CVS: The Fire This Time

CVS: The Fire This Time

Larry Dignan

Drugstore retailer CVS Pharmacy has a prescription for the systems running the 1,260 Eckerd stores it acquired over the summer-decommission them by the end of December.

Since CVS bought the stores in July for $2.15 billion, the Woonsocket, R.I.-based chain decided that the best method of integrating Eckerd’s systems was to apply the torch. “It’s like when Sherman went through Atlanta,” says Jack DeAlmo, vice president of supply chain and logistics at CVS. The Civil War-like strategy? “Burn it all down and start over.”

The most critical applications CVS is installing include systems for automated inventory management, pharmacy workflow and loss prevention. None will be carried over from Eckerd.

“CVS notified us quickly that it would not keep Eckerd’s systems,” says Salena Gallo, public relations manager for Eckerd enterprise software supplier Retek, based in Minneapolis. “We obviously tried to change their minds.”

But the controlled burn is proceeding rapidly. As of Sept. 29, CVS had converted 450 Eckerd stores to its systems, and was converting about 90 more every week. The goal is for all Eckerd stores to be remodeled and operating under CVS signage and systems by July 2005.

CVS bought Eckerd’s pharmacy benefits and mail-order business from J.C. Penney, as well as Eckerd stores primarily in Florida and Texas. Eckerd’s remaining stores were sold to Canadian drug chain Jean Coutu.

To complete the integration as rapidly as possible CVS decided that it wasn’t worth keeping any of Eckerd’s information systems. In the past four years, Eckerd had taken back operation of its systems, whose operation and maintenance it had contracted out to IBM. The goal was to catch up to the fast-response distribution system of industry leader Walgreens.

But Eckerd’s re-created systems will simply be junked. In buying Eckerd, CVS is larger than Walgreens in number of stores, at least at the moment. CVS operates 5,383 stores compared to Walgreens’ 4,595.

Walgreens, however, generates more sales. Through Sept. 30, Walgreens has this year produced sales of $28.2 billion. CVS’ sales through Oct. 3 were $21.7 billion.

Walgreens is also more profitable, with earnings of $327 million in its most recent fiscal quarter, compared to CVS’ earnings of $234.5 million in its most recent quarter.

Next Page: The burning of Eckerd’s systems comes at a price.

The burning of Eckerd’s systems comes at a price, of course. CVS plans to spend $300,000 to $350,000 on each store to integrate systems, remodel and change signage, CFO David Rickard said on the company’s latest earnings conference call Aug. 4.

CVS is not commenting beyond DeAlmo’s quip about Gen. William T. Sherman and his fiery conduct in what Atlantans often call the War of Northern Aggression.

But how CVS operates can be pieced together from the company’s recent analyst meeting, filings with the Securities and Exchange Commission and Wall Street research reports.

For quick changeovers, CVS employs a strategy called “swarming.” Plans for makeovers are made even before the ink touches paper on an acquisition. Once the ink starts to dry, employees are ready to descend on locations needing conversion.

For instance, one week after the Eckerd deal closed, CVS announced that three Eckerd distribution centers had been integrated with its own. CVS also had sync’ed up the two companies’ supply chain, merchandising and purchasing systems.

To accomplish this, CVS employed what the company calls a “data bridge” where items such as prices, product availability, and payroll and benefits were swapped between the CVS and Eckerd systems. According to DeAlmo, CVS systems tell Eckerd’s what to do-at least until the Eckerd systems are terminated.

According to J.C. Penney filings with the SEC, the company will operate Eckerd’s information systems, accounting, banking, vendor contracting, and tax and other transition services for 12 months. Data management for pharmacy systems can last up to 15 months. CVS is on pace to cut over to its systems before the agreements with J.C. Penney expire.

Next Page: Wall Street is watching.

Wall Street is closely watching not only how quickly CVS can put its systems in place but how fast the company can turn around weak performance at the Eckerd stores.

“The business we acquired was declining, so there’s a lot of work to do,” said Rickard on the conference call.

Indeed, CVS expects the Eckerd acquisition to initially hurt results. For 2003, CVS had sales per store of $6.4 million. Adding Eckerd to the family will knock sales per store down to $5.7 million. Sales per square foot is expected to decline to $708 in 2004, down from $816 in 2003. Growth in same-store sales for CVS is now expected to be in the range of 1% to 2% for 2004, down from a previous projection of 2% to 3%.

Eckerd’s performance this year is elusive. Former parent J.C. Penney classified the chain as a discontinued operation when it was planning the sale. For the third quarter ended Oct. 25, 2003, however, J.C. Penney in regulatory filings called Eckerd’s results a drag on business. For that quarter, Eckerd’s same-store sales were down 1%, and operating profit was more than halved to $34 million from $79 million during the previous year.

Such performance is one reason why CVS is trying to move quickly to make Eckerd more efficient. At the company’s late-September meeting with analysts, CVS told Wall Street that it had made solid progress, retraining 20,000 employees, remodeling the stores and installing CVS’ systems. The most critical systems CVS is installing govern automated inventory management, pharmacy workflow and loss prevention.

One big area to fix: Eckerd’s shrink, a retailing term for shoplifting. At Eckerd, shrink was running 5% of front-end sales of items such as shampoo and toothpaste. Inventory was literally walking out the door. CVS’ levels are estimated to be 2.2% of store sales, according to J.P. Morgan Securities estimates.

Morgan Stanley analyst Mark Wiltamuth says data showing whether CVS’ systems can stem the losses won’t arrive until late 2005 and 2006.

In the meantime, Wall Street will be watching. Says Wiltamuth in a research note: “We believe CVS’ systems will play an important role in the Eckerd turnaround, and accordingly, we believe information-technology integration will be an important area to monitor.”

Next Page: Key performance indicators: Tale of two drugstores.

Key Performance Indicators: Tale of Two Drugstores

If CVS wants to measure the success of its acquisition of Eckerd’s stores in the southern U.S., the company will have to bring the purchased stores up to its own standards. Here are the 2003 performance metrics for CVS and Eckerd overall.

 CVSEckerd

Sales$26.6 billion$7.2 billion

Gross margin (% of sales)$6.9 billion (25.8%)$1.7 billion (22.7%)

SG&A (% of sales)$5.1 billion (19.2%)$1.4 billion (19.4%)

EBITDA (% of sales)$1.8 billion (6.6%)$241 million (3.3%)

Source: Company filings, J.P. Morgan

Copyright © 2004 Ziff Davis Media Inc. All Rights Reserved. Originally appearing in Baseline.