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Walgreen Company (NYSE:WAG)

F3Q06 Earnings Conference Call

June 26, 2006 8:00 am ET

Executives

Rick J. Hans - Director of Finance

Rick J. Hans

Hello, and thanks for tuning in to Walgreens audio webcast for the third quarter of fiscal year 2006. I’m Rick Hans, Walgreens Director of Finance, and I invite you to use this information in conjunction with the press release and other financial information posted on our web site.

Before we begin, I’d like to go over the safe harbor language. Certain statements and projections of future results made in this presentation constitute forward-looking information that is based on current market, competitive and regulatory expectations that involve risk and uncertainty. Please see our Form 10-K for the fiscal year ended August 31, 2005, for a discussion of factors as they relate to forward-looking statements.

Today we announced third quarter earnings were up 14.2% to $469 million, or $0.46 per share diluted. That came on a sales increase of 12.4% to $12.2 billion. This quarter’s earnings were reduced by $20.1 million pre-tax for employee stock option program expenses. Last year these options weren’t expensed.

The quarter’s earnings also include the benefit of a $13.6 million credit from the settlement of certain prior years Internal Revenue Service matters. I should also note that last year’s quarter includes a pre-tax gain from litigation settlements of $6.6 million.

For the first nine months of fiscal 2006, sales increased 11.1% to $35.2 billion. Net earnings rose 8.8% to $1.34 billion, or $1.31 per share diluted. This year’s nine month earnings were reduced by $83.7 million pre-tax for employee stock option program expenses, and include the previously mentioned $13.6 million tax benefit. Last year’s nine month period includes a similar $7.8 million tax benefit, as well as a pre-tax gain of $26.3 million from litigation settlements.

This year’s third quarter LIFO provision was $24.2 million, the same as the previous year’s third quarter.

Front-end, or non-pharmacy sales were strong in the quarter as we gained market share in 57 of our top 59 core product categories, versus our drug store, grocery and mass merchant competitors, compared to a year ago. Pharmacy sales increases turned the quarter in May after a mild flu season with fewer related prescriptions compared to a year ago. We’re also seeing more patients filling prescriptions under the Medicare Drug Benefit program. Pharmacy accounted for 65.2% of our third quarter sales.

This year’s store growth is ahead of last year’s pace. We opened 112 new stores in the third quarter, compared to 87 in the year ago period. For the first nine months of the fiscal year, we opened or acquired 334 stores, putting us on schedule to open 475 new stores in fiscal 2006, including 390 net new locations. That doesn’t include the 76 Happy Harry’s pharmacies that will merge with Walgreens when that transaction closes in the coming weeks. Our store count as of May 31 is 5,251 - a net increase of 414 from a year ago. We remain on track to operate more than 7,000 stores in 2010.

Taking a closer look at sales - total comparable drug store sales for stores open more than a year - we’re up 7.6% in the quarter, while front end comparable drug store sales rose 4.6%. Pharmacy sales climbed 13.5% overall, and 9.3% on a comparable drugstore basis in the quarter. The number of prescriptions filled in comparable drug stores rose 4%.

As I noted earlier, prescription gains were held back during the first two months of this quarter by a mild flu season compared to last year. We’re also working against Medicaid issues in Tennessee and Puerto Rico that led to fewer patients from those plans coming in to our stores. Most of the effect of these reimbursement issues will become comparable in September.

Gross profit margins decreased 39 basis points versus the year ago quarter to 27.46 as a percent of sales due in part to lower pharmacy margins from additional Medicare Part D business, as well as a continued shift in our overall sales mix toward prescriptions, which carry lower margins than front-end merchandise. Those factors were partially offset by the introduction of new higher margin generic drugs. Front end margins also decreased as a result of sales mix.

Meanwhile, selling, occupancy and administration expenses decreased 25 basis points to 21.65 as a percent of sales, despite our expensing of employee stock options. Lower legal and digital photo conversion expenses helped the SO&A ratio.

The effective tax rate for the third quarter this year was 35.12% compared to 37.25% in last years third quarter. The effective tax rate for the first nine months of this year was 36.35% compared to 36.85% in the year ago period. We’re anticipating a 37% tax rate in this year’s fourth quarter.

The consolidated balance sheet and statement of cash flows can be found within our press release. Cash and short term investments increased from $1.4 billion at the end of last year’s third quarter to $1.8 billion at the end of this year’s third quarter. Accounts receivable increased 34.7% while account payable increased 32%. Both were driven by growth in our pharmacy benefit management business under the new Medicare prescription plan. LIFO inventories were $5.54 billion, as 6.5% increase from the year ago quarter.

For the first nine months of fiscal 2006, we repurchased 5.6 million shares of stock for $243 million under our $1 billion share repurchase plan announced in July 2004.

Through the first nine months of fiscal 2006, we’re on pace to open more net new stores this year than in any year in our 105 year history, and that doesn’t include the 76 Happy Harry stores we expect to add when the deal closes within the next few weeks. Our focus continues to be on organic growth, which alone will take us to 7,000 stores in 2010.

As more industry consolidation takes place, we’ll consider select acquisitions, but we’re not counting on them. As our Chief Executive Officer, Dave Bernauer said in today’s press release, “We’ll only pursue ones with a solid strategic fit, and those are rare.” Opening up more stores on the most convenient corners in America will help us attract seniors to our pharmacies. With a new Medicare Benefit, cost is taken out of the equation for most seniors when they decide where to fill their prescriptions. They’ll pay virtually the same co-pay wherever they go in their network. That means service and convenience will be the deciding factors. That’s where we are winning with our convenient locations, reputation and senior friendly services, like drive through pharmacies and large type prescription instructions.

Thank you for listening. Our next earnings announcement for the fourth quarter and fiscal year end of 2006 is scheduled for September 25. Once again, thanks for being a loyal Walgreen shareholder, and remember, you are always welcome at Walgreens.

Question-and-Answer Session

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Source: Walgreen Company F3Q06 (Qtr Ending May 31, 2006) Earnings Conference Call Transcript (WAG)
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