沃博聯公司 (WBA) 2010 Q4 法說會逐字稿

Good day everyone and welcome to today's Walgreen Company fourth quarter 2010 earnings conference call.

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

At this time, for opening introductions I would like to turn the call over to Mr.

Rick Hans.

Please go ahead, sir.

Thank you, Brendon, and good morning everyone.

Welcome to our fourth quarter and fiscal 2010 year end conference call.

Today Greg Wasson, our President and CEO will discuss the quarter and fiscal year highlights, and our continued progresses in executing our core strategies.

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

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

When we get to your questions, please limit yourself to one.

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 the reconciliations.

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, 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 risk 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 this morning.

Today I want to cover three main points.

First, our fourth quarter and year-end results.

Second, I'll discuss the initiatives we have under way to improve front end sales through our Customer-Centric Retailing initiative, and finally I'll highlight the industry-leading efforts we are making to provide our customers with convenient access to flu immunizations as we continue to transform community pharmacy.

As you saw from our press release this morning, we reported record sales of $16.9 billion in the quarter, which is a 7.4% increase over last year.

Fourth quarter net earnings per diluted share increased 11.4% to $0.49, which includes $0.05 per diluted share in acquisition and restructuring-related costs.

That compares with $0.44 in the same quarter a year ago, and including $0.03 per diluted share in restructuring-related costs.

This quarter we generated record cash flow from operations of $925 million, an increase of 8.6%.

Net sales for fiscal year 2010 grew 6.4% to a record $67.4 billion, and net earnings per diluted share were up 5% to $2.12.

Cash flow from operations in fiscal 2010 totaled $3.7 billion, and free cash flow was a record $2.7 billion.

Looking back on fiscal 2010, I feel very good with the number of significant milestones we've achieved.

We filled a record 778 million prescriptions, up 7.5% from last year, and our retail pharmacy market share has increased 60 basis points from a year ago to 19.5%.

We administered more than seven million seasonal and H1N1 flu shots, far more than any other retailer.

We opened 291 net new drug stores.

We acquired Duane Reade's 258 drug stores, the largest acquisition in our Company's history, which gives us a leading drugstore position in the New York Metro area.

We converted or opened more than 1500 stores to our Customer-Centric Retailing or CCR format.

Beer and wine was added as part of our selection to more than 3500 stores.

And fiscal year SG&A growth adjusted for restructuring costs and the Duane Reade acquisition fell to 6.5%, its lowest level in decades.

And Wade will provide more details on the quarter's SG&A growth a little later.

And finally we returned $2.2 billion to our shareholders through dividends and share repurchases in fiscal 2010, and in September, we completed the $2 billion share repurchase program we announced in October of 2009.

So I take great pride in our team's operating execution this past year.

Their efforts give me great confidence that we will continue to drive our core strategies in 2011.

We'll continue to slow store openings with a goal of 2.5% to 3% this fiscal year.

Our efforts to enhance the customer experience will continue to gain momentum, with the acceleration of CCR store refreshes and we plan for our cost reduction and productivity efforts to provide $1 billion in savings in fiscal 2011 versus our base year of 2008.

You can see the impact of these saving efforts when looking at the progress we've made in SG&A dollar growth the last few years.

This chart shows how generic drug introductions produced peaks and valleys in gross profit dollar growth during much of the decade, hitting a high point in 2007, before reaching a low in 2009.

In addition, we felt the effects of the slowing economy beginning in the first quarter of fiscal 2009, which further negatively impacted gross profit dollar growth.

As you can see, unfortunately we have had periods when SG&A dollar growth exceeded gross profit dollar growth.

However, excluding the impact of Duane Reade and restructuring costs, SG&A dollar growth slowed in the last two years.

That resulted from the Rewiring for Growth initiative, scaling back on new store openings and progress from other cost savings initiatives.

Today, we are in a much better position to manage SG&A dollar growth in relation to gross profit dollar growth.

And it's worth noting that in the latest quarter, despite the economy's impact on gross profit dollar growth, we were able to increase those dollars faster than SG&A.

Now I'd like to provide an update on CCR, and how it's driving improvements to our front end.

As I've talked about previously, CCR is reducing working capital and store labor, and most importantly, it is improving sales and the overall shopping experience by optimizing and enhancing our existing product assortments, by improving category and product adjacencies, through improving sight lines throughout the store, and by refreshing all our stores with a new in-store decor package.

As a reminder, we have about 5,500 out of our 7,500 stores targeted for CCR refreshes.

Since the end of the third quarter, we have opened or converted more than 500 additional stores to CCR, bringing our total number to more than 1,800.

By the end of calendar 2010, we'll have over 2,000 CCR stores.

A roll-out of beer and wine has now reached nearly 4,200 stores, and we expect to have it in more than 5,000 stores by the end of the calendar year.

Our customers find this selection a convenient way to consolidate their shopping trips, and it builds basket size.

This extensive refresh of our stores is being accomplished at an average cost of $50,000 per store.

And I'm very encouraged by the favorable customer response these stores are receiving, and the improved performance we're seeing from this investment.

In fact, the overall performance of our CCR pilot stores is getting better and better as we continue our refinement.

On our last conference call, we showed you the pilot store's performance, measured by our four product classes versus a controlled group of stores.

For the 26 week period ending May 29, our pilot stores outperformed the control stores during that period by 2.6% across all product classes.

In the latest 26 week period ending August 28th, our pilot stores outperformed the control group overall by an even better 3.7%.

The improvement that's we're making including new product adjacencies, new assortments in merchandise and the in-store decor package all are contributing to our results.

Now let's update results from our Wave 1 and Wave 2 CCR roll-outs.

As you know, after we launched our pilot stores in spring 2009, we rolled out wave one of CCR to all stores in the Dallas and Houston markets.

These two markets have faced unique economic factors, impacting their comparisons to non-CCR stores in other markets.

Therefore, we're focusing on our market share in Dallas and Houston.

Our latest reports for these two markets show that we are maintaining our market share across our top 60 categories versus our food, drug and mass market competitors.

We're also encouraged by the improving sales results we're seeing in both markets.

In addition, these stores will get a lift from the new in-store decor package they received during the fourth quarter.

Next, our wave two stores, which consist of 203 locations are outperforming our non-CCR stores in the 13 weeks after their conversion.

CCR continues to gain momentum, and we fully expect it to contribute it to front end sales as we complete its roll-out by the end of calendar 2011.

Now I'd like to cover my last major topic, this year's flu season.

Let's start by reviewing last year's monthly sales comps.

It's easy to see that script growth and front end sales reacted very strongly to the early flu season.

Both benefited from customers coming to stores to get immunized and from the prevalence of H1N1.

Meanwhile, the rest of the year showed more normal trends with front end comps generally improving since December.

In the fourth quarter, our margins also improved and we saw increases in comp store market share for our top 60 categories.

Here you see the incidence of cough, cold and flu throughout last year.

It was the early onset of flu activity that caused our first quarter spike in comp sales.

In particular, script comps, including flu shots peaked by the end of September.

And by November, we administered nearly all the seasonal flu vaccine we had, and we believe we could have administered many more doses had we not run out of vaccine.

As a result, for the rest of the season, we administered H1N1 vaccinations and finished up the program by February.

As I mentioned, we easily surpassed our goal, and provided over seven million total shots.

With this graph, you see how unusual last year's cough and cold and flu incidence was, when comparing it to the two previous years.

It's more typical for the incidence of flu to peak around February, which is what happened in the two seasons prior to last year.

If this year's flu season is typical, we have from late August to early January to provide flu shots before the flu peaks.

Now, I'd like to highlight some of the key differences in this year's flu season from last.

First, customers only need to get one flu shot this year that will cover both the seasonal and the H1N1 flu strains.

Second, the Centers for Disease Control and Prevention now recommends everyone over six months of age get a flu shot versus an emphasis in past years on seniors and those with compromised immune systems.

And third, manufacturers made over 40 million more doses this year.

So of course we can't predict the timing or the intensity of this season's flu activity, but we are ready with an unprecedented effort to deliver as many as 15 million flu shots to our customers.

We now have more than 26,000 certified immunizing pharmacists and nurse practitioners compared with 16,000 at the start of last year's flu season.

Which is why we are offering flu shots all day, every day this year, versus the limited hours last year.

Importantly, we have a new direct medical billing option through several health plans, including national agreements with United Healthcare and Cigna and regionally with -- we offer it for Blue Cross and Blue Shield of Illinois and North Carolina, among others.

In addition, we made it easier for our staff to handle the administrative work for flu shots by streamlining the process.

In terms of marketing, we sent direct mail pieces with pre-populated flu shot forms and ramped up our online and TV advertising including a partnership with the ever-popular Dr.

Oz.

With all these efforts in action, we have already provided more than two million flu shots through yesterday.

And remember, as I've pointed out earlier, the typical peak of cough and cold and flu incidence is still more than four months away.

In closing, we believe our flu shot program is a great example of how close we are to patients and how easily we can reach them.

That's what health plans and other payers are saying they need from us.

Face-to-face access to improve patient outcomes and provide preventative care.

We're doing that with our 25,000 certified immunizing pharmacists, more than 1,000 nurse practitioners and 7,500 pharmacies located within five miles of nearly 75% of the population.

We've heard very clearly from payers how important we are to their network of providers.

No one else can match our base of retail pharmacy locations, hospital and medical facility pharmacies, work site health centers and retail clinics and specialty and infusion pharmacy centers.

We have the reach and capability to help payers lower their total healthcare costs while improving quality and clinical outcomes through a complete pharmacy and health and wellness solutions.

As we begin fiscal 2011, we are positioning our Company to serve as a true community based retail, health and daily living destination.

Toward that end, we recently named Mark Wagner, previously our Executive Vice President of Community Management and Operations, to the new position of President of our Community Management Division.

Also, Kermit Crawford who was our Executive Vice President of Pharmacy has been named to the new position of President of our Pharmacy Services Division.

These moves and other realignments will result in improved execution throughout the chain and strengthen the alignment of initiatives across the organization.

Before I close, I want to say I'm very optimistic about our Company's future.

I also want to thank all of our employees for their tremendous execution over the past year, and for what I know they can accomplish in the upcoming year.

Now I will turn the call over to Wade, who will update you on financial results from the quarter and the year.

Wade?

Thank you, Greg.

And good morning everyone.

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

Greg covered sales and earnings, so let me skip down to prescription sales, which rose 6.5% and represented 66% of sales for the quarter.

We filled 194 million prescriptions, an increase of 6.7% from a year ago.

And that includes a benefit of 0.8 percentage points for patients filling 90 day versus 30 day scripts.

On a comp store basis, the number of prescriptions filled increased 3.3% and that includes a benefit of 1.2 percentage points from 90 day scripts.

Prescription sales in comp stores rose 1.6%.

Front end comp store sales in the quarter were up 1.2% in spite of the slow demand for discretionary goods.

Total comp store sales were up 1.5%.

For fiscal year 2010, again I will focus on sales numbers on this chart.

Prescription sales rose 6.3% and represented 63.2% of sales for the year.

We filled 778 million prescriptions, an increase of 7.5% from last year.

That includes a benefit of 0.8 percentage points from patients filling 90 day versus 30 day scripts.

On a comp store basis, the number of prescriptions filled increased 4.5%, and that includes a benefit of 1.2 percentage points from 90 day scripts.

Prescription sales in comp stores rose 2.3%.

Front end comp store sales were up 0.5% for the fiscal year, while total comp store sales increased 1.6%.

Compared to the industry, our sales continue to perform well.

When viewing a true apples-to-apples time period, that compares our front end comps to the top three competitors based on their most recent quarterly performing, we are outperforming two of the three as shown in this chart.

We were only 40 basis points below the third competitor.

Turning to gross profit, the margin improved 70 basis points in the quarter.

Front end margins benefited from pricing, promotion and other improved efficiencies as well as lower Rewiring for Growth expenses.

On the pharmacy side, margins benefited from new generic introductions, partially offset by reimbursement.

Gross profit dollars grew by $1.4 billion in fiscal 2010, and we view that as an especially strong performance in the face of several headwinds during the year, such as the economy which we estimate slowed comparable store sales by two to three percentage points, that's equivalent of about a $500 million gross profit impact, and other headwinds included pharmacy reimbursement such as the new AWP definition for Medicaid prescriptions and the slowdown in the rate of new generic introductions, among others, and combined we estimate those factors were about $1 billion headwind over the course of the year.

In spite of this, we grew gross profit dollars faster than SG&A dollars in the quarter, excluding restructuring costs and Duane Reade.

The two year stacked SG&A dollar growth was higher this year compared with the year ago, primarily due to costs associated with the Duane Reade acquisition.

When you adjust for the acquisition and restructuring related factors you will see the two year stack drops to 12.1% versus a 14.1% two year stack a year ago and 23.4% stack two years ago.

Although SG&A continued to trend down, it gets a little tougher each quarter to maintain the same rate of reduction as we lapse significant progress made over the previous periods.

To get to core SG&A growth, let me walk you through the adjustments for the quarter.

Our reported increase in SG&A dollar growth was 11%.

As you can see, Duane Reade's acquisition-related costs and operating SG&A slightly offset by the impact in the quarter of Rewire costs contributed five percentage points of total SG&A dollar growth.

In addition, new store openings contributed 3.8 percentage points to SG&A dollar growth.

Remaining SG&A dollar growth was a combination of inflation, acquisitions, and business mix, including strategic investments and CCR conversions.

We achieved the net benefit of $615 million for Rewiring for Growth in fiscal 2010, versus our goal of $500 million.

That's primarily the result of moving some costs for the program into fiscal 2011, and for some benefits arriving earlier than expected.

Therefore, we are expecting an additional $400 million in net benefit in fiscal 2011 as we remain on track to reach our goal of $1 billion in savings in the current fiscal year.

This chart summarizes the EPS impact of Rewire savings and costs for restructuring since last year's fourth quarter.

The net savings in the quarter was $0.08 per diluted share.

Again, you will see that restructuring benefits are slightly ahead of schedule, with cumulative savings by quarter at $0.16 per share and the run rate over the 2008 base year at $0.46 per share.

Now let's review some additional income statement details.

The LIFO provision was $61 million versus $48 million in the fourth quarter of 2009, and that represents a LIFO provision of 1.7% for the year, as we experienced inflation in the pharmacy, partially offset by slight deflation on the front end.

We plan for the LIFO provision to be 1.5% in fiscal 2011.

Total Rewire expenses this quarter were $19 million, and for the fiscal year they totaled $106 million.

The effective tax rate in the fourth quarter was 35.6% compared with a tax rate of 35.8% in the year-ago period.

We are planning for a tax rate of approximately 37% in fiscal 2011.

Accounts receivable, inventory and accounts payable are the components of working capital that we can most directly impact and the net sum of these as a percent of sales fell 1.9% in the quarter, compared with a year ago.

Total FIFO inventories rose 9.1%, against total sales growth of 7.4% and total store growth of 8.1%, including Duane Reade.

FIFO total inventories on a per store basis increased 0.9% in the fourth quarter.

And this small increase comes after an 11.1% decrease in the year-ago period.

To update you on capital expenditures, CapEx for fiscal 2010 was $1.0 billion, short of our original estimate.

That was primarily due to a strategic decision to delay the investment of our new point of sale system and other IT investments, and the timing of certain real estate investments.

We expect CapEx to increase in fiscal 2011 to approximately $1.4 billion, as we now move ahead on our point of sale system roll-out and other key investments.

Cash flow from operations for the fiscal year was $3.7 billion, just slightly short of last year's record $4.1 billion.

Free cash flow increased to $2.7 billion in the fiscal year, versus $2.2 billion for the same period last year.

Cash and cash equivalents and short-term investments totaled $1.9 billion, and long-term debt totaled $2.4 billion.

Our strong cash flow and balance sheet allowed us to pay out $541 million in dividends during the fiscal year, an increase of 21.3% over fiscal 2009.

Our fiscal 2010 dividend payout ratio was 26%, and you will recall that we had previously set a long-term dividend payout target of between 30% and 35% of net earnings.

During the year, we repurchased $1.6 billion in stock.

Combined with our dividend payouts, we returned a record $2.2 billion to shareholders in fiscal 2010.

And I'm very proud to report, this month we have completed the $2 billion stock repurchase plan that we announced in October 2009.

Three years ahead of schedule.

As we consider future uses of cash, we will keep following our four basic guidelines.

First, we'll maintain a strong balance sheet and financial flexibility.

Next, we'll continue to reinvest in our core strategies.

Third, we'll invest in strategic opportunities that reinforce our core strategies and meet our return requirements.

And last, but importantly, we will return cash to shareholders from surplus cash flow in the form of dividends and share repurchases over the long term.

This policy demonstrates our ongoing commitment to delivering value to our shareholders.

I'd like to briefly conclude by saying that we remain very optimistic about our Company's future as we continue down a path of smart growth with an emphasis on the customer and costs and productivity gains.

I want to thank all of you for your support.

We are very proud to have returned a record amount of cash to our shareholders in fiscal 2010, especially in this difficult economic environment.

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 questions.

(Operator Instructions).

And we will take our first question from Mark Miller with William Blair.

Hi, good morning.

My one question is going to be on gross margins.

Can you describe the change from last period?

I know new generics moved up through the quarter, but it's hard to see that that would have explained fully the change in trend, and so without any guidance going forward, it's very tough to get the quarters right.

Can you tell us what might have been unique to this quarter, what here is recurring?

And then if you can give us some sense for how you're planning expenses in fiscal 2011, do you think gross profits grow at least in line with sales or less than sales?

Thanks.

Okay.

I guess the things I would say, first, gross profit as you know we were up nicely this quarter, and a couple of factors have played into it.

First on the front end, we were up nicely, which was a combination of many things.

It was more effective pricing, promotions, more effective -- less markdowns, better buying, lots of different factors.

But we feel very good about the directionality of the gross profit in the front end.

If you look at the pharmacy, basically we had some help from generics in this quarter.

As you know in prior quarters, we've had some lags.

But we had some help from generics, and that helped to offset some of the underlying reimbursement pressure, and we've also had some positive efforts in reimbursement as well.

So that was effectively a mixed bag there.

Going forward, what I'd really say is that our key model over time, and again, understand quarter to quarter there can be some volatility, but what you should be seeing over time is our continued effort to focus on gross profit dollars, and to make sure that those gross profit dollars over time are able to outrun our SG&A.

And we feel pretty confident we can do that, but that's really the model that we're focusing on.

Thanks.

And appreciate the more aggressive share repurchase.

Thanks, Mark.

Thanks, Mark.

Our next question comes from Scott Mushkin with Jefferies & Company.

Hi, guys.

Thanks for taking my questions.

So I was wondering if you could just give us some thoughts about SG&A dollar growth as we go into next year.

I mean, are we going to see that continue to be -- should it be less than sales, or should we -- or is it going to be more than sales, and how is the CCR program going to fit into that?

Yes, Scott.

Greg here.

And I'll jump in and let Wade kind of tag on a little bit.

But our goal is obviously is to keep our SG&A growth, dollar growth trending down.

We feel good with where we've been over the last quarter or two, and our bigger goal is frankly to make sure that SG&A dollar growth is less than gross profit dollar growth.

So, I think we feel good with where we are with rewiring.

We're going to deliver the $1 billion that we had set out by the end of 2011.

I think we'll continue to see some improvement from the slowing down of new store openings that we called down actually on this call.

And we really have some good focus across the entire organization on just cost focus or cost control, we have a relentless focus on cost.

I think what we could say is we're focused on continuing to drive that trend down, and keep it less than GP dollar growth.

Is Wade going to add anything?

No, I think Greg said it all.

I think we've done a good job of bringing it down.

You have some reconciling items that you can see when you dig out things like new store openings and others.

We're making real progress.

We feel very confident in our Rewire for growth uptick from year to year.

Beyond that, we put a significant amount of effort into looking at how do we do a continual reengineering process improvement.

It's really an ongoing process of improving things versus getting to one-time.

Again, we're focused on driving gross profit dollars up, and trying to drive SG&A dollars below that, and I think we feel very good about all the different initiatives and interventions we put in place.

So just two quick clarifications, and I'll give up the floor.

First, was there any one-time payment in that gross margin number you reported in the fourth quarter, which was quite strong?

That's question number one.

And number two is, when you give the order, Wade, of what you're going to do with your cash, it seems like the shareholder is number four.

Should we think of it as number four, or is it just the way you kind of present it?

The first one, there was no one-time payment, or at least nothing substantive or material that I can even think of in that number.

That was true operating performance.

And the second one, I would say because it's number four, it doesn't mean it's number four priority.

I view these almost as a balanced matrix.

We are not going to compromise a strong balance sheet, but we're also not going to focus on returning cash to shareholders.

If that's the fundamental question.

Thanks very much.

I appreciate your answers.

Nice quarter, by the way.

Thank you.

Thank you.

Our next question comes from Ed Kelly with Credit Suisse.

Yes, hi, guys, good morning.

I just want to start with maybe a follow-up.

On the gross margin side, Wade, it sounds like you're clearly encouraged by what you're seeing on the front end.

Is there going to be follow-through on that now through 2011?

Is that how we should be reading how you answered that question?

Look, I would say I think the store ops, and the merchandising folks and marketing folks are doing a terrific job of focusing on all levers, right?

We have a lot of good initiatives in place.

The CCR initiative is working, and it continues to improve.

The various subsets, things like beer and wine are working well.

The focus on price and promotion is working well.

We're being very disciplined in buying.

We're doing better buying.

So, I really feel like there's a lot of great blocking and tackling across all things, and they'll continue to work on that.

So I would say there's no magic in the improvement.

It's just a lot of hard work across a lot of core initiatives, and we feel that we're doing the right things right.

And Ed, I'd like to add, certainly we still have a tough economy.

We still have a tight consumer.

And I would agree with everything Wade said.

I think we're doing everything we can do to manage that, through that profitably, but we still have a tough consumer.

We have to make sure that we balance swinging doors without giving up too much margin.

I think the operations folks and merchandisers have done a nice job in balancing that.

All right, and then if I could just ask a last question here.

Greg, where do you stand on flu shots currently, where they were at this time last year?

And then sort of intertwined with that, you don't give guidance obviously for next year, but at your analyst meeting a couple of years ago, you laid out getting back to double-digit growth.

The Street's going to be up probably at least mid-teens now for next year, given where they were before today's report.

Can you do double-digit growth for 2011?

Is that in the mix?

Ed, I'll answer the second one first, and then go to the flu and maybe I'll turn it over to Kermit.

But certainly our goal as we stated in 2008 is to get back to double-digit earnings growth, and stronger return on invested capital trends, in order to grow our shareholder return, our shareholder value.

So that goal hasn't changed.

As far as giving timing, obviously we don't do that, Ed, but the goal certainly has not changed, and I think we're doing all the right things to achieve that goal.

As far as flu shots, as I said, we're just over two million through yesterday.

I'll let Kermit kind of maybe take it from there, and talk about maybe where we are versus last year, some of the things we're doing this year to give us confidence that we'll hit that 15 million flu shots.

Yes, Ed, as you remember, last year in the first quarter we provided five million flu shots, and as Greg said, through yesterday we've provided over two million flu shots this year.

And I think what I'd like to say is last year we were very disappointed that we couldn't help more of our customers because of the lack of the flu vaccine.

And this year that won't happen.

I mean, we're prepared to be there for our customers, and to be in stock.

So, we have an unprecedented campaign this year that we put in place to reach our goal of 15 million flu shots.

Greg talked about our 26,000 certified pharmacists and nurse practitioners, more than any one or any other retailer in this country.

We're also providing more access and convenience this year versus last year, by offering flu shots every day, all day.

I actually had a customer send me an e-mail just the other day to talk about how wonderful it was that she could get a flu shot at 9.30 PM at night.

And in our flu patient satisfaction scores, we've had greater than 90% give us a satisfied or very satisfied overall experience.

So we have truly reformed the delivery system for flu shots in this country.

And also, Greg talked about the CDC recommending a universal flu vaccine, with everyone over six months of age getting a flu shot.

And if you think about last year, our seven million shots only represented 3.5% of the market, so with that market significantly growing this year, our 15 million goal is certainly going to be aggressive and a challenge, but we certainly think that that's something that we can meet.

And our flu gift card has given us a tremendous amount of early awareness.

Remember last year, the CDC moved up the flu season to September.

Normally the flu season doesn't actually start until October.

So that gift card has given us a tremendous amount of early awareness.

So we're excited about this season, which actually doesn't start until sometime in the next two weeks for us, but we're already two million scripts, two million shots into it.

Thank you.

Thanks, Ed.

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

Good morning.

Good morning, Eric.

The execution, Wade, you talked about of the merchants, and the positive gross margin, front end gross margin trends in the fourth quarter, can you just talk a little bit about how the performance improved so markedly in 4Q relative to 3Q.

The 4Q gross margin seemed like it improved a lot more than 3Q.

Was there something that they improved on even further, or what contributed to that material step up in 4Q relative to 3Q?

Eric, Greg, maybe I'll jump in ahead of Wade a little bit.

I think certainly for the quarter, we saw less aggressive markdowns of summer clearance than we did a year ago.

I think that contributed some.

I think also less aggressive clearance in our CCR markdowns, we're pretty much through that.

That obviously contributed some.

But I also think they did a nice job in really maintaining and balancing that payoff between price and promotion.

And I think we've done a nice job with what we call our key value items.

Our basic everyday items, and making sure we're priced right to show value, as well as what we put on the front and back page of our ads.

But also at the same time not giving up excess margin.

I think what we're really enthusiastic about is there's the opportunity that we still have to drive private brand penetration, and the learnings that we're able to bring back from Duane Reade to help us expand that.

Just a good balance of price and promotion.

Related to this, then, the second part of the question is, I understand the vision long-term for the gross margin dollars to grow faster than the SG&A dollars, which makes sense.

As you think about achieving that goal in 2011, what are the factors that are in your favor or not in your favor to accomplish that goal in 2011?

I guess what I would say is, on the front end we'll continue to gain the momentum on the core initiatives we've laid out.

CCR, as you've seen the results, it's still only partially out there, because they're getting stronger all the time.

So we believe that's going to give further momentum.

If you think about the pharmacy, obviously there's a balancing act where we've done a lot of good job to take efforts to strengthen or stabilize reimbursement, although pressure will still be there.

But we still have the expansion of script life services coming in our favor, and then ultimately we'll have a new generic wave.

We do have things like Amp out there, which are unknowns, but I think in our model we try to do as good as we can with planning for the toughest case, and then if a better case comes, then that's a tailwind as well.

Those are the core kinds of things.

Again, Greg alluded to the economy before.

It's very tough out there.

Whether it's going to get easier any time soon, nobody knows.

But we're trying to plan a model that's going to be successful even in tough times.

That's what we're focused on.

Eric, this is Kermit.

One of the things that Wade has mentioned in the past is that we can't control the introduction of new generics.

And so between the slowdown in new generics, some of the deflation in the old generics, and AWP, we had a huge headwind against us last year.

Okay.

Thank you.

Thanks, Eric.

Our next question comes from Deborah Weinswig with Citi.

Great.

If we, I know it, one more question on gross margins, but you mentioned improved pricing, promotion, other efficiencies.

How much did that contribute to the 70 basis points, and what exactly did you do to improve pricing and promotion?

And then how far along are you on the test of the loyalty card, and did that have any impact?

And then just since we're on the gross margin topic, can you talk about what you saw with regards to private label penetration for the year and the quarter, and where are you right now, and what are the goals?

I think I got all those, Deborah.

This is Greg.

Okay.

I think first of all -- .

It was in one breath, so it counts as one question.

That's good.

Rick has them written down for me here, Deborah.

Okay.

I think as far as front end, there's a contribution to total margin, I don't know if we have broken that out, Wade, if we have, but I think we definitely were encouraged by what we did do with the front end.

As far as a breakdown, as I said, I think that really focusing to make sure that we were priced right on key items that really drive value in our consumer's mind today.

And our folks are looking for value in both private brand, bonus sizes of national brands, and I think that we just did a nice job as I said not giving up excess, but at the same time swinging doors.

So I think we have to understand, and we have a pretty good idea of what the value of our convenience is, and what that delta is that we can get for that convenience, and I think we're really on top of making sure we manage that delta.

I think your next question was on loyalty.

Yes.

As you know, we have rolled out or started a pilot in three markets in May of this year.

So we have about three to four months of data now.

We feel good.

We're encouraged with the early results from those three markets.

We also, as you know, through the acquisition of Duane Reade, have acquired a loyalty program that gives us a lot more data, and some rich data.

We're encouraged where we are.

We really want to get about a good six months to maybe eight months in data before we decide how to fine-tune it, and when we would begin to implement it nationwide.

We should have enough data after the first year to begin to think about when we would go nationwide.

Let's see.

I think you talked about private label.

I think what I'm encouraged most with was private label is, we've over-penetrated, over-indexed in our private label with where you would think we do, and that's in over-the-counter cough, cold, the health and beauty type items.

We've under-indexed to our 20% or so total penetration in consumables.

That's where Duane Reade brings a tremendous amount of expertise and talent because of their history with Loblaw's and coming out of a strong private brand consumable retailer.

So we're looking forward to bringing through a lot of their expertise to drive our penetration in the consumables.

And we began that last month or two with our first introduction of the Duane Reade private brand throughout the chain with about 15 to 20 core SKUs.

So I think it feels like to a lot of us, this is a real breakout quarter from a gross margin perspective.

I mean, was this driven more by process or technology, or how would you kind of sum it up?

I think all of the above.

I think one of the things that we probably haven't maybe talked about as much, or maybe even made that clear is that CCR is much more than just what you physically see in a store.

And certainly we're focused on the results that we're seeing in store, sales, customer experience and so forth.

And all of that we feel extremely good about.

But we -- in the last 12 to 18 months, Bryan Pugh and his team frankly have rebuilt the entire plumbing of our merchandising process, so we have much better sophistication in the systems to be able to manage multiple planograms or categories.

We've really improved our ability to understand pricing in that delta we're talking about for convenience.

I think it's frankly a lot of process, system improvement, that's helping us manage that, and maintain -- and achieve that balance I'm talking about between price and promotion more so than we have in the past.

Great.

Thanks so much.

And congratulations again on a great quarter.

Thanks, Deborah.

Our next question comes from Robert Willoughby with Banc of America Merrill Lynch.

Hi, just a quick one on Duane Reade dilution going forward.

Anecdotally, what's left to consolidate there, and can you hazard a guess on the EPS impact for the next fiscal year.

Our dilution this year ended up being about $0.05, which was a little bit more than we had, or $0.06 maybe, a little bit more than we had anticipated prior, as we pulled some items forward.

I think next year we're roughly saying around $0.02 to $0.03 dilution.

That might be a little bit on the low end of that, because again we pulled some of those forward, and then going on we move into our accretive path.

For the most part, we're now at the point where it's roughly a wash.

But again, probably a little bit of dilution last year, but I'd say it's at the low end of the $0.02 or $0.03 because we did pull some of those one-times forward into this fiscal -- this prior fiscal.

That's great.

Thank you.

Thanks, Robert.

Our next question comes from Tom Gallucci with Lazard Capital Markets.

Good morning.

Thanks for all the details.

On the Rewire, just wanted to clarify, you got about $100 million extra savings in fiscal 2010, so you're sort of bumping down the $500 million to $400 million in fiscal 2011, is that exactly right?

We had, between the savings of being -- $60 million, $70 million more, and then the one-times being $40 million less, which pushes over.

We effectively --.

Right, okay.

So, do we see a lot of that incremental upside, $500 million to $600 million of net positive in the fourth quarter?

Well, we certainly saw a nice tick up because we actually accelerated some of our plans for next year into the fourth quarter.

So that certainly helped.

But I think moving forward, those will carry through as well.

So our goal is to at least meet our goal of $1 billion.

Hopefully we'll beat it.

But what we're really focused on is meeting it.

That's the goal, is to absolutely meet it under any condition.

Okay, and then just on generics, I think Kermit mentioned before, fewer new generics in fiscal 2010, and some deflation on some older ones.

How are you thinking about fiscal 2011 versus fiscal 2010 on the generic front, sort of all-in?

Well, Tom, Greg here, I think on the generic front where Kermit was going is, last year was a really tough year as far as the new generic growth that we saw versus the year before.

We're still going to see -- we'll still have a tough or a tighter year for new generics this year, but it's certainly less than the dip that we saw last year from the previous year.

And then as you know, by next fiscal year, the following fiscal year, then we're going to be into the new generic wave.

Great.

Okay.

Thank you.

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

Thank you.

Good morning, congratulations on the quarter and year.

Wanted to ask you first on the uptick in the remodels, was that for the control group, the 40 or 50 stores, or is that -- what's the sample size there?

And can you discuss how that translates to the 1,800 stores you have done, and stores going forward?

And also, can you discuss if you've done any other large metro markets, and what the results would be in one of those markets?

Yes, Andy, Greg.

I think the first number you're referring to that I gave is the 35 store pilot group, which we're seeing a 3.7% or so tick up from the previous quarter.

And really, that's our best control group, or our best group to be looking at because we have a good control group of stores to measure.

So, we feel good with the improvements we're making, and the trend we're seeing.

The other group that we're really focused on is, that I called out, were the 200 stores in the wave two, and we feel good with where they are, as I said the 13 weeks after conversion.

So, and obviously, we're running up in comp sales in a tough economy, so we feel good overall.

Keep in mind that even though we will only have or will have 2,000 stores converted to CCR, a lot of the CCR benefits, we're seeing chain-wide now, with the enhanced categories and the assortments that we're able to roll out.

So hopefully that answers your question.

Well, I guess outside of Texas, or markets that are very competitive, or the economy nose-dived quickly or something, why shouldn't what you're getting at the pilot stores eventually translate to a large majority of the remodels?

We hope that it would, Andy, and the good thing is as I said, that we're a year into those pilot stores, or nearly, and we've made a lot of improvements.

So we feel good with that trend.

Remember that this is really, I would say, kind of foundational work.

It's really, we're just trying to get the base platform right for the future to the extent that it is increasing our sales, it is increasing our margins, it is helping reduce our working capital, and we're providing a better customer experience.

I think that's the key thing, is trying to keep these four metrics positive as we build that base for the future.

So, it sounds like you think in terms of sales growth, CCR is more of a cumulative process than a one-time wonder, great remodel, we hit it, that type of thing.

Yes, this is an ongoing, this is just the first step of a many year, many leg journey, so it's really trying to improve our store experience to the benefit of our customers.

And another topic, if I could, and then I'll get off.

Can you update us on some of the direct payer progress that might be -- you're seeing either in the marketplace, or I think there might have been some internal changes in how you're going to market there, and how you're managing that?

And perhaps as you emphasize that way of going to market, what is the strategic value of having a PBM for Walgreens?

Well, Andy, we feel good with where we are with our direct to payer, and by payer we look at that as employers, our pharmacy benefit, management partners that we work with, health plans, and the government and so forth.

I think a good example of the progress we're making in our direct to payer approach is what I talked about with our flu shots.

We have national agreements with United Healthcare and Cigna on providing flu shots to millions of their members, as well as many of the regional Blues.

And that was the result of how Rosenbluth and his team that we've, I think you were alluding to, we've consolidated our sales and client services organization under Hal and his teams.

We now have one group that's bringing all Walgreen's pharmacy and health and wellness solutions to all those payer segments.

And I'm feeling very good.

We're really encouraged with what's happening there, and I think across all payer segments.

Okay, thank you.

Thanks, Andy.

Our next question comes from Ann Hynes with Caris & Company.

Good morning.

Good morning, Ann.

In your prepared comments, you talked about a $1 billion gross profit headwind that you've faced in 2010.

I think you said $500 million came from the economy, you mentioned generics, you mentioned AWP.

When we look to fiscal 2011, I guess is that $1 billion, what do you think won't be repeated?

And then also, maybe what things could be impacting gross profit in 2011 that would be a headwind, like AMP for instance?

I guess what are your expectations on that?

Thanks.

I think that's an excellent question.

I guess what I would say is on a relative year on year, the economy's already factored in.

Now it's up to us to make interventions to be successful in any economy, so you don't have that kind of, call it step down effect.

There undoubtedly will be reimbursement pressure.

We don't think it's going to be as much pressure as we saw last year.

That was probably the greatest year, as we said $0.5 billion-ish between the generic, less than normal generic lift between AWP and between a variety of other reimbursements.

So we think it will be challenging, but not as challenging.

And a key part of that is AMP.

There's certainly a lot of activity happening around that.

For us to speculate when or if that kicks in exactly on the day and the amount is probably a bit premature.

There is a lot of activity, but certainly we're assuming across all reimbursement, it will still be a challenging environment, although I would say probably not as challenging.

So is it fair to say maybe of that $500 million, you only experienced half of that in fiscal 2011?

I would hesitate to give any number.

Okay.

I think it's premature.

Some of these things are very binary.

I would just say that last year there was a lot of challenging factors, and I just don't see this year at least repeating that in aggregate.

Okay.

Great.

Thank you.

And our final question comes from John Heinbockel with Guggenheim.

Hi, Greg.

A couple of things.

On the reimbursement issue, what's the prognosis for state Medicare this year?

You would think that that might be tougher than last year.

And then long-term, how do you think the reimbursement tug of war between retail and PBMs plays out?

Because you might think long-term after the generic cycle maybe it gets tougher secularly as they try to protect profitability.

How do you think about those two things?

Hi, John, good to hear from you.

I think that state Medicaid, AMP, I would lump those all together, as Wade said.

I think that certainly it's going to be a headwind, and right now there's a lot of moving parts in AMP that we're on top of regarding timing, and what the final impact will be.

But certainly, whatever we end up seeing, not only have we planned for it already, as Wade said, but I think we'll still be working with states, both regarding state Medicaid as well as Medicare with the government.

But as far as states, we think we can bring a lot of value to states, not only with how we can help them on their pharmacy costs, but also on the total medical cost.

And that's, John, I think where we really are focused, and probably the biggest maybe difference between us and others would be, we're focused on helping provide value to all payers, including states to lower the medical costs and improve the quality, total medical cost, not just pharmacy.

So we'll be focused on working with them across the entire medical spend.

As far as the relationship or the reimbursement environment with the commercial payers, the PBMs and others, I think that it's all about providing value.

And I think payers going forward are all going to be looking for help to improve the quality of their healthcare spend, as well as controlling that cost.

And as I've said several times, keep in mind, pharmacy is only about 10% to 12% of total medical spend for most employers across this country.

We're seeing employers more and more focused on looking at how to improve their total medical spend, both from a quality and a cost.

So, I think it's all about us providing value, and that's why we're trying to transform community pharmacy as we are doing, to provide more value.

This is Kermit.

I would add, if you recall, Amp was included in the deficit reduction act of 2006.

And there's certainly reasons that that implementation has been delayed, and one of those is that there's a study out that says over 12,000 pharmacies, independent pharmacies, would have to close their doors, and couldn't survive in an environment where you have further rate cuts.

So there is a challenge around the implementation of AMP, and we recognize reimbursement pressure will continue, but we expect to be able to manage our commercial segment going forward as we have in the past.

And although the pricing index may change, we wouldn't expect it to have a dramatic impact on our current reimbursement economics.

Okay.

Then one final question.

When you think about the front end as it sits today in this economy, how do you look at price elasticity?

The question of how much do you want to invest promotionally.

How do you look at price elasticity today versus maybe a couple of years ago, and is the dynamic going to change here such that maybe gross profit grows less because of sales growth, more because of margins improving than might have been the case a while back?

I think the key thing is, in any challenging economy, one learning globally is that it is important to focus on value, but value doesn't always mean price.

In fact, value is about reframing the value you provide.

We provide fantastic convenience.

We have great private label offerings.

If you look across the store, we're expanding things to make it even more convenient for people to get more things.

As Greg mentioned, we've done a terrific job of focusing on things like the key value items that people really, really, really want to make sure that we're sharp on.

So I think the important thing for us is not to just get into a price war game, but to really say, what are the things that we can do to provide value?

And even on the back end, flu shot, a flu shot from Walgreen's at $30 is a tremendous value.

It's cheaper than going to the doctor and getting it, and it's certainly a lot cheaper than getting sick and being out of work or having to get Tamiflu or whatever.

I think we are in a good spot to provide good value in the front end and the back end.

And I guess what I would just say is, it's important for us to recognize that that doesn't mean just cutting prices.

Okay, thanks.

Thanks, John.

That concludes our question-and-answer session.

I would like to turn the call over to Mr.

Hans for any additional or closing remarks.

Folks, that was our final question.

Thank you for joining us today.

We'll announce September monthly sales on October 5.

After that, our next investor relations event will be our Analyst Day on November 4.

We'll look forward to seeing many of you there.

For those who will not be attending in person, Analyst Day will be simultaneously webcast through our Walgreen's Investor Relations website.

Our next quarterly financial announcement will be Wednesday, December 22.

That's when we'll announce fiscal 2011 first quarter results.

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

That does conclude today's call.

Thank you all for your participation.