Q4 2011 Earnings Call Transcript
Transcript Call Date 09/27/2011

Operator: Good day, everyone, and welcome to the Walgreen Company Fourth Quarter 2011 Earnings Conference Call. As a reminder, today's call is being recorded. Now at this time, I'd like to turn the conference over to Mr. Rick Hans, Divisional VP of IR. Please go ahead, sir.

Rick J. Hans - Divisional VP of IR and Finance: Thank you, Cathy. Good morning, everyone. Welcome to our fourth quarter conference call. Today, Greg Wasson, our President and CEO; and Wade Miquelon, Executive Vice President and Chief Financial Officer will discuss the quarter and fiscal year. Also joining us on the call and available for questions is Kermit Crawford, our President of Pharmacy, Health and Wellness Services and Solutions; and Mark Wagner, President of Community Management. When we get to your questions, please limit yourself to one question.

As a reminder, today's presentation includes certain non-GAAP financial measures, and I would direct you to our website at investor.walgreens.com for a reconciliation. Also, I'm available throughout the day by phone to answer any additional questions you may have. You can find a link to our webcast under our Investor Relations website. After the call, this presentation and a podcast will be archived on our website for 12 months.

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. 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 the assumptions or otherwise. Please see our latest Form 10-K and 10-Q filings for a discussion of risk factors as they relate to forward-looking statements.

Now, I'll turn the call over to Greg.

Gregory D. Wasson - President and CEO: Thank you, Rick. Good morning, everyone, and thank you for joining us on our call. Today I'll begin with a review of our quarter and fiscal year; second, I'll provide an update on our status with Express Scripts; and finally I'll discuss our strategies to become America's first choice for health and daily living; and then I'll turn it over to Wade who will give you more details on our quarterly and full-year performance, offer context around Express Scripts, and frame the key considerations for fiscal year 2012.

Starting with our results today, we had a solid quarter and a strong year as we made substantial progress on our transformation strategy. As you saw on our release this morning, we reported record fourth quarter sales of $18 billion, up 6.5%, from $16.9 billion a year ago. Excluding the after-tax gain from the sale of WHI, our pharmacy benefit manager, which closed in June, fourth quarter EBIT increased to $832 million, fourth quarter net earnings were $519 million, and fourth-quarter earnings per diluted share increased to $0.57. Our earnings this quarter marked the fifth consecutive quarter of double-digit growth in earnings per share.

On a GAAP business, which included $434 million pre-tax, $273 million after-tax gain, or $0.30 per diluted share from the sale of WHI, fourth quarter EBIT was $1.3 billion, fourth-quarter net earnings were $792 million, and fourth quarter earnings per diluted share were $0.87.

In addition to the gain from the sale of WHI, both our reported and our adjusted earnings per diluted share include $0.02 of dilution from our acquisition of drugstore.com and $0.01 of restructuring and restructuring-related costs associated with our Rewiring for Growth initiative. Last year's fourth quarter results included the negative impact of $0.04 per diluted share related to the acquisition of Duane Reade and $0.01 per diluted share in Rewiring for Growth cost. As we previously stated in fiscal 2012 we expect $0.03 to $0.04 of dilution related to drugstore.com.

Now turning to our performance for the fiscal year, we posted record sales of $72.2 billion, up 7.1% from $67.4 billion last year. Excluding the after-tax gain from the sale of WHI, our adjusted fiscal 2011 EBIT was $3.9 billion, up 13.7% and our adjusted fiscal 2011 earnings per diluted share were $2.64 or 24.5% increase. On a GAAP basis including the after-tax gains from the sale of WHI, fiscal 2011 EBIT was $4.4 billion, up 26.2%. Net earnings for the year were $2.7 billion, up 29.8% and fiscal year 2011 earnings per diluted share were $2.94 up 38.7%.

Finally, operating cash flow for fiscal 2011 was $3.6 billion versus $3.7 billion in fiscal 2010. In the fourth quarter, we grew gross profit dollars at 5.8% or $277 million versus SG&A dollars at 4.8% or $191 million, yielded $86 million difference. For the full year, the spread between gross profit dollar growth and SG&A dollar growth was $473 million, the spread reflects the success of our strategies to drive top-line growth in our front-end and our pharmacy, health and wellness services, while carefully managing our costs.

Overall our strong performance and solid results this year demonstrated that we are on the right track in our transformation as we continue to leverage the best store network in America and expand our pharmacy, health and wellness solutions, most of all our results this year demonstrated the value that Walgreens provides everyday in communities across our nation.

Let me touch on some of the key milestones we achieved in fiscal 2011. On the pharmacy and health care side, Walgreen's now fills one out of every five retail prescriptions in America, with a record 819 prescriptions filled, an increase of 5.3% for fiscal 2011. We also administered 6.4 million flu shots during the last flu season, as we continue to be the largest provider of flu shots in the country outside of the government.

To expand the role we play in health care, we established important partnerships with top health systems including Johns Hopkins Medicine, Ochsner Health System and Louisiana State University to name a few in order to enhance coordinated care to patients.

Turning to the daily living side, we refreshed and revitalized our front-end, completing our plan launched in 2009 to convert or open 5,500 stores through our Customer Centric Retailing format, which offers more target assortment and better sidelines and new decor packages. Our CCR stores are reporting higher customer satisfaction and improved sales.

We've also expanded our product offerings across all of our stores completing our rollout of beer and wine, adding fresh foods, launching a new format with expanded grocery in our food oasis stores and building our private brand business, including the August launch of Nice.

In addition, we opened or acquired 199 net new drug stores this past year, including the 20,000 square foot flagship Duane Reade store at 40 Wall Street, with the pharmacy powered by Walgreens. We expanded our multi-channel capabilities with the acquisition of drugstore.com, which enables us to reach an additional 3 million online customers, forge relationships with new vendors and partners and add approximately 60,000 health, personal care, and beauty products through online offering.

In terms of our financial highlights and in addition to record sales and earnings per diluted share, we completed our three-year Rewiring for Growth, our cost saving initiatives, and exceeded our $1 billion goal. Finally, we announced the largest dividend increase in the history of the Company in July and including share repurchases this year, we returned a record $2.4 billion to shareholders.

Looking ahead, let me touch on our status with Express Scripts and the opportunities we see. As you know, our contract renewal negotiations have been unsuccessful and we are planning not to be part of the Express Scripts network as of the first of the year. At the time we made our announcement on the last earnings call, we emphasized that the terms Express Scripts offered us including rates that were below the industry average cost to provide the prescription were not in the best interest of our Company, our customers, our employees, or our shareholders, and we still firmly believe that.

We also said, we intend to work closely with our partners who are focused on lowering overall health care costs and recognize the critical value that community pharmacy can provide. Since then, many of these partners have indeed made clear that they value the choice, cost effectiveness, convenience and service of Walgreen's and want to move forward with us. Also, patients and employees have made it clear. They want to continue having the choice of Walgreens, maintaining their personal relationship with the pharmacies they've come to trust. This interest of our partners to maintain access to Walgreens community pharmacies has created additional opportunities for us.

Finally, during the upcoming open enrollment period, Medicare beneficiaries will be able to choose a plan that best meets their healthcare needs. Many Medicare plans include Walgreens in their pharmacy provider networks and we expect the beneficiaries will take that into account as they make these important plan decision.

The interest in continuing the relationship with Walgreens demonstrates what our data has shown that employers and plans are not interested in restricted networks for little or no savings and that without Walgreens and the network their cost could actually go up, while at the same time creating unnecessary patient disruption. We know that Walgreens can play a vital role in advancing cost-effective pharmacy health and wellness solutions.

To make that clear, we recently released a white paper demonstrating the real value of Walgreens, the pharmacy benefit networks. In addition to our competitive base pricing, we reduced overall cost per payors in many ways, including our generic convergence and utilization and our 90 day at retail program. With 74% generic penetration in Express Scripts' own network which is 140 basis points better than the average of their network, that does not include Walgreens, we produce a savings of around $2 per script. That comes about $180 million in total savings each year to Express Scripts and its clients

Through our leading 90-day at retail program, Walgreens promotes 90-day prescription for patients on chronic medications, offering 6% to 8% savings compared with 30-day scripts, allowing patient to receive extended supplies of chronic medications, through a 90-day at retail benefit in addition to a 90-day mail benefit has been demonstrated to substantially lower costs, increased compliance and improve the overall health of patients.

In addition, we help to reduce overall costs with our broad array of health services. Clean immunizations, adherence programs, and help screening and testing services. When you combine all these efforts to save overall costs, price, generic efficiency in 90-day scripts it is clear why excluding Walgreens is not in the best interest of patients and payers and why many of our partners want to stay with us. If you haven't already, I invite you to take a look at our – the value Walgreens white paper on our website.

Now, let me turn to the five key strategies that we are focused on to create even greater value for our customers and patients in the fiscal year and beyond. As we enter fiscal 2012 we continue to refine and strengthen our strategies to become the first choice for health and daily living for customers and patients across the country.

First, as we complete the refresh of our stores we are also moving forward to completely redefine the drugstore experience set as a partner industry and establish Walgreens as a destination for consumers to meet a broad range of health and daily living needs. We are bringing together all the transformation strategies we've developed over the past three years to pilot an exciting new concept store for Walgreens.

These new pilot formats give us the opportunity to create the physical expression of all the work we've talked about with you over the last several years, a redesigned pharmacy, a new front end with fresh food, expanded beauty and all of our learning from CCR in one place. Through this year we have converted or opened 20 of these new concept stores in the Chicago area and we have been expanding the pilot to Indianapolis, and in New York at our 40 Wall Street store we brought together the best of Duane Reade and Walgreens to create a truly unique shopping environment.

We've also added food oasis stores to provide fresh food and underserved food dessert communities and plan to open or convert at least 1,000 more over the next five years. With the large existing presence in underserved markets, more than any other retailer today, we are uniquely positioned to address this opportunity.

We continue to focus on advancing community pharmacy to play a greater role on healthcare through integration and expanded services. As you know we've been very successful with our flu shot program a great example of customers coming to the community pharmacists for broader healthcare services.

As a result, we have added more healthcare solutions such as additional immunizations and vaccinations, both test in screenings and clinical services. We also plan a more significant role in improving health outcomes for patients by helping to improve adherence, medication management and the use of advanced specialty infused – and infused medications through counseling, support and education.

With our partnerships with Health Systems, we're taking the next steps in our communities to coordinate and integrate with national, regional and local health systems and advance the care our patients receive with some of the best physicians and clinicians in healthcare.

For more about this we just issued a second white paper that outlines our expanding scope of traditional pharmacy services, our leadership in home infusion and specialty pharmacy, our partnerships with major hospital systems managing their outpatient pharmacies and the expanding health and wellness service we provide through our Take Care clinics.

Next, as we transform the traditional drugstore in advanced community pharmacy, our third key strategy is to deliver an outstanding customer experience through enhanced employee engagement. Studies have shown that there is a direct link between how engaged employees feel at work, the quality of service they provide to their customers and the value delivered to shareholders. To continue to make that equation work we are strengthening employee engagement by setting new standards, providing additional training and developing strong leadership.

We are also focused expanding across new channels and markets to ensure our customers have access to what they want, when they want and where they want it. Fiscal 2011 was a pivotal year in expansion of our multi-channel businesses as we welcome drugstore.com into the Walgreens family of companies. Our teams are fully engaged and are on track with our integration efforts and we're looking forward to the innovation and growth that will result from their efforts into fiscal 2012.

We've also rolled out new services such as web pick up. Service is now available to all of our Chicago stores, as well as our San Jose pilot market.

Finally, reinventing our cost structure through continuous improvement in innovation rather than driving one-time programs designed to generate savings. We're building that cost discipline into our daily business operations and in corporate D&A making it a way of life at Walgreens as we look at SG&A and COGS differently.

As we close the book from 2011 we're more excited than ever about the plans and initiatives we have underway as we continue the transformation of Walgreens into 2012 provide even greater value for our customers and our patients. We've built a solid financial foundation that gives us a platform to continue to innovate and transform our business. We've accomplished a great deal this year and it's thanks to all of our people, their focused effort and tremendous hard work. We are looking forward to 2012 and to continuing to accomplish great things for Walgreens.

Finally, we want to thank Dana Green, our recently retired General Counsel, for the 37 years of service and welcome Tom Sabatino who joined us this month in that role.

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

Wade D. Miquelon - CFO: Thank you, Greg, and good morning to everyone. This morning I'll first review our quarter, then I'll update you on our plan to move forward without being an Express Scripts pharmacy network, including how we framed the potential fiscal 2012 earnings impact of that decision.

Let me begin by saying that we are pleased with our strong performance on our key financial metrics in what continues to be a challenging economic environment. Following Greg's summary of our financial results, I'll begin with detail regarding comp trends.

Fourth quarter comparable sales and prescription trends have each improved from a year ago with prescription comp sales increasing 4.4%, front-end comp sales increasing 4.6%, total comp sales increasing 4.4%, and comparable prescriptions filled increasing 3.4% for the quarter.

For the year, our comparable sales trends have improved as well with prescription sales comp up 3.3%, front-end sales comp up 3.3%, and total sales comp up 3.3%. Finally, our Rx scripts comp for the year was up 3.7% versus up 4.5% in fiscal '10, reflecting the slowdown of prescription utilization in the industry year-over-year. For fiscal 2011, we achieved 20% retail pharmacy share, up 50 basis points from fiscal 2010.

Looking at our quarterly trends over the past three years, our prescription comp, shown in the green bars, increased by 3.4% in the fourth quarter, up from last year's 3.3% despite the slowdown in the industry from 3.5% growth in the fourth quarter of 2010 to 1% in the fourth quarter of 2011. On a two-year stack basis, represented by the blue line, comparable prescription increases remain in the 6% to 8% range, and finally recall the spikes in the two-year stacks in both the first quarter of 2010 and 2011 was caused by the unusual timing and severity of the 2010 flu season.

Our quarterly front-end comp sales were up a robust 4.6% versus an increase of about 1.2% a year ago. The biggest driver continues to be CCR with over 5,500 stores either converted or opened in a new format today, which was designed to positively impact the shopper experience and increase traffic and basket. In terms of specific categories, beer and wine contributed over 50 basis points to comp this quarter after adding 76 basis points a year ago. We continue to achieve a good mix between traffic and basket with traffic up 1.6% and basket up 3%. Within that basket we are seeing some inflation and believe our convenience model affords us the ability to pass majority of it through. The two-year stack, shown by the blue line, continue to trend up reaching 5.8% in the quarter after bottoming out in the second quarter of fiscal 2010.

Compared to the industry, our sales continued to perform well. When comparing our front-end comps to the next three largest retail pharmacy competitors and adjusting our comps to their calendars, we outperformed all three by wide margin as shown in this chart. On a two-year stack basis, we outperformed all three by over 300 basis points as well. Like everyone, we continue to see a cautious consumer in a competitive retail environment. This outperformance we believe is a reflection of our differentiated strategies coupled with strong execution.

Turning to margin, our gross margin as a percent of sales was up 28.2% in the current quarter compared to 28.4% last year. The front-end margin was lower primarily as we were up against a strong prior year quarter. We believe our strategies are working to drive profitable front-end growth through the balance of mix, pricing and promotion. Over margin change in the quarter was not impacted by pharmacy which was flat year-over-year. Taking a look at our longer term gross margin trends this quarter overall margins were cycling at 70 basis point improvement, so for the two-year period we achieved a 50 basis point gain.

Looking forward keep in mind that we are cycling at 80 basis point improvement in the last year's first quarter, plus we have discussed in recent quarters additional progress becomes increasingly difficult to achieve. As we have frequently remind you, we believe that gross profit dollar growth and increases in traffic and basket rather than gross margin percent are the more than event measures of our progress and will become increasingly important to consider as we move through the upcoming generic wave.

Two-year stack SG&A trends improved versus a year ago with 15.8% growth in the fourth quarter of 2011, down from 20.6% last year. Recall of the fourth quarter in 2010, SG&A growth included 550 basis points impact from the acquisition of Duane Reade, which was a major driver of this year's lower SG&A dollar growth. After adjusting for restructuring-related costs associated with the Duane Reade acquisition in 2010 and costs associated with the drugstore.com acquisition in 2011, our two-year stacked SG&A growth showed improvement at 9.8% for the most recent period.

Finally, I'm pleased to repeat Greg's comments that we have completed our three-year Rewiring for Growth initiative successfully over delivering our $1 billion dollars in one ongoing cost savings versus our 2008 base as reflected in decline in SG&A dollar growth over the past three years.

To get to our core SG&A dollar growth you could see that our reported 4.8% SG&A growth included 70 basis points of operation costs and 30 basis points of transaction costs related to the drugstore.com acquisition. The remaining base SG&A dollar growth was a combination of store openings inflation and business mix. Respect to our CCR, our SG&A included $84 million of CCR conversion costs in fiscal 2011, up from $45 million in fiscal 2010.

This next slide shows our quarterly gross profit dollar growth trends for the past eight quarters with the blue line representing fiscal 2010, and the green line representing fiscal 2011 and the red line showing the two-year stacked trend. The primary driver of our higher gross profit dollar growth in the fourth quarter of 2010 and the first three quarters of 2011 was the acquisition of Duane Reade, when we cycle the acquisition in the fourth quarter of 2011, you can see the slower gross profit dollar growth. As you look at the upcoming first quarter you should considered the following points.

First, the timing of severity of this year's cough, cold and flu season, currently the intensive flu is running about 15% below a year ago. Second, we are cycling two years of strong gross profit dollar growth. Third, on a quarterly basis we will continue to experience volatility resulting from the timing of generic introductions which we believe will impact us more significantly as the year progresses.

Finally, regarding AMP, we're currently analyzing the draft (FULs) that CMS released last week which are subject to a common period and changes are anticipated. We're still awaiting the proposed AMP rule, which will provide direction to manufacturers for calculation on AMP. To-date, manufacturers have been providing AMP database on their interpretation of the Affordable Care Act without regulations. We'll be working with states to increase their dispensing fees to more appropriately reflect pharmacy cost to dispense a prescription, and as we previously said it's still premature to speculate on the ultimate timing and financial impact of AMP.

We had a similar conflict for SG&A dollar growth for the last eight quarters, with the blue line representing 2010, and the green line representing the fiscal 2011, and the red line showing the two-year stack trend. As you can see, SG&A dollar growth in the quarter was 4.8% versus 11% a year ago. Last year's SG&A dollar growth rate included 550 basis points from the impact of the Duane Reade acquisition. Now, as you can see from the slide, our first quarter will be our most difficult gross profit dollar comp of the year when we cycle a 9% gross profit dollar growth. Recall that our first quarter in fiscal 2011 was strong performance versus the prior year as well.

Taking you through our income statement, this quarter included our LIFO provision of $60 million versus $61 million a year ago. Our effective LIFO rate for the year was 2.4%, up from 1.7% a year ago. Restructuring costs were $20 million versus $19 million last year. Net interest expense was $15 million, down from $18 million a year ago. Our effective tax rate was 36.7% versus 35.6% last year. For the year our expected income tax rate came in at 36.8% versus 38% in fiscal 2010. Average diluted shares outstanding were 911 million versus 965 million a year ago, due primarily to our share repurchase program.

Cash and cash equivalents were $1.6 billion as of August 31st, versus $1.9 billion a year ago. Overall working capital increased by 9.3% versus a year ago, driven primarily by increased inventories and the impact of the WHI divestiture. Finally, as a percent of sales, working capital was up 2.6%.

Total FIFO inventory increased by 10% in the quarter versus 6.5% in total sales the FIFO inventory increased by 7.2% on a per store basis. The increase in per store inventory was primarily in the front-end and related to strategic decisions, including inventory we assume with the acquisition of drugstore.com and the increase in certain categories, which is pain, sleep, cough and cold, we have been running low due to supply constraints last year.

For the year, we invested $1.2 billion in capital expenditures, including approximately $300 million in our new stores and $500 million in existing stores, including remodels and store IT. In addition, we invested $100 million in our distribution centers and $300 million in corporate technology and other investments.

For the year ended August 31, 2011, we generated $3.6 billion in cash from operations compared to $3.7 billion a year ago, continuing our strong cash flow generation, driven by our strong earnings.

Cash flow from operations was down slightly from a year ago, due primarily to the impact from working capital. Free cash flow was down as a result of higher capital spending versus 2010 as well as the impact of higher working capital.

As one of our core capital allocation priorities, we continue to return surplus cash to shareholders and in the fourth quarter we returned $759 million, including $159 million in dividends and $600 million through share repurchases.

As of August 31, 2011, we repurchased $425 million against our new $2 billion authorization. As you can see in fiscal 2011, we returned a total of over $2.4 billion to our shareholders.

Now, let me share a plan to move forward without being in Express Scripts pharmacy networks. As Greg noted, we're working with a number of Express Scripts customers consistent with the contractual obligations to help them evaluate all of their options to ensure that their members and our patients have continued access to Walgreens in their pharmacy networks, but we cannot comment on any plans or contracts, specifically, we're very pleased with the response that we're receiving and we expect these plans will make announcements when they are ready.

While it's still too early to quantify how much of this business we will ultimately retain, I can share with you how we think about the various levers, including retention of total sales and cost savings opportunities and the potential resulting impact on our fiscal 2012 earnings. Because we're not going to speculate on the ultimate retention, we're going to illustrate three different retention scenarios among the many possible scenarios to illustrate how we frame the potential financial impacts.

Regarding cost savings, we believe that within the range of 25% to 75% retention the cost savings plans we have in place we can offset the anticipated gross profit impact by approximately 50%, including both COGS and SG&A interventions. Applying this framework under scenario A, which depicts 25% retention, the total revenue retained would be approximately $1.3 billion. To frame our cost savings under 25% retention scenario, consider that our COGS pool is nearly $52 billion, so improvement to supply chain of one third of 1% and generate over $170 million in savings and our SG&A pool is over $16.5 billion. For additional measures here, yield up to $250 million, equal to 1.5% of our total SG&A.

So, again, using this framework under 25% retention scenario we estimate the impacted financial earnings will be approximately negative $0.21 per diluted share. Using the same framework we estimate that the impact is 50% retention it could be approximately negative $0.14 per share and the impacted 75% retention will be approximately negative $0.07 per share.

As I said before, we are not going to speculate at this time on the amount of business we'll ultimately retain and it may be less than 25% or maybe rate than 75%. But I hope the slide helps you dimensionalize the EPS impact that we may be looking at under different scenarios. Of course, on a longer term basis, we believe additional business will move to networks that have Walgreens in the network.

Finally, recall that in light of the planned cost interventions we will implement as a result of our current situation with ESI we have temporarily suspended our goals for our key financial metrics.

The upcoming generic wave will benefit many including payers, PBMs, providers and patients. Generic wave will also help to control drug trend increases, projected to be in the low single-digits compared to overall healthcare spending projected to grow in the high single-digits. Walgreen's proposal to Express Scripts we offered to hold annual average reimbursement cost increases to within an estimated 2% annually over the next three years which compares to a 3.2% annual drug trend increase that Express Scripts reflects in their 2010 drug trend report.

In closing, notwithstanding the fragile external environment our strategies are translating into solid financial results. We continue to leverage our leadership position in the community pharmacy to play a more significant role in the healthcare system as our stores become the first choice in retail, health and daily living. We have strategies in place to create new revenue streams. We continue to reinvest in our stores, expand our offerings, and invest in new channels and keeping absolute focus on continuous improvements and innovations in our cost structure. Finally, we are committed to creating shareholder value through disciplined financial decisions and a sound capital allocation policy, and we thank you for your support as our shareholders.

Rick J. Hans - Divisional VP of IR and Finance: Thank you, Wade. That concludes our prepared remarks. We are now ready to take your questions.

Transcript Call Date 09/27/2011

Operator: Mark Miller, William Blair & Company.

Mark Miller - William Blair & Company: There was a lot discussed there. Wade, in your prepared remarks you went through quickly the Company's objectives to offset the lower gross profits proceeding without Express Scripts. Could you go over that in a little more detail and elaborate basically where you would find the additional savings on the cost of goods and also on SG&A. I guess given the Company has been running lean here the last couple years with the prior objectives?

Wade D. Miquelon - CFO: I guess the first thing I'd say is that we absolutely have plans in place to deliver against the framework that I gave you, both with respect to SG&A and COGS and as you've seen from the data we have (substantive pools) about $50 billion of COGS and over $16 billion of SG&A. With respect to any specific detail plans, that the levers we'll pull are going to be dependent upon how much business we retain or don’t. So, I don’t want to go into significant detail right now on what those are, but I guess I would just say that rest assured that the plans are in place.

Mark Miller - William Blair & Company: Can I just ask one follow-up then? I know one of the things you're working on is doing more direct imports. Is that a significant part of it or I mean can you comment at all on what the bigger buckets would be? It's not obvious what that would be?

Gregory D. Wasson - President and CEO: Yeah, there is no question that expanding our base (floor) suppliers including overseas, being more rigorous about RFP processes are all part of that. Also just we're looking at how we run the fundamental supply chain and how we can use different types of partners to help make us more effective is another piece. But again, when you look at the grand scheme of overall cost, we're talking about a very small percent to get back to what we need to offset half of those retention rates.

Operator: Andrew Wolf, BB&T Capital Markets.

Andrew Wolf - BB&T Capital Markets: The other side of the same question, which is kind of two parted. One is, is it closer to 25-75, zero or a 100 and also timeframe? There is also a theory that even as you may be persuasive in the marketplace that the clock is sort of heading towards the end of the year. Are you going to run up to – are you potentially too close to the end of the year and disruptions with plan changes, how is that potentially impacting timing of potentially going direct with folks? So, it's two parts. Anymore granularity on helping us understand the scope of your conversations, maybe you can, for example, when you gave us the Express book of business, for you it's about 71% MCOs and employer groups. I would hope, I would expect and I guess that that would be where you would expect to see the most retention. Is it sort of a pro rata situation with the customers like if you hit the 50% mark would it be a pro rata to the business or would it be more on one group of payors than the others? Again, the second part is the one I already asked.

Gregory D. Wasson - President and CEO: Andy, it's Greg. As Wade said, as I said, we're not going to speculate on retention. We do feel that we're having positive response from all of our partners. First and foremost, our intent is to work with everyone, all the partners, our patients, their beneficiaries to try to find solutions that allows them to continue to use Walgreens, and we're having positive response from many. I think regarding the timeframe, I think as we get these plans and employers begin to get closer to that time that cut off at the first of the year, I think you'll continue to see more interest and more activity. It is certainly, from our point of view, it's really up to the plans and employers to make that public themselves. We certainly respect their desire to do just that, but we believe that the relationship that we have and we're seeing with patients and employees in the market and the value they place on continuing to use their community pharmacists that they've known and trusted for years is (indiscernible) and we feel good that we're moving in the right direction.

Wade D. Miquelon - CFO: Let me just build on, there is two, this 25, 50 and 75 hypothetical scenarios, this is for a 2012 look. So, $0.07 to $0.21 was the impact dimensionalized on those three scenarios, but make no mistake about it, whatever happens January 1 in that quarter, we see as being the toughest period, because over time we plan to win back more and more of those plans in the next selling season as they come up. So, again, if you think about timeframe, this is the initial timeframe, but we see that will be the toughest period and from that point we're just going to move and build forward.

Andrew Wolf - BB&T Capital Markets: I just wanted to ask a follow-on Greg to your answer about partners announcing things up until the first or whenever they feel like it, but in the back-end don't they have to make a decision sooner than that, so that system conversions and other things can occur?

Gregory D. Wasson - President and CEO: Andy, I think it varies by client and type of clients, size of clients and so forth, but certainly many of them are going to need to be making a decision soon and again, we're just working with all to try to find, solutions that help them through this process and feel good about the response we're getting. One thing I would like to say, Andy, this is really not just about Express Scripts, it's a shifting payor landscape. Going forward, payors in general are looking now more holistically to try to figure out how they lower overall healthcare cost and coordinate care, I think the shift to the individual marketplace away from the employer group business over time plays in our favor. I think the shift that there are more payors emerging health plans, physician groups, health systems all looking for the value that we can help them with, so I think they are going to be a emerging payors that we're partnering with. So, we absolutely feel good about our strategies and where we're headed, the shifting landscape that we're working with and we're headed.

Operator: Tom Gallucci, Lazard Capital Markets.

Tom Gallucci - Lazard Capital Markets: Two things. One, you had mentioned sort of the deal that you had offered Express, can you give any color as to details of what they offered you or to give some indication of how far apart you all really are or were, and then just on the cost saving side of things to the extent you are out of network, curious about given the high fixed cost nature of the business, is Express volume fairly concentrated in some of your stores or is it sort of a little bit everywhere? I guess, I am sort of struggling to see how easy it is to get that cost savings if it's sort of spread out.

Gregory D. Wasson - President and CEO: Yeah. Tom, Greg here. I will take the first half and maybe Wade would follow up with cost. We do think, as I said, unfortunately, the offer and the proposal we received was below the industry cost to fill a prescription and we don't think values that what we truly can bring to payers and patients across the country. So, we do believe that there are hundreds of other networks out there that we work well with that are looking for a lot of the services and solutions that we will bring into the marketplace. That's who we intend to focus on; but unfortunately, as I said, the proposal laid out on the table was below the cost of provided prescription industry average.

Wade D. Miquelon - CFO: On cost, all I would say is this, while in some cases their prescriptions will be basically more concentrated to one store versus another, we are not making this just a store problem or just a pharmacy problem, or just a pharmacist problem. We are looking at this holistically across the entire company making sure that we do everything possible to deliver the right cost savings so that the move forward successfully to a new future. So it's really more about that. It's more about taking a principal stand and looking holistically across the company to make sure that we can begin to move on over the long-term towards our goals.

Tom Gallucci - Lazard Capital Markets: Generally speaking, are some of these cost saving initiatives that you could have in the works, are there things that you could do even if you don't lose the relationship with Express.

Wade D. Miquelon - CFO: Sure. I mean if there is things that are right to do we'll do it anyway, but we will continue to look and be as diligent as we have to be.

Gregory D. Wasson - President and CEO: And Tom I would add that certainly that's the reason we're kind of looking at this based on retention and as we learn more about retention we will pull the right levers that makes sense for our Company long-term and our value in community pharmacy has been the great locations, our convenient hours, effectively more 24-hour pharmacies than the rest of the industry combined. So, we will look at all of those intelligently based on retention.

Operator: Scott Mushkin, Jefferies & Co.

Scott Mushkin - Jefferies & Co.: So, I know you don’t want to tell us exactly who, but has anyone signed a separate deal with you guys yet?

Gregory D. Wasson - President and CEO: Scott as we've said, we’ve got to keep the confidentiality of our partners and respect that. So, as we said, we’re working closely with many and as they intend to or desire to release that, they will.

Scott Mushkin - Jefferies & Co.: So, I am not asking for that. I don’t want to know the name or anything, but I am just asking for this specific question, if anyone actually has signed with you yet?

Gregory D. Wasson - President and CEO: As I said, we’re not going to give information to that detail yet. As I said, we’re encouraged by the response we're receiving.

Scott Mushkin - Jefferies & Co.: Second question is, you guys seem pretty dug in here, so I guess the question comes to mind, is there anything Express can do to change your mind? Seems like you are walking away and, maybe they really can’t do anything or am I misinterpreting here?

Gregory D. Wasson - President and CEO: The principle is very simple, right. One is, we believe we deserve a fair die for what we do, but importantly we don't see any reason to give any PBM a substantially better deal than all the others without having done something to warrant it. So, it's pretty much, as simple as that. If Express wants to give us fair compensation versus the market versus what we receive with other versus the value we provide, then we’ll move forward; but if not, it's not really a productive place for us to be in our business. It’s as simple as that.

Scott Mushkin - Jefferies & Co.: Then how do we analysts, investors kind of frame Medco now, I mean can you maybe talk to that?

Gregory D. Wasson - President and CEO: Well, you know, we can't – I mean, we’re not going to comment on that proposed merger. All what we'll say is that it doesn't change things is that if it were to happen we would expect the fair compensation we get today with them and if we were to get that then we wouldn't be in that network either.

Scott Mushkin - Jefferies & Co.: Was your contract up with Medco?

Wade D. Miquelon - CFO: We don't talk about any specific contract. But the reality is we've had a good relationship with them and we believe we get fair compensation from all the others and that's why we're working with them, but if that were to change then it wouldn't work for us either, we have to make the same kind of decision.

Gregory D. Wasson - President and CEO: I'd like to add on to Wade's point just to be clear, we wouldn't accept similar to what Express Scripts offer this from any PBM regardless of what happens.

Scott Mushkin - Jefferies & Co.: Switching gears just quickly. How many remodels, major remodels you are expecting to do in FY '12?

Wade D. Miquelon - CFO: Well, we haven't set specifically major remodels. Obviously, we plan on the next few months, we are finishing out CCR. We've got lots of different various pilots underway or different stages we are seeing great results on (Script). With respect to our plans to expand that we haven't commented on that at this time.

Operator: Mark Wiltamuth, Morgan Stanley.

Mark Wiltamuth - Morgan Stanley: Just to follow-up a little bit on the Medco question. I mean, clearly Medco is a debate that investors have to have here. If the merger does go through are they about the same size as Express in terms of impact and can you continue to deliver COGS and SG&A savings to kind of offset some of that?

Gregory D. Wasson - President and CEO: As I've said, we're not going to comment on the merger, but I'll go back to exactly what I said. Rates that were proposed by Express Scripts we won't accept those from anyone. Certainly, we will begin to look at what we can do to reduce cost and COGS just as (indiscernible) Express and make the adjustments needed. The main point is, as I said earlier, we are focused on where healthcare is going, what our partners that are out there working with us or looking for us to provide, we're going to drive these key strategies to play a greater role in community pharmacy and greater healthcare going forward. We will see – we believe a shift to the individual marketplace, our strong – consumer brand and trust with patients in that market, we believe, provides value and wins. We do believe that we'll see government entities and state entities. They're looking for additional solutions to provide to their beneficiaries, especially those in underserved communities where 45% of our stores are located. So, we think there is a lot of value to work with health systems and hospital systems like Ochsner and Northwestern, the others I mentioned across the country to help coordinate care. That is where we are headed. So, regardless of what happened and what the landscape looks like, we know where we're headed, and people are looking for us to provide that type of value and that's where we are going.

Mark Wiltamuth - Morgan Stanley: In your estimates of $0.07 to $0.21 of potential impact, are you assuming any front-end impact or is that just the prescription loss and the offsetting actions you're going to take there?

Wade D. Miquelon - CFO: The front-end is in those numbers and the front-end loss is very, very small. So, we've got lots of data and that we've modeled that many, many times. So, it's in those numbers, but it's basically rounding here.

Mark Wiltamuth - Morgan Stanley: What percentage of employers you think could actually go direct with you under their current contracts?

Wade D. Miquelon - CFO: Only they know their contracts obviously, and so they have to decide what their options are. It's not just about within their current contracts people every few years get a choice to consider whether or not they want to stay with that PBM or not. So, at the end of the day, if people can have Walgreens in their network versus not and have it at a competitive price and value proposition over time, people choose that too. So, again, we're looking people to explore all their options, but every customer has different contractual obligations and we honor those, but they have to let us know what it is they want to consider within that framework.

Mark Wiltamuth - Morgan Stanley: Wade, just to get back to the generic wave on the industry themes. You indicated, you thought the second half of the wave in 2012 could be better than the first half in terms of margin impact, is that fair to say?

Wade D. Miquelon - CFO: No question, for our fiscal Q. Remember, our fiscal is starting effectively September 1, but our back half is much stronger for generics on that front-end.

Operator: John Heinbockel, Guggenheim Securities

John Heinbockel - Guggenheim: Couple of things. Wherever you are on an economic difference with Express, because obviously, you can put a number to that, whatever that is, is there room short of wiping out the difference to zero in your favor? Is there room for compromise between those two numbers or not really sort of although nothing from your perspective?

Wade D. Miquelon - CFO: John, again without going into the detail. Again, we're looking for fair reimbursement for the value we provide, and as I said the proposal we offered is well below the industry average cost of sale and we're not going to work in that type of environment. We've got too many payers and partners that want more promise and that's where we're headed.

Gregory D. Wasson - President and CEO: We’re very, very far apart, and the truth is we also have to make sure we fair to all of other partners. So, coming to some spot, that's not optimal and not fair to everyone else, doesn't really work either.

John Heinbockel - Guggenheim: There is a follow-up to that. If you've seen, I guess, you have – have you seen any change in their negotiating posture, as this whole Medco thing is played out. It's before the FTC, as I would have thought, maybe that would be an impetus to create a little bit of compromise on their part?

Gregory D. Wasson - President and CEO: We continue to work with our partners and that's where our focus is and trying to find solutions for them. Again to their comment, we're not dug in if there is a suitable arrangement, we're certainly open. At this point in time, we're miles apart, like Wade said, and we've been working and focusing on helping our partners find solutions…

John Heinbockel - Guggenheim: Getting back on the core business then. If you look at SG&A growth in comparable stores, what do you think that is longer term because you've done a very good job bringing that number down, probably below what I would think it could be longer term. What do you think it is longer term, two to three or do you think it's less than that?

Gregory D. Wasson - President and CEO: What I would say is prior to this Express Scripts is that we had given basically 3.5% to 4.5% as our ongoing kind of systemic model, and within that we plan on opening around 200ish stores, which drives a 1.5% to 2%. So you can then basically make an imprint but somewhere between 1, 1.5 and 2 is more of a normalized comp store range.

John Heinbockel - Guggenheim: Is that impacted by because you talked about wanting to raise service levels training, etcetera, can you do one to two within the context of raising service levels?

Gregory D. Wasson - President and CEO: Lot of it's really just about thinking differently and reengineering. We've put in lot of systems in our stores. Our POS system is one example. We've talked about many times that we are rolling out now. It makes it much easier for a cashier to work much more effective, it gives us much better data integration. These kinds of investments in infrastructure and in our people will then help free up time to do other things to help our customers, and so we have a lot of efforts like that underway, but I think that’s the bigger idea.

Operator: Eric Bosshard, Cleveland Research Company.

Eric Bosshard - Cleveland Research Company: Two questions. First of all, can you give us a sense and obviously we don’t need the specifics, but the $0.07 to $0.21 of dilution that you framed here, which is helpful, can you compare that to the dilution from accepting the terms of Express's offering?

Gregory D. Wasson - President and CEO: I think I've said before that from the offer they proposed, there was no scenario we could think of, none. It wasn’t financially better for us to move on without them. So you can assume that your question is answered from that.

Eric Bosshard - Cleveland Research Company: Secondly, back to the core business, the front-end margin you comment it was down in the quarter and you explained some of that was the comparison. It looked like inventories grew a little bit in the quarter. Can you just talk about what you’re seeing in terms of the front-end margin environment in this quarter and on a go-forward basis and what gives you confidence and where you think front-end margins are going?

Gregory D. Wasson - President and CEO: Yeah, as we've said and others have I think we're still seeing a consumer are wary, consumer confidence as we know is down. The good thing is we feel we're well positioned with our convenience and all that we've done over the past year to really provide solutions to that new consumer. We feel good that we are managing price and promotion well. I think (indiscernible) our merchants are doing a good job there, indicated by the fact that our gross profit dollars are up, traffic is up, basket is up, we are able to pass on (due to our convenience) some of the inflation we're seeing but I think we feel pretty good with our position to continue to do well in a challenging economy.

Wade D. Miquelon - CFO: I think Greg alluded to it, but I think the key point here is really the way we look at our business both in the daily living as well as in the pharmacy area is really total gross profit dollars, making sure we drive those versus just looking at just the margin per se.

Eric Bosshard - Cleveland Research Company: Within that (statistic) and I have a little bit is from a pricing and promotional standpoint considering a more wary consumers you framed it, is there a need to be more aggressive with the pricing promotion, is there any sense you need to get up a little bit of margin to drive the dollars, or just try to find out how that is evolving?

Wade D. Miquelon - CFO: As I've always said, the key to retail swinging doors and managing the price and promotion to get that done, we feel good that we're managing that. The opportunity that we do have is to continue to drive share in private brands. With the launch of Nice and where we're headed there we think that's going to be an opportunity for us. So, we're going to swing doors and continue to make sure that we're driving traffic and basket, but at the same time drive the profitable items that can help us offset that.

Gregory D. Wasson - President and CEO: I think the big idea here we're making lots of progress. We've got a long way to go too. It's really just being more relevant to consumers. What we've done across our assortment, what we've done across our core packages the new lines we keep introducing, additional private label all that is making us much, much more relevant every day, and I think this is the big idea of how we really keep driving bigger basket and more gross profit dollars over time versus just price and promotion per se.

Eric Bosshard - Cleveland Research Company: Then just within that said above trend inventory growth, can you give us any color of what contributed to that and if that has any future profitability ramification?

Gregory D. Wasson - President and CEO: You mean the increased trend in inventory?

Eric Bosshard - Cleveland Research Company: Yes.

Gregory D. Wasson - President and CEO: I would say for the most part it's somewhat of an anomaly. Again we talked about this last year having some low inventory in some of the key categories, but we continue to have many strategies in place to keep driving inventory down and we have still room to go. We haven't put a goal around it, but quarter-to-quarter there could be an impact. Working capital in total too was impacted by the WHI transition, a fairly large number and so we will be out of that now as we move ahead as well.

Operator: Matthew Fassler, Goldman Sachs.

Matthew Fassler - Goldman Sachs: Just a couple questions on the Express issue, just in terms of clarifying timing for your guidance, the EPS impact that you gave is that the 2012 run rate once you get to the level of participation you anticipate to reach those levels or would that be inclusive of a gradual ramp to that level of penetration?

Gregory D. Wasson - President and CEO: That's the fiscal impact. So, that would be the fiscal year. So, obviously the impact will be heavier on January 1 than it was in December, but as we go to the next selling season and then we start to cycle we believe we'll also bring more and more accounts on through different PBMs and so that starts to offset and really strengthens our position over time financially.

Matthew Fassler - Goldman Sachs: So you would anticipate that the annual run rate you would be at by the end of the year, if you had say 25% retention would be nicely better than the number that you put in your presentation?

Gregory D. Wasson - President and CEO: Let's put it this way, those numbers are two thirds of annualized impact, but as I said before, once we get to the next selling season and cycle into next December or in January we believe we'll pick up a lot of that business with other parties who value Walgreens and want us in their network.

Matthew Fassler - Goldman Sachs: A follow-up to that, one, consideration that was not in the mix when you first announced this at the time of your last conference call three months ago was Medco, and obviously this transaction that we might see go through in the relatively near-term, how is that sinking into your strategic consideration given that presumably the two companies once they're merged would be doing business on the same terms?

Gregory D. Wasson - President and CEO: Look whether that happens or not is not for us to say. We have no official opinion on it, but what I will say is that our principle and our stand doesn’t change at all. We need to be provided and compensated fairly by the people we work with, right. To the extent that that were to happen and we would keep getting compensated fairly as we do today, I suppose we would work with those people, but if there were some shift or change in line with what Express Scripts has proposed then we wouldn’t; it's really as simple as that.

Matthew Fassler - Goldman Sachs: Then finally just to clarify on your answer to Eric's question. You basically said that the numbers you lay out with doing business without Express would be better for you financially than had you agreed to their terms. I guess the question is, is that better in 2012 or better in the long run or both?

Gregory D. Wasson - President and CEO: Better forever.

Matthew Fassler - Goldman Sachs: Would that be inclusive of 2012 on a standalone basis?

Gregory D. Wasson - President and CEO: Yes, and more so over time because of our ability to win business back with other parties over time as those contracts renew.

Operator: John Ransom, Raymond James.

John Ransom - Raymond James & Associates: Just a clarification, does the retention include or exclude Medicare Part D lives?

Gregory D. Wasson - President and CEO: It would include.

John Ransom - Raymond James & Associates: The second question is, the PBM consultant feedback says that a lot of clients are saying that even contract provisions would prohibit them from contracting with you separately. There hasn't been any external evidence that you're getting any traction going direct. What can you say to change that perception, because we are just not finding any confirmation that your efforts are gaining traction to go around Express?

Gregory D. Wasson - President and CEO: As I said earlier, we're working with several partners and we are having several positive discussions. We feel pretty good with those that we are having. We're not going to release the information on that because we (indiscernible) that confidentiality of our folks and the people we're working with. I will say at the same time, as Wade mentioned earlier, this is not just going to be a single-year event. In addition to those that we're working with that we believe we will be able to work direct with and be able to continue to move forward with. There are folks who have the opportunity either this year or over the next couple of years to change PBMs, and as we said, January 1st would be potentially the toughest time for us, but we do think that there are folks who want Walgreens or network and will have many alternatives (enjoyed) and ways to do that.

Wade D. Miquelon - CFO: Yeah. We know of many, many PBM shifts, but again for anyone of those, it's going to be up to them when they want to announce it. So, at the end of the day, this isn't going to be a bad, although it's one in the newspaper is or bad it looks one in conference calls. It's going to be about what customers want and their options and their choice and over time we're pretty confident that we'll get back in much of this business with people who value us and see the value proposition we provide.

John Ransom - Raymond James & Associates: Is this contract lower than what you're getting paid on your average Medicaid fee per script?

Wade D. Miquelon - CFO: We don't talk about plan by plan by plan, but just to getting the fact that we said that this is below the industry cost of fill. If everybody took this with every plan, there probably will be no industry. So, again, it's just not acceptable versus what others provide and the value provide and so it doesn't work for us.

Gregory D. Wasson - President and CEO: Again, if I can just wrap up, this is unfortunate example of a PBM that has forced a network provider to a point where no longer makes a sense for us to participate in that network, and with that we know where we're headed. We've got plenty of opportunities to work with the providers that want all the services we provided and that's where we're headed.

Rick J. Hans - Divisional VP of IR and Finance: Ladies and gentlemen, that was our final question. Thank you for joining us today. As a reminder, the Company will report September sales on October 5th and we will report first quarter 2012 earnings on December 21st. Until then, thank you for listening and we look forward to talking with you soon.

Operator: Again, that does conclude today's conference call. We'd like to thank you for your participation.