**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C.   20549**

 

**FORM 10-Q**

 

 

**(MarkOne)**

 

| **ý** |   | **QUARTERLY REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.**  |
|------------|--------|------------------------------------------------------------------------------------------------|
|       |   |                                                                                           |
|       |   | **For the quarterly period ended October 30, 2003**                                            |
|       |   |                                                                                           |
| **o**      |   | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.** |

 

**Commissionfile number 1-8978**

 

**LONGS DRUGSTORES CORPORATION**

(Exact name of registrant as specified in its charter)

 

| **Maryland**                                                                            |   | **68-0048627**                        |
|-----------------------------------------------------------------------------------------|--------|---------------------------------------|
| (State or other jurisdiction of  incorporation or organization)                         |   | (I.R.S. Employer  Identification No.) |
|                                                                                    |   |                                  |
| **141 North Civic Drive  Walnut Creek, California**                                     |   | **94596**                             |
| (Address of principal executive offices)                                                |   | (Zip Code)                            |
|                                                                                    |
| Registrant’s  telephone number, including area code:  **(925) 937-1170** |

 

Indicate by check mark whetherthe registrant:  (1) has filed allreports required to be filed by Section 13 or 15(d) of the Securities ExchangeAct of 1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days.

 

Yes  ý      No  o

 

Indicate by check mark whetherthe registrant is an accelerated filer (defined in Rule 12b-2 of the ExchangeAct).

 

Yes  ý      No  o

 

There were 37,476,396 shares ofcommon stock outstanding as of November 27, 2003.

 

 

----

 

# **Tableof Contents**

 
| **PART I – FINANCIAL INFORMATION** |            |
|-----------------------------------------|-----------------|
|                                    |            |
|                                    | Item 1          | Condensed Consolidated Financial Statements |   |
|                                    | Item 2          | Management’s Discussion and Analysis of  Financial Condition and Results of Operations |   |
|                                    | Item 3          | Quantitative and Qualitative Disclosures of  Market Risk |   |
|                                    | Item 4          | Controls and Procedures |   |
|                                    |            |
| **PART II – OTHER INFORMATION**    |            |
|                                    |            |
|                                    | Item 6          | Exhibits and Reports on Form 8-K |   |
|                                    | Signature  Page |   |

 

----

 

**PART I – FINANCIAL INFORMATION**

 

**Item 1.    CondensedConsolidated Financial Statements**

 

**CondensedConsolidated Statements of Income (unaudited)**

 
|                                                                    |   | **For the 13  weeks ended**              |      | **For the 39  weeks ended** |   |
|-------------------------------------------------------------------------|--------|------------------------------------------|-----------|-----------------------------|--------|
|                                                                    |   | **October 30,  2003**                    |      | **October 31,  2002**       |   | **October 30,  2003** |   | **October 31,  2002** |   |
|                                                                    |   | **(Thousands Except Per Share Amounts)** |      |
|                                                                    |   |                                     |      |                        |   |   |   |   |   |
| Sales                                                                   |   | $                                        | 1,087,293 |                        | $      | 1,064,470 |   | $ | 3,299,886 |   | $ | 3,255,929 |   |
| Cost of sales                                                           |   | 813,289                                  |      | 787,682                     |   | 2,452,736 |   | 2,418,852 |   |
| Gross profit                                                            |   | 274,004                                  |      | 276,788                     |   | 847,150 |   | 837,077 |   |
|                                                                    |   |                                     |      |                        |   |   |   |   |   |
| Operating and  administrative expenses                                  |   | 241,984                                  |      | 249,842                     |   | 744,106 |   | 730,261 |   |
| Depreciation and  amortization                                          |   | 20,066                                   |      | 19,595                      |   | 63,753 |   | 57,677 |   |
| Provision for store  closures and asset impairment                      |   | —                                   |      | —                      |   | 2,543 |   | — |   |
| Legal settlements and other  disputes                                   |   | —                                   |      | —                      |   | — |   | 469 |   |
| Operating income                                                        |   | 11,954                                   |      | 7,351                       |   | 36,748 |   | 48,670 |   |
| Interest expense                                                        |   | 3,648                                    |      | 3,515                       |   | 10,904 |   | 10,243 |   |
| Interest income                                                         |   | (76                                      | )         | (228                        | )      | (315 | ) | (874 | ) |
| Income before income taxes  and cumulative effect of accounting change  |   | 8,382                                    |      | 4,064                       |   | 26,159 |   | 39,301 |   |
| Income taxes                                                            |   | 3,152                                    |      | 1,076                       |   | 9,836 |   | 14,402 |   |
| Income before cumulative  effect of accounting change                   |   | 5,230                                    |      | 2,988                       |   | 16,323 |   | 24,899 |   |
| Cumulative effect of  accounting change (net of tax benefit of $16,410) |   | —                                   |      | —                      |   | — |   | (24,625 | ) |
| Net income                                                              |   | $                                        | 5,230     |                        | $      | 2,988 |   | $ | 16,323 |   | $ | 274 |   |
|                                                                    |   |                                     |      |                        |   |   |   |   |   |
| Basic earnings per common  share:                                       |   |                                     |      |                        |   |   |   |   |   |
| Income before cumulative  effect of accounting change                   |   | $                                        | 0.14      |                        | $      | 0.08 |   | $ | 0.44 |   | $ | 0.66 |   |
| Cumulative effect of  accounting change (net of tax benefit of $0.43)   |   | —                                   |      | —                      |   | — |   | (0.65 | ) |
| Net income                                                              |   | $                                        | 0.14      |                        | $      | 0.08 |   | $ | 0.44 |   | $ | 0.01 |   |
|                                                                    |   |                                     |      |                        |   |   |   |   |   |
| Diluted earnings per common  share:                                     |   |                                     |      |                        |   |   |   |   |   |
| Income before cumulative  effect of accounting change                   |   | $                                        | 0.14      |                        | $      | 0.08 |   | $ | 0.44 |   | $ | 0.65 |   |
| Cumulative effect of accounting  change (net of tax benefit of $0.43)   |   | —                                   |      | —                      |   | — |   | (0.64 | ) |
| Net income                                                              |   | $                                        | 0.14      |                        | $      | 0.08 |   | $ | 0.44 |   | $ | 0.01 |   |
| Dividends per common share                                              |   | $                                        | 0.14      |                        | $      | 0.14 |   | $ | 0.42 |   | $ | 0.42 |   |
|                                                                    |   |                                     |      |                        |   |   |   |   |   |
| Weighted average number of  shares outstanding:                         |   |                                     |      |                        |   |   |   |   |   |
| Basic                                                                   |   | 37,144                                   |      | 37,998                      |   | 37,210 |   | 37,892 |   |
| Diluted                                                                 |   | 37,413                                   |      | 38,274                      |   | 37,411 |   | 38,197 |   |

 

*See notes to condensed consolidated financialstatements.*

 

1

----

 

**Condensed Consolidated Balance Sheets**

 
|                                                                     |   | **October 30,  2003**                    |      | **October  31,  2002** |   | **January  30,  2003** |   |
|--------------------------------------------------------------------------|--------|------------------------------------------|-----------|------------------------|--------|------------------------|--------|
|                                                                     |   | **(Thousands Except Share Information)** |      |
|                                                                     |   |                                     |      |                   |   |
|                                                                     |   | **(Unaudited)**                          |      |                   |   |
| **ASSETS**                                                               |   |                                     |      |                   |   |                   |   |
|                                                                     |   |                                     |      |                   |   |                   |   |
| Current Assets:                                                          |   |                                     |      |                   |   |                   |   |
| Cash and cash equivalents                                                |   | $                                        | 55,088    |                   | $      | 59,576                 |   | $ | 40,195 |   |
| Pharmacy and other  receivables, net                                     |   | 148,090                                  |      | 122,806                |   | 135,610                |   |
| Merchandise inventories,  net                                            |   | 478,209                                  |      | 490,262                |   | 443,435                |   |
| Deferred income taxes                                                    |   | 33,395                                   |      | 24,229                 |   | 32,131                 |   |
| Other                                                                    |   | 11,500                                   |      | 10,098                 |   | 11,290                 |   |
| Total current assets                                                     |   | 726,282                                  |      | 706,971                |   | 662,661                |   |
|                                                                     |   |                                     |      |                   |   |                   |   |
| Property:                                                                |   |                                     |      |                   |   |                   |   |
| Land                                                                     |   | 104,761                                  |      | 105,787                |   | 107,175                |   |
| Buildings and leasehold  improvements                                    |   | 542,069                                  |      | 517,855                |   | 524,768                |   |
| Equipment and fixtures                                                   |   | 526,739                                  |      | 498,523                |   | 487,888                |   |
| Total property at cost                                                   |   | 1,173,569                                |      | 1,122,165              |   | 1,119,831              |   |
| Less accumulated depreciation                                            |   | 567,211                                  |      | 521,130                |   | 523,813                |   |
| Property, net                                                            |   | 606,358                                  |      | 601,035                |   | 596,018                |   |
| Goodwill                                                                 |   | 82,085                                   |      | 82,236                 |   | 82,085                 |   |
| Intangible assets, net                                                   |   | 6,446                                    |      | 5,702                  |   | 5,430                  |   |
| Other assets                                                             |   | 3,719                                    |      | 6,139                  |   | 5,877                  |   |
| Total                                                                    |   | $                                        | 1,424,890 |                   | $      | 1,402,083              |   | $ | 1,352,071 |   |
|                                                                     |   |                                     |      |                   |   |                   |   |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                           |   |                                     |      |                   |   |                   |   |
|                                                                     |   |                                     |      |                   |   |                   |   |
| Current Liabilities:                                                     |   |                                     |      |                   |   |                   |   |
| Accounts payable and  accrued expenses                                   |   | $                                        | 333,958   |                   | $      | 312,021                |   | $ | 270,986 |   |
| Employee compensation and  benefits                                      |   | 94,314                                   |      | 84,010                 |   | 92,185                 |   |
| Taxes payable                                                            |   | 45,454                                   |      | 42,297                 |   | 54,579                 |   |
| Current portion of  long-term debt                                       |   | 63,923                                   |      | 2,345                  |   | 2,348                  |   |
| Total current liabilities                                                |   | 537,649                                  |      | 440,673                |   | 420,098                |   |
| Long-term debt                                                           |   | 147,558                                  |      | 211,481                |   | 181,429                |   |
| Deferred income taxes and  other long-term liabilities                   |   | 35,914                                   |      | 35,788                 |   | 34,074                 |   |
| Commitments and  Contingencies                                           |   |                                     |      |                   |   |                   |   |
|                                                                     |   |                                     |      |                   |   |                   |   |
| Stockholders’ Equity:                                               |   |                                     |      |                   |   |                   |   |
| Common stock (37,481,000,  38,475,000 and 38,501,000 shares outstanding) |   | 18,740                                   |      | 19,237                 |   | 19,250                 |   |
| Additional capital                                                       |   | 168,843                                  |      | 169,362                |   | 169,853                |   |
| Unearned compensation                                                    |   | (2,972                                   | )         | (5,342                 | )      | (4,562                 | )      |
| Retained earnings                                                        |   | 519,158                                  |      | 530,884                |   | 531,929                |   |
| Total stockholders’ equity                                          |   | 703,769                                  |      | 714,141                |   | 716,470                |   |
|                                                                     |   |                                     |      |                   |   |                   |   |
| Total                                                                    |   | $                                        | 1,424,890 |                   | $      | 1,402,083              |   | $ | 1,352,071 |   |

 

*See notes to condensed consolidated financialstatements.*

 

2

----

 

**CondensedConsolidated Statements of Cash Flows (unaudited)**

 
|                                                                               |   | **For the 39  weeks ended** |   |
|------------------------------------------------------------------------------------|--------|-----------------------------|--------|
|                                                                               |   | **October  30,  2003**      |   | **October  31,  2002** |   |
|                                                                               |   | **(Thousands)**             |   |
|                                                                               |   |                        |   |   |   |
| Operating Activities:                                                              |   |                        |   |   |   |
| Net income                                                                         |   | $                           | 16,323 |   | $ | 274 |   |
| Adjustments to reconcile  net income to net cash provided by operating activities: |   |                        |   |   |   |
| Cumulative effect of  accounting change                                            |   | —                      |   | 24,625 |   |
| Depreciation and  amortization                                                     |   | 63,753                      |   | 57,677 |   |
| Provision for store  closures and asset impairment                                 |   | 2,543                       |   | — |   |
| Deferred income taxes and  other                                                   |   | (945                        | )      | 6,985 |   |
| Stock awards, net                                                                  |   | 416                         |   | 1,566 |   |
| Common stock contribution  to benefit plan                                         |   | 6,298                       |   | 6,794 |   |
| Changes in assets and  liabilities:                                                |   |                        |   |   |   |
| Pharmacy and other receivables                                                     |   | (12,480                     | )      | 173 |   |
| Merchandise inventories                                                            |   | (34,774                     | )      | (83,879 | ) |
| Other assets                                                                       |   | 1,654                       |   | (5,719 | ) |
| Current liabilities and  other                                                     |   | 54,976                      |   | (3,533 | ) |
| Net cash provided by  operating activities                                         |   | 97,764                      |   | 4,963 |   |
|                                                                               |   |                        |   |   |   |
| Investing Activities:                                                              |   |                        |   |   |   |
| Capital expenditures and  acquisitions                                             |   | (83,790                     | )      | (71,384 | ) |
| Proceeds from property  dispositions                                               |   | 8,999                       |   | 6,453 |   |
| Net cash used in investing  activities                                             |   | (74,791                     | )      | (64,931 | ) |
|                                                                               |   |                        |   |   |   |
| Financing Activities:                                                              |   |                        |   |   |   |
| Proceeds from long-term  borrowings                                                |   | 30,000                      |   | 15,000 |   |
| Repayments of long-term  borrowings                                                |   | (2,296                      | )      | (2,577 | ) |
| Repurchase of common stock                                                         |   | (20,023                     | )      | — |   |
| Dividend payments                                                                  |   | (15,761                     | )      | (16,066 | ) |
| Net cash used in financing  activities                                             |   | (8,080                      | )      | (3,643 | ) |
|                                                                               |   |                        |   |   |   |
| Increase (decrease) in  cash and cash equivalents                                  |   | 14,893                      |   | (63,611 | ) |
| Cash and cash equivalents  at beginning of period                                  |   | 40,195                      |   | 123,187 |   |
|                                                                               |   |                        |   |   |   |
| Cash and cash equivalents  at end of period                                        |   | $                           | 55,088 |   | $ | 59,576 |   |
|                                                                               |   |                        |   |   |   |
| Supplemental disclosure of  cash flow information:                                 |   |                        |   |   |   |
| Cash paid for interest                                                             |   | 10,216                      |   | 9,989 |   |
| Cash paid for income taxes                                                         |   | 15,820                      |   | 20,561 |   |

 

*See notesto condensed consolidated financial statements.*

 

3

----

 

 

**CondensedConsolidated Statements of Stockholders’ Equity**

Forthe 52 weeks ended January 30, 2003 and the 39 weeks ended October 30, 2003

 
|                                                    |   |            |       | **Additional  Capital** |       | **Common  Stock  Contributions  to Profit  Sharing Plan** |       | **Unearned  Compensation** |       | **Retained  Earnings** |       | **Total  Stockholders’  Equity** |       |
|---------------------------------------------------------|--------|-----------------|------------|-------------------------|------------|-----------------------------------------------------------|------------|----------------------------|------------|------------------------|------------|---------------------------------------|------------|
|                                                    |
|                                                    |
| **Common  Stock**                                       |
| **Shares**                                              |   | **Amount**      |
|                                                    |   | **(Thousands)** |       |
| **Balance at  January 31, 2002**                        |   | **37,977**      | ** ** | **$**                   | **18,988** | ** **                                                | **$**      | **156,977**                | ** ** | **$**                  | **2,939**  | ** **                            | **$**      | **(4,007** | **)** | **$** | **546,676** | ** ** | **$** | **721,573** | ** ** |
|                                                    |   |            |       |                    |       |                                                      |       |                       |       |                   |       |                                  |       |   |   |
| Net income                                              |   |            |       |                    |       |                                                      |       |                       |       |                   |       | 6,702                                 |       | 6,702 |   |
| Dividends ($0.56 per share)                             |   |            |       |                    |       |                                                      |       |                       |       |                   |       | (21,449                               | )          | (21,449 | ) |
| Employee Savings and Profit  Sharing Plan:              |   |            |       |                    |       |                                                      |       |                       |       |                   |       |                                  |       |   |   |
| Issuance of stock for FY02  profit sharing contribution |   | 120             |       | 60                      |       | 2,879                                                     |       | (2,939                     | )          |                   |       |                                  |       | — |   |
| Issuance of stock for  401(k) matching contributions    |   | 303             |       | 151                     |       | 7,410                                                     |       |                       |       |                   |       |                                  |       | 7,561 |   |
| Stock awards, net of  forfeitures                       |   | 101             |       | 51                      |       | 2,519                                                     |       |                       |       | (2,729                 | )          |                                  |       | (159 | ) |
| Amortization of restricted  stock awards                |   |            |       |                    |       |                                                      |       |                       |       | 2,174                  |       |                                  |       | 2,174 |   |
| Tax benefits related to  stock awards                   |   |            |       |                    |       | 68                                                        |       |                       |       |                   |       |                                  |       | 68 |   |
|                                                    |   |            |       |                    |       |                                                      |       |                       |       |                   |       |                                  |       |   |   |
| **Balance at  January 30, 2003**                        |   | **38,501**      | ** ** | **19,250**              | ** ** | **169,853**                                               | ** ** | **—**                 | ** ** | **(4,562**             | **)**      | **531,929**                           | ** ** | **716,470** | ** ** |
|                                                    |   |            |       |                    |       |                                                      |       |                       |       |                   |       |                                  |       |   |   |
| **Unaudited:**                                          |   |            |       |                    |       |                                                      |       |                       |       |                   |       |                                  |       |   |   |
| Net income                                              |   |            |       |                    |       |                                                      |       |                       |       |                   |       | 16,323                                |       | 16,323 |   |
| Dividends ($0.42 per share)                             |   |            |       |                    |       |                                                      |       |                       |       |                   |       | (15,761                               | )          | (15,761 | ) |
| Employee Savings and Profit  Sharing Plan:              |   |            |       |                    |       |                                                      |       |                       |       |                   |       |                                  |       |   |   |
| Issuance of stock for  401(k) matching contributions    |   | 365             |       | 183                     |       | 6,115                                                     |       |                       |       |                   |       |                                  |       | 6,298 |   |
| Stock awards, net of  forfeitures                       |   | (25             | )          | (13                     | )          | (735                                                      | )          |                       |       | 298                    |       |                                  |       | (450 | ) |
| Amortization of restricted  stock awards                |   |            |       |                    |       |                                                      |       |                       |       | 1,292                  |       |                                  |       | 1,292 |   |
| Tax expense related to  stock awards                    |   |            |       |                    |       | (426                                                      | )          |                       |       |                   |       |                                  |       | (426 | ) |
| Stock options exercised                                 |   | 2               |       | 1                       |       | 45                                                        |       |                       |       |                   |       |                                  |       | 46 |   |
| Repurchase of common stock                              |   | (1,362          | )          | (681                    | )          | (6,009                                                    | )          |                       |       |                   |       | (13,333                               | )          | (20,023 | ) |
|                                                    |   |            |       |                    |       |                                                      |       |                       |       |                   |       |                                  |       |   |   |
| **Balance at  October 30, 2003**                        |   | **37,481**      | ** ** | **$**                   | **18,740** | ** **                                                | **$**      | **168,843**                | ** ** | **$**                  | **—** | ** **                            | **$**      | **(2,972** | **)** | **$** | **519,158** | ** ** | **$** | **703,769** | ** ** |

 

*See notesto condensed consolidated financial statements.*

 

4

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**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

 

**1.            Basis of Presentation**

 

The accompanying condensedconsolidated financial statements include Longs Drug Stores Corporation(“Longs” or the “Company”) and its wholly owned subsidiaries.  All significant inter-company accounts andtransactions have been eliminated.  Thecondensed consolidated financial statements have been prepared on a basisconsistent with the accounting policies described in the Annual Report of theCompany on Form 10-K for the fiscal year ended January 30, 2003, andreflect all adjustments which are, in management’s opinion, necessary for afair presentation of the results for the periods presented.  The condensed consolidated financialstatements as of and for the periods ended October 30, 2003 and October 31,2002 are unaudited.  The condensedconsolidated balance sheet as of January 30, 2003, and condensedconsolidated statement of stockholders’ equity for the year then ended,presented herein, have been derived from the audited consolidated financialstatements of the Company included in the Form 10-K for the fiscal year endedJanuary 30, 2003.  Certainreclassifications have been made to prior year financial statements to conformto the current presentation. Such reclassifications included a reclassificationof advertising expenses from operating and administrative expenses to cost ofsales.

 

**2.             Stock-Based Compensation**

 

The Company accounts forstock-based employee compensation using the intrinsic value method inaccordance with the provisions of APB Opinion No. 25, *Accounting for Stock Issued toEmployees*, as allowed by SFAS No. 123, *Accounting for Stock-Based Compensation*.  Stock awards are valued at fair market valueat the date of grant, and are recorded as compensation expense over the vestingperiod.  No compensation expense isrecognized for employee stock options, because it is the Company’s practice togrant stock options with an exercise price equal to the market price of theunderlying common stock on the date of grant. The following table illustrates the effect on net income and earningsper share if the Company had applied the fair value recognition provisions ofSFAS No. 123 to all stock-based employee compensation:

 
|                                                                                                                                          |   | **13 weeks  ended**                     |   | **39 weeks  ended**   |   |
|-----------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------------------|--------|-----------------------|--------|
|                                                                                                                                          |   | **October 30,  2003**                   |   | **October 31,  2002** |   | **October 30,  2003** |   | **October 31,  2002** |   |
|                                                                                                                                          |   | **Thousands, except per share amounts** |   |
| Net income, as reported                                                                                                                       |   | $                                       | 5,230  |                  | $      | 2,988 |   | $ | 16,323 |   | $ | 274 |   |
| Add (Deduct): Stock-based  employee compensation expense (benefit) included in reported net income, net  of related tax effects               |   | (57                                     | )      | 314                   |   | 527 |   | 896 |   |
| Deduct: Total stock-based  employee compensation expense determined under fair value based method for  all awards, net of related tax effects |   | (721                                    | )      | (1,098                | )      | (2,942 | ) | (2,165 | ) |
| Pro forma net income (loss)                                                                                                                   |   | $                                       | 4,452  |                  | $      | 2,204 |   | $ | 13,908 |   | $ | (995 | ) |
| Basic net income (loss) per  share:                                                                                                           |   |                                    |   |                  |   |   |   |   |   |
| As reported                                                                                                                                   |   | $                                       | 0.14   |                  | $      | 0.08 |   | $ | 0.44 |   | $ | 0.01 |   |
| Pro forma                                                                                                                                     |   | 0.12                                    |   | 0.06                  |   | 0.37 |   | (0.03 | ) |
| Diluted net income (loss)  per share:                                                                                                         |   |                                    |   |                  |   |   |   |   |   |
| As reported                                                                                                                                   |   | $                                       | 0.14   |                  | $      | 0.08 |   | $ | 0.44 |   | $ | 0.01 |   |
| Pro forma                                                                                                                                     |   | 0.12                                    |   | 0.06                  |   | 0.37 |   | (0.03 | ) |

 

5

----

 

**3.            Provision for Store Closuresand Asset Impairment**

###### ** **

###### **TheCompany periodically reviews store operations and makes decisions to closestores in the normal course of business. Costs associated with store closures are recognized when the relatedliabilities are incurred.  Such costsare included in the provision for store closures and asset impairment, acomponent of operating income. Following is a summary of the Company’s store closure reserves, whichare included in long-term liabilities:**

 
|                                                           |   | **39 weeks  ended**    |     |
|----------------------------------------------------------------|--------|------------------------|----------|
|                                                           |   | **October  30,  2003** |     | **October  31,  2002** |   |
|                                                           |   | **Thousands**          | * * |
| Store closure reserve,  beginning of period                    |   | $                      | 7,826    |   | $ | 12,551 |   |
| Provision for store closures                                   |   | 1,000                  |     | — |   |
| Net costs incurred for  closed stores, charged against reserve |   | (1,273                 | )        | (4,170 | ) |
| Store closure reserve, end  of period                          |   | $                      | 7,553    |   | $ | 8,381 |   |

 

Substantially all of theCompany’s store closure reserves as of October 30, 2003 were for lease-relatedcosts associated with closed stores with remaining lease terms extendingthrough various dates with the longest lease term ending January 2026.

 

The Company also reviewslong-lived tangible assets and intangible assets with finite useful lives forimpairment whenever events or changes in circumstances indicate that theircarrying values may not be recoverable. Goodwill and other intangible assets with indefinite useful lives arereviewed for impairment annually, or more frequently if events or changes incircumstances warrant.  For the 39 weeksended October 30, 2003, the provision for store closures and asset impairmentincludes $1.5 million of asset impairments related to the write-off ofabandoned information technology assets.

 

**4.             Earnings Per Share**

 

Basic net income per share iscomputed by dividing net income by the weighted average number of common sharesoutstanding during the period.  Dilutednet income per share is computed by dividing net income by the weighted averagenumber of common shares and dilutive common equivalent shares (restricted stockawards and stock options) outstanding during the period.  The following is a reconciliation of thenumber of shares used in the Company’s basic and diluted net income per sharecomputations:

 
|                                                   |   | **13 weeks  ended**    |   | **39 weeks  ended**    |   |
|--------------------------------------------------------|--------|------------------------|--------|------------------------|--------|
|                                                   |   | **October  30,  2003** |   | **October  31,  2002** |   | **October  30,  2003** |   | **October  31,  2002** |   |
|                                                   |   | **Thousands**          |   |
| Basic weighted average  number of shares outstanding   |   | 37,144                 |   | 37,998                 |   | 37,210 |   | 37,892 |   |
| Effect of dilution from:                               |   |                   |   |                   |   |   |   |   |   |
| Restricted stock awards                                |   | 176                    |   | 202                    |   | 165 |   | 186 |   |
| Stock options                                          |   | 93                     |   | 74                     |   | 36 |   | 119 |   |
|                                                   |   |                   |   |                   |   |   |   |   |   |
| Diluted weighted average  number of shares outstanding |   | 37,413                 |   | 38,274                 |   | 37,411 |   | 38,197 |   |

 

The computation of dilutedearnings per share excluded 2,911,500 and 3,345,797 stock options for the13-week and 39-week periods ended October 30, 2003, respectively, and 209,900and 69,967 stock options for the 13-week and 39-week periods ended October 31,2002, respectively, because their effect would have been anti-dilutive.

 

**5.             Merchandise Inventories**

 

Merchandise inventories arestated at the lower of cost or market value. Cost is determined using the last-in, first-out (LIFO) method. Theexcess of specific cost over LIFO values was $174.7 million as of October 30,2003, $169.7 million as of October 31, 2002 and $171.4 million as of January30, 2003.  LIFO costs for interimfinancial statements are estimated based on projected annual inflation rates,inventory levels, and merchandise mix. Actual LIFO costs are calculated during the fourth quarter of the fiscalyear when final inflation rates, inventory levels, and merchandise mix aredetermined.

 

6

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**6.             Goodwill and Intangible Assets**

 

All of the Company’s goodwilland other intangible assets are included in the retail drug store segment.   Goodwill and other intangible assets withindefinite useful lives are not amortized, but are subject to impairmenttesting annually or more frequently if events and circumstances indicate theremay be an impairment.  Intangible assetswith finite useful lives are amortized over those useful lives.  The Company’s intangible assets other thangoodwill include the following:

 
|                                            |   | **Useful  Lives** |   | **Gross  Carrying  Value** |   | **Accumulated  Amortization** |   | **Net  Carrying  Value** |   |
|-------------------------------------------------|--------|-------------------|--------|----------------------------|--------|-------------------------------|--------|--------------------------|--------|
|                                            |   | **Thousands**     |   |
| **As of  October 30, 2003:**                    |   |              |   |                       |   |                          |   |                     |   |
| Intangible assets subject  to amortization:     |   |              |   |                       |   |                          |   |                     |   |
| Pharmacy customer lists                         |   | 1-5 years         |   | $                          | 2,414  |                          | $      | (825                     | )      | $ | 1,589 |   |
| Non-compete agreements and  other               |   | 2-5 years         |   | 102                        |   | (64                           | )      | 38                       |   |
| Total                                           |   |              |   | 2,516                      |   | (889                          | )      | 1,627                    |   |
| Intangible assets not  subject to amortization: |   |              |   |                       |   |                          |   |                     |   |
| Beverage licenses                               |   | N/A               |   | 4,819                      |   | —                        |   | 4,819                    |   |
| Total                                           |   |              |   | $                          | 7,335  |                          | $      | (889                     | )      | $ | 6,446 |   |
| **As of  January 30, 2003:**                    |   |              |   |                       |   |                          |   |                     |   |
| Intangible assets subject  to amortization:     |   |              |   |                       |   |                          |   |                     |   |
| Pharmacy customer lists                         |   | 1-5 years         |   | $                          | 1,121  |                          | $      | (478                     | )      | $ | 643 |   |
| Non-compete agreements and  other               |   | 2-5 years         |   | 91                         |   | (47                           | )      | 44                       |   |
| Total                                           |   |              |   | 1,212                      |   | (525                          | )      | 687                      |   |
| Intangible assets not  subject to amortization: |   |              |   |                       |   |                          |   |                     |   |
| Beverage licenses                               |   | N/A               |   | 4,743                      |   | —                        |   | 4,743                    |   |
| Total                                           |   |              |   | $                          | 5,955  |                          | $      | (525                     | )      | $ | 5,430 |   |

 

Amortization expense forintangible assets with finite useful lives was $171 thousand and $364 thousandfor the 13-week and 39-week periods ended October 30, 2003, respectively.  Estimated annual amortization expense onthese intangibles for fiscal 2004 and each of the succeeding five fiscal yearsis as follows (*in thousands*):

 
| Fiscal Year 2004 |   | $   | 526    |   |
|------------------|--------|-----|--------|--------|
| Fiscal Year 2005 |   | 513 |   |
| Fiscal Year 2006 |   | 393 |   |
| Fiscal Year 2007 |   | 256 |   |
| Fiscal Year 2008 |   | 224 |   |
| Fiscal Year 2009 |   | 79  |   |
| Total            |   | $   | 1,991  |   |

 

7

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**7.**             **Debt**

 

Long-term debt as of October 30, 2003 and January 30, 2003 consisted ofthe following*:*

 
|                                                                                                                                           |   | **October  30,  2003** |    | **January  30,  2003** |   |
|------------------------------------------------------------------------------------------------------------------------------------------------|--------|------------------------|---------|------------------------|--------|
|                                                                                                                                           |   | **Thousands**          |    |
| Unsecured revolving line  of credit, interest based on LIBOR (weighted average rate of****2.88% as of October 30, 2003), expires  October 2004 |   | $                      | 55,000  |                   | $      | 25,000 |   |
| Private placement notes,  fixed interest rates ranging from 5.85% to 7.85%, mature at various dates  through 2014                              |   | 156,429                |    | 158,571                |   |
| Other                                                                                                                                          |   | 52                     |    | 206                    |   |
| Total long-term debt                                                                                                                           |   | 211,481                |    | 183,777                |   |
|                                                                                                                                           |   |                   |    |                   |   |
| Less current portion                                                                                                                           |   | 63,923                 |    | 2,348                  |   |
| Long-term portion                                                                                                                              |   | $                      | 147,558 |                   | $      | 181,429 |   |

 

During the second quarter offiscal 2004, the Company exercised an option to increase the borrowing capacityof its unsecured revolving line of credit, resulting in a $45 million increaseto a total capacity of $195 million. Borrowings on the line of credit do not require repayment until theOctober 2004 expiration date.  TheCompany intends to renew or replace the line of credit prior to expiration;nevertheless all amounts are classified as current liabilities because of theOctober 2004 expiration date.

 

###### **TheCompany’s debt agreements contain limits on borrowings and repurchases of theCompany’s stock, and various quarterly financial covenants that set maximumleverage ratios and minimum fixed charge and asset coverage ratios.  As of October 30, 2003, the Company was incompliance with the restrictions and limitations included in these provisions.**

###### ** **

**8.             Stockholders’ Equity**

 

In February and March 2003, theCompany repurchased 853,100 shares of its common stock at a total cost of $12.0million to complete a share repurchase program authorized by the Board ofDirectors in November 1999.  In March2003, the Company’s Board of Directors authorized the repurchase of up to2,000,000 additional shares of Company stock through January 2008, for amaximum total expenditure of $50 million. The Company repurchased 509,100 shares under the new authorization inMarch 2003 at a total cost of $8.0 million. The Company did not repurchase any of its common stock in the 39 weeksended October 31, 2002.

 

**9.             Segment Information**

 

The Company operates in twobusiness segments, retail drug stores and pharmacy benefit management(“PBM”).  These segments were identifiedbased on their separate and distinct products and services, technology,marketing strategies and management reporting. Management evaluates each segment’s operating performance separately andallocates resources based on their respective financial condition, results ofoperations and cash flows. Inter-segment transactions and balances are eliminated in consolidation.

 

Pharmacy is the cornerstone ofthe retail drug store segment, complemented by such “front-end” categories asover-the-counter medications, health care products, photo and photo processing,cosmetics, greeting cards, food and beverage items, housewares, toiletries,mail centers and seasonal merchandise.  As of October 30, 2003, the retail drug store segment operated 467retail stores in six western states and one mail order pharmacy under the namesLongs, Longs Drugs, Longs Drug Stores, Longs Pharmacy and American DiversifiedPharmacies.

 

The PBM segment, operatedthrough the Company’s RxAmerica subsidiary, contracts with drug manufacturers,third-party health plans and retail pharmacies to provide a range of servicesto third-party health plan members, including pharmacy benefit plan design andimplementation, formulary management, claims processing and genericsubstitution.

 

8

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The following table summarizessignificant financial information by segment as of and for the 13-week and39-week periods ended October 30, 2003 and October 31, 2002:

 
|                         |   | **13 weeks  ended**    |      | **39 weeks  ended**    |   |
|------------------------------|--------|------------------------|-----------|------------------------|--------|
|                         |   | **October  30,  2003** |      | **October  31,  2002** |   | **October  30,  2003** |   | **October  31,  2002** |   |
|                         |   | **Thousands**          |      |
| **Sales:**                   |   |                   |      |                   |   |   |   |   |   |
| Retail Drug Stores           |   | $                      | 1,080,141 |                   | $      | 1,058,496 |   | $ | 3,279,491 |   | $ | 3,239,546 |   |
| Pharmacy Benefit  Management |   | 7,152                  |      | 5,974                  |   | 20,395 |   | 16,383 |   |
| Consolidated Totals          |   | $                      | 1,087,293 |                   | $      | 1,064,470 |   | $ | 3,299,886 |   | $ | 3,255,929 |   |
|                         |   |                   |      |                   |   |   |   |   |   |
| **Operating  Income:**       |   |                   |      |                   |   |   |   |   |   |
| Retail Drug Stores           |   | $                      | 8,688     |                   | $      | 4,721 |   | $ | 27,817 |   | $ | 41,948 |   |
| Pharmacy Benefit  Management |   | 3,266                  |      | 2,630                  |   | 8,931 |   | 6,722 |   |
| Consolidated Totals          |   | $                      | 11,954    |                   | $      | 7,351 |   | $ | 36,748 |   | $ | 48,670 |   |

 
|                         |   | **October  30,  2003** |            | **October  31,  2002** |   | **January  30,  2003** |   |
|------------------------------|--------|------------------------|-----------------|------------------------|--------|------------------------|--------|
|                         |   | **Thousands**          |            |
| **Total  Assets:**           |   |                   |            |                   |   |                   |   |
| Retail Drug Stores           |   | $                      |  1,366,228 |                   | $      |  1,355,187        |   | $ |  1,299,967 |   |
| Pharmacy Benefit  Management |   | 60,218                 |            | 48,543                 |   | 53,710                 |   |
| Intersegment Eliminations    |   | (1,556                 | )               | (1,647                 | )      | (1,606                 | )      |
| Consolidated Totals          |   | $                      |  1,424,890 |                   | $      |  1,402,083        |   | $ |  1,352,071 |   |

 

Consolidated total salesinclude the following product and service types:

 
|                                  |   | **13 weeks  ended**    |            | **39 weeks  ended**    |   |
|---------------------------------------|--------|------------------------|-----------------|------------------------|--------|
|                                  |   | **October  30,  2003** |            | **October  31,  2002** |   | **October  30,  2003** |   | **October  31,  2002** |   |
|                                  |   | **Thousands**          |            |
| Pharmacy sales                        |   | $                      |  516,616   |                   | $      |  480,249 |   | $ |  1,546,097 |   | $ |  1,465,035 |   |
| Front-end sales                       |   | 563,525                |            | 578,247                |   | 1,733,394 |   | 1,774,511 |   |
| Pharmacy benefit  management revenues |   | 7,152                  |            | 5,974                  |   | 20,395 |   | 16,383 |   |
| Consolidated total sales              |   | $                      |  1,087,293 |                   | $      |  1,064,470 |   | $ |  3,299,886 |   | $ |  3,255,929 |   |
|                                       |        |                        |                 |                        |        |  |  |  |  |  |  |  |  |  |  |

 

9

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***Item 2.   Management’s Discussion and Analysis ofFinancial Condition and Results of Operations***

 

*This quarterly report contains certainforward-looking statements within the meaning of Section 27A of the SecuritiesAct and Section 21E of the Securities Exchange Act.  Such statements relate to, among other things, pharmacy andfront-end sales trends, prescription margins, margin improvement, costreductions, changes in supply chain practices, inflation rates, workers’compensation costs, the number of store openings and the level of capitalexpenditures, and are indicated by words or phrases such as “continuing,”“expects,” “estimates,” “believes,” “plans,” “anticipates,” “will” and othersimilar words or phrases.  These statementsare based on our current plans and expectations and involve risks anduncertainties that could cause actual events and results to vary materiallyfrom those included in or contemplated by such statements.  These risks and uncertainties include, butare not limited to, changes in economic conditionsgenerally or in the markets we serve; consumer preferences and spendingpatterns; economic softness and unemployment; the impact of state and federalbudget deficits on government healthcare spending and economic conditionsgenerally; competition from other drugstore chains, supermarkets, on-lineretailers, other retailers and mail order companies; changes in state orfederal legislation or regulations affecting our business; the efforts ofthird-party payers to reduce prescription drug costs; the success of plannedadvertising and merchandising strategies; labor unrest in the same orcompetitive industries; the availability and cost of real estate for, andconstruction of, new stores; accounting policies and practices; our ability tohire and retain pharmacists and other store and management personnel; ourrelationships with our suppliers; our ability to improve our purchasing offront-end products; our ability to successfully implement new computer systemsand technology; our ability to obtain adequate insurance coverage; the effectof war and terrorism on economic conditions and consumer spending patterns; theimpact of rising workers’ compensation, health and welfare and energy costs onour operations; changes in internal business processes associated with supplychain and other initiatives; adverse determinations with respect to litigationor other claims; and other factors discussed in this quarterly reportunder “Risk Factors” and elsewhere or in any of our other SEC filings.  We assume no obligation to update ourforward-looking statements to reflect subsequent events or circumstances.*

 

**RESULTS OF OPERATIONS**

 

***Sales***

 
|                                                  |   | **13 weeks  ended**    |      | **39 weeks  ended**    |   |
|-------------------------------------------------------|--------|------------------------|-----------|------------------------|--------|
|                                                  |   | **October  30,  2003** |      | **October  31,  2002** |   | **October  30,  2003** |   | **October  31,  2002** |   |
|                                                  |   |                   |      |                   |   |   |   |   |   |
| Sales *(Thousands)*                                   |   | $                      | 1,087,293 |                   | $      | 1,064,470 |   | $ | 3,299,886 |   | $ | 3,255,929 |   |
| Sales Growth over Same  Period in Previous Year       |   | 2.1                    | %         | 4.6                    | %      | 1.3 | % | 5.3 | % |
| Same-Store Sales (Decline)  Growth                    |   | (0.7                   | )%        | 2.7                    | %      | (1.1 | )% | 3.4 | % |
| Impact of New  Stores/Closed Stores on Sales Growth   |   | 2.7                    | %         | 1.5                    | %      | 2.3 | % | 1.4 | % |
| Impact of PBM Revenues on  Sales Growth               |   | 0.1                    | %         | 0.4                    | %      | 0.1 | % | 0.5 | % |
|                                                  |   |                   |      |                   |   |   |   |   |   |
| Pharmacy Sales Growth                                 |   | 7.6                    | %         | 6.1                    | %      | 5.5 | % | 7.4 | % |
| Same-Store Pharmacy Sales  Growth                     |   | 3.9                    | %         | 5.4                    | %      | 2.8 | % | 6.5 | % |
| Pharmacy as a % of Total  Retail Drug Store Sales     |   | 47.8                   | %         | 45.4                   | %      | 47.1 | % | 45.2 | % |
| % of Pharmacy Sales Paid  by Third Party Health Plans |   | 89.9                   | %         | 90.9                   | %      | 90.3 | % | 90.9 | % |
|                                                  |   |                   |      |                   |   |   |   |   |   |
| Front-End Sales (Decline)  Growth                     |   | (2.5                   | )%        | 2.7                    | %      | (2.3 | )% | 2.8 | % |
| Same-Store Front-End Sales  (Decline) Growth          |   | (4.6                   | )%        | 0.5                    | %      | (4.4 | )% | 1.0 | % |
| Front-End as a % of Total  Retail Drug Store Sales    |   | 52.2                   | %         | 54.6                   | %      | 52.9 | % | 54.8 | % |
|                                                       |        |                        |           |                        |        |  |  |  |  |  |  |  |  |

 

*Thirteen Weeks Ended October 30, 2003 versus Thirteen Weeks EndedOctober 31, 2002*

 

Sales increased 2.1% in thethird quarter of fiscal 2004 (ended October 30, 2003) over the same quarter infiscal 2003.  Growth in the number ofstores accounted for 2.7% of total sales growth, offset by a 0.7% decrease insame-store sales. Growth in revenues at RxAmerica, our pharmacy benefitmanagement (“PBM”) subsidiary, contributed the remaining 0.1% of total salesgrowth in the quarter.

 

10

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On October 11, 2003, unionworkers initiated a strike against three major grocery chains in SouthernCalifornia, resulting in increased sales in some of our Southern Californiastores.  We estimate that the strikeincreased our third quarter same-store sales by 0.8 to 1.0 percentage points,resulting in an estimated earnings increase of $0.01 per diluted share.

 

Pharmacy sales increased 7.6% inthe third quarter over the same quarter last year, with same-store pharmacysales increasing 3.9%.  Pharmacy saleswere 47.8% of total retail drug store sales in the third quarter of fiscal2004, compared to 45.4% in the same quarter of fiscal 2003.  We expect pharmacy sales to continue toincrease as a percentage of total retail drug store sales as pharmacy salescontinue to increase faster than front-end sales.

 

Prescription volumes in thethird quarter of fiscal 2004 were down slightly from those in the same quarterlast year.  The conversion of theallergy drug Claritin from prescription to over-the-counter status in January2003 negatively impacted prescription volumes. This effect on comparative period volumes will end after the fourthquarter as we reach the anniversary of Claritin’s conversion from prescriptionstatus.  Health concerns over women’shormone replacement therapy drugs, continued sluggish economic growth andhigher patient co-payments under some insurance plans also had a negative impacton prescription volumes.  We expectthese trends to continue for at least the next several quarters.

 

The average retail price perprescription increased 5.0% over the third quarter of fiscal 2003.  We expect that average retail prices forprescription drugs will continue to rise. While utilization of several lower priced, high-volume generic drugs hascontinued to be significant, the rate of growth of generic utilization hasdeclined, and therefore the impact on average retail prices and our pharmacy same-storesales has also declined.

 

Third-party health planscovered approximately 90% of our pharmacy sales in the third quarter of fiscal2004, compared to approximately 91% in the same quarter last year.  We expect third-party sales to remain at ornear 90% of our total pharmacy sales for the foreseeable future due tosignificant consumer participation in managed care and other third-party plans.

 

Front-end sales decreased 2.5%from the third quarter of last year, with same-store front-end sales decreasing4.6%.  Several factors contributed tothe decline in our front-end sales:

 

•                                          Economicweakness and high unemployment, particularly in California, continued toadversely affect our front-end sales.

 

•                                          Wehave experienced a decline in sales in our photo category, primarily due toconsumers’ continued migration to digital photography technology.  In response to this technology migration, werecently completed the installation of updated digital photography technologyin more than 80% of our stores.

 

•                                          Duringthe quarter, we reduced prices on an additional 1,000 high-volume items,bringing the year-to-date total to over 2,000 items, in categories such ashealth and beauty care, over-the-counter medications and convenience grocery inorder to improve our competitive position and increase our sales over thelonger term.

 

•                                          Weexperienced some disruption to our supply chain, which adversely impacted ourfront-end sales, due to the implementation of a new distribution managementsystem in our Northern California distribution center.

 

11

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*Thirty-Nine Weeks Ended October 30, 2003 versus Thirty-Nine Weeks EndedOctober 31, 2002*

 

Sales increased 1.3% in thefirst nine months of fiscal 2004 over the same period in fiscal 2003.  Growth in the number of stores accounted for2.3% of total sales growth, offset by a 1.1% decrease in same-store sales.Growth in revenues at RxAmerica contributed the remaining 0.1% of total salesgrowth in the first nine months of fiscal 2004.

 

Pharmacy sales increased 5.5%in the first nine months of fiscal 2004 over the same period last year, withsame-store pharmacy sales increasing 2.8%. Pharmacy sales were 47.1% of total drug store sales in the first ninemonths of fiscal 2004, compared to 45.2% in the same period last year.

 

Prescription volumes decreasedin the first nine months of fiscal 2004 from the same period last year as aresult of the conversion of the allergy drug Claritin from prescription toover-the-counter status, health concerns over women’s hormone replacementtherapy drugs, continued sluggish economic growth and higher patientco-payments under some insurance plans. The average retail price per prescription increased 5.6% over the firstnine months of fiscal 2003.  Increasedgeneric utilization negatively impacted same-store pharmacy sales byapproximately 1.4% in the first nine months of fiscal 2004.

 

Front-end sales decreased 2.3%from the first nine months of last year, with same-store front-end salesdecreasing 4.4%. Factors contributing to the decrease in front-end salesinclude economic weakness and high unemployment, particularly in California, adecline in our photo category, price reductions in certain high-volume itemsand some disruption to our supply chain associated with the implementation of anew distribution management system.

 

***Gross Profit***

 
|                          |   | **13 weeks  ended**    |    | **39 weeks  ended**    |   |
|-------------------------------|--------|------------------------|---------|------------------------|--------|
|                          |   | **October  30,  2003** |    | **October  31,  2002** |   | **October  30,  2003** |   | **October  31,  2002** |   |
|                          |   |                   |    |                   |   |   |   |   |   |
| Gross Profit *(Thousands)*    |   | $                      | 274,004 |                   | $      | 276,788 |   | $ | 847,150 |   | $ | 837,077 |   |
| Gross Profit as a % of  Sales |   | 25.2                   | %       | 26.0                   | %      | 25.7 | % | 25.7 | % |
| LIFO Provision *(Thousands)*  |   | $                      | 250     |                   | $      | 1,000 |   | $ | 3,250 |   | $ | 4,400 |   |

 

*Thirteen Weeks Ended October 30, 2003 versus Thirteen Weeks EndedOctober 31, 2002*

 

Grossprofit was 25.2% of sales in the third quarter of fiscal 2004, compared to26.0% in the same quarter last year. Several factors contributed to the decline in our gross profit:

 

•                                          Approximately90% of our pharmacy sales are wholly or partially reimbursed by third-partyhealth plans, which have lower gross profit percentages than non third-partysales.  Third-party health planscontinue to reduce the levels at which they reimburse us for the prescriptiondrugs that we provide to their members, resulting in pressure on pharmacy grossprofits.  Recently, the California statebudget included a proposed 5% across-the-board reduction in Medi-Calreimbursements to pharmacies effective January 1, 2004 and reductions inreimbursements for workers’ compensation prescriptions.  If the State of California implements theseor similar or additional reductions in reimbursement levels, our gross profitscould be significantly adversely affected. Pharmacy sales also have lower gross profit percentages than front-endsales, and as pharmacy sales continue to grow as a percent of total sales,overall gross profit percentages will be adversely impacted.

 

•                                          Ourpromotional sales increased as a percentage of total front-end sales in thethird quarter of fiscal 2004 over the same quarter last year.  Promotional sales have lower gross profitpercentages than non-promotional sales. We expect that our promotional sales will continue to be a significantportion of our total front-end sales in light of persistent softness in theeconomy and promotional activities by our competitors, resulting in pressure onour front-end gross profits.

 

12

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•                                          Duringthe quarter, we reduced prices on an additional 1,000 high-volume items,bringing the year-to-date total to over 2,000 items, in categories such ashealth and beauty care, over-the-counter medications and convenience grocery inorder to improve our competitive position and increase our sales over thelonger term.

 

•                                          We experienced higher distribution costs as aresult of the implementation of a new distribution management system in ourNorthern California distribution center.

 

Betterbuying practices and opportunities resulting from our progress in centralizingprocurement, advertising and promotional activities as part of our initiativeto upgrade our supply chain practices partially offset the decline in our grossprofit.

 

Our gross profit included LIFOprovisions, which are included in cost of sales, of $250 thousand in the thirdquarter of fiscal 2004 and $1.0 million in the same quarter last year.  The decrease in the LIFO provision isprimarily due to lower overall net inflation on our merchandise costs duringthe year.  The LIFO provision fluctuateswith inflation rates, inventory levels and merchandise mix.  We estimate LIFO costs for interim financialstatements based on projected annual inflation rates, inventory levels, andmerchandise mix.  We calculate actualLIFO costs during the fourth quarter of the fiscal year when we determine finalinflation rates, inventory levels, and merchandise mix.

 

In the first quarter of fiscal2004, we began classifying advertising expenses as a component of cost ofsales.  Previously, we classifiedadvertising expense as a component of operating and administrative expenses.  We reclassified results for the thirdquarter of fiscal 2003 to conform to this new presentation, resulting in a $5.2million increase in cost of sales and an offsetting decrease in previouslyreported operating and administrative expenses, with no effect on reported netincome.

 

*Thirty-Nine Weeks Ended October 30, 2003 versus Thirty-Nine Weeks EndedOctober 31, 2002*

 

Gross profit was 25.7% of salesin the first nine months of fiscal 2004, consistent with the same period lastyear.  Factors that favorably affectedour gross profit included better buying practices and opportunities resultingfrom our progress in centralizing procurement; advertising and promotionalactivities as part of our initiative to upgrade our supply chain practices; andthe increased usage of generic drugs, which have higher gross profitpercentages than name-brand drugs.  Thefavorable effects of these items were offset by continued margin pressure onour pharmacy sales reimbursed by third-party health plans; higher pharmacy salesas a percentage of total sales; increased promotional front-end sales; pricereductions in certain high-volume items; and higher distribution costsassociated with the implementation of a new distribution management system.

 

Our gross profit included LIFOprovisions, which are included in cost of sales, of $3.25 million in the firstnine months of fiscal 2004 and $4.40 million in the same period of fiscal 2003.

 

The reclassification ofadvertising expenses as a component of cost of sales rather than operating andadministrative expenses resulted in an increase of $16.3 million in previouslyreported cost of sales and an offsetting decrease in previously reportedoperating and administrative expenses for the 39 weeks ended October 30, 2002,with no effect on reported net income.

 

***Operatingand Administrative Expenses***

 

*Thirteen Weeks Ended October 30, 2003 versus Thirteen Weeks EndedOctober 31, 2002*

 

Operating and administrativeexpenses decreased $7.8 million, or 3.1%, to $242.0 million (22.3% of sales) forthe third quarter of fiscal 2004 from $249.8 million (23.5% of sales) in thesame quarter last year.  The decrease inoperating and administrative expenses was primarily due to decreases in laborand related benefit costs as a result of a series of steps we took earlier inthe fiscal year to improve our productivity and reduce our costs.  These steps included a reduction of ouradministrative workforce by approximately 170 people in our California offices,the closure of certain support facilities, store labor savings through workflowand staffing changes, a restructuring of our incentive compensationarrangements and the voluntary separation program for store managers announcedin July 2003.

 

13

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*Thirty-Nine Weeks Ended October 30, 2003 versus Thirty-Nine Weeks EndedOctober 31, 2002*

 

Operating and administrativeexpenses increased $13.8 million, or 1.9%, to $744.1 million (22.6% of sales)for the third quarter of fiscal 2004 from $730.3 million (22.4% of sales) inthe same period last year.  Operatingand administrative expenses for the first nine months of fiscal 2004 includedcosts of $7.1 million, or 0.2% of sales, for the previously mentionedreductions in administrative workforce, facility closures and the voluntaryseparation program for store managers.

 

In addition, workers’compensation and other insurance-related expenses increased $8.2 million, or0.2% of sales, in the first nine months of fiscal 2004 over the same periodlast year.  The increase in workers’compensation expenses was primarily due to regulatory changes in our principalmarkets and higher health care costs, particularly in California.  The California State Legislature iscurrently considering changes to the state’s workers’ compensation laws in aneffort to reduce costs, and we cannot predict the outcome of suchdeliberations.  However, we arecontinuing to develop our existing workplace safety practices in an effort topartially mitigate this increase in costs over time by reducing the number ofworkers’ compensation claims.

 

These increases in operatingand administrative expenses for the first nine months of fiscal 2004 werepartially offset by expense reductions, primarily labor and related benefitcosts, resulting from the aforementioned initiatives, and net gains on thedisposition of certain properties.

 

***Depreciationand Amortization***

 

Depreciation and amortizationexpenses were $20.1 million and $63.8 million in the third quarter and firstnine months of fiscal 2004, compared to $19.6 million and $57.7 million in thesame periods of fiscal 2003.  Theincrease in the year-to-date period was primarily due to accelerateddepreciation of $5.2 million in the first six months of fiscal 2004 arisingfrom the abandonment of a pharmacy information system.

 

***Provisionfor Store Closures and Asset Impairment***

 

In the second quarter of fiscal2004 we recorded a provision of $1.0 million for store closures related to thedefault of a sublease tenant in a closed store location.  We closed one store in the first nine monthsof fiscal 2004 and three stores in the first nine months of fiscal 2003.  In the second quarter of fiscal 2004 we alsorecorded a provision of $1.5 million for asset impairments related to thewrite-off of abandoned information technology assets.  We are currently evaluating certain underperforming stores and,depending upon the outcome of our analysis, could decide to close some of thesestores.  Because many of the stores weare evaluating have leases extending for several years, charges we may incurupon closure could be material.

 

***LegalSettlements and Other Disputes***

 

In the second quarter of fiscal 2003, werecorded a net charge of $0.5 million for the settlement of certain legalmatters. These matters were settled in earlier fiscal years, and as finalpayments were made during the second quarter of fiscal 2003, we incurredadditional net costs over those previously estimated.

 

***NetInterest Expense***

 

Net interest expense was $3.6million and $10.6 million in the third quarter and first nine months of fiscal2004, compared to $3.3 million and $9.4 million in the same periods lastyear.  The increase was due to higheraverage borrowings, partially offset by lower average interest rates.

 

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***IncomeTaxes***

 

Our effective income tax ratewas 37.6% in the third quarter and first nine months of fiscal 2004, comparedto 26.5% and 36.6% in the same periods of fiscal 2003. The increase wasprimarily due to the benefits of tax credits recognized in the third quarterlast year.  We expect our effectiveincome tax rate to be approximately 37.6% for the remainder of fiscal 2004.

 

***CumulativeEffect of Accounting Change***

 

As a result of adopting SFASNo. 142, *Goodwilland Other Intangible Assets*, we recognized a goodwill impairmentcharge of $41.0 million ($24.6 million after tax or $0.65 per diluted share) inthe first quarter of fiscal 2003 as the cumulative effect of a change inaccounting principle.

 

 

**LIQUIDITY AND CAPITALRESOURCES**

 

***General***

 

Our primary sources ofliquidity are operating cash flows and borrowings on our line of credit.  We use cash to provide working capital forour operations, finance capital expenditures and acquisitions, repay debt, paydividends and repurchase shares of our common stock.

 

We have an unsecured revolvingline of credit with a syndication of banks, which expires in October 2004 andaccrues interest at LIBOR-based rates. During the second quarter of fiscal 2004, we exercised an option toincrease the borrowing capacity of this credit facility, resulting in a $45million increase to a total capacity of $195 million.  Borrowings on the line of credit do not require repayment untilthe October 2004 expiration date.  As ofOctober 30, 2003, $55 million was outstanding under this line of credit with aweighted average interest rate of 2.88%. We intend to renew or replace the line of credit prior to expiration;nevertheless we have classified all amounts as current liabilities because ofthe October 2004 expiration date.

 

Additionally, as of October 30,2003, we have $156.4 million in privately placed promissory notes.  These notes mature at various dates through2014 and bear interest at fixed rates ranging from 5.85% to 7.85%.  The notes include penalties for repayment priorto their scheduled maturities.

 

Our debt agreements containlimits on borrowings and repurchases of company stock, and various quarterlyfinancial covenants that set maximum leverage ratios and minimum fixed chargeand asset coverage ratios.  During thefirst quarter of fiscal 2004, we amended our unsecured revolving line of creditagreement to revise certain financial covenants and limitations and increaseour maximum allowable repurchases of company stock.  As of October 30, 2003, we were in compliance with therestrictions and limitations included in these provisions.

 

We believe that cash on hand,together with cash provided by operating activities and borrowings on our lineof credit or replacement facilities, will be sufficient to meet our workingcapital, capital expenditure and debt service requirements beyond the next 12months.

 

***OperatingCash Flows***

 

Net cash provided by operatingactivities was $97.8 million in the first nine months of fiscal 2004, comparedto $5.0 million in the same period last year. The increase in operating cash flows was primarily due to changes inworking capital.

 

During the first nine months offiscal 2004, inventories increased $34.8 million compared to the end of fiscal2003, primarily due to our normal seasonal build-up of inventories for theholiday season.  During the first ninemonths of fiscal 2003, inventories increased $83.9 million compared to the endof fiscal 2002, primarily due to accelerated purchases of certain seasonalmerchandise due to the uncertainty caused by the West Coast port labordisputes, as well as lower than anticipated sell-through of inventory duringthe third quarter of fiscal 2003.

 

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During the first nine months offiscal 2004, current liabilities, excluding the current portion of long-termdebt, increased $55.0 million from the end of fiscal 2003.  The increase in current liabilities wasprimarily due to a $63.0 million increase in accounts payable and accruedexpenses as a result of the seasonal holiday purchases as well as improvedpayment terms with many of our vendors, offset by a decrease of $9.1 million intaxes payable reflecting the timing of payment of income and sales taxes duringthe first nine months of fiscal 2004. During the first nine months of fiscal 2003 current liabilitiesdecreased due to the timing of payment of income and sales taxes and the timingof payments to participating pharmacies by our PBM segment, offset by increasesin accounts payable and accrued expenses for normal seasonal build-up ofinventories for the holiday season.

 

During the first nine months offiscal 2004, pharmacy and other receivables increased $12.5 million from theend of fiscal 2003.  The increase wasprimarily due to increased pharmacy receivables arising from higher sales,increased amounts owed to us from vendors as a result of changes in some of ourcontractual purchase arrangements and the timing of payments from customers inour PBM segment.

 

Working capital, defined ascurrent assets less current liabilities, was $188.6 million as of October 30,2003 and $266.3 million as of October 31, 2002, a reduction of $77.7million.  As of October 30, 2003,current liabilities included $63.9 million for the current portion of long-termdebt ($55 million on our unsecured revolving line of credit, which expires inOctober 2004, and $8.9 million of principal payments due over the next 12months on our private placement and other notes).  Excluding the effect of the current portion of long-term debt, ourworking capital decreased by $28 million on an equivalent-store basis from theend of the third quarter last year. These reductions in working capital have come primarily from inventoryreductions resulting from our progress in centralizing procurement anddistribution, and increases in accounts payable due to improved payment termswith many of our vendors.  Our goal isto reduce our working capital by approximately $50 million on anequivalent-store basis by the end of fiscal 2004, as compared to the end offiscal 2003.

 

Changes in equivalent-storeworking capital serve as a measure of our working capital management, excludingthe effects of changes in the number of stores.  We calculate the change in equivalent-store working capital bymultiplying the change in average working capital per store by the number ofstores open as of the end of the current period.  We have excluded the current portion of long-term debt from ourcalculation of equivalent-store working capital because we intend to renew theline of credit prior to its October 2004 expiration date.

 

***InvestingCash Flows***

 

Net cash used in investingactivities was $74.8 million in the first nine months of fiscal 2004, comparedto $64.9 million in the same period of fiscal 2003.  Investing activities primarily consist of capital expendituresfor new stores, store remodels and improvements, equipment, technology andsupply chain improvements, partially offset by cash receipts from propertydispositions.  In the first nine monthsof fiscal 2004, investing cash outflows also included the acquisition ofAmerican Diversified Pharmacies (ADP), a mail service pharmacy.

 

We opened 13 new stores, offsetby one closed store, in the first nine months of fiscal 2004 compared to 14 newstores, offset by 3 closed stores, in the same period last year.  We plan to open 6****new stores in the fourth quarter of fiscal 2004.  We also plan to remodel up to 20 existingstores by the end of the fiscal year and up to 40 more stores next year.  The average capital expenditure for ourremodels will range from $250 thousand to $350 thousand per store forsmall-scale projects and $750 thousand to $850 thousand per store forlarge-scale projects.  We expect netcapital expenditures in fiscal 2004 to be approximately $110 million to $120million, primarily for new store investments, remodels and improvements toexisting stores, technology and supply chain improvements, includingexpenditures for the supply chain program discussed further below.  In addition, in the ordinary course of businesswe may acquire stores, store-related assets including pharmacy customer lists,or other complementary businesses.

 

In February 2002, our board ofdirectors approved a program for upgrading our supply chain practices in aneffort to increase efficiency and enhance profitability.  Over the term of this program (February 2002through expected completion in fiscal 2006), we expect to spend approximately$60 million in capital additions for supply chain improvements, largely relatedto systems changes.  Since inception ofthe program, we have spent approximately $26 million in capital additions.

 

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***FinancingCash Flows***

 

Net cash used in financingactivities was $8.1 million in the first nine months of fiscal 2004, comparedto $3.6 million in the same period of fiscal 2003.  Our financing activities consist of long-term borrowings andrepayments, repurchases of common stock and dividend payments.

 

In the first nine months offiscal 2004, proceeds from borrowings on our unsecured revolving line of creditwere $30 million.  We used theseborrowings, together with cash flows from operations, to finance capitalexpenditures, stock repurchases and dividend payments.  We also repaid $2.3 million of long-termborrowings, consisting primarily of regularly scheduled principal payments onour private placement notes.  In thefirst nine months of fiscal 2003, we borrowed $15.0 million on our revolvingline of credit, and repaid $2.6 million of long-term borrowings, primarily onour private placement notes.

 

In February and March 2003, werepurchased 853,100 shares of our common stock at a total cost of $12.0 millionto complete a share repurchase program authorized by our board of directors inNovember 1999.  In March 2003, our boardof directors authorized the repurchase of up to 2,000,000 additional shares ofour common stock through January 2008, for a maximum total expenditure of $50million.  We repurchased 509,100 sharesunder the new authorization in March 2003 at a total cost of $8.0 million.  Any future repurchase of our common stockwill depend on existing market conditions, our financial position, and othercapital requirements.

 

Our board of directors makesdecisions about the declaration of quarterly dividends based on, among otherthings, our results of operations and financial position.  We paid dividends of $0.42 per share, or$15.8 million and $16.1 million, respectively, in the first nine months offiscal 2004 and 2003.

 

**RISK FACTORS**

 

You should carefully read the following risk factors.

 

**Continued economic softness could continue toadversely affect consumer-buying practices and reduce our sales andprofitability.**

 

A sluggish economy hasadversely affected our sales and operating profitability for the past twofiscal years.  The economy is very softin many of the markets we serve, particularly California, where unemployment ishigh and a climate of political uncertainty exists.  If the economy remains soft or slows further, or if unemploymentincreases, our pharmacy sales could be adversely affected as consumers may losetheir health insurance due to unemployment. Further, if economic conditions, war, terrorism or other global concernscontinue to worry consumers, they may continue to decrease their purchases,particularly of products other than pharmaceutical products.  We make a higher profit on our sales offront-end products than we do on sales of pharmaceutical products.  Therefore, any continued decrease in oursales of front-end products would decrease our profitability.

 

**The retail drug store and pharmacy benefitmanagement industries are highly competitive, and further increases incompetition could adversely affect us.**

 

We face intense competitionwith local, regional and national companies, including other drug store chains,independent drug stores, mail order pharmacies, on-line retailers, supermarketchains and, increasingly, mass merchandisers. In the PBM industry, our competitors include large national and regionalPBMs, some of which are owned by our retail drug store competitors.  Many of our competitors have substantiallygreater resources, including name recognition and capital resources, than wedo.  As competition increases in themarkets in which we operate, a significant increase in general pricingpressures could occur, which could require us to reduce prices, purchase moreeffectively and increase customer service to remain competitive.  We cannot assure you that we will be able tocontinue to compete effectively in our markets or increase our sales volume ormargins in response to further increased competition.

 

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**Ourability to successfully implement significant organizational changes, includingsupply chain improvements and new systems, is critical to the ongoing successof our business.**

 

We are currently undertakingsignificant organizational changes, including store workflow and staffingchanges, increased centralization, restructured incentive compensationarrangements and other strategic initiatives. In addition, in February 2002 our board of directors approved a programto upgrade our supply chain in an effort to increase efficiency and enhanceprofitability.  Over the term of thisprogram (February 2002 through expected completion in fiscal year 2006), weexpect to spend approximately $60 million in capital additions for supply chainimprovements, largely related to systems changes.  Since inception of the program, we have spent approximately $26million in capital additions.  Mostrecently, our program to upgrade our supply chain included the implementationof new distribution management software in one of our front-end distributioncenters.  This implementation causedsome disruption in our supply chain, which adversely affected our front-endsales and gross profit, during the third quarter of fiscal 2004.

 

We are planning additionalsystems changes as part of our efforts to upgrade our supply chain over thenext several years.  Such systemsimplementations are complex and could cause disruptions that would adverselyaffect our sales, gross profit and operating and administrative expenses.  Our ability to successfully implement theseorganizational, systems and process changes, which are significant to ouroperations and business, is critical to our future profitability.  We cannot assure you that we will be able toexecute these changes successfully and without significant disruption to ourbusiness.  If we are not successful, wewill have spent significant capital and human effort and may not achieve any ofthe expected benefits from these initiatives.

 

**Changes in third-party reimbursement levelsfor prescription drugs continue to reduce our margins on pharmacy sales andcould have a material adverse effect on our overall performance.**

 

We are wholly or partiallyreimbursed by third-party health plans for approximately 90% of all theprescription drugs that we sell. Pharmacy sales reimbursed by third parties, including Medicare andMedicaid plans, have lower gross margins than non third-party pharmacysales.  Third-party health planscontinue to reduce the levels at which they reimburse us for the prescriptiondrugs that we provide to their members. Furthermore, recent Medicare reform legislation included prescriptiondrug benefits.  Also, the Californiastate budget included a proposed 5% across-the-board reduction in Medi-Calreimbursements to pharmacies effective January 1, 2004 and reductions inreimbursements for workers’ compensation prescriptions.  If the State of California implements theseor similar or additional reductions in reimbursement levels, our sales andgross profits could be significantly adversely affected.  If third-party health plans continue toreduce their reimbursement levels, or if Medicare covers prescription drugs atreimbursement levels lower than our current retail prices, our margins on thesesales will continue to be reduced, and our profitability will be adverselyaffected.

 

**Weare making significant investments in our stores that may not generate theanticipated benefits.**

 

We are currently makingsignificant investments in our stores in an effort to increase our sales andprofitability.  These investmentsinclude the installation of new digital photo equipment, technology, andremodels and other improvements to some existing stores.  These investments require significantcapital expenditures and are largely unprecedented at our company.  We are uncertain about consumer reaction tothese changes and therefore we cannot assure you that they will result inincreased sales and profitability.

 

**Continued volatility in insurance relatedexpenses and the markets for insurance coverage could have a material adverseaffect on us.**

 

The costs of employee health,workers’ compensation, property and casualty, general liability, director andofficer and other types of insurance have continued to rise, while the amountand availability of coverage have decreased. Claims costs for workers’ compensation and other self-insured exposureshave also increased.  For the first ninemonths of fiscal 2004, for example, our insurance-related expenses, increased$8.2 million, or 0.2% of sales, over the same period last year.  These conditions have been exacerbated byrising health care costs, legislative changes, economic conditions andterrorism.  If our insurance-relatedcosts continue to increase significantly, or if we are unable to obtainadequate levels of insurance, our financial position and results of operationscould be adversely affected.

 

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**Weare substantially dependent on a single supplier of pharmaceutical products tosell products to us on satisfactory terms. A disruption in our relationship with this supplier could have amaterial adverse effect on our business.**

 

We obtain approximately half ofour total merchandise, including over 90% of our pharmaceuticals, from a singlesupplier, AmerisourceBergen, with whom we have a long-term supplycontract.  Any significant disruptionsin our relationship with AmerisourceBergen, or deterioration inAmerisourceBergen’s financial condition, could have a material adverse effecton us.  Recent news reports indicatethat federal regulatory and law enforcement agencies are investigating certainof AmerisourceBergen’s business practices. If these or other investigations result in significant sanctions orpenalties against AmerisourceBergen, or in significant changes to theirbusiness practices, they could have an adverse impact on our relationship withAmerisourceBergen and thereby adversely affect our business.

 

**Ourability to attract and retain pharmacy personnel or develop alternate fillsources is important to the continued success of our business.**

 

Our industry is continuing toexperience a shortage of licensed pharmacists in the markets in which weoperate.  Our inability to attract andretain pharmacists and other key personnel could adversely affect us.  In order to mitigate this risk we enteredinto a joint venture agreement with AmerisourceBergen to operate a centralprescription fill center.  The successof this fill center, which cannot be assured, is important to our ability toaddress the shortage of pharmacists, but additional efforts may be necessary toaddress this business issue.  Otheroptions may be costly or unavailable to us. Further, a significant disruption in our fill center’s operations couldworsen the effects of the pharmacist shortage and adversely affect ourbusiness.

 

**We are subject to governmental regulations,procedures and requirements.  Ournoncompliance with, or a significant change in, these regulations could have amaterial adverse effect on us.**

 

Our pharmacy and PBM businessesare subject to numerous federal, state and local regulations, many of which arenew and developing.  These include, butare not limited to, local registrations of pharmacies in the states where ourpharmacies are located and applicable Medicare and Medicaid regulations.  In addition, the Health Insurance Portability and Accountability Act (“HIPAA”)imposes certain requirements regarding the protection of confidential patientmedical records and other information. Compliance with these regulations, particularly HIPAA, requires that weimplement complex changes to our systems and processes.  Failure to adhere to these and other applicableregulations could result in the imposition of civil and criminalpenalties.  Furthermore, any new federalor state regulations or reforms, including healthcare reform initiatives orpharmacy benefit management regulation, could adversely affect us.

 

**Certain risks are inherent in providingpharmacy services, and our insurance may not be adequate to cover some claimsagainst us.**

 

Pharmacies are exposed to risksinherent in the packaging and distribution of pharmaceuticals and otherhealthcare products and are significantly dependent upon suppliers to providesafe, government-approved and non-counterfeit products.  Although we maintain professional liabilityand errors and omissions liability insurance, should a product liability issuearise, we cannot assure you that the coverage limits under our insuranceprograms will be adequate to protect us against future claims, that we will beable to maintain this insurance on acceptable terms in the future or that thedamage to our reputation in the event of a product liability issue will nothave a material adverse effect on our business.

 

**Ourgeographic concentration in the western United States presents certain risksthat could adversely affect us.**

 

Our stores, distributioncenters and corporate offices are located in the western United States.  Risks prevalent in this region include, butare not limited to, major earthquakes, periodic energy shortages and risingenergy costs, and shipping and other transportation-related disruptions.  Because of our geographic concentration,these risks could result in significant disruptions to our business orincreased operating expenses.

 

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**Item3.      *Quantitative and Qualitative Disclosures of MarketRisk***

 

Our major market risk exposureis changing interest rates.  We use debtfinancing in combination with operating cash flows to support capitalexpenditures, acquisitions, working capital needs and general corporatepurposes.  Our unsecured revolving lineof credit (with $55 million of outstanding borrowings as of October 30, 2003)bears interest at LIBOR-based rates, and therefore an increase in interestrates could increase our interest expense. We do not currently undertake any specific actions to cover our exposureto interest rate risk and we are not currently a party to any interest raterisk management transactions.  We havenot purchased and do not currently hold any derivative financial instruments.  Depending on the interest rate environmentand subject to approval by our board of directors, we may make use ofderivative financial instruments or other interest rate management vehicles inthe future.

 

A 10% change in interest rates(29 basis points on our floating-rate debt as of October 30, 2003) would havean immaterial effect on our earnings and cash flows and on the fair value ofour fixed rate debt.

 

**Item 4.*  Controls andProcedures***

 

The Company maintainsdisclosure controls and procedures that are designed to ensure that informationrequired to be disclosed in the Company’s Exchange Act reports is recorded,processed, summarized and reported within the time periods specified in theSEC’s rules and forms, and that such information is accumulated andcommunicated to the Company’s management, including its Chief Executive Officerand Chief Financial Officer, as appropriate, to allow timely decisionsregarding required disclosure.

 

As of October 30, 2003, the endof the quarter covered by this report, the Company carried out an evaluation,under the supervision and with the participation of the Company’s management,including the Company’s Chief Executive Officer and the Company’s ChiefFinancial Officer, of the effectiveness of the design and operation of theCompany’s disclosure controls and procedures. Based on that evaluation, the Company’s Chief Executive Officer andChief Financial Officer concluded that the Company’s disclosure controls andprocedures were effective and adequate to provide reasonable assurance thatmaterial information relating to the Company would be made known to them on atimely basis.

 

There have been no changes inthe Company’s internal controls over financial reporting that occurred duringthe fiscal quarter covered by this quarterly report that have materiallyaffected, or are reasonably likely to materially affect, the Company’s internalcontrols over financial reporting.

 

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**PART II – OTHER INFORMATION**

 

**Item6.    Exhibits and Reports on Form 8-K**

 
| (a)    | Exhibits                                                                                                                                                                                                                                                                                                                                                                                                                    |
|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                                                                                                                                                                        |
|   | Exhibit  3.2:  Amended and restated by-laws as adopted by our board of  directors dated November 18, 2003.                                                                                                                                                                                                                                                                                                        |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                        |
|   | Exhibit  31:     Certification of the Chief Executive Officer  and the Chief Financial Officer of Longs Drug Stores Corporation, pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002. *                                                                                                                                                                                                     |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                        |
|   | Exhibit  32:     Certification of the Chief Executive Officer  and the Chief Financial Officer of Longs Drug Stores Corporation, pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002. *                                                                                                                                                                                                     |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                        |
|   | *These  certifications are being furnished solely to accompany this quarterly report  pursuant to 18 U.S.C. §1350, and are not being filed for purposes of Section  18 of the Securities Exchange Act of 1934, as amended, and are not to be  incorporated by reference to any filing of the Company, whether made before  or after the date hereof, regardless of any general incorporation language in  such filing. |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                        |
| (b)    | Reports on  Form 8-K                                                                                                                                                                                                                                                                                                                                                                                                        |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                        |
|   | On August 8,  2003, we filed a Current Report on Form 8-K related to a press release  regarding our July 2003 sales results.                                                                                                                                                                                                                                                                                                |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                        |
|   | On August  20, 2003, we filed a Current Report on Form 8-K related to a press release  regarding our second quarter of fiscal 2004 financial results and third  quarter and full year fiscal 2004 financial projections.                                                                                                                                                                                                    |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                        |
|   | On September  8, 2003, we filed a Current Report on Form 8-K related to a press release  regarding our August 2003 sales results.                                                                                                                                                                                                                                                                                           |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                        |
|   | On October  10, 2003, we filed a Current Report on Form 8-K related to a press release  regarding our September 2003 sales results.                                                                                                                                                                                                                                                                                         |

 

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**SIGNATURES**

 

 

Pursuant to the requirements ofthe Securities and Exchange Act of 1934, the registrant has duly caused thisreport to be signed on its behalf by the undersigned, thereunto dulyauthorized.

 

 
|   |              |   | LONGS DRUG STORES CORPORATION |                                                                                       |
|--------|-------------------|--------|-------------------------------|--------------------------------------------------------------------------------------------|
|   |              |   | *(Registrant)*                |                                                                                       |
|   |              |   |                          |
|   |              |   |                          |
| Date:  | December 12, 2003 |   |                          |  /s/ S. F. McCann                                                                     |   |
|   |              |   |                          | (S. F.  McCann)                                                                            |
|   |              |   |                          | *Senior Vice President, Chief Financial Officer and Treasurer*                             |
|   |              |   |                          |
|   |              |   |                          |
| Date:  | December 12, 2003 |   |                          |  /s/ R. L. Chelemedos                                                                 |   |
|   |              |   |                          | (R. L.  Chelemedos)                                                                        |
|   |              |   |                          | *Vice President – Controller and Assistant Secretary  (Principal Accounting Officer)* |
|        |                   |        |                               |                                                                                            |  |  |

 

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