沃博聯公司 (WBA) 2010 Q2 法說會逐字稿

Good day everyone around welcome to the Walgreen Company second quarter 2010 earnings conference call.

Today's call is being recorded.

At this time, for opening remarks and introductions, I would like to turn the conference to Rick Hans.

Please go ahead, sir.

Thank you and good morning everyone.

Welcome to our second quarter conference call.

Today Greg Wasson, our President and CEO, will discuss the quarter's highlights and sales trends, the flu's impact on our results, acquisitions, Customer-Centric Retailing and the recent restructuring of our healthcare divisions.

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

As a reminder, I am available throughout the day by phone to answer any additional questions you may have.

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.

Before I move into our quarterly numbers, let me share a few thoughts on the historic healthcare bill that passed the House on Sunday.

The bill will impact us both as an employer and a provider and we've said all along that we support the three core tenants of healthcare reform, improved quality, greater access to care and lower costs.

The bill is expected to provide health insurance to an additional 32 million Americans and we expect to benefit from that as a provider.

As an employer, of 238,000 people, we'll be examining the impact of the bill on our workforce and our retirees along with the bill's financial implications.

In future calls, we'll share with you more details of its impact particularly as changes to the Senate bill are directed through the reconciliation process.

Now let's move to our quarterly results.

Net sales for the quarter were nearly $17 billion, up 3.1% over a year ago.

We managed our business in a soft economy and through a significantly lower incidence of flu compared with a year ago.

Net earnings were up 4.6% to $660 million,(Sic-see press release) from $640 million a year ago.

Earnings per diluted share were $0.68, a 4.6% increase from $0.65 per diluted share last year.

The quarter includes the impact of $0.02 per share restructuring related costs compared with an impact of $0.06 in the year-ago quarter.

We continued to generate strong cash flow from operations in the quarter, reaching $595 million.

Cash flow not only supported our strategic investments in the quarter, including our announcement -- announced acquisition of Duane Reade drug stores in New York, but it also allowed us to return $370 million in cash to shareholders through dividends and stock repurchases.

For the first six months of the fiscal year, sales increased 6.1%, while net earnings increased 10.5% to $1.2 billion or $1.17 per share.

The unusual pattern of this year's flu season impacted our overall comparable sales performance for the quarter.

Both scripts and front end sales spiked in the first quarter, when the flu hit hard, and were relatively weak in the second quarter when the flu subsided.

This quarter in particular was helped by the 7 million seasonal and H1N1 flu shots that we provided this fiscal year.

We remain focused on growing market share through organic store growth, acquisitions, prescription file purchases, and strong store execution.

Over the past six years, the annual number of retail prescriptions in the US has grown 15%.

In that same time period, the number of prescriptions we fill each year has grown 61%.

We've also steadily grown our market share from less than 14% in 2004 to 18.9% of all retail prescriptions today, according to IMS Health Data.

I apologize for missing a few of the slides, starting out.

Looks like we've got them back online for you.

I'd like to bring you up-to-date on the progress we've been making on our three key strategies.

Leveraging the best store network in America, enhancing the customer experience, and achieving major cost reductions and productivity gains.

Let me start with the impact of one of our very important initiatives, and that's slowing new store openings.

This initiative is freeing up cash for strategic acquisitions, even while we open more stores, more new stores, than all of our drugstore competitors combined today.

The acquisitions help us fill in important regions of the country and widen our footprint more quickly than through organic growth.

As you can see from this map, in just the past few years we've strategically filled in our store base with acquisitions of pharmacies from El Amal in Puerto Rico, Drug Fair in New Jersey, Eaton Apothecary in Boston, Snyders in Minnesota and last week's announcement of 17 USA drug pharmacies in the Memphis market.

Our most significant retail acquisition was last month's agreement with Duane Reade drug stores.

Duane Reade's 257 drug stores in the New York Metro area are an exciting acquisition, of course for several reasons.

First, finding good real estate in Manhattan is very challenging.

It would take us many years of organic growth to reach the store count that this acquisition brings us.

Second, Duane Reade's store footprint in New York is also highly complementary to our own existing store base, so together we'll be able to use this critical mass to drive additional growth in highly attractive northeast markets.

Third, we see significant complementary strengths between Duane Reade's focus on urban retailing, customer loyalty and private brand products and our own initiatives in pharmacy, health and wellness, and Customer-Centric Retailing.

Together, we intend to build a unique urban drugstore proposition.

One other transition this year I'd like to note is the acquisition of the prescription files from SpecialtyScripts LLC, a subsidiary of Cardinal Health.

Acquisitions like this are an important part of building our specialty pharmacy business.

I'd like to move to our second core strategy, enhancing the customer experience.

One of our key initiatives under this strategy is CCR or Customer-Centric Retailing.

As promised on our December earnings call, we're going to take a deep dive into CCR in order to give you a little more color on this call.

I'll start by showing you a few photos of one of our fully converted CCR stores including our new decor package.

This is our over-the-the counter and pharmacy section where you see the arch that calls out the pharmacy.

Also, notice the lower fixture heights that allow customers to identify the pharmacy from anywhere in the store.

This shot shows the new beauty area.

An important department to 75% of our customers who are female and an area where we intend to grow.

Here is our food and consumables section.

We're adding beer and wine and looking at more fresh food offerings in the future.

And finally, our photo plus department, where we have the number one market share in the country in photo finishing and have even more services under consideration.

As we've said from the beginning, we've looked at CCR as a four-way win.

It will improve sales.

It will reduce working capital deployed.

It will take work out of the stores.

And it will provide a better customer experience with greater relevancy and efficiency for our shoppers.

Next, I'll cover the four key drivers of CCR.

First, we're optimizing our existing assortments.

We identified the best selling, high value products that best meet the needs of our customers.

In the process we eliminated roughly 3500 SKUs per store.

Second, we're improving our category and product adjacencies in order to help our shoppers easily find and purchase related items.

We call this solution selling and a good example is our new dental category.

Dental products are now adjacent to shaving needs, bringing together categories that are part of the customer's morning routine.

Third, we're improving sight lines throughout the store, by lowering the profile of our merchandise and improving our signage.

Finally, we're refreshing all of our stores with a new decor package which will brighten the stores with contemporary colors and updated signage.

An important first step in the CCR process was categorizing all of our products into four classes.

Our strategy is to win in the categories that are most important to us.

While offering an assortment of the most important products in our convenience categories.

Here's how we've segmented our product categories and the percentage of SKUs that we removed from each class.

Our signature class includes the categories we're known for and we intend to win in.

This includes categories like vitamins.

Next, is the power class.

These are categories in which we want to be the best in the drugstore industry, such as hair care.

Third is staples, everyday needs such as paper goods and fourth is the complement class which are the impulse buys or convenience items in categories like automotive.

With that as background, here's where we are today with CCR.

Now, it's important to keep in mind that when we talk about CCR, we've converted nearly 700 stores and we have parts of CCR rolled out across the entire chain.

So to start, we've eliminated, as I've said, around 3500 SKUs per store.

We've reset 36 categories chain-wide to the new CCR assortment which account for nearly 40% of our front end sales.

And these 36 categories now include the solution selling I described earlier and increased facings of 800 products.

This is intended to not only increase sales, but also to decrease both stock replenishment time and out-of-stocks of our better selling products across the chain.

In addition, across all 7100 stores, we're dedicating more space to key categories like skin care and vitamins.

We're also adding entirely new categories like beer and wine.

Currently we offer a moderate selection of beer and wine in more than 2500 stores and we're looking to grow that number to 5,000 by the end of our fiscal year.

In the 700 converted stores, we've optimized category adjacencies and assortments and improved sight lines with lower shelving and this spring we're adding the new decor package.

And we've worked to refine our costs for this refresh initiative.

To date, we have a complete conversion package including the new decor package at an estimated cost of $40,000 to $55,000 per store, and we expect to improve on those costs as we move forward.

Let's now look at some of the early results.

First, since the ultimate goal of CCR is to improve our customer shopping experience, here's what they've had to say.

More customers say the converted stores feel more open and spacious.

They also say they can get in and out more quickly while enjoying a more pleasant shopping experience.

Their perception of us as a health and wellness retailer is increasing.

And finally, we're getting good feedback on how we're providing value for their shopping dollar on the products they want.

Next, CCR's impact on inventory reduction has been dramatic.

Total inventory has been reduced by more than $500 million chain-wide.

And I want to point out that this alone more than pays for the entire initiative.

Lastly, we're seeing good results with CCR removing work from our stores due to lower -- due to fewer store level SKUs, increased facing of our better selling items and lighter stock rooms.

As a result, we are hearing from store managers that they have less replenishment work to do.

This means we can use those labor savings for more customer service, and additional cost savings which are included in our rewiring for growth initiative.

Now we'll give you some color on CCR's impact on sales.

Let's start with data on how our four product classes have performed in the 31 pilot stores compared with the control group.

Our best data comes from these stores since they have been converted the longest.

When we compare them it's important to keep in mind that even the control group benefited from CCR changes we've made chain-wide including the assortment optimization and category resets.

In addition, the pilot stores have not had the benefit of our new decor package which is just now rolling out.

As you can see on this slide, pilot store are outperforming the control group in each product class except complement and taking all product classes together sales in the pilot stores were up nearly 2%.

I also want to point out the data below the chart which shows the percent of front end sales for each product class.

The signature class accounts for 29% of front end sales, and is outperformed the control group by nearly 5%.

The power class accounts for nearly half of front end sales and is outperforming the control group by 3%.

Staples, a smaller class, accounts for only 17% of front end sales and it shows a slight increase, slight sales increase versus the control group.

And finally, the complement category, complement class, is the smallest in terms of front end sales at 6%, and has underperformed the control group by about 8%, partly due to a dramatic SKU and space reduction.

We intend to add some items back to this class and I'll cover that a little later.

Overall, we're happy with the results we're seeing from the pilot stores and we expect the trends to get even better when these stores receive the new decor package.

As we said, the next step was to pilot CCR to two main markets.

Our two goals were to vair verify that we could roll this out to an entire market with a minimum of disruption and within budget and secondly we wanted to gather learnings from piloting in a mass market in terms of its performance at a market-wide level.

In terms of comp sales, Houston and Dallas are to date underperforming the rest of the Company, primarily reflecting regional economic conditions.

However, since rolling out CCR, the stores in these two markets have seen their market share slightly improve compared with the inbound trend.

One other trend we've also noticed was that for stores with a higher percentage of sales coming from the complement categories, there was a greater decline in overall front end sales.

Clearly, the greater SKU reduction in the complement categories led to a more pronounced sales impact in these select stores.

So though we've always merchandised our stores by peer groups, the key learning out of Houston and Dallas is that CCR needs to be further tailored according to these groupings.

We've already added back on average a few hundred relevant items and more are on the way to stores with a higher percentage of sales coming from the complement class.

In addition, to optimizing our existing assortments, we're now working to enhance our product assortment.

We currently have approximately 20 enhanced categories scheduled to hit stores chain-wide this summer, such as our new electronics department.

We expect to have converted between 2,500 and 3,000 stores by late fall 2010.

The next 1,200 store conversions will lean more to stores with less dependence on the complement class.

This gives us more time to make the needed adjustments to CCR plans for the stores hardest hit by the SKU reductions in the complement product class.

Of course, all CCR stores moving forward will have the benefit of the new decor package.

So wrapping up our CCR discussion, our early results absolutely show we're moving in the right direction.

Customer satisfaction has been positive.

We're incorporating learnings from early roll-outs to improve the offering and it's produced good economics for the Company.

We've already seen, as I said, a $500 million reduction in inventory.

I'd like to turn now to a significant announcement we made earlier this month intended to drive our revenue and top line growth.

We announced the strategic restructuring of our healthcare divisions, in order to offer integrated pharmacy and health and wellness solutions to our wide range of clients, including employers, managed care organizations, pharmacy benefit managers and government agencies.

Today we're going directly to these clients with a single sales and client services organization for the entire Company, headed by Hal Rosenbluth.

Kermit Crawford, Executive Vice President of Pharmacy will oversee the integration of our specialty pharmacy, home care, infusion, long-term care businesses with our retail pharmacy business.

We're looking forward to the upcoming selling season.

Before closing, let me briefly touch on our third category, reducing costs and increasing productivity.

We continue to make significant progress executing on this strategy and as this chart shows, we controlled SG&A growth even in a weak sales environment.

Gross profit dollar growth slightly exceeded SG&A dollar growth in the quarter.

We remain on track to deliver $1 billion in annual savings in fiscal 2011 under our rewiring for growth.

With the progress we've made in the last quarter, I can assure you we remain confident in our three key strategies while managing to a soft economy.

While our ongoing focus -- with our ongoing focus on growth, we are making strategic acquisitions that were enabled by our strong cash position.

As we continue rolling out CCR, we're moving ahead with our success, while responding to customer feedback and applying learnings.

Our goal is to deliver the most compelling value with respect to convenience, assortment and price.

We're restructuring to bring our pharmacy and health and wellness services and the one cohesive integrated solution.

One that leverages our center of gravity, our community of drug stores, and allows us to serve all of our clients better.

And the solution, these solutions are aligned with the goals of healthcare reform.

I would like to say Walgreens is skating where the puck will be and we're well positioned on the front line of healthcare to do so.

Thank you for joining us at this time.

At this time I'll ask Wade to update you on the financial results from the quarter.

Wade?

Thank you, Greg and good morning everyone.

Let's review the quarter's results in more detail.

In the quarter, net sales increased 3.1%.

Net earnings were up 4.6% and earnings per diluted share were $0.68 or $669 million, up from $0.65 per diluted share or $640 million in the same quarter a year ago.

This quarter's results include the impact of $0.02 in restructuring related costs associated with the Company's rewiring for growth initiatives and that compares with $0.06 in cost in the year-ago quarter.

Prescription sales rose 3.2% and represented 63% of sales for the quarter.

Prescription sales in comp stores rose 0.6%.

We filled 192 million prescriptions during the quarter, an increase of 6% from a year ago and that includes a benefit of 0.9 percentage points from patients filling 90 day rather than 30 day scripts.

On a comp store basis the number of prescriptions filled increased 3.4% and that includes a benefit of 1.3 percentage points from 90 day scripts.

The second quarter was significantly impacted by the level of the flu.

This slide illustrates just how much the flu season has varied over the past three years.

During our fiscal second quarter, included in the red line, you can see the incidence of flu dips below the previous two years.

This year's number shows the early rise in flu cases.

That's what contributed substantially to our first quarter's 19.6% earnings increase.

I would also like to note these stats released by the CDC in February, only 1.8% of doctor visits near the end of February were flu-related.

Compared with 3.5% in late February 2009, and an even larger 6% two years ago.

Let me say a few words about our front end comp store sales.

These sales in the quarter were down 1.6% primarily due to the weaker flu season and the way we've managed seasonal inventory and seasonal sales.

Now, when viewing a true apples-to-apples time period, that compares our front end comps with our top three competitors, we are outperforming them in the same periods they most recently reported, as shown in this chart.

Gross profit in the second quarter was $4.9 billion, a 5.1% increase versus the year-ago quarter.

Gross margin increased 50 basis points compared with the year-ago quarter to 28.8%.

Helping overall margins were improved seasonal margins due to decreased markdown activity year-over-year, a lower provision for LIFO, and lower rewiring for growth expenses.

Retail pharmacy margins were flat, partly driven by a slower year-over-year rate of generic introductions.

The two-year stacked SG&A dollar growth shows substantial improvement compared with the year-ago quarter, dropping from 16.9% to 12.6%.

As we cycle these comparisons, it is more difficult to continue on that pace of SG&A reductions.

Some of that improvement can with traced to benefits from our rewire for growth initiatives.

This chart summarizes the savings and costs for rewiring for growth restructuring since the year-ago quarter.

Total rewire expenses for the quarter were $28 million for the first six months they totaled $70 million.

We anticipate approximately $140 million in rewire expenses in fiscal 2010.

We remain on target for a net pretax savings of about $500 million this fiscal year, and a net pretax savings of $1 billion in fiscal 2011, both versus our base year of 2008.

Now let's review some additional income statement details.

The LIFO provision was $27 million versus $49 million in the second quarter of 2009.

That represents an anticipated LIFO provision of 1.5% for the year.

Next are the $28 million from restructuring costs in the quarter including $6 million in SKU discontinuation, $17 million in consulting and other of expenses and $5 million in costs associated with the workforce reductions.

The effective tax rate was 37%, compared with a tax rate of 36.7% 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 the components of working capital that we can most directly impact.

The net sum of these, as compared to sales, fell 6.3% in the quarter,compared with the year ago.

Total inventories were down $400 million or 5.1%, against total sales growth of 3.1% and total drugstore growth of 7.5%.

Among other interventions, we were helped by our SKU optimization program, the sell-through of which is now 85% complete.

FIFO total inventories on a per store basis fell 9.6% in the second quarter, controlling inventory continues to be a top priority.

As you can see, we have consistently made great strides over the past six quarters.

Cash flow from operations for the first half of the fiscal year was $1.8 billion.

Free cash flow increased to $1.2 billion in the first six months, versus $648 million for the same period last year.

And cash and cash equivalents and short-term investments totaled $3.1 billion, while long-term debt totaled $2.3 billion.

To update you on capital expenditures, we have previously estimated about $1.6 billion this fiscal year of spend.

We now expect to be closer to $1.4 billion, with the change primarily due to strategic delays in the new POS system roll-out.

You'll recall that last month we announced that we are purchasing Duane Reade for a total enterprise value of $1.075 billion which includes the assumption of approximately $457 million in debt.

We plan to fund the entire acquisition through existing cash.

We have several alternatives with respect to Duane Reade's outstanding debt which we are currently evaluating.

This transaction is aligned with our strategy, our capital allocation priorities and our return objectives.

We believe this transaction will generate strong IRRs as well as create value for our shareholders.

We spent a lot of time evaluating our alternatives in New York City market and believe that this acquisition compares favorably to an organic growth strategy.

As previously stated we anticipate the acquisition will be dilutive to earnings per share in the first 12 months after closing and accretive in the following 12 months and beyond.

And now, recall, that much of the first year's dilution is related to one-time costs that are now expensed under the new purchase accounting rules.

We expect to achieve $120 million to $130 million in synergies in the third year after closing, primarily in purchasing and SG&A.

And in the future we could see some revenue opportunities as well.

Our strong cash flow and balance sheet allowed us to pay out $136 million in dividends during the quarter, and buy back $234 million in Company stock.

In the first half of the fiscal year, we returned $272 million in dividends, and $384 million in share repurchases.

We plan to continue returning cash to our shareholders through a combination of dividends and buybacks which nearly tripled in the first half compared with the year-ago period.

You will recall that our December dividend was 22.2% increase over the year-ago quarter.

In addition, we set a long-term dividend payout target of between 30% and 35% of net earnings.

As we plan for our third quarter there are a few things to keep in mind.

First, Easter falls on April 4th this year, about a week earlier than last year.

And that will push more Easter sales, we estimate about 40%, into March.

Looking beyond our March sales report, we will also report a March, April combined comp with our April sales results.

Now, also like other retailers, we are cycling the impact of cigarette tax increases that was implemented in March 2009.

This may negatively impact March April combined comps by about 100 to 150 basis points.

Now, in closing, I remain very optimistic about Walgreens' future with many opportunities as we focus on executing on our core strategies.

We continue to drive smart growth, both organically and through acquisitions.

We are enhancing the customer experience through CCR and other initiatives and we are meeting our goals for cost reduction and productivity gains, in part through the rewiring for growth initiative.

So to reiterate Greg's point, we are confident in our strategies and we are cautious about the economy and the pharmacy reimbursement environment, but as we move through the soft economy, we will continue to be agile, do what's right and drive smart decisions for both the short and the long-term.

And now I'll turn the call back over to Rick.

Thank you, Wade.

Ladies and gentlemen, that concludes our prepared remarks.

We are now ready to take your questions.

Thank you.

The question-and-answer session will be conducted electronically.

(Operator Instructions) Our first question will come from Lisa Gill of JPMorgan.

Thanks very much and good morning.

Greg, I just had a couple of questions around your healthcare initiative.

Our understanding is that Walgreens has signed another relationship kind of similar to Caterpillar with Delta.

Can you maybe just go into a little bit more detail around the kind of offering that you have in the marketplace and how it differentiates from some of the PPMs?

And then secondly I think you made the comment that you're looking forward to the selling season.

Can you maybe just give us an idea of the number of RFPs that you participated in this year versus previous years?

Are you ramping that up dramatically as you continue to grow your healthcare offering?

Thanks, Lisa and good morning.

As far as Delta, I don't want to comment specifically.

We don't actually have a signed deal with Delta.

There has been discussion out in the marketplace.

I will say that we're excited with the interest that we've had in this Caterpillar-like offering.

With Delta, by the way, we already have a healthcare center and a pharmacy on center with Delta and we're looking to just expand services in any way we can and if PME is something that makes sense for them, we're certainly going to be able to offer it.

With the restructuring, I'm excited about it.

I think what it does, as I said, it really takes and integrates our pharmacy services around a center of gravity, a retail community pharmacy.

Kermit Crawford's going to lead that.

I think we're really going to accelerate our integration of those offerings.

Hal Rosenbluth, as I said, has been in the B to B space for his entire career.

We're bringing the sales organizations together, segmenting by customers, and I think -- that's what I mean by I'm excited about getting into the selling season because I think we are really focused with some good solutions.

As far as RFPs, Lisa, I'm not really focused on responding to RFPs.

We want to get in and work directly with employers, managed care organizations, PBMs, government agencies, whoever they might be, and really find out what are the problems they have.

What are the problems they're looking for us to solve and how do we bring some of our solutions to help them do this?

So I'm not a real fan of just responding to RFPs.

I think there are folks out there looking for real solutions and I think we've got real solutions to take to them.

Just as a follow-up to the solutions that you offer.

Are you talking about fee for service type solutions?

Are you talking about trying to bring more volume into the Walgreens store?

How do we think about this over the next several years and how it should flow through our financial models?

It's a good question, tough question.

I think there will be a combination, Lisa, of certainly fee for service.

I think healthcare reform -- I think where the industry's going, where everybody probably would like to see us get is more pay for performance and more coordinated care.

So where fee for service goes long-term, I don't know.

But there's still going to be a lot of fee for service going forward.

I think at the same time what we want to do is we want to be able to get in and certainly bring more services per client.

Maybe in addition to looking at the number of retail prescriptions we fill and the margin we make on that retail prescription, we're also looking to drive what I call the total value of a client.

So with Delta.

If we're able to go direct or with other employers we want to be able to drive a lot more services.

Some of that may be volume related.

If someone wants to work directly with us and we're able to give them direct pricing via direct contract and that drives additional volume for them to realize the savings, then we'll be doing more of that as well.

And then if I could just squeeze in a follow-up with Wade.

Wade, you made a comment about drugstore margins, pharmacy margins.

You said slower generic introductions.

Are you saying that helped to maintain your margins and how should we be thinking about as we have a number of generics that will come in the next couple years, are generics generally better for you on the total gross margin dollar?

What I meant to imply is this is a weaker generic season certainly than prior periods.

It starts to pick up in latter years.

That was the net.

You were saying that you were happy that retail margin, gross margins were flat just considering the fact that you didn't have as many generics?

Exactly.

Thank you for the clarification.

Thanks, Lisa.

Our next question will come from Mark Miller of William Blair.

With regard to the cost savings and your comments that you're on track to achieve the $500 million savings this year, it looks like you'll need an accelerated pace of cost reduction in the second half of the year.

And I was hoping you could talk about where you expect to see that acceleration in the coming quarters, because it looks like the run rate needs to pick up pretty quickly.

Thanks.

There is some acceleration, Mark, but actually we actually have delivered substantial savings in the first half as well.

You have to -- going back to the last quarter is getting to the full reconciliation of how much SG&A was driven by the new store openings, which was still in total our stores were still 7.5% year on year as well as some of the acquisitions and then the SG&A burden we picked up along with that and some of the other things as well.

It certainly ramps up a little bit through the year.

But again if you look at the run rate the last couple quarters, we have delivered a pretty robust savings as well.

Can you I guess talk about what has -- how it's materialized different than you originally might have envisioned relative to sourcing, the overhead store labor and then within power.

Of the three buckets I would basically say we're basically on track with all three buckets.

So there's some minor puts and calls here and there, but I would say plus or minus 10% across indirect spend, across all the areas of labor and across the transforming community pharmacy initiative, we're pretty much on track.

If I could just ask one on the CCR stores, you didn't talk about the cost side of those stores.

You talked about in general terms.

I was hoping you could address the gross margin.

You're saying in the CCR stores, given the complement categories are down, has that negatively impacted the gross margins or are you mixing out actually more favorable and then the cost to operate those stores, how is that?

Is that more favorable as well?

Thanks.

Yes, Mark.

Overall, we're seeing actually the gross margins somewhat improve in the CCR stores.

But there's a lot that certainly can influence that beyond CCR.

We're seeing more private brand utilization and so forth.

I think the key thing that we're looking at, as I said, in addition to four way win that we're looking for with sales, labor reduction, capital reducing, so forth, I think we're really focused on gross profit per basket.

As we add more and more items like beer and wines, as we add more fresh food, we're really focused on gross profit per basket and that's what we're encouraged to see.

Thank you, Mark.

Okay.

Thanks.

We'll go next to Robert Willoughby with Banc of America-Merrill Lynch.

Wade, just a quick one.

Have you stopped the share repurchase with the Duane Reade announcement, or is that ongoing in the current quarter and do you thing it will keep going?

And then secondarily, maybe Greg, any color whatsoever you can provide on the healthcare business, was it accretive to margin this quarter year-over-year, just performance wise, how did the various pieces do?

We have not stopped the share repurchases and we'll continue that going forward.

Okay.

Bob, we don't -- as you know, we don't break out the healthcare divisions, but I think that we're encouraged with our growth we're seeing, especially pharmacy and again, I think the integration we're talking about the retail pharmacy leverages what I think is our key differentiator.

A lot of times internally there's no reason why Mrs.

Smith if she's used Walgreens retail pharmacy for years should not be able to stop in and at the same time get her specialty needs.

We are encouraged there and I think it's a real differentiator.

Infusion continues to grow.

I think there again, that's a differentiator for us with specialty.

We're encouraged with what we're doing.

I think going directly to managed care, they're certainly looking for solutions today.

And I think will be even more so going forward.

So we're pleased with the performance of the healthcare divisions.

Take Care, the health and wellness side retail clinic.

We began to roll out more and more services, Bob, in addition to acute services we give such as screenings, chronic care and so forth and our employer solutions that we talked about with Cat and Delta and others is extremely encouraging right now.

And are you looking at -- profitability moved up with the growth trajectory as well or too early to comment on profit improvement.

I think we feel good with where we are.

I think we're seeing what we expected in all business units.

Okay.

Thank you.

We'll go next to Neil Currie of UBS.

Good morning.

Thanks for taking the question.

Just another question on gross margin.

In terms of the 50 basis point improvement in gross margin year-over-year, excluding LIFO, how much of this was down to markdowns and was there anything else that contributed to the gross margin improvement?

A lot of it was less markdowns and just smarter buying, I would say.

Those two combined activities absolutely.

Go ahead.

I'm sorry.

Sorry.

I was just going to say in terms of competitive activity, what impact did that have net on your gross margin?

It's a fairly promotional environment out there, but it has been a promotional environment for some time.

So I'm not sure that's ticked up.

In fact I think you've seen maybe a few players being more measured as of late, so that's probably a good sign.

Again, I think it was full, it was the impact of lower markdowns largely and again, I think buying a little bit smarter to recognize the economy reality we're in, I think our people did a very good job there.

Neil, I think our merchants and our operators are doing a good job in balancing the items that we need to be hot on, we need to shop value with the items that you might be able to get a little bit more on.

So I think with our rotos we've done a nice job balancing that mix to be able to swing doors at the same to be able to provide value as well as our in store everyday pricing.

Thanks.

In terms of the pilot groups of stores with the 2% improvement over the control group, how happy are you with that?

What were your original expectations in your budgets?

And how are your returns going?

Neil, I think we feel real good about that.

I think as we tried to break down kind of where that's coming, if you look at the signature class, we're winning where we want to win.

You look at that power category and that power class, we're winning there.

So I think we feel good.

I think we know what we need to do in that complement class to bring that category back to where we want it.

So strategically, we're right in line with where we want to be.

And I think that -- and again, that doesn't include the new decor package.

It doesn't include the add-backs that we're going to be looking at and some of the enhanced categories that we've worked on since Houston and Dallas.

So we feel real good with where we are right now, Neil.

Thanks very much for taking the questions.

John Heinbockel of Goldman Sachs has our next question.

Couple of things.

Wanted to drill down on CCR a little bit.

When you look at signature and power.

The 3% and the 5%, how would that break down?

Where's most of that growth coming from?

Is that traffic or transaction value?

Transaction, John.

Almost entirely?

So traffic's pretty flat in those stores relative to pilot?

It's not that noticeable between the control group.

It's mostly transaction.

Okay.

And then secondly, with the complementary down 8, is that more SKU rationalization or the economy do you think?

In Houston, Dallas, we're seeing a little bit of both, as I said, but I think the complement class is more SKU reduction and space reduction.

John, we've always focused on peer grouping within our markets and I think what this shows is we just need to further tailor CCR to those stores that have a higher percentage of sales coming from the complement class and we've identified those items.

We know what categories we need to add back and feel like we've got that under control.

All right.

Then secondly, it looks like the reimbursement environment is relatively tame right now.

You didn't see a lot of pressure.

Do you think that picks up over the next year, given different expense pressures on companies, state governments, not as much generic coming out to reduce cost?

Do you think we see a pick-up in that pressure prior to all of the 2011 or not really?

Yes, John, I think we will continue to see reimbursement pressure.

I think that everyone in this country is focused on healthcare costs, and as I've said several times, there certainly are threats and opportunities to healthcare reform and certainly the threat is the reimbursement pressure.

We manage that entity by entity as we have for years and we're going to be all over that going forward.

The opportunity is the fact that certainly we're going to have more people that have prescription drug coverage going forward.

But yes, we're going to continue to see more reimbursement pressure.

The good thing is, in the back half of 2011 or so, we're going to see some new generics coming out that will help offset that and we'll see the additional volume in 2013 with the folks that have additional coverage.

All right.

Finally, do you think that any cat-like deal would by necessity have the market share incentives that you have in the cat deal, kind of make sure that it's a win-win for you?

I think, John, it will vary by employer and their need.

So I think you could see future cat-like deals, but again, I think that it really varies by what they're looking for.

Again, we're going directly to these employers and managed care organizations, PPMs, everybody I mentioned with a complete solution.

They may need or may want a PME solution, but they also may want healthcare services and a pharmacy on site.

We're kind of going in, trying to help them understand -- or trying to understand what they need and how we can help.

It could be -- you could see a little bit of both, I guess.

Okay.

Thanks.

Andrew Wolf of BB&T Capital Markets has our next question.

Good morning, can you hear me?

Hi, Andy.

Just getting this off speaker phone.

Just on the quarter, Greg, I know you managed margins terrifically in Christmas.

If you look back on it, you're so skinny on the inventory side and the Christmas didn't turn out to be disaster, was a decent Christmas.

Do you think net-net so we can think about the quarter, if you have really fine-tuned it even better and maybe put a little more inventory in there, you might have generated more profit just so we can think about what the quarter might have normalized to.

Or do you think you got it perfectly right between inventory and the strong sell-through?

I'll never say I'm perfect.

I think that's tough to do in retail.

I will say I'm not looking back with any remorse, so-to-speak.

I think that we did actually what we should have done.

We were conservative when we bought and knowing that we were going to come into a very soft economy and a cautious consumer.

I think the good thing is we came out of this season extremely well-positioned.

Our inventories are right.

Our store managers now are able to spend a lot more time out on store -- out in the store versus stock rooms.

Andy, could we have maybe bought an item or two more, maybe did we miss a sale here or there?

I'm sure we did.

I'm sure other retailers probably are in the same camp.

I think the approach we took is right on.

I was just trying to get a general sense of that.

And then another -- I also want to look at or ask you about the first quarter earnings, up 20% and here they're up 5%.

Can you relate that to -- is that pretty much -- what percent, if you've done this thought processor analysis, to what degree was that just the dramatic swing in the flu versus other things that could be on, I think Wade referenced that things aren't getting worse competitively, but other things going on, maybe the consumer just tightening up and not coming into the stores as much or do you think it's mainly close to 100% the flu swing?

Andy, I think as we said, this was a story of the flu.

There's no doubt, the first half with the early flu season, the great job our folks did to execute upon flu shots and flu related sales, this is definitely a flu story.

Second half, obviously with the lighter flu season, impacted the quarter.

And that's the reason we really have looked at it, the first half versus quarter by quarter.

Great.

Thanks.

Lastly, I missed the beginning of the call, so I don't know if you covered your sort of broad outlook on healthcare reform for the industry or for Walgreens.

I was thinking in terms of some of the things that might be obvious like prescription versus margin.

You kind of talked about that.

The donut hole I suppose is good.

What about the clinic business?

We're speaking with Hal Rosenbluth a while ago.

He suggested that with the shortage of primary care physicians, the clinic business may become a very relevant going forward and utilization might really get a lot better for that business and might even entail a change in capital allocation for Walgreens.

Could you speak to any of that?

Well, Andy, I definitely would agree with the first half of your comments.

I absolutely think that healthcare reform, with or without healthcare reform, frankly, I think the clinic business was going to continue to grow and be strong.

There's just not enough access, as you know, out there and certainly if we have another 30 million folks with coverage, it's going to become an even greater need.

So we're bullish on the clinics.

I think -- but I will say, we're looking at our clinics really kind of in two buckets, not only the number of clinics and what healthcare reform may do to accelerate the growth, but also the services within the clinics.

And as you know, this past year we've spent a lot of time really looking at the additional services we can roll out through the existing clinics we have.

So I think both number of clinics and the services that we can offer within those clinics certainly we should see more demand for.

Thank you.

Deborah Weinswig of Citi has our next question.

Hi, this is [Shane Palahicky] on behalf of Deborah Weinswig.

My first -- my core question is what is the current private label penetration that you have?

Roughly 20%.

Okay.

And then how do you plan on leveraging what Duane Reade is doing in their private label business in their stores and applying it to the entire chain?

Certainly, Shane, we have to -- once we close, we'll certainly be able to get a better understanding of where the opportunity is.

I will say, and as I said before, John Letter and his team probably some of the best in the retail industry as far as private brand and building a strong private brand.

They've done a heck of a job in New York City with that private brand.

That's one of the things that really excited me and I think the opportunity to potentially accelerate our private brand strategy with their knowledge and expertise is certainly a strong possibility.

Thank you very much.

Our next question will come from Scott Mushkin of Jefferies.

Hi, thanks.

Just wanted to get a feel on maybe since we're saying the flu is the big contributor of the swing in the quarters, how we're looking as we moved into March, any thoughts on sales as we go through the rest of the year?

We did have H1N1 become an issue I guess late spring last year.

How should we be thinking about your sales as we move through the back half of the year?

Couple things.

Obviously, we've got a bit a shift in Easter timing, but that will work its way out over time.

I think a couple things.

On the front end, I think we're starting to cycle a fairly weak period.

I think we're doing a lot of good things, even on CCR where we've got opportunities to improve, we've seen it and so we're making those fixes.

I think we feel pretty good about that.

Last year's -- I don't think we're going to see -- it doesn't appear we'll see a second bump in the flu, although you'll never know.

So we're probably not going to pick up from that.

We're cycling a little stronger baseline.

I guess what I would say is probably in terms of what we're cycling, we're going to see more upside probably on the front end in the pharmacy, and again, what's happening in the economy remains to be seen.

We'll see whether we get any economic help.

I think we're certainly dragging along the bottom and any pickup at all would be extremely helpful.

In the first few weeks of March you didn't really see any changes, we saw in February?

We can't comment on that.

Obviously, so.

Second question, I just want to have clarity on SG&A.

Wade, I think you made comments to the effect that you had a really good quarter as far as that growth rate went and maybe not to expect the same levels as we move forward.

As we model in our SG&A growth rating is in the 5s in the second quarter, is that something you can replicate as we move through the back half of the year or are we going to -- I think it was 9 and change in the first quarter, 5 and change in the second.

Are we thinking more in the 7s as far as the SG&A dollar growth rate?

We certainly have every intention of delivering the full billion to the bottom line in true analytical form.

I think what I was trying to imply is if you look over those two year stats the last couple years, you don't want people taking that and extrapolating that out forever.

There comes a point in which you deliver the savings and then you're kind of cycling the full delivery.

That's all I want to imply.

Look out two or three years and this trend continues forever, then it will be X -- that's the only thing.

But we -- if you do the model though, in terms of those building blocks I gave you, we have every intent of delivering half a billion net savings this year and a full billion next year.

Just going specifically to the SG&A dollar growth rate, I know on the last conference call, I thought you made some comments, maybe I'm misremembering, about sevenish is kind of what you thought the dollar growth rate was kind of the right look and then of course it came in a lot below that this quarter and I guess I'm trying to understand the rest of the year.

And what your expectations are for the SG&A dollar growth rate.

Yes, I don't recall ever giving a specific percent range.

Maybe we were using that for something contextual.

We haven't given that.

As you know, a lot of it is a function of how many stores you put down over the past 12 month period.

That's the number one driver by far.

Do you think the 5%, almost 5 and change is replicable or no?

I can't give specific guidance on it.

Okay.

Then the final question I have is the next CCR market, do you want to tell us which one that is?

Next what?

CCR market.

No, Scott, I don't really want to giving our competitors any advance warning.

I appreciate your attempt.

And then if I could maybe slip one last one in.

I want to make sure I understand Dallas and Houston correctly.

Are you feeling like the execution there was there was what you wanted it to be and it was all economic related.

Is that how I would read your comments?

I'd go back to exactly what I said, Scott.

I think certainly it's a tough economic or tough region, as I said.

I think we have -- I think there are good learnings coming out of Houston, as I said, those stores with a high percentage of complement sales.

I think the good thing is I think through the -- this is exactly what we wanted to do in Houston and Dallas.

We wanted to really learn more about a mass market roll-out and the good thing is is that the further we get through the SKU reduction and we're about 85% through that now, the easier these conversions will become and that's why we're focused on and we think that we can get some cost reduction as we go forward.

So with store managers as they convert and go through the conversion, if they're dealing with less of the close-out inventory it's a much easier process.

I think we accomplished exactly what we wanted to accomplish in Houston and Dallas.

Building on Greg's comments, I think as he referenced, our overall market share there was flat to slightly up.

In aggregate we held our own despite all the changes.

On the ones that were less skewed toward heavy complement we were obviously stronger than that and then the one that's were heavily complement we were less.

The good news is we held our own in aggregate.

The better news is we also have learned a lot from this as we go forward.

I will say, if there's something I would like to have had, I would like to have had the new decor package in Houston and Dallas.

I think it would have given us a better indication of how we would have done.

Going forward we're going to have that synced up with the most recent conversions.

Housekeeping item.

Did you tell us H1N1, how much it helped RXLs, the shots, for the second quarter?

Just a housekeeping item and thanks for your answers on the other ones.

I don't know if we gave it broken out on sales, but we administered nearly 2 million H1N1 shots.

I believe that was pretty much second quarter.

It's not going to be a needle mover on sales, though.

How about on script volumes, because I know you put that in your volumes?

That 2 million would be included as 2 million scripts.

Do you know what -- how much did it increase the script volumes?

Off hand?

We'll get it to you.

But it was 2 million on 170 million scripts.

So maybe about 1%.

Okay.

Thank you.

Thanks, Scott.

Our final question will come from Meredith Adler with Barclays Capital.

Good morning, this is actually Brian Wang on for Meredith.

Thanks for taking the questions.

I guess just a few quick follow-ups.

In terms of the CCR comparisons that you gave and all that detail, I guess could you just tell us what time period is that for?

Is that for second quarter or for the life of the program?

Because I think you did mention hurricanes and stuff in the first quarter last year.

So are these results excluding that or if you could just discuss that, please.

Brian, it was the last six months and I think we had that detailed on the slide.

So it was --

We couldn't get the presentation yet.

We're still waiting for that.

And then just if you could just speak to the AWP impact, I think you had guided to about $80 million to $90 million impact and there was about $25 million in 1Q.

Is that still pretty much on track?

That's right.

And could you just give what it was in the second quarter or -- ?

I think it was about $25 million.

$25 million again.

And then just finally, just going back to the healthcare reorganization, is that -- does that reflect a change in strategy or is that just kind of a consolidation of the same strategy you were running with already?

Yes, no, good question, Brian.

It's not a change of strategy.

I think it just organizes us a little more efficiently.

It's a stronger go-to-market strategy and really leveraging the strengths of folks like Hal Rosenbluth and Kermit Crawford with stronger execution.

All right.

Great.

Thanks very much for taking the questions and good luck the rest of the year.

Thanks, Brian.

Well, folks, that was our final question.

Thank you for joining us today.

We'll announce March sales on April 5th.

Our next quarterly financial announcement will be Tuesday, June 22nd.

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

Until then, thank you for listening and we look forward to talking to you soon.

That does conclude today's conference.

Thank you all for your participation.