沃博聯公司 (WBA) 2009 Q4 法說會逐字稿

Good day everyone and welcome to the Walgreen Co.

fourth quarter 2009 earnings conference call.

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

And now I'd like to turn the call over to Rick Hans, Divisional Vice President of Investor Relations and Finance.

Please go ahead.

Thank you, and good morning everyone.

I apologize for the little bit of a late start here, little technical problem.

Welcome to our fourth quarter conference call.

Today, Greg Wasson our President and CEO will discuss the quarter's highlights and the macro environment.

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

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

You can find a link to our webcast under Investor Relations at Walgreens.com.

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

We're also making the call available as a podcast for the first time.

You can download that too at our Investor Relations website.

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 latest Forms 10-K and 10-Q 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.

Today I'm going to review our progress this quarter, address the macro environment, including the economy and healthcare reform, and update you regarding some of the innovative programs we're implementing across the Company.

In the fourth quarter, we posted solid results in a difficult economy, while seeing the first net financial benefits from our restructuring initiatives.

Net sales for the quarter were $15.7 billion, up 7.6%.

Consumers are concerned about rising unemployment, keeping their homes and paying down their credit cards.

They're focused on value and are buying needs versus wants but even in this challenging environment, our people delivered record sales.

Net earnings were $436 million or $0.44 per diluted share, compared with $443 million or $0.45 per diluted share a year ago.

For the fiscal year, net sales were a record $63.3 billion, up 7.3%.

Net earnings were $2.01 billion or $2.02 per diluted share.

In fiscal 2008, net earnings were $2.16 billion or $2.17 per diluted share.

Cash flow from operations in fiscal 2009 was up 35% over a year ago, fully a record $4.1 billion.

Looking back on fiscal 2009, we reported another record sales year which was marked by one of the most important strategic and operational transformations in our Company's 108 year history.

We did it while navigating through the most severe economic downturn in decades and preparing for potentially the biggest reform of our healthcare system since Medicare.

As a result, we've adjusted our retail model to respond to what we believe will be lasting changes in consumer behavior.

In addition, we're positioning our Company for healthcare changes that will place a greater focus on preventing and managing chronic disease and promoting health and wellness.

Let me take a few minutes to talk about healthcare reform in the context of our strategy.

With nearly 170 million Americans currently insured by their employer, corporate America will undoubtedly continue to play a vitally important role in the healthcare system and most employers want to including Walgreens.

We support the Obama administration's guiding principles of improved access, greater affordability, and higher quality as part of any reform platform.

And we agree with a need to shift focus, to preventing and managing chronic disease and emphasizing health and wellness.

We're on the front line of healthcare with 68,000 professionals who can impact people's behaviors through direct face-to-face interaction.

Great illustration of that is the current seasonal flu and H1N1 pandemic.

We've already provided more than twice as many seasonal flu shots to patients this fall compared with the total we delivered during all of last year's flu season and all of that is thanks to our nearly 16,000 pharmacists and Take Care health providers who are qualified to administer flu shots.

No other retailer has that many health professionals immunizing the public.

This is one example of how we are advancing the profession of pharmacy as a valuable resource on healthcare's front line.

They're going beyond the dispensing of medication to providing valuable healthcare services.

Our platform for delivering pharmacy and health and wellness services now extends to 7,000 drug stores, the specialty pharmacy and home infusion network and work site health centers and retail clinics.

With that foundation, we're taking Walgreens directly to employers, government entities, managed care companies and PVMs as a provider of pharmacy and health and wellness services.

Our recent agreement with Caterpillar is an example of how we're doing that.

As a result of working directly with CAT, we gave them proprietary transparent pricing to better manage their costs and improve overall health outcomes.

We're certainly encouraged by the traction this approach is getting in the market.

Many other companies are talking to us about similar programs because of this compelling offer.

In addition to taking our services directly to employers and other third parties, we're also going directly to consumers with our Prescription Savings Club.

This program is offering discounted pricing on branded generic medications to nearly two million members today.

Another initiative we announced today will promote wellness and better treatment of chronic disease through a commitment to expand 90 day prescriptions at our retail pharmacies.

We'll work with physicians, employers, managed care, and PVMs to bring a 90 day retail option to a large population of patients across our national network of 7,000 pharmacies.

Patients want a choice of getting prescriptions either through the mail or at their local community pharmacy.

And when they have that choice, more often than not they choose a retail pharmacy.

That increases patient interaction with their pharmacist and studies show that interaction leads to greater adherence to medications.

A good example of the willingness of patients to try 90 day prescriptions can be found under the Medicare part D plan.

Part D has included a 90 day at retail option since its inception and today more than 24% of our part D beneficiary prescription volume is filled in 90 day quantities at our retail pharmacies.

That takes in account that each 90 day prescription fill equals three times the volume of a 30 day fill.

When a 90 day retail option is added to a prescription plan, total 90 day utilization increases.

That benefits overall healthcare spending and lowers cost for both the patient and the payor.

That's a great method for improving health outcomes and spending healthcare dollars more effectively.

Whether patients want retail or mail service, we can serve them through whichever channel they desire.

Now I'd like to update you on the progress of our business strategies.

Our success has evolved from the careful implementation of leveraging the best store network in America, enhancing the customer experience and achieving major cost reductions and productivity gains.

First, leveraging our stores.

After we reached our goal of 3,000 stores in the year 2000, we set a new goal to have 7,000 stores by 2010.

On Thursday, we'll officially celebrate achieving that milestone with the grand opening of our 7,000th store located in Brooklyn, New York.

With a total of 7,042 drug stores as of today, we're once again the largest drugstore chain in the country in terms of both store count and retail revenue.

We're also now in all 50 states with our three Alaska stores opened this past summer.

We reached our goal mostly through organic growth, giving us an incredible foundation to build upon, especially how young our stores are.

For fiscal 2009, we registered a net gain of 554 stores, including 70 acquisitions, compared with 561 the previous fiscal year.

Fiscal 2010 we expect organic store growth of between 4.5 and 5%.

With our current growth strategy we're now balancing the pace of new store openings with our commitment to improving our existing store base and enhancing the customer experience.

Allowing stores to mature and drive higher ROIC is the right strategy in this economy.

It doesn't mean we're walking away from growth opportunities.

We see opportunities to grow market share through continued organic store growth, driving comp store sales and pharmacy file buys.

We'll also continue evaluating potential acquisitions that reinforce our core.

Even before store growth slowed this quarter, we made significant progress on expense control.

Slowing store growth will contribute even more to SG&A control going forward.

In the fourth quarter, SG&A was helped by Rewiring for Growth efforts and in fact -- and the fact that we tightly managed store operating expenses.

We were also helped by 149 stores opening this quarter, down from 199 opened the year-ago period.

Moving to our second strategy of reinventing the customer experience, we're currently rolling out our customer centric retailing format in more than 400 stores in Texas.

We're pleased with the results from our CCR stores so far.

The stores have better sight lines, less clutter, and a brighter look.

We expect CCR will not only improve comparable store sales and the customer experience but it will also increase the number of customer visits and basket size.

As we've said, CCR gives us four-way win.

It helps us improve sales, it takes work out of the stores, it reduces capital deployed, and it provides a better customer experience with greater relevancy and efficiencies.

A key category that we're adding to our stores is beer and wine.

We expect this category to roll out over the next 12 to 18 months and although beer and wine will comprise less than 1% of total shelf space in a typical store we believe it will increase basket size and drive traffic in our stores.

If you didn't take the time to check it out this morning, take a look at our redesigned Walgreens.com site which we launched about a month ago.

It offers a much improved online experience, including new convenience features, product merchandising, integrated health content and a new mobile version.

We also feature seven Health Shops that bring together products, services and latest news and information.

And lastly, our Rewiring for Growth initiative remains on track to deliver $1 billion in annual EBIT cost savings beginning in fiscal 2011.

We have a relentless focus on cost reductions and productivity gains and that will continue.

When you combine our SG&A control with our goals for gross profit dollar growth, we have a real opportunity to expand our operating margins.

As you've heard, our investments focus on the customer experience, getting more from our core store base and bringing innovative programs to the market, positioning us for the new economy and healthcare reform.

Tying all this together is a new branding campaign we launched about a week ago.

Our new branding includes the tag line Walgreens, there's a way.

This reflects our customers' desire for someone to help make life easier for them.

They want a little reminder, a little inspiration to live all around better healthier lives.

Walgreens will do that by providing simple solutions or small improvements such as flu shots to stay healthy or the convenience of photo services to connect with family.

You'll see and hear a lot from this campaign in the weeks and months ahead.

If you want to see the commercials on demand check them out on YouTube.

We provided a link on our Investor Relations website directly to the videos.

Before I turn the call over to Wade, I'd like to mention a couple of recent additions to our management team.

Jason Dubinsky recently joined us as divisional Vice President and Treasurer.

Jason is leading our Treasury department and Corporate Risk Management practice.

He has a strong background in retail and consumer sectors having worked closely with corporate clients in those industries while with Goldman Sachs.

And also Tim Theriault joined us as our new Senior Vice President and Chief Information Officer.

Tim joins us from Northern Trust Company and brings a unique combination of leadership, innovation and business intellect with a background as both a technology and banking executive.

I know both Tim and Jason will do very well in their new positions.

Now Wade will update you on our financial results in the quarter.

Wade?

Thank you, Greg.

Let me get right into the financial details.

In the quarter, net sales increased 7.6% while total comp sales rose 2.4%.

Prescription sales rose 9%, and represented nearly 67% of sales for the quarter.

Prescription sales in comp stores rose a solid 4.5%.

We filled 182 million prescriptions during the quarter, an increase of 9.1%.

That includes a benefit of 1.4 percentage points from patients filling 90 day rather than 30 day scripts.

On a comp store basis the number of prescriptions increased 5.9% and that includes a benefit of 1.8 percentage points from patients filling 90 day versus 30 day scripts.

We exceeded by five percentage points the industry-wide pharmacy growth rate excluding Walgreens as reported by IMS.

Net earnings in the fourth quarter were $436 million or $0.44 per diluted share.

And that included the impact of $0.03 in rewiring costs and $0.07 in savings associated with the Company's Rewiring for Growth initiatives.

This reflects a 1.5% decrease from the $443 million or $0.45 per diluted share in the same quarter a year ago.

But recall that last year's quarter included the benefit of a vacation accrual adjustment of $79 million or $0.05 per diluted share.

In addition, the quarter included impacts of negative $0.01 per diluted share for the LIFO reserve, negative $0.01 per diluted share for interest expense versus year ago, and a positive $0.01 per diluted share from a lower tax rate.

For the fiscal year, net sales increased 7.3% to $63.3 billion.

While net earnings in the year was $2.01 billion or $2.02 per diluted share.

And that includes the impact of $0.16 in costs and about $0.16 in savings associated with the Company's Rewiring for Growth initiatives.

Net earnings reflect a 7% decrease from last year and also include the impact of last year's $0.05 diluted share benefit from the vacation accrual adjustment.

Negative $0.04 per diluted share for this year's LIFO reserve, negative $0.04 per diluted share versus year ago for interest expense and a positive $0.02 per diluted share from a lower tax rate.

Total prescription dollar sales increased 7.8% while the number of scripts increased 6.9%.

Comp front end sales were down slightly for the fiscal year.

Total comp sales increased 2% and comp scripts increased 3.6%, higher than the previous year.

Gross profit in the fourth quarter was $4.3 billion, a 7.7% increase versus the year ago quarter.

Gross margin was up 10 basis points compared with the year ago quarter to 27.7%.

This includes a LIFO provision of $48 million in this year's quarter, versus the provision of $24 million in last year's fourth quarter.

Helping overall margins was an increase in retail pharmacy margins due to generics.

Negatively impacting margin were nonretail businesses, front end product mix, a higher LIFO provision and CCR markdowns.

For the full fiscal year our gross profit declined 40 basis points while the same factors were at play, the increases in retail pharmacy margins didn't completely offset the negative factors.

Our focus on cost control continued in the fourth quarter as we recorded an increase in SG&A dollars of 9.6%.

This includes 2.6 percentage points due to last year's vacation accrual adjustment and 0.9 percentage points for Rewiring for Growth costs.

On a two year stacked basis, SG&A dollar growth for the fourth quarter declined from 23.4% to 14.1%.

As Greg showed you, slowing new store openings will continue to benefit SG&A growth as will the significant cost benefits resulting from Rewiring for Growth.

We will also have incremental SG&A expenses due to CCR store resets as we previously discussed.

This next chart summarizes the savings and costs for Rewiring for Growth restructuring charges for fiscal year 2009.

$0.16 in savings were offset by $0.16 in costs for the fiscal year.

Total Rewire expenses for the year were approximately $257 million.

So you can get approximately $140 million in fiscal 2010.

We are on target for a net pretax savings of about $500 million in fiscal year 2010, and a net pretax savings of $1 billion in fiscal 2011.

We talked about sales margins and earnings so let's review some additional income statement detail now.

The LIFO provision was $48 million versus $24 million in the fourth quarter of 2008.

Our LIFO provision this year was 2% compared with the provision of 1.28% in fiscal 2008.

We're expecting the LIFO provision for 2010 to be approximately 2%.

Next there was $51 million in restructuring costs in the quarter, including $23 million in consulting and other costs, $19 million in SKU discontinuation, and $9 million in costs associated with workforce reductions.

For the fiscal year we incurred $63 million in write-downs related to SKU discontinuations.

And we're about 70% through that process.

Net interest expense was $23 million, compared with $7 million last year.

Due to the issuance of a $1 billion bond in January of 2009.

Net interest expense benefited from a fixed rate to floating rate swap executed in July of 2009 on the $1.3 billion note issued that same month.

The effective tax rate was 35.8% compared with a rate of 37.1% in the year-ago period.

We expect a tax rate of approximately 37% in fiscal 2010.

Accounts receivable inventory and accounts payable are the components of working capital that we most indirectly impact.

The net sum of these as a percent to sales has improved by 14.1% in the quarter, primarily due to inventory improvement.

Total inventories were down $460 million or 6.3% against total sales growth of 7.6% and a total drugstore growth of 8.6%.

FIFO total inventories on a per store basis fell 11.1% in the most recent quarter.

Controlling inventory continues to be a top priority.

Even with lower inventories, our in stock conditions improved in the fourth quarter, compared with a year ago.

Now, as you're aware, controlling inventory helps cash.

Our net cash position at the end of the quarter was $236 million, which compares favorably with a net cash of $52 million at the end of the third quarter and a net debt of over $1.5 billion at the end of the first quarter.

Cash and cash equivalents and short-term investments totaled $2.6 billion and long-term debt totaled $2.3 billion.

Our financial flexibility and liquidity are in very good shape and our balance sheet should only strengthen as we slow our store growth, control inventory and drive cost savings over the next few years.

For fiscal year 2009 we invested $1.9 billion in additions to property, plant and equipment versus $2.25 billion last year.

For fiscal 2010, reducing the number of store openings will result in lower CapEx for our new stores but we will increase our investments for systems and other improvements in existing stores.

In total, we anticipate fiscal 2010 capital expenditures to be approximately $1.6 billion.

Now let me cover our cash flow performance.

These graphs demonstrate the improvement in cash that we have generated from our store operations and improved working capital.

Our cash flow from operations in the quarter increased to $852 million, from $548 million a year ago.

A 55% increase.

Meanwhile, free cash flow this quarter stood at $459 million, compared with a negative $24 million a year ago.

For the fiscal year, cash flow from operations increased 35% to a record $4.1 billion.

And free cash flow for the year increased 168% to a record $2.2 billion.

We plan to continue returning cash to our shareholders through a combination of dividends and buybacks.

And we are developing a specific cash policy that will complement our business plan.

That policy will give all stakeholders more clarity regarding our capital allocation decisions and principles going forward.

So, looking ahead, I'm very optimistic about Walgreens' future.

We have many opportunities, starting with our three core strategies, which is leveraging the best retail network in America, driving CCR as the beginning of our journey towards a new customer focus and realizing the benefits of Rewiring for Growth.

Walgreens is very well positioned to emerge from this economic climate as a leader in pharmacy and health and wellness services.

For healthcare payors, accessibility, cost efficiency and better outcomes are the top priority and we're able to step up here and help.

On the consumer side, growing companies with winning strategies and a strong balance sheet can gain loyal customers in unprecedented ways during down economies and we intend to be one of those strong companies and a true winner.

This was another quarter of strong cash flow and we're positioned to take advantage of growth opportunities and provide attractive returns.

We believe the initiatives and progress that Greg and I have outlined this morning will benefit investors through accelerated earnings growth and continued dividend increases and share repurchases.

No doubt we do face some headwinds such as pharmacy reimbursement and an AWP reduction for Medicaid brand name drugs that could impact us by as much as 80 million to $90 million this next fiscal year.

We also face a slowdown in generic introductions for the next one or two years and an uncertain economy.

But we also have key strategies and wonderful assets that give us unprecedented opportunities and I remain very confident.

So I'll close by saying we are committed to returning double-digit earnings growth as soon as possible and improving ROIC as part of our overall plan to create long term shareholder value and I hope that I've conveyed that message to you today.

Now I'll turn the call back over to Rick.

Thank you, Wade.

That concludes our prepared remarks.

We're now ready to take questions.

Thank you very much.

(Operator Instructions) We'll pause for one moment as we assemble our roster.

Our first question today will come from John Heinbockel with Goldman Sachs.

Hey, guys, a couple of things.

How far are we through the CCR related clearance of SKU rationalized inventory and how much more is to go?

Yes, John.

Greg.

We're probably a little more than 70% through and feel pretty good about that.

As you know, we've kind of took an early strategy to where we took the markdowns and did them within the departments.

So feel pretty good.

We're about a little over 70%.

All right.

And then secondly, when you look at the -- sort of sounds like you think pharmacy margins could be down over the next year, but I would also think maybe front end could be up, and overall maybe end up closer to flat.

Is that sort of a fair take on the two parts of the business?

Well, I think certainly on the front end we're going to have to, with the tight consumer and a cautious consumer, we're going to have to make sure that we stay focused and swing doors and really drive value.

We've got to balance that, obviously.

We think we've got some good opportunities there with private brand, CCR, what we're doing there, so we think we've got opportunities to balance what we may have to do to drive value and drive traffic.

As far as pharmacy margins, I think that certainly with the headwinds that Wade mentioned with the AWP reduction, we're going to be tackling that and staying aggressive there.

On the commercial side we feel like we've made good progress.

Most of the commercial payors realize they need to keep us whole.

State by state we'll be working with those.

We'll see how that comes out.

I'd just say, John, I think you have to balance that.

Obviously there is some reimbursement pressure but I think we've got good traction in the business.

We've got good services.

We talk about things like the flu shots and then the overall margin we've made good progress in cost control across the board and as we move Rewire, that's going to get stronger.

One final thing for me.

How do you guard against taking too much cost out to the point that it impacts service?

Today I don't think that's happened but how do you guard against that?

Good question, John.

Basically by just staying on top of the surveys and our employees' surveys and customer surveys and we feel good there.

We're doing from what we see coming back from pharmacy, we've got good satisfaction responses there.

Our wait time has improved from last year as I mentioned a couple weeks ago.

We actually cut our wait time pretty dramatically in pharmacy.

Actually the store operators, our folks out in the stores are doing a darn good job in maintaining service levels while we take expense out.

I would just remind you that our transformation initiative, Rewire for Growth does include the growth word.

And the whole key of this thing is really around reengineering and the way we do work.

CCR is a classic example.

Right?

How can we not only be more consumer centric and provide a better experience but do those things in a way which take work out of the stores for our employees and get a double, triple, quadruple win.

So I think it really is around reengineering.

We've done a lot of that and we'll have to do a lot more.

Thanks, guys.

Our next question comes from Lisa Gill, JPMorgan.

Hi, thanks very much and good morning.

I was just wondering if you could comment on the Caterpillar deal and maybe just talk us a little bit through how that works and what this proprietary pricing is?

And secondly, as we think about the 90 day script at retail, is that more profitable for you than a 30 day script?

As far as Caterpillar deal, as I said, the neat thing there is that's us going directly to an employ to give them proprietary pricing and I think that's what's really exciting about that.

Those are the two big points, that we went directly to an employer and because of that we were able to give them our proprietary pricing and I think we're encouraged as I said because we're getting a lot of interest in that.

Switching to the 90 day, I think this is really a win-win-win.

It's great for patients.

There's definitely a market out there for it.

We know that through part D.

And through our Prescription Savings Club card.

As I said with part D, 90 day retail and mail option has been available since its inception.

We're up to as I said, 23, 24% penetration there.

So consumers want it and the payors are beginning to see the real value.

It's good for patients, good for payors, good for us.

Obviously, as far as the margin, when you've got to recall when we take the cost down of refills, versus one fill with the 90 day so we expect the margins to be pretty good.

So just so I understand.

So the margins generally will be better on a 90 day script than a 30 day script and as you thing about these relationships are you signing any preferred relationships with any of the managed care companies around 90 day scripts to try to drive volume to a Walgreen store?

I'll handle the margin question.

Obviously, it's -- every situation is going to be different but as Greg said, I think we can provide a better experience for patients, a better cost for the payor, and be fine on our end.

With respect to managed care, certainly we'll be working broadly with managed care, PVMs and other employers direct to make sure that they have the opportunity to avail of the 90 day.

But I think, Lisa, as far as any preferred relationships, our intent really is just to make sure that we offer this to all payors on a broad approach.

If somebody wants to prefer us, that's great.

We want to make sure we can offer this to all payors, regardless of how they want to construct their network.

Just one follow-up question.

As you talked about the margins on pharmacy, the fact that Apotex is out of the market and some of the generic manufacturers are raising price, are you taking that into account in your previous comments around generic margins?

I think we have a pretty sophisticated model.

Obviously it's a very complex matrix of lots of different drugs, lots of different payors, lots of different parts of the country.

That's all factored in.

Are you seeing an impact from that from less manufacturers in the market?

No.

I mean, it's all manageable.

Okay.

Great.

Thank you.

And our next question will come from Scott Mushkin with Jefferies.

Hey, thanks, guys and obviously a real solid fourth quarter.

I was hoping to do a tag on the last two questions that were asked.

Number one, I really didn't understand the margin answer for 2010.

The way I'm penciling it out with $500 million of savings, maybe give back of 80 to 90 is that we could earn 240 to 250 next year.

And I'm just trying to understand, the margin question seemed to -- you guys seemed to hint that margins may be down both in the front end and the pharmacy, was wondering if you could give us a little clarity on that and then I want to follow up on Lisa Gill's question if I could?

I would say, obviously t's a lot more complex than just the 500 benefit and the 80 to 90 AWP.

Reimbursement pressure, there are other pressures.

There's still an A&P issue pending and of course there's lots of payors that are under pressure so there are other reimbursement pressures beyond that.

Now, there always has been and kind of always -- it's always every year is always the same struggle but I wouldn't want to say that's the only reimbursement pressure.

I think what Greg was alluding to on the front end, I think we have a wonderful opportunity to drive a much bigger basket and more traffic.

There might be some balancing over time though to make sure that the value equation is right.

So we'll be looking also at total gross profit dollars delivered there by becoming more relevant and driving a lot more volume versus just focusing on the gross profit percent.

It doesn't mean that it will definitely go down but again I think what we want to do over time is become much more relevant, drive much more volume through there.

If we can maximize gross profit dollars, that might be a better way to go.

As we look at next year because we notice in the marketplace that you guys are reducing your prices pretty actively with the green tags in the front end, do we need a substantial uptick in front end sales to maintain that dollars that you mentioned, Wade?

No.

Scott, this is Greg.

As I said, retail obviously balances -- is balancing margin and traffic and we are getting sharper on value items and rotos.

Some key value items within the stores, making sure we're priced right.

We have to do that to make sure we stay relevant.

At the same time we've got to manage mix as we always do and we have to drive private brand to be able to offset that and believe me, that's what we'll be doing is focusing on that right balance.

It's a portfolio, Scott.

There's items where we just weren't competitive on key driving items and we're getting competitive.

There's a lot of other items where we were far below the price of anyone and that probably doesn't make a lot of sense for us or not.

I think it's really making sure that we play the portfolio in the smartest way to be relevant on the items where we have to be dead on relevant.

Okay.

Now, switching gears to the 90 day script issue that Lisa was talking about.

You guys have always said that 90 day scripts and I think it's always been common in the retail industry are less profitable than three 30 days.

Has something changed there?

That's kind of how Walgreen and everyone else has always presented it.

I was just wondering if you could clarify that margin issue when you go from 30 to 90.

Scott.

Greg.

I think, again, when you look at the gross profit dollars of a 90 day script versus a 30, and then you look at the cost to fill reduction obviously from three fills to one, we feel pretty confident.

We launched this if you recall back in probably 2003, 2004 maybe with advantage 90 through WHI.

That's when it really began, 90 day at retail really began to take off.

Then as you know we worked hard to get it into part D plans.

We feel confident that if a patient wants a 90 day quantity and they want to be able to get it at retail then we should be able to offer it.

We feel we're okay on the margin.

I can also tell you there's a very, very big market out there people who are getting 90 day at mail who wish they had the opportunity to get it at retail.

Obviously for them to be able to have the opportunity and the choice as we said before, more often than not they choose retail when they have that choice.

That incremental business for us is a very good business.

What we want to do is really be able to be -- I'd say agnostic in terms of 30 day, 90 day, drive-through, in-store, mail, you name it and give the patient and the payor the choice that's right for them, whatever that might be.

And then one final then I'll give it up.

Is the CAT deal restricted?

In other words, people have to fill at Walgreen?

Or no?

Or is it preferred, in other words?

I'll give you a simple -- obviously we don't want to -- we're not going to go into a lot of detail on proprietary pricing but the general construct is, is that the more services that CAT avails of that Walgreens can offer and the more volume that comes through the better the pricing we can offer.

What we're really trying to do is incent a win-win.

So it's similar to CVS's maintenance choice and it's a preferred network.

No, it's not preferred, it basically just incents the pricing for the more volume that comes through the network.

Scott, I think with Caterpillar, they certainly are going to try to encourage folks to use Walgreen to take advantage of the pricing we're giving them.

But it's not an excluded network by any means.

We're not interested in that.

All right.

Thanks.

I'll give up the floor.

Thanks for taking my questions.

And our next question will come from Andrew Wolf, BB&T Capital Markets.

Good morning.

Congratulations on the quarter.

Just wanted to ask you a follow-up on it.

First on -- can you update sort of the cost to do the remodel that's you spoke to last quarter?

You said you learned -- get some learnings on that, if you could where that might -- and also on the flip side, the kind of sales lift, either you're getting or you expect and how much of that could be offset because last quarter most of us came away trying to figure out what the net impact of that would be on this year's earnings.

Yes, the cost as we said before is between 30,000 and $50,000 per store.

I think we're tracking dead center on that.

So I'd say we've estimated that pretty accurately.

In terms of the sales lift, we haven't given a number.

I would say the payback period from what we've seen and projecting is pretty quick.

If you take 5,000 stores times $40,000 you get to around a couple million dollars.

We're going to see we believe in the fiscal year benefit from sales uplift, cost reductions that should offset most or all of that.

So we've kind of basically called that a wash for the most part.

And again, because of the payout period, it's a very high ROIC.

Making these current stores more productive is really the single biggest lever we can pull on ROIC.

As far as the cost, the good thing is now we're in a couple major markets like Dallas and you Houston, where we can really leverage, scale the reset teams we're looking forward to what seeing what we can do as far as the efficiencies and drive that cost down.

Are these remodels -- I know you still have a pretty small sample size, is it still on the sales lift, still tracking above what you had originally planned?

We're still encouraged with what we're seeing.

I just wanted to flip onto one follow-up.

On the Caterpillar deal, some of the industry consultants have characterized it as market share-driven but discount pricing and I'm just trying to understand what that means for Walgreens, particularly since there's a large cost component removed by not using a full service PVM.

How the -- using part of that exclusion of that -- of flow of some of the profit dollars, where that leaves Walgreens.

Obviously we know where it leaves Caterpillar, but where it leaves Walgreens?

Andy, again, I think the neat thing is because we went direct to CAT, we were able to give them pricing that is good, fair pricing for both they and us and as Wade said it's based on volume.

It's the first time where instead of giving a price without the opportunity to grow volume or other services that we've been able to work on an arrangement where it's good for CAT and for us.

They're realizing the savings because there's no one between they and us.

So your contribution dollars, are they going to go up exponentially or linearly with market share?

I wouldn't comment exactly.

I would just say, I'd reiterate what Greg said which is it's a good deal for us and it's a good deal for CAT.

It's a true win-win.

Thank you.

Mark Miller with William Blair has a question.

Hi, good morning.

A follow-up to the prior question on remodels.

About how many of the the new format stores do you think you might convert in the next fiscal year?

I know your plan's been 5,000 but how does that get spread across fiscal '10 and fiscal '11.

And then as you look at that expense drag net of the sales lift, how large of a negative might that be for remodels versus the benefit to earnings as you're slowing the store growth in this next year?

Could those two balance out or would it tip one way or the other?

We're still identifying the number of stores but we're probably talking somewhere around 4,000ish.

There's a very low end 3500 to 5000 on the very upper end but we've got a lot of new stores coming out that don't need the remodel.

We've got certain other formats that it doesn't make sense to.

What I would say, Mark, is kind of per the previous comment we think that for the most part they'll balance out.

Right?

So might it go 20 million, 30 million one way or the other, it might.

For the most part we believe it will be balance out because of the lift we're getting, some of the cost efficiencies and some of the other work we're doing around CCR to be more effective in our promotion, our pricing, et cetera, so I would say I think it's largely going to be a wash.

My question, Wade, was also factoring in the benefit to earnings as you slow the store growth.

Does that imply that it becomes a net benefit when I take those two dynamics together?

There will be some benefit from slowing store growth.

We haven't put a number out there but obviously that really compounds over time so as we go from 8, 9% to 5%, you get some benefit but over time it really starts to roll through.

So it will be even stronger the following year and much stronger the year after that.

But yes, there could be some incremental benefit from that.

Okay.

Thanks.

My second question is looking at the inventory, impressive management overall, how much of that is coming from SKU rationalization?

How much is it from other working capital initiatives power?

I'm wondering if that could be a benefit.

Then just how much further can Walgreens go optimizing inventory turns?

Thanks.

Yes, Mark.

Greg.

We're seeing probably about an equal mix between what we're seeing from CCR and what we're seeing from supply chain initiatives and I'm really enthused with frankly what we're seeing more on the supply chain.

I think the CCR reductions we kind of expected but I think we're making real progress on supply chain with Randy Lewis working with our vendors and we're also really making progress on the pharmacy side as well and that's more from really fine-tuning the safety stock and the actual quantity that we need to have on hand.

So I think there's still upside for us.

I think we've got a lot of potential to improve our supply chain.

I think the real trick for us is we do believe there's opportunity but we're going to make sure we keep taking on inventory while we improve our service levels at the same time and we're going to be able to do those two things in concert by changing how we think about it, how we work, how our processes work.

We're working with vendors in a much greater way than we have in the past.

As I said in the past, Randy now has inventory from the day it leaves the vendor to the day it hits the consumer's hands.

Lot of opportunity there.

Thanks.

Just finally, looking for the flaw in these results, not obvious, but only comment would be nice if you bought back stock sooner and hopefully that will come.

Thanks.

Thanks, Mark.

And our next question will come from Ed Kelly with Credit Suisse.

Yes, hi.

Good morning, guys.

Nice results.

Thank you.

Wade, your D&A was up only about 1% this quarter.

It's been more up a lot more than that historically.

Is there something we should read into that?

Is there a reason that it was up so much?

How should we look at that going forward.

Is this going to be a more normalized growth rate now that your CapEx spend is coming down?

I think that's right.

I think it's more normalized now, what you're seeing.

Slowing store growth started to impact it a bit and then the mix in terms of where we've been spending, it will be more normalized now.

At best we should be thinking about low single digit type D&A growth going forward?

Maybe single to mid.

We'll do some refining on that.

Then, Wade, if you could just go through the $1 billion in cost saves, when you initially laid that out you had a few buckets there.

Could you talk about where you are in each of those buckets, in terms of relative to your initial plan?

There was the three core big buckets.

The first one was basically indirect spend.

That's $250 million, all the things that we buy that we don't sell to people.

And then there's $500 million which was corporate labor, field labor, store labor, et cetera, payroll, effectively and then another $250 million of benefits associated with transforming community pharmacy.

I would say that on all three of these, we are on plan with what we predicted.

In fact, the net benefit what we had originally said would be zero this year, it basically did end up zero but we had a lot more cost this year and a lot more benefit than originally thought.

That's because we pulled forward many of these initiatives so we pulled forward the one time but in some cases also pulled forward the benefits.

So again, without giving the specific year by year of the buckets on all three we believe we're on track.

We're on track for $500 million for next year and we believe we're on shape for the billion in 2011.

Great.

Then, Greg, just last question for you, you mentioned acquisitions as sort of supplementing the core strategy.

Could you maybe just talk a little bit about what you have in mind there?

Are we talking facility healthcare, retail opportunity.

Are these just sort of smaller bolt-on deals?

Would you consider something larger?

Any help there would be great.

Yes, Ed.

I think as I've said, we want to stay flexible to look at whatever opportunities come our way.

We think we've built some pretty sophisticated platforms on the healthcare side.

We've got leading infusion platform now, strong speciality platform and we're combining those because we think there's true differentiation to take a specialty/infusion platform to the payors.

We feel good there.

I think the Take Care clinic platform gives us the ability to really launch more and more health and wellness services as we do focus more on prevention of chronic disease going forward.

I feel good there.

Our employer health sites as well, we've got a good platform.

So other than some gap fillers maybe on the healthcare side, we may need to look at but I think just -- we want to just stay flexible and look at whatever may come to us.

There will definitely be some consolidation on the retail side of the business but we'll run it through our filter and make sure we make good decisions.

Thank you.

Thank you.

Our next question will come from Steve Alper with Thomas Weisel Partners.

Just to clarify.

so the AWP hit based on the settlement that was announced a couple of days ago, that's a done deal, that's what you think the cost is going to be in 2010?

I wouldn't say it's a done deal.

I think the range we feel very confident with.

I think there's a lot of work to be done, Steve, we're going to do everything we can do to even improve upon that.

As I said, the commercial side we feel good about.

We've got some work to do but they've pretty much realized they want to make us whole.

On the state side, it will be state by state.

And I think states are strapped with cash so they've been a little slower to come along but as we've dealt with each state in the past, we handle each one uniquely and continue to try to work with them, help them find other ways to save money.

Would you characterize the 80 to 90 as your worst case?

I think that's safe to say.

Okay.

Great.

Thanks.

Next we'll hear from John Ransom with Raymond James.

Just following up on the AWP question, I think when we were out there in August you had that number at about $150 million.

Have you just refined your estimates or have you had any state wins to bring that number down?

No, there's been a lot of work done, John, in the last several months.

Certainly all of us in this industry has had this as one of our top priorities.

We've had our folks working the commercial side aggressively and have really made some good progress there.

And again, the states have been a little slower but we're going to continue to work with each state to try to help them find other ways to reduce costs.

We worked with the State of Washington, State of Delaware, ended up with good results in both those states and we expect to do the same.

Second question, your script trends per store were up quite a bit year-over-year.

How much of that is market growth and how much of that is market share, do you think?

We're exceeding the market -- the IMS numbers without lag pretty significantly so we feel pretty good there.

Obviously we're rounding some softer comparisons from a year ago.

John, I think we're also seeing some positive numbers from the file buys that we've made over the recent 12 months.

I think we're also seeing people begin to stay more compliant on their drugs.

I think in the heat of the economic downturn I think we saw people splitting pills and skipping doses and I think we're beginning to see that soften a little.

Okay.

And then lastly, talking about your 90 day at retail, you're fillings about 5% I think of -- up quite a bit.

Just looking at the strictures of your commercial plans and the ones that will only do 90 day on their own mail platform, what's the upper limit that you could do 90 day at retail do you think?

And how much should we expect that script, that penetration to grow and what kind of effect you think it has on your P&L?

Thanks.

On an adjusted number when I look at what's going on with part D in the marketplace and even our Prescription Savings Club card part D the marketplace we're at about 24% as I said on an adjusted basis.

Prescription Savings Club card we're looking at nearly 40%.

I think there's a big upside as the payors begin to see more value as well as patients.

The good thing about this is when -- is when a payor adds a 90 day retail benefit to an existing 90 day mail benefit.

90 day utilization increases, adherence improves, patients and payors both save.

I think there's a huge market out there.

Is there a structural, at least in the short term a structural resistance from the Medcos and ExpressScripts of the world that don't want to lose that 90 day mail?

There will be some natural resistance, certainly.

But again, I always go to the marketplace.

And as patients begin to want it and demand it and as the payors that are offering it begin to see value, the marketplace begins to dictate it.

Right.

As you guys go through your Board process for allocation of future free cash flow.

Your cash exceeds your debt.

You're obviously going to be generating a lot of cash flow.

How do you plan to communicate that to the marketplace?

Are you going to have some press release file on your board or are you just going to talk about it on your next conference call?

How do you plan to get that message to the marketplace?

We definitely once we finalize it and approve its we definitely will communicate it.

I don't know exactly how we will but we'll make sure that we do and we do it broadly and we're very clear about it.

Okay.

All right.

Thank you very much.

Thank you.

And our next question will come from Deborah Weinswig with Citi.

Good morning.

This is actually [Nathan Rich] filling in for Deb.

First question I wanted to touch on is on your Rewiring for Growth initiative, it seems like you've seen pretty strong performance in store payroll.

I was just wondering if you could share some more details on the work that you've done there and what changes we could expect going forward?

Yes, I think on store payroll as far as a lot of it is the work that we're removing from stores chain-wide.

Some of that is coming from CCR.

Others is just us relooking at a lot of the processes.

I think some of them has been looking at hours of operation to make sure we're right for the marketplace.

But really, just a real good effort in improving the efficiencies, relooking at some of the processes and the work that we've been asking our stores to do and one of the things I'm most encouraged by with CCR in the early responses we're getting from store managers is the fact they say it's getting easier to run the drugstore.

That in itself could be one of the biggest benefits we realize.

Great.

Thanks.

And then just one follow-up.

In terms of your Prescription Savings Club, it seems like the customer response has been pretty encouraging.

I was just wondering if you see any opportunity to expand your loyalty program?

Well, I think I agree with you on our Prescription Savings Club card, we're really encouraged with it and we think we can continue to grow it and we are looking at a loyalty initiative and beginning to lay the early groundwork on it.

We're probably kind of pursue a CCR type journey, that we'll build a foundation and begin to look at pilot and go from there.

Thanks a lot .

Next we'll take a question from Meredith Adler.

Thanks and congratulations on a good quarter.

Thanks, Meredith.

You were talking about the three buckets from Rewire for Growth.

And I was wondering if the last piece was about community pharmacy and making some changes there?

Are you still focused on central fill?

I know you also talked about central phone calls.

Can you talk about kind of where that stands and how that's going?

Yes, I mean, obviously there's different components to the whole transformation of pharmacy.

There's what we call dynamic work flow balancing which is pushing paperwork across pharmacies.

There's the front end processing which is streamlining and taking out call center work, paperwork, et cetera, and there's central fill.

I think what we're finding is -- remember in the end what this is really about is being able to free up pharmacists' time to do more services, to do more consultations, to provide a better experience.

It's about also being able to get scale so that we can do some of the work more efficiently on the cost side.

We're finding in different places, there's different permutations that make more sense than others.

Sometimes central fill makes sense, sometimes it might not, other times the central fill capability could be a great thing to think link the specialty to provide that kind of option in retail.

It plays a key role but it depends on where we are geographically as to what makes the most sense.

Meredith, I'd like to add to that, certainly this has been nationwide, but when we talk about transforming community pharmacy, in addition to what Wade's saying, we're really looking to not only take cost out but improve the opportunity for our pharmacist to really play more of a greater role within healthcare.

This flu shot program that we've launched and really helped provide a solution for is a great illustration of what pharmacists on the front line of healthcare can do in addition to what they've done in the past.

So we're really pleased with this as an example of was we can do going forward.

Great.

Wonderful.

And then I have another question.

Maybe to talk a little bit more about how you will leverage the Take Care centers on-site clinics to do even more in terms of managing chronic health conditions and are you putting a focus for the Take Care centers on getting managed care to pay for that?

Yes, Meredith, both good questions.

I look at our Take Care clinics as the platform that we have to now launch more and more health and wellness services and as we move more toward a need for more prevention and management of chronic disease and health and wellness services we're positioned well to offer more health screenings, point of care diagnostics as we go forward.

Second question was?

The second -- actually, not quite sure.

I think I wanted to know whether managed care was paying for the Take Care clinics?

Yes, managed care is.

We're most nearly 70, 75% contracted.

Depends on market but most managed care is definitely contracted.

I think one of the neat things and the real opportunity you get with this business is it's been kind of a consumer pull model in the past.

Where we've marketed, consumers are coming in, using them on their own, satisfaction is off the charts.

As managed care now begins to see more value and understand how it can help them offer affordable, accessible healthcare I think you'll begin to see folks encourage the use of them.

Just maybe my final question would be about paying for some of these services.

I mean, that's always been perhaps the hardest thing in healthcare is to demonstrate real value from counseling and then to get paid for it.

Can you talk about maybe how those conversations are developing with managed care organizations?

Yes.

Obviously it's all about outcomes and obviously we need the analytics to begin to be able to show what we are able to do.

Managed care is extremely interested in paying for these services, more so than I probably have seen in the last year or two years and I think as long as we are able to show them the results and the outcomes, there's -- we can monetize that.

And you have the analytics built?

We've got -- we need a little more sophistication there but we've got some pretty good clinical folks and pretty good clinical teams that are helping us there and I want to begin to throw a little more sophistication at it but we're headed where we need to be.

I think the work site group that we have under Take Care has a big head start there because we've been able to work with a lot of employers directly with their data on-site to help manage outcomes at point of work and point of care.

I think that's probably here a big advantage that we have.

Great.

Thank you very much.

Folks, this is Rick.

That was our final question.

Thank you for joining us today.

We'll announce our September sales on October 2.

Please keep in mind that we include flu shots in our script totals rather than as front end sales.

Our next quarterly financial announcement will be on Monday, December 21.

That's when we'll announce fiscal 2010 first quarter results.

Until then, thank you for listening.

Thank you everyone.

And that does conclude our conference.

Thank you for your participation.