Walgreen Co posted an unexpected drop in quarterly profit as the largest drugstore chain's margins were hurt in part by its contract dispute with pharmacy benefits manager Express Scripts Inc .

Walgreen's shares fell as much as 8 percent on Wednesday as the company tried to show how it can thrive without being in Express Scripts' pharmacy network.

Since June, Walgreen has said it was ready to stop filling Express Scripts' prescriptions as the parties could not agree on terms for a contract to replace one expiring on December 31.

Walgreen is moving on after another serious attempt to reach a deal last week showed that the companies are increasingly unlikely to sign a new contract before January, Chief Executive Greg Wasson said during a conference call.

The company has been trying to show the strength of its massive network of more than 7,810 pharmacies. However, as health-care costs rise, employers and other contract managers are doing whatever they can to control spending.

The market is moving in a direction that at this point is away from Walgreen's core strengths, said Scott Mushkin, analyst at Jefferies & Co.

While Walgreen has some partnerships, it cannot go out and negotiate prescription contracts like others such as CVS Caremark Corp can, he said.

Their strategic positioning appears to be a little bit off, he said. One solution would be to beef up their retail market share.

Walgreen had hoped to reach a new deal before the end of 2011, in order to minimize the disruption that is likely to occur when Express Scripts clients start filling their prescriptions outside of Walgreen's 7,811 U.S. drugstores.

CVS, Rite Aid Corp , Safeway Inc and other chains have been advertising for some time that they will accept Express Scripts patients if they are turned away at Walgreens stores, hoping to cash in on their competitor's contract difficulties.

On Tuesday, CVS said its earnings could rise as much as 11 cents per share next year if it fills some of the prescriptions Walgreen has been filling until now.

Walgreen shares were down 2.8 percent at $32.56 in midday trading after sinking to $30.81.


Walgreen said it remains open to any fair and competitive offer from Express Scripts, which contends that it would only keep Walgreen in its network at rates and terms that it believes are right for its clients.

Separately, Medco Health Solutions Inc shareholders overwhelmingly approved the plan for the company to be sold to Express Scripts.

Now, Walgreen is trying to retain as many clients as possible by brokering deals. It estimated that it will have 97 percent to 99 percent of last year's prescription volume in fiscal 2012, assuming it does not resolve its impasse with Express Scripts.

Seeking to downplay the potential impact of the dispute on its business, Walgreen said that more than 100 health plans, employers and various Express Scripts clients told it they have either had changed PBMs or made sure patients would still have access to Walgreens pharmacies in 2012.

A deal between Walgreen and Express Scripts is still likely to be reached in early 2012, which would limit the potential impact, said S&P Capital IQ analyst Joseph Agnese.

Walgreen said the decision to part ways with Express Scripts cost it a penny per share in comparable pharmacy sales in the first quarter, and another penny per share in expenses.

Walgreen earned $554 million, or 63 cents per share, in the fiscal first quarter that ended on November 30, compared with a profit of $580 million, or 62 cents per share, a year earlier.

Analysts were expecting 67 cents per share, according to I/B/E/S.

Along with the costs related to Express Scripts, profit was pressured by lower reimbursement rates for prescriptions and by the chain administering roughly 600,000 fewer flu shots than at the same time last year.

Sales rose 4.7 percent to $18.16 billion. Sales at stores open at least a year, or same-store sales, rose 2.5 percent. Prescription sales, which make up nearly two-thirds of business, rose 2.6 percent at drugstores open at least a year.

(Reporting By Phil Wahba in New York and Jessica Wohl in Chicago; Editing by Maureen Bavdek and Gunna Dickson)