2nd UPDATE: Walgreen 2Q Profit Falls 7.7% On Express Scripts Exit

NEW YORK (Dow Jones)--Walgreen Co.'s (WAG) fiscal second-quarter earnings fell 7.7% as the drug store chain's exit from pharmacy-benefit manager Express Scripts Inc. (ESRX) network and a mild cold and flu season weighed on its performance.

The drugstore giant, which operates roughly 8,290 locations, reported that same-store sales fell 2.1% as a decline in its pharmacy section offset growth in the front of the store. Customer traffic edged up and basket size improved, though prescriptions filled dropped 4.9% on a same-store basis.

Walgreen's latest results come as prescription payers and providers gear up for a volatile pharmacy-benefit manager selling season. President and Chief Executive Greg Wasson told analysts during a conference call that Walgreen has "never been this busy this early in a season and every indication is that this will be the most active selling season in recent memory."

Walgreen at the end of last year allowed a contract with Express Scripts to expire, resulting in some clients going elsewhere to fill their prescriptions. Wall Street is also waiting to see if Express Scripts' planned acquisition of rival PBM Medco Health Solutions Inc. (MHS) wins Federal Trade Commission approval.

Investors and analysts have long mulled about what would happen to Walgreen's contract with Medco if the latter company was acquired by Express Scripts. Chief Financial Officer Wade Miquelon on Tuesday called Walgreen's ongoing contract with Medco "fair for both parties" and added it intends to serve all patients unless the new company took "an extraordinary action terminating existing contact."

Walgreen has defended its decision to let a contract with Express Scripts expire, instead touting changes to its stores including the consolidation of its existing private brands and by adding more prepackaged foods, fresh flowers and other seasonal items. Walgreen is also expanding to new channels through acquisitions, including last year's purchase of online retailer Drugstore.com Inc. and the pending $225 million deal for BioScrip Inc. (BIOS), which would give it expanded access to new and limited-distribution drugs for HIV, cancer and organ transplants.

Still, the loss of major customer Express Scripts is a top concern among investors and analysts. The company has attempted to retain as many customers as possible through the use of coupons and a special Prescription Savings Club membership discount, while also moving to cut costs to help protect profits.

For the quarter ended Feb. 29, Walgreen reported a profit of $683 million, or 78 cents a share, down from $739 million, or 80 cents a share, a year earlier. Analysts polled by Thomson Reuters most recently projected earnings of 77 cents.

The company said the impact of no longer being in Express Scripts network hurt results by 7 cents a share, and Walgreen warned it expected the loss of that business will result in a roughly 21-cent hit to fiscal year earnings. That estimate incorporates some planned cost savings initiatives and should be balanced throughout the last three quarters of the year.

A mild cold and flu season reduced profit by 3 cents in the latest quarter. The weak flu season has broadly hurt the industry and particularly affects Walgreen, the second-largest provider of flu immunizations after the federal government.

Gross margin edged up to 28.9% from 28.8%. Overhead costs were up 4.1%.

Margins benefited from strong demand for a generic version of cholesterol-lowering drug Lipitor, launched as the quarter began. Generics carry higher margins than name brand drugs do, though analysts say they are a headwind to same-store sales as they carry lower prices. Among the big drugs next on the patent-expiration list are Plavix and Lexapro.

Earlier this month, Walgreen reported that total sales edged up 0.8% to $18.7 billion.

Walgreen shares were up 0.7% to $34.62 in recent trading. The stock has underperformed the broader market's gain so far this year.

-By John Kell, Dow Jones Newswires; 212-416-2480; john.kell@dowjones.com

--Tess Stynes contributed to this article.

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