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WAG > SEC Filings for WAG > Form 10-Q on 27-Dec-2013All Recent SEC Filings

Show all filings for WALGREEN CO

Form 10-Q for WALGREEN CO


27-Dec-2013

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of our financial condition and results of operations should be read together with the financial statements and the related notes included elsewhere herein and our consolidated financial statements, accompanying notes and Management's Discussion and Analysis of Financial Condition and Results of Operations contained in our Annual Report on Form 10-K for the year ended August 31, 2013. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from those discussed in forward-looking statements. Factors that might cause a difference include, but are not limited to, those discussed under "Cautionary Note Regarding Forward-Looking Statements" below and in Item 1A "Risk Factors" in our Annual Report on Form 10-K for the year ended August 31, 2013.

INTRODUCTION

Walgreens is principally a retail drugstore chain that sells prescription and non-prescription drugs and general merchandise. General merchandise includes, among other things, household items, convenience and fresh foods, personal care, beauty care, photofinishing and candy. We offer customers the choice to have prescriptions filled at our retail pharmacies as well as through the mail, telephone or online including through our mobile application. At November 30, 2013, we operated 8,681 locations in 50 states, the District of Columbia, Guam, Puerto Rico and the U.S. Virgin Islands. Total locations do not include 405 Healthcare Clinics that are operated primarily within other Walgreens locations or locations of unconsolidated partially owned entities such as Alliance Boots GmbH.

                                                             Number of Locations
Location Type                                      November 30, 2013          November 30, 2012
Drugstores                                                     8,200                      8,058
Worksite Health and Wellness Centers                             372                        369
Infusion and Respiratory Services Facilities                      96                         80
Specialty Pharmacies                                              11                          7
Mail Service Facilities                                            2                          2
Total                                                          8,681                      8,516

The drugstore industry is highly competitive where we compete with other drugstore chains, independent drugstores and mail order prescription providers.
We also compete with various other retailers including grocery stores, convenience stores, mass merchants, online pharmacies, warehouse clubs and dollar stores.

Our sales, gross profit margin and gross profit dollars are impacted by, among other things, both the percentage of prescriptions that we fill that are generic and the rate at which new generic drugs are introduced to the market. In general, generic versions of drugs generate lower total sales dollars per prescription, but higher gross profit margins and gross profit dollars, as compared with patent-protected brand name drugs. The positive impact on gross profit margins and gross profit dollars typically has been significant in the first several months after a generic version of a drug is first allowed to compete with the branded version, which is generally referred to as a "generic conversion." In any given year, the number of major brand name drugs that undergo a conversion from branded to generic status can increase or decrease, which can have a significant impact on our sales, gross profit margins and gross profit dollars. Because any number of factors outside of our control or ability to foresee can affect timing for a generic conversion, we face substantial uncertainty in predicting when such conversions will occur and what effect they will have on particular future periods.

The long-term outlook for prescription utilization is strong due in part to the aging population, the increasing utilization of generic drugs, the continued development of innovative drugs that improve quality of life and control health care costs, and the expansion of health care insurance coverage under the Patient Protection and Affordable Care Act (the ACA). The ACA seeks to reduce federal spending by altering the Medicaid reimbursement formula (AMP) for multi-source drugs, and when implemented, is expected to reduce Medicaid reimbursements. State Medicaid programs are also expected to continue to seek reductions in reimbursements independent of AMP. We continuously face reimbursement pressure from pharmacy benefit management (PBM) companies, health maintenance organizations, managed care organizations and other commercial third party payers; our agreements with these payers are regularly subject to expiration, termination or renegotiation. In addition, plan changes typically occur in January and in fiscal 2013, the high rate of introduction of new generic drugs moderated the impact of any associated rate adjustments. We experienced a lower rate of new generic introductions in the first quarter and anticipate a significantly lower rate of introduction of new generics in the second quarter of fiscal 2014, compared to the same periods last year.

On July 19, 2012, Walgreens and Express Scripts announced their entry into a new multi-year agreement pursuant to which Walgreens began participating in the broadest Express Scripts retail pharmacy provider network available to Express Scripts clients as of September 15, 2012. From January 1, 2012, until September 14, 2012, however, Express Scripts' network did not include Walgreens pharmacies. The positive impact of this agreement generally has been incremental over time since September 15, 2012.

Periodically, we make strategic acquisitions and investments that fit our long-term growth objectives. Consideration is given to retail, health and well-being enterprises and other potential acquisitions and investments that provide unique opportunities and fit our business objectives. In the first quarter of fiscal 2014, we acquired certain assets of Kerr Drug and its affiliates, which includes 76 retail drugstore locations, as well as a specialty pharmacy business and a distribution center, all based in North Carolina. In fiscal 2013, we acquired Stephen L. LaFrance Holdings, Inc. (USA Drug), which includes 141 drugstore locations operating under the USA Drug, Super D Drug, May's Drug, Med-X and Drug Warehouse names. Additionally, we acquired an 80% interest in Cystic Fibrosis Foundation Pharmacy LLC. This investment provides joint ownership in a specialty pharmacy for cystic fibrosis patients and their families in addition to providing new product launch support and call center services for drug manufacturers.

In August 2012, we acquired a 45% equity interest in Alliance Boots GmbH (Alliance Boots) and a call option that provides Walgreens the right, but not the obligation, to purchase the remaining 55% over a six month period beginning February 2, 2015. Additional information regarding our investment in Alliance Boots is available in our Current Reports on Form 8-K filed on June 19, 2012 and August 6, 2012 (as amended by the Form 8-K/A filed on September 10, 2012). The amendment to our August 6, 2012 Form 8-K filed on September 10, 2012, includes as exhibits thereto Alliance Boots audited consolidated financial statements for the years ended March 31, 2012, 2011 and 2010 (prepared in accordance with International Financial Reporting Standards (IFRS) as issued by the International Accounting Standards Board) and unaudited pro forma consolidated financial information related to our 45% investment in Alliance Boots. Alliance Boots audited consolidated financial statements for the years ended March 31, 2013 and 2012 (prepared in accordance with IFRS) are available on our Form 8-K filed on May 15, 2013. We account for our 45% investment in Alliance Boots using the equity method of accounting. Investments accounted for under the equity method are recorded initially at cost and subsequently adjusted for our share of the net income or loss and cash contributions and distributions to or from these entities. Net income reported by Alliance Boots is translated from British pounds Sterling at the average rate for the period. See Note 5 to our unaudited Consolidated Condensed Financial Statements for additional information regarding our equity method investments. We utilize a three-month lag in reporting equity income from our investment in Alliance Boots, reported as equity earnings in Alliance Boots on the Consolidated Condensed Statements of Earnings. The investment is recorded as equity investment in Alliance Boots in the Consolidated Condensed Balance Sheets.

Fiscal 2014 combined synergies across both companies are estimated to be between $350 million and $400 million. The three-month lag impacts the quarterly and fiscal year timing of when Alliance Boots results and synergies will be reflected in the equity earnings in Alliance Boots included in our financial statements. See "Cautionary Note Regarding Forward-Looking Statements" below.

The Alliance Boots business is seasonal in nature, typically generating a higher proportion of revenue and earnings in the winter holiday and cold and flu season. Because we utilize a three-month lag in reporting equity income from our investment in Alliance Boots, the results of Alliance Boots for December, January and February will be reflected in the equity income included in our financial statements for the fiscal quarter ending May 31. See "Cautionary Note Regarding Forward-Looking Statements" below.

On March 19, 2013, the Company, Alliance Boots GmbH and AmerisourceBergen Corporation (AmerisourceBergen) announced various agreements and arrangements, including a ten-year pharmaceutical distribution agreement between Walgreens and AmerisourceBergen pursuant to which we will source branded and generic pharmaceutical products from AmerisourceBergen; an agreement which provides AmerisourceBergen the ability to access generics and related pharmaceutical products through Walgreens Boots Alliance Development GmbH, a global sourcing joint venture between Walgreens and Alliance Boots; and agreements and arrangements pursuant to which we and Alliance Boots together have the right, but not the obligation, to purchase a minority equity position in AmerisourceBergen and gain associated representation on AmerisourceBergen's board of directors in certain circumstances. AmerisourceBergen began to distribute all branded pharmaceutical products that we historically sourced from distributors and suppliers, effective September 1, 2013. Over time, beginning in calendar year 2014, AmerisourceBergen is expected to distribute increasingly significant levels of generic pharmaceutical products that we currently self-distribute. In addition to the information in this report, please refer to our Current Report on Form 8-K filed on March 20, 2013 and our Quarterly Report on Form 10-Q filed on March 25, 2013 for more detailed information regarding these agreements and arrangements. See "Cautionary Note Regarding Forward-Looking Statements" below.

Investments accounted for under the equity method are recorded initially at cost and subsequently adjusted for our share of the net income or loss and cash contributions and distributions to or from these entities. Our investment in Alliance Boots and the related call option were recorded as assets with a $7.3 billion aggregate value on our November 30, 2013 Consolidated Condensed Balance Sheets, which represented 29.5% of our long-lived assets as of that date.
Because our investment in Alliance Boots is denominated in a foreign currency (British pounds Sterling), translation gains or losses impact the value of the investment. See Note 5 to our unaudited Consolidated Condensed Financial Statements for additional information.

OPERATING STATISTICS

                                                          Percentage Increases/(Decreases)
                                                                 Three Months Ended
                                                                    November 30,
                                                           2013                     2012
Net Sales                                                         5.9                      (4.6 )
Net Earnings                                                     68.3                     (25.5 )
Comparable Drugstore Sales                                        5.4                      (8.0 )
Prescription Sales                                                7.3                      (7.2 )
Comparable Drugstore Prescription Sales                           7.2                     (11.3 )
Front-End Sales                                                   3.3                       0.2
Comparable Drugstore Front-End Sales                              2.4                      (2.0 )
Gross Profit                                                      1.0                      (0.1 )
Selling, General and Administrative Expenses                     (0.4 )                     4.6




                                                  Percent to Net Sales
                                                   Three Months Ended
                                                      November 30,
                                                  2013             2012
Gross Margin                                         28.1             29.4
Selling, General and Administrative Expenses         23.9             25.4




                                                              Other Statistics
                                                             Three Months Ended
                                                                November 30,
                                                           2013                2012
Prescription Sales as a % of Net Sales                           64.7               63.8
Third Party Sales as a % of Total Prescription                   95.8               95.7
Sales
Number of Prescriptions (in millions)                             175                169
Comparable Prescription % Increase/(Decrease)                     3.3               (7.4 )
30 Day Equivalent Prescriptions (in millions) *                   213                201
Comparable 30 Day Equivalent Prescription %
Increase/(Decrease) *                                             5.5               (4.8 )
Total Number of Locations                                       8,681              8,516

* Includes the adjustment to convert prescriptions greater than 84 days to the equivalent of three 30-day prescriptions. This adjustment reflects the fact that these prescriptions include approximately three times the amount of product days supplied compared to a normal prescription.

RESULTS OF OPERATIONS

Net earnings attributable to Walgreen Co. for the first quarter ended November 30, 2013 were $695 million, or $.72 per diluted share. This was a 68.3% increase in net earnings over the same quarter last year. The net earnings increase in the quarter was primarily attributable to fair market value gains related to the AmerisourceBergen warrants, equity earnings in Alliance Boots, and lower selling, general and administrative expenses as a percentage of sales partially offset by lower gross margins. Included in the first quarter net earnings and net earnings per diluted share, respectively, was income of $161 million, or $.17 per diluted share, related to fair value adjustments and amortization related to our warrants to purchase AmerisourceBergen common stock; $58 million, or $.06 per diluted share, in acquisition-related amortization; $37 million, or $.04 per diluted share, from the quarter's LIFO provision; $28 million, or $.03 per diluted share, in Alliance Boots related tax; $16 million, or $.02 per diluted share, of other acquisition-related costs and $15 million, or $.02 per diluted share, of organizational efficiency costs. Included in the first quarter ended November 30, 2012 net earnings and net earnings per diluted share, respectively, was $59 million, or $.06 per diluted share, in acquisition-related amortization, $34 million, or $.04 per diluted share, from the quarter's LIFO provision, $24 million, or $.03 per diluted share, in costs related to Hurricane Sandy and $23 million, or $.02 per diluted share, of other acquisition-related costs.

Net sales for the quarter ended November 30, 2013 increased by 5.9% to $18.3 billion. Sales increased from new stores, each of which include an indeterminate amount of market-driven price changes, and higher comparable store sales. Sales in comparable drugstores were up 5.4% in the quarter ended November 30, 2013. 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 8,681 locations (8,200 drugstores) as of November 30, 2013, compared to 8,516 locations (8,058 drugstores) a year earlier.

Prescription sales increased by 7.3% and represented 64.7% of total net sales for the quarter ended November 30, 2013. In the prior year's quarter, prescription sales decreased by 7.2% and represented 63.8% of total net sales.
Comparable drugstore prescription sales were up 7.2% for the quarter ended November 30, 2013. The effect of generic drugs, which have a lower retail price, replacing brand name drugs reduced prescription sales by 0.9% in the current quarter versus 8.8% in the prior year's quarter. The effect of generics on total net sales was a reduction of 0.5% in the current quarter compared to 4.9% in the prior year's quarter. Third party sales, where reimbursement is received from managed care organizations, the government, employers or private insurers, were 95.8% of prescription sales for the quarter ended November 30, 2013, compared to 95.7% in the prior year. We receive market driven reimbursements from third party payers, a number of which typically reset in January. The total number of prescriptions filled for the current quarter (including immunizations) was approximately 175 million compared to 169 million for the same period last year.
Prescriptions adjusted to 30 day equivalents were 213 million in the current quarter versus 201 million in last year's quarter.

Front-end sales increased 3.3% and were 35.3% of total net sales for the current quarter ended November 30, 2013. In comparison, prior year front-end sales increased 0.2% for the quarter, and comprised 36.2% of total net sales. Comparable drugstore front-end sales increased 2.4% for the current quarter compared to the prior year which decreased 2.0%. The increase in comparable front-end sales in the quarter was primarily attributed to an increase in basket size and, to a lesser extent, increased customer traffic.

Gross margin as a percent of sales was 28.1% in the current quarter compared to 29.4% last year. Retail pharmacy margins were negatively impacted by generics, including a significant reduction in the number of brand to generic drug conversions, and lower market driven reimbursements, each as compared to the comparable prior year period. Front-end margins were negatively impacted by meaningful promotional investments throughout the quarter to drive store traffic and were also negatively impacted in the convenience and fresh foods, non-prescription drug, beauty and photofinishing categories. Retail pharmacy and front-end margins were positively impacted by purchasing synergies realized from the joint venture formed by Walgreens and Alliance Boots.

Gross profit dollars increased $53 million or 1.0% over the first quarter of the prior year. The increase is attributed to higher sales volumes partially offset by lower retail pharmacy and front-end margins.

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 $58 million for the quarter ended November 30, 2013 versus $55 million a year ago. As of the first quarter, our estimated annual inflation rate for the current year was 2.75% compared to 2.50% last year.

Selling, general and administrative expenses as a percentage of sales were 23.9% for the first quarter and 25.4% a year ago. As a percentage of sales, expenses in the current quarter were lower primarily due to lower store compensation costs, advertising costs, acquisition-related costs and occupancy expenses. The current period comparison also benefited from certain nonrecurring costs incurred last year, including expenses related to Hurricane Sandy.

Selling, general and administrative expense dollars decreased $19 million or 0.4% over the first quarter of the prior year. New stores expenses added 1.3%, organizational efficiency costs added 0.4% and comparable store expense added 0.3%. These were offset by lower headquarters and acquisition-related costs of 1.2% and 0.3%, respectively. In addition, Hurricane Sandy costs in the prior year were 0.9%.

Earnings in the 45% Alliance Boots equity method investment for the three month period ended November 30, 2013 were $151 million as compared to $4 million for the three month period ended November 30, 2012. Alliance Boots earnings are reported on a three-month lag. As a result, the fiscal quarter ending November 30, 2012 only included August's results of operations of Alliance Boots reflected in the equity earnings in Alliance Boots. Current period earnings included an income tax benefit of $71 million from remeasuring deferred tax balances related to UK tax law changes enacted in July 2013, which reduced the future income tax rate for UK entities. In addition, current period earnings included $19 million in fair value adjustments and amortization related to Alliance Boots warrants to purchase AmerisourceBergen common stock. Earnings reflect $10 million, $8 million net of tax, of incremental acquisition-related amortization for the quarter ended November 30, 2013, compared to the same period last year of $12 million, $10 million net of tax, of which $8 million related to inventory.

Other income for the three month period ended November 30, 2013 was $225 million. The increase in fair value of our AmerisourceBergen warrants resulted in recording other income of $220 million. The increase in the fair value of the warrants was primarily attributable to the increase in the price of AmerisourceBergen's common stock. In addition, we recorded $5 million of other income relating to the amortization of the deferred credit associated with the initial value of the warrants.

Interest was a net expense of $41 million and $37 million for the periods ending November 30, 2013 and 2012, respectively. Interest expense for the periods ending November 30, 2013 and 2012 is net of $2 million that was capitalized to construction projects.

The effective tax rate was 36.8% compared to 38.2% in the prior year's quarter. The decrease in the current year's effective tax rate, as compared to last year's rate is primarily attributed to favorable changes in the geographic mix of our pre-tax results, which were partly offset by incremental discrete period income tax expenses.

LIQUIDITY AND CAPITAL RESOURCES

Cash and cash equivalents were $1.0 billion at November 30, 2013, compared to $1.8 billion at November 30, 2012. 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.

Our long-term capital policy is to maintain a strong balance sheet and financial flexibility; reinvest in our core strategies; invest in strategic opportunities that reinforce our core strategies and meet return requirements; and return surplus cash flow to shareholders in the form of dividends and share repurchases over the long term.

Net cash provided by operating activities for the three months ended November 30, 2013 was $133 million compared to $601 million a year ago. When compared to the prior year, cash from operating activities decreased primarily as a result of changes in working capital balances. For the three months ended November 30, 2013, working capital used $846 million of cash as compared to the prior year, where working capital used $214 million. The increase in cash used for working capital was primarily attributable to the timing of payments related to the AmerisourceBergen transition. Cash provided by operations is the principal source of funds for expansion, acquisitions, remodeling programs, dividends to shareholders and stock repurchases.

Net cash used for investing activities was $925 million for the three months ended November 30, 2013 compared to $809 million a year ago. Additions to property and equipment were $364 million compared to $336 million last year.
During the first three months, we added a total of 132 locations (99 net) compared to 231 last year (131 net). There were 14 owned locations added during the first three months and 55 under construction at November 30, 2013 versus 16 owned locations added and 46 under construction last year.

                                                            Infusion and
                                                             Respiratory         Specialty
                            Drugstores       Worksites        Services          Pharmacies         Mail Service        Total
August 31, 2013                   8,116             371                82                  11                  2         8,582
  New/Relocated                      53               8                 -                   -                  -            61
  Acquired                           57               -                14                   -                  -            71
  Closed/Replaced                   (26 )            (7 )               -                   -                  -           (33 )
November 30, 2013                 8,200             372                96                  11                  2         8,681

Business acquisitions this year were $243 million versus $471 million in the prior year. Business acquisitions in the current year include the purchase of certain assets of regional drugstore chain Kerr Drug and its affiliates for $173 million, subject to adjustment in certain circumstances. Business acquisitions in the comparable prior year period included the purchase of the regional drugstore chain USA Drug from Stephen L. LaFrance Holdings, Inc. and members of the LaFrance family for $416 million net of assumed cash, and selected other assets (primarily prescription files). In connection with our strategic relationship with AmerisourceBergen, we purchased AmerisourceBergen common stock in open market transactions totaling $290 million during the three month period ended November 30, 2013.

Capital expenditures for fiscal 2014 are expected to be approximately $1.4 billion, excluding business acquisitions, joint ventures and prescription file purchases, although the actual amount may vary depending upon a variety of factors, including, among other things, the timing of implementation of certain capital projects. Excluding acquisitions, we expect to add a total of approximately 85 to 160 new drugstores in fiscal 2014. In addition, we continue to allocate a portion of our capital budget to relocating stores to more convenient and desirable freestanding locations.

Net cash used by financing activities was $345 million compared to the prior year net cash provided of $740 million. We repurchased shares to support the needs of the employee stock plans totaling $205 million and $50 million for the three months ended November 30, 2013 and 2012, respectively. We had proceeds related to employee stock plans of $173 million during the first three months versus $45 million for the same period last year. Cash dividends paid were $298 million during the first three months of fiscal 2014, versus $260 million for the same period a year ago. Last year we received proceeds from a public offering of $4.0 billion of notes with varying interest rates (see Note 9). The . . .

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