CVS Health Corp (CVS) 2002 Q1 法說會逐字稿

Please stand by. Good day everyone,

and welcome come Long Drug store's first-quarter

results conference call. This call is being

recorded. At this time for opening remarks and

introductions, I would like to turn the call over

to Mr. Tim [Marin]. Please go ahead, sir.

Thank you. And good afternoon.

We'll begin with remarks by president and chief

executive officer, Harold Somerset, followed by

chief operating officer, Terry Burnside's

operations review. Chief financial officer Steve

McCann will provide insight into our financial

performance, along with our expectations for the

second quarter, before we respond to your

questions.

But first, we will be making forward-looking

statements within the meaning of federal

securities laws during this call. We believe that

our expectations are reasonable and are based on

reasonable assumptions. However, risks and

uncertainties relating to future events could

cause actual results to differ materially from

expectations.

For a full discussion of these risks and

uncertainties, please refer to our recent SEC

filings. Long's does not intend, and assumes no

obligation to, update any forward-looking

statements. If you need a copy of the release we

distributed at market close, please call

925-210-6737.

With that, here's Harold Somerset.

Thanks, Tim, and good afternoon,

everyone.

In February when I became CEO, I said I had one

major expectation for my term. That was to move

our company forward at an accelerating pace. That

remains my priority and I'm pleased with our early

progress.

I also said my job is to drive consistent top-line

growth, while managing the implementation of our

strategic initiatives.

We're making headway towards those goals.

The last few months have been a crash course in

our day-to-day operations, and I'm enjoying it.

The experience has convinced me that while we have

a great deal to do, we have the strategies, the

resources, and we have the people to get the job

done. I'm also making sure that our senior

management team shares an understanding of where

we're going and why, and how we're going to get

there. We're spending a lot of time building that

common understanding into our plans and

priorities, and resolving issues.

That's particularly important in relation to the

five priority initiatives we announced in late

February. They are: 1. Improving our supply

chain processes to match or surpass those seen as

the best in our industry, and delivering the

products our customers want when they want them;

2. Increasing front-end sales; 3. Improving the

profitability of our core pharmacy business; 4.

Enhancing a customer service tradition that has

made Long's the drugstore chain of millions of

consumers in the western United States; and 5.

Improving processes across our operations to

maximize our efficiency.

Turning to our search for my successor, we've

selected [Korn Ferry] to lead the search and we

have begun that process. My personal goal is to

have my successor in place by the end of this

year. I will then assume the role of lead

director on our board to maintain the excellent

link between the board and our management team.

Summarizing our first quarter, we're pleased with

our sales performance. We have made a good start

on reversing the year-long negative trend of

front-end sales. We have work to do on the

expense side to drive more dollars to the bottom

line, and both of those efforts will continue in

parallel. We are still very early in this change

process but I'm encouraged by our progress. There

has been no pause whatever during this transition.

I'm confident that our senior management team

agrees that our pace has accelerated, which was my

priority.

That brings me to the end of my remarks, but I'll

be glad to respond to your questions later in the

call. Thanks for your attention, and here's Terry

Burnside.

Thanks, Harold.

There are two key points I hope you take away from

today's call. First, we made progress in

same-storefront-end sales, reversing what had been

a negative trend for more than a year. Second,

our first-quarter sales performance demonstrates

we have the ability to develop marketing

strategies and programs that store operations can

effectively implement to attain or surpass the

desired results.

What's really encouraging is the fact that

promotional products featured in our revitalized

advertising program drove our front-end sales

improvement, and we made that gain without

sacrificing margin.

We understand that one quarter doesn't make a

year, but our first-quarter performance certainly

motivates us to step up our promotional activity.

Part of the new advertising look that I mentioned

is our big-buy items, featured in our weekly print

ads. Our personal reporting confirms that these

items are positively impacting customer count and

sales, which is exactly what they're intended to

do. We're also experimenting with shifting our

print ads to Wednesdays, in an effort to avoid the

clutter associated with being in Sunday's papers.

We introduced our new event marketing strategy in

the first quarter with a chain-wide sidewalk sale

promotion. Here again, we're encouraged by the

positive consumer responses our stores are

reporting.

We have another event this coming weekend and

another just before the 4th of July. Both will be

supported by our new television, radio, and print

advertising campaign that's designed to drive more

traffic through our doors and increase market

share.

On that subject, Nielson research shows Long's

with a share of more than 20% of the California

drugstore market in the 13 weeks ended April 20th.

Nielson also reported that we outperformed our

drugstore competitors in all but one of the

categories Nielson tracks. These categories

include dry grocery, health and beauty aids,

frozen foods, nonfood grocery, liquor, and general

merchandise.

The same research shows we're also keeping pace

with grocery and mass operators in the product

categories that Nielson covers.

Turning to our core category performance, we

enjoyed solid first-quarter growth in soft drinks

and water, diet, liquor, and cosmetics. We're

still not where we want to be in photo or in

over-the-counter, where we've experienced softness

over recent months.

Pharmacy sales increased 9.2% over a year ago,

primarily the result of a 8.6% increase in average

script price that reflects manufacturers' price

increases and the use of newer, more expensive

pharmaceuticals.

We also saw improvement in generic utilization

during the quarter.

Same-store pharmacy sales were up 8.4% over a year

ago and our script count increased:

Our automated prescription fill center continues

to set processing records on a regular basis. The

facility processed its millionth prescription in

early April and has exceeded our expectations by

filling more than 10,000 scripts on several

different days.

The center's current daily output is roughly equal

to that of about 60 pharmacists. It's taking a

tremendous load off of our in-store staff, as it

continues to help offset the impact of the ongoing

pharmacist shortage. The fill center is currently

processing around 40,000 scripts weekly, a number

we expect to continue to steadily increase.

Let me spend a few minutes up dating you on a few

of the initiatives we introduced in February.

As we've said, improving our supply chain

practices and processes is of paramount

importance, and I'm pleased to tell that you we're

progressing on schedule with that initiative.

We've concentrated on developing manual processes

in the first quarter, in preparation for the

transition to automated procedures in development

with our [Reed Tech] partners as part of our

supply chain initiative.

Focusing on quick- hit opportunities that don't

remember technology we've aggressively increased

the number of promotional products that are

centrally allocated, improving our position in

vendor negotiations and sell-through on advertised

products.

Our seasonal allocation program for the upcoming

November/December holiday season has already been

completed, which will help greatly in related

advertising and promotions this year.

We've moved several key categories into our

mainland distribution centers resulting in

significant cost savings and, importantly,

lessening our dependence on third-party

distributors.

We've also benchmarked our supply chain against

more than 20 companies who have maximized their

supply chain practices, enabling us to monitor our

progress as we move ahead.

We communicated our supply chain and advertising

plans to more than 100 brokers and manufacturers

last week, to a very enthusiastic reception.

Working with our partner, [Demand Tech], on the

price optimization phase of the initiative, we've

completed approximately 40 front-end categories.

Our activities in the current quarter will

continue to be focused on quick-hit opportunities

and preparing for the technology phase to begin in

the next fiscal year. But importantly, the

initiative is clearly delivering the benefits

we've anticipated from the quick-hit process

changes we're focusing on.

I've already talked about our new advertising

program, which is an integral part of our

initiative to improve front-end sales. Toward

that end, we're designing new food [plan-o-grams]

for our stores to accommodate more convenience

products, including dry, refrigerated, and frozen

foods.

Again, the emphasis is on convenience and becoming

a destination for fill-in shopping trips,

something today's customers are increasingly

making.

Our other priority initiatives are coming together

and I look forward to keeping you apprised of our

progress. As Harold said, these initiatives

impact every aspect of our business, and we're

making sure they're carefully developed and rolled

out.

That's it. I thank you for your attention. Now,

here's Steve McCann.

Thanks, Terry, and good afternoon,

everyone. I'll begin with a financial review of

the quarter before providing you with guidance for

the second quarter and the full year.

Total sales for the quarter were up 5.6% over last

year. The same-store sales increasing 4.3%.

Front-end same-store sales increased 1%, as Terry

said, reversing a negative trend we'd experienced

for the past year. This was driven primarily by

increased promotional sales.

Pharmacy same-store sales rose 8.4%, primarily

driven by an increase in average script price.

Pharmacy sales increased to 45.9% of total sales,

compared to 44.6% last year.

In addition, third-party pharmacy sales were 90.6%

of total pharmacy sales, compared to 89.1% a year

ago.

RX America, the pharmacy benefits management

company we purchased in the third quarter of last

year had $5 million in sales in this quarter, with

a pretax income contribution of just over

$2 million.

Last year, RX America contributed about $660,000

in pretax profit to Long's.

Our gross margin rate in the quarter on a FIFO

basis was 26% compared to 25.7% last year. This

improvement was primarily driven by increased

generic utilization on the pharmacy side of the

business.

Front-end margins were essentially flat with the

first quarter of last year. This was a terrific

performance as we were able to manage front-end

margins while increasing our promotional sales at

the same time.

Earnings this quarter before the cumulative impact

of the implementation of SFAS 142 were

$11 million, or 29 cents per share, as stated in

our release. We had a net loss, after the

cumulative effect of the accounting change - our

net loss was $13.7 million, or a negative 36 cents

a share.

We adopted FAS 142 which eliminates amortization

for goodwill and certain other intangible assets

at the beginning of the quarter. Our goodwill on

our books primarily relates to store acquisitions

we've made in the Pacific Northwest and in

California. An independent valuation determined

that goodwill, as now defined by FAS 142, in three

districts was impaired, resulting in a charge of

$41 million, or 24.6 million on an after-tax

basis.

This new accounting standard also eliminates the

amortization of goodwill expense beginning this

year. Long's had goodwill amortization of

$1 million on a net of tax basis during the first

quarter of last year, and had goodwill

amortization been excluded in last year's

first-quarter results, net income for the quarter

would have been $12.6 million or 34 cents a share.

Prior to the implementation of FAS 142, the

company had goodwill totaling approximately

$123 million on its balance sheet, so this

write-down accounts for about one-third of our

total goodwill. The remaining goodwill on our

books relates primarily to stores purchased from a

competitor in fiscal year 2000.

Turning to our supply chain initiative, it was on

track with the first-quarter impact of a negative

1 cent per share. As you may remember, we had

projected an impact of up to a negative 4 cents on

our last call. Looking ahead, we expect the

initiative to cost us from 1 to 3 cents a share in

the second quarter, and our estimate for the full

year is that its impact will be flat to slightly

negative, or the same as our projection that we

gave you on our last call.

Operating and administrative expenses for the

quarter were 22.2% compared to 21.5% a year ago,

with the increase resulting from a couple of

items. First of all, RX America expenses are now

included under our O and A expenses. Last year, RX

America was a joint venture that was recorded on

the equity method of accounting, and we included

our share of their profits last year in O and A

expenses. Now we're splitting out each element of

their P and L and their balance sheet, along with our

line items.

Second, O and A expenses now include the incremental

expenses we're incurring related to our supply

chain initiative. So those are the two primary

items that are driving the expense write-up.

Depreciation and amortization expenses were

$18.9 million compared to 18.6 million a year ago.

As I mentioned, this year's number also excludes

the goodwill amortization expense, as we stopped

incurring that expense as of the beginning of this

year.

Net interest expense in the quarter was

$3 million, compared to 3.7 million last year.

This year's interest expense, both - interest

expense reflects both lower borrowings and lower

interest rates.

Our tax rate for the quarter, excluding the impact

of the tax on the accounting change, was 37.6%

compared to 39.9% a year ago.

Most of the decrease was due to a tax law change

that allows us to now deduct dividends paid on

shares in our ESOP plan.

Moving to the balance sheet, cash and other

current assets are up about $21 million from last

year, primarily the result of, again, adding RX

America's receivables to our balance sheet.

Our inventories are in good shape. They're well

under control, with quarter-ended FIFO inventories

on average per store at about $1.3 million

compared to 1.4 million a year ago.

Inventory turns in the quarter rose to 1.4 times

compared to 1.33 times last year.

Net debt, defined as short and long-term debt less

cash on hand, was $133.7 million at quarter end

compared to 164.8 million at the end of the first

quarter a year ago, down $31 million. Good

performance.

On the cash flow statement, net cash from

operating activities declined this quarter,

primarily because of a change in the timing of our

quarter end. With last year being a 53-week year,

our first quarter this year ended in May, compared

to an April ending a year ago. Our year-end is

shifted later by one week.

As a result, calendar month-end oriented

payments - for example, sales and income tax,

rent, and some merchandise payments - were paid

in the quarter this year, compared to being

included in cash and liabilities a year ago.

As you can see, on our balance sheet, our current

liabilities are down about $32 million from a year

ago.

In short, this reduction is primarily a matter of

timing.

Capital expenditures in the quarter were

$18 million compared to 20 million last year. We

continue to anticipate net capex of about

$120 million for the full year.

We opened four stores and closed one in the

quarter, giving us 439 stores at quarter end. The

stores we opened in the quarter increased our

selling square footage to just over 7.2 million

square feet at quarter end. We anticipate opening

another 7 stores in this quarter - that's the

second quarter - continuing to concentrate on

increasing our presence in high-potential existing

markets, especially California.

In total, we continue to expect to open 25 to 30

new stores this year.

Okay. Well, let's turn our expectations to the

current quarter.

We project second-quarter total sales growth of 4

to 6% over the second quarter of last year. With

same-store sales increasing between 3 and 5%.

Earnings per diluted share, including the impact

of a negative 1 to 3 cents for our supply chain

initiative, are projected at 27 to 31 cents

compared to 30 cents in the second quarter of last

year.

For the first year - or I'm sorry, for the full

year, we're projecting total sales growth of 2 to

4% over last year, remembering that last year was

a 53-week year. We continue to project full-year

earnings of $1.25 to $1.35 per share, excluding

the impact of onetime items.

That brings my comments to a close and I'll ask

the operator to begin polling to your questions.

Thank you. Today's question and

answer session will be conducted electronically.

If you'd like to ask a question, please press star

1 on your touch tone keypad. We'll take as many

questions as time permits and proceed in the order

that you signal us. Once again, that is star 1 to

ask a question, and we'll pause for just a moment

to assemble our roster.

And we'll take our first question from Meredith

Adler with Lehman Brothers.

Good morning. Oh, good

afternoon, I should say. What planet am I on?

A couple of questions for you, just to talk a

little bit about the impairment you took.

I gather if it's three districts, then it's fair

to say that you had to take an impairment not only

on the stores in the Pacific Northwest but also

some of the [Rite-Aid] stores that you acquired?

Yeah, Meredith. This is Steve.

Good to hear from you again. The impairment that

we took writes off essentially all the goodwill in

the northwest and our approach to impairment for

the company was to actually look at it at a

district level, and when we did that, we had two

districts that had stores that we had purchased

from a competitor a number of years ago, and so we

did - we did also write off that goodwill as

well. So your presumption is correct. There is

some -

Okay. And then another question

I have is to just, you know, talk a little bit

about, you know, kind of what's going on in the

environment that you see. Certainly the

promotional environment. It was good to see that,

you know, Nielson is saying that you're not losing

share, but I was just wondering if you, you know,

could talk about kind of what the environment

looks like, and then I have one more question.

From - Meredith, specifically,

this is Terry. Are you talking about the

promotional environment?

Yeah.

Okay.

And sales environment. You

know, how is the consumer doing.

Okay. What we see in the

marketplace from - let me break out the classes

of trade as we look at them.

From - from drug, we do see one competitor in

particular becoming stronger in terms of their

promotional advertising, or buy one get one free

offers, that type of thing. Grocery, I haven't

seen a great deal of change. I can't say as I've

seen a great deal of change in mass. From our

Nielson data that we look at, it appears that our

promotional activity changed a couple of things.

Clearly, the trajectory of front-end sales was

changed. But in particular, we fared far better

and grew market share against drug, even in spite

of a key competitor having what I would deem to be

stronger promotional activity.

We see grocery in mass - and there's always give

and take in these category measurements - we see

some growth there, but it appears that largely,

where our share growth came from and where grocery

in mass came from was from the remaining drug

competitors. That's somewhat the way we had

interpreted what the numbers tell us.

Okay. Great. And then my final

question is: It's nice to see that generics are

helping drive your gross margin. I'm just

wondering what you're seeing on other sort of

reimbursement fronts, whether it's from, you know,

managed care, which is obviously big in

California, or, you know, Medicaid, MediCal, you

know, also very big. You know, are you seeing

pressure on reimbursements in that area?

Meredith, this is Terry again.

We also at the table Bruce sexually, who is our

senior vice president of pharmacy and business

development. I'm going to ask Bruce to take that

one for us.

Yes. As far as the

reimbursement schedules that we're seeing from

managed care, we are seeing a level of activity on

third-party reimbursement, but most of it has to

do with the government programs. There's a lot of

government regulatory issues that are circling

around the country that are trying to drive down

these particular reimbursement rates. But not

necessarily from the private pay sector.

But more so the government-funded portion.

So that means Medicaid or

MediCal?

No, we have not seeing anything

in MediCal yet but we did see in Washington,

they're looking to reduce the reimbursement up

there from about - about 3%. So what we are

starting to see is some impact there. We have not

seen anything in Hawaii or California but that's

not to say that it's not on the table in the

legislature to change that.

Okay. Great. Thank you very

much.

We'll now take a question from

McDonald investments. David Rogers.

Good afternoon, guys.

One - two questions, actually, that I had. First

was about the gross margin, if you could give us a

little more detail on the particular front-end

gross margins and secondly on the generic

[inaudible] rate. The second question I wanted to

ask about was your warehousing in-house. Have you

seen better in-stocks and on-time deliveries and

how do you think that's affecting your business

this year versus last.

Sure. Hi, David. The - on the

front-end side, we've got multiple things going on

here. One is that we're working with an outside

partner to do a fair amount of price optimization,

some demand econometric modeling to help us

understand or - or to help us move the consumer

either in - either to drive additional sales or

to drive additional margins. So we believe that's

working very nicely.

We - in addition, I believe that we're buying

better, and particularly on the promotional side

of the business, so whereas before, a lot of our

activity was store by store based, now it's -

it's being bought as - you know, as a company,

and with our senior VP of marketing, Todd [Vasos],

he's added a degree of expertise that previously

we hadn't had had hammered down here. So we're

pretty pleased with what we're seeing on that

side.

On the generic utilization, you know, we did have

an improvement with Prozac and Glucophage coming

in. That's helped drive utilization. But we

also, internally, are focused on trying to help

our mix in the pharmacy side as well by stressing

the generics as in the stores.

Do you have a specific rate on

that, Steve?

We haven't typically given that out

in the past so I don't think I'm comfortable at

this point giving that out.

Okay. And then on the

distribution centers.

Yeah, this is Terry. Just to add

to one of Steve's comments and then I'll respond

to your question on the distribution centers. One

of the things that I think that has been real key

has been not only did we bring expertise in the

party in Todd that Steve referenced, but with the

ability to get our promotional activity executed

at the store level, that's made all the difference

in the world for his negotiation abilities. When

you go to a vendor and you're looking for the

appropriate deals to reach price points and

whatnot that you want to attain in the marketplace

but you can't guarantee execution or you can't

allocate product which has certainly been one of

the early initiatives, one of the manual processes

that I referenced in my comments, it becomes very

difficult for the vendor to pony up when he or she

doesn't know what that outcome might look like.

So the two pieces that come with Todd's expertise

is our ability total things done at the store

level, get displays executed, and also our ability

using some manual, at this point, to be automated,

processes associated with forecasting product

needs we're in stock and that's led to PO

quantities that frankly generate the funding we're

looking from the vendor.

On the warehouse side, we haven't been without our

challenges, but clearly in the period since we've

taken over the warehouses, we've seen a very

continuous decrease in the cost of operation.

We're ramping up utilization. Also, as I

referenced in my comments, lessening our

dependence on third-party distributors or

wholesalers, using the warehouses, their

capabilities, to a higher degree. We're very

pleased with - with what that picture looks like.

It's improved our in-stock conditions, and in

fact, the utilization of the warehouse as well as

driving down our costs.

Okay. Great. Thank you.

We'll now move on to John Sinclair

with Montgomery asset management.

Hello, gentlemen. I just wanted

to flesh out one issue with respect to the gross

profit margin increase. When I compare your gross

profit margin trend, at least in this quarter,

versus some of your big national competitors, most

are suffering gross profit margin erosion. And

despite the fact that the generics are a positive,

we've got an inherent negative secular mix trend

because RX growing faster than OTC. Is it correct

to interpret that the big plus for you guys is the

price optimization and the better buying that's

driving the increase in gross profit margin?

On the front end of our business,

our front-end margins were actually flat with a

year ago. Our improvement actually came on the

pharmacy side of the business. We've got, you

know, some competing things going back and forth

on the front-end side. I'd say the primary thing

is that I think overall, our margins are lower

than our competitors and so we had more to work

with, with the driving of the - of increased

generics and holding our front ends where they

are.

So it was - front ends were

flat and RX was up fairly materially to equate to

a 30 [inaudible] increase for the aggregate store?

That's correct.

And so just with respect to the

price optimization, that's not a misnomer in that

this is just your getting increasingly better

buying by aggregating your purchasing and then

reinvesting it in the lower price? This is a

combination of inching up some prices to where you

can, and also reducing prices where you can?

It is both, and it's - it is truly

an optimization. In some cases, we're actually

looking for more sales and in some cases, we're

looking for more margin.

Okay. Have you quantified, to

date, the potential benefit from better buying?

Yeah. I don't have that with me,

though. It's the smaller piece of it, though,

so . . . We're -

The smaller piece of the supply

chain initiative?

In terms of what's been implemented

this far, yeah.

I see. Okay. Thank you.

We'll now take a question from Solomon

Smith Barney's Lisa Cartwright.

Hi. It's Elizabeth Lynn calling

on Lisa's behalf.

Hi, Elizabeth.

Hi. I wanted to find out if you

could give us an updated on the automated

prescription fill center. I know when you

reported the first-quarter, you said that you were

averaging about 6,000 prescriptions a shift. I

wondered if there was any update on that.

Yeah. It's - Elizabeth, this is

Terry again, and I'll ask Bruce to kick in here if

there's any add to it. We've just seen continuing

growth on a 6-day fill week. We're basically

running between 40 and 41,000 scripts a week. Our

typical Monday, which is the big day, is right

around that 10,000 number. So doing the math,

we're up around 66, 6700 a day, and it just

continues to inch up every week, so very happy

with the performance and how that's progressing.

Okay. And in terms of the

pharmacist vacancies right now, has that remained

stable? I know that for the past several

quarters, you've reported you had about 70 open

positions.

Yeah. It has not changed much.

We're about at that same number.

Okay. Great. Thank you.

Uh-huh.

I would like to remind everyone that

if you do have a question, to please press star 1,

and we'll take a question from Raj [Urasi] with

[Occzip] capital.

Yeah. Hi, guys. Was just

wondering, what were marketing expenses this

quarter versus last quarter, year over year?

Raj, we don't typically give out

that legal of detail on our P and L.

Got it. Okay. Thanks.

They were - it would be fair to

say that they were slightly up.

Slightly up? Okay.

Slightly up, yeah.

And moving on, we'll take a question

from Kenny O with SAB capital.

Hi. I had a couple of quick

questions, I guess. You mentioned front-end

pressure, you know, front-end gross margins were

flat year over year, there were some benefits but

there were things that were offsetting that a

little bit, there were a host of factors going on.

I guess question number one is, how much were the

offsets, and how much do you expect them to abate

over the course of the year and sort of over what

period of time?

And the second question is, you guys, you know,

significantly outperformed the guidance you gave

on sales before. You guys were originally giving

a range of 2 to 3% on sales, and you ended up

being up sort of 5-and-a-half percent. The delta

on that is about a 25 million-dollar sales

difference and when we compared it with the

expectation for the front end, it seems like most

of that came from front-end, you know, exceeding

expectations and sort of assuming a normal

contribution at 30% gross margins, you know, it

seems like you guys should have had an additional

after-tax contribution from that of 4 to 5 million

and it should have been significantly higher on an

earnings basis, where it seems like that was sort

of offset was on the SG and A line, the SG and A number

ended up being much higher than sort of what we

were anticipating, and we were just wondering, you

know, if you guys had sort of a, you know,

explanation as to why that was up so much.

Yeah. On the front-end side, in

terms of what offsets that are out there, I mean

we had product mix and - product mix and

inventory true-up at the end of the quarter were

the primary items that were kind of the offsets.

We'll continue to - to monitor those as we go

forward.

The product mix piece, is that

something that would be - is that something

that's a sustaining - is that a change that will

continue to persist for the rest of the year, and

was that the bulk of it? Or was it the inventory

true-up a lot?

Well, the inventory true-up was

higher than what we had expected it to be. We had

hoped that some of that would be - would flow

through a little bit more.

In terms of it being sustaining for the rest of

the year, I mean, we will continue to alter the

product mix as we go, but at this point, I don't

have a projection to give you on that.

So I mean I guess my question

is, when you said, hey, gross margins were flat

year over year, product mix and inventory true-ups

were some of the things that sort of offset - you

know, hold back improvement, as we look through

the rest of the year, the - you're saying product

mix is going going to continue to change,

inventory true-ups, though you - some portion of

that offset should abate, basically.

Yeah. I mean I'm - when I say

product mix, I'm talking about the promotional

content.

Sure.

Okay.

But the inventory true-up piece,

it sounds like that was higher than normal and

you'd expect that to abate as we progress through

the rest of the year?

I would hope so, yes.

And how - how much do you think

that contributed to sort of - how much pressure

did you - or offset was that on gross margins for

front end?

I - I don't - I don't have that

number in front of me, Kenny.

Okay. Is that something you can

give us afterwards, as a follow-up?

Call Tim, yeah.

Okay. Thanks. And then the

second question?

On sales being a lot better than

guidance? Yeah. Our - as you're all aware, our

front-end same-store sales trajectory was altered

pretty dramatically in the quarter from where we

were coming out of the fourth quarter, and we made

some decisions to spend some money that we didn't

originally have in the plan, and we also had a few

things that came in higher than what we had

expected them to be. Namely, some insurance-type

costs such as workers' comp and healthcare costs.

The entire insurance industry is evidently going

through quite a bit of a shakeout, and so we're -

we're managing those costs, but they weren't

included in our plan, the way that - the way that

they're coming in at this point.

So we'll continue to manage those as we go

forward, but we intend to make - make the calls

on what we spend going forward based upon how our

sales trajectory looks, so - but you are right,

it was off of the SG and A line.

And when you said you spent more

based on the sales trajectory, was that sort of

investment spending in SG and A that sort of you

expect to pay dividends in the future? Sort of

where were you spending more in SG and A? Because I

think you just made a comment that marketing was

not up that much.

Marketing was up slightly, but that

was actually in the plan.

Yep.

You know, some of it is in payroll.

Particularly as we continue to re- engineer the

corporation - the company as we go forward to a

more traditional-looking organization. So . . .

So when you say some of it is in

payroll, it would tend to be more traditional, is

that you're adding more people and is it mostly

coming from addition of head count.

Yeah.

As you guys change the

organization?

That's right.

Okay. And that sort of addition

of head count sort of at the corporate level, but

over time you'd expect productivity to be

generated from the store level where you're sort

of replacing that - you know, the work effort at

corporate to replace store-level tasks and stuff

like that?

I think that's a legitimate

expectation, yes.

Okay. Oh, one final question. The improvement

from margin to generics, is that something that

will continue throughout the year, you think?

We're going to continue to try to

manage that mix. That's a profit opportunity that

we have, so yes.

Great.

And when you guys talk about

insurance costs being up, how much of your SG and A is

insurance and, you know - because I can't imagine

it's, you know, a huge chunk and you're saying

it's up more than you expected but I think

insurance, workers' comp rates are, you know, up

20% or something. Theations - everybody kind of

had the expectation that they'd be up a lot. Sort

of - how much of your SG and A costs were insurance

related.

Kenny, that's a level of detail

that I really don't want to go into on this call.

Okay. Well, was that a

significant factor in the SG and A being up because

you mentioned that as your - that was the first

explanation you gave. Was that a significant

factor or was it more that payroll and head count

was up dramatically?

Kenny, that was an example.

Oh, sorry, okay.

All right. Can we move on? Kenny,

I - I do want to give everybody a chance to

ask -

Fine.

- their questions. Thank you.

And as a final reminder, that is star

1 if you'd like to ask a question, and we'll pause

for another moment.

And we'll now take a question from Henry Levin

with John A. Levin and company.

Thank you. Maybe you can just

comment on the working capital adjustments in the

quarter?

Well, inventories were relatively

the same.

Uh-huh.

Hang on a second.

Really the payables which were

down a lot.

Yeah, and we discussed that with

the shift in the - in the quarter-end timing with

our 53rd week last year, where a year ago we would

have had payments that are month-end, calendar

month-end oriented, such as rent and sales and

income tax payments would have been included in

our liability balance.

Uh-huh.

At the end of the year last year,

our - or at the end of the quarter last year,

which was April 26 last year, this year our

quarter ended May 2nd, so those payments were paid

out this year with that one-week shift in our

quarter ended calendar. So the big - the

reduction is primarily a matter of timing.

Thank you. Apologies. Thank

you.

Sure.

And we do have a follow-up question

from John Sinclair with Montgomery asset

management.

Hello, gentlemen. Once again,

could you flesh out a little bit what the - what

the benefit was in the first quarter from better

buying, if so, and secondarily, if you could just

give us a sense of you talked a little bit of

price optimization and that's helpful but if you

could talk about what you're doing in aggregate

relative to - to year-ago with respect to

pricing? Are prices - front-end specifically -

moving down, and if so, could you quantify that to

the degree that you could?

Yeah, let me see if I can tackle

the question. This is Terry. As far as the

pricing piece, to be honest with you, I'm trying

to remember the start date and I'm having mental

failure here in giving you that date, versus a

year ago, but we've looked at really several

different metrics associated with our relationship

with [Demand Tech]. As I mentioned, we've gone

through about 40 different categories of product,

and as Steve referenced in his comments, one of

the things we're trying to do there, it isn't one

size fits all, so it's a little difficult to

answer your question, and here's why: We have

certain categories that have been soft in the

front end that are very core to a drugstore

environment, so our approach there has not

necessarily been the same as, say, a noncore

category. By that, I mean our desire to move

sales that drives the synergy with other

categories in the store has been equally offset

with driving margin without the sacrifice of

sales.

Uh-huh.

But we do a roll-up very frequently

and meet to take the projections of what we

believe to be attainable and see where we are in

terms of a report card basis, but there is - we

have the ability within the price optimization -

some people tend to think of price optimization as

only being raising prices. Price optimization is

really a combination of margin sales and pricing

optimizations, so we've taken different tactics in

different categories to balance that, so I don't

have a net number to give you, other than that

it's based on projected activity.

How about if I ask the question

a different way. For every 100 basis points that

you could gain in better buying or through supply

chain efficiencies, how much of that would you

anticipate investing in lower price?

Boy, I wouldn't have a number for

you. We frankly hadn't even thought of it quite

that way.

I see. So you're not

necessarily thinking about what you can save in

being more efficient and how much you can reinvest

in front-end prices to drive sales? That's not

necessarily the way you're looking at it?

No. We're tending to look at

the - the activity associated with the

promotional activity and better buying, we're -

we've tended to look at that that the better

buying funds the better promotional activity. And

the price optimization reflects our need to drive

sales in given categories versus extract margin

from different categories to balance, you know,

the entire picture, so it's been looked upon in

that fashion.

And when you say "promotional

activity, you mean increased A and P as well as

reduced pricing?

Yes.

Okay. Thank you very much.

You bet.

And we'll go back to Kenny O with SAB

capital?

Hi. I just had a quick

follow-up. In terms of the sales guidance, I -

you know, you guys also upped the guidance on that

from 1 for 2 for the full year to 2 to 4. The

earnings guidance has stayed the same. Is most of

the offset coming from sort of higher than

expected SG and A expenses as well? Sort of mostly

head count and all that sort you have stuff as it

relates to the full year.

That's right, Kenny.

Okay. Thanks.

You're we will comment.

And that does conclude the question

and answer portion of today's conference.

Mr. [Marin], I would like to turn the call back

over to you.

Thank you. And ladies and

gentlemen, thanks for joining us today. We'll

talk to you soon.

Once again, thank you, everyone, for

joining us today. That does conclude the

presentation.