| LONGS DRUG STORES CORP Item 1A Risk Factors You should carefully read the following risk factors |
| If we are unable to successfully execute our strategic initiatives and the related organizational changes, our future productivity and profitability may be adversely affected |
| We are currently undertaking a series of strategic initiatives designed to make Longs a stronger competitor and more profitable company |
| These initiatives address several core elements of our operations, including our supply chain, front-end sales, pharmacy profitability, customer service and operational processes, and involve significant organizational change |
| Such organizational changes are complex and could cause disruptions that would adversely affect our revenues and profitability |
| Our ability to successfully implement these changes, which are significant to our operations and business, is critical to our future profitability |
| If we are not successful, we may not achieve the expected benefits from these initiatives, despite having expended significant capital and human effort |
| Furthermore, we may encounter difficulties implementing this amount of change in our organization that could have a negative impact on our implementation plans and project budgets |
| If the construction of and transition to our new front-end distribution center is not successful, our retail drug store sales and profitability could be adversely affected |
| We are currently constructing an 800cmam000 square foot distribution facility for front-end merchandise in Patterson, California, scheduled for completion in the summer of fiscal 2007 |
| If we are unable to successfully complete construction of this facility on a timely basis, to transition hundreds of front-end vendors to direct supplier relationships, or successfully implement the necessary systems and process changes associated with the transition to the new facility, our supply chain could experience significant disruptions |
| Such disruptions could adversely affect our retail drug store sales and increase our cost of sales and operating and administrative expenses |
| We may also determine that additional investment of time or money is required to successfully complete the transition to this new facility |
| If our new prescription drug plans do not generate the anticipated revenues or profitability, our financial results could be adversely affected |
| Effective January 1, 2006, through our pharmacy benefit services subsidiary, we began offering three prescription drug plans that provide prescription drug benefits under the Medicare Prescription Drug, Improvement and Modernization Act of 2003 |
| Because this is a new federally subsidized benefit and we have not previously offered such plans, it is difficult to predict the revenues and profitability of this new business |
| If the revenues we generate from providing these benefits are not sufficient to cover the related prescription drug costs, our profitability will be adversely affected |
| Furthermore, these plans are subject to annual bidding and regulatory approval |
| Changes in legislative, regulatory or competitive conditions could affect our ability to continue to offer prescription drug plans or to generate profitable prescription drug plan revenues |
| Changes in economic conditions could adversely affect consumer buying practices and reduce our revenues and profitability |
| Our performance is affected by economic conditions such as overall economic growth and unemployment, especially in California, our primary market |
| Higher gasoline prices have also had a significant impact on consumer spending in our markets |
| Deterioration in economic conditions, particularly in California, could adversely affect our revenues and profitability |
| For example, an increase in unemployment could cause consumers to lose their health insurance, which could in turn adversely affect our pharmacy sales |
| Further, a decrease in overall consumer spending as a result of changes in economic conditions could adversely affect our front-end sales |
| Our profit margins are higher on our front-end sales than our pharmacy sales and therefore any decrease in our sales of front-end products would have a disproportionate negative impact on our profitability |
| 6 ______________________________________________________________________ [33]Table of Contents The retail drug store and pharmacy benefit services industries are highly competitive and further increases in competition could adversely affect us |
| We face intense competition with local, regional and national companies, including other drug store chains, independent drug stores, on-line retailers, supermarket chains and mass merchandisers, many of whom are aggressively expanding in markets we serve |
| In addition, competition from mail order pharmacies is rapidly intensifying, and some third-party health plans require mail-order fulfillment of certain medications |
| In the pharmacy benefit services industry, our competitors include large national and regional pharmacy benefit managers and insurance companies and managed care providers, some of which are owned by or have affiliations with our retail drug store competitors |
| Many of our competitors have substantially greater resources, including name recognition and capital resources, than we do |
| As competition increases in the markets in which we operate, a significant increase in general pricing pressures could occur, which could require us to reduce prices, purchase more effectively and increase customer service to remain competitive |
| We may not be able to continue to compete effectively in our markets or increase our revenues or margins in response to further increased competition |
| Reductions in third-party, including government, reimbursement levels for prescription drugs continue to reduce our margins on pharmacy sales and could have a significant effect on our retail drug store sales and gross profits |
| Third-party health plans cover more than 90prca of all the prescription drugs that we sell |
| Pharmacy sales covered by third parties have lower gross margins than non third-party pharmacy sales, and third-party health plans continue to reduce the levels at which they reimburse us for the prescription drugs that we provide to their members |
| Furthermore, government-sponsored health plans such as Medicare and Medicaid are making continuing efforts to reduce their costs, including prescription drug reimbursements, and the new Medicare prescription drug benefit resulted in lower reimbursement levels for prescription drugs provided to Medicare participants |
| If third-party health plans, including government-sponsored plans, continue to reduce their reimbursement levels, our retail drug store sales and gross profits could be significantly adversely affected |
| The significant investments we are making in our stores may not increase our retail drug store sales and profitability, which could adversely affect our results of operations, financial condition and cash flows |
| We have recently made and are continuing to make significant investments in our retail drug stores in an effort to increase our sales and profitability |
| These investments include the installation of new digital photo equipment, pharmacy and other technology, and remodels and other improvements to some existing stores |
| We also plan to significantly increase the rate of new store openings in fiscal 2007 |
| Some of these investments require significant capital expenditures and human effort |
| We are uncertain about consumer reaction to these changes and therefore these investments may not result in increased sales and profitability |
| A failure to increase our retail drug store sales and profitability would adversely affect our results of operations, financial condition and cash flows |
| If our insurance-related costs increase significantly, our financial position and results of operations could be adversely affected |
| The costs of many types of insurance and self-insurance, especially workers’ compensation, employee health care and others have been highly volatile in recent years |
| These conditions have been exacerbated by rising health care costs, legislative changes, economic conditions, terrorism and heightened scrutiny of insurance brokers and insurance providers |
| If our insurance-related costs increase significantly, our financial position and results of operations could be adversely affected |
| We are substantially dependent on a single supplier of pharmaceutical products to sell products to us on satisfactory terms |
| A disruption in our relationship with this supplier could have a material adverse effect on our business |
| We purchase over 90prca of our pharmaceuticals from a single supplier, AmerisourceBergen, with whom we have a long-term supply contract |
| Any significant disruptions in our relationship with AmerisourceBergen, 7 ______________________________________________________________________ [34]Table of Contents deterioration in AmerisourceBergen’s financial condition, or industry-wide changes in wholesaler business practices, including those of AmerisourceBergen, could have a material adverse effect on us |
| Our ability to attract and retain pharmacy personnel and develop alternate fill sources is important to the continued success of our business |
| The retail drug store industry is continuing to experience a shortage of licensed pharmacists in the markets in which we operate |
| If we are unable to attract and retain pharmacists, our business could be adversely affected |
| In order to mitigate this risk we have established centralized prescription fill centers and have also installed robotic prescription fill equipment in many of our pharmacies |
| The success of these efforts, which at this time is uncertain, is important to our ability to address the shortage of pharmacists, but additional efforts may be necessary to address this business issue |
| Additional investment may be costly, and could adversely affect our results of operations, financial condition and cash flows |
| We are subject to governmental regulations, procedures and requirements |
| Our noncompliance with, or a significant change in, these regulations could have a material adverse effect on us |
| Our retail drug store and pharmacy benefit services businesses are subject to numerous federal, state and local regulations, many of which are new and developing |
| These include, but are not limited to, local registrations and regulation of pharmacies in the states where our pharmacies are located or licensed and applicable Medicare and Medicaid regulations |
| In addition, the Health Insurance Portability and Accountability Act, or HIPAA, imposes certain requirements regarding the protection of confidential patient medical records and other information |
| Compliance with these regulations, particularly HIPAA, requires that we implement complex changes to our systems and processes |
| In the future we may also be subject to various state insurance laws and regulations in connection with our prescription drug plan business |
| Failure to adhere to these and other applicable regulations could result in the imposition of civil and criminal penalties |
| Furthermore, any new federal or state regulations or reforms, including healthcare reform initiatives or pharmacy benefit management regulation, could adversely affect us |
| Should a product liability issue arise, inadequate insurance coverage against such risks or inability to maintain such insurance may result in a material adverse effect on our business |
| Pharmacies are exposed to risks inherent in the packaging and distribution of pharmaceuticals and other healthcare products and are significantly dependent upon suppliers to provide safe, government-approved and non-counterfeit products |
| Should a product liability issue arise, the coverage limits under our insurance programs may not be adequate to protect us against future claims |
| In addition, we may not be able to maintain this insurance on acceptable terms in the future and damage to our reputation in the event of a product liability issue may have a material adverse effect on our business |
| Our geographic concentration in the western United States presents certain risks that could adversely affect us |
| Our stores, mail order pharmacy operations, distribution centers and corporate offices are located in the western United States, with the majority of our stores in California |
| Risks prevalent in this region include, but are not limited to, the adverse economic effects of significant state budget deficits, legislative or other governmental actions reducing prescription reimbursement payments to us or increasing our liability with respect to workers’ compensation, major earthquakes, volatility in energy supplies and costs, and shipping and other transportation-related disruptions |
| Because of our geographic concentration, these risks could result in significant disruptions to our business or increased operating expenses |