沃博聯公司 (WBA) 2010 Q1 法說會逐字稿

Good day, everyone.

Welcome to the Walgreen Company first quarter 2010 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.

Thank you, Brendan, and good morning, everyone.

Welcome to our first quarter conference call.

Today, Greg Wasson, our President and CEO, will discuss the quarters highlights, sales trends and the macro environment.

Wade Miquelon, Executive Vice President and Chief Financial Officer, will detail the first 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 can 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.

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 uncertainty.

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 joining us on our call.

We appreciate your continued interest in Walgreens.

Today I'm going to review the highlights of this past quarter to update you on our sales trends and provide the latest on the progress we're making our three strategic initiatives.

The first quarter we reported record everything and sales with solid double digit earnings growth, even in this difficult economic environment.

We also continued to generate strong cash flow, a direct result of improved working capital, especially inventory, and drug store performance.

Net sales for the quarter were $16.4 billion, up 9.5% over a year ago.

Net earnings were up 19.6% to $489 million from $408 million a year ago.

Earnings per diluted share were $0.49, a 19.5% increase from $0.41 per diluted share last year.

This quarter includes the impact of $0.03 of restructuring and related costs.

Cash flow from operations in the quarter more than tripled to nearly $1.2 billion from $312 million a year ago.

Meanwhile, free cash flow stood at $864 million compared with a negative $326 million a year ago.

This strong cash flow gives us the financial strength and flexibility to continue investments in our three core strategies.

In the quarter, we also increased our dividend by 22% and bought back $150 million of Company stock under the stock repurchase program we announced in October.

Looking at our sales in more detail, comparable store trends improved in the first quarter and early flu season and a well executed flu shot campaign, which started a month earlier than last year contributed substantially to the performance, especially in September and October.

We saw some softening in November as this year's flu season declined and we faced tougher comparison with last year's flu season.

The quarter saw some challenges, including a slow start to the holiday shopping season over Thanksgiving weekend, which dampened November sales.

It's clear that consumer concerns about unemployment levels and the economic climate are weighing on spending.

Consumers are focused on value and discretionary items are not high on their shopping lists.

That lead to the weak sales trends we saw in late November, and that continued through mid December.

We ended the holiday season with lower inventory levels and with a focus on basics as we anticipated a cautious consumer, and while we don't report December sales results until next month, we believe we will see good sell-through on seasonal items.

Like every Christmas season, our performance is driven by the final days, which makes this a big week.

It could be a more important this year as more consumers delayed the holiday shopping to last minute.

The calendar works in our favor this year with Christmas falling on a Friday.

That means the convenience of our more than 7100 drug stores with over half the US population living within two miles of them, will make them ideal destinations for last minute shopping needs and as always, our stores will be open on Christmas day.

In addition to the final Christmas rush, we anticipate growing demand this week for H1N1 flu vaccine as additional supply is delivered.

We're working with government agencies to obtain more H1N1 vaccine, and we intend to have it available at virtually all of our pharmacies as soon as possible.

Mobilizing our pharmacy staff for flu shots is a great example of how we are advancing the profession of pharmacy as a valuable resource on the front line of healthcare.

Our pharmacists are going beyond dispensing the medication to providing preventive healthcare services.

Now I'd like to update you on our three key strategies, which is are leveraging the best store network in America, enhancing the customer experience, and achieving major cost reductions and productivity gains.

We continue leveraging our existing store base and growing market share even as we slow our new store openings.

Over the past seven years, as the prescription market has grown 16%, we've steadily grown our retail pharmacy market share from 13% in 2003 to 18.5% of all retail prescriptions today, according to IMS health data.

We see opportunities to continue that growth not only through organic store openings but also through comp store sales increases, prescription file purchases and acquisitions that reinforce our core.

An example of that is our recent transaction with Eaton Apothecary Pharmacies in Boston, which is expected to close in January.

As most of you know, one of our major initiatives as part of reinventing the customer experience is our Customer-Centric Retailing format, which is now in more than 400 stores in Texas.

The stores have better sight lines, a new layout organized around customer solutions, and an overall improved customer experience.

We're pushing the CCR rollout a few weeks to the beginning of March, so that we can also include our new store decor package with the conversion work.

The decor package is an important piece of the overall CCR customer experience, which we want to include in this next wave of conversions.

We expect to meet our goal of nearly 3000 stores converted to CCR by the end of Fall of 2010.

Related to CCR, our beer and wine rollout is now in nearly 1600 stores.

This category provides another reason for customers to shop in our stores.

So to sum up, CCR gives us a four way win.

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

As we reinvent the customer experience, we are also transforming community pharmacy.

We intend to create a new service model in which our pharmacists focus more on the patient than administrative tasks.

Transforming community pharmacy will improve service, quality and efficiency so that we can offer patients valuable new healthcare services that generate incremental revenue.

As a first step, we implemented centralized pharmacy operations in Florida and Arizona and work to fully leverage our work load balancing system.

These centralized operations made a significant impact during the Fall flu season in Florida where our pharmacists provided more than 600,000 seasonal flu shots with virtually no additional payroll.

Chain wide, we provided more than 5 million seasonal flu shots this Fall, up from 1.2 million for all of last year's flu season.

As we expand from immunizations into other areas we're taking our suite of health and wellness services to the marketplace by going directly to employers, government entities, managed care companies and pharmacy benefit managers.

Let me be clear.

Our center of gravity is our community drug stores, and this slide shows the depth of our national footprint of pharmacy, Health and Wellness services which include more than 7100 retail pharmacies and a pipeline of more than 500 already approved new drug store locations, over 350 Take Care clinics, more than 380 work site health centers on the campuses of major employers, more than 110 pharmacies located in hospitals, clinics and Medical Centers, a Specialty Pharmacy distribution network with nine locations, five institutional pharmacies, and more than 100 home infusion respiratory service centers, and finally two state-of-the-art prescription mail service facilities.

This unique set of services allows us to tailor our offering to the needs of our clients.

For example, we've recently expanded our relationship with HighMark Blue Cross Blue Shield for which we currently are a provider of specialty and home infusion services for the members.

We now also offer HighMark employees access to work site health centers and pharmacies at their Pittsburgh and Camp Hill, Pennsylvania offices creating a unique employer healthcare solution.

What makes this important is that we are bringing more services directly to not only employers but also to manage care companies and PBMs.

Our bundled programs are an example of how the private sector is innovating to make healthcare more accessible and affordable.

Finally, we continue to make significant progress on our strategies to reduce costs and improve productivity.

As you see from this chart, we achieved our goal this quarter of gross profit dollar growth exceeding our SG&A dollar growth, and we remain on track to deliver $1 billion in annual savings in fiscal 2011.

Looking ahead, we plan to build on the progress we've made this quarter.

We have the right strategy in place and remain very confident in our ability to execute it.

At the same time, we are cautious in our view of the economy and we'll focus on consumers' basic needs.

In this environment, we have an opportunity to drive our winning strategies while others may not have the resources to do the same.

Our strong cash flow and balance sheet provides us with flexibility to invest in programs and opportunities for future growth.

Meanwhile in Washington DC, talks continue on a healthcare reform Bill.

Certainly remains difficult to say what a final bill may look like but in general we support the Obama administration's guiding principles of improved access, greater affordability and higher quality as part of any reform platform.

The shift in focus to preventing and managing chronic disease by emphasizing Health and Wellness is something we intend to capitalize on.

Our extensive network of community pharmacies in more than 70,000 health professionals position us on the frontline of healthcare, our pharmacists and nurse practitioners can have a positive impact on people's behavior through direct face to face interaction.

Finally, I'd like to thank three Board members who announced last month that they will retire from our Board of Directors at January's annual shareholders meeting.

Cordell Reed and Marilou von Ferstel provided invaluable insight and contributed greatly to the Board over many years and Charles R.

Walgreens III, grandson of our Founder, is retiring after 46 years of Board service.

As we said in our Annual Report that many of you recently received, his legacy surrounds us.

When he started with the Company in 1952, we had 403 stores.

By the time he retired as CEO in 1998, Cork expanded the Company to nearly 3000 stores.

Along the way, he built a record of sustained success, provided huge career opportunities for thousands of people throughout the Company and established a culture of quiet determination.

In October, I really enjoyed the chance to be with Cork at the grand opening of our 7,000th store.

He's provided amazing leadership and we're really going to miss him.

Cork, we wish you, Cordell, and Mary Lou the best in retire and I want to thank all our Walgreens team members to the contribution for these strong results as well, and I also want to wish them and all of you a happy holiday season and now Wade will give you an update on financial results for the quarter.

Wade?

Thank you, Greg, and good morning, everyone.

Let me get into the details behind our financial results.

In the quarter, net sales increased 9.5% while total comp sales rose 4.9%.

Prescription sales rose 10% and represented 56% of sales for the quarter.

Prescription sales in comp stores rose a solid 6.1% and that was helped by a 1.1 percentage point from our flu program, a program which we lead the drug store industry.

We filled 194 million prescriptions during the quarter, an increase of 12% from a year ago, and that includes the benefit of 0.7 percentage points from patients filling 90 day rather than 30 day scripts.

On a comp store basis, our number of prescriptions filled increased 9.2% and that includes a benefit of 1.2 percentage points from 90 day scripts.

We exceeded by 5.5 percentage points the industry wide pharmacy growth rate, excluding Walgreens as reported by IMS, and that is in line with the trend over the past six months.

As Greg mentioned and I'm pleased to report, earnings per diluted share were $0.49 in the quarter or $489 million, including the impact of $0.03 in restructuring and related costs and $0.08 in savings associated with the company's Rewiring for Growth initiative.

This reflects a 19.5% increase from $0.41 per diluted share or $408 million at the same period a year ago.

Excluding restructuring charges, earnings per share would have been $0.52.

Gross profit in the first quarter was $4.5 billion, a 9.3% increase versus the year ago quarter.

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

Negatively impacting margins were front end product mix, non-retail businesses and CCR markdowns.

Helping overall margins was an increase in retail pharmacy margins due to the impact of generics and flu shots, although those gains were partially offset by third party reimbursement pressure including the impact of AWP changes on Medicaid prescriptions.

Also helping margins was a lower LIFO provision compared with the year ago quarter.

The two year stacked SG&A dollar growth shows improvement compared with a year ago quarter, dropping from 18.6% to 16% and up from the fourth quarter two year growth rate of 14.1%.

Clearly, as we cycle these comparisons, it becomes more difficult to continue that pace of SG&A reduction.

Given the inherent complexity of our business, we want to provide you with a better understanding of the key drivers and building blocks of SG&A growth, so let's review those drivers in detail.

First, store openings which we anticipate at 4.5 to 5% this year but on a four quarter moving average basis, the store count will effectively grow 6% to 7%.

This tempers the immediate benefit to SG&A of our slower store openings.

Our four quarter moving average remains high, and as you won't see a significant dip in that average until the Fourth Quarter this fiscal Year.

At that point we expect to see some SG&A leverage from our slowdown in store openings.

Second driver to keep in mind is inflation, which we expect to run about 2% to 3%.

Third, acquisition and business mix SG&A is anticipated to increase about 1% to 2%.

Fourth, CCR resets, as Greg mentioned we planned to have nearly 3000 stores converted by the end of Fall 2010 and these are at a cost of $30,000 to $50,000 per store and then there's always a few other puts and calls in any quarter that take place.

Finally, while Rewiring for Growth is expected to provide a net benefit of $500 million, the net benefit to SG&A is expected to be about $425 million in fiscal 2010.

This chart summarizes the savings and costs for Rewiring for Growth restructuring charges since the initiative has started in last year's first quarter.

Total Rewiring expenses this quarter were $42 million.

We anticipate approximately $140 million in Rewire expenses in fiscal 2010 and we remain on target for net pre-tax savings of about $500 million this fiscal year and a net pre-tax savings of $1 billion in fiscal 2011 both versus our base of 2008.

Now, let's review some additional income statement details.

The LIFO provision was $34 million versus $43 million in the first quarter of 2009 and that represents anticipated LIFO provision of 1.75% for the year.

It's also lower than the 2% we anticipated heading into the quarter and the 2% we recorded in fiscal 2009.

Next were the $42 million of restructuring costs in the quarter including $28 million in SKU discontinuation, $7 million in consulting and other costs and $7 million associated with workforce reduction.

Net interest expense was $21 million compared with $15 million last year.

Due to the issuance of $1 billion in long term debt in January 2009.

Net interest expense benefited from a fixed rate to floating rate swap executed in July 2009 on the $1.3 billion note issued a year prior.

The effective tax rate was 37% compared with a rate of 37.6% in the year ago period, and we expect a tax rate of approximately 37% for the fiscal year.

Accounts receivable, inventory and accounts payable are all components of working capital that we can most directly impact and the net sum of these as a percent of sales has improved by 24% in the quarter, primarily due to inventory improvement and I should mention that Accounts Receivable benefited from timing issues this quarter but even without that, receivables would have been virtually flat.

Total inventories were down $800 million or 9.9% against total sales growth of 9.5% and total drug store growth of 7.8%.

Among other interventions, we were helped by our SKU rationalization program which is now roughly 80% complete.

FIFO total inventories on a per store basis fell 13.7% in the first quarter.

Controlling inventory continues to be a top priority and as you can see, we have made great strides over the past four quarters.

Controlling inventory of course helps cash.

Our net cash position at the end of the quarter was $773 million which compares favorably with net cash of $236 million at the end of the fourth quarter and a net debt of over $1.5 billion at the end of last year.

Cash and cash equivalents and short-term investments totaled $3.2 billion and long term debt totaled $2.4 billion and we were also able to pay out $136 million in dividends during the quarter and buy back $150 million in Company stock.

Our financial flexibility and liquidity are in very good shape.

Greg gave you the details on cash flow performance but this slide shows the comparisons and improvements in cash that we have generated from store operations and improved working capital.

We plan to continue returning cash to our shareholders through a combination of dividends and buybacks and you will recall that our September dividend was a 22.2% increase over the year ago quarter and in addition, we set a long term dividend payout target of between 30 and 35% of net earnings, and as I mentioned, we also announced a $2 billion stock repurchase program at the same time and by the end of first quarter we had repurchased $150 million in Company stock under the program and you'll recall the plan was approved in mid October which left us with a limited number of open trading days to make purchases.

In closing, I remain very optimistic about Walgreens future with many opportunities as we folks on executing our core strategies and we will continue to drive smart growth both organically and through smart acquisitions, including prescription file purchases.

I emphasize smart growth, because it's all built around prudent risk taking and ROIC focus designed to deliver long term shareholder value.

To reiterate Greg's point, we are confident in our strategy and cautious about the economy.

As we move through this uncertain economy, we continue to be agile and do what's right and drive smart decisions for both the short and the long term, and building on Greg's earlier comments, I also want to thank everyone at Walgreens for all of the accomplishments this quarter.

It would not have been possible without all of our team members efforts.

We thank them for that and we wish them and you a happy holiday season and now, I'll turn the call back over to Rick.

Thank you, Wade.

Folks, that concludes our prepared remarks.

Brendan, we're now ready to take questions.

(Operator Instructions).

We'll take our first question from Ed Kelly with Credit Suisse.

Yes, hi, good morning guys.

Wade?

You gave the number of about $425 million in net benefits.

That's right.

For Rewire and that's, I mean previously you've been saying $500 million isn't that correct and is there something that's changed to bring that number down?

No.

I think obviously it's 500 net benefit year to year but what we want to do is point out that if you do the reconciliation of where one-time costs have gone because some of those one type costs go in items like COGS, that the SG&A impact is $425 million, but the total impact in terms of P & L is $500 million and we can give you the detail break down of again where the benefits are coming through and where the costs and then you can do the reconciliation from SG&A to COGS and other.

So in your mind there's zero change in the way that you're looking at this or in your expectations?

Yes, there's zero change.

As we give the detail on the P & L line items I don't think we've ever done a clear reconciliation of exactly how the difference hits the various lines and that's what we want to do here.

Okay, and then just the cost savings in general, obviously you continue to progress towards realizing more cost savings on a quarterly basis.

How should this flow for the year?

Is this something that takes place sort of fairly even where it will continue to build each quarter?

A little bit but I'd say it's always going to be a little bit lumpy because different initiatives are timed when they're timed, things like inventory clean out when they clean out and the other ones depending on when they're announced they can have different impacts so yes it's going to build but I wouldn't say it's perfectly linear and we can't always predict it exactly because of the timing of certain events.

Okay, and as we think about the gross margin, how should we be looking at this line item for the rest of the year?

You got some benefit this quarter from the flu shot, comparisons ease quite a bit over the next couple quarters.

Is it unreasonable to think that your gross margin should be up for the year?

Yes, maybe I'll jump in there Ed, on this one.

I think obviously we're going to continue to see a cautious consumer so there's going to be looking for non-discretionary products and more value.

We're also going to be countering that reimbursement pressure on pharmacy but I do think obviously where we're going to try to counter the margin pressure will be to drive more private brand.

I think there's more opportunity in pharmacy to drive more services such as seasonal flu but we're definitely going to continue to see a cautious consumer, so I think that it's tough to predict right now.

Okay, and then just on the share repurchase side, I know Wade, you touched on it.

I was a little disappointed.

I thought the number would be higher.

What should we expect going forward do you think?

I guess as I alluded to, we actually didn't have a lot of days from the time we announced the program to where we weren't in blackout so I think given that actually $150 million was pretty good, so I don't know exactly, Ed.

I hesitate to throw a number out there but I can say we certainly, 150 doesn't reflect that we weren't confident in buying our stock back.

It was really a matter of number of trading days we had available.

Okay, great.

Thank you.

Our next question--

We are by the way setting up a 10 B-5 so we'll be able to purchase even when we are in blackout systemically through the rules of that program.

Okay, perfect.

Our next question comes from Mark Wiltamuth with Morgan Stanley.

Hi.

If you could just talk a little bit about the discounting environment on the front end right now.

It sounds like the sales are a little softer and I'm curious if that the kind of spurred more discounting?

Yes, Mark, Greg here.

I think that certainly there are a lot of folks out there driving promotions and I think we've seen softer seasonal sales than we had last year.

I think as far as the promotions we've been and will remain pretty surgical on where we're going with markdowns and promotions.

I think the good thing is that we anticipated a softer season, bought down in seasonal goods last year, and I think we're in better shape, so we'll need to be as aggressive in markdowns post-holiday.

Last year quite the opposite happened.

We had to be aggressive, we had a lot leftover, so I think we're going to be extremely surgical about where we go with markdowns, additional promotions and try to balance that with swinging doors.

Okay, and just all the commentary on the SG&A components, are you trying to tell us that investors have gotten a little ahead of you on expectations on the SG&A reduction or just a little signal that 2010 is a little too high right now?

Well, I guess what I'd say is we're completely confident in the savings we'll deliver but again because I think it's some of these components, I'm not sure that everyone has the same understanding and clarity of the different building blocks of how we get there.

So for example, when you think about the impact of SG&A on new stores it's not the number you do for the year, it's the 12 year impact that you cycle and that's considerably higher.

So I think I guess what I would say is you've got all of the building blocks now to do the math but again, making sure that people have kind of the understanding and the clarity of what goes in there I think is important so that over time, people can see the direct impact of the Rewire initiative and how it flows through.

Mark, I'd add, we feel pretty good about the job we've done in the past four quarters with store SG&A and our store folks have done a tremendous job so certainly we'll be comping those tougher months or quarters going forward.

Okay, and then Wade, any way you could quantify how big the AWP hit was on gross margin this quarter?

Well, you know, it was about $25 million, so that range, right?

This is Greg, Mark.

It's pretty much in line with our forecast that we had given for the year and we're watching it monthly but so far it's pretty much what we predicted.

Okay, thank you very much.

Our next question comes from Eric Bosshard with Cleveland Research Company.

Good morning.

Good morning, Eric.

Can you talk a little bit about how the reset stores strategy is evolving, you talked today about the decor and pushing them to March.

Can you just talk about how that whole thing is progressing?

Yes, Greg here, Eric.

Certainly, we start off with the 35 pilot stores, we're able to compare performance of those versus the control stores that we had set up.

We're still feeling good about how they're performing versus control.

The next phase was to go to Houston and Dallas, rollout mass markets which we completed about mid October.

The learning there was one, how do we roll this out in a mass market versus individual stores around the country and I think a lot of good learnings came out of that to help us improve that process and reduce the cost of the rollout itself.

We're still analyzing obviously numbers coming out of Dallas and Houston to look at maybe if there's opportunities to improve before we rollout in March.

The real reason for delaying the two weeks into March is we do want to add the decor package, and it didn't make sense for us to start a rollout before that new decor package was finalized, I actually saw it Saturday, we got good results on it and I liked what I saw so by March 1 we're rolling out the conversion as well as the new decor package in parallel.

Does the addition of the decor package change the cost or time to implement meaningfully?

No, but it's always factored into the cost and it pretty much can be done in parallel but again I think making sure that we have it right is important to the overall proposition.

Yes, it was included in the $30,000 to $50,000 total cost that we've been talking about.

Okay, and as the data has moved on with Houston and Dallas, what have you learned?

I think you talked about maybe a comp improvement you needed of a point or two to make the math work.

Can you talk about how that's going?

Yes, we're still analyzing the data.

The only thing is we probably wouldn't have picked Houston because we're comping on a hurricane so it's difficult to get apples-to-apples numbers.

I think the key learning that we're really addressing looking at is again we're looking at SKU by SKU, did we take out some SKUs that maybe we needed to add back but we feel good with the 3500 items that we have reduced.

I also think what we want to do is look at localized or local unique stores.

For example, this has worked well in the majority of our stores that are pretty much according to prototype but when we begin to look at Hispanic stores, African American stores, maybe beach stores and so fourth, the uniqueness there is what we want to now address, but we have more data and I think hopefully by our next quarter call we'll be able to share more.

I think we'll have a good two months of being able to drive through the data and analyze it and give you more color on the next call.

And then lastly, on the beer and wine rollout, can you give us any sense on is the comp benefit from that material and how is the profitability of that influence the overall store?

Yes, we're in about 1600 stores now, the comp benefit will be material.

We think that not only will it drive sales but also it's a nice basket item that drives basket size as well.

As far as the margin, we're really working through the mix now as far as what we hope to attain.

We've got a private label wine that we just launched that has a little higher margin that we feel good about, but we'll know more about that as well as we come through the season.

Very good.

Thank you.

Our next question comes from Ann Hynes with FTN Equity.

Good morning.

Good morning can you give us details around H1N1?

I guess what is your internal expectations, how plan it flu shots do you think you'll receive and I guess the economics, I'm assuming that you get the flu shots for free and you're just charging an incremental charge to administer it, so how should we look at that I guess in the coming months?

Yes, Ann, this is Greg.

It's kind of hard to predict because we're really working with obviously the government and the individual State.

Most of the states at this time have worked through what they call the priority high risk population and now they're opening distribution up to the pharmacies across the country.

We have provider agreements in 49 states excluding North Dakota.

We have product in about 3000 stores in 36 states today, and we've given about 350,000 H1N1 vaccinations to date and we're really depending on how the states begin to open up and utilize pharmacists across the country.

We think they will and we're working with the states and the government to make sure that they understand how we can help.

Okay, great, thank you.

Okay.

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

Yes, hi, good morning.

Good morning.

Just not to be simplistic but on the SG&A side if I'm hearing you correctly, we should be looking for the kind of same type of differential over the next couple quarters?

I know year to year comparison get maybe a little bit tougher but on a two year basis it looks actually fairly flat.

I'm just, so the improvement we saw this quarter is it fair we should just kind of assume that's a good proxy for the next couple quarters?

Well kind of again, you got to kind of run the model out quarter by quarter and putting the timing of how that store lag happens and like I said things like the CCR, the CCR initiative is almost all SG&A contract labor resetting stores so when those stores hit and things like that, so it's a little more complicated than that, but in general you're probably not too far off.

Okay, and then just a follow-up on the pharmacy side, you talked about the AWP hit.

I'm assuming some of that has been offset by a better dispensing fee starting in the states.

Any other positive offsets we can look forward to as the year goes on?

Yes, I think David, we are working state by state to try to get improved dispensing fees and that's certainly something we're focused on.

I think the things like improving our generic penetration rate to help offset it, the services we're talking about with flu shots and so fourth are going to be rolling, it will help offset some of that.

We're also looking at taking out the supply chain costs as well and the operating costs with our transforming community pharmacy initiative as well as our supply chain efforts to try to offset it.

Will generics be enough positive or negative this year?

We have another like year ahead of us here and I'm just wondering how the profitability levels will be for that product anyway.

Yes, I think obviously we're not going to see another big wave until the latter half of 2010 or 2011 on generics but at the same time we work to improve our utilization, our penetration of generics of the existing generics as much as we can.

Great, thanks a lot.

Yes.

We'll take our next question from Meredith Adler with Barclays Capital.

Hi, thanks for taking my question.

I'd like to just go back and talk a little bit more about Medicaid.

The states all have pretty significant budget problems.

Do you think that they're looking at the AWP cut as maybe stationed for them to cut their Medicaid reimbursement or are you expecting there could be another round of cuts as they try to balance their budget?

Good question, Meredith, this is Greg.

I think it's hard to say.

It varies state by state and I think some of them may see the reduction as sufficient, so depending on the State maybe looking for more and we're just going to have to certainly work with each State individually and try to bring them other solutions to help reduce costs, but believe me, we've got focus on each individual State today.

And the states generally don't do much to incent patients to go with generics.

Is that changing?

Are they getting more understanding about the benefit of that?

Yes, we're working with them to help them understand that for every X percent in generic utilization there's X percent savings and I think us getting with State Medicaid Directors and helping educate them and look for alternative solutions it is exactly where we're going.

Okay, and then, I have another question just about AMP.

Can you give us an update about where that stands?

Is that going to be putting a place?

Yes, it's obviously hard to predict what comes out of the healthcare reform, certainly with the Senate probably passing something or most likely passing something before the holiday, there is AMP legislation in language in both bills.

We feel good about the new definition of AMP, how the benchmark is established and we're obviously looking to make sure we get enough of the multiplier on top of that AMP to make sure the pharmacists can afford to continue to serve Medicaid patients across the country.

Okay, great.

Thank you very much.

Our next question comes from Deborah Weinswig with Citigroup.

Great.

Thanks so much.

Obviously the flu program by any measure has been a huge success.

So two questions, one, what do you learn from this that you can apply to potentially other initiatives internally and then have you done any analysis around the retention rate of the new customers?

Deborah, I think the first thing this tells me and tells us is that this is a great illustration that consumers across the country value the convenience and access that community pharmacists can bring in addition to prescription drugs.

For us to administer better than 5% of the nation's seasonal flu shots, I think basically indicates that.

As far as learning, I think certainly there are ways that now if we go into next season we'll be able to improve the process as far as some of the administration work and so forth as patients come in, but I think as far as new services, there's plenty of opportunity to do more script-like services in our community pharmacists such as flu shots.

Retention rate?

I think we saw that about 40 to 42% of the flu shot patients were new to Walgreens.

We won't know the retention probably for another 30, 60, 90 days.

Certainly that's something we'll be analyzing to get a better understanding and once we do know then next year we can certainly work to make sure we have good programs out there to improve that retention rate.

Okay, and then in terms of power, can you talk about the savings, obviously it's just been a few markets driven so far by the initiative and how should we think about a rollout plan?

Well, you know, the big kind of the big idea here is we call it transform community pharmacy of which Power is one initiative, there's other things, dynamic work load, balancing, some of the reengineering efforts we're doing but so far so good and in power as you know we're strong in two states now and Florida is over 10% of our business and we've rolled out now in Arizona and Phoenix but so far so good.

We're seeing again we're seeing good customer service levels now.

We're seeing more importantly a lot of time freed up for other things and Florida and flu shots we gave 15% or more of our total flu shots in Florida without adding any overtime pay and honestly that would not have been possible or even remotely possible without the power initiative to pull some of that transactional work out so we feel very good about it.

Again, it's taking short time to fill pharmacy and wait times is one of the key elements of success so that's helping as well but we feel good about it and we feel that both the front end and the central fill has broader applications across the country.

And I think with Transforming Community Pharmacies that initiative there's really three buckets that we talk about.

One is what we're doing within Florida and Arizona with centralization and some of these tasks that Wade just mentioned, and the others we're continuing to leverage the dynamic work load balancing technology and system across the entire nation to leverage excess capacity at some stores to help others and then third, we're just going back into the existing pharmacies and looking at the complete work flow and the work process that takes place, that continue to find ways to improve processes to take costs down.

Okay, and then last question, can you talk about traffic ticket in the quarter and were there any real differences by month?

Could you repeat the question, sorry?

Can you talk about traffic and ticket in the quarter and were there any real differences by month?

Yes, I think we're seeing traffic hold pretty good.

We're up in traffic.

We are down a little bit in ticket.

Our items or units per customer are running a little bit down, so therefore, we feel good that we're swinging doors.

People are coming in and that kind of goes to the promotional point that we don't really need to over promote people to get inside.

The real focus now is driving and working basket size and unit per customer.

And even though our traffic has been robust as Greg suggested over the quarter it was a bit heavier in September and October driven by the flu shots traffic but still even as today, we still feel pretty good about what we're seeing in the numbers.

Great.

Well thanks so much and best of luck.

Thanks.

We'll take our next question from John Ransom with Raymond James.

Hi, good morning.

You guys redid your distribution contract with Cardinal.

How much did that help in the gross margin in the November quarter?

John, this is Greg.

That must have been over what a year ago I guess at this point in time, but certainly we worked with Cardinal, they're our main suppliers, obviously we got good costs and good rate with Cardinal but we don't give that out, John.

When you talk about your gross margin, gross profit savings in the Rewire, sorry not in Rewire but when you talk about your gross profit savings as part of your $1 billion, is that the skew rationalization or how should we think about that?

You mean the $1 billion CCR?

Yes.

You broke it out, it's not all SG&A, part is gross profit, could you talk a little bit more about the gross profit savings?

Well yes, let me explain.

The Rewire for growth initiative which will have ultimately a billion dollars benefit in the short-term some of the one-time costs are in things like SG&A, consulting fees and reduction in force, et cetera but a lot of the one-time costs are in cost of goods for inventory writedowns due to SKU elimination and the like, so it's the timing of the one-times in cost of goods year on year that means that de facto, all of this doesn't flow net to SG&A, so we can give a reconciliation table but you'll see year by year benefit and year by year cost and some of those costs end up being in SG&A and some of those costs end up being in COGS and some in other, and you have to reconcile each one of those to know where the net impact shakes out.

Okay, so once you work through this short-term, is there any cost savings in your gross profit line long term or is it all going to be in SG&A?

It's going to be in SG&A basically.

Okay, I misunderstood that, I'm sorry.

And then I guess there was a pretty big cancer injectable drug that went off patent in August, Aloxatin.

Just to clarify, through your specialty, you aren't really participating in any of the oncology market, and is that a market you're looking at long term?

Yes, John to clarify, we are in the oncology space, and we anticipate playing a bigger role in oncology going forward.

Frankly our infusion platform that we have built over the last couple of years with Option Care positions us extremely well to play in oncology going forward because a lot of those drugs are not only injected but they're infused drugs so we definitely think we can put together a unique service model to work with both payers and pharmaceutical companies that are in the oncology space.

Okay, and then lastly just sequentially in the February quarter as the flu shots slowdown just isolating the flu in your gross margin in the November quarter going to the February quarter how should we be thinking about pulling that out in the February quarter?

Well, I mean, there's a lot of different puts and calls, obviously we had the basic quarter and next quarter we'll have H1N1, how much remains to be seen as Greg said so those are effectively helps because of margin and how that flows through.

We also have other things like reimbursement pressure which might have slight different timing quarter to quarter so again I think that it's probably a little bit too early to say how all those will flow through exactly especially because H1N1 remains a little bit of an unknown for now.

Okay, thank you.

Our next question comes from Andrew Wolf with BB&T Capital Markets.

Good morning and first, congratulations on the quarter.

Thanks, Andy.

Absolutely.

Greg, did I hear you say you expected good sell-through for Christmas and if I heard you right, that more driven by the lien inventories or sort of the day fall or do you have some history that says when there's a big snowfall it kind of, with this kind of timing it's going to force people into the stores as well?

Yes, Andy, to that weather point, I tell people this is the time of year when a retailer becomes a weatherman, but I do think that based on our position going in that depending on how this last week certainly comes together, I feel pretty good with as far as where we will be on the amount of seasonal leftover that we have to reduce, so and then last year as I said I think it's an opportunity for us.

Last year all retailers out there certainly were in a position with some pretty large carryover quantities, so I think I guess combination of where I believe we are this year depending on how this last week comes through and compared to last year, I think there's opportunity there for us.

Okay, can you remind me, did you make a concerted effort last year to reduce the packaway, which means really take some margin hits?

Yes, I don't think you'd say our philosophy had changed much.

We had always kind of had a pretty aggressive markdown where we would go 50% maybe throughout the season and then depending on the quantity of the item we have a pretty sophisticated system that will help us determine what that markdown needs to be.

Is it 50%, do we immediate to go to 75%.

Based on last year's inventory level, we were in many cases we were on the more aggressive end of that markdown program, so nothings really changed as far as our carryover, our packaway program.

I think this year as I said, I think we're in a better position so I'm not as concerned about the aggressive markdowns that we took last year.

And my other question, could you update us more on the direct to payer initiatives that you started and I think you just briefly mentioned it, maybe could you quantify maybe the number of folks you're talking to or proposals on the table or what kind of expectations you might expect to see for closed deals similar to the one you had with Caterpillar in maybe the next year or so?

Yes, Andy.

I think first of all I want to clarify.

When we talk about going direct to employers, managed care, PBMs, we're talking about going direct with all of our services and if you go back in time, five, 10 years ago when the industry was more fragmented, it was a little more difficult for a drug store chain to go direct to an employer, direct to Managed Care organization.

Today, with our suite of services, we have everything that an employer, or Managed Care organization would like to take to their clients, so we're talking about going direct with retail pharmacy programs, our work sites which are now in what I would say becoming more of an employer healthcare solution to take to employers as well as Managed Care organizations, so we've got a robust pipeline.

If you look at the employer healthcare solution model, a lot of employers that are interested trying to figure out how to control their healthcare costs while improving the quality of health for employees is a lot of interest in that product.

Great.

Lastly, for Wade, sneak one more in but just a technical one.

The Texas stores, is the cost to do that, is that in part of the $42 million of restructuring or is that in addition to or was that captured during previous quarters?

With the cost of the CCR refurbs is not included in the kind of one-time costs so it's a separate initiative.

And again, you know this 30 to $50,000 per store is mostly SG&A, mostly SG&A and again, for the Texas area we don't have the refurb package in yet and that will be coming, the refresh package will be coming on the next wave of all stores.

Okay.

So was most of the work completed the quarter you just reported or sort of split with the prior quarter?

A little bit split.

Got it.

All right, thanks a lot.

Thanks, Andy.

Our next question comes from John Heinbockel with Goldman Sachs.

Greg, if you look at what you're seeing from the consumer, do you think they have slowed down their spending in the last month and a half or do you think you guys as a channel are getting crowded out by mall based retailers as people kind of go back and spend on those type of products.

Such as post Christmas, you don't get crowded out as much?

John, I do think that it's the macro consumer in general that they are indeed spending less on discretionary and I think that includes seasonal this year.

I don't believe we are being crowded out and I think what we are seeing for the past several seasons, whether it's Halloween, back-to-school, or Christmas, we are seeing shoppers that are becoming more and more last minute, and that's the reason we said this week obviously is an important week for us because we're well positioned to take advantage of those last minute shoppers.

Because when you think about the consumer, if that's the case then January is not going to be a lot different than December, when you think about the consumer getting healthier, do you think your comps, outside of CCR and beer and wine, your comps will basically keep pace with the labor market and unemployment and that will be the telltale sign for an improvement in comps?

Well, I do think that post the Christmas holiday season, there are a lot of non-discretionary purchases with seasonal goods and I think once we get through the holiday, we should see less of an effect on pure seasonal merchandising and the affect it has on our comp.

Okay, and as part of the CCR retool with the decor package, are you making any other changes to departments, whether it be cosmetics or it's basically just the decor?

With CCR-one as we kind of call it which is basically the refresh that we're talking about in Houston and Dallas and in addition to the decor package, that's pretty much as is.

We are looking at certainly the modifications and maybe the changes that we learn regarding SKUs and so fourth that I mentioned earlier.

We are indeed looking at additional opportunities to improve the format whether it's in Beauty, whether it's in expanded food, and beginning to look at pilots and a better understanding of how we can improve the experience and become more relevant to the future shopper.

We could see that, that could be part of CCR 2011.

I don't know if I'd call it part of CCR.

I think that CCR, you'll see a CCR-2 which will be just continued modification improvement of the refresh that we have out there now.

I think some of these others I'm talking about, John, would be bigger format changes as we understand how we can leverage that footprint that we have now in areas like beauty, food and so fourth.

And finally, Wade, two quick ones.

The CCR cost, how much of that is incremental as opposed to what you normally would have spent and then secondly, you guys now have $3 billion plus of gross cash.

How do you think about doing something with that because obviously you aren't earning much in the bank.

Well the CCR cost effectively almost all of it is incremental and it's really because of the nature of how we're executing it doing it very quick and using outside crews to make sure we have minimal disruption in our stores so now again we're hoping the benefits of CCR kind of help close to pay for this thing on the run so that's how we've positioned and talked about that and I think in terms of the size of the investment it's actually pretty miniscule investment relative to the impact that we get from the stores and expect to get.

On cash, we've laid out our cash priorities.

Obviously, it's not great having money in the bank earning almost no interest but we also want to be very smart and very ROIC driven so just because we're generating cash it doesn't mean we'll feel compelled to do something that doesn't earn a good robust return for the Company for the shareholder.

Okay, thanks.

We have time for one more question.

Our next question comes from Scott Mushkin with Jefferies.

Hi guys, thanks.

I'll be quick.

I know we're at the end of the call.

So I just wanted to go back to the CCR in Houston.

Is that helping or hurting sales?

I know we didn't answer what it's moving comps up by but you view it as helping sales at this stage or hurting?

I think Scott as I said earlier it's a little too early to tell, with some of the variables that we've got going at us right now as far as the season and the hurricane, we're comping in Houston so forth but believe me, we'll have better insight by the next call and be able to feel a little bit better about where we are and what kind of numbers we are seeing.

Note all these stores always had a planned dip just from the initial not shut down but just the work going on, so we've modeled what that planned dip is, in most cases, we're doing better than the planned dip but still there is a structural bend as you get into this initially.

So as we look at, I guess I also had a question on the decor package.

My impression being down in Houston was you actually did switch the decor package and so was to say another switch of decor or just a clarification there?

No, Scott, a good question.

When we gave in we gave a refresh to the existing decor package which was minimal on cost but what we're looking at rolling out in March is a complete new decor package with different graphics and so forth.

And then Wade, talking about the dip as we do 3000 stores, any magnitude of what kind and is it mostly front end or how do we look at the dip?

Yes, mostly front end.

It's something that we haven't given the number but it's something that for two or three weeks come out of it and go positive but I don't think it's going to be that material that I would worry too much about it.

Okay, and then one final thing on the SG&A, just so I know we've kind of beaten this ale little bit but are your thought process here that I think you said that kind of 7% to 8% growth range there that would seem to be a little bit above where the street was and could take your earnings down below the $2.40 level, is that how I should be looking at this?

Yes, well the reason we give clarity on SG&A first and foremost is just because we want to make sure we maintain transparency and credibility with you and all of our stakeholders in terms of these Rewire for growth benefits so that people can see they actually are being delivered and again because there's lots of moving parts in that is G & A and in some cases maybe lack of clarity of how new stores the rolling average how that impacts whatever, there is kind of a wide range out there in terms of how SG&A is modeled but that I think is really the key thing we wanted to focus on was just to make sure people understood how should they look at SG&A, how can they have confidence over time that in fact these Rewire savings are being delivered as committed.

And consulting fees in the quarter and that's my last one.

What were they?

I think it was about $7 million.

That coming down nicely?

Clearly over time, I think we feel we did the right thing by getting lots of outside help so because in fact a lot of what we've been doing is changing the tires while the car's moving and our people are working very hard in their day job, so the additional capability has been helpful so that we can keep running the business but clearly over time, we've got a lot of great people and we would like to be much less reliant upon that and much more dependent upon our great people.

Sounds good.

Thanks for taking my questions.

Thanks, Scott.

And we have no further questions at this time.

I'd like to turn it back to our presenters for any additional or closing remarks.

Folks that was our final question.

Thank you for joining us today.

We'll announce December sales on January 6th.

Please note that reflects our new schedule of announcing monthly sales on the third business day of the month rather than the second business day.

The following week, we will hold our Annual Shareholders Meeting on January 13th at Navy Pier in Chicago starting at 2 p.m.

Central Time.

Afterward we will host a Q & A session for analysts who are attending.

We hope to see you there.

Our next quarterly financial announcement will be Tuesday, March 23rd.

That's when we will announce Fiscal 2010 second quarter results.

Until then, thank you for listening and have a happy holiday and a great New Year.

That does conclude today's call.

Thank you for your participation.