沃博聯公司 (WBA) 2011 Q1 法說會逐字稿

Good day, everyone and welcome to this Walgreens Company first quarter 2011 earnings conference call.

Today's call is being recorded.

At this time I am pleased to turn the conference over to Mr.

Rick Hans.

Please go ahead, sir.

Thank you, Jennifer and good morning everyone.

Welcome to our first quarter conference call.

Today, Greg Wasson, our President and CEO, will discuss the quarters highlights and our continued progress in executing our core strategies.

In addition, Wade Miquelon, Executive Vice President and Chief Financial Officer, will detail our first quarter 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 nonGAAP financial measures and I would direct you to our website at investor.walgreens.com for reconciliations.

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

You can find a link to our webcast under investor relations-- on our investor relations website.

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

We're also making that call available as a podcast.

You can download that too at our Investor relations website.

Just to remind you certain statements and projections of future results made in this presentation constitute forward-looking information that is based on current market, competitive and regulatory expectation that involve risk and uncertainty.

Except to the extent required by law, we undertake no obligation to update publicly any forward-looking statement after this presentation whether as a result of new information, future events, changes in assumptions or otherwise.

Please see our latest Form 10-K 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 I want to cover three main points.

First, I'll review our first quarter financial results.

As you saw in our release this morning, this was a particularly strong quarter in terms of earnings growth as we continue our focus on gross profit margins and controlling our costs.

I'd like to point out that we were up against a very strong quarter a year ago as well.

Second, I'll discuss the economic environment and some of the challenges we're likely to face as we move into the second quarter and the balance of the year.

And finally I want to highlight our progress in the quarter on our key initiatives, particularly some of the great work our people are doing and also bring you up to speed on our flu shot program.

We reported record first quarter sales of $17.3 billion, which are up 6% from $16.4 billion last year.

Net earnings for the quarter were $580 million, up almost 19% from $489 million in the same quarter in 2010.

First quarter net earnings per diluted share were up 26.5% to a record $0.62, that compared with $0.49 per diluted share in the first quarter a year ago which included $0.03 in restructuring and restructuring-related costs associated with our Rewiring for Growth initiative.

Strong cash flow trends continued this quarter with cash flow from operations of $1.2 billion and free cash flow of $892 million.

Now, taking a more in depth look at the quarter, let me turn to our front-end performance.

In this chart, we're comparing our front-end performance this quarter to last years' first quarter by month.

As you can see, we cycled some challenging comparisons in September and October.

For quarter front-end comps increased by 0.4% versus 2.7% a year ago.

We continue to focus on and enhance our approach to merchandising to strike the right balance between margin and sales.

We're sourcing product globally and having great results from our recently opened office in Hong Kong and we're managing our pricing models and promotional investments.

All of this is having a positive impact on front-end margins.

We continue to expand our new beer and wine convenience category.

We're now in nearly 5,000 stores up from just under 2,000 in November 2009 and that growth has contributed more than 75 basis points to the front-end comp.

Our fresh food initiative is bringing healthy products to food (inaudible) in Chicago and other select locations and we're taking the best of Duane Reade's approach to urban retailing and beauty and expanding it into select Walgreens stores.

We're also integrating the best of Walgreens pharmacy expertise into Duane Reade.

As we rollout our Customer-Centric Retailing initiative across the chain, we're seeing improved sales, increased efficiencies, lower inventory and a better customer experience evidenced by our improved customer satisfaction scores.

We call it a four way win and you'll see it reflected in our front-end comp, gross margins and SG&A.

For second quarter, our December holiday season will once again be influenced by the final days.

We opened the season with a solid Thanksgiving weekend but this is an important week for us, with our stores open Christmas Eve and Christmas Day, we are an ideal destination for last minute shoppers.

Just as our front end performed well this quarter our pharmacy turned in solid results especially when you consider the double-digit script comps in September and October of the prior year.

Prescription sales in comparable stores grew 0.9% compared to last year while comparable script growth was 2% over the same quarter last year.

Recall that flu shots are included in our script comps.

Prescription sales accounted for nearly 66% of sales in the quarter and climbed 5.3% compared to the same quarter last year.

As of November 30, we increased our leading retail prescription market share 40 basis points from a year ago to 19.7%.

Even with our strong results this quarter, we believe it's important to remain very focused on the economic outlook and the challenges it presents for our business and the quarters ahead.

Unemployment remains high at 9.8% across the country.

Spending on discretionary items remains slow and value continues to be a priority for customers.

We are convinced that the new consumer, focused on convenience, value and day-to-day necessities is here to stay and we intend to be well positioned to serve her needs.

Looking ahead, we expect to see continued pressure from third party payors including the government.

While it's too early to speculate on the eventual impact of AMP, states will continue to experience budget difficulties and as a result, we anticipate increased reimbursement pressures.

While we face uncertainty in the economic and political environment, our results this quarter demonstrate that the execution of our core strategies is generating the results we want to achieve.

We're seeing impact of slowing store openings in our performance.

We're on track for store openings of 2.5% to 3% in fiscal 2011 compared with nearly 9% growth just three years earlier.

Our efforts to enhance the customer experience are gaining momentum.

CCR along with other initiatives is helping us serve customers more effectively and is driving better results for the front end.

And we continue to remain focused on our cost reduction and productivity efforts to provide $1 billion in savings by the end of fiscal 2011 versus our base year of 2008.

The impact of these savings efforts is clear when you look at the progress we've made in SG&A dollar growth this quarter and over the last few years.

To give you a sense of how deeply our strategies are penetrating, here is a look at CCR through Q1.

We've converted or opened approximately 2100 CCR stores which is nearly 30% of the chain.

By the end of 2011, we will have reached our plan of more than 70% of the chain or approximately 5500 existing stores transitioned to CCR.

Now let me provide a brief update on our flu program.

As we mentioned in our last call, we have 26,000 certified immunizing pharmacists across our store base plus nurse practitioners in Take Care clinics to deliver flu shots all day, every day.

As a result, through the end of the first quarter we were able to administer 5.6 million flu shots, more shots than we were able to provide last year in the middle of the H1N1 pandemic.

Today, aside from the Federal Government, Walgreens provides more flu shot immunizations than any other single entity in America.

This is part of our overall initiative to transform community pharmacy and give our highly trained and skilled pharmacists and nurse practitioners the opportunity to provide access to care and preventive services in a way that no one else can.

And our efforts in flu are just beginning.

We're taking our proven expertise and expanding into the nearly $40 billion total immunization market.

Let me make one final comment on the flu.

We don't know how the rest of the season will play out.

There are fewer shots being administered across the country this season, but with strong support from our vendors and a $0.02 per share flu vaccine inventory write-off this quarter, we believe there is minimal inventory risk the rest of the season.

At the same time, we are prepared to continue serving our customers who come in for flu shots.

With our strategies in place, we have a strong foundation to achieve our financial objectives.

At Analyst Day, we stated a goal of increasing gross profit dollar growth by 100 basis points faster than SG&A dollar growth, and with the upcoming generic wave gross profit dollar growth becomes a critical top line metric.

Wade will get into this in more detail but I want to provide some context.

As you can see from this chart, this quarter, we're getting the relationship between gross profit dollar growth and SG&A dollar growth right.

The impact of the recession into late 2009, generic cycles from a high point in 2007 to a low third quarter 2010 and meaningful reimbursement impact in 2010 all affected our gross profit dollar growth across quarters.

We clearly must continue to manage the impact all these issues have on our business.

As we make progress working for example, with states and payors to find solutions on reimbursement for all stakeholders and continue to generate momentum on our initiatives, our goal is to create solid gross profit dollar growth.

In terms of SG&A dollars, you can see we've had periods when SG&A dollar growth exceeded gross profit dollar growth.

Our goal over the past several years has been to create a culture where cost efficiency and a focus on productivity are always part of our decision set.

As our results show in this quarter, we're right on track.

We are in the final year of our Rewire initiative.

We expect to reach $1 billion in savings and transition the discipline of Rewire into continuous process improvement innovation to make it part of our DNA.

Our goal continues to be annual SG&A growth of 6.5% to 7.5% for fiscal 2011 which includes costs associated with the restructuring, Duane Reade and new store openings.

At the same time though, we expect we will continue to have some of the volatility you see on this chart from quarter-to-quarter, even as we keep our growth target in sight.

Keep that volatility in mind as you consider our performance in the second quarter, which is typically driven by seasonal sales and cough, cold and flu, all of which we can't predict in advance.

Shifting from SG&A, I want to conclude by emphasizing our committment to creating value for shareholders.

Over our history, we've paid a dividend for 312 straight quarters and raised our dividend for 35 consecutive years.

In the last eight years, the Company's dividend has grown at a compound annual growth rate of nearly 22%.

And in the last two years, we've returned a record amount of cash back to our shareholders in the form of dividends and share repurchases.

Last July, the Board approved a dividend increase of 27.3% compared to the year ago dividend and during the quarter we paid out $0.175 in dividends per share.

As a part of our share repurchase programs we completed our $2 billion initiative buying $360 million in Company stock.

We launched our newly announced $1 billion share repurchase program with the purchase of an additional $150 million.

These share repurchases added $0.04 of EPS to our quarterly results.

Through both the dividend and share repurchase programs, we've returned a total of $676 million to shareholders in the quarter putting us on track to continue our tradition of creating meaningful long-term shareholder value.

Before I turn it over to Wade, I want to wrap up by saying that while we are very pleased with this quarter, we are far from complacent.

We still face a difficult economic and political environment with a lot of uncertainty and we don't expect our competitors to stand still either.

Nonetheless, it is great to see our strategies yielding the results all of us expect from our Company.

These results reaffirm our belief in the work we're doing and in our conviction that we can become My Walgreens for everyone in America.

That's what we're focused on, making and making the most of our center of gravity, our 7600 stores, owning outright the strategic territory well.

We want to ensure when customers experience Walgreens they know we are there to help them live well, stay well and get well.

Delivering products that meet customers needs every-- and meet customers' everyday needs and providing solutions that improve prevention and chronic disease management, we are focused on becoming Americas first choice for health and daily living needs.

As we do that right, we will deliver value for customers, for our 244,000 employees are who are working hard this season and for our shareholders.

In closing today, I want to thank all of our employees who have done so much over the past couple years to make our results this quarter a reality.

We're asking people to work differently and think differently, and I know it's not always easy but Walgreens people are resilient and committed.

We wouldn't be here today without all of their hard work and good ideas, so thank you to every one of our employees who is doing what it takes to make this such a great Company.

With that, I'll turn the call over to Wade.

Thank you, Greg and good morning, everyone.

This morning, I'll review our financial results in more detail including a discussion of recent gross margin and SG&A trends.

I'll take you through our other key financial metrics and I'll update you on our front end and pharmacy productivity.

Greg covered our sales and earnings so I'm going to start off this morning with some detail our prescriptions.

Prescription sales increased by 5.3% accounting for 65.8% of sales in the quarter.

We filled 202 million prescriptions, an increase of 4.6% from a year ago including 0.8 percentage points from patients filling more 90 day versus 30-day prescriptions.

Pharmacy comp sales increased by 0.9%.

Front-end comp sales increased by 0.4% and total comp sales increased by 0.8%.

Finally, our script count increased by 2% versus a challenging 9.2% a year ago.

As Greg detailed we were cycling difficult comps in the quarter from the impact of H1N1 on both our front end and our pharmacy.

Because of those difficult year-over-year flu comparisons, traffic was down 0.9% for the quarter but we're very pleased the basket improved by 1.3%.

Turning to gross profit, our margins increased by 80 basis points in the quarter to 28.5% while our gross profit increased by $407 million or 9%.

As in fourth quarter 2010, our front-end margins improved significantly year-over-year as a result of improved merchandising, including promotions and pricing, sell-through and other efficiencies.

And recall in the year ago quarter we had markdowns associated with our CCR inventory reductions.

Last year we had $28 million of inventory impact versus only $1 million this year.

On the Pharmacy side, margins were up slightly benefiting from generics but partially offset by reimbursement pressure.

We also began cycling the impact of AWP which went into effect in September of 2009.

To help you better understand the quarterly progression of our gross margin let's look more closely at how margins have progressed over the past six quarters.

This chart illustrates the directional impact of the front end and the Pharmacy and provides the combined impact year-over-year.

In this quarter, as in last quarter, we were comping lower front-end margins.

Each of the last four quarters has seen improvement in the front end making increasing gross margin gains more challenging to achievement.

In Pharmacy we were comping a positive margin driven a year ago by generics.

Finally a couple other considerations as you model our margins and gross profit dollar growth for future quarters.

First, we will continue to see some volatility resulting from timing of generic introductions.

As we said before we expect a lift from new generics in 2011 to be less than the lift we received in 2010.

In addition, January is typically the month when the benefit plans reset and we see some changes.

As a result, we expect to see some incremental reimbursement pressure.

I'd like to now turn to our SG&A trends.

As Greg highlighted, SG&A dollars increased by $263 million, or 7% on a GAAP basis, versus 7.4% a year ago and a two year stacked SG&A of 14.4%.

Now this compares favorably to our previous first quarter two year stacks highlighted in the graph, stepping down steadily from 28% in 2008.

This graph adjusts SG&A further for Duane Reade and Rewire.

Our two year stacked SG&A growth fully adjusted is 10.3% and even more favorable comparison to our prior years adjusted two year stack growth which showed a steady decrease from 28% in 2008.

Looking at the first quarter more closely, you can see that we reported SG&A growth of 7%.

Duane Reade was our major swing factor in the quarter impacting SG&A by 20 basis points, or $8 million from acquisition expenses, and by 410 basis points from operating expenses, leaving us with core SG&A growth in the quarter of 2.9%.

Our net cost for Rewire had a 20 basis point positive impact on a reported quarter as they were lower than a year ago.

With respect to Duane Reade, let me remind you that we continue to expect approximately $0.02 of net profit dilution in this fiscal year.

Taking a look at SG&A growth by quarter for fiscal 2010 you can see that last year our second quarter SG&A growth was 5.1%, due to a slowdown in our CCR rollout and solid cost management in light of an earlier flu season last year.

This will be particularly difficult quarter from an SG&A compare standpoint.

In the third and fourth quarters, SG&A growth stepped up as a result of our Duane Reade acquisition and these fluctuations demonstrate that unique drivers impact both our gross profit and our SG&A dollar growth.

While we may continue to experience volatility on a quarterly basis, I want to remind everyone of our longer term SG&A goals and how this quarter fits into that framework.

As we stated at Analyst Day, we have an SG&A dollar growth goal of 6.5% to 7.5% for fiscal 2011 with the following building blocks.

Our goal for SG&A growth attributable to new store openings is 2.5% to 3% for the year and this quarter it was up 3% as a result of the impact from lower new store openings.

In the quarter we opened about 60 fewer stores than last year, and while next quarter we expect to equal last years' pace for store openings.

Our goal for SG&A attributable to our business mix inflation is about 2% to 2.5% for the year.

But in the first quarter it was actually down 0.1%.

This is a tribute to the fantastic store level expense control in the quarter in spite of continued wage inflation and business investment SG&A pressure.

Finally, we anticipate an SG&A impact from Duane Reade acquisition and our restructuring initiatives to be about 2% for the year.

Remember we will cycle out of this in April, so almost half of the year will not be impacted by Duane Reade.

However, this entire quarter did include the Duane Reade impact.

In Summary we believe 6.5% to 7.5% is the appropriate fiscal 2011 goal given what we know today.

We hope all this gives you a better understanding of the volatility we're experiencing quarter-to-quarter and the building blocks of our SG&A and the progress that we've made over the past couple of years.

And finally I want to tie all this back to our financial goals, particularly how we will work to return to consistent double-digit earnings per share growth.

As we have said, that with respective inputs to our model, SG&A is where we believe we have the greatest control.

Our long term goal is 3.5% to 4.5% growth.

To meet our long-term goal of double-digit EPS growth, we need to grow gross profit dollars by about 100 basis points more than our SG&A dollars.

And as we meet our financial goals, we will continue to include our shareholders in that success.

As you know we completed our $2 billion share repurchase authorization this quarter and we've announced and executed against our new $1 billion authorization.

Now I'd like to give you some more detail on some of the initiatives that help lead to our results this quarter.

As you know, our Rewire assumptions are incorporated into the SG&A goals, but we will continue to provide quarterly detail to the completion of the program.

We are on track for $1 billion in savings by the end of this fiscal year and this quarter we recorded an incremental savings of $0.09 versus the year ago period related to our Rewire initiatives.

Restructuring charges in the quarter were $8 million and we anticipate approximately $40 million in related expenses in the remaining months of fiscal 2011.

Since inception, we have incurred $366 million on our Rewire program.

Our total annual benefit run rate is now at $0.55 per share versus our 2008 base.

Turning to our income statement, we increased our LIFO provision in the quarter to 2% up from 1.8% year ago giving us a LIFO charge of $42 million versus $34 million a year ago.

Our net interest expense of $20 million is on trend with a year ago as is our tax rate of 37%.

As a result of our share repurchases, our average shares outstanding including dilution were 934 million, down 5.9% from last years 993 million share count.

Cash and short-term investments were $2.1 billion, down from last years' $3.2 billion.

While our cash and short-term investments are down, we have been very active over the past 12 months.

We invested $1 billion in capital expenditures, $1.1 billion in Duane Reade including the assumption of debt and $252 million in file buys and other acquisitions, and we also returned $2.6 billion to shareholders.

This was all funded by very strong cash flow generation.

Accounts receivable, inventories and payables are the working capital components that we can most directly impact.

Accounts receivable were $2.5 billion, or down 4.1% versus the prior year due to changes in Medicare Part D payment terms and offset partially by Duane Reade.

LIFO inventories of $7.9 billion were up 5.8% year-over-year which includes $300 million in Duane Reade inventories.

Accounts Payable were just short of $5 billion, down 1.7% versus last year.

Looking more closely at our inventory trends, total FIFO inventories increased by 6.6% against the total drug store count increase of 7.1% including Duane Reade.

On a per store inventory basis, inventories decreased by 0.4% following a decrease of 13.7% year ago.

The cash flow from operations for the first quarter was $1.2 billion and on trend with last years' $1.2 billion.

Free cash flow of $892 million was slightly higher than last years' $864 million.

And we expect capital expenditures for the year to be about $1.4 billion.

For my final set of metrics I will update our front end and Pharmacy productivity performance.

This chart gives front-end sales per store by class of year and it shows that sales increased from year one to year five by 44% to 51% which I've highlighted here for you.

Despite a tough economy and our focus on rebalancing margin and sales, our performance stands up to last year which we feel very good about.

In addition, our sales by class year remain very close to our averages.

Looking at first year sales for the last nine class years, you can see that front-end sales have averaged about $2 million per store each class year.

We recognize that recent first year sales are slightly lower than average but especially in light of current economic conditions and with our CCR goal to increase front-end sales productivity, balance of margins we are pleased that these first year numbers are remaining steady over time.

On the Pharmacy side of our business, scripts more than doubled from year one to year five.

And our 2005 stores, the most recent class of stores with five years in operation are performing quite well.

They are posting the highest growth in scripts per day as well as the most scripts per day per store.

And first year script counts continue to average between 110 and 120 scripts per day.

So as you can see the numbers show our pharmacies are continuing to turn into a consistent performance despite one of the most challenging economies we faced in years and factors such as a number of new 24-hour stores and the slower introduction of blockbuster drugs.

Now I want to close today emphasizing that we are very pleased with our performance this quarter.

We posted strong earnings with an emphasis on cost control.

Gross profit dollar growth and SG&A growth are trending in the right direction, although we remain focused on the continuing volatility in our quarter-to-quarter performance.

But nonetheless, we feel we are on the right track to meet our goals.

Our strategies are yielding the results that we expect and we are creating value for all of our stakeholders.

I want to thank you for your support and with that I'm going to turn the call back over to Rick for Q&A.

Thank you, Wade.

Ladies and gentlemen, that concludes our prepared remarks.

We're now ready to take questions.

Thank you, sir.

(Operator Instructions).

And our first question will come from Andrew Wolf with BB&T Capital Markets.

Good morning, and congratulations on the fruition of a lot of what you've been working on.

Thanks, Andrew.

I wanted to ask you, I think at the Analyst Day you laid out about, it was around $500 million over last fiscal year of expenses from AWP and generics and reimbursement pressures, and I think everybody understands this year that's, as you said, it's less controllable for you all, given it's partly political and other pressures.

But could you help us, give us qualitatively your sense of, to what degree it will be less this year?

I assume you think it will be less.

And then maybe even quantitatively if you have some kind of range budget, how much less those expenses might be this year?

Yes, Andy, I'm not going to give a specific number.

I think we said last year that last year we-- in terms of about $0.5 billion in step up and reimbursement pressure again combination of things like AWP, less generics, et cetera.

But there's certainly reimbursement pressure that exists, we'll have some this year.

I think that said, that we don't anticipate it's going to be as tough as last year, so with that, I'll leave it there.

Andy, I think what we had said several times is that 2010, all that coming together last year was against a pretty good year on 2009, so we don't expect the hurdle to be as much.

The other thing we do know is that 2011 will have less new generic introductions than 2010, but we're hoping that all of that that came together in 2010 was a pretty huge impact to have to go against over 2009.

There are unknowns, too.

The impact of that remains to be seen, so I think even, there are things that we just don't know as well.

Okay, I appreciate that, but I think most people are looking at this, and saying, generics, I think you've been talking about it a lot less pressure, reimbursements, at least on the private side less pressure.

Is it fair to say the government and the State Medicaid as they look at AMP, that's where the most variability might come in?

Yes, I think, Andy, I think we're going to continue to see pressure across all buckets, commercial, government and State, and I think we continue to do what we've done over the years.

Certainly we're going to negotiate for fair and predictable rates as we have in the past.

We have to begin to provide, and continue to provide value-added services that help reduce the entire medical cost, not just pharmacy such as immunization and so forth.

And certainly keep it focused on our cost.

With that said, I think the plans typically reset in January, and so I think we have to keep that in mind for Q2.

I think the states, we will see as they try to manage their budgets, they're going to continue to look for ways to reduce costs.

And that's the reason we have to get to them with solutions that is beyond just pharmacy reimbursement, but helping them on their medical costs, with our Take Care Clinics and everything else that we think we can do to help them, in addition to increasing generic utilization [inherent].

So, we're going to continue to see pressure, but I think we understand that, and we have to continue to work to provide value.

Okay.

I wanted to ask on the basket size being up in dollars, if you can give us a flavor for whether any of that was item count, or was that all on the price side?

And Greg, if it was price driven, was it are you actually getting some price increasing in the drugstore categories, or is it more efficient promoting?

Yes, I would say, Andy, it's a little bit of both as far as item and price, but I think (inaudible) again as I've said, and this past quarter I feel good with how they've managed their pricing promotion.

I think they've really gotten laser focused on finding the right items to drive value in both front end -- both the every day items that we have, as well as in the ads, and making sure that we're buying better.

I think better sourcing, which has created less markdowns over the past quarter and quarter before, so I think it's kind of all of the above.

I think they've really done a nice job figuring out how to drive and shout value for the consumer with key items.

Okay, and what percent of the skews, this being the last question, the skews that you took out of the store, what percent or maybe in hundreds have you kind of put back in, where you kind of over did it on some of the rationalization?

It's really just in the low hundreds, a couple hundred skews.

Given the magnitude of the circa 5,000 skew reduction, I'd say that they were pretty close to the mark.

We had some opportunities, but again we've added back just a couple hundred skews.

Got it.

All right, well, thanks a lot.

Thanks, Andy.

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

Hi, guys.

Thanks for taking my question.

So, I think you were hinting that we should not extrapolate the first quarter results, since the second quarter it seems like there's some tougher compares.

So my question is that if holiday sales are strong, and then we get into January and February, and flu, cough and cold are up year-over-year, and they were basically non-existent last year, can you see nice earnings growth through the second quarter?

I guess I also want to understand your front-end gross margin improvement in the context of some of the promotions you're running right now to first, what level of vendor support are you receiving from programs like Jingle Cash or is it all self-funded?

And how should we think of your level of promotion activity during the holiday season year-over-year?

And then finally, how with the promotional program, we'll have spent $25 get a $5 coupon, does that work mathematically, so gross margins are not pressured?

I know there's a lot in there, but -- .

That's a lot, so I'll start and maybe then Greg can take it, and if we miss something you'll have to come back and help us circle the wagons here, but -- .

Sure, sorry, it's a lot.

I think this is definitely a very, very good quarter, so we feel good about that moving ahead.

I mean we're focused really on getting back to those long-term goals, so I think the message here is that quarter-to-quarter in any given quarter there can be some volatility up or down, and we really want to keep people focused on kind of the more longer term picture of creating value.

There are some unknowns still in the quarter.

We'll see how the holiday season finishes out, we'll see whether we get cough/cold, all those things will help.

So, I think all we're really saying is, first and foremost is, there will be some quarterly volatility but we remain committed over the long haul to deliver these goals, and we feel that we're off to a very good start for the fiscal.

Yes, Scott, hopefully I'm not repeating what Wade said, I'm trying to get to your questions.

I do think that as you said, Q2 is highly dependent on Christmas sales, holiday sales and certainly cough, cold, flu, we don't know how that will turn out, it's hard to predict.

But we're certainly going to drive as much as we possibly can.

To your point, we are against some tough compares in both SG&A from last year.

We did a nice job last year with a weak-- because of a weak flu season, weak holiday sales with cost containment and managing SG&A, and with gross margin as well.

If you recall because of the less markdowns last year, we had a pretty good margin increase in December, which offset the tough comps.

So we do have some tough compares, but at the same time, we're going to continue to drive price and promotion.

We think we'll -- a lot of our initiatives that are clicking in will help.

Keep in mind, and I think we did say at the same time, we do have the January time period when third party plans typically reset, and we may see some incremental reimbursement pressure there.

But you put all that in together, and we're going to continue to focus on driving GP above SG&A as we stated our goal to be at the Annual Meeting, or at the Analyst Day.

So that's really great color, so it sounds to me, it's safe to say that how goes sales is kind of how goes second quarter because of some of the tough compares in the -- is that fair to say?

Well, I would say obviously top line is everything, but I think it's all three.

I think we have to drive comps as we said, but it will be how we manage the gross profit and the margin, SG&A, and how we manage that against those tough compares from last year.

And then getting into the Jingle Cash promotion, and I know I threw a lot into my first question, but how do I look at that from a mathematically, I mean $25 spend, I get a $5 coupon to use in a week.

Is there a level of lift that we should be looking for when you report your December sales in January where we know the program has been successful?

Scott, obviously we're still analyzing the performance of it as we speak.

It ends, I think it's actually tomorrow, so yes, I think it's been a good promotion.

I'll tell you from awareness standpoint, such as, you're aware of it yourself, I think it's been a great promotion from us.

We're analyzing the numbers now, we'll know more as we complete the program.

But I think it was a good opportunity for us to get out there on national TV and advertising, I think we've driven awareness, and I think we've driven people in our stores because of it.

Okay, and then the final question, and I'll yield the floor, is when we look at Duane Reade, and we've been very impressed and we ran a whole note about that, and we look at Walgreens and some of the stores in your urban areas, I mean how quickly can you get some of these stores Duane Reade-ized?

And is there-- are there 1,000 stores in the Walgreens portfolio that can bring in most of what Duane Reade is doing, and what would the cost be, and how quickly could that be done?

I guess I would say is, we're not going to just do a cut and paste of what we've done in Duane Reade.

What Duane Reade has done is right for Duane Reade, and there's elements of that that are right at different stores and different permutations.

So, we're already taking many of the learnings across, whether it's private label or beauty or fresh, et cetera, but again, there's not going to be just one cut and paste that goes back across the whole franchise.

Scott, and I will weigh in here, I think the way to look at Duane Reade is in addition to what it gave us in New York with a leading position at (inaudible), many of their initiatives that you're talking about really support the initiatives we have in place, private brand.

We are expanding and enhancing private brand.

They have some great expertise there, so we're going to bring that together and be able to accelerate that.

Their upscale beauty, fresh food.

The good thing is they really complement and enhance many of our initiatives, which will help us accelerate.

So it really won't be just a plug and play, 1,000 stores here, 1,0000 stores there.

It really depends on what makes sense across the entire footprint for us to put in place.

There may be some stores where we can expand grocery, there may be some stores where an upscale beauty offering makes sense, and there may be others where it doesn't.

So it'd be -- and it's pretty much just helping us accelerate the initiatives, and that's the reason we think we have such tremendous opportunity in front of every store, CCR is the beginning and these initiatives now will help us really drive the front end.

Thanks for taking the time to answer my questions, really appreciate it.

Yes, thanks, Scott.

And our next question will come from Robert Willoughby with Banc of America Merrill Lynch.

Hi, Wade, I was a bit surprised that cash flow wouldn't be up more year-over-year.

Are you -- on the stronger earnings, are you scraping the bottom of the pickle barrel on the working capital improvement?

And then just secondarily, do you have a share-based goal for fiscal 2011 that you mentioned?

Well, there's still probably some more pickles in there.

I think, recall a year ago we had I think same-store inventory down around 14% or something, so that's part of what just cycling that kind of number.

And in these numbers, of course, now we have, if you extracted Duane Reade and the impact they have of receivable/payable and inventory, actually the numbers would look a little bit more impressive.

So, I think we certainly have opportunities in working capital, in particular inventory, and we're focused against that and we'll continue to drive that.

With respect to the share goal, I really can't speculate.

As you know, we have the $1 billion program out there.

We've announced that we'd like to complete that within two years, how fast again we'll go, as that remains to be seen.

Okay.

And lastly, if you look at the Lipitor opportunity, can you remind us, are you expecting a better gross profit dollar per script on that product, or will there be pressure on that gross margin dollar?

Well yes, I think, Robert, any time with a generic you will see an increased gross profit per dollar, so how much it will be is yet to be determined, but certainly over the branded product we'll see an increased gross profit.

That's great.

Thank you.

Yes, thank you.

Our next question comes from Mark Miller with William Blair.

Hi, good morning.

My question is on the CCR store remodels.

You're not providing the breakout by category, and you didn't comment on the lift, and probably because a lot of the initiatives here apply across the whole chain, but would you be willing to bridge some of the prior comments on the comp lift you're seeing versus control stores?

Are you seeing a different rate of gross margin improvement in those remodeled stores?

If you can comment on the cost of running those stores with fewer skews, and any further customer research you've done on those?

Yes, Mark, Greg.

I do think your first point is right on, we've actually had 2,200 or so stores that are actually converted.

But a lot of what we're doing in CCR now is embedded throughout the entire chain, and I think that is what's helping us with our comp and our margins and so forth.

With that said, we're seeing good customer satisfaction scores, we're continuing to see efficiencies in the stores themselves with more holding power of the best selling items, less stock room inventories, so therefore that's helping us with store labor.

It is our four way win that we're looking for.

So the trends that we shared quarters before are still for the most part directionally the same, but it gets more difficult as we spread most of CCR throughout the entire chain to compare or convert the store to the rest of the chain.

Okay, and then my other question is on purchasing and sourcing, I guess we're talking a lot about the things that Walgreen is doing interfacing with the customer and the assortment, but I'd like to look at it the other side and think about initial mark up.

Can you just tell us again where we are with direct imports?

You did highlight some initial gains, but I guess my understanding is Walgreens is still very underdeveloped in terms of contracting and bringing your own product out of the Orient, so where are we in that, and just give us, if there's any long range objectives you could share, that'd be helpful?

Well, yes, Mark.

I think we are probably in the beginning stages.

We've sourced product from the Orient for years, obviously we've used a third party entity to help us with that, and so we've set up an office in Hong Kong.

We have folks over there that are beginning to become educated and more informed as far as what we can do directly ourselves.

We feel good there, but we are in the beginning stages.

I think we've also made a lot of broadly, both domestically and overseas, a lot of end roads on better private label buying, or private brand buying I should say, and I think that we'll only get better and better in that domain as well.

And just final question, if we think about the gross margin change on the front end, how much of it would you say would be reduction of markdowns, more appropriate promotion, if you will, versus improvement in the initial mark up?

Well, I think it's all the factors we laid out, right?

It's more effective pricing, more effective promotion, less markdowns.

I think all of the more effective use of funds, straight funds, I think all of those I would say are fairly balanced.

There's no one in particular that stands out.

All right, thanks a lot.

And next, we'll take a question from Matt Fassler with Goldman Sachs.

Thanks a lot.

Good morning to you.

My primary question relates to expenses.

Quick clearly some terrific progress here at the core.

You guided to 6.5% to 7.5% SG&A growth for the year.

You were at 7% this quarter, and store growth is going to come down progressively, so any reason why the SG&A growth wouldn't -- why this wouldn't be a quarter of highest SG&A growth, and why you might not see [decelerating] cost growth from here?

Well, I think part of what will help guide you is to go back and look at that year ago trends and where we cycle, and in particular, last year the second quarter was a very good quarter for SG&A, so that's one of the harder ones to cycle.

And then as you move forward, a month or two post that, we move out of Duane Reade, that helps us.

So, I would just guide you to look at the various building blocks we've given, and then also to look at the year ago period for a two year stack look at some of those.

And are there any incremental cost cutting initiatives, Wade, that you've implemented since the commencement of the fiscal year that could contribute incrementally to that expense set decline?

Well, I think what we're trying to do is rather than get into these once every periodic major cost cutting efforts, or re-engineering or whatever efforts, we're trying to really make re-engineering cost discipline a way of life, so that we don't get into that position.

And so, we'll see what additional benefit comes beyond the $1 billion, and then in future years, but I guess what I would say is we're really looking at it as how do we continually transform and reengineer to be as effective as possible in all areas.

And Matt this is Greg, I'd like to add to that.

Obviously, we're going to continue to look for opportunities, but at the same time, we need to continue to look for strategic investments to grow some of the future parts of our business.

And I've talked about before, eCommerce and our sales organization and so forth, so a lot of that will be -- obviously will help offset the cost of strategic investments, but we need to continue to invest in the future of this Company, and where we need to put resources.

And just by way of quick follow up, on the cash flow, the only line item that stood out was the payables ratio coming off a bit year-on-year, just interested in what drove that, and what kind of trend you might expect for payables to inventory going forward?

For the payables piece?

Yes.

The payables in part is again impact with the mix effect of Duane Reade year-on-year, as well as there is just some of the impact in the various plans and the particular timing of those plans.

So I think payables over the long haul is -- you average it out is pretty consistent, but quarter-to-quarter you get some of the quarter end effects, and like I said we also had Duane Reade in there, which we didn't have a year ago.

Got it.

Thank you so much.

Thanks, Matt.

Our next question comes from Tom Gallucci with Lazard.

Good morning, happy holidays to everybody.

Just on the SG&A build up that you showed, Wade, it seemed like the big delta in the quarter anyway was on the inflation business mix and investment line.

Now, I know you held your goal steady for the year overall, was that line a lot better than you were looking for in the quarter, or was there something in particular that you were expecting it to be lower this quarter?

I think it was pretty much in line with where we expected for the quarter.

And like I said, part of it is always how you look at the quarter is what you're cycling the year prior.

And again, if you look forward, again Q2 last year, we had a lot of very solid intervention, so we had a very robust quarter, and then again, in the latter quarters we had Duane Reade which made an impact.

So, I think we're all focused here very aggressively on trying to reduce cost.

Part of what, for our $1 billion program, a big part of that was transforming community pharmacy, about a quarter of that, and over the last couple quarters, the pharmacy folks have done a terrific job of stepping into the next level of savings.

So, I think you also saw that coming through in both Q4 of last fiscal, as well as Q1 of this fiscal.

So that's probably the biggest single chunk in there.

All right.

Okay, and I'm not sure if I missed it, you were expecting the incremental $385 million to get to that $1 billion on Rewire, where were you for the quarter at this point?

Well, I think the year-on-year, we had a step up of $0.09.

Right.

Net, right?

So, pretty much in terms of that complete step up.

And that delta by the way, remember we had a goal of zero net, and then $500 million net for last fiscal, and then $1 billion step up, but we're very on track to do that.

It's $0.55, is what we're right now our annual run rate versus our 2008 baseline, and our total goal for the $1 billion is about $0.64, so there's a little bit more to step up but we're most of the way home.

Okay.

And last one, I know that there's still some time left here, and it's sort of unpredictable but you had a $15 million vaccination goal on the flu side of things.

Have you changed that or updated it at this point given some of the slow start?

So, Tom, this is Kermit.

So, first of all, at the end of this week, we will have administered over six million flu shots, really more than any other retail provider in this country, and as Greg said earlier, we're still the single largest provider of flu shots other than the US Government.

So if you think about the conference call we had with HHS and CDC last week, we've administered over 6% of all flu shots that were given in this country, and that's up from our 3.5% market share a year ago, so we've had strong support from our vendors.

You saw where we wrote off the $0.02 in the vaccine inventory on the first quarter.

And we certainly can't speculate how the rest of the flu season will play out, but I will tell you we were very aggressive this year, and we will again be aggressive next year.

Our goal is to remain the leading provider of flu shots in this country, and last year we disappointed a lot of our customers by not having that inventory, and that won't happen in this flu season.

Okay, thank you.

Thank you.

Next, we'll hear from John Heinbockel with Guggenheim.

Hi, guys.

Two things I wanted to drill down on.

So number one, how do you feel about the balance between front-end margin improvement and front-end comp?

And what opportunity is there to make some investments, again, you want to be careful about demand elasticity, but make some investments to see if you can move the front-end comp dial a bit?

And if you did that, would it be more, do you think it would be more productive to do something promotionally or to tinker with shelf pricing?

John, Greg.

Obviously, that's the art of retailing right, you're asking.

I think we're managing that very well, and there's opportunity to continue to invest to drive comp for sure, and we'll continue to look for those opportunities.

But I think right now, I think it's -- I think we're striking the right balance.

I think we're swinging doors, we were down a little bit in customer count in the quarter, but that was against a very strong flu season as you know last year.

So, I think that we're using our money and our spend properly, and we'll continue to look for ways if there's opportunity to invest to continue to drive comp we will, but I feel good with the balance we've achieved.

Yes, I would completely echo that.

I think any time you go after smart sales, you might see a little bit of toughness in the comp, but it shows up in the earnings.

But I think on top of that, our folks are doing a terrific job of making our store experience better, and also making sure that the items are more relevant, that we have more solutions, and I think over time you're going to see that that's going to be kind of the next meaningful bump versus just promoting.

Because if you look at -- you talk about value longer term in a tougher economy, where do you think your value perception stands today at the front end?

And do you think longer term, the price gap versus discount or discount type retailers versus drug guys, do you think that price gap on HBA, OTC needs to come down, or it's okay where it is because of the superior convenience?

I think that the delta that we -- I talk about a lot, John, I think we monitor that to make sure that we're right.

We're not over -- the delta doesn't become too large to where we lose the convenience factor, but yes, I think we're right.

I think that our convenience will indeed afford a delta between us and a mass retailer.

Now, believe me, we have to watch that, and there are items that we bring down, and then others that we try to compensate for that.

But I think we still have -- our convenience still affords us a delta, but I think then beyond that it's what Wade is talking about, there's other ways to shout value.

As we come in with beer and wine, and a better experience, and fresh food and serving the food desert locations within the south side of Chicago.

That gives you -- that affords you elasticity, John.

So, I think we're managing our delta well, and I think the convenience will afford us that in the long term.

And just to reiterate what Greg said, people aren't looking for price, they're looking for value, and I think it's -- value can be served through an enhanced private brand program, our pharmacy services, the things we're doing in expanding the role of the pharmacist, all of these things versus other alternatives, we think we can provide meaningful value.

All right, and then finally, how much visibility do you have on the January 1 contract changes, term changes?

And do you think, I know relations with the PBMs have been getting better given what [health's] been up to, but they are going to be under a little bit of pressure too this next nine months because of what's happening with generics.

Do you think that leads to more pressure in 2011 than that comes off in 2012, and do you have visibility on that now, or do you think the pressure won't be any worse than it's been historically?

So John, I think there's constant pressure on reimbursement as plans look for ways to lower their overall costs.

And typically plans do reset the rates in January, and some of the benefit design changes which we do expect.

But when we think about how we are working with our partners and/or payor, there's more about bringing value.

When you look at some of the programs that we've put in place around adherence, that drive more adherence, programs like WOW where we're actually doing screenings for patients with diabetics, driving more adherence on their medications, all of these things are leading to a decrease in the number of blindness, amputations, kidney failure, so we're helping them to lower the overall medical costs, and really bring more value than just looking at a reimbursement rate on 30-day scripts.

Okay, thanks.

Thanks, John.

And our last question will come from David Magee with SunTrust Robinson Humphrey.

Yes, hi, good morning, guys, a good quarter.

Hi, David, thanks.

Really just have a two part generic question.

Generics were positive here in terms of year-to-year impact in the last couple quarters I believe, I'm just curious what you think about this current quarter, or do we now turn into more of a negative year-to-year impact for the next couple quarters.

And then later next year, anything different with regard to what you see with the generic wave in terms of timing of the different drugs, so for the next year or so, and how they come to market and what the reimbursements might be?

Well, David, just real quick.

Although the impact of this quarter was positive, I mean we expect that the gross profit impact of new generics to be slightly a step down this year versus last year.

And the way you look at generics, we mentioned it in our Analyst Day, is that some of the big generics that are coming, the Lipitors and things, are really going to impact us FY 2012.

So I don't think much has changed since our last quarter on the impact of new generics and how we look at it.

And with respect to quarterly outlook, Q2 and Q3 last year were not particularly good generic quarters, right?

So in terms of, there is a little bit of step down year-on-year, but for the next couple quarters, we're circling what was a pretty dry base as well.

I see.

But then later next year, late 2011 and 2012, anything different that you've seen that would -- ?

Pretty much what we showed at the Analyst Day remains our current best thinking.

Okay, great.

Thank you.

Thanks, David.

Well, folks, that was our final question.

Thank you for joining us today.

We'll announce December monthly sales on January 5.

Our next investor relations event will be our annual shareholders meeting on January 12.

Our next quarterly financial announcement will be March 22, we will announce fiscal 2011 second quarter results.

Until then, thank you for listening.

Happy holidays to everyone, and we look forward to talking to you soon.

Thank you, sir.

That does conclude today's teleconference.

We do thank you all for your participation.