UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
WASHINGTON,
D.C. 20549
FORM
10-Q
(Mark
One)
|
þ
|
QUARTERLY
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF
1934
|
FOR
THE QUARTER ENDED MAY 31, 2007
OR
|
¨
|
TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF
1934
|
For
the
transition period from _______to _______
Commission
File Number
1-604
WALGREEN
CO.
(Exact
name of registrant as specified in its charter)
|
Illinois
|
36-1924025
|
|
(State
of Incorporation)
|
(I.R.S.
Employer Identification No.)
|
|
200
Wilmot Road, Deerfield, Illinois
|
60015
|
|
(Address
of principal executive offices)
|
(Zip
Code)
|
(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.
|
Yes
þ No
¨
|
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange
Act.
|
Large
accelerated filer þ
Accelerated Filer ¨
Non-accelerated filer¨
|
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).
|
Yes
¨ No
þ
|
The
number of shares outstanding of the registrant's Common Stock, $.078125 par
value, as of June 30, 2007 was 993,648,326.
-1-
WALGREEN
CO. AND SUBSIDIARIES
FORM
10-Q
FOR
THE QUARTER ENDED MAY 31, 2007
TABLE
OF CONTENTS
PART
I. FINANCIAL
INFORMATION
|
Item
1.
|
Consolidated
Condensed Financial Statements (Unaudited)
|
||
|
a)
|
Balance
Sheets
|
||
|
b)
|
Statements
of Earnings
|
||
|
c)
|
Statements
of Cash Flows
|
||
|
d)
|
Notes
to Financial Statements
|
||
|
Item
2.
|
Management's
Discussion and Analysis of Results of Operations and Financial
Condition
|
||
|
Item
3.
|
Qualitative
and Quantitative Disclosure about Market Risk
|
||
|
Item
4.
|
Controls
and Procedures
|
||
PART
II.
OTHER INFORMATION
|
Item
2.
|
Unregistered
Sales of Equity Securities and Use of Proceeds
|
|
|
Item
6.
|
Exhibits
|
-2-
WALGREEN
CO. AND SUBSIDIARIES
CONSOLIDATED
CONDENSED FINANCIAL STATEMENTS
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 Sheet as of May 31,
2007, the Consolidated Condensed Statements of Earnings for the three and nine
months ended May 31, 2007 and May 31, 2006, and the Consolidated Condensed
Statements of Cash Flows for the nine months ended May 31, 2007 and May 31,
2006, 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,
as amended.
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, nor
necessarily indicative of earnings for the full year.
-3-
|
WALGREEN
CO. AND SUBSIDIARIES
|
|||||||
|
CONSOLIDATED
CONDENSED BALANCE SHEETS
|
|||||||
|
(UNAUDITED)
|
|||||||
|
(In
Millions, Except Shares and Per Share Amounts)
|
|||||||
|
May
31,
|
August
31,
|
||||||
|
2007
|
2006
|
||||||
|
Assets
|
|||||||
|
Current
Assets:
|
|||||||
|
Cash
and cash equivalents
|
$
|
567.4
|
$
|
919.9
|
|||
|
Short
term investments - available for sale
|
190.7
|
415.1
|
|||||
|
Accounts
receivable, net
|
2,003.6
|
2,062.7
|
|||||
|
Inventories
|
6,455.7
|
6,050.4
|
|||||
|
Other
current assets
|
200.3
|
257.3
|
|||||
|
Total
Current Assets
|
9,417.7
|
9,705.4
|
|||||
|
Property and Equipment, at cost, less accumulated depreciation
and
amortization of $2,706.3 at May 31 and $2,338.1 at August
31
|
7,753.8
|
6,948.9
|
|||||
|
Other
Non-Current Assets
|
772.8
|
476.8
|
|||||
|
Total
Assets
|
$
|
17,944.3
|
$
|
17,131.1
|
|||
|
Liabilities
and Shareholders' Equity
|
|||||||
|
Current
Liabilities:
|
|||||||
|
Trade
accounts payable
|
$
|
3,709.0
|
$
|
4,039.2
|
|||
|
Accrued
expenses and other liabilities
|
1,942.3
|
1,713.3
|
|||||
|
Income
taxes
|
51.2
|
2.8
|
|||||
|
Total
Current Liabilities
|
5,702.5
|
5,755.3
|
|||||
|
Non-Current
Liabilities:
|
|||||||
|
Deferred
income taxes
|
114.3
|
141.1
|
|||||
|
Other
non-current liabilities
|
1,226.1
|
1,118.9
|
|||||
|
Total
Non-Current Liabilities
|
1,340.4
|
1,260.0
|
|||||
|
Shareholders'
Equity:
|
|||||||
|
Preferred
stock $.0625 par value; authorized 32 million shares, none
issued
|
-
|
-
|
|||||
|
Common
stock $.078125 par value; authorized 3.2 billion shares; issued
1,025,400,000 at May 31 and August 31
|
80.1
|
80.1
|
|||||
|
Paid-in
capital
|
562.8
|
558.5
|
|||||
|
Employee
stock loan receivable
|
(59.1
|
)
|
(70.3
|
)
|
|||
|
Retained
earnings
|
11,724.5
|
10,311.7
|
|||||
|
Treasury
stock, at cost; 32,055,845 shares at May 31 and 17,537,881 shares
at
August 31
|
(1,406.9
|
)
|
(764.2
|
)
|
|||
|
Total
Shareholders' Equity
|
10,901.4
|
10,115.8
|
|||||
|
Total
Liabilities and Shareholders’ Equity
|
$
|
17,944.3
|
$
|
17,131.1
|
|||
The
accompanying Notes to Consolidated Condensed Financial
Statements
are an integral part of these Statements.
-4-
|
WALGREEN
CO. AND SUBSIDIARIES
|
|||||||||||||
|
CONSOLIDATED
CONDENSED STATEMENTS OF EARNINGS
|
|||||||||||||
|
(UNAUDITED)
|
|||||||||||||
|
(In
Millions, Except Per Share Amounts)
|
|||||||||||||
|
Three
Months Ended
|
Nine
Months Ended
|
||||||||||||
|
May
31,
|
May
31,
|
May
31,
|
May
31,
|
||||||||||
|
2007
|
2006
|
2007
|
2006
|
||||||||||
|
Net
sales
|
$
|
13,698.3
|
$
|
12,175.2
|
$
|
40,340.5
|
$
|
35,238.7
|
|||||
|
Costs
and Deductions:
|
|||||||||||||
|
Cost
of sales
|
9,821.1
|
8,832.0
|
28,851.9
|
25,433.7
|
|||||||||
|
Selling,
occupancy and administration
|
3,022.4
|
2,635.6
|
8,941.4
|
7,734.7
|
|||||||||
|
12,843.5
|
11,467.6
|
37,793.3
|
33,168.4
|
||||||||||
|
Other
Income:
|
|||||||||||||
|
Interest
income
|
11.2
|
15.6
|
32.0
|
32.4
|
|||||||||
|
Earnings
before income tax provision
|
866.0
|
723.2
|
2,579.2
|
2,102.7
|
|||||||||
|
Income
tax provision
|
304.8
|
254.0
|
934.4
|
764.4
|
|||||||||
|
Net
earnings
|
$
|
561.2
|
$
|
469.2
|
$
|
1,644.8
|
$
|
1,338.3
|
|||||
|
Net
earnings per common share-
|
|||||||||||||
|
Basic
|
$
|
.56
|
$
|
.46
|
$
|
1.64
|
$
|
1.32
|
|||||
|
Diluted
|
$
|
.56
|
$
|
.46
|
$
|
1.63
|
$
|
1.31
|
|||||
|
Dividends
declared
|
$
|
.0775
|
$
|
.0650
|
$
|
.2325
|
$
|
.1950
|
|||||
|
Average
shares outstanding
|
995.8
|
1,008.8
|
1,000.5
|
1,010.8
|
|||||||||
|
Dilutive
effect of stock options
|
7.6
|
9.1
|
7.8
|
9.3
|
|||||||||
|
Average
shares outstanding assuming dilution
|
1,003.4
|
1,017.9
|
1,008.3
|
1,020.1
|
|||||||||
The
accompanying Notes to Consolidated Condensed Financial
Statements
are an integral part of these Statements.
-5-
|
WALGREEN
CO. AND SUBSIDIARIES
|
|||||||
|
CONSOLIDATED
CONDENSED STATEMENTS OF CASH FLOWS
|
|||||||
|
(UNAUDITED)
|
|||||||
|
(In
Millions)
|
|||||||
|
Nine
Months Ended
|
|||||||
|
May
31,
|
May
31,
|
||||||
|
2007
|
2006
|
||||||
|
Cash
flows from operating activities:
|
|||||||
|
Net
earnings
|
$
|
1,644.8
|
$
|
1,338.3
|
|||
|
Adjustments
to reconcile net earnings to net cash provided by operating activities
-
|
|||||||
|
Depreciation
and amortization
|
495.9
|
408.7
|
|||||
|
Deferred
income taxes
|
(16.6
|
)
|
(62.8
|
)
|
|||
|
Stock
compensation expense
|
62.4
|
83.7
|
|||||
|
Income
tax savings from employee stock plans
|
4.8
|
16.0
|
|||||
|
Other
|
26.9
|
48.5
|
|||||
|
Changes
in operating assets and liabilities
|
|||||||
|
Inventories
|
(377.4
|
)
|
60.2
|
||||
|
Trade
accounts payable
|
(116.5
|
)
|
807.4
|
||||
|
Accounts
receivable, net
|
58.1
|
(630.6
|
)
|
||||
|
Accrued
expenses and other liabilities
|
193.9
|
123.9
|
|||||
|
Income
taxes
|
48.5
|
(27.8
|
)
|
||||
|
Other
|
59.1
|
127.5
|
|||||
|
Net
cash provided by operating activities
|
2,083.9
|
2,293.0
|
|||||
|
Cash
flows from investing activities:
|
|||||||
|
Purchases
of short term investments - available for sale
|
(5,892.8
|
)
|
(7,919.3
|
)
|
|||
|
Proceeds
from sale of short term investments - available for sale
|
6,129.5
|
7,428.7
|
|||||
|
Additions
to property and equipment
|
(1,252.1
|
)
|
(907.2
|
)
|
|||
|
Disposition
of property and equipment
|
31.3
|
17.1
|
|||||
|
Net
proceeds from corporate-owned life insurance policies
|
5.7
|
9.2
|
|||||
|
Business
and intangible asset acquisitions, net of cash received
|
(315.6
|
)
|
(152.2
|
)
|
|||
|
Net
cash used for investing activities
|
(1,294.0
|
)
|
(1,523.7
|
)
|
|||
|
Cash
flows from financing activities:
|
|||||||
|
Stock
purchases
|
(895.8
|
)
|
(520.9
|
)
|
|||
|
Proceeds
related to employee stock plans
|
205.1
|
187.9
|
|||||
|
Cash
dividends paid
|
(233.2
|
)
|
(197.3
|
)
|
|||
|
Bank
overdrafts
|
(213.9
|
)
|
-
|
||||
|
Other
|
(4.6
|
)
|
(13.4
|
)
|
|||
|
Net
cash used for financing activities
|
(1,142.4
|
)
|
(543.7
|
)
|
|||
|
Changes
in cash and cash equivalents:
|
|||||||
|
Net
(decrease) increase in cash and cash equivalents
|
(352.5
|
)
|
225.6
|
||||
|
Cash
and cash equivalents at beginning of year
|
919.9
|
576.8
|
|||||
|
Cash
and cash equivalents at end of period
|
$
|
567.4
|
$
|
802.4
|
|||
Statements
are an integral part of these Statements.
-6-
WALGREEN
CO. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(1)
Inventories are valued on a lower of last-in, first-out (LIFO) cost or market
basis. At May 31, 2007 and August 31, 2006, inventories would have been greater
by $936.8 million and $899.5 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. Included in inventory are product cost and inbound freight. Cost
of
sales is primarily based upon point-of-sale scanning information with an
estimate for shrinkage and adjusted based on periodic inventories.
(2)
The
principal retirement plan for employees is the Walgreen Profit-Sharing
Retirement Trust to which both the company and the 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. The
profit-sharing provision was $77.1 million for the third quarter and $229.5
million for the nine month period of this fiscal year. This compares to $64.4
million and $187.1 million for the same periods last year. The company's
contributions, which are made annually in the second quarter, were $253.0
million for the nine month period ended May 31, 2007. This compares to $216.1
million for the nine month period ended May 31, 2006.
(3)
Total
stock-based compensation expense was $12.6 million for the quarter and $62.4
million for the nine month period compared to $20.1 million and $83.7 million
for the same 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. For the quarter ended May 31, 2007, the
company did not issue any significant grants.
(4)
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 currently are not funded.
|
Three
Months Ended
|
Nine
Months Ended
|
||||||||||||
|
Components
of Net Periodic Benefit Costs (In
Millions)
|
May
31, 2007
|
May
31, 2006
|
May
31, 2007
|
May
31, 2006
|
|||||||||
|
Service
cost
|
$
|
3.4
|
$
|
4.6
|
$
|
10.2
|
$
|
13.7
|
|||||
|
Interest
cost
|
5.5
|
5.3
|
16.5
|
16.0
|
|||||||||
|
Amortization
of actuarial loss
|
1.4
|
2.2
|
4.2
|
6.6
|
|||||||||
|
Amortization
of prior service cost
|
(1.0
|
)
|
(1.0
|
)
|
(3.1
|
)
|
(3.0
|
)
|
|||||
|
Total
postretirement benefit cost
|
$
|
9.3
|
$
|
11.1
|
$
|
27.8
|
$
|
33.3
|
|||||
(5)
The
company guarantees a credit agreement on behalf of SureScripts, LLC which
provides electronic prescription data services. This credit agreement, for
which
SureScripts, LLC is primarily liable, has an expiration date of February 16,
2010. The carrying amount of the liability has remained constant during the
current quarter at $2.0 million, while the maximum amount of future payments
that could be required to be paid under the guaranty is $25.0 million, of which
$12.5 million may be recoverable from another guarantor.
(6)
During the quarter, the company completed the following acquisitions: 100%
ownership of Take Care Health Systems, Inc., a convenient care clinic operator;
selected assets from the Familymeds Group Inc., a specialty pharmacy and medical
specialty product provider; the remaining interest in SeniorMed, an
institutional pharmacy, resulting in 100% ownership; and selected other assets
(primarily prescription files). The aggregate purchase price of all business
acquisitions was $269.3 million for the quarter and $315.6 million for the
nine
month period. The allocations of the purchase prices have not been finalized.
Any adjustment made is not expected to be material.
(7)
The
company announced on July 2, 2007 it has reached a definitive agreement to
acquire Option Care, Inc.,
a
specialty
pharmacy and home infusion services provider with a network of more than 100
pharmacies in 34 states, for
$19.50 a share. Including
the assumption of some debt, the transaction has a total enterprise value of
approximately $850 million.
The
acquisition expands the company’s home infusion and specialty pharmacy
businesses, which currently include 20 and 6 locations,
respectively.
-7-
MANAGEMENT'S
DISCUSSION AND ANALYSIS
OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
INTRODUCTION
Walgreens
is 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, seasonal items and convenience food. Customers can have prescriptions
filled at the drugstore counter, as well as through the mail, by telephone
and
on the Internet. As of May 31, 2007, we operated 5,751 stores (including three
mail service, 44 home care and six specialty facilities) located in 48 states
and Puerto Rico. The total store count of 5,751 does not include the 51
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.
Prescription
sales continue to become a larger portion of the company’s business. The
long-term outlook for prescription sales is strong due in part to the aging
population, the introduction of lower priced generics and the continued
development of innovative drugs that improve quality of life and control
healthcare costs. As of January 1, 2006, the Medicare Part D prescription drug
program went into effect. This program has resulted in additional prescription
sales, although the gross margin rates on these sales have been lower. The
Deficit Reduction Act of 2005 becomes effective during fiscal 2007, and is
expected to reduce our reimbursement for Medicaid generic drugs.
Front-end
sales have continued to grow due to strengthening core categories and new
businesses such as digital photo services.
We
continue to expand into new markets and increase penetration in existing
markets. To support our growth, we are investing significantly in prime
locations, technology and customer service initiatives. Organic growth continues
to be our primary growth vehicle; however, consideration is given to
acquisitions that provide a unique opportunity and strategic fit. Our managed
care business continues to grow organically, as well as through
acquisitions.
OPERATING
STATISTICS
|
Percentage
Increases
|
||||||
|
Three
Months Ended
May
31, 2007
|
Nine
Months Ended
May
31, 2007
|
|||||
|
Net
Sales
|
12.5
|
14.5
|
||||
|
Net
Earnings
|
19.6
|
22.9
|
||||
|
Comparable
Drugstore Sales
|
7.8
|
8.7
|
||||
|
Prescription
Sales
|
13.8
|
16.2
|
||||
|
Comparable
Drugstore Prescription Sales
|
9.0
|
10.6
|
||||
|
Front-End
Sales
|
11.7
|
12.4
|
||||
|
Comparable
Front-End Sales
|
5.6
|
5.7
|
||||
|
Percent
to Sales
|
||||
|
Three
Months Ended
|
Nine
Months Ended
|
|||
|
May
31,
2007
|
May
31, 2006
|
May
31, 2007
|
May
31, 2006
|
|
|
Gross
Margin
|
28.3
|
27.5
|
28.5
|
27.8
|
|
Selling,
Occupancy and
Administration
Expenses
|
22.1
|
21.7
|
22.2
|
21.9
|
-8-
|
Other
Statistics
|
||||||||||||
|
Three
Months Ended
|
Nine
Months Ended
|
|||||||||||
|
May
31, 2007
|
May
31, 2006
|
May
31, 2007
|
May
31, 2006
|
|||||||||
|
Prescription
Sales as a % of Net Sales
|
65.9
|
65.2
|
64.6
|
63.7
|
||||||||
|
Third
Party Sales as a % of Total Prescription Sales
|
94.8
|
93.5
|
94.7
|
92.9
|
||||||||
|
Total
Number of Prescriptions (in millions)
|
150.0
|
137.5
|
437.9
|
395.9
|
||||||||
|
Total
Number of Stores
|
5,751
|
5,251
|
||||||||||
RESULTS
OF OPERATIONS
Net
earnings for the third quarter ended May 31, 2007, were $561.2 million or $.56
per share (diluted). This was a 19.6% increase in net earnings over the third
quarter last year. Net earnings for the nine months increased 22.9% to $1.645
billion or $1.63 per share (diluted). Net earnings increases resulted from
improved sales and higher gross margins, partially offset by higher expense
ratios during the quarter and nine month period.
Net
sales
increased by 12.5% in the third quarter to $13.7 billion, and rose by 14.5%
to
$40.3 billion for the 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. Comparable drugstore
sales were up 7.8% for the quarter and 8.7% for the nine month period.
Comparable stores 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 5,751
locations as of May 31, 2007 compared to 5,251 a year earlier.
Prescription
sales increased 13.8% for the third quarter and 16.2% for the nine month period.
Generic drugs introduced in the last twelve months, which have a lower retail
price, reduced prescription sales by 5.1% in the quarter and 3.9% for the nine
month period. Prescriptions accounted for 65.9% of sales in the quarter and
64.6% year-to-date. Prescription sales in comparable drugstores increased 9.0%
for the quarter and 10.6% for the nine month period. Third party sales, where
reimbursement is received from managed care organizations and government and
private insurance, were 94.8% of pharmacy sales for the quarter and 94.7% for
the nine month period in fiscal 2007. This compares to 93.5% for the quarter
and
92.9% for the nine month period a year ago. The total number of prescriptions
filled for the quarter was 150.0 million and 437.9 million for the nine month
period, compared to 137.5 million and 395.9 million for the same periods a
year
ago.
Front-end
sales increased 11.7% in the third quarter and 12.4% for the nine month period.
Comparable front-end drugstore sales were up 5.6% for the quarter and 5.7%
for
the nine month period.
Gross
margins were 28.3% of sales in the quarter and 28.5% for the nine month period
compared to 27.5% and 27.8% for the comparable periods last year. Pharmacy
margins, as well as front-end margins, increased for the quarter and nine month
periods. Although pharmacy margins increased with the growth in generic drug
sales, some of that benefit was offset by growth in Medicare Part D and third
party pharmacy sales (which typically have lower margins than cash
prescriptions) and an overall sales shift toward the pharmacy business, which
carries lower margins than front-end merchandise. Margins for the front-end
increased as a result of a shift in sales mix to higher margin items.
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 interim financial statements are estimated. Cost of sales
included a LIFO credit of $3.5 million ($.00 per share, diluted) for the quarter
and a provision of $37.3 million ($.02 per share, diluted) for the nine month
period ended May 31, 2007, versus provisions of $24.2 million ($.01 per share,
diluted) and $69.2 million ($.04 per share, diluted) for the same periods a
year
ago. This quarter our estimated annual inflation rate was reduced to 0.75%
from
our estimate of 1.25% at February 28, 2007, primarily due to lower than
projected prescription inflation. The estimated annual inflation rate was 1.50%
for the quarter and nine month period a year ago.
-9-
Selling,
occupancy and administration expenses increased to 22.1% from 21.7% of sales
in
the quarter and to 22.2% from 21.9% of sales for the nine month period. The
increase in the quarter was principally caused by higher store level salaries
and expenses. The increase in the nine month period was principally caused
by
provisions for legal matters combined with higher intangible asset amortization
and administrative costs related to acquisitions. The impact of the introduction
of new generic drugs, which tempers the rate of sales growth, continues to
adversely affect expense ratios.
The
effective tax rate was 35.20% for the quarter and 36.23% for the nine month
period this fiscal year compared to 35.12% for the quarter and 36.35% for the
nine month period a year ago. The current quarter reflects the resolution of
a
multiyear state tax matter, while last year’s quarter reflects the settlement of
prior years’ federal tax matters. We expect our effective rate for the fourth
quarter of fiscal 2007 to be 36.75%.
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. Some of the
more significant estimates include liability for closed locations, liability
for
insurance claims, vendor allowances, allowance for doubtful accounts, and cost
of sales. We use the following techniques to determine estimates:
|
Liability
for closed locations -
|
|
|
The
liability is based on the present value of future rent obligations
and
other related costs (net of estimated sublease rent) to the first
lease
option date. We have not made any material changes to the method
of
estimating our liability for closed locations during the last three
years.
Based on current knowledge, we do not believe there is a reasonable
likelihood that there will be a material change in the estimate or
assumptions used to determine the liability.
|
|
|
Liability
for insurance claims -
|
|
|
The
liability for insurance claims is recorded based on estimates for
claims
incurred. The provisions are estimated in part by considering historical
claims experience, demographic factors and other actuarial assumptions.
We
have not made any material changes to the method of estimating our
liability for insurance claims during the last three years. Based
on
current knowledge, we do not believe there is a reasonable likelihood
that
there will be a material change in the estimate or assumptions used
to
determine the liability.
|
|
|
Vendor
allowances -
|
|
|
Vendor
allowances are principally received as a result of purchase levels,
sales
or promotion of vendors' products. Allowances are generally recorded
as a
reduction of inventory and are recognized as a reduction of cost
of sales
when the related merchandise is sold. Those allowances received for
promoting vendors' products are offset against advertising expense
and
result in a reduction of selling, occupancy and administration expense
to
the extent of advertising incurred, with the excess treated as a
reduction
of inventory costs. We have not made any material changes to the
method of
estimating our vendor allowances during the last three years. Based
on
current knowledge, we do not believe there is a reasonable likelihood
that
there will be a material change in the estimate or assumptions used
to
determine vendor allowances.
|
|
|
Allowance
for doubtful accounts -
|
|
|
The
provision for bad debt is based on both specific receivables and
historic
write-off percentages. We have not made any material changes to the
method
of estimating our allowance for doubtful accounts during the last
three
years. Based on current knowledge, we do not believe there is a reasonable
likelihood that there will be a material change in the estimate or
assumptions used to determine the allowance.
|
|
|
Cost
of sales -
|
|
|
Drugstore
cost of sales is primarily derived based on point-of-sale scanning
information with an estimate for shrinkage and adjusted based on
periodic
inventories. We have not made any material changes to the method
of
estimating cost of sales during the last three years. Based on current
knowledge, we do not believe there is a reasonable likelihood that
there
will be a material change in the estimate or assumptions used to
determine
cost of sales.
|
|
-10-
LIQUIDITY
AND CAPITAL RESOURCES
Cash
and
cash equivalents were $567.4 million at May 31, 2007, compared to $802.4 million
at May 31, 2006. 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 top-tier money market funds and commercial paper.
Net
cash
provided by operating activities for the first nine months of fiscal 2007 was
$2.084 billion compared to $2.293 billion a year ago. The change between periods
was caused by inventory growth, decreases in accounts receivable and trade
accounts payable. The declines in accounts receivable and trade accounts payable
reflect the loss of UnitedHealth Group’s Ovations unit contract in our pharmacy
benefit management business as of December 31, 2006. Our profitability is the
principal source for providing funds for expansion, remodeling programs,
dividends to shareholders, the stock repurchase program and most
acquisitions. As announced on July 2, 2007, the company reached a
definitive agreement to acquire Option Care, Inc. for approximately $850 million
including the assumption of some debt. We intend to fund this acquisition with
a
combination of cash on hand and the issuance of commercial
paper.
Net
cash
used for investing activities was $1.294 billion versus $1.524 billion last
year. Proceeds from the sale of auction rate securities exceeded the purchases
of such securities by $236.7 million for the first nine months of the fiscal
year. This compared to purchases exceeding proceeds by $490.6 million for the
same period last year. We actively invest in municipal bonds and student
obligations and purchase these securities at par. While the underlying security
is issued as a long term investment, they typically can be purchased and sold
every 7, 28 and 35 days. The trading of auction rate securities takes place
through a descending price auction with an interest rate reset at the beginning
of each holding period. At the end of each holding period the interest is paid
to the investor.
Additions
to property and equipment were $1.252 billion compared to $907.2 million last
year. In total, there were 352 new or relocated stores (net 290) added during
the first nine months of this year. This compares to 334 (net 266) in the same
period last year. New stores are owned or leased. There were 106 owned locations
added during the first nine months and 71 under construction at May 31, 2007
versus 86 owned locations added and 75 under construction as of May 31, 2006.
Business acquisitions this year include Take Care Health, a convenient care
clinic operator; selected assets from Familymeds Group, a specialty pharmacy
and
medical specialty product provider, and prescription file purchases. Business
acquisitions last year include Schraft's, a specialty pharmacy, which provides
fertility medications and services; SeniorMed, an institutional pharmacy, which
provides prescription services to assisted living communities; Home Pharmacy
of
California and Canadian Valley Medical Solutions, which provide home care
services; and selected assets from the 23-store Medic drugstore chain in the
Cleveland market, in addition to prescription file purchases.
Capital
expenditures for fiscal 2007 are expected to be approximately $1.7 billion,
excluding business acquisitions. We anticipate growth of 500 new drugstores
with
a net increase of more than 400 drugstores after closings and relocations in
fiscal 2007, and a total of more than 7,000 drugstores in the year 2010. We
are
continuing to relocate stores to more convenient and profitable freestanding
locations. In addition to new stores, expenditures are planned for technology
and distribution centers. A new distribution center in Anderson, SC started
shipping merchandise to stores in April 2007. Another is planned for Windsor,
CT
with an anticipated opening date by fiscal 2009.
Net
cash
used for financing activities was $1.142 billion compared to $543.7 million
last
year. During the first nine months of the year, we purchased $895.8 million
of
company shares. Of this amount, $343.2 million related to the stock repurchase
program announced on July 14, 2004 ("2004 repurchase program") and finalized
in
first quarter of fiscal 2007. On January 10, 2007 a new stock repurchase program
("2007 repurchase program") of up to $1 billion was announced, to be executed
over the next four years. Purchases of company shares relating to the 2007
repurchase program were made in the second and third quarters in the amount
of
$256.8 million. An additional $295.8 million of shares were purchased to support
the needs of the employee stock plans. During the nine month period last year,
comparable amounts purchased were $242.7 million relating to 2004 repurchase
program and $278.2 million to support the needs of the employee stock plans.
For
the first nine months of this year we had proceeds related to employee stock
plans of $205.1 million versus $187.9 million for the same period last year.
Cash
dividends paid were $233.2 million during the nine month period versus $197.3
million for the same period a year ago. A $213.9 million wire transfer made
on
August 31, 2006, was not accepted by our disbursement bank until September
1,
resulting in a bank overdraft at fiscal year-end and subsequent repayment on
September 1. There were no new short-term borrowings during either period.
At
May 31, 2007, we had a syndicated bank line of credit facility of $200 million
to support our short-term commercial paper program. As previously discussed,
we
plan to incur short-term borrowings and increase our bank line of credit to
support the acquisition of Option Care, Inc.
-11-
Our
credit ratings as of May 31, 2007, were as follows:
|
Rating
Agency
|
Rating
|
Outlook
|
|
Moody's
|
Aa3
|
Negative
|
|
Standard
& Poor's
|
A+
|
Stable
|
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 future operating lease costs.
CONTRACTUAL
OBLIGATIONS AND COMMITMENTS
The
following table lists our contractual obligations and commitments as of May
31,
2007:
|
Payments
Due by Period (In Millions)
|
||||||||||||||||
|
Total
|
Less
than 1 Year
|
1-3
Years
|
3-5
Years
|
Over
5 Years
|
||||||||||||
|
Operating
leases (1)
|
$
|
27,763.0
|
$
|
1,561.2
|
$
|
3,254.3
|
$
|
3,180.9
|
$
|
19,766.6
|
||||||
|
Purchase
obligations (2):
|
||||||||||||||||
|
Open
inventory purchase orders
|
1,436.2
|
1,436.2
|
-
|
-
|
-
|
|||||||||||
|
Real
estate development
|
817.2
|
816.2
|
1.0
|
-
|
-
|
|||||||||||
|
Other
corporate obligations
|
765.4
|
341.9
|
334.4
|
50.5
|
38.6
|
|||||||||||
|
Insurance*
|
500.1
|
166.9
|
167.6
|
82.8
|
82.8
|
|||||||||||
|
Retiree
health & life*
|
316.6
|
8.4
|
19.7
|
25.0
|
263.5
|
|||||||||||
|
Closed
location obligations*
|
56.4
|
15.9
|
20.0
|
10.9
|
9.6
|
|||||||||||
|
Capital
lease obligations * (1)
|
39.9
|
1.1
|
2.2
|
2.6
|
34.0
|
|||||||||||
|
Other
long-term liabilities reflected on the balance sheet*
|
546.7
|
41.2
|
66.8
|
52.0
|
386.7
|
|||||||||||
|
Total
|
$
|
32,241.5
|
$
|
4,389.0
|
$
|
3,866.0
|
$
|
3,404.7
|
$
|
20,581.8
|
||||||
*
Recorded on balance sheet.
|
(1)
|
Amounts
for operating leases (nominal dollar) and capital leases do not include
certain operating expenses under the leases such as common area
maintenance, insurance and real estate taxes. These expenses for
the
company's most recent fiscal year were $228.8 million.
|
|
(2)
|
The
purchase obligations include agreements to purchase goods or services
that
are enforceable and legally binding and that specify all significant
terms, including open purchase
orders.
|
OFF-BALANCE
SHEET ARRANGEMENTS
Letters
of credit are issued to support purchase obligations and other commitments
(as
reflected on the Contractual Obligations and Commitments table) as follows
(In
Millions):
|
Inventory
obligations
|
$
|
74.3
|
||
|
Real
estate development
|
11.2
|
|||
|
Insurance
|
276.7
|
|||
|
Total
|
$
|
362.2
|
We
have
no off-balance sheet arrangements other than those disclosed in the Contractual
Obligations and Commitments table and a credit agreement guaranty on behalf
of
SureScripts, LLC. This agreement is described more fully in Note 5 in the Notes
to Consolidated Condensed Financial Statements.
Both
on-
and off-balance sheet financing are considered when targeting debt to equity
ratios to balance the interest of equity and debt (real estate) investors.
This
balance allows us to lower our cost of capital while maintaining a prudent
level
of financial risk.
-12-
RECENT
ACCOUNTING PRONOUNCEMENTS
In
July
2006, the FASB issued Interpretation (FIN) 48, "Accounting for Uncertainty
in
Income Taxes - an interpretation of FASB Statement No. 109." This interpretation
clarifies the accounting and disclosure for uncertain income tax positions,
including how income tax positions should be reflected in the financial
statements before they are resolved with the tax authorities. This
interpretation will be effective first quarter of fiscal 2008. We are currently
reviewing this pronouncement to determine the impact that it may have on our
consolidated financial position or results of operations.
In
September 2006, the FASB issued Statement of Financial Accounting Standards
(SFAS) No. 157, "Fair Value Measurements." This statement defines and provides
guidance when applying fair value measurements to accounting pronouncements
that
require or permit such measurements. This statement, which will be effective
first quarter of fiscal 2009, is not expected to have a material impact on
our
consolidated financial position or results of operations.
In
September 2006, the FASB issued SFAS No. 158, "Employers’ Accounting for Defined
Benefit Pension and Other Postretirement Plans - an amendment of FASB Statements
No. 87, 88, 106, and 132(R)." For fiscal years ending after December 15, 2006,
SFAS No. 158 requires companies to recognize the funded status of their defined
benefit pension and postretirement plans directly on the consolidated balance
sheet. In addition, SFAS No. 158 requires that changes in the funded status
of a
defined benefit postretirement plan be recognized in other comprehensive income
in the year in which the changes occur. Had this pronouncement been effective
as
of May 31, 2007, Accumulated Other Comprehensive Income would have decreased
by
$39.4 million, net of tax. This pronouncement will be effective for the
company’s fourth quarter of fiscal 2007.
In
October 2006, the FASB issued proposed Staff Position (FSP) FAS 141-b, 142-e,
and 144-b, "Fair Value Measurements in Business Combinations and Impairment
Tests." This position provides a consistent definition of fair value measurement
under SFAS 141, 142 and 144. It is not expected to have a material impact on
our
consolidated financial position or results of operations.
In
February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for
Financial Assets and Financial Liabilities." This statement gives entities
the
option to carry most financial assets and liabilities at fair value, with
changes in fair value recorded in earnings. This statement, which will be
effective first quarter of fiscal 2009, is not expected to have a material
impact on our consolidated financial position or results of
operations.
CAUTIONARY
NOTE REGARDING FORWARD-LOOKING STATEMENTS
Certain
information in this Form 10-Q, as well as in other public filings, the company
website, press releases and oral statements made by our representatives, is
forward-looking information based on current expectations and plans that involve
risks and uncertainties. Forward-looking information includes statements
concerning pharmacy sales trends, prescription margins, number and location
of
new store openings, outcomes of litigation, the level of capital expenditures,
demographic trends; as well as those that include or are preceded by the words
"expects," "estimates," "believes," "plans," "anticipates" or similar language.
For such statements, we claim the protection of the safe harbor provisions
of
the Private Securities Litigation Reform Act of 1995.
Forward-looking
statements may involve risks and uncertainties, known or unknown to the company,
that could cause results to differ materially from management expectations
as
projected in such forward-looking statements. A discussion of important factors
relating to forward-looking statements is set forth in the company’s documents
filed with the Securities and Exchange Commission, including its Form 10-K,
as
amended, for the period ended August 31, 2006. Unless otherwise required by
applicable securities laws, the company assumes no obligation to update its
forward-looking statements to reflect subsequent events or
circumstances.
-13-
Item
3.
Qualitative and Quantitative Disclosure about Market Risk
Management
does not believe that there is any material market risk exposure with respect
to
derivative or other financial instruments that would require disclosure under
this item.
Item
4.
Controls and Procedures
Based
on
their evaluation as of May 31, 2007, pursuant to Exchange Act Rule 13a-15(b),
the company's management, including its Chief Executive Officer and Chief
Financial Officer, believe the company's disclosure controls and procedures
(as
defined in Exchange Act Rules 13a-15(e)) are effective.
In
connection with the evaluation pursuant to Exchange Act Rule 13a-15(d) of the
company's internal control over financial reporting (as defined in Exchange
Act
Rule 13a-15(f)) by the company's management, including its Chief Executive
Officer and Chief Financial Officer, no changes during the quarter ended May
31,
2007, were identified that have materially affected, or are reasonably likely
to
materially affect, the company's internal control over financial
reporting.
|
PART
II. OTHER INFORMATION
|
|
Item
2. Unregistered Sales of Equity Securities and Use of
Proceeds
|
|
(c)
|
The
following table provides information about purchases by the company
during
the quarter ended May 31, 2007, of equity securities that are registered
by the company pursuant to Section 12 of the Exchange
Act:
|
|
ISSUER
PURCHASES OF EQUITY SECURITIES
|
|||||||||||||
|
Period
|
Total
Number of Shares
Purchased (1)
|
Average
Price Paid
per Share
|
Total
Number of Shares Purchased as Part of Publicly Announced Plans
or
Programs
|
Approximate
Dollar Value of Shares that May Yet Be Purchased Under the Plans
or
Programs
(2)
|
|||||||||
|
3/1/2007
- 3/31/2007
|
-
|
-
|
-
|
$
|
874,983,942
|
||||||||
|
4/1/2007
- 4/30/2007
|
2,203,000
|
$
|
46.05
|
1,203,000
|
819,597,721
|
||||||||
|
5/1/2007
- 5/31/2007
|
2,704,000
|
$
|
44.82
|
1,704,000
|
743,255,970
|
||||||||
|
Total
|
4,907,000
|
$
|
45.37
|
2,907,000
|
$
|
743,255,970
|
|||||||
|
(1)
|
The
company repurchased an aggregate of 2,000,000 shares of its common
stock
in open-market transactions to satisfy the requirements of the company's
employee stock purchase and option plans, as well as the company's
Nonemployee Director Stock Plan.
|
|
(2)
|
On
January 10, 2007, the Board of Directors approved a stock repurchase
program ("2007 repurchase program"), pursuant to which up to $1 billion
of
the company's common stock may be purchased prior to the expiration
date
of the program on January 10, 2011. This program was announced in
the
company's report on Form 8-K, which was filed on January 11, 2007.
The
total remaining authorization under the repurchase program was
$743,255,970 as of May 31, 2007.
|
-14-
Item
6.
Exhibits
| (a) |
Exhibits
|
|
3.
|
(a)
|
Articles
of Incorporation of the company, as amended, filed with the Securities
and
Exchange Commission as Exhibit 3(a) to the company's Quarterly Report
on
Form 10-Q for the quarter ended February 28, 1999, and incorporated
by
reference herein.
|
|
|
(b)
|
By-Laws
of the company, as amended and restated effective as of July 9, 2003,
filed with the Securities and Exchange Commission as Exhibit 3(b)
to the
company's quarterly report on Form 10-Q for the quarter ended November
30,
2003, and incorporated by reference herein.
|
||
|
31.1
|
Certification
of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002.
|
||
|
31.2
|
Certification
of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002.
|
||
|
32.1
|
Certification
of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002,
18
U.S.C. Section 1350.
|
||
|
32.2
|
Certification
of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
18
U.S.C. Section 1350.
|
||
-15-
SIGNATURES
Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant
has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.
|
WALGREEN
CO.
|
|
|
(Registrant)
|
|
|
Dated:
July 3, 2007
|
/s/
W.M. Rudolphsen
|
|
W.M.
Rudolphsen
|
|
|
Senior
Vice President
|
|
|
(Chief
Financial Officer)
|
|
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Dated:
July 3, 2007
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/s/
M.M. Scholz
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M.M.
Scholz
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Controller
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(Chief
Accounting Officer)
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