CVS Will Take Ax to Eckerd

After reporting solid earnings, CVS says it will close up to 225 Eckerd drugstores.
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Updated from 8:32 a.m. EDT

CVS

(CVS) - Get Report

said Wednesday it will close as many as 225 underperforming

Eckerd

drugstores it is acquiring from

J.C. Penney

(JCP) - Get Report

after it completes the transaction next month.

Regarding the acquisition, CVS Chief Financial Officer David Rickard said on a conference call with analysts: "The biggest surprise to me has been that there have been no surprises thus far."

Earlier Wednesday, the company announced that first-quarter earnings and revenue rose thanks to strong sales of generic drugs and good inventory management. The company earned $244.6 million, or 59 cents a share, compared with $196.3 million, or 48 cents a share, in the prior-year quarter. Analysts had been calling for a profit of 56 cents a share.

Sales in the latest quarter were $6.82 billion, compared with $6.31 billion in the year-earlier period. Same-store sales increased 6.4%. By segment, pharmacy same-store sales were up 8.3% and front-end same-store sales increased 2%. Pharmacy sales were 70.3% of total sales for the quarter and third-party prescription sales were 93.6% of total pharmacy sales.

CVS said front-end same-store sales increased 50 basis points due to the earlier Easter holiday, which also added 20 basis points to total same-store sales.

Gross margin rose 55 basis points in the quarter to 26%; operating margin was 5.95%, an improvement of 70 basis points over the prior-year quarter; and total inventory losses were 0.73% of sales, compared with 1.05% in 2003.

"The improvement in our gross margin was driven by an increase in generic drug sales, a continued decrease in inventory losses and a more profitable promotional product mix," the company said.

Shares of CVS were lately trading up 66 cents, or 1.7%, at a new two-year high of $40.65 on the

New York Stock Exchange

.

Regarding the Eckerd deal, which was

first announced April 5, CVS said it filed paperwork April 16 and is currently in the 30-day approval waiting period. The company plans to finance the $2.15 billion acquisition via short- and long-term debt with total borrowings of $200 million. Most of the 1,260 Eckerd stores it will acquire are in Florida and Texas.

Once approvals are in place, CVS plans "to hit the ground running" and close between 200 and 225 existing Eckerd stores. Of that amount, the company said about half will have their pharmacy files transferred to nearby CVS stores; the others will be straight closures. The company will write off the leases of stores it is closing and take a charge. It will sell locations where it makes sense.

The company plans to start closing or rebranding Eckerd stores in Florida first. CVS expects it will generally take 12 to 18 months from the close of the deal to rebrand existing Eckerd stores.

Including stores in the Eckerd pipeline, the company reiterated that it plans to open 250 to 275 new or relocated stores in 2004, which is up from original guidance of 225 to 250 stores before the Eckerd deal was announced. The company said 125 of those stores will be in newer markets.

As a result, the company said it will net about 1,000 stores from the Eckerd deal and plans to have about 5,300 stores by year-end 2004, including new stores it plans to build aside from the Eckerd acquisitions.

On the conference call, CVS addressed one of the biggest problems it must fix at existing Eckerd stores: inventory loss. "They have levels of shrink above industry averages," Rickard said, but CVS plans to improve in-stock levels once rebranding starts.

Consequently, "Our aggregate shrink numbers might migrate to higher levels once the acquisition is complete," said Rickard, though he does not expect that to be a long-term problem.

In the second quarter, CVS expects to earn 52 cents to 54 cents a share, excluding Eckerd-related impacts, with sales up 6.5% to 7%. Same-store sales are seen up 5% to 6%.

Analysts polled by Thomson One Analytics are expecting 54 cents a share, on average.

The company noted, however, that because its second quarter ends in early July, earnings could be affected by charges related to Eckerd store closings and existing store improvements. As a result, including the Eckerd deal, earnings would increase 10% from last year's 49 cents a share, CVS said.

In full-year 2004, including the Eckerd deal, earnings are seen at $2.08 to $2.11 a share with total sales up 5% to 7%. Total same-store sales are seen up 5% to 7% with pharmacy same-store sales up 7% to 9% and front-end same-stores up 1% to 2%.

The Wall Street consensus is for a profit of $2.09 a share in 2004.

Looking to 2005, CVS predicted total revenue of $37 billion from its expected total of 5,500 stores. Dilutive effects on full-year 2005 earnings from the Eckerd deal are still seen at 15 cents to 20 cents a share.

Analysts have forecast a profit of $2.59 a share in the year.