INTRODUCTION

Walgreens is principally a retail drugstore chain that sells prescription and non-prescription drugs and general merchandise. General merchandise includes, among other things, beauty care, personal care, household items, candy, photofinishing, greeting cards, convenience foods and seasonal items. Customers can have prescriptions filled in retail pharmacies, as well as through the mail, by telephone and via the Internet. As of November 30, 2008, we operated 7,123 locations in 49 states, the District of Columbia, Guam and Puerto Rico. Total locations do not include 293 convenient care clinics operated by Take Care Health Systems, Inc.

                                     Number of Locations at November 30,
        Location Type                   2008                       2007
        Drugstores                            6,630                     6,032
        Worksite Facilities                     368                         3
        Home Care Facilities                    110                        91
        Specialty Pharmacies                     13                        11
        Mail Service Facilities                   2                         2
        Total                                 7,123                     6,139

The drugstore industry is highly competitive. In addition to other drugstore chains, independent drugstores and mail order prescription providers, we also compete with various other retailers including grocery stores, convenience stores, mass merchants and dollar stores.

The long-term outlook for prescription utilization is strong due in part to the aging population and the continued development of innovative drugs that improve quality of life and control health care costs. Certain provisions of the Deficit Reduction Act of 2005 seek to reduce federal spending by altering the Medicaid reimbursement formula for multi-source (i.e., generic) drugs. These changes are expected to result in reduced Medicaid reimbursement rates for prescription drugs.

We believe deteriorating economic conditions and heightened turmoil in the financial markets have adversely impacted discretionary consumer spending, including spending at retail drugstores. It is unclear the extent to which these conditions will persist and what overall impact they will have on future consumer spending.

Front-end sales have continued to grow due to strengthening core categories, such as consumables, over-the-counter non-prescription drugs, household products and beauty care items. Walgreens strong name recognition continues to drive private brand sales, which are included in these core categories.

We continue to expand into new markets and increase penetration in existing markets. To support our growth, we are investing in prime locations, technology and customer service initiatives. Retail organic growth continues to be our primary growth vehicle; however, consideration is given to retail and other acquisitions that provide a unique opportunity and strategic fit for our business.

We are currently engaged in company-wide strategic initiatives to broaden access to our products and services, enhance the customer experience for our shoppers, patients and payors and reduce costs to improve productivity. These strategies are intended to enable us to provide the most convenient access to consumer goods and services, and pharmacy and health and wellness services; offer a consistent customer experience across all channels; and ensure that cost, culture and capabilities support and enable our strategies. On October 30, 2008, we announced an initiative to improve efficiency and effectiveness, which targets $1 billion in annual cost savings by fiscal 2011. In conjunction with this initiative, we anticipate incurring total costs of approximately $300 million to $400 million over fiscal 2009 and 2010. During the current quarter we incurred approximately $17 million in pre-tax costs associated with these programs. There were no significant savings realized in the current quarter.

OPERATING STATISTICS

                                                               Percentage Changes
                                                        Three Months         Three Months
                                                       Ended November       Ended November
                                                          30, 2008             30, 2007
Net Sales                                                         6.6                 10.4
Net Earnings                                                    (10.4 )                5.5
Comparable Drugstore Sales                                        1.7                  5.4
Prescription Sales                                                6.2                 11.1
Comparable Drugstore Prescription Sales                           2.6                  5.9
Front-End Sales                                                   7.2                  9.1
Comparable Drugstore Front-End Sales                              0.0                  4.6
Gross Profit                                                      5.9                  9.7
Selling, General and Administrative Expenses                      9.1                 10.0



                                                              Percent to Net Sales
                                                        Three Months         Three Months
                                                       Ended November       Ended November
                                                          30, 2008             30, 2007
Gross Margin                                                     27.8                 28.0
Selling, General and Administrative Expenses                     23.3                 22.8



                                                                 Other Statistics
                                                        Three Months
                                                       Ended November     Three Months Ended
                                                          30, 2008        November 30, 2007
Prescription Sales as a % of Net Sales                           65.9                   66.1
Third Party Sales as a % of Total Prescription Sales             95.4                   95.1
Total Number of Prescriptions (in millions)                       156                    151
Total Number of Locations                                       7,123                  6,139

RESULTS OF OPERATIONS

Net earnings for the first quarter ended November 30, 2008 were $408 million or $0.41 per share (diluted). This was a 10.4% decrease over the same quarter last year. The net earnings decrease resulted from lower gross margins, higher selling, general and administrative expenses as a percentage of sales and higher interest costs.

Net sales for the first quarter increased by 6.6% to $14,947 million. Drugstore sales increases resulted from sales gains in existing stores and added sales from new stores, each of which include an indeterminate amount of market-driven price changes. Sales in comparable drugstores were up 1.7% for the quarter. Comparable drugstores are defined as those that have been open for at least twelve consecutive months without closure for seven or more consecutive days and without a major remodel or a natural disaster in the past twelve months. Relocated and acquired stores are not included as comparable stores for the first twelve months after the relocation or acquisition. We operated 7,123 locations as of November 30, 2008, compared to 6,139 a year earlier.

Prescription sales increased by 6.2% for the first quarter and represented 65.9% of total sales. In the prior year, prescription sales increased 11.1% and comprised 66.1% of total sales. Comparable drugstore prescription sales were up 2.6% in the current quarter. The effect of generic drugs, which have a lower retail price, replacing brand name drugs reduced prescription sales by 2.3% in the current quarter versus 4.2% last year, while the effect on total sales was a reduction of 1.4% in the current quarter versus 2.6% in the prior year. Third party sales, where reimbursement is received from managed care organizations as well as government and private insurance, were 95.4% of prescription sales compared to 95.1% a year ago. The total number of prescriptions filled for the quarter was approximately 156 million compared to 151 million for the same period last year.

Front-end sales increased 7.2% for the current quarter and were 34.1% of total sales. In comparison, prior year front end sales increased 9.1% and comprised 33.9% of total sales. In addition to new stores, the increase is due in part to improved sales dollars related to consumables, non-prescription drugs and household items. Comparable front-end sales were flat in the current quarter compared to a 4.6% increase last year.

Gross margin as a percent of sales was 27.8% in the current quarter compared to 28.0% last year. Overall margins were negatively impacted by non-retail businesses, which have lower margins and are becoming a greater part of the total business and a higher provision for LIFO. This was partially offset by an improvement in retail pharmacy margins, which were positively influenced by generic drug sales, but to a lesser extent negatively influenced by the growth in third party pharmacy sales and lower market driven reimbursements. Front-end margins remained essentially flat from the prior year.

We use the LIFO method of inventory valuation, which can only be determined annually when inflation rates and inventory levels are finalized; therefore, LIFO inventory costs for the interim financial statements are estimated. Cost of sales included a LIFO provision of $43 million for the current quarter compared to a provision of $27 million a year ago. Our estimated annual inflation rate was 2.25% for the current quarter compared to 1.50% a year ago. The increase is attributed to higher anticipated inflation for non-prescription drugs and front-end merchandise.

Gross profit increased 5.9% in this year's first quarter versus 9.7% last year. The change from the prior year is primarily due to lower sales growth.

Selling, general and administrative expenses as a percentage of sales were 23.3% for the current quarter compared to 22.8% a year ago. Higher occupancy expenses, store closing costs, amortization expenses and other miscellaneous expenses were partially offset by lower employee benefit plan expenses and store direct expenses as a percentage of sales.

Selling, general and administrative expenses increased 9.1% this year compared to 10.0% a year ago primarily due to store level salaries and expenses. Although store level salaries and expenses increased at a faster rate than sales, the rate of growth for the current year was lower than a year ago.

Interest was a net expense of $15 million in the current quarter compared to a net expense of zero in the prior year. The increase in interest expense is primarily attributed to the issuance of long-term debt. The current year's interest expense is net of $5 million, which was capitalized to construction projects versus $7 million capitalized last year.

The effective tax rate was 37.6% for the first quarter as compared to 37.4% for a year ago. The increase is attributed to additional provisions for state tax matters.

CRITICAL ACCOUNTING POLICIES

The consolidated condensed financial statements are prepared in accordance with accounting principles generally accepted in the United States of America and include amounts based on management's prudent judgments and estimates. Actual results may differ from these estimates. Management believes that any reasonable deviation from those judgments and estimates would not have a material impact on our consolidated financial position or results of operations. To the extent that the estimates used differ from actual results, however, adjustments to the statement of earnings and corresponding balance sheet accounts would be necessary. These adjustments would be made in future statements. For a complete discussion of all our significant accounting policies please see our 2008 annual report on Form 10-K. Some of the more significant estimates include goodwill and other intangible asset impairment, allowance for doubtful accounts, vendor allowances, liability for closed locations, liability for insurance claims, cost of sales, and income taxes. We use the following methods to determine our estimates:

Goodwill and other intangible asset impairment - Goodwill and other indefinite-lived intangible assets are not amortized, but are evaluated for impairment annually or whenever events or changes in circumstances indicate that the value of a certain asset may be impaired. The process of evaluating goodwill for impairment involves the determination of fair value. Inherent in such fair value determinations are certain judgments and estimates, including the interpretation of economic indicators and market valuations and assumptions about our business plans. We have not made any material changes to the method of evaluating goodwill and intangible asset impairments during the last three years. Based on current knowledge, we do not believe there is a reasonable likelihood that there will be a material change in the estimate or assumptions used to determine impairment. Allowance for doubtful accounts -
The provision for bad debt is based on both specific receivables and historic write-off percentages. We have not made any material changes to the method of estimating our allowance for doubtful accounts during the last three years. Based on current knowledge, we do not believe there is a reasonable likelihood that there will be a material change in the estimate or assumptions used to determine the allowance. Vendor allowances -
Vendor allowances are principally received as a result of purchase levels, sales or promotion of vendors' products. Allowances are generally recorded as a reduction of inventory and are recognized as a reduction of cost of sales when the related merchandise is sold. Those allowances received for promoting vendors' products are offset against advertising expense and result in a reduction of selling, general and administrative expenses to the extent of advertising incurred, with the excess treated as a reduction of inventory costs. We have not made any material changes to the method of estimating our vendor allowances during the last three years. Based on current knowledge, we do not believe there is a reasonable likelihood that there will be a material change in the estimate or assumptions used to determine vendor allowances.

Liability for closed locations -
The liability is based on the present value of future rent obligations and other related costs (net of estimated sublease rent) to the first lease option date. We have not made any material changes to the method of estimating our liability for closed locations during the last three years. Based on current knowledge, we do not believe there is a reasonable likelihood that there will be a material change in the estimate or assumptions used to determine the liability. Liability for insurance claims -
The liability for insurance claims is recorded based on estimates for claims incurred and is not discounted. The provisions are estimated in part by considering historical claims experience, demographic factors and other actuarial assumptions. We have not made any material changes to the method of estimating our liability for insurance claims during the last three years. Based on current knowledge, we do not believe there is a reasonable likelihood that there will be a material change in the estimate or assumptions used to determine the liability.
Cost of sales -
Drugstore cost of sales is derived based on point-of-sale scanning information with an estimate for shrinkage and adjusted based on periodic inventories. Inventories are valued at the lower of cost or market determined by the LIFO method. We have not made any material changes to the method of estimating cost of sales during the last three years. Based on current knowledge, we do not believe there is a reasonable likelihood that there will be a material change in the estimate or assumptions used to determine cost of sales. Income Taxes -
We are subject to routine income tax audits that occur periodically in the normal course of business. U.S. federal, state and local and foreign tax authorities raise questions regarding our tax filing positions, including the timing and amount of deductions and the allocation of income among various tax jurisdictions. In evaluating the tax benefits associated with our various tax filing positions, we record a tax benefit for uncertain tax positions using the highest cumulative tax benefit that is more likely than not to be realized. Adjustments are made to our liability for unrecognized tax benefits in the period in which we determine the issue is effectively settled with the tax authorities, the statute of limitations expires for the return containing the tax position or when more information becomes available. Our liability for unrecognized tax benefits, including accrued penalties and interest, is included in other long-term liabilities on our consolidated balance sheets and in income tax expense in our consolidated statements of earnings.

In determining our provision for income taxes, we use an annual effective income tax rate based on full year income, permanent differences between book and tax income, and statutory income tax rates. The effective income tax rate also reflects our assessment of the ultimate outcome of tax audits. Discrete events such as audit settlements or changes in tax laws are recognized in the period in which they occur. Based on current knowledge, we do not believe there is a reasonable likelihood that there will be a material change in the estimate or assumptions used to determine income taxes.

LIQUIDITY AND CAPITAL RESOURCES

Cash and cash equivalents were $886 million at November 30, 2008, compared to $295 million at November 30, 2007. Short-term investment objectives are to minimize risk, maintain liquidity and maximize after-tax yields. To attain these objectives, investment limits are placed on the amount, type and issuer of securities. Investments are principally in U.S. Treasury market funds.

Net cash provided by operating activities was $312 million compared to $390 million a year ago. The decrease is attributed to lower net earnings, decreased cash from accounts receivable and inventories partially offset by an increase in cash from accounts payable. Cash provided by operations is the principal source of funds for expansion, acquisitions, remodeling programs, dividends to shareholders and stock repurchases. In fiscal 2009, we supplemented cash provided by operations with short-term borrowings.

Net cash used for investing activities was $684 million versus $531 million last year. Additions to property and equipment were $638 million compared to $490 million last year. During the current quarter we added a total of 220 locations (189 net) compared to 169 last year (142 net). There were 59 owned locations added during the quarter and 82 under construction at November 30, 2008 versus 53 owned locations added and 60 under construction as of November 30, 2007.

                          Drugstores       Worksites       Home Care      Specialty Pharmacy       Mail Service         Total
August 31, 2008                6,443             364             115                      10                  2         6,934
  New/Relocated                  200               2               1                       3                  -           206
  Acquired                        12               2               -                       -                  -            14
  Closed/Replaced                (25 )             -              (6 )                     -                  -           (31 )
November 30, 2008              6,630             368             110                      13                  2         7,123

Capital expenditures throughout fiscal 2009 are expected to be $1.8 billion, excluding business acquisitions. We expect to open approximately 540 new drugstores in fiscal 2009, with a net increase of approximately 475 drugstores and anticipate having a total of more than 7,000 drugstores in 2010. We intend to increase new drugstore organic growth between 4.0 percent and 4.5 percent in fiscal 2010 and between 2.5 percent and 3.0 percent in 2011. In the first quarter, we added a total of 220 locations, of which 200 were new or relocated drugstores, with a net gain of 187 drugstores after relocations and closings. We are continuing to relocate stores to more convenient and profitable freestanding locations. In addition to new stores, expenditures are planned for distribution centers and technology. A new distribution center in Windsor, Connecticut is anticipated to open in the current fiscal year.

Net cash provided by financing activities was $815 million compared to $181 million last year. Net proceeds from short-term borrowings during the current period were $998 million compared to $317 million a year ago. Shares totaling $99 million were purchased to support the needs of the employee stock plans during the current period as compared to $78 million a year ago. On January 10, 2007, a new stock repurchase program ("2007 repurchase program") of up to $1,000 million was announced, to be executed over four years. No repurchases were made during the current or prior year's quarter and we do not anticipate executing stock repurchases under the 2007 repurchase program while having short-term debt outstanding. We will continue to repurchase shares to support the needs of the employee stock plans. In the first three months of the current year, we had proceeds related to employee stock plans of $32 million versus $68 million for the same period last year. Cash dividends paid were $111 million during the first three months versus $94 million for the same period a year ago.

We had $1,068 million of commercial paper outstanding at a weighted average interest rate of 1.80% at November 30, 2008. In connection with our commercial paper program, we maintain two unsecured backup syndicated lines of credit that total $1,200 million. The first $600 million facility expires on August 10, 2009, the second on August 12, 2012. Our ability to access these facilities is subject to our compliance with the terms and conditions of the credit facilities, including financial covenants. The covenants require us to maintain certain financial ratios related to minimum net worth and priority debt, along with limitations on the sale of assets and purchases of investments. As of November 30, 2008 we were in compliance with all such covenants. The company pays a facility fee to the financing bank to keep this line of credit facility active. We do not expect any borrowings under these facilities, together with our outstanding commercial paper, to exceed $1,200 million. On December 9, 2008, we entered into an additional $175 million line of credit that expires on December 31, 2008.

Our current credit ratings are as follows:

Rating Agency            Long-Term Debt Rating      Outlook       Commercial Paper Rating      Outlook
Moody's                                A2            Stable                    P-1              Stable
Standard & Poor's                      A+            Stable                    A-1              Stable

In assessing our credit strength, both Moody's and Standard & Poor's consider our business model, capital structure, financial policies and financial statements. Our credit ratings impact our future borrowing costs, access to capital markets and operating lease costs.

CONTRACTUAL OBLIGATIONS AND COMMITMENTS

The following table lists our contractual obligations and commitments as of
November 30, 2008:

                                                      Payments Due by Period (In Millions)
                                                Less than 1
                                    Total          Year          1-3 Years       3-5 Years       Over 5 Years
Operating leases (1)              $  33,807     $     1,849     $     3,941     $     3,849     $       24,168
Purchase obligations (2):
Open inventory purchase orders        1,438           1,438               -               -                  -
Real estate development                 810             810               -               -                  -
Other corporate obligations             703             408             197              55                 43
Long-term debt*                       1,350               8               3           1,303                 36
Interest payment on long-term
debt                                    320              87             127             106                  -
Insurance*                              492             159             116              83                134
Retiree health*                         379               9              22              28                320
Closed location obligations*             73              17              23              12                 21
Capital lease obligations *(1)           41               2               4               3                 32
Other long-term liabilities
reflected on the balance
sheet*(3)                               645              48             116              98                383
Total                             $  40,058     $     4,835     $     4,549     $     5,537     $       25,137

* Recorded on balance sheet.

(1) Amounts for operating leases and capital leases do not include certain operating expenses under the leases such as common area maintenance, insurance and real estate taxes. These expenses for the company's most recent fiscal year were $298 million.
(2) The purchase obligations include agreements to purchase goods or services that are enforceable and legally binding and that specify all significant terms, including open purchase orders.
(3) Includes $38 million ($15 million due in 1-3 years, $14 million due in 3-5 years and $9 million due over 5 years) of unrecognized tax benefits recorded under FIN No. 48, which we adopted in fiscal year 2008.

OFF-BALANCE SHEET ARRANGEMENTS

Letters of credit are issued to support purchase obligations and commitments (as
reflected on the Contractual Obligations and Commitments table) as follows (In
millions):

                         Insurance                $ 265
                         Inventory obligations       62
                         Real estate development     14
                         Other                        8
                         Total                    $ 349

We have no other off-balance sheet arrangements other than those disclosed on the Contractual Obligations and Commitments table and a credit agreement guaranty on behalf of SureScripts-RxHub, LLC. This agreement is described more fully in Note 6 in the Notes to Consolidated Condensed Financial Statements.

Both on-balance sheet and off-balance sheet financing are considered when targeting debt to equity ratios to balance the interests of equity and debt (including real estate) investors. This balance allows us to lower our cost of capital while maintaining a prudent level of financial risk.

RECENT ACCOUNTING PRONOUNCEMENTS

In September 2006, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 157, Fair Value Measurements. This statement, and the related pronouncements, defines and provides guidance when applying fair value measurements to accounting pronouncements that require or permit such measurements. We adopted the provisions of SFAS 157, Fair Value Measurements for financial assets and liabilities beginning in the first quarter of fiscal 2009. FASB Staff Position No. 157-2 deferred the effective date of nonfinancial asses and liabilities until fiscal year 2010. We do not expect to have a material impact in 2010 when we apply the statement to our nonfinancial assets and liabilities. In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interest in Consolidated Financial Statements - an amendment of Accounting Research Bulletin . . .