CVS Health Corp (CVS) 2003 Q3 法說會逐字稿

Good day everyone, and welcome to Longs Drug Stores fiscal '04 third-quarter earnings results conference call.

At this time, for opening remarks and introductions, I'd like to turn the call over to Phyllis Proffer.

Please go ahead.

Thank you, Jesse.

Good afternoon, and thank you for joining us today as we review Longs' results for the third quarter ended October 30th, 2003.

On the call with me today are Warren Bryant, Chairman, President, and Chief Executive Officer; and Steve McCann, Senior Vice President and Chief Financial Officer.

After our prepared remarks, we will be happy to take your questions.

Before we start, let me advise you that we will be making forward-looking statements within the meaning of the Federal Securities Laws during this call.

We believe that our expectations are reasonable, and are based on reasonable assumptions.

However, certain risks and uncertainties relating to future events could cause actual results to differ materially from our expectations.

For a full discussion of these risks and uncertainties, please refer to our SEC filings, including the discussion of forward-looking statements in our recently-filed Form 10-Q for the quarter ended July 31st, 2003.

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

Now, I will turn the call over to Warren, who will provide an overview of our operating performance for the third quarter and update you on the progress we are making on our initiatives.

He will be followed by Steve McCann, who will comment on our financial results and outlook.

Thank you, Phyllis.

And good afternoon to all of you.

We are pleased to report a 75 percent increase in net income for the third quarter, despite a difficult sales environment.

Net income for the quarter of $5.2 million, or 14 cents per diluted share, compares with the $3.0 million, or 8 cents per diluted share, reported last year.

Our ability to report this increase in net income on total sales increase of 2.1 percent is attributable to the significant productivity improvements and expense reductions we have achieved.

While there is still a lot to do we are moving in the right direction.

My remarks today are divided into two parts.

First, I will talk about our operating performance, and then close with the quarterly update on the progress we are making on the initiatives we shared with you previously.

Now, onto Longs operating performance during the third quarter.

Total sales increased 2.1 percent, and same-store sales for the third quarter decreased 7/10 of a percent.

There were several factors that impacted our sales this quarter that we need to talk about today.

This is an unusual time in the state of California.

We have the largest state budget deficit in the United States, high unemployment, and a new governor as the result of the unprecedented recall of his predecessor.

All of this serves as a backdrop to the grocery strike and the wildfires in Southern California.

Although we have found our California customers and employees to be resilient, the combination of these unusual events, with the soft economy, magnifies an already-uncertain environment.

On October 11, approximately 70,000 United Food and commercial workers set up picket lines at more than 850 supermarkets in Southern California, as part of a labor dispute with some of the largest grocery chains in the state.

We are estimating that the benefit we gained from this event increased our third-quarter same-store sales in the range of 80 to 100 basis points.

About two weeks after the strike began, a number of brushfires ignited in Southern California and rapidly spread.

The fires destroyed more than 3,300 homes, and displaced many families.

We feel fortunate to have experienced only minor disruptions to our business and did not lose any stores or warehouses during the wildfires.

We anticipate that the economy in California will remain weak, short-term.

We believe that it will eventually improve, but at a more gradual rate than the rest of the country.

We are strengthening our competitive positioning while focusing on profitability and productivity initiatives.

We think we are gaining ground in a tough economy, and that increases our confidence about the future.

During the quarter, or pharmacy same-store sales grew 3.9 percent, year-over-year, and front-end same-store sales declined 4.6 percent compared with last year.

Our script count was flat for the quarter, despite losses in volume of the allergy and hormone replacement therapy drugs.

The loss in volume, as a result of OTC Claritin, will complete its cycle in January.

Also, the number of prescriptions we fill for HRT drugs continues to decline, and we expect this year-over-year decline to continue for the next several quarters.

We are focused on a number of sales initiatives to strengthen our script count.

Several factors significantly influenced our front-end same-store sales this quarter.

The soft economy, for which we continue to experience a negative effect, offset by the strike in Southern California that I have already discussed.

Secondly, our markets continue to be aggressively competitive, and we were, again, highly promotional this quarter.

Photo sales continue to decline in the third quarter.

We have addressed this decline that has been negatively impacting our same-store sales for the last year.

This month, we recently completed the installation of full-service, customer-oriented digital photo technology in a total of 370 stores.

Our services extend beyond self-service prints to include trained photo technicians that can ensure the highest quality of prints for customers and provide a multitude of other services from digital media.

We now have one of the most competitive offerings of full-service customer-facing digital capabilities in more than 80 percent of our chain.

And we expect to see improvements in our photo category sales.

Some of our front-end sales decline this quarter is attributable to permanent price reductions that we have taken on our best-selling items in categories such as health and beauty care, over-the-counter medications, and convenience grocery.

During the third quarter, we permanently reduced prices on another 1,000 high-velocity SKUs, bringing the total number of price reductions to nearly 2,100 SKUs in the last two quarters.

We had a lot to do in better aligning our prices, and we are encouraged by the results we have seen so far.

We are seeing significant improvement in the unit volume of these items.

The comparison data that AC Nielsen provides on our unit volume trends and the major front-end categories they measure across all classes of trade, is encouraging, as well.

We are confident that improving the price value proposition we offer our customers will lead to increased sales in the longer-term.

Now, let's review our gross profit and operating and administrative expenses.

Our third-quarter gross profit of 25.2 percent is down from the 26.0 percent for the third quarter last year.

Our performance this quarter reflects our promotional pricing, permanent price reductions, and continued margin pressure by third-party payers.

We reduced our operating and administrative expenses during the quarter by approximately $7.9 million from last year.

Operating and administrative expenses this quarter were 22.3 percent of sales, compared with 23.5 percent for the third quarter last year.

We are driving value through productivity improvements and expect a string of quarterly improvements to O&A expenses.

Now, let's move on to the progress we're making on our initiatives.

First, the successful completion of our initiative to realign our corporate office and support areas contributed to our expense improvement for this quarter.

Secondly, we are making progress on our initiative to improve the cash flow performance of 25 underperforming stores.

The cash flow has improve, in total, for the group within the last 9 months.

We're making similar progress on our initiatives to improve the performance of stores opened in the last three years.

In addition to reducing the operating expenses at these stores, we are focusing on achieving the most appropriate merchandise mix to drive sales, improve gross profits, and better leverage expenses.

The cash flow has improved, in total, for this group, as well.

We have made significant progress in many stores.

However, it may be necessary to close the stores that cannot improve their performance.

We will update you on their status during our next conference call.

Another initiative is phasing out inefficient technology systems.

We have successfully completed the replacement of our pharmacy processing system in all of our stores.

We also successfully completed the rollout of our new POS system in all of our stores.

We installed a new distribution management system at our distribution facility serving Northern California.

System integrations of this size are typically difficult, and our experience has been no different.

Today, though, we are working through the remaining issues of this major installation, our throughput today is higher than it has ever been through before.

There is still a lot to do, though, in achieving the full potential of this new system.

We will continue to pursue technological improvements to increase our operational efficiencies and enhance our shopping experience.

Our work process improvement initiatives at store level are on-track, and we continue to refine them.

We expect more improvement as the use of these workflow standards becomes a routine part of our daily operations.

Another initiative announced earlier this year is to close four support facilities.

We closed two facilities in the first half of the year, and we will close the other two in the current quarter.

We're making progress on our initiative to centralize the procurement of all office, store supplies, and equipment.

Our supply expenses continue to decline.

Another important initiative is improving our pharmacy profitability.

We have automated processes, increased our utilization of robotics, centralized our purchasing, and have enhanced our fill center capabilities.

In addition, we acquired a mail-order center in the first quarter of this year.

We're making progress on this initiative, which is very important in an environment of margin pressure by third-party payers.

We made progress on our process improvement initiative for new stores.

We have reduced, by more than half, the time and costs required to merchandise new stores and prepare them for opening.

As for our working capital initiative, we have reduced working capital by $28 million, on an equivalent store basis, compared with the third quarter of last year.

Now, I would like to spend some time talking about our initiative to remodel up to 20 stores this fiscal year.

To date, we have completed six store remodels, and have another seven under construction.

The visual elements and productivity improvements developed for these remodels are also being incorporated into the new stores, as well.

This is a very important initiative for us.

The remodels aggressively pursue points of differentiation in the areas that our customers have given us the authority to serve.

Although encouraged by the initial results, we continue to evaluate the appearance, merchandising, and financial metrics of the remodeled stores.

We will make modifications, both as we learn more about how customers are responding, and as we measure the productivity improvements we have incorporated into the design.

We think the stores look great!

We have achieved a fresh new look, with wider aisles, brighter lighting and signage, along with the use of color that makes our stores easier to navigate.

We are experimenting with some new features in the pharmacy that go beyond the traditional offering.

Our larger and more contemporary beauty department captures the authority we have with our customers.

The entire store is designed to create a more-exciting shopping experience for our customers, while improving our productivity and our efficiency.

Steve will discuss our remodeling initiatives in greater detail.

In summary, we are pleased with the continued progress that we're making on our initiatives.

We are encouraged by the results we achieved in the third quarter, and we are confident that we are headed in the right direction.

We plan to continue strengthening our operations and building a foundation for profitable growth that can only get better with improved consumer spending and a stronger economy.

Now, I will turn it over to Steve for an analysis of our third-quarter financial results, and our business outlook for the rest of the year.

Steve?

Thanks, Warren, and good afternoon.

Net income for the third quarter ended October 30th was $5.2 million, or 14 cents per diluted share, an increase of 75 percent over net income of $3 million, or 8 cents per diluted share reported last year.

This is consistent with our guidance.

The grocery strike that Warren mentioned earlier added about a penny to our net income per share this quarter.

Total sales increased 2.1 percent to 1.09 billion for the quarter ended October 30th.

Again, consistent with our guidance.

Same-store sales for the quarter decreased 7/10 of a percent, with pharmacy same-store sales increasing 3.9 percent, and front-end same-store sales decreasing 4.6 percent.

We are estimating that our retail same-store sales were favorably impacted by 80 to 100 basis points as a result of the grocery strike in Southern California.

RxAmerica, our PBM subsidiary, generated revenues for the quarter of $7.2 million, an increase of 20 percent from the $6 million reported for the third quarter last year.

Our consolidated gross profit rate for the third quarter was 25.2 percent, down from 26 percent last year.

The decline was primarily due to continued pricing pressure on our pharmacy from third-party and government payers, as well as price reductions and increased promotional sales on the front end.

The benefits we are realizing from our centralized buying and promotional initiatives partially offset some of the decline.

Our gross profit for this quarter was also negatively influenced by the installation of a new distribution management system, which began in early August at our facility serving Northern California.

The integration did disrupt some of our warehouse operations serving a portion of our stores during the quarter.

As Warren mentioned, our throughput today is higher than it has ever been, although we still have a lot to do.

The LIFO provision for this quarter was $250,000, compared to $1 million last year, due to lower overall net inflation, year-to-date.

As we noted on the last couple of quarterly calls, we have begun classifying advertising expenses in costs of sales rather than operating and administrative expenses.

For comparison purposes, we have reclassified last year's cost of sales and O&A expenses.

The result was a decrease of $5.2 million in last year's reported gross profit, and a comparable decrease in last year's reported O&A expenses, with no impact on reported net income.

I would like to reemphasized that this is a reclassification of costs among lines on our P&L, and has no impact on net income.

Operating and administrative expenses decreased $7.9 million, or 120 basis points, as a percent of sales this quarter, primarily due to our productivity improvements and cost reductions.

Operating and administrative expenses for the third quarter were 22.3 percent of sales, compared with 23.5 percent last year.

We are pleased with the progress we are making here.

Moving down the income statement.

Third-quarter depreciation and amortization expenses were $20.1 million, compared with 19.6 million reported for the third quarter last year.

Net interest expense was $3.6 million, compared with $3.3 million last year.

And our effective tax rate was 37.6 percent for the third quarter.

This compares with 26.5 percent for the third quarter last year, which reflected certain tax credits recognized in that quarter.

On the balance sheet, working capital was $189 million, down from $266 million a year ago.

Our revolving line of credit expires in October of 2004.

The $55 million we had borrowed against this facility, as of the end of the third quarter, is now included in current liabilities on the balance sheet.

Our additional principal payments for private placement notes, due between now and October of 2004, were also moved to current liabilities.

These two reclassifications have reduced our working capital by about $62 million.

On an equivalent store basis, excluding the impact of the debt reclassification that I just outlined, we have reduced working capital $28 million, compared to last year.

We remain committed to our very-challenging goal of reducing working capital by $50 million on an equivalent store basis by the end of this fiscal year.

Our total inventory, on a LIFO basis, was down $12 million from a year ago, or 2.5 percent.

This is against a 4.5 percent increase in store count.

Average inventories per store decreased 5.3 percent on a FIFO basis.

This decrease reflects an 11 percent reduction in our average in-store inventories, offset by increases in our distribution center inventories.

The increase in distribution center inventories are related to increased self-distribution, and our installation of the new distribution system in our Northern California distribution center that I mentioned previously.

We continue to make progress in centralizing our procurement, reducing in-store inventory levels, and improving our distribution capabilities.

Net CapEx for the first 9 months of the fiscal year was $75 million.

We have opened 13 new stores, and remodeled three stores in the first 9 months of the year.

We plan to open 19 new stores, and remodel up to 20 stores this fiscal year.

Net CapEx, on a full-year basis, is expected to be 110 to $120 million.

We will announce our CapEx plans for fiscal 2005 on our next call, but I don't expect a significant variation from this year's level.

We are currently planning to open 5 to 10 new stores next year, and remodel up to 40.

Many of you have asked about the cost of our remodeling program.

Depending on the scope of each project, the average capital investment of our remodels per store will range from 250 to 350,000 for small-scale projects, and 750 to 850,000 for large-scale projects.

We will update you on our expansion and remodeling plans for fiscal 2005 in more detail on our next conference call.

Our net debt, which is short and long-term borrowings less cash on hand at the end of the third quarter, was relatively flat compared with last year.

As I mentioned earlier, our revolving line of credit expires next year, and we do intend to renew it.

For the first 9 months of fiscal 2004, we earned $16.3 million, or 44 cents per diluted share, on sales of $3.3 billion.

Included in net income for the first 9 months of this year were charges totaling $7.1 million after-tax, or 19 cents per share, for a number of items that are described in detail in the announcement we released today, reporting our third-quarter results.

That detail is also included in our 10-Q filed with the SEC for the quarter ended July 31st, 2003.

Income for the first 9 months of last year, before the cumulative effect of an accounting change related to our adoption of SFAS 142, was $24.9 million, or 65 cents per diluted share, on sales of $3.3 billion.

Now, onto the outlook for the rest of the year.

But, before I talk about our guidance, I want to talk about Medi-Cal.

Some of you may be aware that the state budget -- the California state budget -- adopted last summer included a 5 percent across-the-board reduction in Medi-Cal reimbursement to pharmacies, effective January first, 2004.

It has received a fair amount of publicity, and we have received a few questions about its impact on our pharmacy business.

Longs, along with the California Retailer Association, as well as the National Association of Chain Drugstores, is vigorously opposing this change.

We are hopeful that we will achieve a satisfactory resolution, but we are uncertain, at this time, about the outcome.

We are reiterating our guidance for the fourth quarter.

We estimate that total sales will be flat to up 3 percent, and same-store sales will be down 2 percent to up 1 percent from the fourth quarter of last year.

Given these sales assumptions and the continued progress we plan to achieve on our initiatives, our goal is to achieve net income in the range of 38 to 41 cents per diluted share for the fourth quarter.

This compares with net income for the fourth quarter last year of 17 cents per diluted share, including net charges of 10 cents per diluted share, as reported last year.

We are tightening the reins of our guidance for the full year to reflect actual results for the third quarter.

We estimate that total sales will be up 1 to 3 percent, and same-store sales will be down 2 percent to flat with last year.

Our outlook for net income is 82 to 85 cents per diluted share for the full fiscal year, including the negative impact of 19 cents per diluted share, net, for the charges recorded in the first half of this year.

This compares with income for fiscal 2003, before the effect of an accounting change related to the adoption of SFAS 142, of $31.3 million, or 82 cents per diluted share, which included after-tax net charges of 10 cents per share that I described earlier.

We have begun our planning process for next year, and will be in a better position to provide guidance for fiscal 2005 on our next call.

As we have previously discussed, we believe any economic recovery in California will be more gradual than in other regions in the U.S.

We are also assuming that our gross profits will continue to be under pressure, due to the factors that we have already discussed.

A major focus for us will continue to be expense reductions through our productivity initiatives, technological efficiencies, and work process improvements.

We are pleased with the progress we're making on our initiatives, and will provide more guidance about our outlook for fiscal 2005 on our next call.

Now, I will open up the call for questions.

Operator?

(OPERATOR INSTRUCTIONS).

Meredith Adler, Lehman Brothers.

Good afternoon.

A couple of questions for you.

I was wondering if you could talk about a comment you made on the call that there was pressure on your gross margins from lower reimbursement rates?

Can you talk about where you are seeing pressure on reimbursements, especially because it doesn't sound like Medi-Cal has acted yet.

So, are you seeing this on the private side?

Meredith, this is a constant and ongoing activity in pharmacy.

We are always receiving pressure on margin reimbursement rates from third-parties providers.

We are in constant negotiation.

It is actually a fact of life in the pharmacy business.

Surprising, because other retailers seem to talk about their reimbursement rate on the private side as being more-or-less flat.

Do you think that is something specific to California?

I do not know how to comment on what other retailers are seeing, but we constantly are in negotiations with third-party providers.

We constantly have pressure on our margins.

We are constantly negotiating and renegotiating.

It is simply, today, a fact of life in the pharmacy business.

Okay, and I was wondering if you could talk about the changes you made to your systems in your distribution centers.

Obviously, there was a little bit of disruption from that change.

Would you say that that actually was visible in the numbers?

Would we have seen that somewhere contributing to the reduction in the gross margin?

We're finding that very, very difficult to quantify.

We did experience some disruptions in deliveries; some late loads, some mis-loads.

But, it was very inconsistent across the state.

Sure, we will get a delivery on time early in the week, and then, later in the week, it would be late.

Obviously, we do have inventory in stock in the stores while we are waiting for distribution.

So, it is very, very difficult for us to quantify in the stores, in a sales number, the disruption.

But, there was some through the quarter.

These are difficult things to do -- changing our distribution center systems.

Ann, when you talk about -- switching gears -- you talked about the good work you are doing to try to improve the performance, both of your bottom 25 stores and also any store that is three years old or younger.

And you talked about the potential for closing some stores.

Is that both groups that where you might consider closing?

Or just the bottom 25?

It is really both groups, Meredith.

We are focused on the cash flow of the stores and the future potential of the stores and their ability to me targets and improve.

And so, the potential list would not be exclusive to one group or the other.

And would they be mostly stores that you own, as opposed to stores that you lease?

Or a mixture?

We don't even look at it that way.

I know, I'm just wondering what kind of -- how big of a long-term obligation.

If you have a store that you just opened within the last couple of years, you would have a pretty big lease liability.

We would again, Meredith, look at the cash flow implications of the closing of the store and make, I believe, the appropriate financial decision.

That is good.

I just want to go back to what Steve talked about with Medi-Cal.

I know you guys are fighting this hard, and that is obviously what you need to be doing.

Will there be a point when you give us some guidance?

I mean, I've crunched some numbers myself that said that a 5 percent cut -- and if you assume -- I'm not sure if you have ever said this, but Medicaid -- Medi-Cal, let's say -- is 12 percent -- is that fair -- of your pharmacy volume in your California stores? (multiple speakers)

We don't call that out, Meredith.

Okay, most companies will give that number, but that is fair.

Let's just say that it is similar to what Walgreen is -- it is significant.

The way I crunched the numbers, it could be as much as 4 cents a quarter.

Are you going to give us any guidance?

Well, Meredith, we are very concerned about this issue.

And, we are in discussions with the leadership in Sacramento, aggressively negotiating these issues with them.

We are actually hopeful that there will be a satisfactory compromise in this.

We have obviously quantified various scenarios, and we will have various decision points.

And, should it impact our '05 guidance when we give it, we will certainly call it out.

That is great.

Thanks very much.

Gary Giblen, CL King & Associates.

I would like to focus on some different things than what Meredith was -- in terms of the strike impact, I noticed that the fourth-quarter guidance remains unchanged, both on comp sales and on earnings.

So, however, you must be achieving some benefit from the strikes, which -- at least partially into the quarter here -- have shown no signs of letting up.

I mean, are you, in effect, lowering your non-strike items?

Is that how we should understand this?

Not at all.

As you know, and as you correctly pointed out, the strike still goes on.

And, we will call out its impact when we release or November sales.

We don't have any certainty -- any understanding about when the strike will be over.

Nor do we know what the supermarkets will do to win back their sales when the strike is concluded.

So, we think it is very premature to estimate any impact for the quarter on the strike.

There is just too many variables here to determine.

Okay, so the guidance really just doesn't contemplate anything included for the strike --? (multiple speakers)

That is correct.

Okay.

Thanks for clarifying that.

And then, are you making efforts to retain business that you're getting during the strike?

Of course.

Okay.

You know, what is the history there?

Because there was a Teamster strike in Northern California a few years ago that affected the supermarkets.

So, you know, what kind of retention rate is there?

The Teamster strike in Northern California was much different; this was a distribution center strike, which I believe -- I wasn't here -- but, I believe spread to stores in the form of a boycott.

The consequence of that kind of activity is much different than a full grocery store strike.

I was not here, and I do not have access to the numbers of that time, but my estimate would be that the impact -- during the strike and after the strike -- in Northern California, on Longs was very minimal.

Okay.

And then, are you getting a significant number of script files transferred from customers?

Let's say, Vaughn's (ph), who don't want to cross picket lines, so they take their prescription files over?

We have called out our sales increase last month.

And you, I think, know our mix of business.

I would say that it is the same mix, but we are seeing benefit on both sides.

Okay.

Just a couple of more sort of along the same lines. (indiscernible) made the comment that there was considerable costs to taking on a new business because you get the bulge in business from the strike because you have more shrink and some overtime required and so forth.

You know, can you comment on how that is affecting your -- is there meaningful cost increases involved in servicing the extra business during the strike?

Yes, there are.

Of course, we see a substantial increase in business in some places.

And, it is hard to react to the surprising amount of business, at least in the first few days.

After the volume levels normalize -- not normalize -- but, after a few days, I think you're able to manage it by adjusting your operations of the store and your distribution center.

The immediate two weeks is the most difficult to manage through.

And, after that, I think you would adjust your supply chain to accommodate the volume increases.

As a follow-up to that, I would like to say that we are delighted with the increased traffic in our stores and the additional business that it is bringing us.

That will be good.

Are trends, so far, in November, sales-wise, similar to what we have seen?

Or anything to comment on there?

We will comment on the impact of the strike at the end of our November sales and at our sales release.

Okay, and then absolutely last question -- somebody's going to ask you, so I may as well ask it.

(laughter)

Can you comment on -- in terms of the buyout rumors?

I guess the question is -- can you say whether you have had any approaches?

I guess that would be the only thing you could possibly talk about?

We have a policy of not responding to rumors, speculation.

Okay.

I had to ask.

(laughter).

Okay.

Thank you very much.

(OPERATOR INSTRUCTIONS).

Lisa Cartwright, Smith Barney.

It's his actually Elizabeth Flynn (ph) calling for Lisa.

I wanted to ask a question about your new prototype stores, just in terms of what sales or margin benefits you guys are seeing or expecting for the prototypes.

It is much too early to quantify a sales margin mix or operating expense impact.

We do have budgets, of course, around these things, and we do have expectations of improvements, through which we justify the capital spending for the remodel.

We would not comment on our expectations only to say that we are determined that these will produce healthy return for our shareholders.

We think these stores are very exciting.

And, the initial customer response has been just terrific!

And, our employees' response has been terrific!

Thank you very much.

David Magee, SunTrust Robinson Humphrey.

This is actually Katie Driver (ph) for David Magee.

I just wondered if you could comment quickly on the comment that you made earlier about reducing the prices on 2,000 SKUs?

I wondered if you could tell us how many SKUs are on the front end, so we could get an idea of what the impact is there?

And also, if you could talk about why the change was not as impactful to the gross margin in the second quarter as it apparently was this quarter?

I'm sorry, I missed the second question.

Okay.

What was the second question?

Could you just explain why, maybe, that change in prices on the second 1,000 SKUs that you did in the third quarter was more impactful to gross margin than the change in the first 1,000 SKUs was last quarter?

Actually, the price reductions in the second quarter, combined with the price reductions in the third quarter, and the run rate of the reductions on the sales line, is the combination of the two, because we have not yet cycled them for the year.

Okay.

And so, the impact would actually gain momentum -- the more prices that you reduce -- particularly if, as I said, they are in your highest SKUs.

An how many SKUs do you have on the front end?

20 to 25,000 SKUs on the front end.

We have significantly-large-sized cosmetics departments and OTC and lots of convenience grocery.

Do you have any comment thus far on the stores where you have introduced the digital photo?

How that category may be working in the stores?

We have experienced with digital now in one of our markets.

We are very pleased with our customers' response to our digital offering.

We believe -- where we have put this in place and have advertised it and promoted it -- we have developed quickly a reputation for digital headquarters.

And, that experience has encouraged us to accelerate the rollout and complete it, as you heard announced today.

Okay.

Great.

Well, thank you.

I appreciate it.

Bob Summers, Banc of America Securities.

Of the items that pressured the gross margin, could you give us a sense of magnitude for each one?

Bob, we don't typically break that out, but I think we basically gave it in the order of magnitude without actually quantifying it.

Okay.

And then -- the operating income on RxAmerica?

Hang on a second;

I will get that for you. 3.5 million, Bob.

What was it off the six in the prior year?

Off of the same quarter a year ago was 2.9 million.

I think it had the exact same run rate as sales, in terms of the increase, year-over-year.

Okay, so there is no real impact either way, in terms of how we should think about the retail segment?

Meaning if the operating income in RxAmerica grew faster.

Yes, but on a much lower base.

Sure.

Let me see if I can ask this question in a way that you might answer it.

So, the strike benefit was 80 to 100 basis points.

Can you maybe talk about how that trended over the 19 days of the strike?

Until the end of October?

The initial first days of the strike actually started a little slow, as the customers, I think, that shopped the supermarket channel wanted to wait and see.

When they realized, I think, that the strike was going to last more than a few days, we saw a substantial increase in business; the business spiked dramatically.

Then, it leveled off to somewhat below the peak, but it still has had, in a number of stores, still a strong impact.

So, it is kind of the first couple of days, small impact, then a literal explosion, and then it's leveled off.

Okay.

In terms of the reimbursement issue, are you seeing -- are branded drugs being impacted more?

Is it generic?

Or is there any difference there at all? (multiple speakers) I guess the real question is -- what are you seeing in terms of generic pricing?

I don't think we can call out the brand that is being more affected than generic.

Generic is probably a little more affected than brand.

Okay.

Thank you.

Jack Murphy, Credit Suisse First Boston.

I guess, if you could go into the SG&A a little bit further, just in terms of the basis point improvements in some of the bigger-expense categories.

If you could maybe help us understand how much of that might be labor and rent, whatever you could provide in terms of a little more specificity on that?

Sure.

Well, without actually breaking out the numbers, let me try to give you some clarity around it.

As you are aware, earlier this year, we did a reduction in force; we did a voluntary separation program.

And, you know, we have been working on labor standards in stores.

So, a big, big chunk of this is in the labor and benefit line.

So, that is where the lion's share of it was, but we have also had reductions on the expense -- on the supply expenses that we called out, as well.

So, we are trying to attack this at virtually every level, but since labor is such a large component of our operating expense, that is logical that that is where the lion's share of the savings would come from, as well.

So, would you say it is kind of proportional to how much labor is as a percent to your total expenses?

I have not actually sat there and done the math, but I can tell you that labor is where a good chunk of the savings came from.

But, within that component, there's many, many components of the labor management, and we believe we have managed each one -- productivity, mix of employees, health and welfare, overtime -- all of the components that you would typically manage in the labor.

I don't want the impression that this was simply an hours reduction at retail.

But rather, I think, management across most of the elements of the labor, including administrative support.

Okay.

Just a separate -- going in a separate direction.

Could you talk a little bit about what you are seeing, in terms of competitive openings?

And, at this stage, of the stores that you have in California, how many Walgreen's you're facing?

And if you look out, a year or maybe three years in the future, where you think that might be going, given the fact that -- I am sure you have a sense of what type of deals are in the pipeline for your competitors?

We do, and we do track that.

I would be going from memory as to how many Walgreen's have opened in the last quarter or the last year.

But, we do track that number.

I'm sure we can get that for you on an off-line call if you want to make that.

It is pretty public information.

I would say, in the competitive environment, that generally, the quality of our competitors is improving.

Because, you are getting more brand-new square footage.

I think we have had -- the last year, it was 67 -- the last two years, 67 Walgreen's.

We have had 34 supermarket competitors.

We have had 42 Targets, twenty-four Wal-Mart -- this reflects the quality issue -- twenty-four Kmart's have closed.

Just to be clear, that is the incremental --

No, this is the net numbers; this is what we see.

That is what you see, in terms of a static number of Walgreen's facing you today or (multiple speakers) were added in the last few years?

This is the additive -- (multiple speakers) These are the additions.

This is over the last two years.

Two years -- okay.

And as you look just 12 months out, is that number stepping up?

Or is that relatively flat?

We look at that -- that is a difficult number because we may know that a site has been acquired.

But, the timeframe, particularly with the zoning requirements, is wildly variable in this state.

So, we don't, you know --

We would expect to continue to see the run rate on the Walgreen's side.

Rite-Aid has been closing locations just like Kmart has.

So, we will continue to monitor it as we go forward.

Okay.

Thanks.

Eric Woodworth (ph), BSM (ph) Capital.

Two questions for you.

You mentioned that traditional photo sales were down, so you were ramping up digital photo operations.

Can you quantify at all, or give a ballpark range, of how much traditional photo sales are down, year-over-year?

And maybe how much growth you are seeing in the digital photo operations?

The traditional photo is declining substantially, and it is an important part of our front-end categories.

We would not quantify -- we have also done price reductions on our photo processing, which causes the decline to look even worse than the pure numbers of prints that we are doing.

It is a substantial category for us; these are substantial declines.

We think this business is changing to digital very fast.

We have a very strong photo business.

We intend to be the photo headquarters in our stores and the regions within which we compete.

Are you seeing some of those traditional photo sales move into the digital --?

Absolutely.

Absolutely.

Okay.

Then second question for you -- you mentioned, I guess, about 25 stores that, if you could not get fixed, you may consider closing.

Is there anything similar with those stores, in terms of regions or managers, or anything like that? (multiple speakers) Or are they just kind of spread out everywhere?

They are spread out everywhere.

There's no particular regions; there no particular area.

They are spread out.

And there is a combination of issues that we think cause them to underperform.

Great.

Thank you.

Many of which we are changing.

Great.

Thank you.

Meredith Adler.

Yeah, I got a couple of follow-ups, if I could.

I just wanted to talk a little bit about the working capital improvements.

Actually, you gave us some data on inventory reduction, would you mind just giving that to us again?

Average was down 5.3 -- is that right?

Sure, hang on a second, let me say it again.

Let me find it.

Okay, total inventory, Meredith, on a LIFO basis, was down $12 million from a year ago.

That is a 2.5 percent -- or against a 4.5 percent increase in store count.

Average inventories per store -- that is for the total chain -- decreased 5.3 percent on a FIFO basis.

And that decrease is comprised of two pieces.

One is an 11 percent reduction in our average in-store inventories, offset by an increase in inventory in our distribution centers.

We continue to bring more and more SKUs through our own DCs (ph), plus we brought in incremental inventory into our Northern California distribution center while we were going through the change out of the system.

Okay.

When I calculate inventory turn, I don't actually show it improving.

I did see a big improvement, though, in the vendor financing ratio.

Have you -- ? (multiple speakers)

You should see an improvement.

And we've got -- inventory turns have improved in the quarter.

Are you using a four-quarter --?

Yeah, we are.

We are.

We lost ground on inventory turns earlier in the year (multiple speakers) So, that is what you are seeing.

But, in the quarter, turns did improve.

Okay.

Cool.

I did also notice an improvement in the vendor financing ratio.

Have you changed anything in your terms?

As we have gone through the centralization of procurement, we have absolutely renegotiated deals.

So, we do have improved turns.

Okay.

Improved terms.

Just another question -- you talk about closing two support centers and two more to come.

And, I guess I just wasn't quite sure what kind of support centers we were talking about.

Are these regional offices or --?

These are regional offices, support training centers, support IT centers.

And how many will you be left with when you're done getting down to where you want to be?

Oh my goodness!

We will end up with 3 major offices -- our main office in Walnut Creek -- our two main offices in Walnut Creek, and then we have a regional center in Antioch, California.

And additionally, we do have a district office -- offices, and of course, we will keep those.

Okay.

I think that is it.

Thank you.

Gary Giblen, CL King & Associates.

I appreciate you gave the kind of progression of how the strike sales came in.

I mean, was there a measurable impact of the (indiscernible) of picketing at Ralph's (ph) over there?

Is that what caused such stabilization of the strike volume?

Or did it cause -- was surprised that that wasn't --?

The stabilization of the strike volume, I think -- there might have been a little panic buying.

The customers' pantries got emptied, and they realized that the strike may be a while, and so they rushed out to fill up their pantries.

And then, it got to a fairly level, if you can call it level -- volume.

Obviously, where the pickets went down at the Ralph stores, my belief is those stores benefited.

The Ralph stores benefited when the pickets came down.

How much, I don't know.

But, our traffic continued to be good.

Okay, so that didn't seem to impact you own -- .

Okay, that is good, then.

Thank you very much.

There are no further questions.

Okay.

Great.

We would like to thank all of you for participating in today's call and for your interest in Longs.

We look forward to speaking with you again and reporting on the continued progress we have made on our initiatives during the fourth-quarter earnings conference call in February.

Thanks again, and good afternoon.

That does conclude today's conference call.

We thank you for your participation, and have a good evening.