SEPTEMBER 27, 2011, 1:57 P.M. ET.

Walgreen Profit Surges 69%

By MAXWELL MURPHY

NEW YORK—Walgreen Co.'s fiscal fourth-quarter earnings surged 69% as the drugstore giant benefited from the sale of its pharmacy benefits management business, but shares dipped as the looming loss of major customer Express Scripts Inc. appeared no closer to resolution.

Excluding the sale of Walgreens Health Initiatives to Catalyst Health Solutions Inc., adjusted earnings rose 10% in the quarter, the result of sales growth at the front end of its stores and higher prescription sales.

Walgreen said there has been no progress in talks to renew a pact with pharmacy-benefits manager Express Scripts that it expects will bring $5.3 billion in annual revenue this year. The pact expires Jan. 1, 2012.

Shares of Walgreen were down 5.4% at $34.07 amid Tuesday's broad market surge as Wall Street reacted to the Express Scripts impasse. The stock is up 15% over the past year, even after a nearly 17% drop over the past three months.

On a conference call to discuss results, Walgreen Chief Executive Greg Wasson said it is in talks with Express Scripts clients to evaluate ways to retain patients who prefer to continue a relationship with their current pharmacist. It is too early to tell how many customers Walgreen can retain and giving firm 2012 guidance isn't possible, Chief Financial Officer Wade Miquelon said.

The Deerfield, Ill., company has modeled three scenarios for customer retention. If Walgreen retains 25% of the Express Scripts business, its fiscal 2012 earnings would be crimped by 21 cents a share. At 50%, that number shrinks to a 14 cents hit, and at 75% about seven cents of earnings would be lost. This intimates that it would lose 28 cents from earnings if it is unable to retain any Express Scripts customers.

"We have said all along that we would welcome Walgreen's in the network, but at rates that are right for our clients," Express Scripts said in a statement. "We have also had positive feedback from our clients and some are already moving to networks without Walgreens."

"At its current rates, Walgreens would be the highest cost pharmacy in our network," Express Scripts said.

"If Express wants to give us fair compensation versus the market versus what we received with others versus the value we provide, then we'll move forward," Mr. Wasson said on the call.

Walgreen executives said they couldn't imagine a scenario where continuing in the Express Scripts network under Express Scripts' proposed terms is financially better for Walgreen than leaving the partnership. Mr. Wasson said that the $2 per generic prescription it can save Express Scripts and its clients as part of the Express Scripts network is worth $180 million to those parties.

Walgreen and Express Scripts are set to enter arbitration to hash out a dispute over Walgreen's marketing blitz toward customers that Express Scripts has said includes disparaging remarks. Express Scripts had tried to take the matter to court, but agreed to the arbitration process when Walgreen countered that the companies' agreement explicitly calls for arbitration in a situation like the one Express Scripts raised.

Ratings firm Moody's Investors Service recently assigned Walgreen a negative outlook, noting the company's June decision to stop participating in Express Scripts' pharmacy benefit network put its revenue at risk.

For the quarter ended Aug. 31, Walgreen reported a profit of $792 million, or 87 cents a share, up from $470 million, or 49 cents a share, a year earlier. Excluding an after-tax gain of 30 cents a diluted share associated with the company's sale of its pharmacy benefits management business, earnings rose to 57 cents a share. Analysts polled by Thomson Reuters expected earnings of 55 cents a share.

Gross margin slipped to 28.2% from 28.4% as lower front-end margins negatively affected overall margins in the period.

The company said total sales improved 6.5% to $18 billion. Same-store sales improved 4.4%, rising 4.6% at the front end of the store. Same-store prescription sales increased 4.4%.

—Mia Lamar contributed to this article.
Write to Maxwell Murphy at maxwell.murphy@dowjones.com

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