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 February 28, 2009, we operated 7,173 locations in 49 states, the District of Columbia, Guam and Puerto Rico. Total locations do not include 334 convenient care clinics operated by Take Care Health Systems, Inc.

                                       Number of Locations
Location Type               February 28, 2009         February 29, 2008
Drugstores                              6,678                     6,129
Worksite Facilities                       367                         5
Home Care Facilities                      108                        89
Specialty Pharmacies                       18                        12
Mail Service Facilities                     2                         2
Total                                   7,173                     6,237

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. Also, in conjunction with a recently approved class action settlement, the methodology used to calculate the average wholesale price (AWP), a pricing reference widely used in the pharmacy industry, is expected to change for many brand-name prescription drugs effective September 2009. The company expects to reach agreement on adjustments with its third party payors.

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

Front-end sales have continued to grow primarily due to the addition of new stores. Additionally, front-end sales grew 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.

RESTRUCTURING CHARGES

On October 30, 2008 we announced a series of strategic initiatives, approved by the Board of Directors, to create shareholder value. One of these initiatives was a program designed to reduce cost and improve productivity through strategic sourcing of indirect spend, reducing corporate overhead and work throughout our stores, rationalization of inventory categories, realignment of pharmacy operations and transforming the community pharmacy. In conjunction with these initiatives approximately $300 to $400 million of costs are anticipated over fiscal 2009 and 2010. We anticipate achieving approximately $1 billion in annual cost savings by fiscal 2011 related to these initiatives.

As of February 28, 2009 we have recorded the following pre-tax charges associated with our restructuring initiatives within the Consolidated Statement of Earnings:

                                        Three Months Ended       Six Months Ended
                                        February 28, 2009       February 28, 2009
Severance and other benefits           $                 59     $               59
Inventory write-downs                                    11                     11
Restructuring expense                                    70                     70
Consulting                                               23                     37
Restructuring and restructuring
related costs                          $                 93     $              107

Cost of sales                          $                 11     $               11
Selling, general and administrative
expense                                                  82                     96
                                       $                 93     $              107

The $59 million of severance and other benefits includes the charges associated with the 435 employees who participated in the voluntary separation program and 231 employees who were involuntarily separated from the company.

As of February 28, 2009 we have recorded the following balances within the accrued expenses and other liabilities section of our Consolidated Balance Sheets:

                                                                                              February 28,
                                  August 31, 2008                                             2009 Reserve
                                  Reserve Balance      Charges         Cash Payments            Balance
Severance and other benefits      $             -     $       64     $                1     $             63

We have realized savings related to these initiatives of approximately $30 million in the current quarter and $52 million for the first six months.

OPERATING STATISTICS

                                                                         Percentage Changes
                                                Three Months Ended                                 Six Months Ended
                                    February 28, 2009         February 29, 2008       February 28, 2009        February 29, 2008
Net Sales                                          7.0                      10.5                     6.8                     10.4
Net Earnings                                      (6.7 )                     5.2                    (8.2 )                    5.3
Comparable Drugstore Sales                         1.3                       4.7                     1.5                      5.1
Prescription Sales                                 7.8                      11.1                     7.0                     11.1
Comparable Drugstore
Prescription Sales                                 2.9                       5.2                     2.8                      5.5
Front-End Sales                                    5.7                       9.4                     6.4                      9.3
Comparable Drugstore Front-End
Sales                                             (1.2 )                     4.0                    (0.7 )                    4.3
Gross Profit                                       4.8                      10.1                     5.3                      9.9
Selling, General and
Administrative Expenses                            8.1                      11.2                     8.6                     10.6




                                                                        Percent to Net Sales
                                                Three Months Ended                                 Six Months Ended
                                    February 28, 2009         February 29, 2008       February 28, 2009        February 29, 2008
Gross Margin                                      28.3                      28.9                    28.0                     28.4
Selling, General and
Administrative Expenses                           22.0                      21.8                    22.6                     22.2




                                                                      Other Statistics
                                                Three Months Ended                             Six Months Ended
                                                                                                             February 29,
                                    February 28, 2009         February 29, 2008       February 28, 2009          2008
Prescription Sales as a % of Net
Sales                                             63.2                      62.8                    64.5              64.4
Third Party Sales as a % of
Total Prescription Sales                          95.2                      95.1                    95.3              95.1
Total Number of Prescriptions
(in millions)                                      164                       157                     320               308
Total Number of Locations                                                                          7,173             6,237

RESULTS OF OPERATIONS

Net earnings for the second quarter ended February 28, 2009 were $640 million or $0.65 per share (diluted). This was a 6.7% decrease over the same quarter last year. Net earnings for the six months decreased 8.2% to $1,048 million or $1.06 per share (diluted). The net earnings decrease in the quarter and six months was attributed to a lower rate of sales growth, lower gross margins, higher selling, general and administrative expenses as a percentage of sales and higher interest costs. Additionally, in the quarter and six month periods we recorded $70 million in restructuring expenses and $23 million in the quarter and $37 million for the six month period for consulting related to our restructuring activities. Prior year's results benefited from one extra day because of leap year.

Net sales for the second quarter increased by 7.0% to $16,475 million and rose by 6.8% to $31,422 million for the first six months. 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 1.3% for the quarter and 1.5% for the six month period. 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 7,173 locations as of February 28, 2009, compared to 6,237 a year earlier.

Prescription sales increased by 7.8% for the second quarter and 7.0% for the first six months and represented 63.2% and 64.5% of total sales, respectively. In the prior year, prescription sales increased 11.1% for both the quarter and year to date and represented 62.8% and 64.4% of total sales. Comparable drugstore prescription sales were up 2.9% in the current quarter and 2.8% in the six month period. 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 and six month period versus 4.4% in the previous quarter and 4.3% in the previous six month period. The effect of generics on total sales was a reduction of 1.3% in the current quarter and year to date compared to 2.4% in the prior year's periods. Third party sales, where reimbursement is received from managed care organizations as well as government and private insurance, were 95.2% of prescription sales for the quarter and 95.3% for the first six months this year compared to 95.1% in the prior year's periods. The total number of prescriptions filled for the second quarter was approximately 164 million compared to 157 million for the same period last year.

Front-end sales increased 5.7% for the current quarter and 6.4% for the first six months and were 36.8% and 35.5% of total sales, respectively. In comparison, prior year front end sales increased 9.4% and 9.3% and comprised 37.2% and 35.6% of total sales. The overall increase is due to the addition of new stores and an increase in sales dollars related to consumables and household items. Offsetting the increase were decreases in sales dollars from seasonal items, photo and personal care. These factors contributed to comparable front-end sales decreasing 1.2% in the current quarter and 0.7% year to date compared to increases of 4.0% and 4.3% last year.

Gross margin as a percent of sales was 28.3% in the current quarter and 28.0% for the first six months compared to 28.9% and 28.4% 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, lower front-end margins due to promotional pricing and product mix 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.

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 $49 million and $92 million for the quarter and six month period ended February 28, 2009 versus $31 million and $58 million a year ago. Our estimated annual inflation rate was 2.25% for the quarter and six month period compared to 1.50% a year ago. The increase is attributed to higher anticipated inflation for non-prescription drugs and other front-end merchandise.

Gross profit increased 4.8% in the quarter and 5.3% year to date versus 10.1% and 9.9% increases in the same periods last year. The change from the prior year is primarily due to lower sales growth and lower gross margins.

Selling, general and administrative expenses as a percentage of sales were 22.0% for the current quarter and 22.6% for the first six months compared to 21.8% and 22.2% a year ago. In the current quarter higher restructuring expenses were partially offset by lower store level salaries as a percentage of sales. Year to date higher restructuring, occupancy and other miscellaneous expenses were partially offset by lower store level salaries as a percentage of sales.

Selling, general and administrative expenses increased 8.1% in the second quarter and 8.6% for the six month period ended February 28, 2009 compared to 11.2% and 10.6% a year ago. Restructuring expenses accounted for 2.4% of the increase in the current quarter and 1.5% of the increase for the six month period. Partially offsetting restructuring expenses was a reduction in store level salaries for the current quarter and year to date. Store level salaries increased at a lower rate of growth than sales, contrary to the prior year where the rate of growth was higher than sales.

Interest was a net expense of $20 million in the quarter and $35 million year to date, compared to $2 million and $2 million in the prior quarter and year to date, respectively. The increase in interest expense is primarily attributed to the issuance of long-term debt. The current year's interest expense is net of $4 million in the quarter and $9 million year to date, which was capitalized to construction projects versus $5 million in the quarter and $12 million year to date capitalized last year.

The effective tax rate was 36.7% for the quarter and 37.0% for the first six months compared to 36.8% and 37.1% a year ago.

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 to an actuarially determined estimate 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. Cost of sales will continue to be impacted by our restructuring initiatives which include inventory rationalization and the subsequent write-down of inventory to the lower of cost or market. 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 $909 million at February 28, 2009, compared to $255 million at February 29, 2008. 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 and Treasury Bills.

Net cash provided by operating activities for the six months ending February 28, 2009 improved $234 million to $1,740 million compared to $1,506 million a year ago. The increase is primarily attributable to working capital improvements. For the six months ended February 28, 2009 we generated $157 million in cash flow from working capital improvements, primarily through better inventory and accounts payable management. Working capital improvements were partially offset by lower net earnings. Working capital in the prior period was a cash use of $5 million. 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 long-term debt.

Net cash used for investing activities was $1,896 million versus $1,121 million last year. Using the proceeds from our issuance of long-term debt we invested $650 million in short-term Treasury Bills. Additions to property and equipment were $1,092 million compared to $1,043 million last year. During the first six months we added a total of 303 locations (239 net) compared to 290 last year (240 net). There were 88 owned locations added during the first six months and 71 under construction at February 28, 2009 versus 104 owned locations added and 70 under construction as of February 29, 2008.

                         Drugstores       Worksites       Home Care      Specialty Pharmacy       Mail Service         Total
August 31, 2008               6,443             364             115                      10                  2         6,934
  New/Relocated                 245              19               3                       4                  -           271
  Acquired                       24               2               1                       5                  -            32
  Closed/Replaced               (34 )           (18 )           (11 )                    (1 )                -           (64 )
February 28, 2009             6,678             367             108                      18                  2         7,173

Business acquisitions this year were $183 million versus $90 million in the prior year. Business acquisitions in the current year include the acquisition of McKesson Corporation's specialty pharmacy, a business within McKesson's Specialty division and IVPCARE, a specialty pharmacy focused on reproductive health and selected other assets (primarily prescription files).

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 achieve 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 six months, we added a total of 303 locations, of which 245 were new or relocated drugstores, with a net gain of 235 drugstores after relocations and closings. We are continuing to relocate stores to more convenient freestanding locations. In addition to new stores, expenditures are planned for distribution centers and technology. A new distribution center in Windsor, Connecticut opened in the current quarter.

Net cash provided by financing activities was $622 million compared to a net cash use of $385 million last year. On January 13, 2009, we issued $1,000 million of 5.25% notes due in 2019. The notes were issued at a discount. The net proceeds after deducting the discount, underwriting fees and issuance costs were $987 million. The proceeds were used to pay down short-term borrowings with the excess used to purchase short term investments in Treasury Bills. Short-term borrowings paid during the current fiscal year were $70 million compared to $122 million a year ago. Shares totaling $140 million were purchased to support the needs of the employee stock plans during the current period as compared to $148 million a year ago. On January 10, 2007, a stock repurchase program ("2007 repurchase program") of up to $1,000 million was announced, to be executed over four years. No repurchases were made under the 2007 repurchase program during the current or prior year. We plan to continuously evaluate executing any stock repurchases under the 2007 repurchase program throughout the year. We will continue to repurchase shares to support the needs of the employee stock and option plans. In the first six months of the current year, we had proceeds related to employee stock plans of $77 million versus $106 million for the same period last year. Cash dividends paid were $223 million during the first six months versus $188 million for the same period a year ago.

We had no commercial paper outstanding at February 28, 2009. 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 . . .