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Walgreen Company 10-Q 2009 UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
WASHINGTON,
D.C. 20549
FORM
10-Q
(Mark
One)
FOR
THE QUARTER ENDED MAY 31, 2009
OR
For the
transition period from _______to _______
Commission
File Number
1-604
 WALGREEN
CO.
(Exact
name of registrant as specified in its charter)
(847)
914-2500
(Registrant's
telephone number, including area code)
Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days.
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer or a smaller reporting
company. See definitions of "large accelerated filer”, “accelerated
filer" and “smaller reporting company” in Rule 12b-2 of the Exchange
Act.
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).
The
number of shares outstanding of the registrant's Common Stock, $.078125 par
value, as of May 31, 2009 was 992,380,086.
WALGREEN
CO.
FORM
10-Q FOR THE QUARTER ENDED MAY 31, 2009
TABLE OF
CONTENTS
PART
I. FINANCIAL
INFORMATION
PART
II. OTHER INFORMATION
PART
1. FINANCIAL INFORMATION
The
consolidated condensed financial statements included herein have been prepared
by the company pursuant to the rules and regulations of the Securities and
Exchange Commission. The Consolidated Condensed Balance Sheets as of
May 31, 2009, August 31, 2008 and May 31, 2008, the Consolidated Condensed
Statements of Earnings for the three and nine months ended May 31, 2009 and
2008, and the Consolidated Condensed Statements of Cash Flows for the nine
months ended May 31, 2009 and 2008, have been prepared without
audit. Certain information and footnote disclosures normally included
in financial statements prepared in accordance with accounting principles
generally accepted in the United States of America have been condensed or
omitted pursuant to such rules and regulations, although the company believes
that the disclosures are adequate to make the information presented not
misleading. It is suggested that these consolidated condensed
financial statements be read in conjunction with the financial statements and
the notes thereto included in the company's latest annual report on Form
10-K.
In the
opinion of the company, the consolidated condensed statements for the unaudited
interim periods presented include all adjustments, consisting of normal
recurring adjustments, necessary to present a fair statement of the results for
such interim periods. Because of the influence of certain holidays,
seasonal and other factors on the company's operations, net earnings for any
interim period may not be comparable to the same interim period in previous
years or necessarily indicative of earnings for the full year.
The
accompanying Notes to Consolidated Condensed Financial
Statements
are an integral part of these Statements.
The
accompanying Notes to Consolidated Condensed Financial
Statements
are an integral part of these Statements.
The
accompanying Notes to Consolidated Condensed Financial
Statements
are an integral part of these Statements.
WALGREEN
CO. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(1) The
consolidated condensed financial statements include the accounts of the company
and its subsidiaries. All intercompany transactions have been
eliminated. 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. For a complete discussion of all our significant
accounting policies please see our 2008 annual report on Form 10-K.
The May
31, 2008 balance sheet reflects the reclassification of debt, which was
previously condensed within the accrued expenses and other liabilities line and
other non-current liabilities line. In addition, software development
costs were reclassified from other non-current assets to property and
equipment.
(2) On
October 30, 2008 we announced a series of strategic initiatives, approved by the
Board of Directors, to enhance 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.
As of May
31, 2009 we have recorded the following pre-tax charges associated with our
restructuring initiatives within the Consolidated Statement of
Earnings:
The $65
million of severance and other benefits includes the charges associated with 438
employees who participated in the voluntary separation program and 362 employees
who were involuntarily separated from the company.
Inventory
charges consist of on-hand inventory that has been reduced from cost to current
selling prices and the loss we incurred on the sale of inventory below
cost.
As of May
31, 2009 we have recorded the following balances within the accrued expenses and
other liabilities section of our Consolidated Balance Sheets:
(3)
Short-term investments at May 31, 2009 include a $100 million Treasury Bill
maturing in October 2009. The interest rate on the Treasury Bill is
less than one percent. The investment is held to maturity and
recorded at cost in accordance with SFAS 115 Accounting for Certain Investments
in Debt and Equity Securities. The fair value of the Treasury
Bill at May 31, 2009 approximated cost.
(4)
Inventories are valued on a lower of last-in, first-out (LIFO) cost or market
basis. At May 31, 2009, August 31, 2008 and May 31, 2008, inventories
would have been greater by $1,191 million, $1,067 million and $1,042 million
respectively, if they had been valued on a lower of first-in, first-out (FIFO)
cost or market basis. LIFO inventory costs can only be determined
annually when inflation rates and inventory levels are finalized; therefore,
LIFO inventory costs for interim financial statements are estimated. Inventory
includes product cost, inbound freight, warehousing costs and vendor allowances
not included as a reduction of advertising expense.
(5) The
principal retirement plan for employees is the Walgreen Profit-Sharing
Retirement Trust to which both the company and participating employees
contribute. The company's contribution, which is determined annually
at the discretion of the Board of Directors, has historically related to pre-tax
income; however, beginning January 1, 2008, a portion of that contribution is in
the form of a guaranteed match. The profit-sharing provision was $73
million for the current quarter and $221 million for the nine month period
compared to $81 million and $242 million in the same periods last
year. The company’s contributions, which are made annually in the
second quarter, were $301 million for the nine month period ended May 31,
2009. This compares to $261 million for the prior year.
(6) The
company granted 234,716 and 16,906,061 stock options under the Walgreen Co.
Executive Stock Option Plan and the Walgreen Co. Stock Purchase/Option Plan
(Share Walgreens) for the quarter and nine month period ended May 31,
2009. This compares to 99,917 and 4,255,915 stock options granted in
the quarter and nine month period ended under the plans last
year. Total stock-based compensation expense was $19 million for the
quarter and $68 million for the nine month period ended May 31, 2009 compared to
$11 million and $56 million for the comparable periods last year. In
accordance with Statement of Financial Accounting Standards (SFAS) No. 123(R),
compensation expense is recognized on a straight-line basis over the employee's
vesting period or to the employee's retirement eligible date, if
earlier. There was $1 million of fully recognized retiree eligible
expense recorded in the current quarter and $15 million recorded for the first
nine months. This compares to no fully recognized retiree eligible
expenses and $16 million for the quarter and nine months ended May 31,
2008. Therefore, compensation expense for the quarter and nine month
periods is not representative of compensation expense for the entire fiscal
year. There has been no material change in the assumptions used to
compute compensation expense during the current quarter or year.
The
company granted 15,423 and 514,470 restricted stock units under the new Walgreen
Co. Restricted Stock Unit Award Program and 17,443 and 546,096 performance
shares under the new Walgreen Co. Performance Share Program for the quarter and
nine months ended May 31, 2009. In accordance with SFAS No. 123(R),
compensation expense is recognized on a straight line basis based on a three
year cliff vesting schedule for the Restricted Stock Unit Award Program and
straight line over a three year vesting schedule for the Performance Share
Program. For the quarter and nine month periods ended May 31, 2009
the company recognized $3 million and $10 million of expense related to these
new plans, respectively.
(7) The
company provides certain health insurance benefits for retired employees who
meet eligibility requirements, including age, years of service and date of
hire. The costs of these benefits are accrued over the period earned.
The company's postretirement health benefit plans are not
funded.
In May
2009, we amended the company’s postretirement health benefit plans to change the
eligibility requirements. As a result of this amendment we recognized
curtailment income of $16 million for the quarter ended May 31,
2009.
Additionally
in the second quarter, the company recognized a special retirement benefit
expense of $4 million related to accelerating eligibility for certain employees
who elected special early retirement as a part of our initiative to enhance
shareholder value.
(8) The
company guarantees a credit agreement on behalf of SureScripts-RxHub, LLC, which
provides electronic prescription data services. This credit
agreement, for which SureScripts-RxHub, LLC is primarily liable, has an
expiration date of June 30, 2011. The liability was $10 million at
May 31, 2009, $8 million at August 31, 2008 and $7 million at May 31,
2008. The maximum amount of future payments that could be required
under the guaranty is $25 million, of which $13 million may be recoverable from
another guarantor. In addition, under certain circumstances the
company may be required to provide an additional guarantee of up to $10 million,
of which $8 million may be recoverable from other guarantors. This
guarantee arose as a result of a business decision between parties to ensure
that the operations of SureScripts-RxHub, LLC would have additional support to
access financing. Should SureScripts-RxHub, LLC default or become
unable to pay its debts, the company would be required to fulfill our portion of
this guarantee.
(9) The dilutive effect of
outstanding stock options on earnings per share is calculated using the treasury
stock method. Stock options are anti-dilutive and excluded from the
earnings per share calculation if the exercise price exceeds the average market
price of the common shares for the periods presented. At May 31, 2009
and 2008, outstanding options to purchase common shares of 49,354,716 and
12,998,212, respectively were excluded from the calculation.
(10)
Short-term borrowings and long-term debt consists of the following at May 31,
2009 and 2008 (in millions):
In fiscal
2009 and 2008 the company issued commercial paper to support working capital
needs. The short-term borrowings under the commercial paper program had the
following characteristics (in millions):
The
carrying value of the commercial paper approximates the fair value.
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 expires 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. The
company pays a facility fee to the financing bank to keep the line of credit
facility active. As of May 31, 2009, there have been no borrowings
against the credit facilities. On December 9, 2008, we entered into
an additional $175 million line of credit that expired on December 31,
2008.
On July
17, 2008, we issued notes totaling $1,300 million bearing an interest rate of
4.875% paid semiannually in arrears on February 1 and August 1 of each
year, beginning on February 1, 2009. The notes will mature on
August 1, 2013. We may redeem the notes, at any time in whole or from time
to time in part, at our option at a redemption price equal to the greater of:
(1) 100% of the principal amount of the notes to be redeemed; or
(2) the sum of the present values of the remaining scheduled payments of
principal and interest thereon (not including any portion of such payments of
interest accrued as of the date of redemption), discounted to the date of
redemption on a semiannual basis (assuming a 360-day year consisting of twelve
30-day months) at the Treasury Rate, plus 30 basis points, plus accrued interest
on the notes to be redeemed to, but excluding, the date of
redemption. If a change of control triggering event occurs, unless we
have exercised our option to redeem the notes, we will be required to offer to
repurchase the notes at a purchase price equal to 101% of the principal amount
of the notes plus accrued and unpaid interest to the date of
redemption. The notes are unsecured senior debt obligations and rank
equally with all other unsecured senior indebtedness of the company. The notes
are not convertible or exchangeable. Total issuance costs relating to
this offering were $9 million, which included $8 million in underwriting
fees. The fair value of the notes as of May 31, 2009, was $1,394
millio. Fair
value was determined based upon discounted future cash flows for these
notes.
On
January 13, 2009, we issued notes totaling $1,000 million bearing an interest
rate of 5.25% paid semiannually in arrears on January 15 and July 15 of each
year, beginning on July 15, 2009. The notes will mature on January 15, 2019. We
may redeem the notes, at any time in whole or from time to time in part, at our
option at a redemption price equal to the greater of: (1) 100% of the
principal amount of the notes to be redeemed; or (2) the sum of the
present values of the remaining scheduled payments of principal and interest
thereon (not including any portion of such payments of interest accrued as of
the date of redemption), discounted to the date of redemption on a semiannual
basis (assuming a 360-day year consisting of twelve 30-day months) at the
Treasury Rate, plus 45 basis points, plus accrued interest on the notes to be
redeemed to, but excluding, the date of redemption. If a change of
control triggering event occurs, unless we have exercised our option to redeem
the notes, we will be required to offer to repurchase the notes at a purchase
price equal to 101% of the principal amount of the notes plus accrued and unpaid
interest to the date of redemption. The notes are unsecured senior
debt obligations and rank equally with all other unsecured senior indebtedness
of the company. The notes are not convertible or exchangeable. Total
issuance costs relating to this offering were $8 million, which included $7
million in underwriting fees. The fair value of the notes as of May
31, 2009, was $1,048 million. Fair value was determined based upon
discounted future cash flows for these notes.
(11)
During the quarter the company aquired and opened 29 Drug Fair
locations in addition to selected other assets (primarily prescription
files). The aggregate purchase price of all business acquisitions was
$348 million for the nine month period ended May 31, 2009. These
acquisitions added $210 million to goodwill and intangible
assets. The remaining fair value relates to tangible assets, less
liabilities assumed. The allocations of the purchase price for all
acquisitions, except Drug Fair, McKesson Specialty and IVPCARE, have been
finalized. Operating results of the businesses acquired have been
included in the consolidated statements of earnings from their respective
acquisition dates forward. Pro forma results of the company, assuming
all of the acquisitions had occurred at the beginning of each period presented,
would not be materially different from the results reported.
(12) The
company is involved in legal proceedings, and is subject to investigations,
inspections, audits, inquiries and similar actions by governmental authorities,
incidental to the normal course of the company’s
business.
In
October 2006, a $31 million judgment was entered against the company in Illinois
state court. In March 2009, the Illinois Appellate Court reversed the
punitive portion of the judgment in the amount of $25 million and the company
settled the balance of the claim. Other parties of interest in
the matter have appealed the reversal of the punitive damages to the Supreme
Court of Illinois.
On April
16, 2008, the Plumbers and Steamfitters Local No. 7 Pension Fund filed a
putative class action suit against the company and its former Chief Executive
Officer and Chief Operating Officer in the United States District Court for the
Northern District of Illinois. The suit was filed on behalf of
purchasers of company common stock during the period between June 25, 2007, and
November 29, 2007. The complaint, which was amended on October 16,
2008, charges the company and its former Chief Executive Officer and Chief
Operating Officer with violations of Section 10(b) of the Securities Exchange
Act of 1934, claiming that the company misled investors by failing to disclose
declining rates of growth in generic drug sales and a contract dispute with a
pharmacy benefits manager that allegedly had a negative impact on earnings. The
company and the officers named in the suit believe the allegations are without
merit, and intend to defend against them vigorously.
Although
the outcome of these and other legal proceedings and investigations to which the
company is subject cannot be forecast with certainty, management believes the
final disposition of these matters will not have a material adverse effect on
the company's consolidated financial position or results of
operations.
(13) Cash
interest paid for the nine months ended May 31, 2009 was $45 million compared to
$11 million in the prior year’s nine month period. Cash paid for
income taxes was $523 million and $897 million for the nine months ended May 31,
2009 and May 31, 2008, respectively.
(14) Non-cash
transactions in the current fiscal period include $97 million due to the
reduction in the liability for postretirement health benefit plans and $19
million in deferred tax assets related to the identification of net operating
losses in acquired businesses. There were no material non-cash
transactions in the prior year’s period.
(15) We
adopted the provisions of SFAS 157, Fair Value Measurements for
financial assets and liabilities beginning in the first quarter of fiscal
2009. With the exception of short term investments, we currently do
not hold any financial assets or liabilities that are included within the scope
of this statement. Our debt instruments are not reported at fair
value in our statement of financial position and as a result, we will continue
to report under the guidance of SFAS 107, Disclosures about Fair Value of
Financial Instruments that requires us to disclose the fair value of our
debt in the footnotes. The Financial Accounting Standards Board
(FASB) Staff Position No. 157-2 deferred the effective date of nonfinancial
assets 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.
(16) Accumulated
other comprehensive income at May 31, 2009 was $59 million compared to $9
million in the prior year. In May 2009 the company’s postretirement
health benefit plans were amended to change eligibility
requirements. As a result of the amendment, our postretirement health
benefit plan liability was decreased by $97 million and accumulated other
comprehensive income was increased by $50 million net of deferred
taxes.
(17) In
December 2007, the FASB issued SFAS No. 160, Noncontrolling Interest in
Consolidated Financial Statements – an amendment of Accounting Research Bulletin
No. 51. The objective of this statement is to improve the
relevance, comparability, and transparency of the financial information that a
reporting entity provides in its consolidated financial statements by
establishing accounting and reporting standards for the noncontrolling interest
in a subsidiary and for the deconsolidation of a subsidiary. The
statement significantly changes the accounting for transactions with minority
interest holders. This statement, which will be effective for the
first quarter of fiscal 2010, is not expected to have a material impact on our
consolidated financial position or results of operations.
In
December 2007, the FASB issued SFAS No 141(R), Business
Combinations. This statement establishes principles and
requirements for how the acquirer recognizes and measures identifiable assets
acquired, liabilities assumed and any noncontrolling interest in a business
combination. In addition the statement provides a revised definition
of a business, shifts from the purchase method to the acquisition method,
expenses acquisition-related transaction costs, recognizes contingent
consideration and contingent assets and liabilities at fair value, and
capitalizes acquired in-process research and development. This statement, which
will be effective for the first quarter of fiscal 2010, will be applied
prospectively to business combinations. In addition, changes in an
acquired entity’s deferred tax assets and uncertain tax positions after the
measurement period will impact income tax expense.
In May
2009, the FASB issued SFAS No. 165, Subsequent
Events. This statement establishes general standards of
accounting for and disclosures of events that occur after the balance sheet date
but before financial statements are issued or are available to be issued. In
particular, this statement sets forth (1) the period after the balance sheet
date during which management of a reporting entity should evaluate events or
transactions that may occur for potential recognition or disclosure in the
financial statements; (2) the circumstances under which an entity should
recognize events or transactions occurring after the balance sheet date in its
financial statements; and (3) the disclosures that an entity should make about
events or transactions that occurred after the balance sheet
date. This statement, effective for the fourth quarter in the current
fiscal year, will be applied prospectively in future filings.
In June
2009, the FASB approved its Accounting Standards Codification, or Codification,
as the single source of authoritative United States accounting and reporting
standards applicable for all non-governmental entities, with the exception of
the SEC and its staff. The Codification, which changes the referencing of
financial standards, is effective for interim or annual financial periods ending
after September 15, 2009. Therefore, in the first quarter of fiscal 2010, all
references made to US GAAP will use the new Codification numbering system
prescribed by the FASB. As the Codification is not intended to change or alter
existing US GAAP, it is not expected to have any impact on our consolidated
financial position or results of operations.
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
May 31, 2009, we operated 7,361 locations in 49 states, the District of
Columbia, Guam and Puerto Rico. Total locations do not include 343
convenient care clinics operated by Take Care Health Systems, Inc.
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 be reduced 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. 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 primarily due to the addition of new
stores. Additionally, front-end sales grew due to strengthening core
categories, such as over-the-counter non-prescription drugs, beauty care items,
household products and consumables. 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 enhance 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.
Additionally,
in conjunction with our Customer Centric Retailing (CCR) initiative we are
enhancing the store format to ensure we have the proper assortments, better
category lay-outs and adjacencies, better shelf height and site lines and better
assortment and brand layout, all of which are designed to positively enhance the
shopper experience and increase customer frequency and purchase
size. This format will be rolled out to approximately 5,000 to 5,500
stores beginning in the fall and continuing through calendar
2010. Although we will continue to refine our estimates as the
roll-out progresses, based on our experience with the first thirty-five pilot
stores, we expect the cost to be $30 thousand to $50 thousand per
store.
As of May
31, 2009 we have recorded the following pre-tax charges associated with our
restructuring initiatives within the Consolidated Statement of
Earnings:
The $65
million of severance and other benefits includes the charges associated with 438
employees who participated in the voluntary separation program and 362 employees
who were involuntarily separated from the company.
Inventory
reserve charges consist of on-hand inventory that has been reduced from cost to
current selling prices and the loss we incurred on the sale of inventory below
cost. In addition, as a part of our restructuring efforts we sold an
incremental amount of inventory below traditional retail prices. The
dilutive effect of these sales on gross profit was $32 million in the current
quarter and nine month period.
As of May
31, 2009 we have recorded the following balances within the accrued expenses and
other liabilities section of our Consolidated Balance Sheets:
We have
realized savings related to these initiatives of approximately $87 million in
the current quarter and $139 million for the first nine months. The
savings, which are included in selling, general and administrative expense, are
primarily the result of reduced store labor and headcount
reductions.
OPERATING
STATISTICS
RESULTS
OF OPERATIONS
Net
earnings for the third quarter ended May 31, 2009 were $522 million or $0.53 per
share (diluted). This was an 8.8% decrease over the same quarter last
year. Net earnings for the nine months decreased 8.4% to $1,570
million or $1.58 per share (diluted). The net earnings decrease in
the quarter and nine 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
current quarter we recorded $47 million in restructuring expenses, $20 million
for consulting and other expenses and $32 million in margin dilution related to
our restructuring activities. For the nine month period we have
recorded $117 million in restructuring expenses, $57 million for consulting and
other expenses and $32 million in margin dilution related to our restructuring
activities.
Net sales
for the third quarter increased by 8.0% to $16,210 million and rose by 7.2% to
$47,632 million for the first nine 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 2.8% for the quarter
and 1.9% for the nine 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 7,361 locations as of May
31, 2009, compared to 6,727 a year earlier.
Prescription
sales increased by 8.2% for the third quarter and 7.4% for the first nine months
and represented 65.6% and 64.9% of total sales, respectively. In the
prior year, prescription sales increased 8.9% for the quarter and 10.3% year to
date and represented 65.5% and 64.7% of total sales. Comparable
drugstore prescription sales were up 3.8% in the current quarter and 3.1% in the
nine month period. The effect of generic drugs, which have a lower
retail price, replacing brand name drugs reduced prescription sales by 3.8% in
the current quarter and 2.8% for the first nine months versus 3.4% in the
previous quarter and 4.0% in the previous nine month period. The
effect of generics on total sales was a reduction of 2.1% in the current quarter
and 1.5% year to date compared to 1.9% in the prior year’s quarter and 2.2% year
to date. Third party sales, where reimbursement is received from
managed care organizations as well as government and private insurance, were
95.4% of prescription sales for the quarter and the first nine months this year
compared to 95.5% and 95.2% in the prior year. The total number of
prescriptions filled for the third quarter was approximately 168 million
compared to 158 million for the same period last year. Prescriptions
adjusted to 30 day equivalents were 187 million in the third quarter verses 173
last year.
Front-end
sales increased 7.4% for the current quarter and 6.7% for the first nine months
and were 34.4% and 35.1% of total sales, respectively. In comparison,
prior year front end sales increased 11.1% and 9.9% and comprised 34.5% and
35.3% 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 increasing 0.9% in the current quarter and decreasing
0.2% year to date compared to increases of 4.6% and 4.4% last year.
Gross
margin as a percent of sales was 27.5% in the current quarter and 27.9% for the
first nine months compared to 28.3% and 28.4% last year. Overall
margins were negatively impacted by lower front-end margins due to product mix,
non-retail businesses, which have lower margins and are becoming a greater part
of the total business, restructuring and restructuring related costs and a
higher provision for LIFO. These items were 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 $32 million and $124 million for the quarter and nine month period ended May 31, 2009 versus $16 million and $74 million a year ago. This quarter our estimated annual inflation rate was reduced to 2.0% from our estimate of 2.25% at February 28, 2009, primarily due to lower than projected prescription drug inflation. Last year, during the third quarter the estimated annual inflation rate was reduced to 1.25% from 1.5%, due to lower than projected non-prescription drug inflation. Gross
profit increased 5.0% in the quarter and 5.2% year to date versus 9.5% and 9.7%
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 22.3% for the
current quarter and 22.6% for the first nine months compared to 22.2% and 22.3%
a year ago. As a percentage of sales, the current quarter and nine
month period increases were due to higher restructuring and restructuring
related expenses and occupancy, partially offset by lower store level salaries
and savings related to our restructuring activities.
Selling,
general and administrative expenses increased 8.4% in the third quarter and 8.5%
for the nine month period ended May 31, 2009 compared to 10.2% and 10.5% a year
ago. Restructuring and restructuring related expenses accounted for
1.0% of the increase in the current quarter and 1.3% of the increase for the
nine month period. Partially offsetting restructuring and
restructuring related 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 $25 million in the quarter and $60 million year to date,
compared to $2 million and $4 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 $3 million in the quarter and $12 million year to
date, which was capitalized to construction projects versus $4 million in the
quarter and $16 million year to date capitalized last
year.
The
effective tax rate was 36.4% for the quarter and 36.8% for the first nine months
compared to 37.3% and 37.1% a year ago. The decrease in rate is
attributed to additional permanent tax benefits in the current
year.
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:
LIQUIDITY
AND CAPITAL RESOURCES
Cash and
cash equivalents were $2,300 million at May 31, 2009, compared to $472 million
at May 31, 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 nine months ending May 31, 2009
improved $768 million to $3,259 million compared to $2,491 million a year
ago. The increase is primarily attributable to working capital
improvements. For the nine months ended May 31, 2009 we generated
$602 million in cash flow from working capital improvements, primarily through
better inventory management. Working capital improvements were
partially offset by lower net earnings. Last year, working capital
improvements generated $114 million in cash flow. 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 $1,936 million versus $2,154 million last
year. Using the proceeds from our issuance of long-term debt we
invested $650 million in short-term Treasury Bills of which $550 million was
redeemed in the third quarter. Additions to property and equipment were $1,534
million compared to $1,653 million last year. During the first nine
months we added a total of 525 locations (427 net) compared to 797 last year
(730 net). There were 140 owned locations added during the first nine
months and 53 under construction at May 31, 2009 versus 166 owned locations
added and 67 under construction last year.
Business
acquisitions this year were $348 million versus $527 million in the prior
year. Business acquisitions in the current year include the
acquisition of 34 Drug Fair locations, 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 $1.9 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 nine months, we added a total of 525 locations,
of which 407 were new or relocated drugstores, with a net gain of 414 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. Capital expenditures for fiscal 2010 are expected to be
approximately $1.6 billion, excluding business acquisitions and prescription
file purchases.
Net cash
provided by financing activities was $534 million compared to a net cash use of
$120 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 proceeds of $263 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 $220
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 nine
months of the current year, we had proceeds related to employee stock plans of
$106 million versus $161 million for the same period last year. Cash
dividends paid were $334 million during the first nine months versus $283
million for the same period a year ago.
We had no
commercial paper outstanding at May 31, 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 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 May 31, 2009
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. While we are still able to access these lines of credit, as
of May 31, 2009, there were no borrowings outstanding against these credit
facilities. We do not expect any borrowings under these facilities,
together with our outstanding commercial paper, to exceed $1,200
million.
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