CVS Health Corp (CVS) 2003 Q1 法說會逐字稿

Good day, everyone.

Welcome to the CVS Corporation's first quarter conference call.

Today's conference is being recorded.

At this time, I would like to turn the call over to the Vice President of Investor Relations, Ms. Nancy Christal.

Thank you.

Thanks for joining us today for the first quarter 2003 conference call.

I am here with Tom Ryan, Chairman, President and CEO of CVS Corporation who will cover highlights of first quarter results, and David Rickard who will present financial review and earnings guidance.

Before turning to this morning's news, I have a few administrative items to cover.

First, just a reminder that our annual analyst and investor meet willing take place on Thursday, May 22, at the Woldorf (inaudible) Hotel in New York City.

If you haven't received an invitation but would like to join us, please call my office at 914-722-4704.

If you have received the invitation and haven't responded yet, please sign up soon via email

Second, I want to once again remind you that 2003 will be a 53-week year for CVS.

Most have factored that into the model but this is a reminder for anyone new.

Dave will discuss this again when he provides earnings guidance later.

In light of regulation, we'll only accept them for the first week in the earnings call.

This review and comment will be limited to suggesting changes based on information disseminated to the public on the call.

We'll check it out for appropriate interpretations of what we set.

In addition, please note during this call we will discuss one non-GAAP financial measure and discuss our company's performance which is free cash flow.

In accordance with new SEC regulations you can find the reconciliation of free cash flow to comparable GAAP measures on the investor relations portion of our web site and Dave Rickard will remind you of the definition of free cash flow in his remarks today.

Our attorneys have asked me to read the Safe Harbor statement.

During this presentation, we will make certain forward-looking statements that are subject to risks and uncertainties that could cause actual results to differ materially.

For these statements we claim the protection of the safe what are for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995.

We strongly recommend that you become familiar with the specific risks and uncertainties that we have outlined for you under the caption cautionary statements concerning forward-looking statements in our annual report on 10-K for the year ending December 28, 2002.

Note that this call may not be rebroadcast without prior written consent from CVS.

Today's call will be simulcast and archived for a period of one week.

This morning's earnings press release is available on the web site as well as the April release which should be reviewed along with the information in the call.

Following the call, please feel free to call me with any questions.

Now I'll turn it over to the chairman, Tom Ryan.

Thanks, Nancy.

Good morning.

Thank you all for joining us today.

Well, despite a difficult environment, with slowing pharmacy trends and a cautious consumer, I'm very pleased with the results for our quarter.

Our total sales in first quarter increased 5.7% to a record 6.3 billion dollars.

Same-store sales grew 3.9%, and pharmacy same-store sales rose 7.1.

We continue to take share in both the pharmacy and the front end which has been one of the keys to our results.

Now, while we saw slightly slower sales trends than we hoped for, improvement in gross margin led to earnings per share of 48 cents in first quarter which is up 11.6% from the prior year.

We talked a little bit about pharmacy.

If you adjust the negative impact on the top line from generics which reduced pharmacy comps by about 220 basis points for the quarter, pharmacy comps were 9.3 for if first quarter.

This morning, we also reported our April same-store sales.

Total comps rose 7.1 while pharmacy comps rose 7.0.

Adjusting for generics again, pharmacy comps would have been 8.6.

I want to touch on some of the trends I've noted a little earlier in discussions across the pharmacy industry.

There's been a lot of focus on the IMS data that compiles prescription volume growth trends.

The monthly IMS data showed scrip growth in November and December of '02 was five-plus percent, decreasing to 1% for the first quarter of '03.

We believe the key reasons for the slowing scrip volume are primarily cyclical.

One there's a reduction in the use of hormonal replacement therapies which we calculated about 50 to 60 basis points.

The Claritin to OTC switch and some rising co pays of other RX non-sedating antihistamines, in total that accounts for 90 to 95 basis points.

Obviously, the generic impact has a negatively impacted the top line by about 220 basis points as I mentioned.

And also we note the mailorder is growing, and we estimate that the retail impact on mailorder is about 130 basis points.

You add to that the lack of any new drugs, the impact of a slowing flu season and you can see the comparisons are difficult.

Having said that, retail pharmacy still has the demographic wins of aging and utilization at its Beck.

We pretend to participate in that growth.

We talked of the front end of our business.

Front end comps were down 2.7 in first quarter.

And this is obviously impact by the Easter shift.

In April, front end comps were 7.4% and benefited from that same Easter shift.

We estimate about 650 to 660 basis points.

For the combined April/March period, front end comps were essentially flat.

Year to date, our front end comps are flat -- essentially flat.

Remember that front end comp comparisons are tougher in first half than they are in the second half of this year.

The good news is that the latest AC Nielsen data shows we continue to gain share in the front end categories.

We continue to see strength in health, beauty, private label, consumables, seasonal and general merchandise.

In fact, our Valentine's Day and Easter sell throughs were solid and best we've had in a number of years.

We're working on some new products and services in the beauty and photo categories that we are very enthusiastic about.

And for those of you who come to the May conference, you'll be hearing more about that at that time.

Our Extra Care program continues to grow.

We now have nearly 37 million cardholders and the feedback from our cardholders on some if enhancements has been outstanding.

We now give extra bucks every day.

We give extra bucks at the register once a quarter.

And customers who own the CVS card have thrown away their scissors.

That no longer have to clip coupons.

As far as the promotional investment, it has been stable compared to recent periods.

We are spending smarter and aggressively fighting for share.

We have the unique ability to balance our investment in weekly circulars and our targeted promotion through Extra Care to our most loyal customers.

And as we have said, we have also ramped up the broadcast spend in TV and radio this year.

Also in the quarter, we continue to expand hours of store operations with the number of 24-hour and extended hour stores up 8% versus the first quarter last year.

In addition, we continue -- we completed the rollout of the system for the front end last November and we are seeing significant benefits in inventory reductions as well as better in-stock position.

Dave will talk a little bit more about our inventory turns a little later.

Our rollout this year of the AIM solution for pharmacy is well under way and currently we have about 700 stores in test and in place and the entire chain should be utilizing AIM by the end of the year.

We also plan to tend AIM application for seasonal items with a rollout schedule to be developed once the test is completed.

I would say most likely it will be in 2004.

Now, let me turn to our new store program which I'm pleased to say is right on track year to date.

During first quarter, we opened up 61 stores, including 37 new and 24 relocations and closed 25 others.

Our net growth was 12 stores.

Of the new stores, 14 were in new markets.

We opened seven in Chicago, one in Texas, two in Florida and four in Arizona.

We are still on track for our plan to open approximately 250 to 275 new or relocated stores in '03.

That will result in net unit growth of about 100 to 125 stores or approximately 4% square footage growth.

You'll be hearing more about PharmaCare, but I wanted to give you a quick update.

We had an acquisition in the fourth quarter of last Fallon clinic which the (inaudible), our President will talk more about that.

But we continue to be pleased with the integration of PharmaCare and ProCare.

We have been able to integrate the specialty business into our existing book of business at a fairly good rate and we think that's some more opportunity to market the combined services to new clients.

As you know, in 2000, PharmaCare did 200,000 in billion and today it represents the fifth largest PMB in the company we continue to gain new business, and continuing to grow faster than our core business.

I'm extremely pleased with PharmaCare's results to date.

Now, I'll turn it over to David for some financial details and then we'll come back for some Q&A.

Thanks, Tom.

Good morning, everyone.

I'll start by reviewing the first quarter results in detail.

Then I'll provide some guidance for the full year as well as the second quarter.

So first the income statement.

As Tom said, total sales increased 5.7% in first quarter to a record 6.3 billion dollars.

Pharmacy sales represented over 69% of total sales in first quarter.

Up approximately 200 basis points from first quarter of 2002.

Third party pharmacy sales were 92.6% in the quarter, compared to 91.4% in the first quarter last year.

Our overall gross margin increased by 42 basis points to 25.43%.

The improvement in our gross margin was driven by several factors.

Significant among them were a favorable product mix, driven by the expansion of the use of generic drugs.

Reduced mark downs due to better seasonal sell throughs.

And as Tom said, we're spending smarter on fully competitive promotional levels combining broad promotions in our circulars with targeted rewards to our best customers through Extra Care.

These positive influences on our margin were partially offset by the continued mix shift toward pharmacy as well as the continue shift of our pharmacy business from cash to third party customers.

Which have a negative impact on overall margins.

I want to take a moment to address the improvement we're seeing in our shrink.

We took physical inventories in about 1,200 stores in first quarter and about 1,600 stores year to date.

Indications are good that we're back on track for where we plan shrink to be for the year.

However, since we only completed physical inventories in about a quarter of our stores in the first quarter to be prudent we have not yet broadly adjusted accruals.

Our 10-Q will provide the data, but let me summarize it here.

Total inventory losses in the first quarter were 1.05% of sales, compared with 1.07% in the first quarter of 2002.

An improvement of only two basis points to a gross margin in this quarter.

But clearly, if we continue to see the type of shrink improvement in the rest of the stores that we saw in the stores we have done to date, we'll recognize the positive impact in our gross margins begin manager the second quarter.

As a side bar, we have got an lot of questions on the impact of the new rule on vendor allowances, EITF 0216.

We have responded generally that it should not change our accounting practices.

That's true.

However, because of a clarification provided in March on the calculation methodology, we do have a nominal timing shift of some of these funds.

We will defer $8 million of pretax earnings benefit to future periods that otherwise would have fallen into first quarter.

This is clearly not material, but I wanted to update you on it.

Now, I'll turn to SG&A.

Our total SG&A as a percentage of sales including depreciation and amortization modestly increased year over year by 13 basis points to 20.18% in first quarter.

As we indicated in our previous guidance, we are continuing to invest in our growth vehicles, especially in regard to new store expansion.

Additionally, we have invested more in our advertising with our branding and new pharmacy ad campaign as planned.

On the flip side, we had the absence of the litigation expense incurred last year.

But every quarter we have some one-off expenses.

For example in this year's first quarter we had a significant incremental expense for snow removal which nearly off set the litigation expense.

On the expense reduction side, we saw continuing benefits from technology and other expense containment efforts.

That those technologies would be Epic and AIM.

They helped improve the level of customer service throughout our stores through gains in productivity and in-stock positions as well as reducing inventory carrying costs.

Operating margin was 5.25% in first quarter, an improvement of 28 basis points over the first quarter of 2002.

And within our expectations.

Net interest expense was 13 million dollars in the quarter.

We were slightly better than guidance due to greater improvement in working capital combined with more favorable average interest rate.

Our tax rate was 38.4% in first quarter as expected.

Increasing slightly versus last year due to some state tax increases.

And as Tom indicated earnings per share were 48 cents for the quarter, up 11.6% over last year.

Now, let's turn to the balance sheet and cash flow.

Inventory continues to post significant improvement.

In first quarter, inventory decreased by 5.5% versus last year even though sales increased by 5.7%.

The AIM initiative that we completed last year for front-end regular merchandise continues to help reduce inventory in the stores while also reducing out of stocks.

Our distribution efficiency is also helping us improve inventories.

For example, we only shipped part of our promotional 40th anniversary goods to stores initially and then delivered additional quantities as needed.

Last year, we also built our pharmacy inventory are reduce out of stocks which we didn't have to do this year.

Our store inventories dropped by almost 8% from the first quarter of '02, and by over 3% from the levels we saw in the last quarter.

Our turns also showed improvement, rising to 4.62 times.

This is up from 4.55 times last quarter and compares to 4.31 times in the last year first quarter.

As Tom indicated in his remark, we have over 700 stores utilizing the AIM system in the pharmacy so we expect to continue to deliver good results on the inventory front.

First quarter gross and net capital expenditures were 176 million dollars as we had no sale act activity during the quarter.

We had positive cash flow of 8 million dollars in the quarter.

This is a new first quarter record.

First quarter results in both 2002 and 2001 were approximately a 200 million dollar cash use.

The swing is due in large part to improve. s in working capital, especially around inventory as I previously discussed.

You will recall that we defined free cash flow as earnings after taxes, plus non-cash charges, plus changes in working capital, less net capital expenditures.

So free cash flow excludes acquisitions and dividends.

Now I'll turn to 2003 guidance.

For the full year of 2003 we expect total sales to grow 8 to 10%.

That includes the 53rd week in total comps in the four to six percent range.

Pharmacy comps are expected to be in the 6 to 8% range and front end comps to be flat to 1% positive.

As I discussed in the last conference call, full year 2003 gross margin should improve as we continue to benefit from the shift toward generics and make further progress in shrink.

Full year 2003 SG&A as a percent of sales should reflect the continued investment in store expansion and advertising that I've noted before.

Thereby modestly increase versus the record level achieved in 2002.

Therefore, we're still only counting on operating margin to expand slightly for full year 2003, but of course on a higher sales base.

Our tax rate is expected to be 38.4%, above the 38% we saw in 2002.

Our diluted share count is expected to be about 407 million shares for 2003.

As you know, we have a strong history of success and in cost control and we are managing the business to accommodate somewhat slower sales.

As a result, we still expect 2003 earnings per share for the 53-week period to increase 10 to 14% from the $1.75 reported in 2002.

That would give us a range of $1.92 to $2.

This includes 2 to 3 cents for the 53rd week.

We will continue to aggressively pursue inventory turn improvements in 2003.

We have a minimum goal of between 4.8 times and 4.9 times for the year.

Capital expenditures net of sale lease back transactions are now projected to be between 550 million and 650 million in 2003.

You'll note we have modestly increased the projection.

This reflects the decision to purchase some of our store equipment rather than lease it as originally planned.

While this increases our capital expenditures a bit this year, we will see financial benefits from this over the long term.

Free cash flow in 2003 is still expected to be between 200 and 300 million dollars for the 53-week year.

I haven't previously given second quarter guidance, so let me do that now.

For the second quarter we expect comp store sales growth of between 4 and 6% including the Easter shift.

And total sales growth of 6 to 8%.

Pharmacy comps are expected to be 5 to 7%, while front end comps are anticipated to increase by approximately 2 to 3% including the benefits of the Easter shift.

So for the second quarter, we expect front end comps on the minus 1 to plus 1% for the Easter shift and plus 2 to plus 3 with the Easter shift.

Of course, second quarter comp comparisons are a bit tougher due to the closed store benefit in last year's numbers.

And we expect EPS of 46 to 49 cents which will be up from the 43 cents reported in the second quarter of last year.

In summary, first quarter financial performance was solid with record sales and record free cash flow.

We continue to operate in a challenging retail environment, but we're demonstrating solid progress toward our earnings per share and free cash share growth targets.

I look forward to seeing you in two weeks.

Thanks for your attention.

Now I'll turn it back to Tom.

Thanks, Dave.

Well, David said it's certainly a challenging environment for retail, and we are working hard to make it easy for our customers, especially during these difficult times.

We remain focused on execution in our stores, and to our stores.

We will continue to open new stores in both new and existing markets in a controlled, measured way to ensure we get the best locations and operate the stores with the best personnel.

Despite the industry growth occurring at somewhat a slower rate, retail pharmacy remains among the best demand trends across all of retail.

And CVS is well positioned to participate in that growth.

So with that, I will open it up for some Q&A.

Thank you.

The question and answer session will be conducted electronically.

If you would like the ask a question, please do so by pressing the star key followed by the digit one on your telephone keypad.

If you're on a speakerphone, please make sure the function is on mute to allow it to reach our signal.

Please press star one for questions.

We'll take our first question from Meredith Adler with Lehman Brothers.

Good morning, and congratulations on a solid quarter.

Just a couple of questions for you.

Dave, I wasn't sure I understood why you were so conservative on the shrink.

Is there some -- you know, some sort of internal guideline that you have to have a certain number of stores with an improvement before you feel comfortable putting that the your accruals?

Well, I think Meredith, that it simply a judgment that we make based only the facts in front of us.

We could have been more aggressive and booked the favorability.

We simply chose to wait.

Sometimes these things can snap back pretty quickly against you.

We didn't want to have that running through our numbers.

All right.

I like that conservatism.

Another question is about cash flow.

I mean, clearly you are doing everything that you set out to do in terms of cash flow.

First, I'd like to know whether you see significant more opportunity to improve inventory turns as I think your inventory turns are lower than a competitor like Walgreens.

I'm trying to understand the use of free cash flow.

I know the rating agencies still have a negative outlook.

Do you think that's any chance this year a that they say we're comfortable for you to buy back some shares?

Well, first of all, on the question of inventory opportunity, yes, I believe we have considerable inventory opportunity.

We obviously had a terrific result this past quarter.

We're keeping the pedal to the metal on that.

We've got, you know, the full benefit of AIM on the front store regular.

We're going to be getting the impact of AIM on pharmacy.

That's a big pile of inventory as well.

And then we'll get it on our seasonal and promotional as we roll that out next year.

So, you know, for that reason alone, I think we've got opportunity.

But there are a lot of people in this company working very hard outside of AIM per se to do things smarter, to do things better, to optimize their inventory.

All those efforts continue to go.

That stuff is built in to people's compensation, and I'll tell you if they keep going like they're going right now they'll have good compensation this year.

So yes, I think there's plenty of opportunity.

As to the rating agencies, I think that our continued really strong performance here over the last five quarters since that rating outlook was created should be influential with them, but you never know exactly when that's going to happen.

My next meeting with them is three weeks away.

I'll get a better reading at this time.

Okay.

Great.

Thank you very much.

We'll take our next question from Mark Husson with Merrill Lynch.

Good morning.

Could you talk of the PharmaCare business an just put, you know, some parameters around the performance of PharmaCare in terms of is it a positive swing to earnings firstly?

Secondly, if it's increasing at 130 basis year over year are damaging your retail sales, you're in the mail business, what's happening to your mail business and what was the year-ago number for that current 130 bit change?

Mark this is Tom.

The PharmaCare definitely accretive in terms of positive earnings to us and has been for some time.

Our mail business in PharmaCare continues to grow.

And having said that, we have been in contact with many payers and employers particularly to talk about the advantages of retail pharmacy and, you know, we have been tempting the 90-day supply, but we have been testing to understand the economic impact of one copay, two co pays, three copay, different dispensing fee, the impact of the number of people transferring from existing customer, transferring from 30 to 90 days versus slowing down the erosion of retail to mail.

I mean, that's two different dynamics here.

So, you know, mail is going to continue to grow.

We expect it to continue to grow.

But at the same time, PharmaCare is on the one hand participating in that growth and CVS retail on the other hand is experimenting with how we can, you know, manage that -- slow down that switch.

Okay.

So if it's a 130 basis point slow down this year has that accelerated significantly over last year?

No, it's not.

It's about the same?

Yes.

In terms of the segmental reporting we'll put this out in the 10-Q obviously, but you will see PharmaCare's combined sales are up just over 20% and profitability is up over 80% on a pretax basis.

The reason for that obviously is we're getting the benefits of the combination of PharmaCare and ProCare as well as taking advantage of the growth that's inherent in the markets.

And one final question if I may on the generic flow through.

I think it's about the 160 basis points, therefore, in the last month of a hit to the top line.

When does that slow down further still from this kind of range for the year?

And then also can you talk of the gross margin flow throughout the year?

We will be cycling against Prozac.

So we should see it starting to slow down in the third -- third quarter or so when we look about -- look at the comparisons.

And, you know, obviously Prozac was a big one for us and we're cycling against that shortly.

We have Prilosec (ph) coming out, but it's -- Prilosec actually went generic in the fourth quarter of '02.

So we could start to see that slow down in third quarter.

It would then keep us down in the 160 kind of area.

Right.

As we go forward.

So 150 to 160 for the whole year?

That's our guess right now, but obviously it depends on what actually happens.

And then the flow of gross margin, is there any reason to suppose that the gross margin doesn't continue the throw through the current rate?

The generic effects should continue at about the current rate.

So the positive should continue.

There is no sort of falloff in '04 or anything?

I don't believe.

So not related to generics certainly.

Mark Husson Excellent.

Thank you.

We'll take our next question from John Heinbockel from Goldman Sachs.

Tom, one of the buckets in the IMF data is the whole macro consumer purchasing power under pressure, copay sticker shock.

How does that play out, and is that more -- is that more cyclical or structural and when do we get a moderation in that?

Well, you know, obviously co pays are increasing.

I think the -- you know, the economy is certainly impacting utilization slightly many in the pharmacy.

You have a number of people laid off.

You have people losing their copay benefits.

I think there's some quote/unquote pill splitting going on a little bit.

You know, obviously when the economy comes back we should start to see that trend reverse.

But we have seen a little bit, John, as I mentioned earlier in the nonsedatings, Zyrtec and Allegra.

Some plans have raised the co pays there.

So we should be cycling against that.

Okay.

What progress are you guys making -- I know you're litigating with Massachusetts.

You know, what's the prognosis for success there and have any other states got the bright idea to tax pharmacy or is that in the works anywhere?

No, no other states have got that idea.

In fact, we have had states where we have been able to get them to look at other solutions to their rising health care costs and their state deficits.

North Carolina in particular is one.

Rhode Island is another to some degree.

Massachusetts, you know, we're -- we filed a brief, it's not just CVS, but a number of other chains and also independents.

And, you know, we at this point in time we can't really comment on the lawsuit.

All right.

You guys are absorbing under a penny a share of -- of hit from that?

I mean, you didn't quantify it in the call, but it's obviously decent-sized number, correct or not?

We're absorbing it and it's close to that.

In that neighborhood, yeah.

So is there anything you're doing proactive to off set that or there was conservatism in your guidance to begin with?

No.

John, listen, at the end of the day, if you get a slight slow down in sales you're balancing all the levers. 're balancing all the lever, in sales, margin, expense and inventory.

So it's kind of just -- you know running the business.

All right.

One final thing.

The 52 million of acquisition, what does is that compromised of?

Roughly.

The acquisition in the fourth quarter of last year, is that what you mean?

Was that the -- --

Oh, the Fallon clinic?

Caller: Did that fall into this quarter?

Yeah.

Of the I guess tail end of last year, first part of this year.

I think we closed it actually on January 2.

So Fallon clinic, it's a very small chain of clinics up in the Boston area.

The -- hold on.

We've got the PBM business and some clinics and some small files.

So that was the bulk of the acquisition for the quarter?

Right.

All right.

Thanks.

We'll go next to Lisa Cartwright with Smith Barney.

Good morning.

Elizabeth Lynn calling for Lisa.

Okay.

I was wondering if you talk of what you're seeing in the consumer right now, whether you're seeing any change in the traffic count and the lower gas prices?

Well, we can still see the consumer fairly cautious.

You know, store visits are slightly down.

And the consumers -- other than the seasonable business were excellent.

So the consumer is trading down a little bit and certainly more promotional conscious.

And we expect that to continue for certainly the remainder of this year.

You know, I think obviously gas prices I read recently for every penny decrease -- or penny increase in gas prices its takes a billion dollars out of the economy.

So as gas prices continue to drop, obviously, that will be beneficial for the consumer and ultimately for us.

Okay.

Great.

Then I was wondering, you talked a little bit about the refinements that you made to your extra bucks program.

I was wondering if you can talk of what impact you're seeing from those on the front end?

Well, from -- from our standpoint, The fact that we're giving out extra care bucks right at the register has lowered our SG&A a little bit in that program.

We used to mail them out directly to the consumer.

And then as consumers get the extra bucks, they typically in the past continue to spend about 38% more than the extra bucks themselves.

So the consumer gets an immediate satisfaction when they get them at the register every quarter.

We continue to see a benefit from Extra Care, obviously.

Thank you very much.

We'll go next to John Emrick (ph) with Brickamore Capital (ph).

Two unrelated questions.

You're talking of comps in the second and first halves.

So it sounds leek you have two months of more challenging comparisons left before they start getting easier in July, is that right, and is that true for both the front end and pharmacy?

Yes, that is correct.

Okay.

Secondly, where does your second quarter guidance assume for the accrual benefits from improved shrink that you talked about?

You kind of delayed until your physical inventory is done?

Yeah.

I mean, I'm not going to give you a specific number for that, but I do expect things --assuming things continue as they now are going will start to adjust the accrual in the second quarter.

So there is some assumption there.

Obviously, we're managing many MM, pieces of the expense line.

And that's just one.

Okay.

If you were to kind of end up at the higher end of the earnings range, would you assume the most likely cause of that happening would be that the -- that the benefits from lower shrink would start come in kind of the way you said at end of last year and beginning of this year?

I think the main drivers if we were at the higher end would have to do with sales vibrance (ph) and the mix of regular sales as compared to promotional sales.

Gotcha.

Thank you.

Yep.

We'll go next to Michael Elman (ph) with GMO.

Thank you.

Can you comment on the number of file buys this year, please?

We expect to do about 275 to 300, 325.

And how many did you do in this last quarter?

I don't have the quarter -- I don't have the quarter with me, but it's similar.

We'll give you a call back.

It's similar -- on a year to year basis, it will similar to last year in total and the timing I don't suspect is any much different in this quarter.

But Nancy will give you a call back on that.

Okay.

Terrific.

And with respect to your -- I just wanted to make sure I understood your comment about vendor allowances and the adoption of the new accounting standard.

You basically deferred 8 million dollars or you -- you essentially reduced your -- I guess increased cost of sales by 8 million dollars?

That's right.

In this quarter.

And this you'll recover the benefit of that accrual in the next three?

Did I understand that properly?

That's basically right.

We'll recover it as we saw the related inventory out.

What happened is they issued the EITF in November of last year, 2002.

Right.

And then in a -- what I think is a somewhat unusual pattern, they had a further deliberation on it in March.

February, March, and then we got additional guidance in March which we then implemented retrospectively for first quarter and this did result in our deferring 8 million dollars of benefit.

Okay.

Thanks very much.

Now, what's going to happen obviously is each quarter we're going to have to go through the same thing and each quarter will have some amount of deferral.

So, you know, it remains to be seen how this thing is going to affect us over the years but we'll see.

Okay.

To save Nancy a call, we got in time information here.

We did about 40 or so less file buys in the first quarter this quarter than last quarter.

Okay.

Thanks.

We'll go next to Mark Wiltamuth with Morgan Stanley.

Good morning.

Dave, the questions on the front end, your comments there suggest suggested that you are doing a little better on gross margins on the front end.

Just wanted to confirm that.

You did say you're spending smarter, does that mean you backed off some of the promotional spending or you're just changing the mix of which products are promoted?

Yeah.

First of all, I can confirm that we did better in front end margin.

Secondly, the spending smarter has to do with our new ability to use the Extra Care card information to target our spending.

So whereas a couple of years ago what we had was circulars and very little information about what customers were doing as a result of circulars other than our sales information.

Now we have all kinds of information.

What they're buying, you know, what products are coupled when they buy this, they also buy that.

So let's stimulate this purchase of this and get the regular sale of that.

That kind of thing.

So we're just -- we're sort of more laser-guided in our promotional approach.

The actual spending level is not considerably lower.

We're just using it better.

We're also targeting supplier dollars better.

Okay.

David, you also look out at the wave of generics as you're lapping that wave of generics, do you have a quarter in mind of overall gross margin declines because the front end is mixing with the pharmacy?

I don't have a projection right now that would suggest that.

But I'm equally not going to tell you it's never going to happen.

I just -- it's not going to happen in the very near term, I don't believe.

Thank you very much.

Yep.

We'll take our next question from Marie Driscoll with Argus Research Corporation.

Hi, can you hear me?

Yes, we can.

Thank you.

Most my questions have been answered so I'm wondering if you can just elaborate on the growth rate you expect to see in the mail order business.

And if you could talk about how much of your growth going forward is a result of, you know the aging demographics and how it will be -- you know, they seal have Scripps that they'll be required to be fulfilling for the rest of their life and could that want be transferred over to mail order?

Thanks.

Sure.

Mail order is about -- I guess 16 or so, 17% of the prescriptions in the country in total.

And it's growing faster than retail.

In total.

And we expect -- we wouldn't be surprised if that was, you know, 20-plus percent at some point in time.

Of the total prescription pie.

But the whole pie is growing to your point earlier about the aging population and the increased utilization.

So there is certainly an opportunity for us to participate in that growth.

Mail order will continue to grow at its pace and retail will continue to grow.

So we're looking as I said -- as

I mentioned earlier, we're looking at having discussions with a number of payers on the economics around mail order.

So while it will continue to grow, I think there will be some retail answers to the mail order question.

The whole issue is improving care and lowering costs and we think that retail pharmacy can do that.

What -- could you quantify what that might be?

No, we can't.

We can't quantify that now.

I mean, the fact that the pharmacy itself is growing is obviously a good indicator for us and the fact that we're moving to growth areas where there is more aging population which will increase drug utilization obviously will -- be beneficial to us.

Mail order has been around a long time in this country, and retail pharmacies continue to grow for a long time in this country.

And we don't foresee that stopping in the future.

Okay.

Thanks.

Okay.

We'll take two more questions.

Thank you.

We'll go to our next question from John Ransom with Raymond James.

Hi, good morning.

Could you tell us if -- on a same-store basis if prescription volumes increased or decreased in the quarter?

Thank you.

Increased.

Okay.

Thanks.

One last question?

We'll take our final question today from David Magee from SunTrust Humphrey.

Good morning.

A couple of questions.

These are in some ways related to earlier questions.

On the mail order side, since you've got both mail order and retail, can you speak to I guess the relative cost of delivery of both -- of both channels?

Is there major differential there?

Well, sure.

The mail order -- the cost of mail order is certainly left to deliver on a per scrip basis.

The issue is what does the ultimate payer pay and that has to do with the number of copay, it has to do with generic utilization, it has to do with rebate pass-through.

And obviously there are some quote/unquote waste with mail order.

So it's really ultimately what the payer pays.

But, you know, on a per scrip basis, it's a little cheaper to do mail because of just the --the volume and the pharmacist technician.

And then secondly, with regard to the pharmacy, pharmacy comps are you seeing a widening of the differential between the unit growth and the sales comp number on the pharmacy side and if so, is there anything besides generic at play there?

Well, we have some of those other items that we talked about TRX to OTC switch of some of the key -- some of the key items.

But inflation is down slightly, you know, year over year in pharmacy.

So that's some of the Delta difference.

Is that true on both the generic and the branded side?

Branded, a little less.

Down little further.

But essentially true.

Okay.

Thank you.

Okay.

Thank you and if you have obviously any questions as usual you can give Nancy Christal a call.

Thank you very much.

Thank you.

This does conclude today's conference.

We do appreciate your participation