CVS Health Corp (CVS) 2002 Q3 法說會逐字稿

Good day everyone.

Welcome to Longs Drug Stores third quarter earnings results conference call.

This call is being recorded.

At this time for opening remarks and introductions I'd like to turn the call over to Mr. Tim Maron.

Please go ahead, sir.

Thanks operator.

And welcome to Longs third quarter conference call.

We'll begin with President and Chief Executive Officer, Warren Bryant, who will give us his initial observations after spending most of the last three weeks since his appointment familiarizing himself with our store operations, personnel and customers.

Chief Operating Officer, Terry Burnside, will review our operations for the quarter ended October 31and Chief Financial Officer, Steve McCann, will discuss our financial performance before providing our guidance for the fourth quarter.

Vice Chairman Harold Somerset, who has served as our interim CEO is on hand to respond to questions.

Harold is overseeing our day-to-day business while Warren accesses company wide operations.

Let me point out that we will be making forward-looking statements within the meaning of federal security laws.

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.

Please refer to our recent S.E.C. filings for a full discussion of these risks and uncertainties.

Longs does not intend and it assumes no obligation to update any forward-looking statements.

If you need a copy of the release that we distributed just after market close today, please call [inaudible] 925-210-6624.

Now let's begin with Warren Bryant.

Thank you, Tim.

Good afternoon, ladies and gentlemen.

Its been just three weeks since my appointment and I'm still very much in a fact finding and analysis stage so I'll limit my comments today.

I am three weeks into a systematic evaluation of Longs business model, its processes, and execution.

That evaluation began in our stores and includes a market by market review both physically and of the numbers.

It includes analysis of store and administrative processes, IT systems, execution capabilities, value drivers, and organizational structure and strength.

I visited many stores across several markets on the mainland and in Hawaii.

I've talked with employees, senior and administrative staff, I've talked with suppliers and customers.

Three weeks seem like an instant and there's much more to do, but I've had the luxury of a terrific interim CEO in Harold Somerset.

His contributions have allowed me the time to focus on learning Longs, which is one of my initial objectives.

I'll have the benefit of Harold for just a few more weeks and I intend to use it.

I believe our shareholders and our employees will benefit from our smooth and careful transition.

One thing that is has really impressed me is how committed our store teams are to providing our customers with the products and service they've come to expect from us.

I've also observed how well we market to the specific needs of the communities in which we do business.

The time I've spent with our corporate management team and staff has also shown me a genuine commitment to making Longs a stronger competitor.

Analyzing their strategic priorities and our financial models I found our strategies to be well planned and sound.

I also believe we have the financial flexibility required to execute our priority programs.

We'll provide you with more details on our priorities for fiscal 2004 on our year end call.

Let me add that I reviewed the guidance we'll be sharing later on this call, and taking the current economic conditions into consideration, I'm confident that the guidance is on target.

As I mentioned, I plan to move into my full time CEO role late next month, and I'd like to once again acknowledge and thank Harold Somerset for overseeing our operations while I've been out in the field.

That concludes my remarks.

Thank you for your attention and for your patience.

I expect to have more information to share with you on our next call.

Let's turn to Terry Burnside.

Thank you, Warren.

Good afternoon, everyone.

If there's one point I want to make today it's that we maintain the operational momentum we built over the first half of the year in spite of an economic environment we've all become too familiar with.

Our priority initiatives and other performance improvement programs are on schedule.

Let me stress, as we have on previous calls, that these are long term strategies requiring significant investment over the next few years.

It will also be some time before we start receiving a full return on our investments.

We expect to layout the time tables and budgets on our priority initiatives on our year-end call.

What's important to realize now is that these initiatives are designed to put us in a much improved competitive posture over time.

That's exactly where we want to be when the economic picture begins to brighten.

More on this later.

First, let me address our third quarter performance.

Total sales were up 4.6% over the third quarter last year.

Total same-store sales rose 2.7% with pharmacy same-store sales up 5.4%, and front-end same store sales rising .5%, one half percent.

Due to price deflation we believe our front end sales actually grew at a higher rate in the quarter.

We continued our more aggressive promotional strategy in the quarter which included a three week Truck Load Value sale and a series of Big Buys in our print advertising.

Syndicated market data on reported categories indicates our front end market share increased over the third quarter a year ago.

Let me bring you up to date on our marketing programs already underway in the fourth quarter.

Given the economy, our competitors increased promotions, and the fact that this holiday season is six days shorter than last year's, you can expect us to continue to be promotions driven going forward.

We consider that to be the soundest strategy in today's competitive environment and it's also the philosophy that help make the Longs brand one of the most recognized in the west.

Let's take a look at our pharmacy results.

Same store sales growth was driven by a 7.9% increase in average script price impeded by just under two and a half percent from the introduction of new generic drugs.

Overall pharmacy gross margins were increased by our rapid introduction of new generic items.

Script counts declined slightly as several key markets in which we operate have been seriously impacted by the downturn in the economy.

We take prescription growth seriously and are taking several actions to improve our pharmacy script growth.

One is our October adoption of a new generic pricing strategy, which has improved our competitive position in the market.

We also introduced an innovative senior program earlier this month and I'll discuss that in more detail in a few moments.

We're also planning to aggressively pursue script file purchase opportunities to help build both count and share.

Now, a few words about our new pharmacy discount program.

It's a unique approach called Senior Advantage and we think it's an excellent alternative to the senior discount programs being discussed in Washington and in some state capitals.

Senior Advantage provides qualified senior citizens with savings on a prescription cost, plus additional savings on Longs private label products, greeting cards and assorted merchandise from Hallmark and our Longs photo processing.

We believe the program addresses the needs of an important consumer segment and early customer response is well above our expectations.

Our pharmacy profitability improvement initiative is also underway.

Created to significantly expand automated prescription filling technology in our in store pharmacies.

Let me update you on on our joint venture automated fill center which continues to take a significant load from our store pharmacies.

The center continues to cost effectively fill prescriptions at a rate well above our plans.

It's been so successful, in fact, that we've approved the installation of a second dispensing line that is expected to begin filling prescriptions for our higher volume Southern California stores in the spring.

We're also pleased with the performance of RxAmerica, our pharmacy benefits management subsidiary, which continues to increase the number of scripts it processes while contributing nicely to the bottom line.

Okay let me bring you up to date on our priority initiatives.

I've already mentioned our pharmacy profitability initiative, so let me begin with our program to improve operational processes across the company.

We've retained a nationally recognized consulting firm to conduct a comprehensive assessment of our overall operations and recommend ways to significantly improve processes and remove costs.

This assessment addresses store processes and store support functions that at our general offices and our distribution centers.

It also incorporates the changes made necessary by our other initiatives.

Our supply chain initiative meanwhile is on schedule.

And we are introducing process changes to support more efficient methods of doing business.

I hope that helps put the quarter and our priorities in perspective and I appreciate your attention.

Now here is Steve McCann with his financial review.

Thanks, Terry.

Good afternoon, everyone.

I'll begin with a financial review of the third quarter before providing guidance for our fourth quarter.

Third quarter net income stated in today's release was $3 million or 8 cents a share.

That's up from $2.5 million or 7 cents a share a year ago.

Total sales of $1.1 billion reflected growth of 4.6% over the third quarter of last year.

Same store sales meanwhile increased 2.7%.

We began the quarter with sales that were within our forecasted range before slowing in mid-September .

Our October sales, in fact, were the softest of the quarter.

That naturally causes us to view our fourth quarter with a degree of caution.

Third quarter front end same store sales were up .5% over last year with October again being the softest month of the period.

Pharmacy same store sales increased 5.4%.

But, as Terry said, let me point out the fact that without the impact of the generic substitutions for higher price brand name drugs we estimate that pharmacy same store sales would have been up about 7.5%.

Over all, pharmacy sales accounted for 45.4% of total drug store sales compared to 44.5% a year ago.

Third party sales meanwhile made up 90.9% of pharmacy sales compared to 88.9% a year ago.

Moving to gross margins.

Our total gross margin rate of 26.5% was up about 1.3 percentage points over our rate a year ago.

Two factors were primary contributors to the performance.

First, is the benefit that we received from the increase in generic drug utilization in our pharmacy business.

And second is the benefit from our price optimization activities related to our supply chain initiative along with better buying.

But I should point out, that the increase was driven primarily from the pharmacy side of the business.

Our supply chain initiative, as I've said, had a positive impact of a couple of cents on net earnings as we forecasted in our last call.

Looking at the fourth quarter we anticipate the initiative will have a similar impact on earnings as we continue with the project implementation.

Operating and administrative expenses at 24.0% of sales were up 1.4 percentage points over a year ago.

While we're not at all pleased with this performance, there are a number of items that contributed to the increase.

Included in our expenses - included are the expenses associated with our supply chain initiative, those costs were incremental to last year.

And RxAmerica expenses are now being consolidated into our financial statements.

We continue to make managerial and staff additions that are incremental to our existing head count, designed to increase our internal talent and expertise.

And as as we've said before, we are experiencing functional redundancy at the corporate offices as we prepare for various process changes related to the initiatives.

Our O&A increase was also impacted by consulting cost, employee termination and new hire expenses as well as an incremental workers comp expense charge related to a revaluation of our prior year and current year reserves.

This revaluation of our workers comp reserves are the result of increased cost expected to be incurred as a result of regulatory changes in California.

To say it differently the affect of these changes were underestimated when the reserves were initially established.

New stores also contributed to our expense rate erosion as we opened six new stores during the quarter.

This gives us a total of ten new stores through the first three quarters of the year.

We expect to open nine more stores in the fourth quarter for a total - year end total of 456 stores.

With our current store expansion program adding 20 to 25 stores annually over the last several years, nearly a quarter of our stores are now less than three years old.

The last and final item affecting our O&A increase was the increase in generic usage.

Which actually reduces our total sales creating a negative impact on our O&A expense as a percent of sales.

Moving on, depreciation and amortization expenses were $19.6 million in the quarter compared to $18.7 million last year.

This year's numbers exclude the amortization of goodwill expense and other intangibles which was $1.6 million in last year's third quarter.

As noted on earlier calls, we stopped expensing goodwill at the beginning of this year with the implementation of FAS-142.

Net interest expense was $3.1 million in the quarter compared to $3.4 million a year ago.

That's primarily due to lower interest rates.

Our effective tax rate was 26.5% in the quarter compared to 40% last year.

The change was primarily due to the benefit of a tax planning initiative begun earlier this year.

We did incur consulting fees related to this project and they're accounted for in our O&A expenses.

For information, we're now expecting our full year tax rate to be in the 26% to 27% range for this year before moving back to a more normalized expense rate next year -- Or tax rate next year.

Turning on to our results for this first 39 weeks of fiscal 2003.

Total sales increased 5.3% to $3.26 billion.

Same store sales were 3.4% over last year with pharmacy same store sales rising 6.6% and front end same store sales rising 1%.

Again, as Terry mentioned, we believe that our real front end same store sales growth is actually a bit higher than what's reported due to the price deflation that we've incurred this year, that has occurred this year.

Net income through the first three quarters before the cumulative affect of adopting FAS-142 was $24.9 million or 65 cents a share compared to $25.4 million or 67 cents per share last year.

Moving on to the balance sheet.

Quarter end FIFO inventories were up over a year ago.

That reflects the fact that we accelerated the receipt of certain seasonal merchandise due to the uncertainty caused by the West Coast port labor situation.

In addition, our inventory purchasing was geared to a higher level with anticipated sales than what actually occurred.

We anticipate inventories being back on their targeted levels by year end.

Goodwill is lower than last year due to the option of FAS-142.

Current liabilities were up slightly in the quarter reflecting primarily reflecting the higher inventory levels.

Net debt which is short and long term debt, less cash on hand, was $154 million at quarter end, essentially flat with a year ago.

Net cash from operating activities declined this quarter due primarily to the higher inventory levels.

Capital expenditures through the first three quarters were $64.9 million compared to $84.3 million a year ago.

We expect net CAP-X in the $90 to $100 million range for the full year.

With that let's move on to our guidance for the fourth quarter.

We're projecting that sales for the 13-week quarter, fourth quarter, will decrease 2% to 4% from last year's 14-week fourth quarter.

Again we had a 53-week year last year.

We expect same store sales growth of 1% to 3% on a 13-week to 13-week basis.

We are maintaining our earlier guidance of 51 to 56 cents per share for the quarter which would give us earnings per share of $1.16 to $1.21 for the full fiscal year.

Again excluding the affect of adopting FAS-142.

With that, I'll ask the operator to begin the question and answer session.

Operator?

Thank you.

At this time we will begin the electronic question and answer session.

If you would like to ask a question we would ask that you respond by pressing the star key followed by the digit 1 on your touch tone phone.

Once again, that's star 1to ask a question.

Then if you have your phone on a speaker phone, please remove the mute function function so your signal can reach our equipment.

We'll go ahead and pause for a just a moment to assemble our roster.

Our first question comes from Meredith Alder from Lehman Brothers.

Hi.

Just a couple questions for you guys.

First question is: You said that you saw a marked slow down in sales in October .

Do you particularly notice a difference between your Northern California business and the rest of your business?

Is it noticeably slower in Northern California?

Meredith, it's Terry Burnside.

There's markets in the north that are not performing as well as the south.

But I'd definitely have to say it's fairly mixed bag.

We still continue to see softness in that Silicon Valley area, for example.

That's probably the most market differential.

But the softness is pretty much state-wide.

Okay.

And I was wondering if you could talk about why your inventories were up so much in the quarter?

Sure.

Meredith, this is Steve, how are you doing?

Hey, Steve.

On inventories, a couple things.

One is, like we said, we did accelerate some of the receipts, the imports because of the dock strike piece that was looming.

As well as we did buy heavier -- buy for a heavier level of anticipated sales.

The other piece of it was, we did buy into our pharmacy warehouse some additional inventory for forward buy opportunities.

And we did add some additional SKUs in our pharmacy warehouse as well.

But overall we don't think this is a big issue.

We think we'll be back to where we need to be by year end.

So you are not needing to invest permanently in working capital by putting more SKUs in the pharmacy warehouse?

There may a little bit of that.

But we think there's also opportunity on the other side of the business.

And maybe you could talk a little bit more about how you managed to accomplish this stunning reduction in your tax rate?

And give us some ideas what the tax rate is going to be in the fourth quarter.

Is that a personal question?

Yes.

Yes, please.

We can give you the name of the consultant.

I would actually prefer not to go into details but it's a tax credit relative or related to a lot of the IT investment that we've done over the past few years.

And it will continue in the fourth quarter, the tax rate?

Yeah actually the second piece of this will happen -- The way it actually has to record this is, when you record it you look at your full year anticipated tax rate, and you take the portion that you expect to get you to the full year tax rate relative or that amount to get you to the tax rate in the quarter that you are actually in.

So you had some correction of the prior two quarters?

Is that fair to say?

No, it's not, because we didn't actually finish the project until this quarter.

I see.

Once we finished the project is when we can book it when we're certain of what we think the benefit will be.

So we've booked this quarter's tax rate to an amount that would get to us the anticipated full year tax rate the equivalent.

Which is 26 to 27%.

And what does that imply for the fourth quarter's tax rate?

It implies that we will book an equivalent amount so for the full year we'll be at a 26 to 27% tax rate.

Okay so.

Pretty low tax rate in the fourth quarter?

It will be lower.

But remember we have higher earnings so there's a weighting issue you know.

So you wouldn't book the quarter -- The quarter amount wouldn't be at 26 to 27%, the full year would be.

Okay.

Just a final question about -- More of a big picture kind of question.

Based on some of the initiatives you have begun, the marketing, some other things, do you have any customer research that, you know, indicates there's, you know, customers are noticing what you are doing and responding to it?

Meredith, it's Terry again.

No.

Just to respond to that. ,We haven't, since we've launched the new marketing programs we've not done anything to specifically measure or monitor customer response.

Have not conducted that.

Frankly, what we look at is the issue of what's happening with market share.

That's the true indicator for us.

And is it right that you don't have market share data that looks at, what at least in the front end what discounters -- what share they might be taking in the market?

We don't have the where with all to be able to understand where those pieces are moving internally, no.

We can look at it across our own class of trade and that type of thing.

But who is taking from what whom is impossible for to us tell.

Okay great.

Thank you very much.

Thank you.

Once again if you would like to ask a question please press the star key followed by the digit 1 on your touch tone phone.

Our next question comes from Jack Murphy with CSFB.

Good afternoon.

Good afternoon.

Wonder if you could try to follow up a little bit on the merchandising marketing.

What are you seeing in the market relative to promotion?

Especially with traditional competitors but I guess also with non-traditional.

And I am interested in particular if you have any information about what competitors might be doing with ad pricing.

Are you seeing additional ad pages and maybe any kind of additional circulars, that type of increased spending?

Jack, I think the answer is yes to all the above.

We've seen hotter pricing, we've seen more advertising, more print pages.

It's a tough economic and competitive climate.

And I guess compared to this time last year would you say its definite increase year over year?

Yes absolutely.

Okay.

Couple questions for Steve McCann.

I wonder if you could break out for us the SG&A impact from RxAmerica.

Obviously had some you know big kind of sequential change there and what your SG&A rate changes year to year.

And if we could kind of isolate that, it would be helpful.

The RxAmerica piece incrementally is about $3 to $4 million a quarter.

And that was the same in the prior quarter; is that right?

Pretty much runs pretty even quarter to quarter.

Okay.

So we could isolate that.

And then the - then on the generic impact.

Could you give us a sense of what that was, basis point impact on both gross margin and SG&A?

Yeah.

We've -- Again this is an estimate you understand.

But we think it was in the 30 to 40 basis point range.

That's to total gross margins; is that right?

I'm sorry I thought you were talking about SG&A.

The impact on the SG&A rate.

I asked both actually.

So we have the SG&A.

But on the gross margin?

I don't think we want to give out that specific number on that.

But suffice it to say it was significant.

I'm sorry I missed the last part there.

It is significant.

I don't think we want to get in to giving out a specific number on that.

Okay.

Thanks.

Our next question comes from Rick Church with Shumway Capital.

Thank you.

I just wanted a little clarification with regard to the full year guidance on the tax rate.

And your EPS guidance.

Assume that your guidance for earnings reflects the lower tax rate?

That would be correct.

All right.

Thank you.

Thank you.

Our next question comes from Monica Otterwall with Merrill Lynch.

Hi.

This is Mark Hudson here with Merrill Lynch.

Just a quick clarification on generics because there is some concern out there that generics may not be as good as people think they are.

Net/net you'd rather be selling an increase in generic penetration.

It is more profitable for you to do so.

Is that fair to say at this stage?

Yes.

That is correct.

Then second I just wanted to talk about RxAmerica and your relationship with RxAmerica and why you have it in the first place.

What does a sort of fully integrated house have that a stand alone drug store business like yours for a long time didn't have?

And then secondly do you have a mail order capability within there and can you tell us what's happening to that?

We've got Bruce Schwallie, our Senior Vice President of Pharmacy here.

I think I'll turn that question to him.

As far as the advantage of having RxAmerica, having a PBM that operates in your backyard and you know works with the various payors that are within the states we operate in, we believe it's a strategic advantage that we have that that other chains in the area do not have.

So from that perspective we see that as being a competitive weapon.

And the follow-up question was with regard to?

Do you have mail order capability in there?

We do not currently have mail order capability.

But -

Why not?

We're just -- We are precluded from being in that business at this particular time.

Okay.

In terms of working with the payors in the market place, does that mean that you get to enter some plans with -- exclusives that other people can't get into?

Or what is it that gives you the advantage?

I believe we don't really move towards exclusive arrangements, but we do have preferred arrangements with area suppliers.

Yes.

Then a more general question.

As we've seen some agitation around the states because of state budgets being under pressure on trying to take it out on retailers in terms of Medicaid reimbursement rates.

Is there any such pressure in your markets right now and how you are dealing with it?

Yes.

I mean we continue to see pressure in all states with regard to Medicaid and expect that probably will continue on through next year.

Okay.

Is that a measurable number in terms of the impact on gross margin?

It's something that we've been able to see these changes but we have primarily tried to mitigate that.

Through our buy size improvements the impact on gross margin.

Great.

Thanks for your help.

Thank you.

Our next question comes from Raja Rasy with RX Capital.

I had some housekeeping questions.

I was wondering if you could give the exact amount of the PBM contribution both from sales as well as operating profit then also the life of the reserve?

I'm sorry could you repeat that.

I wanted to see if you guys could give the exact PBM revenue contribution as well as it's operating income contribution.

Then finally the LIFO charge in the quarter.

The LIFO charge in the quarter was $1.4 million, I believe.

I'm sorry. $1 million in the quarter.

And RxAmerica's revenues in the quarter were right at $6 million.

Okay.

What about its operating profit contribution?

We gave you the range where the expenses were coming in the three to four million dollar range.

Oh, the expenses were $3 to $4 million.

Yeah.

Got it.

So it's two to three falling to the bottom line.

Okay great.

Thank you.

Thank you.

Thank you.

As a final reminder if you would like to ask a question please press star 1 now.

Next we'll go to a follow-up question with Meredith Alder.

Actually my question has been answered.

Thank you.

Great.

One correction I'd like to make on my prepared I believe I said we had ten new stores opened year to date.

That actually should have been 17.

I apologize for that.

Okay, ladies and gentlemen, if there are no further questions we'll close the call now.

Thanks for joining us and happy holidays.

Thank you.

That does conclude today's teleconference.

We appreciate your participation and you may now disconnect.