merchandiser from outside, not just outside Walgreens but from the discount store industry?

I don't see a permanent shift, Andy.

I do think that the right balance between making sure we have good value items, such as Affordable Essentials that are stacked up in stores with prominence in our ads, in our stores, to swing doors is critical.

Obviously the right balance is to make sure we offset any margin pressure that we'd see from value pricing.

It's got to be adjusted in the mix and how we promote.

And I think one of the things you'll see us do is really aggressively promote our private brand to help offset that.

I do think going to Bryan Pugh, who we now moved into our merchandising area, I think Brian is going to bring a lot of great experience.

We're really looking to get to understand our customer, and know our customer more, we can file, I think you'll see a lot more targeted merchandising towards our customers.

I will just pile on there and say I think part of this is also recognizing that we do have the best retail corners in America and making sure we have the right staple offerings there is just simply the right thing to do.

In terms of driving traffic or just because gets back to the original point of the question, because that's at least now and maybe into the future what a drugstore can expect consumers to take away.

As I said, Andy, I'm hoping I get to your question.

I think you'll see us continue to make sure that we're swinging doors as I said.

We're going to have good value items on the front page of rotos.

We're going to have good value items stacked up in our stores.

At the same time, I think the merchandise selection, promotional activity you'll be seeing will help offset that margin, and I think there's tremendous upside generally on private label.

So you're going to remain committed to general merchandise and a pretty robust gift and Christmas program?

Absolutely.

One of the things we hear loud and clear is that our consumer likes our fun atmosphere, they like seasonal, they like being able to find items quickly, the new items as they're launched, so we're not going to deviate from that part of our business.

That's where we excel and have excelled for years.

Thanks, and just one follow-on, Wade, on the cost, on the rewire initiatives.

I've heard that, and I assumed that this would be the case anyway, so you're really managing down full-time equivalents with some top down directives at the store level and also overtime pay whether it's for assistants or what have you.

How are you considering that?

Is that part of your Rewire savings or is that part of the normal course of just running a tighter ship at Walgreens?

I guess what I would say is that we are looking at everything off of the 2008 base.

We're looking for, as you know, savings in three buckets.

The middle bucket is really looking for savings in corporate overhead, field management and at the store level, to the extent there is some tightening there, yes, that's factored into it.

Okay.

So on a pro forma or run rate basis, have you given what you've done at the store level, have you already reached the 1,000 heads on a full-time equivalent basis?

That 1,000 heads isn't a store level number really.

That 1,000 heads is more of a corporate and field level.

So that's a really separate initiative.

Again, for the 1,000 number we've been targeting, it's really primarily corporate and field management separate from store labor.

Let me one follow-up and then I'll surrender.

So at the store level, could you take -- what is the full-time equivalent reduction that you think is it's going to work out to?

We haven't given any numbers or thoughts on that.

Obviously, if we're going to reduce labor there, we're going to have to reengineer processes.

People work very hard at the store, they have a lot to do, so making sure we that we have simpler promotions, fewer allotments, that's going to help.

We haven't given any specifics on that to date.

Okay.

Thank you.

And next we'll go to Robert Willoughby of Banc of America.

Good morning, Robert.

Good morning, Robert.

On the receivables build there, can you comment on how much may be attributable to the shift into the healthcare franchises that you have and then just a follow-up, have you really clearly laid out kind of plans for cash, how much kind of goes into retail, how much goes into healthcare over the next 12 months?

Yeah, I would say that there's not really any market shift from the mix in healthcare there.

The primary reason for the slight receivables change year on year again is really the Saturday timing.

So you'll see that balance out over time.

Also as has been in the public domain, a little bit of timing on some of the Medicaid payments but that should work its way out over time.

Essentially what you see is anomaly, mostly of ending on a Saturday.

And just how you split your CapEx going forward between healthcare and retail?

Well, you know, the bulk of it is still going to be on the core, right?

Everything we're doing is to reinforce the core.

The bulk of our spending is things like new store openings, remodel refreshing on our stores, IT infrastructure and distribution infrastructure to support our stores.

So the overwhelming majority will continue to be on the core.

I can't get you to kind of commit to a healthcare acquisitions spend by any means, could I?

No.

Okay.

All right.

Thank you.

Next we'll go to John Ransom of Raymond James.

Hi, good morning.

Could you tell me your SKU rationalization, how much is that affecting your front end sales and when do you think you'll be through that process?

John, this is Greg.

We are just beginning to as I said roll out some of the categories.

We're not seeing any effect on front end sales.

Actually, we're looking for an opportunity to grow sales.

But keep in mind, we're through about 50 to 60% of the categories and merchandise we have now.

Okay.

We're going to roll out 40 of those as I said by fall.

We're looking at the results as we roll them out.

And then we'll begin to pilot full CCR formats in 35 stores this spring.

Just an idea of how many SKUs you're trying to take out and has that changed since you talked, started talking about it this fall.

Has the type of stuff you're taking out changed as you learn more?

I think the one thing that we are doing is we had maybe a year ago had kind of had a benchmark goal out there of a percent reduction but I think it's much more laser focused now by category.

You may see some categories where there may be a 20, 30% reduction.

Maybe see some of our signature categories with maybe a single digit reduction.

I think it's really using shopper based principles to really determine what those merchandise categories should be and how to optimize them.

What percent of your front end is Walgreen private label versus third party and where do you thing think that could get to in a couple years?

About 20% of our business is private label now, still growing, fairly healthily.

I only have to surmise what it could be.

As we're seeing countries overseas, Germany, UK, et cetera.

Those, at the very high end, can approach 40% over time.

I think it depends by category and at the end of the day how do we make our brands play very well with our private label to kind of have an overall portfolio to give the customer the right choice.

Okay.

That's helpful.

And then the other thing I wanted to ask you was this 30 day going to 90 day at retail, I know one of your responses is to do more automated prescription fills to lower your costs.

Is there any other strategic response that you might use with your mail order or otherwise to get ahead of this?

Yeah, I think one of if things we're most excited about is the Power initiative that we talked about.

I think we have tremendous opportunity there to take costs out.

We're central filling in Orlando now about 19% of chronic prescriptions.

We think there's tremendous upside there yet.

Okay.

We're also moving as you know a lot of the work such as insurance verification, so forth, out, which is reducing a lot of the tasks within the store.

I also think our PSC card, what we're really seeing is we're seeing 20% of the prescriptions filled are being filled for 90 day supplies versus the typical prescription trend of about 4%.

So we're encouraged that folks look for 90 day supply within the drug channel and the convenience we offer.

Okay.

And then finally, how much is Take Care costing you this year?

I know CVS has talked about something like about a nickel dilution.

Is Take Care going to be profitable?

When do you think that might hit profit assuming it's not profitable now and how much is that costing you?

It's costing almost $0.06 a share.

We believe this year is probably the most dilutive year.

In other words, we'll start to accrete moving forward.

Although we won't move in the black next year, it will be less losses.

Just remember, this mode,l to become profitability on a stand alone basis without a script or front end sale, so our model typically runs two to three years.

Those losses we're incurring are not because our older stores, our older clinics aren't accretive or productive, it's just the timing of putting in so many clinics in the last year.

When we become profitable is sort of a function on when those overall majority of stores start to get in that two to three year aging cycle.

I'd like to add, we're seeing our mature stores that are surpassing breakevens.

I would like to point out, I do not see this as a seasonal business.

I absolutely think that strategically, long-term these providing access to affordable healthcare is a huge opportunity for us to leverage our community stores within the -- that's the reason we're putting a lot of effort into additional services that can be offered through the clinics as well as leveraging Walgreens' labor model to help improve the operating model within the clinics.

Are you guys still taking off the table, if a big health plan wants to sell their PBM, is that still something strategically that you would say is off the table or is that something you might look at now?

We certainly continue to -- our key strategy is to broaden and deepen our payer relationships with managed care organizations and PBMs at large.

.

So we don't certainly see a deviation from that at this point in time.

And I can't comment on any specifics in that

All right.

Thank you.

And next we'll go to Neil Currie of UBS.

Hi, thank you for taking my question.

Just a quick one.

Bryan Pugh's appointment as head of the merchandising initiatives at the front end, and also he has a role in format.

Could you maybe give us a bit more detail as to what his role is here, and what formats you might be considering and whether you might venture into any particularly new formats?

Yeah, Neil.

I originally brought him to lead new formats and I've recently given him front-end merchandising.

As far as new formats I think initially it will be making sure that we launch the CCR initiative that we have across the chain in a very prudent, efficient manner.

We will be testing, as I said, in 35 stores, that new format, which is lower profile, low profiles, as well as optimized merchandising.

But also, we will begin to explore new formats, based on our customer research that we're getting from Kim Feil, our new CMO, and begin to pilot in select stores.

I think there's tremendous opportunity, now that we've brought all the resources together under Bryan to really begin to be more efficient, to learn and study what we pilot.

We're looking at high volume urban locations and how we can leverage new formats to help accelerate our growth in urban areas and so forth.

So I think Bryan's going to really help thus.

Would you consider formats without a pharmacy?

I don't think anything is off the table but certainly being a pharmacy and that being our franchise, I think it really be something that we'd have to consider.

So I don't see that being studied right now.

We do have a few stores today that are very successful without a pharmacy but those are in very specialized locations, maybe tourist areas or whatever but broad scale it really doesn't make any sense for us.

I'm just wondering where you are right now in terms of SKU rationalization, are there any figures you can give us around that?

As we outlined in the script, we're getting ready to move not only to those 30 or so pilot stores but also a reset of 40% of the categories through the fall here.

Again, as Greg said, there's no one size fits all for categories.

We're probably looking in that 15% to 17% overall reduction range.

Some categories maybe being flat or slightly up if they're signature, other ones being down more markedly.

I do want to emphasize that because of the SKUs we're taking out, either very slow moving, have lots of better alternatives in the store, aren't desired by our customer base, et cetera, that category by category we believe that it's an opportunity to actually build sales through better facings, through more relative seeds for better preselection, than it is to risk losing sales and the key will be executing it flawlessly.

Certainly signature categories I referred to such as skin, and over-the-counter cough and cold and so forth you're seeing less SKU reductions than some our discretionary categories such as hardware our automotive, and so forth.

Okay.

Thank you.

Next we'll go to Deborah Weinswig with Citi.

Good morning.

A few questions.

Previously, I think it was at the analyst meeting back in 2008, you had talked about a comprehensive loyalty program which would include the Walgreens Prescription Savings Club but also potentially more of like a typical rewards card like CVS has with Extra Care.

Can you talk about your current thoughts there?

We brought Kim Feil in as our new Chief Marketing Officer.

As you know, she's got a strong IRI background, customer insight, customer research.

Certainly we believe that to improve and accelerate customer loyalty within our franchise, it's an opportunity.

Kim's first objective was to study and learn who our customer is and more about our customer and how to target those customers.

With that we certainly think a loyalty program is of value and she's working through how we would consider going to market and the proper loyalty program for Walgreens.

So lot of effort being put there, Deborah.

Okay.

Very helpful.

On the real estate side since you are one of the retailers who are still growing, can you talk about what you're seeing with regards to construction costs, site availability and also your ability to renegotiate leases?

I think restructuring costs have been basically flat, maybe slightly better.

I think availability, we're probably going to see more availability than we've seen in the past.

Again, we only go for best corners.

Historically, we tend to maybe be looking at those corners versus retail banks and others so that will probably open up over time.

But on renegotiation, I would say no.

In general, I think we structure these deals, these long-term deals in a way that we believe is beneficial for both parties.

I think that even if we're able to renegotiate or restructure some, it wouldn't be a marked amount of money.

Last question, on the Power initiative on Florida, how are the stores benefiting and have you seen am impact on the consumer as a result of increased attention by the pharmacist and maybe how are you measuring that?

That's exactly one of the main benefits from Power is to improve service levels and free the pharmacists up, and certainly we're measuring, and we see kind of a neutral effect right now and I think that's probably good, Deborah, because there's -- with any system roll-out, there's a lot of technology, a lot of change management that we're throwing into the market.

I think we're certainly pleased with what we're seeing.

I think the potential to improve service levels and really allow that pharmacist to spend more time with patients is going to be incredible and that's the reason we continue to roll it out.

Thanks so much and best of luck.

Thank you.

Next we'll go to John Heinbockel with Goldman Sachs.

Couple things.

How would you guys when you look at the front end margin reduction, how would you generally break that out, discretionary, clearance, markdowns, around Christmas versus normal promotional activity that you'll have pretty much every quarter?

I'll give it to you a few different ways.

We have a little bit of drag from the businesses like specialty which have a lower margin but very small.

Our gain was from the RX retail margin, and then the front end margin was down maybe 70% of that.

But at the end of the day, almost the entire reduction could be attributed to seasonal, close-out and clearance.

I think we did pretty well this seasonal period, all things considered, especially since our buying happened far before we saw the total impact of the recession.

And I think as we move forward, we made the right adjustments for that.

But I guess the other way I'm saying is you could slice it is that almost all of it is essentially some type of seasonal or write-down mix.

Yeah.

John, I think we did a pretty good job in pulling down our seasonal buy for the hot Christmas and holiday.

But at the same time, obviously there are a lot of folks out there that were early with markdowns that we had to react to.

I think even more so is we did decide to take some markdowns because we wanted to turn that inventory into cash this year and I think that was a prudent thing to do.

Certainly, we've reacted to the upcoming season as Wade said, to make sure that we adjusted due to the new economy.

And Easter's fundamentally different than Christmas in terms of discretionary importance, so you would not expect the same type or anything close to it for Easter?

We feel pretty good with Easter right now.

Again, we were able to make the adjustment with our buy.

We've got the longer selling season this year, two extra weeks in April.

So we certainly don't expect and hope to have the same type of markdown challenge that we had with the Christmas holiday.

We feel pretty good.

Is there a plan to sort of manage non-discretionary front end growth to a certain level, maybe flat, and keep investing in value along side whatever cost reduction you're getting or do you actually think you see some improvement there?

I think we're seeing a lift in non-discretionary categories and other items now, offsetting the drop and deterioration we're seeing in more discretionary categories.

I think that balance will be critical and that's the reason again I think there's more opportunity for us to continue to grow our private label sales which will offset that margin.

I wouldn't see any reason why we couldn't strive to make improvements in margin in all of our categories, whether we're being more targeted in discretionary or whether we're flowing our staples through more effectively, or whether we're driving more business to private label, et cetera.

All right.

Finally, what do we see right now with regard to reimbursement pressure?

I mean, I know it's always there.

Has it picked up given the macro, will it pick up and doesn't look like we're seeing a lot of issue -- a lot of big cuts on the Medicaid front state-wide.

But is that coming?

I think as you said, we've experienced reimbursement pressures and constantly manage that.

Hey, John, I think with healthcare reform, there's going to be opportunities for us to provide access solutions, but at the same time, there's going to be continued reimbursement pressure and I think we've got to continue to do what we've done over the years and manage that aggressively, build the resources, make sure Stan Blaylock over at Walgreen Health Services has the horsepower to continue to manage and get the best reimbursement for us.

I think we'll continue to see it.

I don't see it accelerating any more aggressive than it's been in the past but certainly we're prepared for it.

Okay.

Thanks.

Looks like we have time for two more questions today.

We'll take our next one from Ed Kelly from Credit Suisse.

Good morning, guys.

Hi, Ed.

Greg, how do you manage the risk of hurting sales by pulling product out that maybe your more loyal customers are looking for in terms of the SKU rationalization and does not having a loyalty card program raise that level of execution risk?

Well, yeah, good question, Ed.

I think as far as how we manage the risk, as I said, we're really using what we call shopper based principles to look at these departments and we're truly looking item by item and what the true profitability of an item is, but we're also looking at the regional and the geographic value of each item as well.

So we're really being careful not to select and not to cut out what's really made us unique, and that's the fact that we typically do have the items that fit certain geographies.

So being real careful there.

As far as the loyalty, not having a loyalty program, does it add additional risk?

I don't believe so.

I think I see us -- I see tremendous opportunity as we go forward as we know more who our customer is and how to market directly towards the customer.

I think we're managing that risk prudently and appropriately.

I'll just build on Greg's comments here.

On the SKU reduction, we're being extraordinarily thoughtful and apart from the profitability analysis, also we're doing detailed shopper basket analysis by category to make sure the end proposition is even better, the vetting process for testing, for wave rollouts, is going to give us lots of opportunities to make sure that our read is what we believe.

We should be good there.

As Greg said, I think building more loyalty is a great opportunity for us and we invested heavy in loyalty in the past in things like the best corners in America but to the extent there's other things we can do that make sense, we'll certainly consider it.

You've been more aggressive on the new store acquisition front recently.

How important will this be going forward?

How do you evaluate these opportunities?

And just how do you balance doing this with focusing just on improving your core store base?

I think that as we always do, we certainly look at every opportunity to make sure it fits strategically, Ed, as well as gives us the right ROIC that we need going forward.

I think we're continuing to see pressure and industry consolidation that we have to look at and analyze and do it appropriately.

That's kind of what I meant by Tom Connelly changing our real estate strategy to more of a portfolio strategy going forward.

If there is an opportunity that makes sense in a certain geography, we'll consider it.

But we'll certainly manage that mix between organic and potential opportunities in a prudent way.

Greg, I mean, the the Company in the past made a bid more or at least attempted to look at Longs Drugstores.

Now that you're CEO, I mean, are you open to doing something like a larger deal or do you think there's just more value in focusing on your core store base right now?

I think right now we're absolutely focused on our three part strategy, Ed, which is the taking and leveraging those 6500 stores we have and improving the front end.

I think there's tremendous value there.

I do think that we will absolutely consider every opportunity and if it makes sense strategically and if it makes sense financially we'll certainly consider it going forward.

Okay.

Thank you.

And we'll take our last question from Lisa Gill of JPMorgan.

Thanks very much and good morning.

Greg, in the past you've talked about utilization trends and I think you made the comment that there are less doctor visits, et cetera, but yet it looks like your numbers are pretty strong on the pharmacy side and then additionally, it looks like RX retail gains on the gross profit side are coming from generic utilization.

Could you talk about those two things.

Are you taking market share, is that why your numbers still look positive on the pharmacy side?

Secondly, could you talk about what you're seeing for generic utilization trends, are you seeing a conversion within your book and as you take that opportunity to now do some central sale and have more time with the member, is this giving you an opportunity to convert people from a one therapeutic class, I'm sorry from one therapeutic prescription to another, for example, within the statin class, moving a member to a generic.

Good questions, Lisa.

I'll try to get to all of them.

We do continue to take and grow our market share within pharmacy.

We do have the luxury as state in the call that we're going against some softening trends this time last year but we're also continuing to outpace IMS.

I think there's several things going on.

I think that we are doing very well with our PSC card in response to the class of $4 generics from a year ago.

We're actually seeing an increase in that category going forward.

So I think that shows that our convenience and our strategy work there.

I think we're continuing to see some struggles within the industry in this economic environment with independents and regional chains and potential there.

I think we're really, really promoting service as we go forward.

As far as generic utilization and our book, I think we are and will continue to see increased utilization over the next several years.

I wouldn't say that we're where we want to be yet on therapeutic generic opportunities.

I do think that the opportunity exists with our pharmacists having more time and being freed up by Power to do more therapeutic switches, but I wouldn't say that we've seen a huge opportunity there yet.

But I do think the other opportunities that we're seeing, immunizations and vaccinations are tremendous opportunities with Zostavax being a vaccine for 55-year-old and older seniors across the country.

So hopefully that gets to your questions, Lisa.

Just as a follow-up, when you think about central fill and obviously you're doing it in the Florida market but is there an opportunity to roll this out nationwide and if so, what percentage of your prescriptions do you think you could see going through central fill?

Maybe I'll take the second question first.

I think there's potential for maybe 30, 35% or so of our prescriptions to go through central fill, that's kind of backing in from the percentage of chronic prescriptions that we could fill ahead of time.

The second will be really more dependent on how successful we are with state regulations, legislation, that allow us to fill across states and between states.

We certainly are leveraging our Orlando mail service facility in Florida.

We intend to leverage our Tempe mail service facility in Arizona to begin to central fill and aggressively work to show the value that we are seeing in Florida, as we work with other states to improve the legislative process.

Is that it, Lisa?

That does conclude the question-and-answer session for today.

At this time Mr.

Hans, I would like to turn the conference back over to you for any additional or closing remarks.

Folks, that was our final question.

Thank you for joining us today.

We'll announce March sales on April 2nd.

Please keep in mind that Easter falls in April this year compared to last year's March Easter, which was the earliest since 1913.

This will of course have a big impact on our March front-end sales comps .

You'll need to look at combined March-April sales to get a true picture of performance for those months.

Our next quarterly financial announcement will be Monday, June 22nd, when we announce fiscal 2009 third quarter results.

Until then, thank you for

We thank you for your participation.

That concludes today's conference.

You may now disconnect.

Have a great day.