沃博聯公司 (WBA) 2010 Q3 法說會逐字稿

Good day, ladies and gentlemen.

Welcome to this Walgreen Company third quarter 2010 earnings conference call.

Today's call is being recorded.

I would now like to turn things over to Mr.

Rick Hans, Divisional Vice President of Investor Relations.

Please go ahead, sir.

Thank you, Erin.

Good morning, everyone, welcome to our third quarter fiscal 2010 conference call.

Today, Greg Wasson, our President and CEO, will be discussing the quarter's highlights and our continued progress in executing our growth strategies.

In addition, Wade Miquelon, Executive Vice President and Chief Financial Officer will detail our third quarter financial results.

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.

Also joining us on the call and available for questions is Kermit Crawford, Executive Vice President of Pharmacy.

As a reminder, today's presentation includes certain non-GAAP financial measures and I would direct you to our website at Investor.Walgreens.com for a reconciliation.

Also, I'm available throughout the day by phone to answer any additional questions you may have.

You can find a link to our Webcast under our Investor Relations website.

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

We're also making the call available at a podcast.

You can download that too on our 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 discuss third quarter earnings I'd like to briefly acknowledge our Friday announcement where we reached a multi-year agreement with CVS Caremark.

We won't be providing specific details regarding the economics of the deal.

But I would say that we are very pleased with the outcome.

The agreement provides the framework we need to operate our business going forward which is also good for our patients, our pharmacists and shareholders.

We look forward to continuing to meet the needs of patients and payers across the country.

We also look forward to building a mutually beneficial relationship with CVS Caremark and other PBMs.

Now let's move to the quarter.

You saw from our press release this morning, Walgreens reported record sales of $17.2 billion in the quarter, a 6.1% increase over last year.

Third quarter net earnings were $463 million, compared with $522 million in the same quarter a year ago, and we generated strong cash flow from operations of $1 billion in the quarter, and $2.8 billion fiscal year-to-date.

Our reported EPS of $0.47 included $0.04 in costs resulting from the Medicare Part D tax charge, $0.02 from the impact of the Duane Reade acquisition and $0.01 from our Rewiring for Growth initiative.

Net sales for the nine month period grew 6.1% to $50.6 billion, and net earnings were up 3.2%.

We anticipated that this would be a challenging quarter for several reasons.

First, the weak economy continued to impact discretionary spending.

Second, we faced prescription reimbursement pressure, compounded by slower period in the rate of introduction of new generics.

And third, we were cycling last year's high incidence of H1N1 flu, which impacted prescription comps by more than 1% in the quarter.

While we planned for these headwinds and saw a number of positive signs in the quarter, we also believe there is more we can do.

Let me touch on some additional highlights of the quarter.

We filled a record 198 million prescriptions and increased our market share to nearly 20%.

We made significant progress on our Customer-Centric Retailing initiative, opening or converting 500 stores.

We closed on our acquisition of Duane Reade and began the integration to drive the expected benefits and synergies.

We continued on track with our cost control initiatives.

We took steps to directly address some of the reimbursement pressure we're experiencing, and we restructured our healthcare division to bring new and unique Pharmacy, Health and Wellness Solutions to the market.

Now let's take a more detailed look at the quarter.

This slide provides a good snapshot of the quarter's performance relative to the recent trends.

During the third quarter, gross profit dollars increased by $290 million or 6.5%, SG&A dollars increased $307 million or 8.6%.

Important to note that without Duane Reade, gross profit dollars grew 3.2%, and SG&A dollars grew 6%.

This rate of growth is near the low point of our SG&A dollar growth over the last six years.

And even at this low rate of SG&A dollar growth, we are investing in areas that will generate incremental sales.

These include our eCommerce group, our sales and client services organization and our private brand business.

The same time, we continue our relentless focus on cost control.

Gross profit dollars were impacted by the weak sales and reimbursement I mentioned earlier.

Our goal was to consistently drive gross profit dollar growth in excess of SG&A dollar growth.

Next, I'll give an update on our Customer-Centric Retailing initiative.

Here's a quick look at where we stood at the end of last quarter with total CCR stores.

As you may recall, we expect CCR, when fully implemented, to improve sales, reduce working capital and store labor, and enhance the overall shopping experience.

In order to achieve that, we are optimizing and enhancing our existing assortments.

We're improving category and product adjacencies, improving sight lines throughout the store, and finally, refreshing all our stores with a new in-store branding package.

Through the end of the third quarter, we've completed the opening or conversion of over 1200 stores, 500 more than we reported to you last.

We now expect to have over 2,000 CCR format stores by the end of the calendar year.

While this is fewer than the 2500 to 3,000 we had previously anticipated, this slowdown is critical to applying important lessons to future conversions.

Our latest CCR accomplishments include the following.

The time needed to convert a store to CCR format is currently 20% less than the earlier conversions.

We're adding key categories such as our successful beer and wine rollout, which is now in nearly 3600 stores and on track to be in more than 5,000 stores by the end of the calendar year, and in the third quarter alone, this category added more than 50 basis points to front end sales comps.

We added back several hundred products, primarily to the complement product class in categories such as automotive and hardware, and we initiated the introduction of new SKUs in existing categories, such as our new branded electronic set.

All of this adds up to a refresh of our stores at a relatively low cost.

Recall last quarter that we showed you the performance of our pilot CCR stores.

At that time, front end sales at those stores were outperforming the controlled stores by 1.9%.

I'm pleased to report today that for the 26 week period ended May 29th, the same pilot stores are now outperforming the controlled stores by 2.6%.

The signature product class in which we want to win versus all retailers continues to outperform the control group by nearly 5%.

Our power product class, in which we want to be the best in the drugstore industry, has experienced an increase in sales from 2.4% last period to 3.1% this period.

The staples product class, which includes everyday needs, slipped slightly.

We are sorting through the reasons now and will continue to focus on improving it.

And in the complement product class, which are impulse buys or convenience items, we added back SKUs to all stores including the control group, and as you can see, the CCR stores improved versus the control group.

The complement product class comprises 6% of front end sales and we are very pleased with the improved performance.

Although results are preliminary, our second wave of CCR store conversions is trending well against the rest of the chain, and in Dallas, we're encouraged by the improvement in sales, versus the rest of the chain as well.

If you recall, Houston had a larger percentage of stores impacted by the reduction of SKUs in the complement product class.

That led to more pronounced sales impact in those select stores, which are now showing improvement with the reintroduction of key SKUs.

We're also making good progress integrating Duane Reade into our Company.

Duane Reade's new format is performing well and I would encourage you to visit our recently relocated midtown Manhattan store which is performing well above expectations.

Duane Reade contributed $272 million of sales in the quarter.

We believe that this business represents an excellent strategic fit with Walgreens.

Since the acquisition, we are even more excited with our capabilities in urban retailing, loyalty, private brands and beauty.

We believe there is real opportunity to leverage these areas of the rest of our chain and for example an initial selection of Duane Reade's Delish private brand consumables will be offered across the chain in August.

As I mentioned earlier, this was a challenging quarter, as we anticipated.

Our strategy, which is built on the strength of our center of gravity, our 7500 community drug stores, gives me confidence we can win in any environment.

We're located within five miles of nearly 75% of the US population.

Our plan with CCR is enhancing the customer experience and providing a low cost refresh of all stores.

We continue to transform community pharmacy to build on our nearly 20% market share, and improve the patient experience.

This includes expanding our scope of services by offering flu shots and other immunizations.

We're bringing new and unique pharmacy and health and wellness solutions to employers and other payers from our work site clinics to our hospital on-site pharmacies and from our specialty pharmacy to our market share leading home infusion capabilities, we offer a broad spectrum of healthcare solutions.

And we continue to have a relentless focus on cost control and productivity gains.

In spite of the environment, we hit many milestones in the quarter.

We generated strong cash flow and we continue to return that cash to shareholders through a combination of share repurchases and dividends.

Walgreens has already returned over $1 billion to shareholders this fiscal year.

Looking ahead, I'm very optimistic about our Company.

We're focused on leveraging our 7500 convenient community drug stores and I'm confident in our strategies and our goal to deliver double-digit earnings growth, increasing return on invested capital and top tier shareholder return.

Finally, I want to say how proud I am of the way our team members responded to a difficult environment.

And their commitment to drive sales, reduce costs, and improve Customer Service.

I firmly believe their efforts will be reflected in our performance in future shareholder returns.

Now I'll turn the call over to Wade, who will update you on the financial results in the quarter.

Wade?

Thank you, Greg.

Good morning, everyone.

In the quarter, net sales increased 6.1%.

Net earnings declined 11.4%, and earnings per diluted share were $0.47 or [$463] million, down from $0.53 per diluted share or $522 million in the same quarter a year ago.

Our reported EPS of $0.47 includes $0.04 in costs resulting from the Medicare Part D tax charge, $0.02 from the impact of the Duane Reade acquisition, and $0.01 from our Rewiring for Growth initiative, and that compares with $0.06 in Rewire costs in the year-ago period.

Prescription sales rose 5.7% and represented 65% of sales for the quarter.

Prescription sales in comp stores rose 1%.

As Greg noted, we filled a record 198 million prescriptions during the quarter, an increase of 5.9% from a year ago.

That includes a benefit of 1 percentage point from patients filling 90 day rather than 30 day scripts.

On a comp store basis, the number of prescriptions filled increased 2.5% and that includes a benefit of 1.3 percentage points from 90 day scripts.

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

These sales in the quarter were up 0.1% as we continue to face slower demand for discretionary goods.

Also hampering the quarter were weak flu season compared with last year's unusual H1N1 flu and the recall of certain OTC products.

Despite this performance, we compare well to the industry.

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

This is another reason why we feel good about CCR.

Turning to gross profit, the margin improved 10 basis points in the quarter.

The primary driver was an increase in front end margin which more than offset the negative impact of lower margins in the pharmacy.

On a dollar basis, I'll start by pointing out that the front end provided the majority of gross profit dollar growth in the quarter.

As you may know, the rate of generic introductions and other factors can affect gross margins in ways that we believe distort our underlying performance and as a result we focused on gross profit dollar growth as an important performance metric and that grew by $290 million in the quarter.

Now let's look at some of the drivers of that gross profit dollar growth.

The pharmacy gross profit dollar growth was negatively impacted by two primary factors.

First, we are in a period of slower rate of generic drug introductions.

We expect less impact from this in fiscal 2011 and significant benefit in fiscal 2012 due to large number of new generic introductions scheduled for that year.

Second, we continue to be impacted by reimbursement pressure, which we have experienced for years.

Looking at the bigger picture, our core pharmacy business is strong, and expected to get stronger as indicated by our records scripts filled, market share increases, our expanded pharmacy, health and wellness solutions and that includes flu shots and other innovative programs such as Optimal Wellness and 90 day refills.

Moving to SG&A trends ,the two year stacked SG&A dollar growth shows some improvement compared with the year-ago quarter, dropping from 17.6% to 16.5%.

When you adjust the two year stacked SG&A dollar growth to the acquisition of Duane Reade, you will see it drops from 17.6% last year to 13.4% this year.

This illustrates our continued focus on SG&A control.

Let me walk you through this SG&A adjustment.

We reported SG&A growth of 8.6% in the quarter.

First we adjusted for the net impact of Rewiring for Growth which had higher costs last year and next we accounted for the acquisition and operating expense associated with Duane Reade, which gets us to SG&A growth for the quarter of 6%.

Some of our improvement can be traced to the benefits from Rewiring From Growth, and this chart summarizes the savings and costs for restructuring since its inception.

The net savings in the quarter was $0.04 per share, versus the year-ago period.

And please note we added two new lines to this chart to illustrate the cumulative savings by quarter and total run rate savings over the 2008 base year.

You can see the restructuring benefits are on track with cumulative savings by quarter at $0.11 per share and the run rate over the 2008 base year at $0.37 per share.

Total Rewire expenses this quarter were $17 million, and for the first nine months they totaled $87 million.

We expect approximately $140 million in rewire expenses in fiscal 2010, although some of these costs may not be fully realized until early fiscal 2011.

We remain on target for net pretax savings of $500 million this fiscal year, and 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 $18 million versus $32 million in the third quarter of 2009.

That represents anticipated LIFO provision of 1.25% for the year.

Next, of the $17 million of restructuring costs in the quarter.

The effective tax rate was 42.5%, compared with a tax rate of 36.4% in the year-ago period.

The higher rate was impacted by a non-cash charge due to the elimination of Medicare Part D subsidy.

We expect a tax rate of approximately 37% in the fourth quarter.

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

Net some of these as a percent to sales fell 4.1% in the quarter compared with the year ago.

Total FIFO inventories rose 4.3% against total sales growth of 6.1% and total store growth of 9.7% including Duane Reade.

FIFO total inventories on a per store basis fell 4.9% in the third quarter.

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

Cash flow from operations for the first nine months of the fiscal year was $2.8 billion.

Free cash flow increased to $2 billion in the first nine months, versus $1.7 billion the same period last year.

Cash and cash equivalents and short-term investments totaled $2.3 billion, and our long-term debt totaled $2.4 billion.

To update you on capital expenditures, last quarter we estimated $1.4 billion for the year.

We now anticipate CapEx for the fiscal 2010 to be around $1.2 billion, as we make sure we're focusing on investing in the right projects at the right time.

Our strong cash flow and balance sheet allowed us to pay out $136 million in dividends during the quarter and buy back $254 million in Company stock.

In the first nine months of the fiscal year, we returned more than $1 billion in dividends and share repurchases.

We plan to continue returning cash to our shareholders through a combination of dividends and buybacks, which nearly triples in the first nine months compared to the year-ago period.

Our current dividend payout ratio is 25% and you will recall that we previously set a long-term dividend payout ratio of between 30 and 35% of net earnings.

The next dividend announcement will be on July 14th.

Like Greg, I am confident in our strategies.

We are focused on driving smart growth, enhancing the customer experience, and meeting our goals for cost reduction and productivity gains to create value for our shareholders.

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.

(Operator Instructions).

And we'll go first to Ann Hynes with Caris & Company.

Good morning.

Good morning.

My questions have to do with CCR.

When I look at your estimates on FirstCall, they're all over the place.

I think part of that is because people modeling the CCR initiative differently.

So in 2010, 2,000 stores should be done, and you'll have 3,500 to 4,000 left.

How should we break that out annually for fiscal 2011 and 2012?

Are most supposed to be done in 2011?

And I guess the costs associated with it also, I think you had been saying that the costs per store would be $30,000 to $50,000 and in your last 10-Q I believe you said it was up to $40,000 to $55,000 per store now.

Can you just clarify how we should model that going forward, so maybe some of the estimates could come more in line with each other.

And also does that include Duane Reade stores?

And I guess that's it for now.

Thanks, Ann, Greg.

I'll start with the last one, back up.

It does not include the Duane Reade stores as far as the total CCR.

We are doing certainly remodelings within the Manhattan area to help them complete their journey of remodeling those stores.

As far as CCR, you're right, if we looked there's about 5,500 total stores in the chain that would be conducive to a CCR fit.

We'll have 2,000 by the end of the calendar year.

We expect to have the remainder of those done by the end of the 2011 calendar year.

So you can factor that in.

As far as -- you had a third question, Ann, I'm sorry.

I guess the cost per store, in your last 10-Q it said $40,000 to $55,000.

I think in your previous presentations you were saying $30,000 to $50,000.

So I guess how should we model cost per store for fiscal 2011?

I'd probably use the -- I'd use the latest, the $40,000 to $55,000.

We're encouraged, Ann, and we may be able to pull that down and if we are, we'll give an update on that.

As I said, we're seeing from when we started about a 20% reduction in the cost to convert these stores, we're down to about four days.

Okay.

I think we're optimistic, we may be able to get it lower but I think that's probably a good number to use.

All right.

Okay.

Thank you.

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

Yes, hi.

Good morning, guys.

Good morning, Ed.

Greg, you mentioned that you slowed down the conversion of CCR to apply some critical lessons.

Could you elaborate on what you've learned so far and then the impact that those learnings are having on the newer conversions?

And then also, could you maybe give us a bit more color on the performance of the conversions beyond the pilot stores?

Yes, Ed.

I think the key learnings and we kind of called that out on our Q2 call, was the complement categories and again, even though they're only 6% of total sales, there are many stores that have a high percentage of sales coming from the complement categories.

And I think we took out some items that we probably didn't need or shouldn't have taken out.

We've added about 200 items back into those stores and particularly those complement categories.

Things like automotive, hardware, in many stores we may be more like the general store in a particular community.

I think we feel good with what we're putting back in and I think you can see improvement on the complement categories.

The other thing that we're excited about is the recent roll-out of the actual refresh package, the decor and branding package that we're putting out there.

I think as you recall, Houston, we rolled out Houston, Dallas we didn't have it ready.

We're rolling it now with new conversions and we're going back into Houston and Dallas, I believe it's next week, to put the new branding package in those two markets so we're excited there.

Ed, I think you might have had one more question as well.

Did I cover your points?

Well, the other question actually relates to the reimbursement pressure that you've been talking about.

Is there a way to quantify the impact that that's had on the gross margin this quarter?

And then Greg, you mentioned that you are beginning to address some of the issues causing the reimbursement rate pressure.

I assume that means the CVS deal but is there more work to do on that front?

Meaning is there other PBMs that you need to go talk to as well?

Maybe I'll take the first one and let Wade jump in on how to quantify it.

The key thing is we're focused on -- you start back, I think with the temporary slowdown in the generic pipeline that we've lived through over the past year, I think that's probably heightened some of the reimbursement focus that payers have.

And I think the good thing is, that's a temporary period.

I think when we get into 2012, with the added generics, there will be a little relief there.

But in this interim I do think we're focused on making sure we get a fair value from payers for the services we provide and I think we have 7500 stores, we're in all 50 states.

We have 24 hour stores in communities across the country that many don't.

We're just focused on working with payers to make sure we get a fair value and I think we're recognizing that people value Walgreens in their network.

Wade?

I'll just add some color.

If you look at kind of the year on year generics, that's call it $0.02 to $0.03 down versus a year ago.

As we talked about the impact of the lower flu incident, about 100 basis points in totality is another $0.02 to $0.03 and then building on Greg we did see some reimbursement pressure.

I would not say that it was unplanned reimbursement pressure, I think I've said for some time that while it's always tough out of there, that this is kind of an 18 month period that we see to be maybe a little bit more challenged than usual.

But again, I don't think that's anything we haven't anticipated.

I think moving forward, all three of these things have a potential to get stabilized and get stronger over time.

Does this contract, this with CVS Caremark change your view on growth at all going forward, whether it be new store openings or acquisitions, does it mean that you want to fill holes faster.

We can't comment that much on the CVS Caremark, the situation itself.

Our plans haven't changed regarding our organic growth rate that we set out there 2.5% to 3% by the end of fiscal 2011.

We still have a strong balance sheet.

We're going to be taking, looking for acquisitions that make sense strategically and our plans still remain as they have been the past several months and year.

Thank you.

Thanks, Ed.

We'll take our next question from Mark Wiltamuth with Morgan Stanley.

Hi, good morning.

Wanted to get a feel for how much of a headwind we're going to be facing here from the swine flu in the fourth quarter.

Because swine flu obviously was building from basically this point all the way through December, and just wanted to get an idea of how much of a drag we should expect on both the prescription comp and the front end.

Well, Mark, good question.

Last year as we've said, we administered 5 million, 5.5 million seasonal flu shots in addition to a couple million H1N1 and most of that was in the first quarter.

So we're going against about 7.5 million total flu shots.

We expect to play a big role in the seasonal flu program this fall.

Last year I think we had 16,000 to 17,000 of our pharmacists certified.

Today, Kermit Crawford is with me, tells me we have about 23,000 certified pharmacists.

We're looking forward to adding the Duane Reade pharmacists of nearly 1,000 to participate.

We did a good job last year.

We certainly expect to do a better job this year.

I'd add, we're certainly looking forward to another strong flu season.

Like Greg said, we have over 23,000 of our pharmacists are certified.

Over 91% of our stores have two full-time certified pharmacists in it, so when we look at pneumonia, zostavax, tetanus, other immunizations, we look to have a very strong season this year.

I understand you would like to get back to a normal flu season pattern, but the quarter -- this fourth quarter that we're working on now has got a very big swine flu year-agos it's comparing against.

Just curious if you could quantify how big that was.

I think, Mark, we actually experienced quite a bit of that this third quarter.

And in fact, probably a significant amount in the third quarter that we're going against.

And we absolutely anticipate in the fourth quarter, I don't know if I've got a number that Wade can give, but it is a headwind.

We anticipate aggressively going after more flu shots in the first quarter, as well as the tail end of the fourth quarter.

I think you saw the impact of more of this last quarter and then remains to be seen in the first quarter.

The fourth quarter, I don't think there's going to be a huge impact either way.

And again, there's big upside on the flu shot part of the season which should hopefully offset any reduction in the first quarter from the overall trend.

Okay.

And then Wade, on the SG&A cost savings, for a long time we were talking about 25% of that savings coming out of the Florida central fill.

Have you really achieved much of that or is that really all still to come in 2011, and what areas are you looking for in 2011 to get the additional $500 million in savings?

What we've actually said is that the 25% or $250 million is actually a broader umbrella called Transforming Community Pharmacy for which Florida Power plays one part but it's much broader than that.

So as we look at our aggregate across the country, the work to be done, and Kermit's leading, maybe you can comment, we're very confident that we'll be able to deliver that.

Beyond that, looking over to Kermit, beyond that, we've got indirect spend opportunities as well as corporate, field and other SG&A opportunities.

So all three buckets will step up next year, and there is a big step up in the TCRx, that what we call the transform community pharmacy overall umbrella.

Mark, we're very confident that we're going to meet our cost savings goal for 2011 under TCRx.

In addition to that, we talked about enhancing our customer experience and our Customer Service and we have put some automation and enhanced our -- some of our technology to improve that Customer Service by using up some of the additional capacity we have in the system.

For example, if a patient were to touch tone a prescription in for tomorrow in one of our 24 hour stores, our scheduling system now schedules that prescription to be filled on the overnight where we have capacity.

Therefore, freeing up the pharmacist during the day.

So we're filling the same number of prescriptions but we're creating more free time during the day and as well, the third part of that was the script like services, which we talked about, the flu and other immunizations.

So all three of those parts of TCRx we think are on track.

Okay.

And Kermit, while we've got you, obviously during the dispute with CVS there was some disclosure there that maintenance choice was pressuring you.

Is there anything you can do to counter that as they continue to try to build that out?

Mark, as we talked about, we're very pleased with our agreement that we have with CVS.

We were not going to go into any specific details around that agreement.

Okay.

Thank you.

Thanks, Mark.

Our next question comes from Derek Leckow with Barrington Research.

Thank you.

Good morning.

Good morning.

Just another question on the SG&A growth.

I mean, 6% SG&A dollar growth and that's adjusted obviously, but Wade, can you help me understand what the SG&A dollar growth is doing at store level and is there a bigger component coming out of some of the corporate activities here in the fourth quarter?

Yes, I mean, it's actually -- we tried to get the bridge before.

It's a fairly complex bridge but at the store level we have some base level store salary inflation, maybe 18 bips as a percent of sales.

What also is up that might have been missed a bit is occupancy.

Our occupancy is up about 20 bips as a percent of sales and that's really driven by the fact that we have skewed over the last few years more store openings to really the A plus sites on the East Coast and West Coast.

Other than that, I mean, we've given a little bit of a walk here in the presentation.

I know we can continue to -- Rick can share with you the details, but in aggregate, I'd also say for the number of stores that we opened over the period, 6%, when taking out Duane Reade, is -- I mean, it's about as good as we've done in many years.

It's trending the right direction.

What primarily drives SG&A right now is new store openings.

And like I said, some folks might have missed a bit of the baseline inflation and store salaries as well as the occupancy.

So I'm sorry, I don't have the presentation right in front of me here, Wade, but the 6%, is that roughly what's going on at the store level as well?

No, store level would be much more on a same store basis -- much less on a same store basis, 1% to 2%, call it, which is primarily driven by store salary inflation.

Like I said, there is about 20 bips as a percent of sales from increased occupancy and again, that's because of a decision to open more stores in A plus sites on the East Coast and West Coast.

One question on your working capital here, sounds like inventory is up a little bit.

I wondered if store level inventory is down but where's the rest of the inventory?

Is that something we should be thinking about coming out of the system in the fourth quarter?

Same store inventory is actually down.

Right?

And I think we made good progress there.

It's down across the board in stores as well as distribution, our distribution chain.

I think we have opportunity to continue to improve that, both in pharmacy as well as front end, and will do so.

But again, on a same store basis we've made progress again, albeit not as much as we made in prior periods, but I don't think that we've run the gamut on that yet.

Can you quantify how much opportunity there is in terms of inventory reduction?

I'd hate to do it here on this call.

Obviously we've not said anything publicly.

We've obviously got a lot of low hanging fruit opportunity already from some of the assortment work, streamlining that.

Now we're looking more holistically on our supply chain and opportunities there to operate a bit different, change how we think about some of the buffer stocks, replenishment, et cetera.

And so I think that's kind of the next generation, if you will, of improvement.

Thanks very much.

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

Thanks very much.

I was hoping we could talk a little bit more details, first about reimbursement rate, and is it fair to say that when you talk about fewer generics, you've got older generics are macking and newer generics there aren't as many of them coming in at a more profitable stage?

Or, are we seeing lower reimbursement per script for the drugs that are macked?

So what I'm saying, is it a mix of age or the level of reimbursement?

I'd say it's a little of both, to your point.

I think some of the older macks are coming down a little bit as well as the newer are coming down a little more quickly but at the same time I do think that the bottom line is generic utilization is a win-win-win for everyone and our focus is to continue to drive a higher percentage of generic utilization and I think when we see more and more come out the latter half of 2011, 2012 for our fiscal year, certainly we'll see the benefit there.

But yes, we're having -- we're watching macks diligently with all payers.

I'd also say, I think Greg said it, but there are -- we are in a temporary period of fewer new generics.

At the back end of calendar 2011, that starts to change dramatically.

So that is what it is.

And then maybe you could talk a little bit about -- you've talked about 90 day at retail has been boosting comps.

Could you talk about whether you see that concept, that kind of program expanding?

Are you working on joint ventures with PBMs?

And then I also have a question about limited networks.

Yes, Meredith.

I absolutely think that a regional 90 benefit and offering is going to become a greater and greater part of the pharmacy industry.

I think as more and more generics come out, we see more and more -- a greater percentage of chronic prescription drugs, a 90 day retail benefit just makes sense.

I think the good thing is that employers who have had only a 90 day mail benefit for years by adding a retail 90 in a broad network of retailers, it gives them the opportunity to, one, give their employees a benefit that may have not wanted to use mail.

Lower cost by increasing the penetration of total 90 day prescriptions, and a broader network can be put together to give choice as well.

I think the evidence is coming out that the best way to reduce overall healthcare costs is through better adherence, and 90-day is clearly a tool to drive better adherence and compliance.

So I think that that trend is also favorable and you're going to see that play out over time.

Meredith, to your point, we're working with all payers, all PBMs, managed care organizations to provide them a 90 day retail solution.

But is 90 day at retail profitable if everybody is able to do it, if you're not getting any of the benefits of sort of a limited network for 90 day?

Of course.

Just like 30 day is profitable with the same open networks, so is 90 day.

It can be structured in a win-win for both the payer but also for us.

Like I said, it drives adherence and compliance, and provides an innate lift from that over time, as well.

When we look at -- with what we're able to bring to all payers in a situation where they're able to put a broad network together, you figure Meredith you take two costs to fills out, you have reimbursement that makes sense, it's just a win-win for everyone.

And limited networks, where do you think that goes and are you concerned that that leads to significant more pressure, competition on reimbursement costs?

Yes, I think limited networks in some form or fashion have been around for years.

You go all the way back to the 1980s where HMOs restricted networks.

We know that people, most folks, patients do want choice and there are ways to provide value and lower cost and provide choice at the same time.

So I think there will be limited networks around, as there always have been.

I do think that folks can balance both choice and value and cost with a broader network and I think that's what we're seeing more of.

And while I don't really -- we haven't seen an uptick in that, at the end of the day if that's where it wants to go, having a 20% share and being within 5 miles of 75% of the population, I think that we're positioned extremely well in that case.

Meredith, I think you may begin to see preferred networks based on performance which we would welcome.

You don't think that leads to more competition between retailers on reimbursement rate?

I think where healthcare is going is the provider that can really show value.

Clinical outcomes, reduced costs, provide choice, to lower the entire medical spend, versus just the pharmacy spend is where we're headed as a country, as well as us as a Company.

Great.

Thank you very much.

Thanks, Meredith.

Moving on to David McGee, SunTrust Robinson Humphrey.

Hi, David.

Hi, good morning.

Hi, David.

Couple of questions.

One, a question about the flu season this fall.

Last year there was just a lot of attention being paid to H1N1 and obviously a lot of vaccines being given.

I understand that you're better positioned this year than last year which you had a good performance.

Do you think that the public will be as aware of it this year, and will be as motivated as last fall, and if you had a shot last fall, do you have to go back at all?

Yes, David.

Greg.

Latter question, yes.

The CDC recommends a seasonal annual flu shot.

There was probably some heightened concern last year due to the H1N1 pending pandemic.

I think the fact of the matter is that there's more and more folks getting seasonal flu shots year-over-year because of the effectiveness.

We do know that there were around 150 million or so doses produced last year.

Looks like the latest info we're getting is that there are going to be more produced this year.

We feel good with how we're positioned.

This year as well, David, it's interesting, they're combining the seasonal flu shot with H1N1 in the same dose.

So I think people will probably tend to be more interested because they can get both in one dose.

Thank you.

Then a second question has to do with the performance on the CCR pilot stores.

Do you expect more of a lift?

You've had an acceleration here of late.

Does that have upward potential to it?

I think somebody earlier asked about the non-pilot stores, how they were doing.

I didn't hear an answer on that one.

We are feeling good about the trend we're seeing at CCR.

As I said, we were 1.9% of the pilot stores that were reported on Q2.

2.6% in those pilot stores overall this year.

I feel good that we're making real progress in that complement category.

That's where we saw the significant miss on some of the SKUs.

And at the same time, what we're beginning to see, David, is that last year when we began closing out the 4,000 SKUs, that was Company-wide and what we're beginning to see now is as the new planograms come in nationwide, we're adding items.

We're beyond kind of optimizing the SKU level, we're actually enhancing the categories and the departments that we're putting out chain-wide.

So we're not only seeing improvement in the CCR stores, but we're beginning to see improvement based on the enhanced categories chain-wide.

Dave, let me address the underpinning of your question.

We have been very diligent about looking market by market, of control and pilot stores on our market share in those markets, as well as the overall share in comps.

As we illustrated here we feel pretty good that our aggregate comps on apples-to-apples basis have outperformed our top three competitors, which basically means that the control is strong too.

Obviously it's a tough environment out there but we have to make sure I think that we're not only looking at whatever the comp is, but making sure that from a market share point of view and on a competitive basis that we're actually outperforming others.

So do you think that the 2.6 is an appropriate proxy for the more recent conversions?

Yes, I mean, absolutely.

You can extrapolate again our aggregate versus other comps and add the 2.6 as hopefully a baseline or better move forward.

Great.

Thank you.

And next, from Susquehanna, we'll go to Bob Summers.

Good morning.

Wanted to dig a little bit more into the SG&A line and better understand both the change in the net cost savings as well as -- I can't access the presentation right now but what the 4 point trailing average store growth is and understand maybe why we're not doing a little better job on that line at this point?

Bob, I'll jump in and mayb have Wade give more details.

I agree with his comment earlier.

When we removed Duane Reade and in light of the 5.9% new store growth, our SG&A trend is pretty consistent with where we've been over the last two or three years.

We didn't -- certainly didn't fall out of bed.

We certainly know that there's opportunity, we're going to keep pushing.

The goal I have, I've given this team is make sure that that two year stack year-over-year continues to go down and when you look at the -- I'm sorry, you can't open the presentation, but when you look at the bar graph, the two year stack with Duane Reade out, we've continued to improve year-over-year on a two year stack.

And then sort of secondly, with respect to the overall sales environment, two questions.

First, starting to see any impact from people rolling off of discounted COBRA?

And then second, with respect to the front end, where is the incremental pressure coming from?

Are you seeing share loss to discounters or dollar stores?

Are you concerned that some of this, given the overall employment market, is a little bit structural and longer term?

I can't say we're seeing anything on people rolling off COBRA.

It's something we should dig into, but I can't say we're seeing that, Bob.

As far as the front end, I think we're still seeing some continued pressure on the discretionary categories.

Although we're feeling better with where we are with what we're seeing currently.

I do think that as I said, we're beginning to roll out some new and enhanced planograms, and categories chain-wide.

In addition to CCR, we're beginning to roll back some of the private brands as I said from Duane Reade.

As far as the pressures, mainly still in discretionary categories because customers are still holding onto their cash.

I would add, certainly in this sluggish economy, finances are an important cause of lower adherence to prescription medication therapy.

Between the economy and a tough H1N1 comparison of last spring, I think that's more what's happening in this quarter on the pharmacy side of the business.

Lastly, you talked about a 50 basis point lift from the alcohol roll-out.

Where do you see that trending or what's your internal bogey, where it can go?

Well, I think there's no reason that shouldn't be able to be 2% to 3% of the front end over time.

Right?

But of course, it's how many you roll out and when you cycle, whatever, but I would say that's kind of I think what it should compromise, so what it is in terms of actual lift will depend upon the timing of when they're rolled out and how you cycle that.

And also, we had to watch, Bob, the basket that comes with that, which we're encouraged by.

Okay.

Thanks.

Our next question comes from Deborah Weinswig with Citi.

Good morning.

A few questions.

I know it's early, but any unexpected benefits so far from the Duane Reade acquisition?

Yes, I think, Deb, this is Greg, I think certainly as I said, we're really encouraged and excited with their private brand.

Frankly, expertise, what they've done with private brand in that market, that's the reason we're pulling back some of that in August, as I said, to begin to see what kind of lift we can get throughout the chain.

So I think there's a huge opportunity there.

Their loyalty card, they just relaunched it a couple months ago.

They're seeing pretty good results from it.

I think we can certainly learn from some of the things they're doing as we pilot our loyalty card.

Cosmetics and beauty, we're excited there.

I think their fresh food, urban retailing, so the more we've gotten into it, the more excited we are and the more we think that we can pull a lot of their expertise back to the chain.

And then actually along the -- as you roll out the private label into your traditional Walgreens stores, what will that replace, if you will, in your existing stores?

It's interesting.

We do a terrific job as you might expect in kind of the health and beauty private brand products, the Wal-Tussins and so forth that we're known for.

Where we underpenetrate and have over the years is in consumables, and that's where they overexcel in their Delish, their snacks, their cookies, their food, their consumable items.

So we're going to continue to drive and enhance our OTC offering, which we've done well for years, but we think they can really help us in the consumables space.

Said another way I think we've done a great job at kind of the me too at a better value for consumers but I think that in terms of really differentiated propositions, and particularly in food, they're really Best-in-Class, doing a great job.

Okay.

And then also, Wade, in terms of the -- as you look at it from today, because obviously you've had a lot of success and traction with regard to expense reduction, what would you look at today as the biggest expense reduction opportunities going forward?

Well, I think the key thing is to deliver on job number one is to deliver on our Rewire commitment.

We've got that plan.

Now we just -- we have to run that play.

So that's a good boost.

Beyond that, we're actually doing a lot of work, what I would call in two different streams.

One is kind of the day-to-day, how do we think about making increments, everything we do, every day.

We have a group now dedicated to that.

Separately also, what are the next big breakthroughs, what are the big structural areas we should be looking at to transform.

We've got some ideas there as well.

So but I think I guess just to wrap it up, I think that the first job number one is to deliver on the Rewire commitment and put that to bed, while we also figure out as a Company how do be more systemic and not make these cost reductions a once every five year event, really build it into our day-to-day so we're challenging everything all the time, how can we do it better, more efficiently, faster, and we've put significant resources and a new structure around that for the Company so I feel pretty good on a going basis that we'll be more on a continual process there.

The last question, I agree with your comments with regards to front end comps, and when you look at your front end comps versus the peers, it doesn't look like you're losing share to anyone else in the drugstore channel.

It doesn't necessarily look like there's anyone out there in the competitive landscape of all of retail that's doing particularly well.

Maybe the club channels.

Where do you think consumers are going to buy those items?

Well, I think that overall I think consumers are just pulling back their spending in total, Deborah, but I do think that we are encouraged when we look at apples-to-apples that we are winning against our major competitors and we are gaining share across many markets so I think some it's just they cut back on discretionary spend in total.

If you look at the internals, our foot traffic remains strong.

People are coming.

The items remain fairly strong.

It's really the dollar ring per item where people had to trade down or make sacrifices.

You see it in other trends too, in terms of people spending more after paycheck and less at the end of it.

People moving more away from credit to cash, et cetera.

I think it really is in aggregate right now a bit of a suppressed consumer which I think is good for us as it comes back.

But I think the key thing we're doing is through CCR and the other efforts to make our stores much more relevant.

There's I think a big opportunity to make those assets more accretive over time, and so the items we're launching in a new environment is going to help with that.

As you are building out your loyalty card and as you're building out your private label, seems like you have a real opportunity in this environment to capture this new consumer as well.

We definitely would agree with that.

I think there's tremendous opportunity to grow our private brand offering and that creates loyalty in itself, as you know.

As Rick said before, we were talking, you look at beer and wine for example, beer and wine is not just what we're going to get for the lift over time.

We're finding when you do the basket diagnostics that actually we're picking up more of that call it 12 item or less consumer who might not have come by Walgreens because there was one or two items they couldn't get from that mini shop and that gives us a lot of encouragement.

Well, thanks so much and best of luck with everything.

Thank you.

Our final question will come from Andrew Wolf with BB&T Capital Markets.

Thanks.

Wade, on the generic impact, I think you said it was $0.02 to $0.03 in the quarter versus last year.

Can you all tell us when do you think that bottoms.

You're kind of hinting at it, that it's sometime between now and sort of next few quarters.

And are you implying that even though fiscal 2011 through August 2011 is not going to be when the big waves kicks in, that you're still going to have that swing will turn positive on fiscal 2011 on generic.

We had a step down through this whole year.

So we've seen it throughout the year.

We're going to have another bit of a step down next year and then really at the end of calendar 2011 is where we get a really nice step-up.

And then the following year, an even nicer step-up.

I hesitate to quantify the exact numbers, in part because actually no one can predict exactly when these things hit but that's the basic pattern.

So is it fair to say this $0.02 to $0.03 is kind of the worst type of impact you would expect, realizing it's more like horseshoes than precise, but in terms of magnitude that's about as big as you would expect in any one quarter?

I would say next year you could see another one to two on top of it, but it's got a lot of good stuff going as well.

In aggregate, there's lots of moving parts, big moving parts.

We do see a bit of a step down next year, not to the degree we've seen this year and we begin to see a sequential year step-up.

And then on the housekeeping side, I think you talked about the AWP lawsuit settlement.

Is that still running at about $25 million a quarter?

Yes, we'reabout the same flowthrough.

Okay.

We'll start to cycle that next fall.

And what about I think in the past you've called out the expense from dilutive expense from clinics.

Did that -- is that neutral this year?

Is that still dilutive?

That's now moving to slightly accretive.

On a relative basis.

It's not accretive -- it's still a loss but it's less loss than a year ago, and I would expect that that's going to keep becoming relatively accretive moving forward and we are still very much big believers in this, not only from the amazing experience, what it does to our halo effect but also our stores that are moving from three and four years, many of those are moving into the black, and that's the torture test of fully loaded economics with no benefit in the front end or the script basis.

On a relative basis it's year on year accretive, but we're also, the older ones are ramping nicely as planned.

So it gives us a lot of confidence that this is the way to go.

Yes.

In terms of Bob's questions with some of the extended COBRAs, following up, it might be interesting to see since there are cheaper ways to get healthcare if you're not insured, how that goes.

We definitely think we're going to be able to play a big role in access challenges with healthcare reform as you might expect.

That's the reason we're so bullish on these clinics.

On the front end, the release -- you said the markdowns were lower, is that due to the competitive environment in any way, or is that due to the amount of markdowns you took last year with Rewire?

The markdowns we took last year due to Rewire.

Are you saying the competitive environment is about the same or it's -- I mean, I'm seeing some signs of rationality versus some of the competitors like the supermarkets, where some milk prices are moving up.

I think in prior quarters they were using them as loss leaders.

You are trying to say the competitive environment -- how would you characterize incrementally the competitive environment overall in retail?

I would say it's pretty much what we've seen in the past 6 months to 12.

I think there are folks that are out there, still trying to go after the discretionary spend, with consumers.

I do think, and as I said, we're encouraged with what we're seeing currently, so we'll see.

I think people are still watching their cash, Andy.

My last question is on your direct to employer offering and is there a way or is that an offering that can be run by an HR department in parallel with a PBM that has a mandatory element to it, where the maintenance drugs can still be done in that type of a situation at Walgreen.

Andy, we have several relationships where we have direct arrangements with a payer over the years.

The real opportunity we have as you know is our direct to employer program is really -- we lead with the work side health center solution that we have and once we get in and really begin to provide real value and build a relationship with the employer, there's other services that we can offer and that we're able to deliver.

If that indeed includes prescription drugs, then we can do that as well.

But what we really want to do is get in and provide real value to an employer's medical spend in total.

Great.

Thank you.

Thanks, Andy.

Folks, that was our final question.

Thank you for joining us today.

We'll announce June monthly sales on July 6.

The next quarterly financial announcement will be September 28.

That's when we'll announce fiscal 2010 fourth quarter and year-end results.

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

Once again, ladies and gentlemen, that concludes our conference today.

Thank you all for your participation.