**UNITED STATES****SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

 

| **(Mark One)**                                  |
|-------------------------------------------------|
|                                            |   |
| **ý**                                      | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934.** |
|                                            |   |
| **For  the quarterly period ended May 1, 2003** |
|                                            |   |
| **o**                                           | **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934.** |

 

**Commissionfile number 1-8978**

 

**LONGS DRUG STORES 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 markwhether the registrant:  (1) has filedall reports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.

 

| Yes    ý |   | No    o |
|------------------------------|--------|------------------------|

 

Indicate by checkmark whether the registrant is an accelerated filer (defined in Rule 12b-2 ofthe Exchange Act).  Yes ý  No o

 

There were 37,359,125shares of common stock outstanding as of May 29, 2003.

 

 

----

 

# **Tableof Contents**

 
| **PART I –  FINANCIAL INFORMATION** |
|------------------------------------------|
|                                     |
|                                     | Item 1 | Condensed  Consolidated Financial Statements | 1 |
|                                     | Item 2 | Management’s  Discussion and Analysis of Financial Condition and Results of Operations | 10 |
|                                     | Item 3 | Quantitative  and Qualitative Disclosures of Market Risk | 17 |
|                                     | Item 4 | Controls  and Procedures | 17 |
|                                     |
| **PART II – OTHER INFORMATION**     |
|                                     |
|                                     | Item 6 | Exhibits and Reports on Form 8-K | 18 |
|                                     | Signature Page | 19 |
|                                     | Certifications of Chief Executive Officer  and Chief Financial Officer | 20 |

 

----

 

**PART I****–FINANCIAL INFORMATION**

 

**Item1.****                                           Condensed Consolidated FinancialStatements**

 

**CondensedConsolidated Statements of Income (unaudited)**

 
|                                                                    |   | **For the 13 weeks ended**               |      |
|-------------------------------------------------------------------------|--------|------------------------------------------|-----------|
|                                                                    |   | **May 1,  2003**                         |      | **May 2,  2002** |   |
|                                                                    |   | **(Thousands Except Per Share Amounts)** |      |
|                                                                    |   |                                     |      |   |   |
| Sales                                                                   |   | $                                        | 1,103,130 |   | $ | 1,089,829 |   |
|                                                                    |   |                                     |      |   |   |
| Cost  of sales                                                          |   | 818,023                                  |      | 813,801 |   |
| Gross  profit                                                           |   | 285,107                                  |      | 276,028 |   |
|                                                                    |   |                                     |      |   |   |
| Operating  and administrative expenses                                  |   | 250,520                                  |      | 236,612 |   |
| Depreciation  and amortization                                          |   | 21,796                                   |      | 18,866 |   |
| Operating  income                                                       |   | 12,791                                   |      | 20,550 |   |
| Interest  expense                                                       |   | 3,559                                    |      | 3,331 |   |
| Interest  income                                                        |   | (115                                     | )         | (370 | ) |
| Income  before income taxes and cumulative effect of accounting change  |   | 9,347                                    |      | 17,589 |   |
| Income  taxes                                                           |   | 3,514                                    |      | 6,619 |   |
| Income  before cumulative effect of accounting change                   |   | 5,833                                    |      | 10,970 |   |
|                                                                    |   |                                     |      |   |   |
| Cumulative  effect of accounting change (net of tax benefit of $16,410) |   | —                                   |      | (24,625 | ) |
| Net  income (loss)                                                      |   | $                                        | 5,833     |   | $ | (13,655 | ) |
|                                                                    |   |                                     |      |   |   |
| Basic  earnings (loss) per common share:                                |   |                                     |      |   |   |
| Income  before cumulative effect of accounting change                   |   | $                                        | 0.16      |   | $ | 0.29 |   |
| Cumulative  effect of accounting change (net of tax benefit of $0.43)   |   | —                                   |      | (0.65 | ) |
| Net  income (loss)                                                      |   | $                                        | 0.16      |   | $ | (0.36 | ) |
|                                                                    |   |                                     |      |   |   |
| Diluted  earnings (loss) per common share:                              |   |                                     |      |   |   |
| Income  before cumulative effect of accounting change                   |   | $                                        | 0.16      |   | $ | 0.29 |   |
| Cumulative  effect of accounting change (net of tax benefit of $0.43)   |   | —                                   |      | (0.65 | ) |
| Net  income (loss)                                                      |   | $                                        | 0.16      |   | $ | (0.36 | ) |
| Dividends  per common share                                             |   | $                                        | 0.14      |   | $ | 0.14 |   |
|                                                                    |   |                                     |      |   |   |
| Weighted  average number of shares outstanding:                         |   |                                     |      |   |   |
| Basic                                                                   |   | 37,449                                   |      | 37,770 |   |
| Diluted                                                                 |   | 37,601                                   |      | 38,085 |   |

 

*See notesto condensed consolidated financial statements.*

 

1

----

 

**CondensedConsolidated Balance Sheets**

 
|                                                                     |   | **May 1,  2003**                         |      | **May 2,  2002** |   | **January 30,  2003** |   |
|--------------------------------------------------------------------------|--------|------------------------------------------|-----------|------------------|--------|-----------------------|--------|
|                                                                     |   | **(Thousands Except Share Information)** |      |
|                                                                     |   | **(Unaudited)**                          |      |             |   |
| **ASSETS**                                                               |   |                                     |      |             |   |                  |   |
|                                                                     |   |                                     |      |             |   |                  |   |
| Current  Assets:                                                         |   |                                     |      |             |   |                  |   |
| Cash  and cash equivalents                                               |   | $                                        | 48,823    |             | $      | 60,392                |   | $ | 40,195 |   |
| Pharmacy  and other receivables, net                                     |   | 133,143                                  |      | 123,945          |   | 135,610               |   |
| Merchandise  inventories, net                                            |   | 428,882                                  |      | 416,272          |   | 443,435               |   |
| Deferred  income taxes                                                   |   | 30,821                                   |      | 24,231           |   | 32,131                |   |
| Other                                                                    |   | 9,165                                    |      | 4,601            |   | 11,290                |   |
| Total  current assets                                                    |   | 650,834                                  |      | 629,441          |   | 662,661               |   |
|                                                                     |   |                                     |      |             |   |                  |   |
| Property:                                                                |   |                                     |      |             |   |                  |   |
| Land                                                                     |   | 106,741                                  |      | 107,563          |   | 107,175               |   |
| Buildings  and leasehold improvements                                    |   | 533,196                                  |      | 494,027          |   | 524,768               |   |
| Equipment  and fixtures                                                  |   | 500,307                                  |      | 478,298          |   | 487,888               |   |
| Total  property at cost                                                  |   | 1,140,244                                |      | 1,079,888        |   | 1,119,831             |   |
|                                                                     |   |                                     |      |             |   |                  |   |
| Less  accumulated depreciation                                           |   | 536,338                                  |      | 490,559          |   | 523,813               |   |
| Property,  net                                                           |   | 603,906                                  |      | 589,329          |   | 596,018               |   |
| Goodwill                                                                 |   | 82,085                                   |      | 82,276           |   | 82,085                |   |
| Intangible  assets, net                                                  |   | 5,379                                    |      | 5,632            |   | 5,430                 |   |
| Other  assets                                                            |   | 5,607                                    |      | 7,047            |   | 5,877                 |   |
| Total                                                                    |   | $                                        | 1,347,811 |             | $      | 1,313,725             |   | $ | 1,352,071 |   |
|                                                                     |   |                                     |      |             |   |                  |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                            |   |                                     |      |             |   |                  |   |
|                                                                     |   |                                     |      |             |   |                  |   |
| Current  Liabilities:                                                    |   |                                     |      |             |   |                  |   |
| Accounts  payable                                                        |   | $                                        | 254,408   |             | $      | 241,442               |   | $ | 242,440 |   |
| Employee  compensation and benefits                                      |   | 92,149                                   |      | 80,462           |   | 92,185                |   |
| Taxes  payable                                                           |   | 21,383                                   |      | 25,976           |   | 54,579                |   |
| Current  portion of long-term debt                                       |   | 5,025                                    |      | 2,536            |   | 2,348                 |   |
| Other                                                                    |   | 29,184                                   |      | 40,260           |   | 28,546                |   |
| Total  current liabilities                                               |   | 402,149                                  |      | 390,676          |   | 420,098               |   |
| Long-term  debt                                                          |   | 211,558                                  |      | 191,584          |   | 181,429               |   |
| Deferred  income taxes and other long-term liabilities                   |   | 34,368                                   |      | 26,659           |   | 34,074                |   |
| Commitments  and Contingencies                                           |   |                                     |      |             |   |                  |   |
|                                                                     |   |                                     |      |             |   |                  |   |
| Stockholders’  Equity:                                              |   |                                     |      |             |   |                  |   |
| Common  stock (37,308,000, 38,250,000 and 38,501,000 shares outstanding) |   | 18,654                                   |      | 19,125           |   | 19,250                |   |
| Additional  capital                                                      |   | 166,012                                  |      | 163,848          |   | 169,853               |   |
| Unearned  compensation                                                   |   | (4,071                                   | )         | (5,853           | )      | (4,562                | )      |
| Retained  earnings                                                       |   | 519,141                                  |      | 527,686          |   | 531,929               |   |
| Total  stockholders’ equity                                         |   | 699,736                                  |      | 704,806          |   | 716,470               |   |
|                                                                     |   |                                     |      |             |   |                  |   |
| Total                                                                    |   | $                                        | 1,347,811 |             | $      | 1,313,725             |   | $ | 1,352,071 |   |

 

*See notesto condensed consolidated financial statements.*

 

2

----

 

**Condensed Consolidated Statements ofCash Flows (unaudited)**

 
|                                                                                                 |   | **For the 13 weeks ended** |   |
|------------------------------------------------------------------------------------------------------|--------|----------------------------|--------|
|                                                                                                 |   | **May 1,  2003**           |   | **May 2,  2002** |   |
|                                                                                                 |   | **(Thousands)**            |   |
|                                                                                                 |   |                       |   |   |   |
| Operating Activities:                                                                                |   |                       |   |   |   |
| Net income (loss)                                                                                    |   | $                          | 5,833  |   | $ | (13,655 | ) |
| Adjustments to  reconcile net income (loss) to net cash provided by (used in) operating  activities: |   |                       |   |   |   |
| Cumulative effect of  accounting change                                                              |   | —                     |   | 24,625 |   |
| Depreciation and  amortization                                                                       |   | 21,796                     |   | 18,866 |   |
| Deferred income taxes  and other                                                                     |   | 1,536                      |   | 3,587 |   |
| Stock awards, net                                                                                    |   | 65                         |   | 446 |   |
| Common stock  contribution to benefit plans                                                          |   | 2,679                      |   | 1,777 |   |
| Changes in assets and  liabilities:                                                                  |   |                       |   |   |   |
| Pharmacy and other  receivables                                                                      |   | 2,467                      |   | (966 | ) |
| Merchandise inventories                                                                              |   | 14,553                     |   | (9,889 | ) |
| Other assets                                                                                         |   | 2,395                      |   | (26 | ) |
| Current liabilities                                                                                  |   | (20,626                    | )      | (56,985 | ) |
| Net cash provided by  (used in) operating activities                                                 |   | 30,698                     |   | (32,220 | ) |
|                                                                                                 |   |                       |   |   |   |
| Investing Activities:                                                                                |   |                       |   |   |   |
| Capital expenditures  and acquisitions                                                               |   | (31,833                    | )      | (18,078 | ) |
| Proceeds from property  dispositions                                                                 |   | 2,268                      |   | 121 |   |
| Net cash used in  investing activities                                                               |   | (29,565                    | )      | (17,957 | ) |
|                                                                                                 |   |                       |   |   |   |
| Financing Activities:                                                                                |   |                       |   |   |   |
| Proceeds from long-term  borrowings                                                                  |   | 35,000                     |   | — |   |
| Repayments of long-term  borrowings                                                                  |   | (2,194                     | )      | (7,283 | ) |
| Repurchase of common  stock                                                                          |   | (20,023                    | )      | — |   |
| Dividend payments                                                                                    |   | (5,288                     | )      | (5,335 | ) |
| Net cash provided by  (used in) financing activities                                                 |   | 7,495                      |   | (12,618 | ) |
|                                                                                                 |   |                       |   |   |   |
| Increase (decrease) in  cash and cash equivalents                                                    |   | 8,628                      |   | (62,795 | ) |
| Cash and cash  equivalents at beginning of period                                                    |   | 40,195                     |   | 123,187 |   |
|                                                                                                 |   |                       |   |   |   |
| Cash and cash  equivalents at end of period                                                          |   | $                          | 48,823 |   | $ | 60,392 |   |
|                                                                                                 |   |                       |   |   |   |
| Supplemental disclosure  of cash flow information:                                                   |   |                       |   |   |   |
| Cash paid for interest                                                                               |   | 3,747                      |   | 3,370 |   |
| Cash paid for income  taxes                                                                          |   | 15,809                     |   | 17,110 |   |

 

*See notes to condensed consolidatedfinancial statements.*

 

3

----

 

 

**CondensedConsolidated Statements of Stockholders’ Equity**

For the 52 weeks endedJanuary 30, 2003 and the 13 weeks ended May 1, 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  ($.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                                             |   |             |       |                    |       |                                                      |       |                       |       |                   |       | 5,833                                 |       | 5,833 |   |
| Dividends  ($.14 per share)                             |   |             |       |                    |       |                                                      |       |                       |       |                   |       | (5,288                                | )          | (5,288 | ) |
| Employee  Savings and Profit Sharing Plan:              |   |             |       |                    |       |                                                      |       |                       |       |                   |       |                                  |       |   |   |
| Issuance  of stock for 401(k) matching contributions    |   | 165              |       | 83                      |       | 2,596                                                     |       |                       |       |                   |       |                                  |       | 2,679 |   |
| Stock  awards, net of forfeitures                       |   | 4                |       | 2                       |       | (2                                                        | )          |                       |       | 50                     |       |                                  |       | 50 |   |
| Amortization  of restricted stock awards                |   |             |       |                    |       |                                                      |       |                       |       | 441                    |       |                                  |       | 441 |   |
| Tax  expense related to stock awards                    |   | (426             | )          |                    |       |                                                      |       |                       |       |                   |       |                                  |       | (426 | ) |
| Repurchase  of common stock                             |   | (1,362           | )          | (681                    | )          | (6,009                                                    | )          |                       |       |                   |       | (13,333                               | )          | (20,023 | ) |
|                                                    |   |             |       |                    |       |                                                      |       |                       |       |                   |       |                                  |       |   |   |
| **Balance at May 1, 2003**                              |   | **37,308**       | ** ** | **$**                   | **18,654** | ** **                                                | **$**      | **166,012**                | ** ** | **$**                  | **—** | ** **                            | **$**      | **(4,071** | **)** | **$** | **519,141** | ** ** | **$** | **699,736** | ** ** |

 

*See notes tocondensed consolidated financial statements.*

 

4

----

 

**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS**

 

**1.****                                   Basisof Presentation**

 

The accompanyingcondensed consolidated financial statements include Longs Drug StoresCorporation (“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 May 1, 2003 and May 2, 2002 areunaudited.  The condensed consolidated balancesheet as of January 30, 2003, and condensed consolidated statement ofstockholders’ equity for the year then ended, presented herein, have beenderived from the audited consolidated financial statements of the Companyincluded in the Form 10-K for the fiscal year ended January 30, 2003.  Certain reclassifications have been made toprior year financial statements to conform to the current presentation. Suchreclassifications included a reclassification of advertising expenses fromoperating and administrative expenses to cost of sales.

 

**2.****                                      Stock-BasedCompensation**

 

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:

 
|                                                                                                                                          |   | **May 1,  2003**                         |   | **May 2,  2002** |   |
|-----------------------------------------------------------------------------------------------------------------------------------------------|--------|------------------------------------------|--------|------------------|--------|
|                                                                                                                                          |   | **Thousands, except  per share amounts** |   |
| Net income (loss), as  reported                                                                                                               |   | $                                        | 5,833  |             | $      | (13,655 | ) |
| Add: Stock-based  employee compensation expense included in reported net income (loss), net of  related tax effects                           |   | 295                                      |   | 227              |   |
| Deduct: Total  stock-based employee compensation expense determined under fair value based  method for all awards, net of related tax effects |   | (1,117                                   | )      | (428             | )      |
| Pro forma net income  (loss)                                                                                                                  |   | $                                        | 5,011  |             | $      | (13,856 | ) |
|                                                                                                                                          |   |                                     |   |             |   |
| Basic net income (loss)  per share:                                                                                                           |   |                                     |   |             |   |
| As reported                                                                                                                                   |   | $                                        | 0.16   |             | $      | (0.36 | ) |
| Pro forma                                                                                                                                     |   | 0.13                                     |   | (0.37            | )      |
| Diluted net income  (loss) per share:                                                                                                         |   |                                     |   |             |   |
| As reported                                                                                                                                   |   | $                                        | 0.16   |             | $      | (0.36 | ) |
| Pro forma                                                                                                                                     |   | 0.13                                     |   | (0.36            | )      |

 

5

----

 

**3.****                                      EarningsPer Share**

 

Basic net income pershare is computed by dividing net income by the weighted average number ofcommon shares outstanding during the period. Diluted net income per share is computed by dividing net income by theweighted average number of common shares and dilutive common equivalent shares(restricted stock awards 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** |   |
|--------------------------------------------------------|--------|--------------------|--------|
|                                                   |   | **May 1,  2003**   |   | **May 2,  2002** |   |
|                                                   |   | **Thousands**      |   |
| Basic weighted average  number of shares outstanding   |   | 37,449             |   | 37,770 |   |
| Effect of dilution  from:                              |   |               |   |   |   |
| Restricted stock awards                                |   | 148                |   | 167 |   |
| Stock options                                          |   | 4                  |   | 148 |   |
| Diluted weighted  average number of shares outstanding |   | 37,601             |   | 38,085 |   |

 

The computation of diluted earnings per share in thefirst quarter of fiscal 2004 excluded 3,544,550 stock options because theireffect would have been anti-dilutive.

 

**4.****                                      MerchandiseInventories**

 

Merchandise inventoriesare stated at the lower of cost or market value.  Cost is determined using the last-in, first-out (LIFO) method.The excess of specific cost over LIFO values was $173.4 million as of May 1,2003, $167.0 million as of May 2, 2002 and $171.4 million as of January 30,2003.  LIFO costs for interim financialstatements are estimated based on projected annual inflation rates, inventorylevels, and merchandise mix.  ActualLIFO costs are calculated during the fourth quarter of the fiscal year whenfinal inflation rates, inventory levels, and merchandise mix are determined.

 

**5.****                                      Goodwilland Intangible Assets**

 

All of theCompany’s goodwill and other intangible assets are included in the retail drugstore segment.   Goodwill and otherintangible assets with indefinite useful lives are not amortized, but aresubject to annual impairment testing. Intangible assets with finite useful lives are amortized over thoseuseful lives.  The Company’s intangibleassets other than goodwill include the following:

 
|                                            |   | **Useful  Lives** |   | **Gross  Carrying  Value** |   | **Accumulated  Amortization** |   | **Net  Carrying  Value** |   |
|-------------------------------------------------|--------|-------------------|--------|----------------------------|--------|-------------------------------|--------|--------------------------|--------|
|                                            |   | **Thousands**     |   |
| **As of  May 1, 2003:**                         |   |              |   |                       |   |                          |   |                     |   |
| Intangible assets subject  to amortization:     |   |              |   |                       |   |                          |   |                     |   |   |   |   |
| Pharmacy customer lists                         |   | 1-5 years         |   | $                          | 1,121  |                          | $      | (548                     | )      | $ | 573 |   |
| Non-compete agreements  and other               |   | 2-5 years         |   | 91                         |   | (52                           | )      | 39                       |   |
| Total                                           |   |              |   | 1,212                      |   | (600                          | )      | 612                      |   |
|                                            |   |              |   |                       |   |                          |   |                     |   |
| Intangible assets not  subject to amortization: |   |              |   |                       |   |                          |   |                     |   |
| Beverage licenses                               |   | N/A               |   | 4,767                      |   | —                        |   | 4,767                    |   |
|                                            |   |              |   |                       |   |                          |   |                     |   |
| Total                                           |   |              |   | $                          | 5,979  |                          | $      | (600                     | )      | $ | 5,379 |   |
|                                            |   |              |   |                       |   |                          |   |                     |   |
| **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 |   |

 

6

----

 

Amortization expense forintangible assets with finite useful lives was $75 thousand for the 13-weekperiods ended May 1, 2003 and May 2, 2002. Estimated annual amortization expense on these intangibles for fiscal2004 and each of the succeeding four fiscal years is as follows (*in thousands*):

 
| Fiscal Year 2004 |   | 289    |   |
|------------------|--------|--------|--------|
| Fiscal Year 2005 |   | 221    |   |
| Fiscal Year 2006 |   | 150    |   |
| Fiscal Year 2007 |   | 27     |   |
| Fiscal Year 2008 |   | — |   |
| Total            |   | $      | 687    |   |
|                  |        |        |        |  |

 

**6.****                                   Debt**

 

Long-termdebt as of May 1, 2003 and January 30, 2003 consisted of the following*:*

 

|                                                                                                                                   |   | **May 1,  2003** |    | **January 30,  2003** |   |
|----------------------------------------------------------------------------------------------------------------------------------------|--------|------------------|---------|-----------------------|--------|
|                                                                                                                                   |   | **Thousands**    |    |
| Unsecured revolving  line of credit, interest based on LIBOR  (weighted average rate of 2.57% as of May 1, 2003), expires October 2004 |   | $                | 60,000  |                  | $      | 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               |   |
| Equipment notes and  other                                                                                                             |   | 154              |    | 206                   |   |
| Total long-term debt                                                                                                                   |   | 216,583          |    | 183,777               |   |
| Less current portion                                                                                                                   |   | 5,025            |    | 2,348                 |   |
| Long-term portion                                                                                                                      |   | $                | 211,558 |                  | $      | 181,429 |   |

 

On May 9, 2003, theCompany exercised an option to increase the borrowing capacity of its unsecuredrevolving line of credit, resulting in a $45 million increase to a totalcapacity of $195 million.  Borrowings onthe line of credit do not require repayment until the 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.  During the first quarter of fiscal 2004, theCompany amended its unsecured revolving line of credit agreement to revise certainfinancial covenants and limitations and increase the maximum allowablerepurchases of the Company’s stock.  Asof May 1, 2003, the Company was in compliance with the restrictions andlimitations included in these provisions.**

 

**7.****                                      StoreClosure Reserves**

 

The Company periodically reviews store operations and makes decisionsto close stores in the normal course of business.  Costs associated with store closures are recognized when therelated liabilities are incurred.  Suchcosts are 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:

 

|                                                           |   | **13 weeks ended** |   |
|----------------------------------------------------------------|--------|--------------------|--------|
|                                                           |   | **May 1,  2003**   |   | **May 2,  2002** |   |
|                                                           |   | **Thousands**      |   |
| Store closure reserve,  beginning of period                    |   | $                  | 7,826  |   | $ | 12,551 |   |
| Provision for store  closures and asset impairment             |   | —             |   | — |   |
| Net costs incurred for  closed stores, charged against reserve |   | (329               | )      | (2,202 | ) |
| Store closure reserve,  end of period                          |   | $                  | 7,497  |   | $ | 10,349 |   |

 

Substantially all of theCompany’s store closure reserves as of May 1, 2003 and May 2, 2002 were forlease-related costs associated with closed stores.

 

7

----

 

**8.****                                      Stockholders’Equity**

 

In February and March2003, the Company repurchased 853,100 shares of its common stock at a totalcost of $12.0 million to complete a share repurchase program authorized by theBoard of Directors in November 1999.  InMarch 2003, 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 firstquarter of fiscal 2003.

 

**9.****                                      SegmentInformation**

 

###### **TheCompany operates in two business segments, retail drug stores and pharmacybenefit management (“PBM”).  Thesesegments were identified based on their separate and distinct products andservices, technology, marketing strategies and management reporting.  Management evaluates the segments’ operatingperformance separately and allocates resources based on their respectivefinancial condition, results of operations and cash flows.  Inter-segment transactions and balances areeliminated in consolidation.**

 

###### **Pharmacyis the cornerstone of the retail drug store segment, complemented by such“front-end” categories as over-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 May 1, 2003, the retail drug storesegment operated 459 stores and one mail order pharmacy in six western statesunder the names Longs, Longs Drugs, Longs Drug Stores, Longs Pharmacy andAmerican Diversified Pharmacies.**

###### ** **

###### **ThePBM segment, operated through the Company’s RxAmerica subsidiary, contractswith drug manufacturers, third-party health plans and retail pharmacies toprovide a range of services to third-party health plan members, includingpharmacy benefit plan design and implementation, formulary management, claimsprocessing and generic substitution.**

 

The following table summarizes significant financial information bysegment as of and for the 13 weeks ended May 1, 2003 and May 2, 2002:

 

|                 |   | **Retail  Drug  Stores** |      | **Pharmacy  Benefit  Management** |   | **Inter-  Segment  Eliminations** |   | **Consolidated  Totals** |   |
|----------------------|--------|--------------------------|-----------|-----------------------------------|--------|-----------------------------------|--------|--------------------------|--------|
|                 |   | **Thousands**            |      |
| **13  weeks ended:** |   |                     |      |                              |   |                              |   |                     |   |
| **May 1,  2003:**    |   |                     |      |                              |   |                              |   |                     |   |
| Sales                |   | $                        | 1,096,537 |                              | $      | 6,593                             |   | $                        | — |   | $ | 1,103,130 |   |
| Operating income     |   | 9,753                    |      | 3,038                             |   | —                            |   | 12,791                   |   |
| **May 2,  2002:**    |   |                     |      |                              |   |                              |   |                     |   |
| Sales                |   | $                        | 1,084,714 |                              | $      | 5,115                             |   | $                        | — |   | $ | 1,089,829 |   |
| Operating income     |   | 18,694                   |      | 1,856                             |   | —                            |   | 20,550                   |   |
|                 |   |                     |      |                              |   |                              |   |                     |   |
| **Total  assets:**   |   |                     |      |                              |   |                              |   |                     |   |
| May 1, 2003          |   | $                        | 1,297,616 |                              | $      | 51,754                            |   | $                        | (1,559 | ) | $ | 1,347,811 |   |
| May 2, 2002          |   | 1,280,381                |      | 33,849                            |   | (505                              | )      | 1,313,725                |   |
| January 30, 2003     |   | 1,299,967                |      | 53,710                            |   | (1,606                            | )      | 1,352,071                |   |

 

8

----

 

Consolidated total sales include the following product and servicetypes:

 

|                                  |   | **13 weeks ended** |      |
|---------------------------------------|--------|--------------------|-----------|
|                                  |   | **May 1,  2003**   |      | **May 2,  2002** |   |
|                                  |   | **Thousands**      |      |
| Pharmacy sales                        |   | $                  | 514,229   |   | $ | 497,960 |   |
| Front-end sales                       |   | 582,308            |      | 586,754 |   |
| Pharmacy benefit  management revenues |   | 6,593              |      | 5,115 |   |
| Consolidated total  sales             |   | $                  | 1,103,130 |   | $ | 1,089,829 |   |

 

9

----

 

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

 

*This quarterly report contains certain forward-lookingstatements within the meaning of Section 27A of the Securities Act and Section21E of the Securities Exchange Act. Such statements relate to, among other things, pharmacy and front-endsales trends, prescription margins, margin improvement, cost reductions,changes in supply chain practices, inflation rates, workers’ compensationcosts, the number of store openings and the level of capital expenditures, andare indicated by words or phrases such as “continuing,” “expects,” “estimates,”“believes,” “plans,” “anticipates,” “will,” and other similar words orphrases.  These statements are based onour current plans and expectations and involve risks and uncertainties thatcould cause actual events and results to vary materially from those included inor contemplated by such statements. These risks and uncertainties include, but are not limited to, amongother things, changes in economic conditionsgenerally or in the markets we serve; consumer preferences and spendingpatterns; economic softness and unemployment; the impact of state budgetdeficits on government healthcare spending and economic conditions generally;competition from other drugstore chains, supermarkets, on-line retailers, otherretailers and mail order companies; changes in state or federal legislation or regulations;the efforts of third-party payers to reduce prescription drug costs; thesuccess of planned advertising and merchandising strategies; the availabilityand cost of real estate for, and construction of, new stores; accountingpolicies and practices; our ability to hire and retain pharmacists and otherstore and management personnel; our relationships with our suppliers; ourability to improve our purchasing of front-end products; our ability tosuccessfully implement new computer systems and technology; our ability toobtain adequate insurance coverage; the effect of war and terrorism on economicconditions and consumer spending patterns; the impact of rising 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** |      |
|-------------------------------------------------------|--------|--------------------|-----------|
|                                                  |   | **May 1,  2003**   |      | **May 2,  2002** |   |
|                                                  |   |               |      |   |   |
| Sales *(Thousands)*                                   |   | $                  | 1,103,130 |   | $ | 1,089,829 |   |
| Sales Growth over Same  Period in Previous Year       |   | 1.2                | %         | 5.6 | % |
| Same-Store Sales  (Decline) Growth                    |   | (0.8               | )%        | 4.3 | % |
| Impact of New  Stores/Closed Stores on Sales Growth   |   | 1.9                | %         | 0.8 | % |
| Impact of PBM Revenues  on Sales Growth               |   | 0.1                | %         | 0.5 | % |
|                                                  |   |               |      |   |   |
| Pharmacy Sales Growth                                 |   | 3.3                | %         | 9.2 | % |
| Same-Store Pharmacy Sales  Growth                     |   | 1.8                | %         | 8.4 | % |
| Pharmacy as a % of  Total Drug Store Sales            |   | 46.9               | %         | 45.9 | % |
| % of Pharmacy Sales  Paid by Third Party Health Plans |   | 91.0               | %         | 90.6 | % |
|                                                  |   |               |      |   |   |
| Front-End Sales  (Decline) Growth                     |   | (0.8               | )%        | 1.9 | % |
| Same-Store Front-End  Sales (Decline) Growth          |   | (2.9               | )%        | 1.0 | % |
| Front-End as a % of  Total Drug Store Sales           |   | 53.1               | %         | 54.1 | % |
|                                                       |        |                    |           |  |  |  |  |

 

Sales increased 1.2% inthe first quarter of fiscal 2004 over the same quarter of fiscal 2003.  Growth in the number of stores accounted fora sales increase of 1.9%, offset by a 0.8% decrease in same-store sales.  Growth in revenues at RxAmerica, ourpharmacy benefit management (“PBM”) subsidiary, contributed the remaining 0.1%of total sales growth in the quarter.

 

Pharmacy sales in thefirst quarter of fiscal 2004 increased 3.3% over the same quarter last year,with same-store pharmacy sales increasing 1.8%.  Pharmacy sales were 46.9% of total drug store sales in the firstquarter of fiscal 2004, compared to 45.9% in the first quarter of fiscal2003.  We expect pharmacy sales to continueto

 

10

----

 

increase as a percentageof total drug store sales as pharmacy sales continue to increase faster thanfront-end sales.

 

Sluggish economic growth,a mild cold and flu season and a delayed allergy season on the West Coastcontributed to a 2.1% decrease in our prescription volumes in the first quarterof fiscal 2004.  The conversion of theallergy drug Claritin from prescription to over-the-counter status, healthconcerns over women’s hormone replacement therapy drugs, and higher patientco-payments under some insurance plans also had a negative impact onprescription volumes.

 

The average retail priceper prescription increased 5.5% over the first quarter of fiscal 2003.  This increase was lower than in previousyears primarily due to the recent introduction of several lower-pricedhigh-volume generic drugs.  Increasedgeneric utilization negatively impacted same-store pharmacy sales byapproximately 2.2% in the first quarter of fiscal 2004.  We expect generic utilization to continue tobe significant, although we also expect that average retail prices forprescription drugs will continue to rise.

 

Third-party health planscovered 91.0% of our pharmacy sales in the first quarter of fiscal 2004, comparedto 90.6% in the first quarter of fiscal 2003. We expect third-party sales to remain above 90% of our total pharmacysales due to significant consumer participation in managed care and otherthird-party plans.

 

Front-end sales decreased0.8% over the same quarter last year, with same-store front-end salesdecreasing 2.9%.  Economic weakness andhigh unemployment, particularly in California, continued to adversely affectour front-end sales.  Uncertaintiesrelated to the war in Iraq, which began in the first quarter of fiscal 2004,also had a negative effect on our front-end sales.

 

***Gross Profit***

 

|                          |   | **13 weeks ended** |    |
|-------------------------------|--------|--------------------|---------|
|                          |   | **May 1,  2003**   |    | **May 2,  2002** |   |
|                          |   |               |    |   |   |
| Gross Profit *(Thousands)*    |   | $                  | 285,107 |   | $ | 276,028 |   |
| Gross Profit as a % of  Sales |   | 25.8               | %       | 25.3 | % |
| LIFO Provision *(Thousands)*  |   | $                  | 2,000   |   | $ | 1,700 |   |

 

Grossprofit was 25.8% of sales in the first quarter of fiscal 2004, compared to25.3% in the same quarter last year. Pharmacy gross profits benefited from better buying practices andopportunities in the quarter.  Theincreased usage of generic drugs, which generally have higher gross profitpercentages than name-brand drugs, also contributed to higher pharmacy grossprofit percentages. We expect generic utilization to continue to besignificant.  Front-end gross profitsalso benefited from better buying practices and opportunities resulting fromour progress in centralizing procurement and promotion as part of our initiativeto upgrade our supply chain practices.

 

Over90% 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.  Pharmacy sales also have lowergross profit percentages than front-end sales, and as pharmacy sales continueto grow as a percent of total sales, overall gross profit percentages will beadversely impacted.

 

Our promotional salesincreased as a percentage of total front-end sales in the first quarter offiscal 2004 over the same quarter last year. Promotional sales have a lower gross profit than non-promotional sales.  We expect that our promotional sales willcontinue to be a significant portion of our total front-end sales in light ofpersistent softness in the economy and promotional activities by ourcompetitors, resulting in pressure on our front-end gross profits.

 

Our gross profit includedLIFO provisions of $2.0 million in the first quarter of fiscal 2004 and $1.7million in the first quarter of fiscal 2003, included in cost of sales.  The LIFO provision fluctuates with inflationrates, inventory levels and merchandise mix. We estimate LIFO costs for interim financial statements based on

 

11

----

 

projected annualinflation rates, inventory levels, and merchandise mix.  We calculate actual LIFO costs during thefourth quarter of the fiscal year when we determine final inflation rates,inventory levels, and merchandise mix.

 

In the first quarter offiscal 2004, we began classifying advertising expenses as a component of costof sales.  Previously, we classifiedadvertising expense as a component of operating and administrativeexpenses.  We reclassified results forthe first quarter of fiscal 2003 to conform to this new presentation, resultingin a $5.7 million decrease in previously reported gross profit and an offsettingdecrease in previously reported operating and administrative expenses, with noeffect on reported net income.

 

***Operating and Administrative Expenses***

 

Operating andadministrative expenses were 22.7% of sales in the first quarter of fiscal2004, compared to 21.7% in the same quarter last year.  In February 2003, we announced a series ofsteps designed to reduce our operating and administrative expenses as a percentof sales in the future.  These stepsincluded a reduction of our administrative workforce by approximately 170people in our California offices, the closure of certain support facilities,store labor savings through workflow and staffing changes and a restructuringof our incentive compensation arrangements. Operating and administrative expenses in the first quarter of fiscal 2004include a charge of $3.4 million, or 0.3% of sales, for the related employeetermination and facility closure costs.

 

Insurance-relatedexpenses, primarily workers’ compensation, increased $3.9 million, or 0.4% ofsales, in the first quarter of fiscal 2004 over the same quarter lastyear.  The increase in workers’compensation expenses was primarily due to regulatory changes in our principalmarkets and higher health care costs, particularly in California.  We expect that rising medical costs andchanges in the regulatory environment will continue to drive workers’compensation claim costs higher in the near future.  However, we are continuing to develop our existing workplacesafety practices in an effort to partially mitigate this increase in costs overtime by reducing the number of workers’ compensation claims.

 

As previously noted, theincreased usage of lower-priced generic drugs had a negative impact on oursales.  This in turn resulted in higheroperating and administrative expenses when measured as a percent of sales, butincreased gross profit percentages.  Weestimate that the higher generic utilization resulted in an increase ofapproximately 0.2% in operating and administrative expenses as a percent of salesin the first quarter of fiscal 2004 compared to the same quarter last year.

 

The remainder of theincrease in operating and administrative expenses as a percentage of sales wasprimarily due to costs for certain consulting projects relating to operationalprocess improvements and increased debit and credit card processing fees,partially offset by a $1.0 million net gain on the disposition of certainproperties.

 

***Depreciation and Amortization***

 

Depreciation andamortization expenses were $21.8 million in the first quarter of fiscal 2004,compared to $18.9 million in the first quarter of fiscal 2003.  Depreciation and amortization in the firstquarter of fiscal 2004 included $2.6 million of accelerated depreciation forthe planned abandonment of a pharmacy information system.  We expect to phase this system out ofoperation by the end of the second quarter of fiscal 2004.  As a result, we will depreciate the system’sremaining $2.8 million of net book value in the second quarter of fiscal 2004.  Of this $2.8 million, approximately $2.6million represents an acceleration of depreciation over last year’s levels.

 

The remainder of theincrease in depreciation and amortization was primarily due to increaseddepreciation expense resulting from capital expenditures for new storeinvestments, improvements to existing stores, supply chain improvements andtechnology.

 

12

----

 

***Net Interest Expense***

 

Net interest expense was$3.4 million in the first quarter of fiscal 2004, compared to $3.0 million inthe same quarter last year.  Theincrease was due to higher average borrowings, partially offset by lowerinterest rates.

 

***Income Taxes***

 

Our effective income taxrate was 37.6% in the first quarters of fiscal 2004 and fiscal 2003. We expectour effective income tax rate to be 37.6% for the remainder of fiscal 2004.

 

***Cumulative Effect of Accounting Change***

 

As a result of adoptingSFAS No. 142, *Goodwill and Other Intangible Assets*, we recognized agoodwill impairment charge of $41.0 million ($24.6 million after tax or $0.65per diluted share) in the first quarter of fiscal 2003 as the cumulative effectof a change in accounting principle.

 

**LIQUIDITY AND CAPITAL RESOURCES**

 

***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 unsecuredrevolving line of credit with a syndication of banks, which expires in October2004 and accrues interest at LIBOR-based rates.  On May 9, 2003, we exercised an option to increase the borrowingcapacity of this credit facility resulting in a $45 million increase to a totalcapacity of $195 million.  Borrowings onthe line of credit do not require repayment until the expiration date.  As of May 1, 2003, $60.0 million wasoutstanding under this line of credit with a weighted average interest rate of2.57%.

 

Additionally, as of May1, 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 repaymentprior to their scheduled maturities.

 

Our debt agreementscontain limits on borrowings and repurchases of company stock, and variousquarterly financial covenants that set maximum leverage ratios and minimumfixed charge and asset coverage ratios. During the first quarter of fiscal 2004, we amended our unsecured revolvingline of credit agreement to revise certain financial covenants and limitationsand increase our maximum allowable repurchases of company stock.  As of May 1, 2003, we were in compliancewith the restrictions and limitations included in these provisions.

 

We believe that cash onhand, together with cash provided by operating activities and borrowings on ourline of credit, will be sufficient to meet our working capital, capitalexpenditure and debt service requirements beyond the next 12 months.

 

***Operating Cash Flows***

 

Net cash provided byoperating activities was $30.7 million in the first quarter of fiscal 2004,compared to net cash used in operating activities of $32.2 million in the firstquarter of fiscal 2003.  The increase inoperating cash flows was primarily due to changes in inventories and currentliabilities.

 

During the first quarterof fiscal 2004, inventories decreased $14.6 million from the end of fiscal2003,primarily due to seasonal factors. Lower store inventories were partially offset by higher distributioncenter inventories as we increased the number of products carried in ourdistribution centers and the number of stores they serve.  Average LIFO inventories per store decreasedfrom $975,000 to $934,000, or 4.1% (2.9% excluding LIFO reserves).

 

13

----

 

During the first quarterof fiscal 2004, current liabilities decreased $20.6 million compared to the endof fiscal 2003.  The decrease wasprimarily due to a $33.2 million reduction in taxes payable reflecting thetiming of payment of income and sales taxes during the first quarter, offset bya $12.0 million increase in accounts payable due to the timing of payments toour vendors.

 

During the first quarterof fiscal 2003, inventories increased $9.9 million compared to the end offiscal 2002,  partially due to thegrowth in the number of our stores, in addition to forward purchases ofmerchandise in order to take advantage of favorable pricing opportunities.

 

During the first quarterof fiscal 2003, current liabilities decreased $57 million compared to the endof fiscal 2002.  The decrease was due tothe payment of income and sales taxes as well as the resolution of a paymentdispute with a vendor that resulted in the payment of amounts during the firstquarter of fiscal 2003 that were in accounts payable as of the end of fiscal2002.

 

Working capital, definedas current assets less current liabilities, was $248.7 million as of May 1,2003 and $238.8 million as of May 2, 2002. We plan to reduce our working capital by approximately $50 million on anequivalent-store basis by the end of fiscal 2004.  We expect working capital reductions primarily in our front-endinventories through reduced assortment and improved replenishment andrestocking processes.

 

***Investing Cash Flows***

 

Net cash used ininvesting activities was $29.6 million in the first quarter of fiscal 2004,compared to $18.0 million in the first quarter of fiscal 2003.  Investing activities primarily consist ofcapital expenditures for new stores, store improvements, technology and supplychain improvements, partially offset by cash receipts from propertydispositions.  In the first quarter offiscal 2004, investing cash outflows also included the acquisition of AmericanDiversified Pharmacies (ADP), a mail service pharmacy.

 

We opened 4 new stores inthe first quarter of fiscal 2004 compared to 7 new stores, offset by 4 closedstores, in the same period last year. We plan to open approximately 15 to 20 new stores and to remodel approximately20 existing stores in fiscal 2004.  Weexpect net capital expenditures in fiscal 2004 to be approximately $110million, primarily for new store investments, remodels and improvements toexisting stores, technology and supply chain improvements, includingexpenditures under the supply chain program discussed further below.  In addition, in the ordinary course ofbusiness we may acquire stores, store-related assets including pharmacycustomer lists, or other complementary businesses.

 

In February 2002, our boardof directors approved a program for upgrading our supply chain practices in aneffort to increase efficiency and enhance profitability.  In fiscal 2004 and 2005 we expect to spend atotal of approximately $30 million in capital expenditures for supply chainimprovements under this program.  Todate we have spent approximately $16 million in capital expenditures under thisprogram.

 

***Financing Cash Flows***

 

Net cash provided byfinancing activities was $7.5 million in the first quarter of fiscal 2004, comparedto net cash used in financing activities of $12.6 million in the first quarterof fiscal 2003.  Our financingactivities primarily consist of long-term borrowings and repayments,repurchases of common stock and dividend payments.

 

In the first quarter offiscal 2004, proceeds from borrowings on our unsecured revolving line of creditwere $35 million.  We used theseborrowings, together with cash flows from operations, to finance capitalexpenditures,  stock repurchases anddividend payments.  We also repaid $2.2million of long-term borrowings, consisting primarily of regularly scheduledprincipal payments on our private placement notes.  In the first quarter of fiscal 2003, we repaid $7.3 million oflong-term borrowings, including a $5.0 million reduction of our line of creditborrowings and regularly scheduled principal payments of $2.2 million,primarily on our private placement notes.

 

In February and March2003, we repurchased 853,100 shares of our common stock at a total cost of$12.0 million to complete a share repurchase program authorized by our board ofdirectors in November 1999.  In March2003, our board of directors authorized the repurchase of up to 2,000,000additional shares of our

 

14

----

 

common stock throughJanuary 2008, for a maximum total expenditure of $50 million.  We repurchased 509,100 shares under the newauthorization 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 directorsmakes decisions about the declaration of quarterly dividends after reviewingour results of operations and financial position.  We paid regular quarterly dividends of $0.14 per share ($5.3million) in the first quarters of fiscal 2004 and 2003.

 

**RISK FACTORS**

 

You should carefully read the following riskfactors.

 

**The retail drug store and pharmacy benefit managementindustries are highly competitive, and further increases in competition couldadversely affect us.**

 

We face intense competition with local,regional and national companies, including other drug store chains, independentdrug stores, mail order pharmacies, on-line retailers, supermarket chains and,increasingly, mass merchandisers.  Inthe PBM industry, our competitors include large national and regional PBMs,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.

 

**Ourability to successfully implement significant organizational changes, includingsupply chain improvements, is critical to the ongoing success of our business.**

 

Weare currently undertaking significant organizational changes, including storeworkflow and staffing changes, increased centralization, restructured incentivecompensation arrangements and other strategic initiatives.  In addition, in February 2002 our board ofdirectors approved a program to upgrade our supply chain practices in an effortto increase efficiency and enhance profitability.  In fiscal 2004 and 2005 we expect to spend in total approximately$30 million in capital expenditures for supply chain improvements under thisprogram.  To date we have spentapproximately $16 million in capital expenditures under this program.  Our ability to successfully implement theseorganizational changes, which are significant to our operations and businesspractices, is critical to our future profitability.  We cannot assure you that we will be able to execute theseinitiatives 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 improvements and initiatives.

 

**Changes in third-party reimbursement levels forprescription drugs continue to reduce our margins on pharmacy sales and couldhave a material adverse effect on our overall performance.**

 

We are wholly or partially reimbursed bythird-party health plans for over 90% of all the prescription drugs that wesell.  Pharmacy sales reimbursed bythird parties, including Medicare and Medicaid plans, have lower gross marginsthan non third-party pharmacy sales. Third-party health plans continue to reduce the levels at which theyreimburse us for the prescription drugs that we provide to their members.  Furthermore, Medicare reform initiatives mayinclude prescription drug benefits.  Ifthird-party health plans continue to reduce their reimbursement levels, or ifMedicare covers prescription drugs at reimbursement levels lower than ourcurrent retail prices, our margins on these sales will continue to be reduced,and our profitability will be adversely affected.

 

15

----

 

**Continued economic softness could adversely affectconsumer-buying practices and reduce our sales and profitability.**

 

A sluggish economy has adversely affected our sales and operatingprofitability for the past two fiscal years. The economy is very soft in many of the markets we serve, particularlyCalifornia, and consumer confidence is low. 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.

 

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

 

Ourindustry is continuing to experience a shortage of licensed pharmacists in themarkets in which we operate.  Ourinability to attract and retain pharmacists and other key personnel couldadversely affect us.  In order tomitigate this risk we entered into a joint venture agreement withAmerisourceBergen to operate a central prescription fill center.  The success of this fill center, whichcannot be assured, is important to our ability to address the shortage of pharmacists,but additional efforts may be necessary to address this business issue.  Other options may be costly or unavailableto us.  Further, a significantdisruption in our fill center’s operations could worsen the effects of thepharmacist shortage and adversely affect our business.

 

**We are substantially dependent on a single supplier ofpharmaceutical products to sell products to us on satisfactory terms.  A disruption in our relationship with thissupplier could have a material adverse effect on our business.**

 

We obtain approximately half of our total merchandise, including over 90%of our pharmaceuticals, from a single supplier, AmerisourceBergen, with whom wehave a long-term supply contract.  Anysignificant disruptions in our relationship with AmerisourceBergen, ordeterioration in AmerisourceBergen’s financial condition, could have a materialadverse effect on us.

 

**We are subjectto governmental regulations, procedures and requirements.  Our noncompliance with, or a significantchange in, these regulations could have a material adverse effect on us.**

 

Our pharmacy business is subject to numerous federal, state and localregulations, many of which are new and developing.  These include local registrations of pharmacies in the stateswhere our pharmacies are located, applicable Medicare and Medicaid regulations,and prohibitions against paid referrals of patients.  In addition, the Health Insurance Portability and AccountabilityAct (“HIPAA”) imposes certain requirements regarding the protection of confidentialpatient medical 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 otherapplicable regulations 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 providing pharmacyservices, and our insurance may not be adequate to cover any claims against us.**

 

Pharmacies are exposed to risks inherent inthe packaging and distribution of pharmaceuticals and other healthcareproducts.  Although we maintain professionalliability and errors and omissions liability insurance, we cannot assure youthat the coverage limits under our insurance programs will be adequate toprotect us against future claims, or that we will be able to maintain thisinsurance on acceptable terms in the future.

 

16

----

 

**Continued volatility in insurance related expenses andthe markets for insurance coverage could have a material adverse affect on us.**

 

The costs of employee health, workers’compensation, property and casualty, general liability, director and officerand other types of insurance have continued to rise, while the amount andavailability of coverage have decreased. Claims costs for workers’ compensation and other self-insured exposureshave also increased.  In the firstquarter of fiscal 2004, for example, our insurance-related expenses, primarilyworkers’ compensation, increased $3.9 million, or 0.4% of sales, over the samequarter last year.  These conditionshave been exacerbated by rising health care costs, legislative changes,economic conditions and terrorism.  Ifour insurance related costs continue to increase significantly, or if we areunable to obtain adequate levels of insurance, our financial position andresults of operations could be adversely affected.

 

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

 

Ourstores, distribution centers and corporate offices are located in the westernUnited States.  Risks prevalent in thisregion include, but are not limited to, major earthquakes, periodic energyshortages and rising energy costs, and shipping and othertransportation-related disruptions.  Forexample, last year’s work stoppage at California ports caused us to purchaseinventory for the holiday season before we otherwise would have done so.  Because of our geographic concentration,these risks could result in significant disruptions to our business orincreased operating expenses.

 

**Item 3****.  *Quantitative and Qualitative Disclosures of MarketRisk***

 

Our major marketrisk exposure is changing interest rates. We use debt financing in combination with operating cash flows tosupport capital expenditures, acquisitions, working capital needs and generalcorporate purposes.  A portion of ourdebt ($60 million as of May 1, 2003) bears interest at LIBOR-based rates, andtherefore an increase in interest rates could increase our interestexpense.  We do not currently undertakeany specific actions to cover our exposure to interest rate risk and we are notcurrently a party to any interest rate risk management transactions.  We have not purchased and do not currentlyhold any derivative financial instruments. Depending on the interest rate environment and subject to approval byour board of directors, we may make use of derivative financial instruments orother interest rate management vehicles in the future.

 

A 10% change ininterest rates (26 basis points on our floating-rate debt as of May 1, 2003)would have an immaterial effect on our earnings and cash flows and on the fairvalue of our 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.

 

Within 90 days prior tothe date of this report, the Company carried out an evaluation, under thesupervision and with the participation of the Company’s management, includingthe Company’s Chief Executive Officer and the Company’s Chief FinancialOfficer, of the effectiveness of the design and operation of the Company’sdisclosure controls and procedures.  Basedon that evaluation, the Company’s Chief Executive Officer and Chief FinancialOfficer concluded that the Company’s disclosure controls and procedures wereeffective.

 

There have been nosignificant changes in the Company’s internal controls or in other factors thatcould significantly affect the internal controls subsequent to the date theCompany completed its evaluation.

 

17

----

 

# **PART II** – OTHERINFORMATION

 

### **Item 6**.                                   Exhibits and Reports on Form 8-K

 

(a)                                  Exhibits

 

Exhibit 10.1:  Separation agreement between the Company andTerry D. Burnside, Senior Vice President and Chief Operating Officer, datedMarch 26, 2003.

 

Exhibit 10.2:  Employment agreement between the Company andMichael M. Laddon, Senior Vice President, Chief Information Officer, dated February25, 2003.

 

Exhibit 10.3:Employment agreement between the Company and William J. Rainey, Senior VicePresident, General Counsel, dated March 18, 2003.

 

Exhibit 10.4:  Second Amendment to the Amended and RestatedCredit Agreement between the Company and the lenders thereunder, dated April30, 2003.

 

Exhibit 99.1:  Certification of the Chief Executive Officerof Longs Drug Stores Corporation, pursuant to Section 906 of the Sarbanes-OxleyAct of 2002. *

 

Exhibit 99.2:  Certification of the Chief Financial Officerof Longs Drug Stores Corporation, pursuant to Section 906 of the Sarbanes-OxleyAct of 2002. *

 

----

*  These certifications are being furnishedsolely to accompany this quarterly report pursuant to 18 U.S.C. §1350, and arenot being filed for purposes of Section 18 of the Securities Exchange Act of1934, as amended, and are not to be incorporated by reference to any filing ofthe Company, whether made before or after the date hereof, regardless of anygeneral incorporation language in such filing.

 

(b)                                 Reportson Form 8-K

 

On February 14,2003, we filed a Current Report on Form 8-K regarding our fourth quarter andfiscal year 2003 financial projections.

 

On February 26,2003, we filed a Current Report on Form 8-K regarding our fourth quarter and fiscalyear 2003 financial results and fiscal 2004 financial projections.

 

On March 7, 2003,we filed a Current Report on Form 8-K regarding our February 2003 salesresults.

 

On March 20, 2003,we filed a Current Report on Form 8-K announcing a new share repurchase programauthorized by our board of directors.

 

On April 15, 2003,we filed a Current Report on Form 8-K regarding our March 2003 sales results.

 

On May 13, 2003,we filed a Current Report on Form 8-K regarding our April 2003 sales results.

 

On May 19, 2003,we filed a Current Report on Form 8-K regarding our first quarter of fiscal2004 financial results and second quarter and full year fiscal 2004 financialprojections.

 

18

----

 

**SIGNATURES**

 

                Pursuant to the requirements of the Securities andExchange Act of 1934, the registrant has duly caused this report to be signedon its behalf by the undersigned, thereunto duly authorized.

 

 
|   |          |   | LONGS DRUG  STORES CORPORATION                                                                                                                                        |
|--------|---------------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |          |   | *(Registrant)*                                                                                                                                                        |
|   |          |   |                                                                                                                                                                  |
|   |          |   |                                                                                                                                                                  |
| Date:  | June 16, 2003 |   |       /s/  S. F. McCann                                                                                                                 |
|   |          |   |       (S.  F. McCann)                                                                                                                   |
|   |          |   |       *Senior Vice President, Chief Financial Officer and  Treasurer*                                                                   |
|   |          |   |                                                                                                                                                                  |
|   |          |   |                                                                                                                                                                  |
| Date:  | June 16, 2003 |   |       /s/  R. L. Chelemedos                                                                                                             |
|   |          |   |       (R.  L. Chelemedos)                                                                                                               |
|   |          |   |       *Vice President – Controller and Assistant Secretary*        *(Principal  Accounting Officer)* |

 

19

----

 

**Certification****of ChiefExecutive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002**

 

I, Warren F. Bryant,certify that:

 

1.  I have reviewed this quarterly report onForm 10-Q of Longs Drug Stores Corporation;

 

2.  Based on my knowledge, this quarterly reportdoes not contain any untrue statement of a material fact or omit to state amaterial fact necessary to make the statements made, in light of thecircumstances under which such statements were made, not misleading withrespect to the period covered by this quarterly report;

 

3.  Based on my knowledge, the financialstatements, and other financial information included in this quarterly report,fairly present in all material respects the financial condition, results ofoperations and cash flows of the registrant as of, and for, the periodspresented in this quarterly report;

 

4.  The registrant’s other certifying officerand I are responsible for establishing and maintaining disclosure controls andprocedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for theregistrant and we have:

 

a) designed suchdisclosure controls and procedures to ensure that material information relatingto the registrant, including its consolidated subsidiaries, is made known to usby others within those entities, particularly during the period in which thisquarterly report is being prepared;

 

b) evaluated theeffectiveness of the registrant’s disclosure controls and procedures as of adate within 90 days prior to the filing date of this quarterly report (the“Evaluation Date”); and

 

c) presented in thisquarterly report our conclusions about the effectiveness of the disclosurecontrols and procedures based on our evaluation as of the Evaluation Date;

 

5.  The registrant’s other certifying officerand I have disclosed, based on our most recent evaluation, to the registrant’sauditors and the audit committee of the registrant’s board of directors (orpersons performing the equivalent function):

 

a)  all significant deficiencies in the designor operation of internal controls which could adversely affect the registrant’sability to record, process, summarize and report financial data and haveidentified for the registrant’s auditors any material weaknesses in internalcontrols; and

 

b) any fraud, whether ornot material, that involves management or other employees who have asignificant role in the registrant’s internal controls; and

 

6.  The registrant’s other certifying officerand I have indicated in this quarterly report whether or not there weresignificant changes in internal controls or in other factors that couldsignificantly affect internal controls subsequent to the date of our mostrecent evaluation, including any corrective actions with regard to significantdeficiencies and material weaknesses.

 

 
| Date:  June 16, 2003 | /s/ Warren F. Bryant                   |   |
|----------------------|----------------------------------------|--------|
|                 | Warren F. Bryant                       |
|                 | President and Chief  Executive Officer |

 

A signed original of thiswritten statement required by Section 302 has been provided to Longs DrugStores Corporation and will be retained by Longs Drug Stores Corporation andfurnished to the Securities and Exchange Commission or its staff upon request.

 

20

----

 

**Certification of Chief FinancialOfficer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002**

 

I, Steven F. McCann,certify that:

 

1.  I have reviewed this quarterly report onForm 10-Q of Longs Drug Stores Corporation;

 

2.  Based on my knowledge, this quarterly reportdoes not contain any untrue statement of a material fact or omit to state amaterial fact necessary to make the statements made, in light of thecircumstances under which such statements were made, not misleading withrespect to the period covered by this quarterly report;

 

3.  Based on my knowledge, the financialstatements, and other financial information included in this quarterly report,fairly present in all material respects the financial condition, results ofoperations and cash flows of the registrant as of, and for, the periodspresented in this quarterly report;

 

4.  The registrant’s other certifying officerand I are responsible for establishing and maintaining disclosure controls andprocedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for theregistrant and we have:

 

a) designed suchdisclosure controls and procedures to ensure that material information relatingto the registrant, including its consolidated subsidiaries, is made known to usby others within those entities, particularly during the period in which thisquarterly report is being prepared;

 

b) evaluated theeffectiveness of the registrant’s disclosure controls and procedures as of adate within 90 days prior to the filing date of this quarterly report (the“Evaluation Date”); and

 

c) presented in thisquarterly report our conclusions about the effectiveness of the disclosurecontrols and procedures based on our evaluation as of the Evaluation Date;

 

5.  The registrant’s other certifying officer andI have disclosed, based on our most recent evaluation, to the registrant’sauditors and the audit committee of the registrant’s board of directors (orpersons performing the equivalent function):

 

a)  all significant deficiencies in the designor operation of internal controls which could adversely affect the registrant’sability to record, process, summarize and report financial data and haveidentified for the registrant’s auditors any material weaknesses in internalcontrols; and

 

b) any fraud, whether ornot material, that involves management or other employees who have asignificant role in the registrant’s internal controls; and

 

6.  The registrant’s other certifying officerand I have indicated in this quarterly report whether or not there were significantchanges in internal controls or in other factors that could significantlyaffect internal controls subsequent to the date of our most recent evaluation,including any corrective actions with regard to significant deficiencies andmaterial weaknesses.

 

 
| Date:  June 16, 2003 | /s/ Steven F. McCann                                           |   |
|----------------------|----------------------------------------------------------------|--------|
|                 | Steven F. McCann                                               |
|                 | Senior Vice President,  Chief Financial Officer  and Treasurer |

 

A signed original of thiswritten statement required by Section 302 has been provided to Longs DrugStores Corporation and will be retained by Longs Drug Stores Corporation andfurnished to the Securities and Exchange Commission or its staff upon request.

 

21

----