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Walgreens Pharmacy

DEERFIELD, Ill. -- Setting the stage for an upbeat Jan. 14 annual shareholders meeting, Walgreen Co. reported another record-breaking sales and earnings performance for the first quarter of fiscal 2004.

The latest in an almost unbroken two-decade streak of record-setting quarterly results came just nine days prior to the annual, powwow with Walgreens stockholders. The growth in sales and profitability set the tone for what has become one of the best-attended and most buoyant yearly gatherings of shareholders and company leaders in all of American business.

Behind the gains: stronger-than-expected sales at the front end and continuing consumer demand for Walgreens' pharmacy services. Those themes were likely to dominate much of the discussion at the annual meeting, which was expected to draw some 2,300 stockholders, investment analysts and guests to the ballroom overlooking Lake Michigan on Chicago's Navy Pier. Company officials also were sure to lay out the steps Walgreens is taking to maintain its store-a-day growth momentum and its industry-leading profit performance as it stalks additional market share in Southern California, Florida, Texas and other fast-growing regions.

For the period ended Nov. 30, Walgreens met or beat Wall Street's expectations with a 10.1 percent rise in net earnings over prior-year levels to $254.9 million. First quarter sales rose 16.5 percent over the same period a year earlier to a record $8.7 billion.

Comparable-store sales at the nation's leading drug chain were up a healthy 11.9 percent, with same-store prescription sales rising 14.7 percent in the quarter over prior-year levels and accounting for 64 percent of Walgreens' total sales. Indeed, noted company president and chief operating officer Jeff Rein, comparable-store pharmacy sales have regained momentum, while total pharmacy sales jumped 18.7 percent versus the first quarter of fiscal 2003.

"Prescription growth moderated in the last year due to concerns about hormone replacement therapy, prescription-to-over-the-counter switches, such as Claritin, and higher copays imposed by insurance companies," Rein said. "But sales increases are moving higher again, and the long-term outlook is as strong as ever when you consider the aging population, innovative new drugs hitting the market and the new Medicare drug benefit, which by itself will add 75 million to 100 million new prescriptions per year."

But front-end sales also were robust, outpacing the predictions of some of the investment firms that follow the company's stock. "Front-end sales in comparable stores increased 7.5 percent in the quarter, our best increase in more than nine years," said chairman and chief executive officer David Bernauer.

Behind the gains: an improving economy and tax rebate checks that made consumers more willing to spend on discretionary items, according to Bernauer. He also credited internal efforts at Walgreens to drive sales through aggressive radio, television and circular advertising, as well as renewed customer service efforts and gains at the photo counter.

"We're benefiting from the growth in digital photography by offering new digital photo services," he said.

Among them is a new service launched in December that offers standard, 4-by-6 photo-quality prints from digital cameras at a price of 29 cents each. With that price, the company noted, "digital photo prints are the same price as prints from traditional film and [are] less than half the cost of home printing, which typically runs 65 cents to 75 cents per 4-by-6 print."

One cautionary note came from its profit structure. Year-to-year gross profit margins in the first quarter dropped 29 basis points to 26.37 percent, Walgreens reported, "as lower-margin pharmacy sales made up a larger percentage of overall sales." The company also blamed competitive pricing on front-end merchandise, especially in November, for the slight drop in margins, but said a corresponding drop in selling, general and administrative costs offset much of the decline. "Compared with a year ago, first quarter SG&A decreased from 21.95 to 21.73 as a percent of sales," Walgreens noted.

Retail analysts generally welcomed the first quarter numbers. Although he cited "lower than ... expected" gross margins in the period, Merrill Lynch's Mark Husson noted that comp-store pharmacy gains bode well for "this well-managed company.

"We continue to have no problem with long-term investors owning this as a portfolio staple," Husson noted.

Responding to the first quarter numbers, Smith Barney analyst Lisa Cartwright predicted continuing pressure on gross margins. However, she added, "We are looking for better results in the back half of the year and into 2005 as more higher margin generics start to cycle in again."

Meanwhile, she noted, "[Walgreens] could have a few more soft quarters--earnings growth lagging sales growth, with inventories up more than sales--as it digests the opening of two new distribution centers, a ramp-up in promotions, [and] an aggressive store opening program in 2004, with more 24-hour stores."

Bernauer said the company remains on track with its goal of opening roughly 450 new stores this fiscal year--for a net increase of about 365 stores--and with its longer-term goal of operating 7,000 stores by 2010. The chain opened 85 new stores in the first quarter, ending the period with 4,291 drugstores in 44 states and Puerto Rico, versus 3,954 a year ago, for a net increase of 337.

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