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Walgreen Company 10-Q 2009 Documents found in this filing:UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
WASHINGTON,
D.C. 20549
FORM
10-Q
(Mark
One)
FOR
THE QUARTER ENDED FEBRUARY 28, 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 February 28, 2009 was 991,708,990. WALGREEN
CO.
FORM
10-Q FOR THE QUARTER ENDED FEBRUARY 28, 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
February 28, 2009, August 31, 2008 and February 29, 2008, the Consolidated
Condensed Statements of Earnings for the three and six months ended February 28,
2009 and February 29, 2008, and the Consolidated Condensed Statements of Cash
Flows for the six months ended February 28, 2009 and February 29, 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
February 29, 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 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.
As of
February 28, 2009 we have recorded the following pre-tax charges associated with
our restructuring initiatives within the Consolidated Statement of
Earnings:
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:
(3)
Short-term investments at February 28, 2009 include three Treasury Bills of $300
million, $250 million and $100 million maturing in April, March and October
2009, respectively. The interest rate on the Treasury bills is less
than one percent. The investments are 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
Bills at February 28, 2009 approximated cost.
(4)
Inventories are valued on a lower of last-in, first-out (LIFO) cost or market
basis. At February 28, 2009, August 31, 2008 and February 29, 2008,
inventories would have been greater by $1,159 million, $1,067 million and $1,026
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 $90
million for the current quarter and $148 million for the six month period
compared to $97 million and $161 million in the same periods last
year. The company’s contributions, which are made annually in the
second quarter, were $301 million durring the current period. This
compares to $261 million for the prior year.
(6) Total
stock-based compensation expense was $17 million for the quarter and $49 million
for the six month period ended February 28, 2009 compared to $13 million and $45
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 no material fully recognized retiree eligible
expense recorded in the current quarter and $14.0 million recorded for the first
six months. This compares to no fully recognized retiree eligible
expenses and $16 million for the quarter and six months ended February 29,
2008. Therefore, compensation expense for the quarter and six month
periods is not representative of compensation expense for the entire fiscal
year. There were no significant grants in the current or prior year’s
quarter. There has been no material change in the assumptions used to
compute compensation expense during the current quarter or year.
(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.
For the
quarter ended February 28, 2009, 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
increase 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
February 28, 2009, $8 million at August 31, 2008 and $7 million at February 29,
2008. The maximum amount of future payments that could be required to
be paid 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 February 28,
2009 and February 29, 2008, outstanding options to purchase common shares of
49,804,413 and 12,880,046, respectively, were excluded from the
calculation.
(10)
Short-term borrowings and long-term debt consists of the following at February
28, 2009 and February 29, 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 both
fiscal years.
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 February 28, 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 will be unsecured senior debt
obligations and will 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 February 28, 2009, was $1,390
million.
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 will
be unsecured senior debt obligations and will 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 February 28, 2009, was $988 million.
(11)
During the quarter the company completed 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). The
aggregate purchase price of all business acquisitions was $183 million for the
six month period ended February 28, 2009. These acquisitions added
$115 million to goodwill and intangible assets. The remaining fair
value relates to tangible assets less liabilities assumed. The
allocation of the purchase price for each of these acquisitions, except McKesson
Specialty and IVPCARE has 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.
During
the quarter we also completed the final purchase price allocation for our
acquisitions of I-trax, Inc. and Whole Health Management with no material
adjustment to the preliminary allocation.
(12)
The company is involved in various legal proceedings incidental to the normal
course of business and is subject to various investigations, inspections,
audits, inquiries and similar actions by governmental authorities responsible
for enforcing the laws and regulations to which the company is
subject. These include a lawsuit for which a $31 million
judgment was entered against the company in October 2006. The company
has appealed this judgment.
In
addition, 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.
Management
is of the opinion that although the outcome of these and other litigation and
investigations cannot be forecast with certainty, the final dispositions should
not have a material adverse effect on the company's consolidated financial
position or results of operations.
(13) Cash
interest paid for the six months ended February 28, 2009 was $43 million
compared to $5 million in the prior six months. Cash paid for income
taxes was $299 million and $405 million for the six months ended February 28,
2009 and February 29, 2008, respectively.
(14) We
adopted the provisions of SFAS 157, Fair Value Measurements for
financial assets and liabilities beginning in the first quarter of fiscal
2009. 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.
(15) 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.
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.
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:
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:
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
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:
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.
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 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 February 28,
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 February 28, 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. On December 9, 2008, we entered into an additional $175
million line of credit that expired on December 31, 2008.
Our
current credit ratings are as follows:
In
assessing our credit strength, both Moody's and Standard & Poor's consider
our business model, capital structure, financial policies and financial
statements. Our credit ratings impact our future borrowing costs,
access to capital markets and operating lease costs.
CONTRACTUAL
OBLIGATIONS AND COMMITMENTS
The
following table lists our contractual obligations and commitments as of February
28, 2009:
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