Despite solid sales gains, Walgreen Co. fell short of Wall Street's earnings forecast for its fiscal 2014 second quarter. The drug chain also announced plans to close 76 drug stores later this year as part of its store optimization strategy.

Walgreens, fiscal 2014, second quarter, net earnings, total sales, close drug stores, same-store sales, Greg Wasson, AmerisourceBergen, Alliance Boots, generic drug, prescription count, Balance Rewards, William Blair & Co. analyst Mark Miller

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Walgreens 2Q earnings dip; store closures planned

March 25th, 2014

DEERFIELD, Ill. – Despite solid sales gains, Walgreen Co. fell short of Wall Street's earnings forecast for its fiscal 2014 second quarter. The drug chain also announced plans to close 76 drug stores later this year as part of its store optimization strategy.

Walgreens said Tuesday that for the second quarter ended Feb. 28, adjusted net earnings came in at $880 million, or 91 cents per diluted share, compared with $915 million, or 96 cents per diluted share, a year earlier.

On average, analysts projected adjusted earnings of 93 cents per share, with estimates ranging from a low of 86 cents to a high of $1, according to Thomson Financial.

Walgreens noted that earnings adjustments in the second quarter had a net positive impact of $126 million, or 13 cents per diluted share. In the 2013 quarter, earnings adjustments had a net positive impact of $159 million, or 17 cents per diluted share.

GAAP net earnings for the fiscal 2014 second quarter totaled $754 million, or 78 cents per diluted share, compared with $756 million, or 79 cents per diluted share, a year earlier.

GAAP total gross profit dollars increased 0.8% in the second quarter, and gross profit margins decreased 1.3 percentage points to 28.8 as a percentage of sales. Adjusted gross profit dollars edged up 0.4%.

Pharmacy gross profit dollars, Walgreens said, were primarily impacted by the shift in the generic drug wave from a peak in the prior year to a trough in the first half of fiscal 2014. In addition, the company said, a less severe flu season in 2014 second quarter negatively impacted pharmacy gross-profit dollar growth. Front-end margins also declined as the company invested in promotions. Incremental winter weather-related expenses added 0.5 percentage points to selling, general and administrative (SG&A) expenses in the quarter

Walgreens reported free cash flow of $877 million and operating cash flow of $1.1 billion in the second quarter, as lower inventories drove improvements in working capital. The company said inventories also benefited from its transition to source generic drugs from AmerisourceBergen Corp., which is slated to be completed by Sept. 1. AmerisourceBergen already supplies all Walgreens stores with branded prescription drugs.

"Our second quarter performance, in spite of expected headwinds from slower generic drug introductions, comparisons with last year's flu season and severe weather, was marked by solid top-line growth driven by record quarterly sales and record second-quarter prescriptions filled," president and chief executive officer Greg Wasson said in a statement. "We also continued to gain prescription market share while we maintained a firm hold on our costs."

Walgreens said that as part of efforts to optimize its asset base, it plans to close 76 drug stores in the second half of fiscal 2014. The company noted that it still expects a net gain of 55 to 75 stores in fiscal 2014, despite the closures.

The store optimization effort is expected to yield an annual operating income (EBIT) benefit of $40 million to $50 million starting in fiscal 2015, resulting in an estimated 2- to 3-cent benefit in adjusted diluted earnings per share, according to Walgreens. The move also will incur charges of $240 million $280 million, virtually all of which will be recognized in the fiscal 2014 third and fourth quarters, the company said.

"While we seize the opportunity for store growth as the population ages and consumers look to community pharmacy for their health care needs, we also continue to focus on optimizing our assets and organization to position Walgreens for our future as a global company," Wasson stated.

Walgreens said it opened or acquired 28 new drug stores in the fiscal 2014 second quarter, compared with 29 in the prior-year period.

On the revenue side in the second quarter, total sales rose 5.1% year over year to a record $19.60 billion from $18.65 billion. Prescription sales, which represented 62.2% of sales in the quarter, advanced 7%.

Same-store sales in the second quarter were up 4.3%, reflecting gains of 2% in the front end and 5.8% in the pharmacy.

Customer traffic in comparable stores dipped 1.4%, while basket size grew 3.4%. Walgreens noted that its Balance Rewards loyalty program reached a milestone in February with more than 100 million enrollees and almost 80 million active members as of the end of the second quarter. The company said it's leveraging insights from the program to provide customers with more value and simplified promotions.

In the pharmacy, prescription count for the second quarter totaled 214 million, up of 2.8% versus a year ago. Prescriptions filled in comparable stores rose 2.2%. Walgreens noted that, as of Feb. 28, the company raised its retail prescription market share 20 basis points from a year ago to 19%, as reported by IMS Health on a 30-day adjusted basis.

Walgreens added that it saw strong growth in prescriptions filled for Medicare Part D patients, with a gain of 16% year over year in the second quarter. The company said its Part D market share edged up 0.8 percentage point in February compared with a year earlier.

The drug chain said it administered 8.6 million Centers for Disease Control and Prevention-recommended immunizations in the first half of the fiscal year, up 11% versus the year-ago period.

Combined synergies for Walgreens and strategic partner Alliance Boots totaled $236 million in the fiscal 2014 first half. The joint synergy program is estimated to deliver second-year combined synergies of $375 million to $425 million, up from the previous estimate of $350 million to $400 million.

"The upward revision in expected synergies with Alliance Boots is driving increased confidence in the potential of a global platform," William Blair & Co. analyst Mark Miller said in a research note Tuesday. "And the strong growth in 90-day prescriptions at retail (+17% at Walgreens year to year) underscores the value of the core retail pharmacy business in an increasingly consumer-driven health care marketplace."

Walgreens said Alliance Boots contributed 8 cents per diluted share to Walgreens' 2014 second quarter adjusted results. The company estimates that the accretion from Alliance Boots in the fiscal 2014 third quarter will be an adjusted 13 to 14 cents per diluted share.

"We head into the second half of the year with nearly 80 million active members in our Balance Rewards loyalty program and with expectations that the generic drug headwind that affected the first half will ease and turn around by the end of the year," Wasson added. "In addition, our joint synergy program with Alliance Boots is expected to exceed its second-year estimate, and we are bringing critical elements of the Well Experience to additional stores."

As Feb. 28, Walgreens operated 8,210 drug stores overall, 138 more than a year ago.

*Editor's Note: Article updated with analyst comment.