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Executives

RickHans – Director, Finance

JeffreyA. Rein – Chairman, CEO

GregoryD. Wasson – President, COO

WilliamM. Rudolphsen – Sr. Vice President, CFO

JohnW. Spina – Vice President, Treasurer

Analysts

EdwardKelly – Credit Suisse

PatriciaBaker – Merrill Lynch

MeredithAdler – Lehman Brothers

AndrewWolf – BB&T Capital Markets

MarkMiller – William Blair & Company LLC

DavidMagee – Suntrust Robinson Humphrey

JohnHeinbockel – Goldman Sachs

ScottMushkin – Banc of America Securities

Lisa Gill – J.P. Morgan

Mark Wiltamuth - Morgan Stanley

RobertSummers – Bear Stearns

DerekLeckow – Barrington Research

Walgreen Company (WAG) F1Q08 Earnings Call December 21, 2007 8:30 AM ET

Operator

Welcome to Walgreens first quarter 2008 earnings conference call. (OperatorInstructions) I would like to turn the call over to Mr. Rick Hans, Director ofFinance, please go ahead sir.

Rick Hans

Thank you and good morning everyone. Thank you allfor joining us today for our first quarter earnings conference call. With meare Jeff Rein,Walgreens’ Chairmanand CEO, Greg Wasson, our President, Bill Rudolphsen, our EFO and John Spina,our Treasurer. During this call we’ll provide abrief overview of thefirst quarter and areview of the costcontrol measures we’ve implemented and thesuccess we’ve seen from them. We’ll also highlight our efforts to leverage ourstores to drive higher sales volume and our investments innew and expanding health care services. I should point out that today’s call isbeing simulcast on our Investor Relations’ website atwww.investor.walgreens.com. Afterthe call, thispresentation will bearchived on our website for 90 days. Following our prepared remarks we’ll behappy to take any questions. Please limit yourself to one question and afollow-up so that wecan give anopportunity to as many investors as possible during our limited time.

Before we get started I’d like to read our Safe Harbor language. Certain statementsand projections of future results made in this presentation constituteforward-looking information that is based on current markets, competitive andregulatory expectations that involve risk and uncertainty. Please see our Form10-K for the fiscal year ended August 31st, 2007 for a discussion of factors as they relate toforward-looking statements. Now I’d like to introduce our Chairman and CEO,Jeff Reins.

Jeffrey A. Rein

Thank you Rick, good morning and thank you for joining us. We appreciateyour time particularly on the Friday before Christmas. Many of you may be awarethat Walgreens has recently made a significant effort to broaden investoraccess to senior management. Today’s call is just one more example of thiseffort and consistent with our commitment to greater transparency, access tosenior management and improved information flow to shareholders. Let’s beginwith our quarter.

As you saw from our release we reported record sales and earnings despitefacing a tougher comparison for 25% earnings increase in the year-ago quarterexpense control is the top priority and our folks came through particularly inpayroll. We also maximized our advertising dollars through greater efficiencywhile keeping up our promotions during the critical pre-holiday season. We arevery pleased that we’re starting 2008 with a strong footing. Due to a number offactors, our sales growth in the period was slower than expected. Among thesewere late quarter weakness in seasonal categories, discounts on digital photoprocessing, a milder than normal flu season and the recall and cautions onchildren’s cough and cold products. We continue to execute on our organicgrowth strategy in the quarter opening a record number of new stores andcontinuing to invest in our future.

As of November 30th we had 6,139 stores nationwide. In additionwe have about 1,800 new store leases in our active pipeline, of those 600 havealready been signed. Taking a closer look at cost controls this quarter, wetook a number of significant actions in response to the unacceptable growth andexpenses in the fourth quarter. In particular, store and district managersredoubled efforts to more closely align store expenses with budgets and sales performance.We also were very careful to manage service levels and discretionary costs witha keen eye to avoid disrupting customer service or slowing sales momentum. Atthe corporate level we put certain non-critical projects on hold. I want toacknowledge and thank our teams in the stores and at corporate office for theirhard work. You’ve done an extraordinary job. While I’m happy with our greatproducts on the cost front, have no doubt we’ll continue to be vigilant.

Looking forward, we expect the first half of fiscal 2008 to remainchallenging from a bottom line perspective as we cycle a very robust period forgeneric drug introduction last year. However, our long term outlook for marginsand sales remain strong and should improve in the second half of fiscal 2008and beyond. I would also like to point out the comparisons in the secondquarter will be difficult versus last year when we recorded gross margin of28.96%. Last year we benefited from new generic introductions, significantSG&A leverage and operating margin expansion. Now I’ll turn the call overto Bill Rudolphsen, our CFO, for more details on the numbers.

William M. Rudolphsen

Thanks Jeff and good morning to all of you. Let’s briefly discuss our firstquarter financial performance. We reported revenue of $14 billion, a 10.4%increase. Comparable store sales were up 5.4%. Net income and earnings pershare grew 5.5% and 7% respectively. Prescription sales rose 11.1% for thequarter and 5.9% on a same-store basis impacted by more sales of lower costgeneric drugs and a milder flu season. The number of prescriptions filled inthe first quarter increased 3.7% on a comparable store basis. Front-end storesales increased 4.6% on a comparable store basis. In terms of the currentenvironment as we’ve indicated, our gross margin dollars and overall profitsare being impacted near term by self-comparisons to what was a stellar year-agoperiod. In addition we saw a positive impact on volumes a year ago from theintroduction of the Medicare Part D benefit. Total gross profit in the quarterwas $3.9 billion, a $331 million year over year increase. Our LIFO rate thisquarter was 1.5% compared to 1.75% in the year-ago quarter. That let to a LIFOprovision of $26.9 million in the quarter, just $.50 million less than lastyear’s first quarter.

As Jeff indicated we made significant progress at slowing the rate of growthof advertising, payroll and direct store expense. SG&A expenses increased9.5% in this year’s first quarter versus 18% in the year-ago quarter primarilydue to lower growth in store salaries, legal expenses, insurance and storeclosing costs. Advertising expenditures grew more slowly than sales in thefirst quarter. Our advertising spend was up 8% in dollars year over year todrive traffic through circulars and other media. Even though payroll and directstore expense dollars grew faster than sales, we made good progress slowing therate of growth compared to the fourth quarter. We believe we can hold the lineon the cost control improvements we’ve already made while making additionalprogress in other areas.

Looking at slide number six, you’ll see that normally changes in SG&Aexpenses closely track changes in gross profit dollars. That didn’t happen inthe fourth quarter of fiscal 2007; we quickly got back on track in this firstquarter with the growth rates of SG&A expenses and gross profit dollarsmoving in [lock step]. Our effective tax-rate was 37.5% compared to a rate of36.8% in the year-ago period. We anticipate a tax-rate of about 37.2% for thefiscal year.

Looking through our cash flow and balance sheet, cash flow from operationstotaled $390 million in the quarter. Our total short-term debt stood at $1.2billion at the end of the first quarter. We will continue managing our balancesheet for maximum financial flexibility and to support our core growthstrategy. I would like to spend a few minutes discussing our store expansionprogram.

Some in the financial community speculate that our new stores are lessproductive than in years past due to high real estate and labor costs. Let meput that myth to rest. Our productivity improvements at the store levelcontinue to be very positive. If you’ll refer to slide seven, you’ll see wepublished for the first time our front-end sales per store for stores we openedeach class year from 2002 through 2006. As an example, the front-end salesafter year one for the 2006 class of stores is just over $2 million whichexceeds the front-end sales for each prior class store shown. On slide eight weshow prescriptions per store per day at the end of each year. Again, for storeswe opened each class year from 2002 through 2006. Both sets of data demonstratethat our 2006 class of stores performed as well in the front-end and thepharmacy as the store classes each year between 2002 and 2005.

On slide nine, we also show our return on average invested capital for thelast five years. Those returns have increased from 9.6% in 2003 to 10.5% in2007. You can find the details of this calculation on our Investor Relations’website. You can use these three pieces of data to come to the same conclusionthat we have, namely that the productivity of new stores has not diminishedover the last five years. Also keep in mind that Walgreens ROIC is greatlyimpacted by the 20% of our stores that are less than three years old. It takesabout three years for an organically developed store to break even. We estimatethat when you adjust for the net operating profit after tax and the investedcapital for these new stores, the after-tax ROIC for our stores opened morethan three years is in the mid teens. This results in a significant spread overour weighted average cost of capital which we calculate at about 8% using themarket value of equity method.

Given these returns we’ll continue the growth of these highly productivestores. Finally from an investment standpoint, it’s important to know that wehave a goal for our capital investments to reach an average ROIC of more than15%. This goal includes strategic growth initiatives such as organic andacquired store growth, new alliances and other ventures and acquisitions wemight consider. Let me know turn the call over to our President, Greg Wasson,who will update you on growth initiatives.

Gregory D. Wasson

Thank you Bill and good morning everyone. I’d like to briefly touch onrecent progress in our overall strategy to leverage our store box to drivehigher sales while investing in new and expanding health care services to growearnings. Our pharmacy business is strong from every competitive vantage point.Just to remind you, we filled more than 580 million prescriptions in fiscal2007. Today our share of the U.S.retail prescription market is more than 17%. Our drugstore sales on a squarefootage basis are $797 among the highest in the industry. As you know, fiscal2008 will not be a year of major new generic drug launches. This is simply partof the ebb and flow of generic introductions. However, we expect to see a newwave of generics in 2009 through 2011 which will bolster and accelerate ourprofit in those years. For example, looking ahead to the next several years,drugs coming off brand include [Lipitor and Nectim] but keep in mind it isdifficult to forecast with certainty the timing of generic launches.

As important as mainstream prescription drugs are to our business, we’realso positioned to take advantage of the fastest growing area of pharmacy,specialty pharmacy, which is rising at a rate of 20% a year. You will recallthat our acquisition of Option Care last summer is a key part of our growth inspecialty pharmacy. I am pleased to report that the integration of Option Careis progressing on plan. This success demonstrates our ability to affectivelyintegrate sensible acquisitions into our broader platform. Consistent with ourstrategy of strengthening our healthcare relationships with consumers, wecontinue to roll out our Take Care Health Clinics during the quarter. Today wehave about 120 clinics operating in 15 cities across 11 states. Again, theconvenience of ordering combined with the cost affective access to basichealthcare services that Take Care Health Clinics offer represent a distinctadvantage.

Take Care Health Clinics offer high quality primary health care services andour staff by nurse practitioners position assistance. We work in collaborationwith primary care physicians. We have an excellent model to retrofit ourexisting stores and we anticipate having more than 400 clinics operational bythe end of calendar 2008. Our early studies indicate that approximately 20% ofTake Care Health patients choose to fill their prescriptions at Walgreens arenot existing Walgreens pharmacy patients. Our financial assumptions for theseclinics are based solely on healthcare reimbursement and cash fees for commonmedical procedures such as vaccinations, basic diagnostic testing and similaractivities. Incremental pharmacy volumes and front-end sales are not consideredin our financial [inaudible].

We continue to look at opportunities to expand access to Walgreens as atrusted source for basic healthcare services. An example of this is our move tooperate pharmacies at non-traditional venues such as Children’s Hospital in L.A.and Northwestern Memorial Hospital here in Chicago.We also have pharmacies onsite at corporate campuses of large employers such asToyota Motor Manufacturing. You may have seen that during the quarter we madethe decision to withdraw as a pharmacy provider for four prescription plansmanaged by [CVS Caremark] due to their unacceptably low below market reimbursementrates. While we continue to seek a negotiated solution, this won’t have amaterial financial impact on our results.

Thank you for your attention let me turn the call back to Jeff to discussour strategy.

Jeffrey A. Rein

Thanks Greg. I want to spend the last few minutes of our prepared remarks onour corporate strategy and outline how our superior competitive will lead us tofuture growth and deliver long-term [inaudible] value.

We are focused on going on market leadership for strength in our competitiveposition. We intend to actively and aggressively manage organic store expansionto capture the best retail corners nationwide. We continue to make sales focusand customer focus investments in our stores, supply chain marketing andinfrastructure. We’re expanding into adjacent sectors of pharmacy andhealthcare services through our acquisitions of Option Care, Medmark,[inaudible] and Senior Med. [inaudible] will allow our patients to continueusing Walgreens’ services as they develop needs for infusion therapy orspecialty pharmacy products, or moving into an assisted living setting. We willprudently evaluate acquisitions that enhance our core service offerings, expandour convenience and meet our [inaudible] goals.

So, how are we uniquely positioned to capitalize on this strategy anddeliver that shareholder value? First and foremost with more than 6,000locations, significant buying power and high service levels, we have anexceptional retail platform that can be leveraged across both the front and theback of the store. As a pharmacy provider we believe our independencedifferentiates us and enables us to successful compete for business as aprovider of choice. We believe any efforts to restrict us [inaudible] provideour networks will prove counterproductive [inaudible] will underscore theinherent conflict of interest to vertically innovative business model. Organicstore growth remains a key part of our strategy. This year we plan to open 550stores for a net increase of 475 stores after relocations and closings. Inaddition, we are targeting total square footage growth of approximately 8% peryear. Geographically we’re aggressively expanding in the northeast and California.These areas have higher real estate costs and in some cases, smaller propertieswith which to work. So we’re using a flexible and adaptable store model tocustomize product selection similar to our successful stores in denselypopulated urban markets, such as San Francisco.

While the break even period is longer for these stores due to higher realestate and development costs, experience has shown that their sales growthtends to be sustained over a longer period than stores in less dense markets. Inother words, these stores continue to improve the performance for many moreyears after they break even. Over the long term, we expect our [inaudible] andsales per square foot to increase as we bring the higher mix of these storesinto our system. In short, we are no where near the saturation point; there isplenty of room to grow. We have the right strategy to get there. We’re also growingmarket share through buy-outs of independent pharmacies which playsparticularly tough economic times, pharmacy reimbursements fall in both thepublic and private sectors. We completed a record number of 200 independentpharmacy buy-outs in fiscal 2007 and we expect this trend to continue.

Our strong balance sheet provides us with the ability to be opportunisticand flexible in pursuit of growth. Our 50% debt to total cap ratio positionedus ideally in this regard. When you look at the different levers we have as an organization,we believe we are well positioned to deliver consistent growth.

That concludes our formal remarks and now we will turn to your questions.

Question-and-Answer Session

Operator

Our first question will come from Edward Kelly – Credit Suisse

Edward Kelly – Credit Suisse

Hi good morning. Could you quantify the benefit from the lower legalinsurance and store closing costs in the quarter. Was that all of the 19 basispoint decline in the SG&A? Is that how we should think about that?

William M. Rudolphsen

No Ed, that’s not, I’d say the major reason for the increase or the changein the growth rate was store salaries. We grew at 18% in the first quarter oflast year, only 9.5% this year. I’d say about a third of that improvement isrelated to store salaries.

Edward Kelly – Credit Suisse

Okay but the year over year lower SG&A rate of 19 basis points, that’smostly the legal, the insurance and the store closing costs right?

William M. Rudolphsen

[inaudible] sales basis, that iscorrect.

Edward Kelly – Credit Suisse

Okay. And then Jeff I was hoping youcould discuss comp trends a little bit. Your comps have obviously deceleratedsomewhat and I understand that generics is playing a role in that, butobviously from the information you provided, your new store comps are stillrobust so can you help us dissect what your older stores are comping at thisstandpoint if we call it stores older than five years? And then what should weexpect now going forward the rest of this year, particularly on the front-endas it seems like things might be slowing down a little bit?

Jeffrey A. Rein

They still are going very well. We did see a traffic slowdown in mid Octoberand that’s what we talked about in November. So that traffic slowdown, you sawthe customer buying down a little bit and the customer count once again wentdown a bit. The comp stores are still doing very well in those stores open morethan three years. Is that what you’re referring to?

Edward Kelly – Credit Suisse

Yeah, I’m talking about your more mature stores.

Jeffrey A. Rein

Right, they’re still doing very well in terms of comp sales, but once againoverall we did see a decrease in customer count starting in about mid October whenthe sub prime and crisis became big news. We saw people trading down a littlebit and that slowed down the comp store sales a bit. With regard to the rest ofthe year, it is a top economic environment right now, but of course we’re notcommenting particularly on sales for this month and also how it’s going to befor the rest of the year.

Edward Kelly – Credit Suisse

I want you to think about what your promotional strategy is going to begoing forward on the front-end, do we think about it as getting more aggressivebecause of this?

Jeffrey A. Rein

We will do what we need to do to either meet or beat competition. If we needto get more aggressive, we certainly can. We do a good job day in, day out. Ihave no problems with that. We’ve always been promotionally oriented not onlyin our ads but in the way we merchandize our stores. As you know, most of theproducts that we sell in our stores are low end products and they lendthemselves to promotional building. People come into our stores based onconvenience looking for 1.6 items, they leave with 3.3 items. That has beenvery, very consistent whether the economy is great or the economy is poor. So Ithink we’ll do just fine, just fine in the months ahead.

Edward Kelly – Credit Suisse

Okay, thank you.

Operator

Our next question comes from Patricia Baker – Merrill Lynch

Patricia Baker – Merrill Lynch

Good morning everyone, I don’t want to dwell very much on the fourth quarterbut since we didn’t have the benefit of this exact access with that quarter,can you just go back and explain to us why you think the fourth quarter did endup with much higher SG&A than was anticipated? Just so that we have abetter understanding going forward.

Jeffrey A. Rein

Yes Patricia, in the fourth quarter of 2007 we did a very poor job ofmanaging and focusing on expenses. We are a $0.03 company and that’s our mantraright now, a $0.03 company. We have got to remain focused. During that timeperiod, our payroll was out of sight. We also had [inaudible] expenses andadvertising that we had in the fourth quarter of last year that we did not havein the previous year. So once again, I would say it was a lack of focus. As youcan tell by this quarter, there’s more focus on controlling discretionarycosts; we are making sure that when we have the budgets and the sales those arebeing matched up. We’re taking [outliners] back to budget. Obviously if theyget and do more sales then the budget is saying, then they get more hours. Butif they do not, then we take hours out. The biggest leverage that the storemanager can control in terms of expenses is that payroll salary line. Onceagain, by matching up the budgeted hours with the budget sales, we will dobetter.

Patricia Baker – Merrill Lynch

Okay thank you, that helps us understand it better.

Operator

Our next question is from Meredith Adler – Lehman Brothers

Meredith Adler – Lehman Brothers

I’d like to talk a little bit more about first quarter expenses, the 18%SG&A growth you had in the first quarter last year, I believe some of thatwas related to Happy Harry. I don’t know how much of that was payroll but is itfair to say that some of the improvement in the payroll this year is of afunction of fully integrating Happy Harry and that those were sort of one-timecosts?

Jeffrey A. Rein

I wouldn’t say that completely Meredith. The reason being it’s an ongoingprocess with Harry’s. We’ve obviously put some payroll in but the stores werenot necessarily all set completely. We’re still going through that right nowwith them, to make sure the [inaudible] are set to Walgreens’ system. So Iwould not classify that at all as the main reason. The main reason once againthat we controlled expenses is that we had diligent efforts and we’re trackingit on a daily and weekly basis much better than we did in the past.

Meredith Adler – Lehman Brothers

Okay and then I’d like to just ask some questions about the slides you werekind enough to provide us about pharmacy productivity both front-end and onething I noted is a footnote that you’ve excluded the 24-hour stores. Can youtell us how many of the stores you’ve been opening are 24-hours and then I havejust a follow-up question related to that.

Jeffrey A. Rein

To answer the 24-hour question, when you say opening, do you mean openingper year? Right now we have approximately 27% of our company 24-hours, about1,600 stores that are 24-hours. It’s hard to determine exactly to say how manywe’re going to open per year because obviously it’s based on script numbers,the competition and so on, so that ebbs and flows. But right now, we’ve beenaround 27%, 28%; we’ll probably stay about that range for quite awhile. Youhave other questions regarding the charts?

Meredith Adler – Lehman Brothers

Yeah, well I mean you had excluded those 27% of the stores more or less fromthese charts, I just wanted to understand that, but also can you talk aboutover the same five year time frame where you’ve had very stable sales andscript count, what’s happened to labor and real estate costs? Have they alsobeen equally stable?

William M. Rudolphsen

Yes, they’ve been fairly stable. Certainly as we do expand into thenortheast and California as Jeffmentioned, we would see slightly higher occupancy costs in those areas. Butoverall our costs have been fairly stable.

Meredith Adler – Lehman Brothers

And finally just the chart you do where you look at return on averageinvested capital, are you capitalizing leases in that calculation?

William M. Rudolphsen

Yes we are.

Meredith Adler – Lehman Brothers

Okay great, thank you.

Operator

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

Andrew Wolf – BB&T CapitalMarkets

Good morning, I just wanted to ask you about the – from your commentary onthe – it sounds like you’re making good progress on the payroll side of the businessbut actually there’s – it’s got to be carefully done, but it sounds likethere’s more to come. Am I understanding that right and if so, what sort of,could you somehow give some quantification of how much more labor rates can bemanaged down?

Jeffrey A. Rein

Thanks for the question. I don’t want to give an exact figure on how muchmore can be managed down. It is a lot more focused than ever before. Onceagain, during the last summer we just did not do a good job of focusing on it,week to week to week. We are definitely doing it now. Focusing on [inaudible]from a corporate point of view and also engaged store level to make sure welook at that payroll. It’s more judicious use of payroll and once again we lookat the out-liers. We have templates that the manager and district manager andstore ops Vice President agree upon, that how many hours are allotted to everystore including pharmacy and front-end. If the sales are there then we’re okay.If the sales get much better than anticipated, obviously we can put hours on.If they get much worse than anticipated we can take hours out. One thing weobviously don’t want to do is hurt service levels and as I’ve mentioned in thepast, we’ve had a pretty track record now of having decreased servicecomplaints in our stores. It’s a focused effort on taking care of the customer,taking care of the patient and once again we’re not going to be so silly as tocut payroll to the bone where we hurt ourselves. We don’t want to do that. Wewant to take care of our people and we want to take care of our customers andpatients all the time.

Gregory D. Wasson

The other thing that we did do intelligently, back to the 24-hour, we didtake a look at some of the 24-hour stores that we had and rolled back a fewthat maybe didn’t make sense and we may have been a little aggressive over theyears in adding some of those 24-hour locations. We rolled a few back thathelps us a little bit in that area. Again, as Jeff said, just an intelligentfocus on labor costs. Our managers and our district managers in the field havedone a great job responding.

Jeffrey A. Rein

That’s a good point by Greg. We’re reviewing the districts; we actually hadsome districts that were 50% 24-hour stores. We just didn’t need that for thecoverage.

Andrew Wolf – BB&T CapitalMarkets

Okay so it sounds like you can at least maintain the current discipline andperhaps do some fine tuning to come.

Jeffrey A. Rein

I think that’s a good way to say it; a fine tuning is the best way to [steady]you’re right.

Andrew Wolf – BB&T CapitalMarkets

Okay and my follow-up if I might is just on the pharmacy side of thebusiness, both at Walgreens and other public chains and the industry at large,this year has been a little slower than last year in the prescription businessand as you all dissect it, there’s different reasons. One is obviously you’relapping in the Part D infusion last year, Wal-Mart and others have made acompetitive bid for business, the economy, add flu, how would you when you lookat this year being a little slower than last year, how do you ascribe theslowing, slight slow down in the scripts?

Jeffrey A. Rein

I would agree with those reasons you listed and Medicare Part D, the fluobviously is playing a part of it. The economy as you mentioned. I think anotherthing coming into play is employers putting more cost on employees. As you seeco-pays rising people unfortunately do not fill their medications as much aspossible. But I think what you’re seeing is more and more people are gettingaccess to care. I’m quite confident the numbers will go up as people get accessto care. For example, through our Take Care Clinics and other clinics that areout there. I think people want to stay well, as insurance companies pay forvisits to the Take Care Clinics for example. That encourages people to comeinto the system. Before, they might be putting it off, for example they didn’twant to go to a doctor, they know it’s very expensive. They just wait it out.There’s also been not a lot of negative publicity as you know regarding variouscough syrups and other medications and people might be taking a little bit of ajaundiced view of it. Well let me just wait it out and see what happens. It’sour job though as a pharmacist and pharmacy profession, to encourage people totake their medication on a regular basis. I think that’s one of our biggestopportunities for us to grow numbers, is to get people to be compliant and adhereon their medications. You know if you miss your medication for a day on [Astatine]for example, or something for high blood pressure, you’re not going to feel anydifferent. But if we can show people that you know what, you’re going to feelbetter, you’re going to be around to see your grandchildren in the years tocome, then it will make a big difference and there’s our opportunity in thisindustry is to drive compliance and adherence.

Andrew Wolf – BB&T CapitalMarkets

Alright, thank you.

Operator

Our next question comes from Mark Miller – William Blair & Company LLC

Mark Miller – William Blair & CompanyLLC

Good morning, first one to say thank you for posting this forum. I thinkit’s going to be helpful for the dialogue going forward. I want to follow-up onan earlier question about the rate of expense control we’ve seen so far andBill you talked about you can improve additional things going forward. I hopeyou can elaborate on that and then Jeff you mentioned the non-critical projectson hold. How long can those stay on hold if the economy does tighten up, howmuch ability do you have to bring down the expense growth rate further?

Jeffrey A. Rein

We have a lot of ability to bring that down as needed without being silly orstupid about it. Obviously what ever we want to do is, in terms of payroll, isto make sure we don’t impact sales. On the expense and [inaudible] we want tomake sure that we don’t impact shareholder value for the long term. As you knowthere’s always been this unique needs and want-to-do. Some of those want-to-dosare not necessary right now. There are some needs to obviously that we aremoving ahead with, but once again, the wants-to-do we just can’t do that. Andany list of projects we obviously have to prioritize what we want to do andwhat we need to make happen and position ourselves well for the future. Interms of the expenses, once again, about one-third of our savings this quarterwas due to payroll, the other two-thirds was due to these higher legal,insurance and store closing costs. Those ebb and flow as you know. And so wecan’t be exact about those, but the biggest SG&A expense line that we cancontrol is payroll. Payroll represents about 50% of our SG&A and that’swhere, if we have a concentrated effort to make a difference, we can do it.

Mark Miller – William Blair &Company LLC

In the stores where you’ve put in the discipline you talked about, have youseen a bigger change in their sales so as comped flowed in November, was thatmore so at those stores that had that greater expense discipline?

Jeffrey A. Rein

No Mark, absolutely not, no, no, no. As a matter of fact it’s kind ofinteresting. If you look at the stores on an individual basis, typically thosefolks that run the most disciplined payroll have the best stores in terms ofbeing in stock, taking care of the employees, taking care of the customers;everything is great. It’s just like inventory for example. You go into somestores and if they’re a lot over in inventory, some folks think well thereshould be no out-of-stocks, but actually those are the worst stores in terms ofbeing in stock.

Gregory D. Wasson

You know our operations folks have done a great job delivering this message tohelp us make this happen. They’ve been in the stores, working with the storesthat might have some challenges making sure it’s done the right way andintelligently. And they’ve been extremely careful and cautious about doinganything that might hurt service levels. I just think it’s been one heck of anexecution from our store ops folks.

Mark Miller – William Blair &Company LLC

Thanks, my other question on the slides, looking at the pharmacyproductivity, it moved up in this past year, but it is down from where you’vebeen a couple years prior despite overall growth in scripts in the market. Iguess I was hoping you could address that and also explain whether that’scoming from more stores in these new markets so you talk about higherinvestment costs in the new markets on the coast, but do you also start withlower sales productivity and then as more of these stores are coming on isthere some risk that return on capital would actually be weighed down for someperiod of time until enough of them are in the maturity phase of the curve?

Jeffrey A. Rein

Let me answer the first part of that. In terms of the slower growth, as weexpand more into areas where we’re not as well known, the prescription growthis slower to begin with. But what we’ve found many, many times particularly inthe northeast and California andso on, that after that four and a half to five year break point, our salesactually go up faster than the other stores in more mature markets. So I thinkwe’ll be okay. Once again long term it shouldn’t be a problem in terms ofgrowing the scripts. Bill, do you have anything to add?

William M. Rudolphsen

Yeah Mark, as I look at the numbers I really don’t see a material differenceamongst the numbers throughout the years, that’s why we posted the chart and Iwould agree with Jeff’s comments that we do start out slower in the northeastbut we ramp up over time as the public becomes more and more aware of Walgreensin the market.

Jeffrey A. Rein

Mark a good thing to always keep in mind is that the market share ofpenetration actually drives the ROIC. So once again, in more mature markets thestores come up to that break even point, break even and above, much quickerthan they do in some of the areas where we have less than a two coverage.That’s stores per 100,000.

Mark Miller – William Blair &Company LLC

And on the ROIC part of the question, it’s intuitive to me that it wouldweigh in returns, is there some reason why that wouldn’t manifest itself in theresults?

William M. Rudolphsen

Yeah Mark early on I would say as we start slower certainly that would weighon the returns but long term we would get where we need to be which is a 15%return on invested capital which is our target.

Mark Miller – William Blair &Company LLC

Right, thanks, enjoy your holidays.

Operator

Our next question comes from David Magee – Suntrust Robinson Humphrey

David Magee – Suntrust RobinsonHumphrey

Good morning, just a question about the generics and your expectations forthe lesser introductions in 2008, would you expect that your generic percentageto still grow this year in the environment and how should we do that? Is itjust less of a positive in this kind of a year or is it actually a negative andthat you’ve got less to offset older generics that are being axed out, etcetera?

Jeffrey A. Rein

As you know David, the generic, the plan going to generic is actually a lowpoint in 2008 then it picks up in 2009, 2010 significantly. I do believe thatour generic penetration will continue to move up, maybe not quite as quickly ofcourse on a percentage basis because you don’t have all the brands going togenerics. But more and more people are familiar with generics, doctors believein generics and the customers and patients know a generic now and are askingfor it. Also it’s part of the design of the co-pays. Most folks, most employersobviously are keeping those generic co-pays down. As a matter of fact, somecompanies now are starting to waive co-pays on certain generics just so peoplewill take their medication, and that’s where I come back to this compliance andadherence. I think there’s realization in the health industry in general, thatif we can get people to take their meds then our total health care costs willgo down over time.

David Magee – Suntrust RobinsonHumphrey

Thank you Jeff, from 10,000 feet, do you think that the genericprofitability would change that much over the next three or four years?

Jeffrey A. Rein

What do you mean change?

David Magee – Suntrust RobinsonHumphrey

Well in terms of just you’re net dollar per script reimbursement that youget for generics? Do you expect that to change much?

Jeffrey A. Rein

No. Not on a per script basis, no I don’t see that happening.

David Magee – Suntrust RobinsonHumphrey

Great, thanks.

Operator

Our next question comes from John Heinbockel – Goldman Sachs

John Heinbockel – Goldman Sachs

Jeff do you think, are we headed toward a period of greater ongoingconfrontation between PBMs and retailers over reimbursement, broadly not just[Care Mark], but Medco and Express as well? Are we headed in that direction anddo you see opting out of other plans or no?

Jeffrey A. Rein

You know John, it’s always been a discussion with the PBMs over the years interms of the reimbursement rate which we feel is needed and fair to us, and atthe same time fair to them. I wouldn’t say it’s more conflict at all. Thesefour plans with [CVS Care Mark] is just something that we haven’t been able towork out yet. I’m hoping that we do come to a resolution but we just have notyet. But in terms of the major PBMs and the conflicts, no I don’t see itintensifying at all. I really don’t. I think we’ll be just fine in the years tocome. They have their point of view, we have our point of view, but once againwith our coverage and the locations and market share we have, I don’t see itchanging from what it was in the past.

John Heinbockel – Goldman Sachs

With regard to Care Mark, do you sense a different agenda than had been thecase a year ago or this issue you had with these four plans, they would havecropped up whether CVS owned it or not?

Jeffrey A. Rein

Yeah, that’s the best way to put it. As you know we have been fighting, ifyou want to term it that way, with the PBMs for a long, long time. Most ofthese don’t get to be public knowledge. You would never hear about it. Thesefour plans unfortunately couldn’t come to an agreement which was fair to bothsides. Again, we’re still talking with them. We hope to have a resolution, butno I wouldn’t say things are going to get worse at all. And obviously we’llcontinue our discussions.

John Heinbockel – Goldman Sachs

And then finally, how much of your front-end do you think is reallyeconomically sensitive, is discretionary and of that, of what is discretionary,how price-elastic do you think that is such that if you increase promotions youget a response?

Jeffrey A. Rein

John in my opinion, we are recession resistant, but we’re not recessionproof. Once again, it depends on your level of income. What might be someone’sdiscretionary spend is someone’s needed spend somewhere else. But withpromotional activity that ebbs and flows as you know, once again, most of oursales happen because folks are in the store. That’s why we want these primelocations on the best corners in America.Once they get them into the store, we are just fine in terms of selling andwhat we need. Now maybe we need to do some price points, lets say instead of$3.19 maybe it’s $2.99 or two for $5 or something of that nature, but our jobin terms of the [rodo’s] and the circulars is to get people in the door. Andwe’ll do what we need to do depending on how competition responds and how theeconomy is and how things have been and are going.

John Heinbockel – Goldman Sachs

Does $3 gas help you in that traffic generation or no?

Jeffrey A. Rein

It is interesting. We are in a neighborhood; we’re close to home so in thatsense when people have a need, once again, the only time we ask for 1.6 itemsso they’re top of mind. They’re out of milk, right. They’re out of bread. Who’snot going to have that for their children in the morning? They think ofWalgreens right off the bat. They think about Walgreens’ milk, they come to ourstore to buy it and then they pick up something else. So I would say actuallywith gas prices increasing, people are coming to our stores.

John Heinbockel – Goldman Sachs

Okay thank you.

Operator

Our next question comes from Scott Mushkin – Banc of America Securities

Scott Mushkin – Banc of America Securities

Just a couple of questions, one just to clarify, I know we’ve drilled onthis SG&A subject but what in basis points would it have been OpEx some ofthese one-time items, legal and insurance and store closings?

William M. Rudolphsen

We’re not going to release the exact amount but it’s not a tremendouslysignificant amount. I would again point to as we look at the increase inSG&A last year in the first quarter of 18% versus 9.5% this quarter, themost significant amount of that reduction in the increase was store salariesand we would point to that being about a third of the change.

Scott Mushkin – Banc of America Securities

But the other two-thirds were pretty much one-time items, not as repeatable?

William M. Rudolphsen

More one-time items, plus other control of expenses in other areas.

Scott Mushkin – Banc of America Securities

And then moving to the gross margin which I don’t think we’ve hit on yetdown 29 [biffs] it’s somewhat surprising, was that all front-end related as welook at that? How do we think about that going forward with sales slowing a bitin the front-end and then maybe just as a follow-up to that, consumer behaviorseems pretty odd this time around. Usually you guys are the last to slow andsupermarkets haven’t really slowed much at all, so maybe a comment on why youthink all of a sudden with employment still very robust you’re actually seeinga pull-back, of why you think it’s not related to some of the actions you’retaking.

William M. Rudolphsen

On the margin side Scott, our pharmacy margins were up, driven by genericsbut our front-end margins were down as we moved to less profitable categoriesbeing sold. But the front-end was the major factor in the reduction of grossmargins.

Jeffrey A. Rein

When you look at the sales once again going back to November where itstarted to tail-off, don’t forget that cough cold is a big, big part of ourbusiness and before the FDA said anything about children’s cough medications,we were up about 15%. The day after that immediately started to drop. Weactually ended up zero for the time period. Just zero. We have never seen, I’dmentioned to several folks, I had never seen us up zero in cough cold.Seasonal-type products we saw starting to decline a bit in November. Onceagain, Halloween was pretty good but not quite as good as we would have likedand we have high expectations of course. Items like vaporizers in November justdidn’t sell. They just aren’t going. People aren’t buying, they don’t needthem, it’s too warm. Products like mittens and hats and clothing are down 20%.Those products we’re not selling. So once again in an environment it’s slowing,people do look at what they’re spending and what’s discretionary. They may ormay not be buying some of the promotional items that we offer. I think a lot ofit is dependent on not only what do they think of the future of course in termsof their mortgage, their job and so on, but also the weather does impact us.Particularly on the cough, cold and the flu index side.

John Spina

I just want to add that you know in a tough economic time, there’s so manymoving parts to our sales, it’s tough to pin it on one thing. So we’re justgoing to make sure we take care of the customer, we have the right advertising,get them in the door, put that extra item in the basket and go forward. But topredict the future, we just never could do that. There’s too many moving parts.

Scott Mushkin – Banc of America Securities

Do you at least anticipate all equal in the economy it just kind of keepschugging along the way it is, which is just so-so, that this gross marginpressure will continue through the year?

Jeffrey A. Rein

We’ll see how it goes. We don’t comment on which way it’s going one way orthe other. It’s a tough economic environment as we said before, we all read thesame papers and see the headlines and so on, but we will have to see how thatgoes.

Scott Mushkin – Banc of America Securities

Thanks guys and thanks again for doing this, I know someone else said thatbut it’s really appreciated.

Operator

Our next question comes from Lisa Gill – J.P. Morgan

Lisa Gill – J.P. Morgan

Thank you and good morning. Jeff I think you talked a little bit aboutexpansion of your healthcare strategy and I’m just wondering if you can maybetalk about areas that you’re looking at. I also think that someone made thecomment that especially pharmacy is fully integrated or unplanned, can you talkabout how your integrating specialty pharmacy into your front-end pharmacy andagain just coming back to how you view the overall strategy for healthcareoffering.

Jeffrey A. Rein

Lisa, just to let you know, we don’t comment on any acquisitions that may ormay not be happening. We’ve never done that in the past and obviously we’re notgoing to comment right now. What we are trying to do with our strategy is makesure that we can take care of folk’s pharmaceutical needs. In the past we’vebeen able to serve folks, in many cases, from the time they were born untilmaybe 65 to 70 and then we’re out of the picture. It just doesn’t make a lot ofsense to us so we with the acquisitions that we’ve done, whether it’s OptionCare, Med Mark, [inaudible] and Senior Meds, it allows us to take care of thatpatient from cradle to grave. And everything we’re doing and seeing is thatmore and more of the pharmaceutical needs of people can be met by the infusionor specialty side. And by the way, these folks who obviously have to be infusedor take specialty meds also take other medications. So if we get the specialtyperson, you also get whatever else they’re taking that they can take orally.Greg I think you had some comments also on this specialty.

Gregory D. Wasson

Yes, I believe obviously a big area of focus for us is the specialty andfusion area. Obviously with it growing at 15%, 20%, $60 billion today, thatcould double in the next five years, maybe even triple. So it’s a huge area offocus for us. As we know, pharmacy, the science of pharmacy is moving more andmore toward biologicals; we want to be there. So we invested a year ago in [MetMart] and bought a lot of expertise and manufacturer relations. With OptionCare we bought what we feel is one of the best national platforms and homeinfusion. We’re working at integrating the specialty side of that with thefusion side as we speak. That’s going well. As far as the retail opportunities,we do think that there’s going to be opportunity to leverage the retailpharmacy as well as to take care of healthcare clinics.

Lisa Gill – J.P. Morgan

And on the retail pharmacy side, are you using your pharmacist in aconsultative way to talk about specialty pharmacy so if someone walks in topick up a specialty prescription they don’t have a specialty pharmacy companytoday, are you using that opportunity to try to cross-sell some of the newservices that Walgreens has?

Gregory D. Wasson

We’re heading towards that. We’re not as far along as we expect to be in thenear future. We absolutely want to determine what it is that a store levelpharmacist should and could add to that specialty patient to provide value. Certainlythe combination between the centralized model, the pharmacist and nurses thatwe have to assist to pharmacist at the store level combined with the actionthat can be delivered at the point of care, is going to be, we believe extremelydifferentiating for us.

Jeffrey A. Rein

Just to remind you that infusion doesn’t necessarily have to bedone in afacility although we dooffer that. It can bedone in thehome. It can bedone in our stores.One of the things thatmanufacturers and insurers getvery worried about of course is, is their medication being used and is itbeing used properly. When they areable to get to someonelike Walgreens that’s easily accessible, we can make sure that they take theirmedication. The payoris assured that themedication was used. Themanufacturer doesn’t have to worry about returns. Soit’s very important that we service these people correctly and that’s whyinfusion is sodifficult, but we think we’re positioned quite correctly because itdoes take a lot oftime, a lot of effort.Also when you Take Care Clinics, you’re probably familiar with this but that’sanother way to getpeople into theWalgreens’ system and getthose folks healthcare and that’s why theinsurance companies arenow paying for that healthcare. Because if they can getfolks into the systemearlier, they can gettaken care of at theneed medication, they getthat. It avoids thehospital visit or anemergency room visit and helps to keep thetotal healthcare costs down.

Lisa Gill – J.P. Morgan

Jeff are you working with the plan sponsors, to advertise for example TakeCare Clinics to a certain health plans members so they know and understand thatthe service offering you have?

Gregory D. Wasson

Certainly we’re working with the [inaudible] plans as we sign up and enterinto contracts with them and certainly encourage them to help us promote ourclinics. It certainly makes sense for them as well to lower their overallhealthcare costs.

Lisa Gill – J.P. Morgan

And then just one last follow-up, obviously AMP has been brushed off by thecurrent court ruling, we’ll probably find out at some point in January as towhere it will move, aside from Medicaid, can you talk at all about any of yourother business that will be impacted by changes in reimbursement around theFederal upper limit or around AMP?

Jeffrey A. Rein

Lisa, it’s very hard to comment on that right now. We don’t know thedetails. We have no idea of the metrics they’re using and how they’re going tofigure AMP. We just don’t know so it’s very tough to comment on that now. Whenwe have more information, obviously we’ll be glad to talk about it. We justdon’t know how it’s going to end up.

Lisa Gill – J.P. Morgan

Okay great. Thanks very much.

Operator

Our next question comes from Mark Wiltamuth – Morgan Stanley

Mark Wiltamuth – Morgan Stanley

Hi, congratulations on your cost control. Looking at your chart there forthe last five years you’re SG&A growth has ranged between 11% and 18%, Ihear you did a 9.5% growth number, do you think you can stay down at that 10%range for the balance of the year?

Jeffrey A. Rein

That’s a good question. That’s going to be difficult to do. What we’rereally shooting for obviously, just as I said before, is around 11% to 12%overall. In trying to get down to that 9% year after year, I think that wouldbe tough particularly to opening new stores. If we weren’t opening all of thesenew stores, 550 of them next year, then I believe we could control expenseseven better. But when you’re opening all of these new stores, you have to hirefolks ahead of time. We’re going into smaller towns so it requires a little bitmore help to get those stores open because you don’t have folks to draw from ina mature market. So once again I don’t want to commit to a 9% or 10% with openingall these new stores.

William Rudolphsen

We have done avery good job in thepast of matching our SG&A growth to our gross profits. That’s our intent for thefuture. We fell off thewagon a little bit inthe fourthquarter. We’re coming back and that’s theplan going forward.

Mark Wiltamuth - MorganStanley

Can you give us anindication, I know labor reductions areone of the major goalshere. How have you done on scaling back some of those 24-hour stores and whatdoes that look like to thecustomer as you’ve been doing that?

Jeff Rein

We’ve taken approximately 60 down year over year. But onceagain, it’s all basedon what the needs areof that particular store. Atleast some folks got alittle too aggressive and opened a24-hour store just to try and capture more volume. That’s not asmart way to run thebusiness, to have allof that open, for thestore to be open whenyou don’t need to cover those expenses like that.

I just want to remind you though that year over year westill have more 24-hour stores than we did last year atthis time. Once again, we’re trying torationalize the use ofthese 24-hour stores and make sure we aresmart business people and match up thesales with what’s actually needed.

Mark Wiltamuth - MorganStanley

Inyour November press release you talked alittle bit about discounting inthe market place. Was that more on thefront end or was itdiscounting to capture prescriptions? Ifyou could just characterize what’s going on out there.

Jeff Rein

That was inreference to the frontend. Itwas more in thefront end.

Mark Wiltamuth - MorganStanley

On theTake Care clinics, how much of anearnings drag are yousuffering right now as those stores getstarted? What year doyou think you’ll shift to profitability?

Jeff Rein

Bill, could you answer that please?

William Rudolphsen

Yes Mark, theearnings drag is going to beabout $75 million for theyear; $0.05 earnings pershare. Thebreakeven point, itprobably is going to take about ayear to two years for units to gain share and become profitable. Soit’s all going tohinge on how fast we rollthem out. Certainly we arerolling a lot of theseout in calendar2008. We’re going to have about 400 ofthem by then end of next calendar year, soit’s difficult to project beyond that.

Gregory Wasson

This is Greg. I’dlike to add that theencouraging part of what we’re seeing is some of our more mature markets,mature clinics those that areover a year, inmany cases we’re already exceeding [inaudible].

Operator

Your next question comes from Bob Summers - Bear Stearns.

Bob Summers - BearStearns

Not to beat adead horse here, but just trying to understand thedirect store expenses and I want to make sure that I heard you correctly when yousaid that direct store expense dollars grew faster than sales, if you couldmaybe frame that alittle bit for us?

Tying that into thecash flow statement, Iam just trying tounderstand why cash flowfrom ops, you had adeterioration versus last year and itlooks like there were some significant changes,particularly on theaccrued expense line. If you could maybewalk us through that? Thanks.

William Rudolphsen

Cash flowfrom operations, we did have animpact versus last year. Last year wehad the Ovationscontract through our PBM. That reallygave a lift to ourcash flow, probably inthe $300 millionrange. We don’t have that contract thisyear. Soas we turn thecalendar year, we will bemore comparable on cash flowand I would expect accruals.

On thedirect store expense line, that again grew faster than sales, but itdidn’t grow as fastas it had inprior periods, just like store salaries.

Operator

Our final question will come from Derek Leckow - Barrington Research.

Derek Leckow - Barrington Research

Itlooks like you were able to take advantage of theweakness in thestock recently to buy back some stock. Could you give us anupdate on your buyback program?

William Rudolphsen

We have not been buying back stock, Derek. Atthis point we areinvesting in thecompany. We certainly doconsider it, but atthis point we don’t have excess cash to return to shareholders. We dohave about $1.2 billion inCT atthis point in time.

Derek Leckow - Barrington Research

Sowe should probably anticipate that to befairly flattish going forward?

William Rudolphsen

I dowant to make sure that you know that we dobuy back stock for our employee program and that’s probably what you’re seeing inthe cash flow.

Derek Leckow - Barrington Research

Afinal question on theTake Care clinics, you said that you’re seeing apositive lift in somemature markets but I just wondered if you could talk on astore level basis, what happens to store profitability when you initially openone of these clinics?

Jeff Rein

We haven’t really seen anything. It’s been very, I would sayit’s de minimus whenyou talk about something like that. Onceagain, you’re getting people into theWalgreen’s system. We really haven’t measured that interms of what you’re asking. What wewant to do is getpeople into theWalgreen’s system, approximately 20% of folks coming inare new to Walgreen’s. Ithelps them get into oursystem and getfamiliar with our stores. They gettheir pharmacy needs atour stores, they getexposed to photo, cosmetics and soon. And, they arebeing serviced properly interms of healthcare needs. SoI wouldn’t quantify itat this point.

Derek Leckow - Barrington Research

But longer term, isn’t ittrue that you’re expecting to seesome incremental lift insome of these other categories when you open up these clinics? Or areyou not anticipating that?

Jeff Rein

Yes, that is true. Whenwe did the proforma for them, we didn’t add anything inbut yes, you do seecross shopping. Obviously if peopledon’t need aprescription, sometimes they need anOTC so they will buy itthere. There is theopportunity to sell other products; that is true.

Derek Leckow - Barrington Research

Okay, thank you very much.

Rick J. Hans

Well, that’s itfolks. That’s our final question. Thank you for joining us today. We sincerely hope you found this call usefuland have a clearunderstanding of our financial results and outlook.

We’re committed to maintaining anopen dialogue with you and look forward to speaking with you again andanswering your questions inthe future. Our next scheduled financial announcementwill be January 3 whenwe release our December monthly sales results.

We also invite our shareholders to our annual meeting onJanuary 9 at Navy Pierin Chicago. For those of you unable to attend, you canlisten via thesimulcast available on our Investor Relations website. Until then, we wish you alla happy holiday and ahealthy New Year.

I’d also like to take amoment to wish my daughter aHappy Birthday, she’s sixtoday. By thefact that she’s aWinter Solstice baby, she sure can throw alot of light into theroom. SoHappy Birthday, Catherine.

Thanks again for listening. Remember, you’re always welcome atWalgreen’s.

Operator

That does conclude our call for today. Thank you allfor your participation.

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