3rd UPDATE: Walgreen, Express Scripts In Drug Benefit Spat

NEW YORK (Dow Jones)--Drug-store giant Walgreen Co. (WAG) and pharmacy-benefit heavyweight Express Scripts Inc. (ESRX) said Tuesday that contract-renewal talks have broken down in their multibillion-dollar relationship, potentially sending millions of Americans elsewhere to have their prescriptions filled.

Provided that talks aren't resuscitated, the companies plan to sever ties starting Jan. 1. Walgreen said dropping out of Express Scripts' pharmacy provider network could cost it about $5.3 billion in annual sales, nearly 8% of its total. Express Scripts is unlikely to feel any immediate pain because its customer contracts are mostly locked in; however, not having a relationship with the nation's largest drug-store chain could weaken its ability to negotiate future agreements.

The stalemate comes as health-care companies prepare their businesses for the further integration of the U.S. health-care overhaul law passed last year. The law, in part, sought to contain rising medical costs but has contributed to rising tensions in the health industry as companies work to adjust to the new regulations.

The dispute also is the latest one between a drug store and pharmacy benefit manager, two groups that are increasingly becoming rivals. PBMs handle prescription-drug benefits and claims for employers and health-insurer clients; in the past, they have worked with drug stores to secure deals for their members. Now, though, PBMs increasingly are operating their own mail-order pharmacies that compete more directly with drug stores.

Walgreen, which also reported a 30% increase in third-quarter earnings Tuesday, said the long-term fallout from accepting unfavorable terms with Express Scripts would be worse than any short-term earnings impact, which the company didn't spell out.

The Deerfield, Ill., drug-store chain "no longer felt like a valued partner" of Express Scripts and made a "very clear, principled decision" about ending negotiations, Walgreen Chief Executive Greg Wasson told analysts during the company's conference call.

Walgreen cited terms that it said made it difficult to plan business operations. These included Express Scripts insisting it can "unilaterally define contract terms," such as what does and doesn't constitute a generic drug, and the PBM rejecting Walgreen's request for advance notice before changes to prescription drug plans, Walgreen said.

Express Scripts, meanwhile, said it isn't seeking any changes to the current contract terms, including the definitions of branded and generic medicines. The PBM also argued that the drug-store chain isn't adjusting its rates to reflect the expected increase in usage of generic drugs.

"Under Walgreens' current proposal, the added cost burden to our clients would result directly in profits to Walgreens," Express Scripts said, noting that, under Walgreen's plan, Medicare prescriptions would cost the federal government an additional $300 million.

The St. Louis company added that it is prepared for a network without Walgreen, noting that it sees "minimal impact to member convenience" because another pharmacy within the network is within one-half mile of a Walgreen pharmacy. Walgreen is expected to fill about 90 million prescriptions processed by Express Scripts in fiscal 2011.

Express Scripts said it remains open to continued negotiations with Walgreen. "It is shocking to us that Walgreens would back away from the table with six months to go in the current agreement," said Express Scripts Chairman and CEO George Paz.

Walgreen CEO Wasson also left open the possibility that the two parties could eventually reach a deal, and history suggests that could happen. Walgreen got into a public spat over reimbursement rates and other issues a year ago with CVS Caremark Corp. (CVS), a rival drug-store operator that also has a pharmacy benefit business. Although the relationship appeared in jeopardy, the companies reached a new agreement for undisclosed terms that kept Walgreen pharmacies in the CVS network.

Any disruption is seen affecting Walgreen more. "Walgreen has much more to lose on a relative basis than Express Scripts does," said Constantine Davides, analyst at JMP Securities. Express Scripts has less at stake immediately, analysts said, because its customers can fill their prescriptions elsewhere.

The different concerns were reflected in how the stocks were reacting Tuesday. Walgreen shares slid 4% to $43.38, while Express Scripts shares added 20 cents to $54.99.

Meanwhile, shares of CVS--which is the second-largest drug-store chain after Walgreen and operator of the Caremark PBM business--recently rose 1% to $37.87. Shares of another PBM, Medco Health Solutions Inc. (MHS), added 1.5% to $56.10.

For the third quarter ended May 31, Walgreen reported a profit of $603 million, or 65 cents a share, up from $463 million, or 47 cents a share, a year earlier. The latest quarter included restructuring-related charges of 1 cent; analysts polled by Thomson Reuters had forecast per-share earnings of 63 cents in the recent quarter.

Sales improved by 6.8% to $18.37 billion, with same-store sales rising by 4.1%, including 3.9% growth in the front of the store and a 4.1% increase in the pharmacy.

Wasson said the company continues to face economic and regulatory uncertainty, and both commercial and governmental reimbursement pressure. Plus, there are inflationary pressures, but Wasson said Walgreen is closely monitoring its competition to try to get the best margin without losing customer traffic.

-By Jon Kamp and Maxwell Murphy, Dow Jones Newswires; 617-654-6728; [e-mail]

--Tess Stynes contributed to this article.