Walgreens Reveals Damage from Express Scripts Partnership Dissolution

Walgreens (NYSE:WAG) is going to take a hit after unwinding their partnership with Express Scripts (NASDAQ:ESRX). The drug store chain’s SEC 10Q filing reveals just how bad the damage could be:

“On June 21, 2011, Walgreens announced that contract renewal negotiations with pharmacy benefit manager Express Scripts, Inc. (Express Scripts) had been unsuccessful, and as a result we do not expect to be part of the Express Scripts pharmacy provider network as of January 1, 2012. Express Scripts, in its capacity as a pharmacy benefits manager, processed approximately 88 million prescriptions filled by Walgreens in fiscal 2011, representing approximately $5.3 billion of our sales. In the first four months of fiscal 2012 ending December 31, 2011, we estimate that Express Scripts, in its capacity as a pharmacy benefits manager, will have processed approximately 26 million prescriptions filled by Walgreens. If a contract renewal is not reached, beginning January 1, 2012, Express Scripts’ network would no longer include Walgreens more than 7,800 pharmacies nationwide. In addition to the approximately $.02 net earnings per diluted share adverse impact in the first quarter of fiscal 2012 resulting from a loss of pharmacy sales and expenses related to our dispute with Express Scripts, this development is expected to adversely affect our net sales, net earnings and cash flows during the remaining portion of fiscal 2012 beginning January 1, 2012 when we are no longer part of the Express Scripts pharmacy network. We intend to moderate the impact of this development on our consolidated financial results by seeking to retain business from Express Scripts’ clients (consistent with their contractual obligations to Express Scripts), expand our business with other payers and customers, and implement cost saving initiatives. As of the date of this filing, over 100 health plans, employers and other Express Scripts clients have informed us that they have either changed pharmacy benefit managers or taken steps consistent with their contracts to maintain access to Walgreens pharmacies in 2012, which we estimate will result in our retention of approximately 10 million prescriptions beginning January 1, 2012 on an annualized basis of the 88 million prescriptions we filled and were processed by Express Scripts in fiscal 2011. We also expect to learn of additional retained prescriptions once information regarding Medicare Part D elections and small plan renewal decisions becomes available in 2012. See “Cautionary Note Regarding Forward-Looking Statements.”

While we cannot predict what percentage of business we may retain or regain from these and other entities and groups that were Express Scripts’ clients in fiscal 2011 in any particular future period, over time, we believe employers and others will want plans with Walgreens in the network. Based on our current estimates, and the current assumption that we will not be in Express Scripts’ pharmacy networks beginning in calendar 2012 (including those of Express Scripts’ clients such as the Department of Defense Tricare plan and WellPoint, Inc.), we expect to achieve 97 to 99 percent of our fiscal 2011 prescription volume in fiscal 2012. We have begun implementing plans designed to offset approximately 50 percent of any reduction in fiscal 2012 gross profit resulting from a loss of up to 75 percent of the business from Express Scripts’ clients, primarily through reductions in selling, general and administrative expenses and cost of goods sold. We expect a substantial majority of these reductions to be realized in the second half of fiscal 2012. There can be no assurance, however, that for the portion of fiscal 2012 beginning January 1, 2012, we will retain any particular level of business from Express Scripts’ clients, and if we were to lose more than 75 percent of such business it is uncertain whether we would be able to offset as much as 50 percent of the reduction in gross profit resulting from the marginal loss of such business above 75 percent. See “Cautionary Note Regarding Forward-Looking Statements.” Additionally, in July 2011, Medco Health Solutions, Inc. (Medco), another large pharmacy benefit manager, and Express Scripts announced an agreement to merge, completion of which is subject to regulatory and other conditions. If the merger is successfully completed, we may face additional reimbursement pressure or potential loss of business. Because the Express Scripts/Medco merger remains under review, we have made no assumption regarding the consummation, timing or impact of the merger related to our business for fiscal 2012.”

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