CVS Health Corp (CVS) 2003 Q4 法說會逐字稿

Thank you for standing by and welcome to Longs Drug Stores financial 2004 quarterly earnings conference call.

Today's conference is being recorded.

Now at this time for opening remarks and introductions, I'd like to turn the conference over to Phyllis Proffer.

Ms. Proffer, please go ahead.

Thank you, Duane, and welcome, everyone, to Longs Drug Stores conference call to discuss our results for the fourth quarter and fiscal year ended January 29, 2004.

With me today are Warren Bryant, Chairman, President and CEO, and Steve McCann, Senior Vice President, CFO and Treasurer.

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 recent SEC filings, including the discussion of forward-looking statements in our recently filed Form 10-Q for the quarter ended October 30, 2003 and in the news release we issued earlier today.

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

Now let me turn it over to Warren Bryant.

Thank you, Phyllis, and good afternoon to all of you.

We reported net income for the fourth quarter of $13.4 million or 36 cents per diluted share compared with $6.4 million or 17 cents per diluted share last year.

Our results for the quarter were below our previous guidance provided last November, primarily due to lower than expected gross profits that became apparent after our customary physical inventory of the stores at the end of the quarter.

Since we don't have a perpetual inventory system, we have limited visibility on actual gross profits in between the inventory counts we perform on a quarterly basis.

Several factors contributed to our lower than expected gross profits in the fourth quarter.

First, we took increased markdowns as we reduced non-core merchandise inventories in our stores and actual markdowns were greater than expected.

Second, we had planned for higher distribution costs related to increased self distribution and our efforts to improve distribution to the stores after our systems conversion in Northern California.

However, actual distribution costs were higher than expected.

In addition, we incurred higher product costs by making more purchases outside of our centralized processes in the quarter in an effort to remain in stock in our stores during the systems conversion.

We also experienced higher than expected distribution costs and higher costs related to making purchases outside of our centralized processes to remain in-stock during the grocery strike in Southern California.

You probably would ask, as we have, how could our tracking be so far off, and, what are you doing to prevent recurrence?

These are the fundamental questions of the quarter and we've spent a significant amount of time dissecting our tracking systems in the last few weeks to try to answer the question of why the variance of tracking versus our actual gross margin results.

Our system historically tracked within acceptable variances that served as a fairly reliable predictor of gross margin outcomes, at least for three of the fourth quarters that I have relied upon it.

What we learned was that the system actually disguised markdowns and inventory clearance activity, and often created the indication that gross margin dollars were being achieved when the opposite was true.

In a period of inventory rationalization, the cumulative effect of right-sizing assortments, both core and non-core, on a centralized basis, had the impact of creating a significant disparity between tracking and actual gross margins.

Each week, we would review our tracking to assure gross margins, even as we engaged in inventory rationalization well (ph) within our plans.

We monitored it carefully and we've receded (ph) with our assortment strategy with discipline, and we thought, prudence.

It is only when we actually took inventory at the end of the quarter that we learned the actual gross profit results, and was only after an exhaustive review of our systems and processes, accounting tracking, a tracking store processes that we learned of these defects in our tracking system.

We are obviously taking steps to correct the tracking deficiency and believe the improvements will give us a better handle on actual gross margins through the quarters.

We also strongly believe, and it is evidenced in our core department sales and mix that centralized assortment planning, planagram (ph) disciplines, centralized promotion and merchandising and efficient and effective assortments, are essential platforms for our growth.

This problem is one of forecasting visibility, not a strategy.

And we're taking steps to correct it.

Our actions during the quarter to improve the quality of our inventories and our distribution capabilities were appropriate.

But our lack of visibility into the impact these changes were having on gross profit is unsatisfactory.

We are implementing additional management controls and processes to reduce our exposure to these type of surprises while we work on our supply chain initiative.

As you are aware, we are actively engaged in upgrading our supply-chain systems and processes, that should provide the opportunity for greater real-time visibility.

We began our supply-chain initiative about two years ago, and we have about two more years ago.

We're very disappointed by the negative impact that gross profits had on our quarterly financial results, particularly since we had made progress in improving our productivity and reducing our expenses in many areas throughout the organization in the last 12 months.

For the full year, we earned $29.8 million in net income or 79 cents per diluted share on total sales of $4.5 billion.

This compares with $31.3 million or 82 cents per diluted share, excluding the cumulative effect of an accounting change, on sales of $4.4 billion.

Now onto Longs' sales performance during the fourth quarter.

Total sales for the quarter of $1.2 billion represent a 4.8 percent increase over last year and the same-store sales increased 2.2 percent.

We have estimated that our same-store sales for the quarter were favorably impacted by 200 to 250 basis points as a result of the grocery strike in Southern California.

During the quarter, our pharmacy same-store sales grew 5.5 percent year-over-year.

Our script count was slightly up for the quarter.

The cold and flu season came early this season.

For the full year, our script count was down primarily due to the loss in volume of allergy and hormone replacement therapy drugs.

We will continue to focus on a number of marketing initiatives to strengthen our script counts.

This brings us to a discussion about Medi-Cal.

As we expected, a great deal has happened since we mentioned this on our third-quarter conference call last November.

On January 10, Governor Schwarzenegger submitted his budget proposal for the fiscal year that begins in July.

The proposed budget is requesting a 10 percent reduction in the reimbursement rate to Medi-Cal providers.

That's pharmacies, physicians, hospitals, etc.

This was intended to be on top of the previously announced 5 percent reduction proposed last summer by our former governor.

The 5 percent reduction to Medi-Cal reimbursement rate did not become effective January 1st of this year, as the original budget had proposed.

A court ruled that the actions by the state violated the federal Medicaid Act and the ruling was upheld on February 12.

The state has 30 days to appeal the decision.

It appears as though they are focusing their energy on a 10 percent reduction to reimbursement to become effective in July.

We continue to vigorously oppose an across-the-board reduction in reimbursement.

We are actively supporting legislation that directs all consideration of reimbursement reductions on the dispensing fee alone rather than the total amount that would include the cost of goods.

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

Also effective January 1st of this year, the California Workers' Compensation Reimbursement Schedule was tied to Medi-Cal rate schedule for those pharmacies that want to direct bill insurance companies or employers.

California Workers' Compensation represents less than 1 percent of our pharmacy sales.

Combined Workers' Compensation and Medi-Cal prescriptions represent approximately 10 percent of our pharmacy sales.

Although we believe that we have the opportunity to work with the State of California to reach a more reasonable compromise that is mutually beneficial, changes to the reimbursement rate could impact our business.

The extent of the impact depends on the effective date of the change in reimbursement rates, our ability to reach a compromise with the State of California, and of course, our ability to offset the impact of Medi-Cal by recruiting other third-party prescription plans.

As I mentioned earlier, we are focused on a number of marketing initiatives to strengthen our script count, even in this uncertain environment.

Now onto sales in the front end of the store.

Front-end same-store sales were down 2/10 of 1 percent in the fourth quarter and down 3.2 percent for the year.

Despite a difficult economy and a highly competitive marketplace, our core categories in the front end throughout the chain gained strength in the fourth quarter according to AC Nielsen data.

Obviously, our stores in Southern California benefited from the grocery strike.

More importantly, customer response in our major markets to our merchandise focus and better aligned prices is encouraging.

We are rationalizing our front-end assortments to make our merchandise offering more effective, productive and meaningful to our customer.

So far, we've rationalized approximately 65 percent of the planagrams for our core merchandise categories, and we're already beginning to see the benefits in our sales.

During the quarter, we took a number of steps to create new planagrams and strengthen our planagram discipline in the stores.

We encouraged stores to sell through old, ineffective merchandise in order to make room for efficient and effective assortments.

Our store managers reduced noncore merchandise inventories by $22 million from the end of last year.

We are pleased with the progress we're making toward improving the quality of our inventories.

In the last few quarters, we've talked a lot about our photo offering and our introduction of digital capabilities.

Although our photo sales were lower than last year, we have made progress in recapturing some of this business through our introduction of digital capabilities in our stores in November.

Our photo sales trends showed sequential improvement in the fourth quarter from the second and the third quarters.

Now let's move onto the progress we have made throughout the year on our initiatives.

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

Secondly, we're making progress on our initiative to improve the cash flow performance of 25 underperforming stores, as well as improve the performance of stores opened in the last three years.

The cash flow has improved for both groups.

Thus far, we have closed one of the underperforming stores.

Another initiative is phasing out inefficient technology systems.

We have completed the installation of a more reliable, higher performance pharmacy processing system in all of our stores.

We also completed the rollout of a new POS system and the rollout of hand-held wireless systems in all of our stores.

We have made progress on Phase I of our longer-term initiative to improve the efficiency of replenishing merchandise in our stores.

During the quarter, we installed a new distribution -- during the third quarter, we installed a new distribution management system at our facility serving Northern California.

The throughput and service levels at this facility increased during the fourth quarter.

We learned a great deal from this difficult installation.

The installation of the same distribution management system is scheduled for our service -- for our facility serving Southern California during this year.

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

We expect more improvement as the use of workflow standards become a routine part of our daily operation.

Another initiative announced last year was to close four support facilities.

We closed three facilities and found that relocating the fourth was the better alternative to reducing cost and closing it.

The relocation occurred in the fourth quarter.

Our initiatives to centralize the procurement of all of office store supplies and equipment has reduced our supply expenses for the year.

Another important initiative is improving our pharmacy profitability.

We're making progress on this goal despite continued margin pressure by third-party payers.

We've automated processes, increased our utilization of robotics, centralized our purchasing, and enhanced field center capabilities.

The mail-order center that we acquired in the first quarter of this year continues to grow.

This acquisition was accretive to earnings within the first year.

Another initiative was to improve our process for opening new stores.

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

We did not achieve our initiative to reduce working capital by $50 million this past year.

We had made solid progress during the first three quarters of the year and had achieved a $28 million reduction by the end of the third quarter.

The ground we had gained was lost in the fourth quarter as a result of increased inventory related to self distribution, the grocery strike in Southern California and our system conversion in Northern California.

We remain committed to reducing working capital by $50 million on an equivalent store basis and this initiative will carry over into fiscal 2005.

By the end of the quarter, we had completed our initiative to remodel up to 20 stores.

Data from our consumer research as well as feedback from employees and customers has been very positive.

The early results for the remodels are encouraging and we continue to refine our merchandise offering.

We are only a few weeks into the promotional programs created for remodeled stores.

So it's too early to make sales or profitability projections about their future performance.

However, we are pleased with what we have seen so far, and we plan to remodel up to 40 stores this fiscal year.

Within the past year, we have challenged, evaluated and examined nearly every aspect of our fundamental business model.

We have built a stronger management team and have made a great deal of progress in better aligning our organizational structure and our incentives with our goals.

Our structure is increasingly more centralized and our bonus programs are better aligned with performance.

We have become more disciplined about our merchandise focus, and the quality of our execution is gaining momentum.

We have invested in the upgrade modification and replacement of many of our technology systems.

We've accomplished a great deal this past year, but we still have a lot more to do to strengthen our operations.

This is a process; it is not an event.

Our focus remains squarely on building a foundation for profitable long-term growth.

For this year, we expect the difficult economy, as well as the highly competitive environment, to continue.

Our initiatives will support our previously stated goal to become a stronger competitor and a more profitable company.

Here is our focus.

First we are proceeding with our initiative to rationalize front-end assortments and to make our merchandise offering more effective, more productive and more meaningful to the customer.

Second, we will remodel up to 40 stores this year.

The remodels aggressively pursue points of differentiation for us that our customers had given us the authority to serve.

Third, our work process improvement at the store level will continue.

We want to significantly improve our management of inventory and operating expenses at the store level.

At the same time, we want to free up our people to deliver superior customer service.

Fourth, we will continue to pursue further cost reduction that better leverage our operating and administrative expenses.

Fifth, we will continue to develop a safety culture at Longs.

Although our number of work-related injuries has declined last year, we want to create a safer workplace.

Sixth, improving our technology will remain an important initiative, both in our stores and in our supply chain.

Seventh, we will continue our initiative to install time and attendance, labor scheduling and labor forecasting in our stores, and this is a carry-over from last year.

Eighth, will continue our initiative to improve the cash-flow performance of underperforming stores.

Ninth, we will continue to improve our pharmacy productivity.

And finally, as I mentioned earlier, we remain committed to reducing working capital by $50 million on an equivalent store basis, and this initiative has also carried over into this year.

Now, I will turn it over to Steve McCann for an analysis of our fourth-quarter financial results and our business outlook for fiscal 2005.

Steve.

Thanks, Warren.

Net income for the fourth quarter ended January 29 was $13.4 million or 36 cents per diluted share on sales of $1.2 billion.

Net income was up compared with last year's reported net income of $6.4 million or 17 cents per diluted share on sales of $1.2 billion.

Our same-store sales for the quarter increased 2.2 percent.

We're estimating that our retail same-store sales were favorably impacted by 200 to 250 basis points as a result of the grocery strike in Southern California.

We also estimate that this contributed 2 to 3 cents per diluted share to our EPS in the quarter.

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

For the fourth quarter, consolidated gross profit margin of 24.2 percent was down significantly from the 25.6 percent we reported for the fourth quarter last year.

This decrease in gross profit margin was the result of a number of factors that Warren mentioned earlier.

As we have discussed in the past, we do not have a perpetual inventory system that gives us visibility into the impact of operational changes during the period.

As a result, the impact of these changes on our gross profit in the fourth quarter were not seen until we counted store inventories at the end of the quarter.

We are implementing additional management controls and processes to reduce our exposure to these types of surprises in the future while we continue working on our supply chain initiative, which concludes the implementation of a perpetual inventory system.

Among other things, we are now tightening controls around markdown tracking and reporting, and we are improving our tracking and monitoring of purchases made outside our centralized processes.

The decrease in gross profits during the quarter was partially offset by a $3.6 million benefit related to the resolution of a pricing dispute with a vendor.

In addition, the LIFO credit in the quarter of $1.8 million compared with a LIFO charge of $1.8 million in the fourth quarter of last year.

This credit was primarily due to lower year-over-year inflation.

Our gross profit margin for the full year was 25.3 percent of sales compared with 25.7 percent last year.

We improved our operating and administrative expenses as a percent of sales again this quarter.

Operating and administrative expenses this quarter were 20.9 percent of sales compared with 22.2 percent for the fourth quarter last year.

This represented our lowest expense rate for the last eight quarters and the second consecutive quarter of rate improvement year-over-year.

We were able to achieve this O&A (ph) rate reduction despite an increase of $5.5 million to our self-insurance reserves for workers' compensation and general liability as a result of a third-party actuarial study completed in the fourth quarter.

This adjustment negatively impacted our O&A rate by 45 basis points in the quarter.

Workers' compensation costs have increased significantly over the last couple of years.

For the year, this year, our total workers' comp costs increased 52 percent over last year and 150 percent over the year before that, even though the number-of work-related accidents has declined over the same period.

Despite significant growth in workers' comp expense, our operating and administrative expenses for the full year declined 30 basis points to 22.1 percent of sales compared with 22.4 percent last year.

We expect continued year-over-year improvement in our O&A expense rate for the next couple of quarters, and we are pleased with the progress we have made thus far.

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

For comparison purposes, we have reclassified last year's cost of sales and operating and administrative expenses.

The result was the decrease a $5.5 million in last year's fourth-quarter reported gross profit and a comparable decrease in last year's reported operating and administrative expenses with no impact on reported net income.

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

Moving down the income statement, fourth-quarter depreciation and amortization expenses were $19.8 million compared with 20.1 million reported for the fourth quarter last year.

Depreciation and amortization expense for the year of $83.6 million is up from 77.7 million reported last year, primarily due to the $5.2 million of accelerated depreciation in the first half of the year for the abandonment of the PPS++ pharmacy system.

During the quarter, we recorded charges relating to store closures and asset impairments of $4.9 million.

In addition, we recorded $7 million in gains related to the settlement of two legal matters during the quarter.

Net interest expense was $2.8 million compared with 3.7 million last year.

The decrease was primarily due to capitalized interest on current construction and system projects.

Our effective income tax rate in the fourth quarter was 32.3 percent, bringing our tax rate for the full year to 35.3 percent.

This rate is lower than we previously expected due to lower than anticipated pretax income as well as adjustments to our tax reserves as a result of the resolution of certain tax matters.

In the fourth quarter of last year, we recorded a net income tax benefit of $1.1 million due to tax credits recognized in that quarter resulting in a 29.8 percent tax rate for last year.

We are estimating an effective tax rate for fiscal 2005 of 37.6 percent.

On the balance sheet, working capital was down 173 -- I'm sorry -- working capital was 173.6 million, down from 242.6 million a year ago.

Our revolving line of credit expires in October of 2004.

The $50 million that we had borrowed against this facility as of the end of the fourth quarter is now included in current liabilities on the balance sheet.

In addition, our principal payments for private placement notes due between now and October 2004 are also now included in current liabilities.

So excluding debt, working capital on a per store basis was $565,000 compared with 538,000 last year.

This increase is the result of an increase in inventories related to the ramp-up to protect our in-stock inventory position during the grocery strike in Southern California and the installation of our new distribution management system in our facility serving Northern California.

In addition, we increased our self distribution, which added $16 million of inventory to our distribution centers in our stores, in lines such as film, batteries, candy, health and beauty care.

Now that the strike is over in Southern California and the throughput at our distribution facility serving Northern California has improved, we expect our total inventory per store to roll back in the next couple of quarters to levels more consistent with our historical levels.

Accounts receivable increased $28 million from a year ago due to increased amounts owed to us from vendors as a result in changes in some of our contractual purchase arrangements, as well as higher receivables from customers in our PBM segment.

Our total inventory on a LIFO basis was up $33.7 million from a year ago, or 7.6 percent.

This is against a 3.3 percent increase in store count and a 4.8 percent increase in sales.

Our average total inventory per store increased to 2.3 percent on FIFO basis.

This reflects a 4 percent reduction in our average in-store inventories, offset by increases in our distribution center inventories, again, related to the grocery strike in Southern California, the system installation in Northern California and increased self distribution.

While we're not at all pleased with our gross profits in the quarter related to our reduction of our non-core merchandise inventory, we believe the quality of our inventory is much improved.

In-store non-core merchandise inventories were down $22 million from a year ago.

Moving onto CapEx, net CapEx for the full fiscal year was $140.3 million.

During fiscal 2004, we opened 18 new stores, closed three stores and relocated one store.

We also remodeled 20 stores this year.

We plan to open five to ten new stores and remodel up to 40 stores during this fiscal year, that's fiscal year '05.

Net CapEx for fiscal 2005 is expected to be between 105 and $115 million.

We also expect depreciation and amortization expense for 2005 -- fiscal 2005 -- to be in the range of 85 to $90 million.

Our net debt, which is short and long-term borrowings less cash on hand, at the end of the year increased by $23 million to 166 million.

This increase was primarily due to higher revolver borrowings resulting from increased inventory, higher net CapEx and our stock repurchases done earlier during the year.

Our revolving line of credit expires in October of this year and we intend to renew it.

Rx America, our PBM subsidiary, generated revenues for the quarter of $7 million, an increase of 1.6 percent from the 6.9 million reported for the fourth quarter last year.

For the year, Rx America generated an 18 percent improvement in revenues to 27.4 million from the 23.3 million reported last year.

For the 52 weeks ended January 29, 2004, we earned $29.8 million or 79 cents per diluted share on sales of $4.5 billion.

Included in that income were charges totaling 19 cents per diluted share for a number of items that are described in detail in the announcement we released today reporting our fourth-quarter and fiscal-year results.

Income for the 52 weeks ended January 30, 2003, before the effect of an accounting change related to our adoption of SFAS 142, was $31.3 million or 82 cents per diluted share, which included after-tax net charges of 10 cents per diluted share.

Now onto our outlook for the rest of the year.

Here are the assumptions we have incorporated into our guidance for fiscal 2005.

We anticipate the economy in California will continue to be difficult.

In addition, the grocery strike in Southern California is now over, and our forecasted for the impacted stores has been normalized for the rest of the year.

We are assuming a 10 percent reduction to the reimbursement rates in Medi-Cal, effective July 1st.

This doesn't mean we're any less committed to reaching a compromise with the state.

But frankly, there isn't enough clarity that would allow us to forecast anything else with certainty.

As we've stated, we're opening five to ten new stores this year and remodeling up to 40 stores.

We have limited experience with our remodeled stores and are still making modifications to the store design and functionality.

What we have seen so far is a slowdown in sales during the construction period and a lift in sales once we roll out the grand reopening promotional program.

Our guidance for the first quarter includes our estimate that total sales will increase in the range of 1 to 3 percent, with same-store sales being in the range of flat to up 2 percent from the first quarter of last year.

Given these sales assumptions and the continued progress we plan to achieve on our other initiatives, our goal is to achieve net income in the range of 24 to 27 cents per diluted share for the first quarter.

This compares with net income for the first quarter of last year of 16 cents per diluted share, including net charges of 8 cents per diluted share.

For the full year, we're estimating total sales will be up 3 to 5 percent, and same-store sales will increase in the range of 1 to 3 percent compared with last year.

Our outlook for net income is $1.05 to $1.10 per diluted share for fiscal 2005.

This compares with fiscal 2004 net income of 79 cents per diluted share, which included net charges of 19 cents per diluted share that are described in detail in our news release today.

Before I open the call up for questions, I would like to thank those of you that participated in our investor relations audit last quarter.

We appreciate the feedback.

Now we will open the call up for questions.

(OPERATOR INSTRUCTIONS).

Jack Murphy, Credit Suisse First Boston.

I'd like to first just talk about the fourth quarter and the issue with the perpetual inventory, or I guess lack thereof.

Could you just kind of update us on -- in terms of the whole time line for initiatives that began two years ago.

Where fitting perpetual inventory fits into that, and in terms of a time line.

And how, in lieu of that, you can manage or are managing, trying to manage gross margins throughout the next say four quarters.

Share.

Thanks, Jack.

The supply chain initiative, as you know, when you're moving from a very decentralized environment to a centralized environment, you know you're basically starting at less than scratch.

So it's a pretty long, tedious progress process.

We are about halfway through the timeline.

But a lot of the work that was done in the first year or year and a half, frankly, was I recall, the manual or the tedious work -- building item files and whatnot.

We are currently in the process -- actually last quarter, we rolled out actually the first system piece of this, and that was in the third quarter.

And that is the warehouse management piece of it; it is called RDM.

We are also -- so we are continuing to roll that out to our other distribution centers as we speak, and we will do that more this year.

Excuse me.

We are also now in the process of rolling out the pricing piece of the system, and that will happen -- that is actually in beta in a couple of stores now and will be going forward.

We have the inventory management piece of that -- is actually on the back end of this process.

And as you can imagine, you have to have all of these pieces built, including centralized procurement, before you can actually have all the pieces to have a perpetual inventory system.

So unfortunately, the perpetual inventory system is on the back end of that process, which we described in the press release as being a couple years out from now.

In the interim, is it -- the risk of having kind of a --

Let me try to address that.

We have been living with blunt instruments for a long time.

We have 470 plus stores that, frankly, were constructed to operate independently and autonomously.

We have some instruments that we can see week in and week out, but they are not sophisticated; they're not sexy at all.

They're basically just designed to give us an estimate of what the gross profit is as things move across the register.

We will improve our controls around managing those processes, managing the markdowns and managing all of the aspects around how we control both cost and retails and whatnot in the stores going forward.

I wish I could tell you that we could eliminate any possibility of a surprise in the future.

But I don't think we can do that.

But I think we can do some things that will significantly reduced the exposure going forward.

I would add to that.

I am determined that we not have a surprise of this magnitude going forward.

And there are a number of store processes, as well as, even though they may be manual, but off-line reports that we can use to measure a margin on items and categories as they move through the systems, particularly as we continue to right-size our inventories.

So, we're putting things in place as we speak.

And we think, through the combination of operational processes, and even though they're manual, some manual control processes, we can reduce our risk in this area substantially.

One -- actually just changing gears and then I will be done.

Could you tell us how much in your 2004 guidance, in cents per share, is the workers' comp reduction, and then how much, in cents per share, is the Medi-Cal reduction, as you said beginning July first?

Jack, we've talked about what it is worth in terms of a percent of our sales.

Giving out the actual EPS impact, frankly, will be able to allow our competitors to triangulate back into what we believe is competitively sensitive data.

So while we wanted to give you a sense that we had in fact estimated the 10 percent reduction in reimbursement rate beginning in July first, we're not willing to hand out basically the keys that we think will give our competitors information we don't want them to have.

Scot Mushkin, Lehman Brothers.

This is actually Meredith Adler.

I'd actually like to follow-on to Jack's last question about -- I can understand you don't want to share that information -- but I was just wondering, since you're essentially talking about flat earnings per share -- I'm sorry I don't have updated numbers -- a bit of an improvement over this year -- but you're obviously talking about 10 percent of your business -- pharmacy business -- being less profitable.

Can you talk about what components you think are going to lead to better earnings first per share?

Is it just not experiencing some of the kind of problem-- s gross margin problems -- you had in the fourth quarter, or more theoretically, is there something else?

There's a number of elements we have working, Meredith.

First, we expect a continuation of the improvement in OG&A (ph) through many of the initiatives we've put in place already, and some additional ones that we have already described previously in today's call.

Secondly, we do expect to have improved margins.

The centralization of our procurement, merchandising and advertising combined with a more effective assortment in our stores should produce the combination of a higher margins gained through better mix management and lower shrink.

So we would expect to get some real benefit this year from both of those.

Okay, great.

I Was just wondering if you could -- my understanding of what happened with the court's stay on Medi-Cal was that it impacted those Medi-Cal recipients who were covered by fee for service plans, and that was about half of the business.

And half of the people were covered by some kind of managed care plan.

Did you actually see any reduction on the managed care side in reimbursement rates because of cuts in Medi-Cal?

Not as yet, we have not.

Is that because none of it went through, or because they haven't come back to you, the managed care companies, and threatened lower reimbursements?

I think pretty much the former, Meredith.

It hasn't gone through.

Even though the stay supposedly only covered the fee-for-service part of it?

I'll introduce you to Bruce Schwallie.

He is the senior vice president of marketing, and has the pharmacy area.

He can give you a little better description.

Meredith, we're seeing a little better pressure from some of the payers, because they're anticipating that that reduction is going to take place during the course of the year.

So we're seeing some movement because they're all expecting that they are going to get some kind of hit, whether that's a 5 percent former reduction or this year's 10 percent.

There is some posturing that's going on there, but nobody really knows at this particular point until he can work through the particulars and the budgeting process this year.

So they didn't put through (ph) anything, even though they might have been able to so far?

Some of them have put through some things.

But we've already experienced some of those in the fourth quarter of this past year.

But we haven't experienced anything you know very recently, and it's been very minor.

I have another question just about the workers' comp, that you, like a lot of people with California operations, especially, made some corrections to your workers' comp liability -- I guess the reserve.

I was just wondering if you have a sense, was that a catch-up for prior periods?

Or should we make an adjustment when we are kind of looking at what the run rate of earnings is?

And do you have any sense of -- there is so much going on with California workers' comp, any sense about whether you are conservatively reserved now for this coming year?

Or could that bite you again sometime in fiscal '05?

Meredith, given that we made a net charge of $5.5 million, I don't think I'm ready to go out on a limb and say that we know all that we need to know about what is happening on the experience rates.

Clearly, with the regulatory changes in workers' comp, the structural changes that have been made in the law, in the last two or three years, what we're seeing is increased experience rates that are causing people to have to update their reserves as they go forward.

Why?

Because nobody has perfect vision into how law changes actually are going to translate into real expense impact over the longer-term.

The structural changes and the law changes started several years ago.

And so this catch-up certainly has something to do with past years.

We believe we have adequately provided in our plans and our guidance for workers' comp expense this year.

And I'll tell you what our actuary told us.

This actuarial report that we're giving you has a 50 percent chance to be right and it has a 50 percent chance to be wrong.

I wish I could (inaudible) something like that (multiple speakers).

All right.

Thank you, very much, guys.

One more follow-up on that.

Our new governor, Governor Schwarzenegger, is out in public stating that he is going to get through some workers' comp reforms.

We, as a company, frankly, are very active with the folks in Sacramento in terms of trying to push our own agenda here, or the business agenda on workers' comp.

So we hope that we've got some momentum to be able to change some of this going forward.

But we are very comfortable with our -- with what our forecast includes right now, based on everything we know.

Gary Giblin (ph) with CL King.

Hi.

I was just wondering if you experienced a lot of pharmacy prescription transfers from the strike supermarkets, and whether that enables you to get some feel for retention of business in that sense?

We obviously experienced some prescription transfers in Southern California as a result of the strike.

And it is our hope and plan to retain a number of those, of course.

And I would say we would have strategies around that.

I would add to that, Gary.

The strike in Southern California was devastating on that entire, frankly, economy down there.

We were delighted to be able to serve the customers that felt displaced by where they had previously shopped.

We went through extraordinary efforts to get in stock, to serve their needs.

And frankly, we hope that that does contribute or help us retain some of those dollars going forward.

As we have talked about in our guidance though, we think we have taken a prudent course relative to our forecast for the year.

We do expect some pretty intense competition from the supermarkets as they get back in business, here in the next quarter.

And we don't know what that looks like.

So obviously we can't predict with that is.

But we certainly hope we've acquitted ourselves well and are able to retain some of those customers.

Sure, were you able to add grocery categories or SKUs in a permanent way, where you could serve those customers and then keep that business going?

One of our strengths, of course, in our company is the ability of the local manager to -- store manager -- to react and respond to the customers' requests locally.

And in fact, one of the consequences of that reaction to our gross margin was that we need to lower margin projects that store managers individually took on in the stores to serve the customers' need during the strike.

So we did add to some assortments.

We obviously tried to serve the customers during the time they were trying to find a place to shop.

And as has been our past, we like to have an assortments that fit the local market.

So I'm sure some of it will carry forward.

Okay sounds like a great opportunity there.

Could you just comment on whatever you think is relevant, really, on the aspect of CVS having recently announced that they were entering Southern California?

I mean do you have a sense -- do you have any specific plan that would go against that?

Or is it just like any other competitor where you play your best game and try to offset the impact?

They, of course, are a competitor in many of the same categories we are in.

So depending on the location and the impact (ph) of store, we will respond as we normally respond with other competitors.

Gary, I would follow up with that.

We already compete against CVS in Nevada.

So they're not new to us as a competitor at all.

Katie Driver, SunTrust Robinson Humphrey.

Good afternoon.

I just had two quick questions to run by you.

The first one being, could you comment on how your employees are receiving your operational initiatives that's been introduced in the last two years, particularly your changing of the processes?

That's a great question.

During this last year, we -- we promoted 150 store managers -- assistant managers -- to store managers; 100 and some department managers to assistant manager; 160 or 70 people to department managers.

We promoted I don't know, 10 district managers.

There has been a lot of promotion, a lot of people that are in new jobs, new positions, and there is a lot of excitement and enthusiasm in the company.

On the other hand, there is an enormous amount of change going on in process discipline, store standards, changing of expectations in the way we do work, in the way we look at stores, in the way we manage our work processes.

And so with change, always comes frustration as you learn new things.

So on one hand, we have a huge amount of enthusiasm and support; on the other hand, we have normal, significant amount of organizational change as people relearn jobs and retrain in jobs.

So is it fair to say that turnover has been above-average?

We have very little turnover historically, almost none in the store manager group.

Turnover has increased a bit.

But I would tell you, based on my experience, our turnover is still lower than retail in general.

Particularly when you take out the voluntary separation program.

I would add to what Warren said Katie, we have terrific employees.

They are up to this challenge, and are responding.

We are actually very delighted with where we're headed.

And then secondly, could you comment at all on how your stores are performing in markets that have already been entered by competitors, such as maybe Walgreens?

We have competed with Walgreens for years and years and years.

And so, we know how to compete with Walgreens.

I would say, whenever you add additional square footage in retail, whether it's pharmacy or front-end consumables, you experience potentially, in the trade area, share loss.

But as we said on the call, our market share, on front-end categories, as measured by -- in core categories -- as measured by AC Nielsen in total, is up.

And that is with Walgreens opening more new stores than what we have.

We compete with them day in and day out.

It's business as usual, basically.

We see a very standard trend if you will.

New retail square footage adds share pressure wherever it occurs.

It does take time for the market to shake out, but generally it does.

Bob Summers with Banc of America Securities.

This is actually Wes Geiroshetz (ph) sitting in for Bob Summers.

First question I had had to do with gross margin.

I know last quarter, you guys talked about some permanent price reductions on certain categories.

First part would be, when do you start to lap some of those price rationalizations that you made in order to bring those categories to a competitive level?

And I guess roughly how much of an impact on the gross margin hit would that have had in the fourth quarter?

The answer to the first question is, we will lap those reductions during the second quarter of this year.

Okay.

And the second question, we wouldn't quantify.

Okay, I think last time, you said it was about 8 percent of your products in the front-end that were targeted for price cuts; is that correct.

No, that's not correct.

What we've said is we've taken reductions in over 2000 of our higher turning front-end SKUs.

I think the number is actually up around 2500 now.

2500 of our fastest turning items.

But we didn't quantify the percent of the front-end.

That's fair.

The second question -- I guess just looking at a comparable base for earnings growth for 2005, given all the sort of onetime items, say we use a 99 cent base, you have got a 1.05 to 1.10 growth -- or EPS for 2005, of which we will conservatively say with the Medicaid cut, that that's going to be 10 to 15 cents in the back half of the year.

And so I guess we will be looking at 20 percent earnings growth to normalized operating EPS?

Is that the correct way of looking at it?

The guidance that we have given actually has to stand on its own.

Unfortunately, the rules these days are pretty restrictive on any kind of non-GAAP kind of a comparison.

So we've laid out all the bloody details for you.

And we will leave you to make the adjustments for those.

Alex Raphael (ph), Maverick (ph) Capital.

Hi.

Two questions;

I'm sorry if these were answered before, but I was cut off.

Is the Medi-Cal impact starting in July included in your guidance?

And then also, what was the LIFO credit for the fourth quarter or charge?

The Medi-Cal is in fact included in our guidance.

We said that we anticipate a 10 percent reduction to reimbursements beginning in July.

As far as the LIFO credit, we took a credit in the quarter of $1.8 million, and that compares with a charge of 1.8 million a year ago.

And then also, I believe your effective tax rate this quarter was around 32 percent.

What do you expect the tax rate to be next year?

And then could you explain why that was so low this quarter?

We had a number of items that drove our fourth-quarter and full-year tax rate below what we normally have.

I think at the beginning of the year, we said 37.6 percent for last year; and that's what we're saying for this coming year.

So we are always working on various tax projects and we've put them in when we accomplish them.

That is our last question.

At this time, I'd like to turn the conference back to the speakers for any additional or closing remarks.

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 progress we have made on our initiatives during our first-quarter earnings call in May.

Thanks, again, and good afternoon.

This does conclude today's conference call.

Again, we'd like to thank everyone for their participation in this conference call.