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Profit growth demonstrates longs is 'gaining traction'.

WALNUT CREEK, Calif. -- Although meaningful sales growth remained elusive, Longs Drug Stores nevertheless rang up strong gains in reported and adjusted earnings for the quarter and fiscal year ended January 26, due largely to strengthened gross margins, lower operating expense ratios and sharply reduced interest costs.

Net income for the final 13 weeks of fiscal 2006 soared 99.4% to $35.3 million, or 92 cents per diluted share, from $17.7 million, or 47 cents per share, a year ago. Bottom-line results in the most recent quarter were bolstered by a $6.6 million after-tax net gain on the sale of the company's Lathrop, Calif., distribution facility and a $3.7 million after-tax favorable actuarial adjustment to self-insurance reserves due to a decline in workers' compensation claims and lower costs per claim.

Earnings in the fiscal 2005 period benefited from a $2 million after-tax favorable actuarial adjustment to self-insurance reserves. Excluding those items, adjusted profits for the 13 weeks climbed 59.2% to $25 million from $15.7 million a year ago. Adjusted earnings per share of 64 cents beat the 60-cent consensus estimate of analysts polled by Thomson Financial.

Fourth quarter retail sales rose 2.4% to $1.22 billion from $1.19 billion, while pharmacy benefits service revenues more than tripled to $25.4 million from $8.46 million. With that, total revenues for the 13 weeks advanced 3.8% to $1.24 billion from $1.20 billion.

Same-store sales increased 2%, as a 5.2% gain in pharmacy was diluted by a 0.7% downturn at the front end. Prescription drugs accounted for 47.1% of Longs' retail sales during the period, up from 45.7% a year ago.

In the pharmacy benefits segment --which is now reported as a separate line item--about $16.2 million of the quarter's revenue gain stemmed from one month of revenues generated by the new prescription drug plan business operated through Longs' wholly owned RxAmerica subsidiary. (Three plans are offered by RxAmerica under the new Medicare drug benefit, which began January 1.) Revenues for the segment also include RxAmerica's pharmacy benefits management services.

For the full year Longs' net income surged 73.9% to $73.9 million, or $1.93 per diluted share, from $36.6 million, or 97 cents per share, in fiscal 2005. Fiscal 2006 net was buoyed by the abovementioned $6.6 million gain on the sale of the Lathrop facility, as well as $5.8 million of after-tax actuarial adjustments to self-insurance reserves.

Earnings for the preceding year, meanwhile, reflected a $6.7 million after-tax charge for legal settlements and a partially offsetting $2.8 million benefit from actuarial adjustments to self-insurance reserves.

Backing out those items, adjusted income for the 52 weeks climbed 51.9% to $61.5 million from $40.5 million in fiscal 2005.

Retail sales for the year inched forward 0.9% to $4.62 billion from $4.58 billion, while pharmacy benefits revenues vaulted 62.9% to $53.5 million from $32.8 million. With that, total revenues grew 1.4% to $4.67 billion from $4.61 billion.

Same-store sales edged up 0.6% during the 52 weeks, with a 3.2% rise in pharmacy nearly wiped out by a 1.7% decrease at the front end. The prescription counter drove 48.6% of total retail sales, up from 47.4% in fiscal 2005.

"We are encouraged by the improvement in our financial results," comments chairman, president and chief executive officer Warren Bryant. "More than three years ago we began working on five broad categories of strategic initiatives to make Longs a stronger competitor and more profitable company. Evidenced by our financial results, we are gaining traction while we develop the organizational competence for change and improvement.

"We plan to make continued progress on our initiatives during fiscal 2007. In addition, we plan to pursue more aggressive store growth, remodel up to 40 more stores, leverage the investments we have made in RxAmerica and mail order, and begin operating our new self-distribution facility for front-end merchandise. We are excited about our long-term prospects for growth."

More specifically, in addition to completing its new Patterson, Calif., distribution center, the chain plans to open or relocate about 20 to 25 retail outlets this year, with capital expenditures estimated to be in the range of $200 million to $220 million.

That contrasts with a more modest growth plan in fiscal 2006, which saw the chain open just five stores and close one established location, giving it 476 units at fiscal year's end. In fiscal 2005 the company added a net of only two units.

Taking a closer look at Longs' operating results, retail gross margin improved 34 basis points during the fourth quarter to 25.75%. Management attributes the increase primarily to a more profitable merchandise mix arising from better buying practices and increased generic drug utilization, partially offset by pricing pressure from third-party payers.

Operating and administrative (O&A) expenses for the fourth quarter dropped 96 basis points to 20.57% of total revenues, as lower self-insurance expenses were partially offset by costs related to establishing the new prescription drug plan operations at RxAmerica.

After including depreciation and amortization, the $11 million pretax gain on the sale of the distribution facility as well as provisions for store closures and asset impairments (which nearly doubled to $2.7 million), consolidated operating income for the quarter jumped 92.1% to $58.8 million, 4.7% of total revenues, including the favorable adjustment to self-insurance reserves. With net interest expenses dropping 32.8% to $1.84 million, pretax profits for the quarter escalated 104.3% to $57 million.

Over the full year, retail gross margin grew 47 basis points to 25.69% while O&A expenses dropped 15 basis points to 21.95% of sales. After including the aforementioned gain on the distribution center sale and store closure/impairment charges, as well as depreciation and amortization, and $10.8 million in pretax gains from legal settlements in fiscal 2005, consolidated operating profits improved 79% to $126.2 million, or 2.7% of total revenues. Factoring in a 41.1% plunge in full-year interest costs to $7.86 million, pretax income surged 107% to $118.3 million.

Meanwhile, Longs continued to buy back shares of its common stock, purchasing about 1.4 million shares at an average price of $38.79 per share during the fiscal year.

Looking ahead, management notes that in the first quarter of fiscal 2007 the company will adopt FAS 123R accounting, requiring the expensing of stock options. Longs estimates that this move will lower annual net income this year by 8 cents to 9 cents per diluted share.

In addition, beginning in the first quarter, the drug will adopt FSP FAS 13-1, the new standard requiring companies to expense rental costs throughout the lease term, including the preopening construction period. The move will result in higher rent expenses during the construction period and lower rent costs over the remainder of the lease. Management projects that the change will lower annual net income by about 4 cents to 5 cents per diluted share.

Including the negative effects of those accounting standards, the company is forecasting net income in the range of $1.70 to $1.80 per diluted share for fiscal 2007. That would represent a decline from the $1.93 posted in fiscal 2006, which was bolstered by about 32 cents in gains from the distribution center sale and adjustment to self-insurance reserves. After excluding those items in both years, Chain Drug Review estimates that adjusted earnings per share would grow at least 13% from about $1.61 in fiscal 2006 to an estimated minimum of $1.82 in fiscal 2007.

Longs forecasts that total revenues will increase 10% to 12% for the year. Retail drug store sales are projected to rise from 4% to 6%, including a same-store advance in the 1% to 3% range.
                 Current    Previous
Chain drugs       close       close      Net        %        52-week
stocks           3/7/06     2/21/06    change     change       high

Dow Jones
  Composite      3737.08     3761.60   -24.52      -0.65

CVS                28.92       28.18    +0.74      +2.63       31.60
Jean Coutu
  Group *          11.32       13.82    -2.50     -18.09       18.18
Longs              42.51       36.97    +5.5      +14.99       47.11
Rite Aid            4.00        3.56    +0.44     +12.36        4.85
Shoppers Drug
  Mart *           39.38       38.75    +0.63      +1.63       39.47
Walgreens          44.14       45.83    -1.68      -3.67       49.01

Chain drugs      52-week                              P/E
stocks           low           Div.       Yield      ratio

Dow Jones

CVS                23.89        0.16        0.6         20
Jean Coutu
  Group *          10.18         --         --         --
Longs              29.51        0.56        1.3         22
Rite Aid            3.23         --         --          11
Shoppers Drug
  Mart *           33.48         --         --         --
Walgreens          40.98        0.26        0.6         29

* Prices are translated to U.S. currency at the exchange
rate of 0.8693.

                       Current     Previous
Internet drug           close       close        Net          %
stores                  3/7/06     2/21/06      change      change            2.65        2.68       -0.03       -1.12

Internet drug          52-week     52-week
stores                   high        low         Div.       Yield            4.78        2.13       --          --

Internet drug            P/E
stores                   ratio            --

                       Current    Previous
Parent companies       close      close        Net        %     52-week
& combo operators      3/7/06     2/21/06     change    change   high

  (combos)                8.20        8.06    +0.14     +1.74    9.30
  combos)                24.76       25.45    -0.69     -2.71   26.12
Cardinal Health
  (Medicine shoppe)      71.79       71.82    -0.03     -0.04    75.50
Kroger(combos)           20.15       20.06    +0.09     +0.45    20.88

Parent companies       52-week                           P/E
& combo operators        low        Div.      Yield     ratio

  (combos)                6.72         --        --        --
  combos)                21.30        1.82       7.3        26
Cardinal Health
  (Medicine shoppe)      52.85        0.24       0.3        26
Kroger(combos)           15.15         --        --        --

                 Current     Previous
Other            close       close        Net        %       52-week
retailers        03/07/06    2/21/06     change    change      high

A&P                 32.04       31.73    +0.31     +0.98       35.20
Sears (Kmart)      119.17      120.31     -1.14    -0.95      163.50
Supervalu           31.57       32.54     -0.97    -2.98       35.88
Target              52.86       53.66     -0.80    -1.49       60.00
Wal-Mart            45.27       45.74     -0.47    -1.03       52.59

Other            52-week                             P/E
retailers            low        Div.     Yield     ratio

A&P                 11.25         --        --          3
Sears (Kmart)      107.83         --        --         24
Supervalu           29.55        0.65       2.1        15
Target              45.55        0.40       0.8        20
Wal-Mart            42.31        0.67       1.5        17
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Title Annotation:Longs Drug Stores Corp.'s sales and earnings
Comment:Profit growth demonstrates longs is 'gaining traction'.(Longs Drug Stores Corp.'s sales and earnings)
Publication:Chain Drug Review
Geographic Code:1USA
Date:Mar 27, 2006
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