CVS Health Corp (CVS) 2004 Q2 法說會逐字稿

Good day everyone and welcome to the CVS Corporation second quarter 2004 conference call.

Today's conference is being recorded.

At this time for opening remarks, I would like to turn the call over to the Director of Investor Relations, Mr. Mike McGuire.

Please go ahead, sir.

Thank you, Stacy, and good morning everyone.

Thanks for joining us today for our second quarter 2004 conference call.

I'm sitting in for Nancy Christal, our Vice President of Investor Relations, who is unable to be here today.

I'm here with Dave Rickard, Executive Vice President and CFO, who will be providing highlights of our business in the quarter, an update on our acquisition of Eckard, a financial review, and earnings guidance.

Before I turn this over to Dave though, I have a couple of administrative items to cover.

First, I want to remind you our annual analysts and investor meeting is scheduled for Wednesday, September 29th.

It will be held at the Plaza Hotel in New York City.

If you haven't sent us your response for the meeting on the new date, please sign up soon.

To make it easy for you, we sent out a reminder invitation via e-mail last Friday to which you can reply.

If you have already signed up, it is not necessary to do so again.

If you would like to attend and you haven't received an invitation, please call Linda Pierre at 914-722-4094 and she will gladly assist you.

By the end of September, we will have owned the Eckerd's stores for two months and we will be able to share our initial impressions at that time.

We are already expecting a big crowd and we hope all of you can join us on September 29th for a full morning of presentations on CVS.

Second, I want to reiterate that in light of Regulation FD, we will only accept analyst models for review within the one week period following each quarterly earnings call.

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

During this period we'll simply check analysts models for appropriate interpretations of what we have said.

In addition, please note that during this call we will discuss one non-GAAP financial measure in talking about our company's performance, namely free cash flow.

Free cash flow is defined as earnings after taxes plus non-cash charges plus changes in working capital less net capital expenditures, so free cash flow excludes acquisitions and dividends.

In accordance with new SEC regulations, you can find the reconciliation of free cash flow to comparable GAAP measures on the Investor Relations portion of our Web site at investor.cvs.com.

As we typically do on these calls, our attorneys have asked me to read this Safe Harbor statement.

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

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

We strongly recommend that you become familiar with the specific risks and uncertainties that we have outlined for you under the caption, "Cautionary Statement Concerning Forward-looking Statements" in our annual report on Form 10-K for the 2003 fiscal year ending January 3, 2004, and in our quarterly report on Form 10-Q for the 2004 first quarter ended April 3, 2004.

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

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

And this morning's earnings press release is also available on our Web site which should be reviewed along with the information on this call.

Following the call please feel free to call me with any follow-up questions at 914-722-4704.

Now I'll turn this over to our CFO, Dave Rickard.

Thanks Mike, and good morning everyone, and thank you for joining us today.

Well, it's great to have another terrific quarter to report.

In the second quarter, we had very healthy top-line growth with the front-end regaining better than expected momentum.

And we had better than expected gross margin improvement.

These combined to deliver a healthy increase in our operating margin enabling us to over-deliver earnings in the quarter by 2 cents.

We achieved diluted earnings per share of 56 cents, up 14% from the 49 cents we reported last year.

I'll talk more about that later during the financial review.

Total sales increased 7.7%, to $6.9 billion.

Our sales per retail square foot reached $826 in the second quarter.

Once again, that leads all major national drugstore chains.

Same-store sales grew 6.1% with pharmacy comps up 7%, and front-end comps up 4.1%.

This quarter's is the best front-end comp performance we've had since the first quarter of 2002.

So our core business continues to thrive.

That's important because there's a lot going on beyond the core.

As we announced on Sunday, we closed the Eckerd deal.

We've acquired approximately 1260 Eckerd stores, the majority of which are in the fast-growing Florida and Texas markets.

We also acquired Eckerd Health Services, which was Eckerd's mail order and pharmacy benefit management business.

So what does that mean?

Well, the acquisition makes us the largest pharmacy retailer in the United States, with over 5,000 stores.

Through those, we will fill approximately 13% of the nation's retail prescriptions, and it gives us higher underlying growth, because the markets we've added are growing faster than the core CVS markets.

Finally with EHS, we'll have a PBM and mail order and specialty pharmacy company with revenues of more than $2 billion that serves approximately 30 million lives.

We have a detailed integration plan in place and a dedicated integration team already deep into execution of that plan.

They are drawing upon our substantial experience in integrating acquisitions.

The business we have acquired is currently declining so there's a lot to do.

In fact, the sales decline in the Florida markets seems to be leveling off, while the deterioration in Texas has worsened somewhat.

Overall, we're almost where we thought we would be, but with a slightly different profile by geography, and as we've said before, we don't expect it to turn around overnight.

This is when the hard work starts.

What do we do?

We'll put the fundamentals in place and we'll provide consistent support.

Most important is store level service delivery to customers.

We plan to improve in-store execution through a number of actions.

First, we'll implement all of the CVS systems including EPIC, PSI, AIM, Viper, and the other loss prevention systems and practices as well as our point of sale and ExtraCare systems.

That will address pharmacy service and efficiency, in stock, inventory control, shrink, customer tracking, and customer loyalty rewards.

Second, we'll focus on customer service and making the stores CVS easy.

As you know, that's our mantra.

We've met with the Eckerd store and field people and talked about what we need to get done.

We've seen great enthusiasm among these newest members of the CVS team who already have begun to positively embrace our customer focused philosophy.

Third, we'll expand staffing and store hours.

Fourth, we'll implement competitive everyday pricing.

And finally, we'll give our ExtraCare customer loyalty program an introductory splash to ensure that new-to-CVS customers can start to enjoy the benefits of ExtraCare right from the start.

The field management team is in place and operating.

Every former Eckerd employee has known for several weeks what his or her job would be once the acquisition occurred.

Those CVS employees who were transferred to new responsibilities in our newly acquired geographies, have been in place for several days to a few weeks.

While it's still early days, it appears that the field management system is off to a good start.

And we've made major progress in systems conversion.

By the end of this week, several capabilities will be operational.

First, merchandise mix and pricing will be systematically driven to the newly acquired Eckerd stores on a daily basis from the CVS store support center here in Woonsocket.

Second, all three newly acquired distribution centers will be completely integrated into the CVS supply chain.

Third, payroll and benefits conversion will be complete for all 25,000 new CVS associates.

And finally, financial processes will be up and running with daily sales, general ledger, accounts payable, and accounts receivable information readily available to meet operational and financial reporting needs.

Hats off to our systems group.

That's lightning speed.

From an accounting standpoint, this is a purchase accounting transaction.

We're having an outside expert value each of the assets and liabilities we've acquired.

We expect to have that work completed in the current quarter.

And therefore have the resulting values reflected in our September quarterly financial statements.

As we stated previously, we'll invest between 300,000 and $350,000 per store on average to convert the stores to the CVS brand.

Each store conversion entails extensive changes, including integrating all CVS systems, reducing shelf heights, resetting merchandise layouts, installing our hallmark CVS carpet, enhancing the lighting and changing the signage, basically making the stores CVS easy for customers to use.

We expect to disconnect from the Eckerd headquarters within four to five months.

We'll complete the store conversions in 12 to 18 months.

The conversion will start with the Florida stores where the most stores are and the biggest opportunities are.

We expect to convert approximately 300 stores before the Christmas season begins, and to complete the remaining conversions next year.

Once each market's conversion is complete, we'll relaunch the stores under the CVS/pharmacy banner.

In a nutshell, those are the most visible, and frankly, most important steps to turning this business around.

We're confident that over time, this will lead to enhanced sales growth, margin expansion, and increased profitability at these stores.

The path to accomplish the turn around is clear.

But we recognize that we have plenty of work ahead.

Now before providing a more detailed financial review of the quarter, I'll update you on some general business trends.

I'll start with the pharmacy business.

As I mentioned, pharmacy comps increased 7% in the quarter, down sequentially from the 8.3% reported in the first quarter.

Part of this reflects industry pricing.

We've seen a little slowdown in inflation which we think will continue in the second half.

Longer term, the retail pharmacy industry is expected to more than double by the year 2012.

While the pharmacy pipeline recently has not been as productive as it was a few years ago, and as we expect it will be again in the future, we're focused on taking share.

As you know, our mission is to make CVS the easiest pharmacy for customers to use and the very good news is that it's working.

CVS continues to take share from our chain drug competitors.

Capturing share bit by bit is an important part of our long-term success.

Our next challenge and opportunity is to improve performance in the former Eckerd stores so we can ratchet up our scale and hike our growth rate.

As we do that, there's a reasonable expectation that the pipeline will improve as well.

As we review the pipelines of the pharmaceutical manufacturers, we're pleased to see more drugs in the pipeline now than there have been over the past few years, and these drugs on average are further along in the pipeline, closer to FDA approval.

So the pharmacy business is doing well with good prospects.

How are we doing in the front of the store?

Well, as I said earlier, front-end comps increased 4.1% in the quarter, up sequentially from the 2.0% reported in the first quarter.

We also experienced a sequential improvement in the growth of front-end customer counts, and we continue to capture market share based on A. C. Nielsen data for the second quarter.

In fact, we took share in 44 of 47 categories from chain drug competition and in 43 of 47 categories from food, drug, and mass.

In the second quarter we saw strength broadly, but especially in our core health and beauty consumables, seasonal, general merchandise, and photo categories.

In fact, our digital photo business is taking off.

As you know we completed the rollout of our digital solution to all of our one-hour photo stores in July of 2003.

We were the first to have a national capability throughout the chain.

Since that time, we've seen a turn around in the overall photo category.

It had been in decline due to the decrease in film sales and overnight processing.

But now, in the second quarter alone, we processed more than 35 million digital images, up from 17 million in the first quarter.

And our one-hour photo sales, including digital, were up over 11% versus last year.

During the quarter we added the ability to upload digital images at cvs.com and pick them up in our stores the next day.

Of course, we plan to install our digital photo processing technologies in the Eckerd stores we just acquired.

This should help drive sales growth going forward.

Another factor driving front store sales this quarter was the expansion in store hours.

Over the past four quarters, we've increased the number of 24-hour and extended-hour stores by 165%, as we put a continued push on customer service.

Our growing ExtraCare loyalty program also helped drive our front-end this quarter.

Last week, the ExtraCare program reached a milestone, when it enrolled its 50 millionth card holder.

That was on Monday, July 26, at about 9:06 in the morning.

Launched chain-wide just three-and-a-half years ago, ExtraCare has grown to become the largest retail rewards program in the country.

ExtraCare builds customer loyalty by delivering great value on relevant products in a highly efficient and targeted way.

Our challenge is to balance the broad promotions in our circulars with our targeted promotions through ExtraCare.

Doing this will enable us to optimize margins and meet our customer service goals.

Now I'll turn to our new store program.

During the second quarter, we opened 39 stores, including 22 new and 17 relocations.

And we closed only three others.

So our net unit growth was 19 stores in the quarter.

Of the new stores, 16 were in our newer markets, six in Florida, three in L.A., two in Orange County, two in Chicago, two in Houston, and one in Las Vegas.

As we said when we announced the Eckerd transaction, including the stores in Eckerd's pipeline that we acquired, our plan for the year is to open a total of about 250 to 275 new or relocated stores in 2004.

That translates to net unit growth of approximately 125 stores excluding the Eckerd closings I'll talk about in a minute.

For the year, about 125 of our new stores will be in our newer markets.

Now, with all the attention on the Eckerd acquisition, we shouldn't lose sight of the progress CVS has made in terms of organic growth over the past few years, in markets such as Chicago, Florida, Texas, Phoenix, Vegas, and L.A.

In total, we anticipate 2004 sales of about a billion dollars for these new markets alone.

These new stores continue to grow rapidly and are adding measurably to our sales results.

In the second quarter, the new stores that were opened less than a year, and were therefore not included in our comps, added approximately 160 basis points to our total sales growth number.

Over the next couple of years, even as we absorb the Eckerd stores we acquired, we will continue to dense up in these newer market areas to build share and drive full-scale economics, market by market.

On our last conference call, three months ago, we gave you preliminary estimate for Eckerd store closings.

We said that of the approximately 1260 stores we acquired, we expected to close between 200 and 225 stores.

Now having had more time to study these locations, we have a bit of good news.

Several locations we thought we needed to close appear to have the prospect for successful rejuvenation.

These are under-performing stores that are well located, but have suffered from significant operational and merchandising inefficiencies.

We believe we can turn these around.

So now we're looking at total closures of less than 200 stores.

About three-quarters of those stores are expected to function like traditional file buys where we close a store and transfer the pharmacy files to a nearby CVS/pharmacy, retaining a significant portion of the business.

The others are straight closures of non-productive stores.

In other words, given the stores we're closing, plus the amount of sales we expect to give up, with the file buys, we're closing the equivalent of approximately 100 stores.

After the planned store closings, we'll net close to 1100 stores from the acquisition.

These stores are in high growth markets both in terms of population and pharmacy utilization.

We're getting high quality real estate with comparable store sizes.

From a store count perspective, then, we'll have the CVS core, the acquired Eckerd stores, and the net new stores from this year's new store program.

So by year-end we expect to be operating more than 5400 stores.

Now let me touch on PharmaCare, our PBM and specialty pharmacy business.

PharmaCare today has about 15 million lives under management.

During the second quarter, PharmaCare's revenues increased 2.5%, while operating profit increased 2.1%.

The acquisition of Eckerd health service will create a 2 plus billion dollar PBM mail order specialty pharmacy company serving 30 million lives.

This provides us a platform to deal with the large corporate players, and enable us to be competitive in a broader spectrum of plans.

We will also have a more significant presence in the mail order pharmacy business which has been growing faster than retail pharmacy.

And while EHS is not currently a direct participant in the specialty pharmacy business, we can enhance the EHS business by adding specialty to their offering.

Now I'd like to provide a more detailed review of our second quarter financial results.

After that, I'll provide guidance for the third quarter and update guidance for the remainder of this year.

Turning to our second quarter income statement as I said earlier, total sales increased 7.7% to $6.9 billion.

Our overall gross margin in the second quarter increased by 96 basis points to 26.3%.

This significant improvement in our gross margin was driven by three key factors: A benefit from the increase in generic drugs as a percent of total, a continued improvement in shrink, and earlier than expected price change activity on the branded pharmaceutical side which we expect to see less of in the second half.

These positive influences on our margin were partially offset by the continued mix shift toward pharmacy, as well as the continued shift of our pharmacy business from cash to third party customers, which have a negative influence on overall margins.

Pharmacy sales represented 69.1% of total sales in the second quarter, up 20 basis points from the second quarter of 2003.

Third party now represents 93.7% of pharmacy sales, up 110 basis points versus the prior year quarter.

The generic pipeline remains healthy.

Since the beginning of the year, drugs such as Cipro and the 80-milligram strength of OxyContin have become available generically, thus improving margins albeit at the cost of lower reported sales.

Industry projections show the pipeline to be even more robust in 2005 and 2006, as many more branded drugs are expected to lose patent protection.

Now I'll turn to SG&A.

As we expected, our total SG&A expense as percentage of sales, including depreciation and amortization, increased year-over-year.

It was up 60 basis points to 20.7% in the second quarter.

As I mentioned before, a key driver of this is store hours expansion.

This investment in payroll and benefits is expected to go a long way toward further improving customer service.

This is a key program for future growth.

Also as expected, our SG&A reflected the integration activities that have been underway since we announced the Eckerd acquisition in early April.

A final driver behind second quarter SG&A results was advertising support behind the Medicare discount card and digital photography.

As I mentioned previously, the digital photo is helping to turn the photo business around and the ad dollars used to increase digital awareness have proven to be well spent.

Operating margin was 5.58% in the second quarter.

This was an improvement of 35 basis points over the second quarter of 2003, driven by our higher gross margin.

Net interest expense was $6 million in the quarter.

Our tax rate was 38.5% in the second quarter as expected.

And as I noted earlier, diluted earnings per share was 56 cents for the quarter, up 14% over last year.

Net earnings increased by 17%.

The difference between the 14% EPS growth, and the 17% net earnings growth, reflects the increase in exercisable stock options, due to the stock's performance over the past year.

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

Inventory performance continues to improve.

In the second quarter, inventories increased by 5% versus last year, while sales increased 8%.

The AIM initiatives for pharmacy and the front of the store continue to perform as expected.

We delivered among our highest ever in-stock levels while simultaneously producing our highest ever inventory turns.

I'm happy to report once again, that we continue to lead our industry in FIFO inventory turnover.

Our inventory turns of 5.15 times were up sequentially from the 5.0 we achieved at the end 2003, and the 4.8 times we delivered in the second quarter of last year.

Now, while this puts us three-quarters of the way toward our year-end goal of 5.2 times, with half of the year left, as I pointed out during the first quarter's conference call, the acquisition of the Eckerd stores may cause us to revise this goal.

As we've noted before, FIFO inventory turns at Eckerd stores are a bit lower than those at CVS.

Once the accounting valuation work on the acquired assets is complete, we'll formalize this.

Second quarter net capital expenditures were $266 million.

Gross capital expenditures of 269 million were offset by only 3 million of sale/lease-back activity during the quarter.

We had a free cash flow use of $29 million in the second quarter, in line with expectations.

And as I noted earlier, we currently expect to reset 300 former Eckerd stores this year, less than we originally expected.

So that means we're shifting some capital spending associated with the Eckerd resets from 2004 into the year 2005.

The two-year impact of which is zero.

Since we haven't completed the accounting valuation work, I think it is premature to provide updated cash flow guidance at this time.

Obviously the timing shift of capital spending will benefit this year at the expense of 2005.

We'll update free cash flow guidance during the third quarter's conference call.

Now I do want to provide earnings guidance for the remainder of this year, which will include the effect of Eckerd.

In the third quarter, we expect total sales to grow 22% to 25%, and total comps to grow in the 5% to 7% range.

We expect to see third quarter earnings per share of between 40 cents and 42 cents, as we continue to make investments in our core business and ramp up the integration of the Eckerd stores.

For the full year 2004, with the Eckerd transaction, we expect total sales to grow 14 to 17%.

Total comps are expected to grow in the 5 to 7% range.

Pharmacy comps are expected to be in the 7 to 9% range, and front-end comps should be about 2 to 3% given the recent strength we've seen.

Let me reiterate that we expect to see a more typical decline in gross margin in the third and fourth quarters.

The effect of our mix shifting toward a higher percentage of pharmacy sales will be a factor, partly offset by increasing generic penetration.

As Eckerd comes to us with lower gross margins, this will reduce average gross margins in the business.

However, including the very positive first half, the gross margin for the combined company is expected to be flat to modestly up for the full year.

So third and fourth quarters down, the year flat to modestly up.

As for full-year SG&A as a percentage of sales, in our core business we will continue to reap the benefits from our systems and work flow enhancements, as well as gain sales leverage.

As a result, we expect full year SG&A as a percent of sales in the core CVS business to modestly improve over 2003's levels.

However, the turnaround investments required in the Eckerd business that I outlined for you earlier will increase our overall SG&A as a percentage of sales over last year's levels.

Thus we expect to see overall operating margin to decline between 50 and 70 basis points versus 2003 levels.

Our tax rate is expected to be 38.5% and our diluted share count is now expected to be about 416 million shares for 2004.

We've previously provided guidance on 2004 EPS of $2.08 to $2.11.

Subsequently, we had a better than expected second quarter.

We've also had a one-month delay in the closing of the Eckerd deal.

This delay, of course, means that while still making substantially all of our planned investments in SG&A to begin the turnaround, we now after shorter period in 2004 to reap the P&L benefits of owning these assets.

So as a result, combining the over-performance in the second quarter with the delay in the Eckerd closing, we are maintaining our EPS guidance of $2.08 to $2.11 for the full year 2004.

While it's obviously too early to give guidance for 2005 and beyond, I would like to confirm that we continue to expect the Eckerd transaction to be accretive to earnings per share in the range of 15 to 20 cents in 2005 and 25 cents to 30 cents in 2006.

In summary, what's the second quarter update from CVS?

First, there are positive trends in the core business.

Sales, margins, shares of market, customer satisfaction, and growth.

Second, the Eckerd transaction has closed and the turnaround is underway.

The field management structure is in place and the integration efforts are advancing with good momentum.

And third, despite a delay in the actual closing of the Eckerd transaction, earnings guidance has been maintained due to the strength of core CVS.

Thanks for your attention, and now we'll be glad to take your questions.

Thank you.

The question-and-answer session will be conducted electronically.

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

If you are joining us using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment.

Once again, it is star one if you do have a question today.

We'll go first to Mark Husson of HSBC.

Good morning.

I got through the mail yesterday a flyer from Rite Aid saying there's a lot of changes happening at the Eckerd stores.

If you're not happy please come over to Rite Aid and here's a voucher.

Are you seeing, are you doing some of that in this marketplace?

How come they've beaten you to it?

What are you seeing in the South in terms of competitive activity to try and destabilize your business?

Well, that is a little naughty of them, isn't it?

We are marketing as of the day of ownership and we expected fully to get this kind of thing from some competitors.

Nothing out of the ordinary, nothing that wouldn't happen in the North or anywhere else.

So I'd chock this up to normal competitive activity to which we'll respond.

Okay.

And then finally, could you just talk about the Medicare card?

It sounds like it cost you a little bit of money to get the thing launched.

Was there any measurable improvement in sales as a result of this, and what happened to the margin?

I'm sorry, Mark.

Could you repeat your question?

It's a question on the Medicare card.

It sounds like it cost you some money to get it launched.

Did you get any measurable uptick in sales and what happened to the margin?

It did cost us a little money to advertise it.

We've seen relatively little in terms of sales.

It was a net cost in the quarter.

This is a program that you have to look at over the years, not by quarter, in the initial period.

Thank you very much.

Okay, Mark.

Our next question comes from Mark Wiltamuth of Morgan Stanley.

Good morning, Mark.

Good morning.

I wanted to ask about the new pricing policy that will you have in the Eckerd stores.

Obviously you're going to reduce the amplitude on the deep discounts on the front-end and move to a more every day price with the traditional items in the front-end.

Do you think this is going to be neutral to gross margins or will you get a little bit of a lift with the new pricing strategy?

I think it will be at best neutral, Mark.

Could be some cost initially but we should make it up with volume.

Okay.

Thank you.

Yeah.

We'll move next to Monica Aggarwal of Merrill Lynch.

Good morning, Monica.

Good morning.

How are you?

The hardest part of the business as we all know is to turnaround the pharmacy and that turned negative at Eckerd at the beginning of the year.

So how quickly can you turn it around and what do you have built in targets over the next 18 to 24 months?

I would say that you're absolutely right that is the hardest part to turnaround.

It is in decline right now in the stores that we have purchased and I would not look for growth out of that in the next 18 months.

And that's obviously reflected in your estimates right now.

That's correct.

Okay.

Thank you.

We'll go next to Edouard Aubin of Deutsche Bank.

Good morning, Dave.

Regarding Eckard's PDM business, I believe you've lost the Aetna contract which was fairly significant for you.

What type of impact will it have on your profitability?

That actually had been announced publicly by Eckerd and Penny before the transaction happened and so we sort of considered that to be in the public domain.

It's absolutely right that the Aetna business is transitioning to an internal execution by Aetna and Eckard, or EHS is cooperating in that in facilitating that.

That is fully reflected in the estimates that we have for the business, and so it won't have any impact on what we've talked about.

Right.

And just finally regarding California I believe you've opened your first store there.

Can you give us some feedback on the, you know, on how you're doing right now in California?

Yes, you're correct, we've had our first stores opened now for about six weeks.

The initial reports are very positive as they always are in new exciting stores with new employees, and we'll see how they go, but initial expectations are quite positive.

Great.

Thanks.

So once again if you do have a question, please press star one at this time.

We'll go next to Steve Chick of J.P.

Morgan Chase.

Hi.

It's actually Janet King for Steve.

How are you?

Good morning, Janet.

Morning.

Just a couple of questions.

Looking at Eckerd sales out to '05 and, you know, we were actually trying to grow CVS sales at a normalized run rate of about 8% which I believe falls within your 7 to 9% guidance if you exclude the extra week.

In order to get to about $37 billion for sales in '05, this implies a double-digit growth rate for Eckerd next year.

Can you comment on whether or not this is consistent with your thoughts?

Yeah, I'm not expecting a double-digit growth rate for Eckerd.

What I'd suggest you do is, you know, pull your model together and send it in.

Mike will take a look at it and give you comments.

Okay.

Not a double-digit growth.

Okay.

Great.

And also, can you tell us how much of the purchase price for Eckerd you are expecting to allocate to goodwill?

I know it's not going to be reflected on the P&L, but on the balance sheet.

Yeah, I really can't tell you that.

Goodwill, of course, is sort of the residual of all the valuations of the assets and the liabilities.

We're within a couple of months of having very sound numbers there and I'd prefer to wait until we get those before we comment on the goodwill portion.

Okay.

And also two more questions.

Do you know what kind of annual depreciation expense we should be modeling for Eckerd?

Yeah, again that will depend on the valuation work.

I'm not expecting huge swings there versus what we've modeled, but, you know, equally I don't want to start putting out guidance in these things until we actually know what the numbers are.

So bear with us until we get the valuations in.

They're well underway, they were started sometime ago, and we'll have them shortly.

Great.

And lastly, if I may, were gross margins up in both pharmacy and front-end segments in the quarter?

We don't break that out but I will tell you that we're very pleased with the results in both front-end and pharmacy.

Great.

Thank you very much.

Thank you.

Our next question comes from John Heinbockel of Goldman Sachs.

Hey, Dave.

A couple of things.

Maybe give us an update on mandatory mail and to what degree that impact has picked up negatively or not.

And what success you guys are having repelling that with your line in the sand on mandatory and to what degree is 90-day retail starting to gain some traction here?

Maybe give us a little color on that.

Well I'd say that in the Michigan market including nearby states where the UAW contract is in place, we are seeing a negative on our business from the UAW mandatory mail contract.

Our line in the sand, you know, will be most important when we come up against new contracts which is mostly in January, February, in terms of execution and the fall in terms of negotiation.

So it's not a time right now when we would expect to have a lot say there.

And indeed we don't.

As far as 90 days at retail where, we have it in place, it's working well.

Marketing research says the employees announced appreciate it, they like it, and so it's a good employee thing, it's good for the employer, it's good for us.

So it's limited today but where we have it, it's doing well.

Does the, where does the copay have to be, the copay differential, 90-day versus regular mail to cause the consumer to pick 90-day, and when do we get there?

Well, as a general matter, we are paralleling the economics offered to employees under the mail program, so that's not much of a feature today.

That's in PharmaCare, right?

No, I'm talking about retail.

You know, the copays today in most mail plans are between two and three copays.

So the sort of co-opping economics of single copays or no copays that were the loss leader starters for this portion of the industry are no longer out there, and we can certainly live on two or three copays.

Do you think we're close enough now that if you got 90-day into these plans, 90-day retail in that you'd pick up a fair bit of share if you got it in?

Yeah.

Alright.

And then secondly, is there any quantification on the shrink improvement and the integration costs related to Eckerd, how big were both of those?

First of all, we're no longer breaking the out shrink numbers.

We did get an improvement in shrink, we're happy with it.

The integration cost, the one-time integration costs for the full year will be in the $90 million range.

I don't have it off the top of my head for the quarter.

Okay.

Thanks.

We'll take one more call.

Our final question will come from Ken Galley of Pioneer Investments.

Morning, Ken.

Good morning.

I was wondering if you could just tell us when the Eckerd stores are going to hit the comp base?

Yes, I can.

They'll hit the comp base in August of next year.

August of next year.

Okay.

To the extent that the pharmacy business doesn't really start to recover next year that could be a drag on comps?

That's correct.

Great.

Thank you very much.

Okay.

Thank you all very much, and good-bye.

And that does conclude today's conference.

Have a great day.