UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q

(Mark One)

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

For the quarterly period ended July 31, 2008

¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

For the transition period from to

Commission file 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)*

(925) 937-1170

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer x Accelerated filer ¨ Non-accelerated filer ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act): Yes ¨ No x

There were 36,007,597 shares of common stock, $.50 par value per share, outstanding as of August 14, 2008.

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

This quarterly report contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Such statements relate to, among other things, the timing and completion of our pending acquisition by CVS Caremark Corporation; our strategic initiatives; supply chain changes; Medicare prescription drug benefits; development of our pharmacy benefit services segment; merchandise and marketing efforts; operational improvements; safety improvements and workers’ compensation claims and costs; labor scheduling and forecasting; the number of store openings, closures and remodels; revenues; pharmacy reimbursements; gross profits and margin; operating and administrative expenses; depreciation and amortization; liquidity and cash requirements; level of capital expenditures; share repurchases; dividends; effective tax rates; contractual obligations; the effect of new accounting pronouncements; and factors affecting front-end sales in fiscal 2009 and are indicated by words or phrases such as “continuing,” “expects,” “estimates,” “believes,” “plans,” “anticipates,” “will” and other similar words or phrases.

These forward-looking statements are based on our current plans and expectations and involve risks and uncertainties that could cause actual events and results to vary materially from those included in or contemplated by forward-looking statements we make. These risks and uncertainties include, but are not limited to, those set forth below:

•

The ability of CVS Caremark Corporation to complete the transactions contemplated by our merger agreement with CVS, including, among others, CVS’ tender offer for all of our outstanding shares, and our ability to satisfy the other conditions in such agreement;

•

The impact of the announcement and pending completion of the tender offer and merger on our business generally, including relationships with customers, suppliers, landlords and employees;

•

Restrictions on the conduct of our business prior to completion of the tender offer and merger;

•

Changes in economic conditions, including economic growth, unemployment levels, consumer preferences and purchasing power and spending patterns generally;

•

The impact of rising gasoline prices and mortgage payments on economic conditions and consumer spending;

•

The impact of state and federal budget deficits on government healthcare spending and on general economic conditions, and in particular the State of California’s state budget deficit and its 10% across-the-board cut to most California government funded programs, including reimbursement rates paid to pharmacies under Medi-Cal;

•

The efforts of third-party health plans, including government-sponsored plans, to reduce pharmacy reimbursements;

•

Our ability to execute our previously announced initiatives;

•

Our ability to successfully manage our prescription drug plans, including the annual bid;

•

Our ability to improve our supply chain and distribution capabilities;

•

Our ability to successfully implement new technology, including an integrated demand forecasting and replenishment system;

•

Disruption in our supply chain due to system and vendor conversions;

•

The success of our merchandise and marketing strategies (including price reduction programs implemented in response to competitive pressures);

•

Our ability to improve the performance of underperforming stores;

•

The timing, number and overall impact of store openings, closures and remodels;

•

The effect of the Medicare prescription drug benefit on our retail drug store and pharmacy benefit services revenues and profitability;

•

Our ability to grow prescription volumes;

•

Our ability to develop and integrate our pharmacy, mail order and pharmacy benefit services capabilities to take advantage of future growth opportunities;

•

The frequency and rate of introduction of successful new prescription drugs;

•

The introduction of lower priced generic drugs, including the timing of introduction and cost structure associated with generic drugs;

•

The effects of war and terrorism on economic conditions and consumer spending;

•

Competition from other drugstore chains, mail order and other pharmacies, supermarkets, mass merchandisers, discount retailers, on-line retailers, other retailers, pharmacy benefit management companies and prescription drug plan providers;

•

The growth of mail order pharmacies and changes in some third-party health plans requiring mail order fulfillment of certain medications;

•

Continued good relationships with our employees;

•

Interest rate fluctuations and changes in capital market conditions or other events affecting our ability to obtain necessary financing on favorable terms;

•

Our relationships with our suppliers, especially AmerisourceBergen Drug Corporation;

•

Our ability to hire and retain pharmacists and other store and management personnel;

•

The availability and cost of real estate for new stores;

•

The impact of pending or future litigation or regulatory proceedings, including the audit of meal period compliance in all California stores;

•

The effectiveness of workers’ compensation reform efforts, especially in California, and the effect of potential further changes to California’s workers’ compensation laws;

•

Changes in state or federal legislation or regulations affecting our businesses;

•

Our ability to make and integrate acquisitions;

•

Changes to accounting policies and practices or internal controls; and

•

Other factors discussed in our Annual Report on Form 10-K under “Risk Factors” and elsewhere or in any of our other SEC filings.

In addition, because we do not have a comprehensive perpetual inventory system, our ability to accurately forecast and track our retail drug store gross profit and inventory levels during periods between our quarterly physical inventories is limited. Therefore, our actual retail drug store gross profit and inventory levels may vary materially from those included in or contemplated by forward-looking statements we make.

We assume no obligation to update our forward-looking statements to reflect subsequent events or circumstances.

TABLE OF CONTENTS


		Page
PART I FINANCIAL INFORMATION

Item 1	Condensed Consolidated Financial Statements (Unaudited)

	Condensed Statements of Consolidated Income (Unaudited) For the 13 and 26 Weeks Ended July 31, 2008 and July 26, 2007	1

	Condensed Consolidated Balance Sheets (Unaudited) As of July 31, 2008, January 31, 2008 and July 26, 2007	2

	Condensed Statements of Consolidated Cash Flows (Unaudited) For the 26 Weeks Ended July 31, 2008 and July 26, 2007	3

	Condensed Statements of Consolidated Stockholders’ Equity (Unaudited) For the 53 Weeks Ended January 31, 2008 and 26 Weeks Ended July 31, 2008	4

	Notes to Condensed Consolidated Financial Statements	5

Item 2	Management’s Discussion and Analysis of Financial Condition and Results of Operations	11

Item 3	Quantitative and Qualitative Disclosures About Market Risk	16

Item 4	Controls and Procedures	17

PART II OTHER INFORMATION

Item 1	Legal Proceedings	18

Item 1A	Risk Factors	18

Item 4	Submission of Matters to a Vote of Security Holders	20

Item 6	Exhibits	20

Signatures		21

PART I - FINANCIAL INFORMATION

Item 1.

Condensed Consolidated Financial Statements

LONGS DRUG STORES CORPORATION

CONDENSED STATEMENTS OF CONSOLIDATED INCOME (unaudited)


	For the 13 weeks ended						For the 26 weeks ended
	July 31, 2008			July 26, 2007			July 31, 2008			July 26, 2007
	*Thousands Except Per Share Amounts*
Revenues:
Retail drug store sales	$	1,201,468		$	1,195,591		$	2,421,113		$	2,380,602
Pharmacy benefit services revenues		131,269			78,958			318,605			190,957

Total revenues		1,332,737			1,274,549			2,739,718			2,571,559

Costs and expenses:
Cost of retail drug store sales		881,268			881,118			1,775,745			1,762,177
Prescription drug plan benefit costs		96,500			54,174			259,589			146,670
Operating and administrative expenses		307,388			295,030			617,049			581,300
Legal settlements and other disputes, net		500			(431	)		500			(431	)
Provision for store closures and asset impairments, net		599			371			816			9,586

Operating income		46,482			44,287			86,019			72,257
Interest expense		2,786			1,772			5,572			3,448
Interest income		(178	)		(282	)		(433	)		(478	)

Income from continuing operations before income taxes		43,874			42,797			80,880			69,287
Income taxes		16,377			17,059			30,300			27,523

Income from continuing operations		27,497			25,738			50,580			41,764
Income (loss) from discontinued operations, net of tax		—			869			456			(2,119	)

Net income	$	27,497		$	26,607		$	51,036		$	39,645

Earnings per common share:
Basic:
Income from continuing operations	$	0.78		$	0.69		$	1.42		$	1.11
Income (loss) from discontinued operations		—			0.02			0.02			(0.05	)

Net income		0.78			0.71			1.44			1.06

Diluted:
Income from continuing operations	$	0.76		$	0.67		$	1.40		$	1.09
Income (loss) from discontinued operations		—			0.02			0.01			(0.06	)

Net income		0.76			0.69			1.41			1.03

Dividends per common share	$	0.14		$	0.14		$	0.28		$	0.28
Weighted average number of shares outstanding:
Basic		35,350			37,417			35,553			37,469
Diluted		36,062			38,326			36,252			38,412

See notes to condensed consolidated financial statements.

LONGS DRUG STORES CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS (unaudited)


	July 31, 2008		January 31, 2008		July 26, 2007
	*Thousands Except Share Information*
Assets
Current Assets:
Cash and cash equivalents	$	26,867	$	27,019	$	24,463
Accounts receivable, net		433,828		334,972		301,157
Merchandise inventories, net		465,981		510,482		494,473
Deferred income taxes		62,611		64,500		59,985
Prepaid expenses and other current assets		23,823		22,043		23,280
Assets held for sale		4,173		4,173		4,177

Total current assets		1,017,283		963,189		907,535

Property:
Land		119,312		116,564		113,279
Buildings and leasehold improvements		755,504		725,930		692,893
Equipment and fixtures		645,383		628,556		612,429

Total		1,520,199		1,471,050		1,418,601
Less accumulated depreciation		752,940		715,682		704,086

Property, net		767,259		755,368		714,515

Goodwill		84,394		84,394		84,450
Intangible assets, net		32,350		32,240		25,775
Other non-current assets		11,419		11,525		5,340

Total assets	$	1,912,705	$	1,846,716	$	1,737,615


Liabilities and Stockholders’ Equity
Current Liabilities:
Trade accounts payable	$	261,973	$	273,953	$	270,740
Pharmacy benefits payable		254,273		176,829		123,475
Accrued employee compensation and benefits		104,350		120,458		120,118
Taxes payable		31,604		58,998		54,383
Other accrued expenses		64,426		63,110		66,769
Current maturities of debt		36,727		36,727		6,727

Total current liabilities		753,353		730,075		642,212

Long-term debt		205,636		183,364		123,364
Other long-term liabilities		100,228		105,352		120,229

Total liabilities		1,059,217		1,018,791		885,805

Commitments and Contingencies

Stockholders’ Equity:
Common stock: par value $0.50 per share, 120,000,000 shares authorized, 35,908,000, 36,204,000 and 37,760,000 shares outstanding		17,954		18,102		18,880
Additional capital		303,982		288,385		283,448
Retained earnings		531,552		521,438		549,482

Total stockholders’ equity		853,488		827,925		851,810

Total liabilities and stockholders’ equity	$	1,912,705	$	1,846,716	$	1,737,615

See notes to condensed consolidated financial statements.

LONGS DRUG STORES CORPORATION

CONDENSED STATEMENTS OF CONSOLIDATED CASH FLOWS (unaudited)


	For the 26 weeks ended
	July 31, 2008			July 26, 2007
	*Thousands*
Operating Activities:
Net income	$	51,036		$	39,645
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		51,436			46,543
Provision for store closures and asset impairments, net		(21	)		5,772
Deferred income taxes and other		(2,543	)		(3,968	)
Stock awards and options, net		8,793			14,162
Excess tax benefits related to stock awards and options		(1,030	)		(6,570	)
Common stock contribution to employee retirement plan		13,784			10,224
Changes in assets and liabilities:
Accounts receivable		(68,484	)		(12,492	)
Merchandise inventories		45,777			(5,403	)
Other assets		(1,674	)		(2,082	)
Current liabilities and other		23,298			(8,044	)

Net cash provided by operating activities		120,372			77,787

Investing Activities:
Capital expenditures		(61,332	)		(67,059	)
Acquisitions		(4,931	)		(12,021	)
Proceeds from dispositions of property and intangible assets		941			19,848

Net cash used in investing activities		(65,322	)		(59,232	)

Financing Activities:
Proceeds from revolving line of credit borrowings, net		25,000			8,000
Repayments of private placement notes and other borrowings		(2,728	)		(2,727	)
Repurchase of common stock		(39,260	)		(29,994	)
Proceeds from exercise of stock options		3,580			13,356
Dividend payments		(10,127	)		(10,614	)
Medicare Part D subsidy receipts (disbursements), net		(30,372	)		(5,937	)
Excess tax benefits related to stock awards and options		1,030			6,570
Other		(2,325	)		(342	)

Net cash used in financing activities		(55,202	)		(21,688	)

Decrease in cash and cash equivalents		(152	)		(3,133	)
Cash and cash equivalents at beginning of period		27,019			27,596

Cash and cash equivalents at end of period	$	26,867		$	24,463

Supplemental disclosure of cash flow information:
Cash paid for interest, net of amounts capitalized	$	5,348		$	3,476
Cash paid for income taxes		44,663			16,402

See notes to condensed consolidated financial statements.

LONGS DRUG STORES CORPORATION

CONDENSED STATEMENTS OF CONSOLIDATED STOCKHOLDERS’ EQUITY (unaudited)

For the 53 weeks ended January 31, 2008 and the 26 weeks ended July 31, 2008


	Common Stock					Additional Capital			Retained Earnings			Total Stockholders’ Equity
	Shares		Amount			Additional Capital			Retained Earnings			Total Stockholders’ Equity
	*Thousands*
Balance at January 25, 2007	37,406		$	18,703		$	250,113		$	546,741		$	815,557
Cumulative effect of accounting change										(526	)		(526	)
Net income										96,201			96,201
Dividends ($0.56 per share)										(21,183	)		(21,183	)
Stock contributions to employee retirement plan	278			139			13,296						13,435
Stock awards, net of forfeitures	144			72			(5,556	)					(5,484	)
Stock-based compensation expense							19,926						19,926
Stock options exercised	850			425			19,268						19,693
Tax benefit related to stock awards and stock options, net							10,094						10,094
Repurchase of common stock	(2,474	)		(1,237	)		(18,756	)		(99,795	)		(119,788	)

Balance at January 31, 2008	36,204			18,102			288,385			521,438			827,925

Net income										51,036			51,036
Dividends ($0.28 per share)										(10,127	)		(10,127	)
Stock contributions to employee retirement plan	306			153			13,631						13,784
Stock awards, net of forfeitures	262			131			(2,374	)					(2,243	)
Stock-based compensation expense							7,137						7,137
Stock options exercised	136			68			3,512						3,580
Tax benefit related to stock awards and stock options, net							1,656						1,656
Repurchase of common stock	(1,000	)		(500	)		(7,965	)		(30,795	)		(39,260	)

Balance at July 31, 2008	35,908		$	17,954		$	303,982		$	531,552		$	853,488

See notes to condensed consolidated financial statements.

LONGS DRUG STORES CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

1. Basis of Presentation

The accompanying interim condensed consolidated financial statements include the financial statements of Longs Drug Stores Corporation (“Longs” or the “Company”) and its wholly-owned subsidiaries. Inter-company accounts and transactions have been eliminated. The interim condensed consolidated financial statements have been prepared on a basis consistent in all material respects with the accounting policies described and applied in the Annual Report of the Company on Form 10-K for the fiscal year ended January 31, 2008, and reflect all adjustments that are, in management’s opinion, necessary for a fair presentation of the results for the periods presented. The condensed consolidated financial statements as of and for the periods ended July 31, 2008 and July 26, 2007 are unaudited. The condensed consolidated balance sheet as of January 31, 2008, and condensed consolidated statement of stockholders’ equity for the year then ended, presented herein, have been derived from the audited consolidated financial statements of the Company included in the Form 10-K for the fiscal year ended January 31, 2008. Certain information and footnote disclosures normally included in the annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been omitted. The interim condensed consolidated financial statements should be read together with the financial statements in the Company’s Annual Report on Form 10-K for the fiscal year ended January 31, 2008.

2. Subsequent Event/Change In Control

On August 12, 2008, the Company entered an Agreement and Plan of Merger (“Merger Agreement”) with CVS Caremark Corporation and their indirect wholly owned subsidiary, Blue MergerSub Corp. (together “CVS”). Pursuant to the Merger Agreement, and upon the terms and subject to the conditions thereof, CVS has commenced a tender offer (the “Offer”) to purchase all outstanding shares of the Company’s common stock at a price of $71.50 per share, in cash without interest (the “Offer Price”). Following the completion of the Offer, Blue MergerSub Corp. will merge with and into the Company (the “Merger”), with the Company surviving the Merger as a wholly owned subsidiary of CVS. At the effective time of the Merger, any remaining outstanding shares of the Company’s common stock not tendered in the Offer, other than shares owned by CVS or any direct or indirect wholly owned subsidiary of CVS or the Company, will be acquired for cash at the Offer Price.

The closing of the Offer is subject to the satisfaction or waiver of a number of customary conditions, including among others, the expiration or termination of applicable waiting periods under the Hart-Scott-Rodino Antitrust Improvement Act of 1976 and the holders of at least two-thirds of the outstanding shares of the Company’s common stock on a fully-diluted basis tendered such shares in the Offer. The Merger Agreement contains certain termination rights for each of CVS and the Company, and if the Merger Agreement is terminated under certain circumstances, the Company may be required to pay CVS a termination fee of $115 million and/or reimburse CVS for its out-of-pocket transaction-related expenses up to $10 million.

The foregoing description of the Merger Agreement and the transactions contemplated thereby does not purport to be complete and is qualified in its entirety by reference to the Merger Agreement, which is filed as Exhibit 2.1 to this Quarterly Report on Form 10-Q.

3. New Accounting Pronouncements

In the first quarter of fiscal 2009, the Company adopted certain of the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 157, Fair Value Measurements, which establishes a standard definition for fair value, provides a framework under generally accepted accounting principles for measuring fair value, and expands disclosure requirements for fair value measurements. Financial Accounting Standards Board (“FASB”) Staff Position (“FSP”) No. FAS 157-b, Effective Date of FASB No 157, issued in December 2007, delays the effective date of SFAS No. 157 to annual reporting periods beginning after November 15, 2008 (the Company’s fiscal 2010) for all nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis.

LONGS DRUG STORES CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

Prepaid expenses and other current assets include participant-directed investments, primarily in money market and mutual funds, which are designated to fund the Company’s non-qualified deferred compensation plan, and which are recorded at fair value based on quoted market prices on a recurring basis. The Company determined that these investments, with a fair value of $9.0 million as of July 31, 2008, are defined as Level 1 in the fair value hierarchy because their fair value is based on quoted prices in active markets for identical assets. The Company has no Level 2 or Level 3 assets.

In April 2008, the FASB issued FSP No. FAS 142-3, Determining the Useful Life of Intangible Assets, which amends the factors an entity should consider in developing renewal or extension assumptions used in determining the useful lives of recognized intangible assets. FSP No. FAS 142-3 is effective for fiscal years beginning after December 15, 2008 (the Company’s fiscal 2010). The Company does not expect the adoption of FSP No. FAS 142-3 to have a material effect on the Company’s consolidated financial statements.

4. Acquisitions

During the first half of fiscal 2009, the Company purchased the assets of seven retail pharmacies. These acquisitions increased the Company’s portfolio of smaller retail pharmacies, many of which are close to the point of care, such as hospitals, clinics and medical office buildings. Four of the acquired stores are located in California, two are in Hawaii, and one is in Nevada. The Company allocated the $4.7 million total acquisition cost to pharmacy prescription files ($2.7 million), inventory ($1.3 million), property and equipment ($0.6 million) and other assets ($0.1 million). The results of operations of the acquired locations are included in the Company’s consolidated financial statements within the retail drug store segment as of their various acquisition dates. The pro forma effects of these acquisitions on the Company’s consolidated financial statements for periods prior to the acquisitions are not significant, either individually or in the aggregate.

5. Earnings Per Share

Basic earnings per share are computed by dividing income by the weighted average number of common shares outstanding during the period. Diluted earnings per share are computed by dividing income by the weighted average number of common shares and dilutive common equivalent shares (stock options and restricted stock awards) outstanding during the period. The following is a reconciliation of the number of shares used in the Company’s basic and diluted earnings per share computations:


	13 weeks ended		26 weeks ended
	July 31, 2008	July 26, 2007	July 31, 2008	July 26, 2007
	*Thousands*		*Thousands*
Basic weighted average number of shares outstanding	35,350	37,417	35,553	37,469
Effect of dilution from:
Stock options	476	704	476	738
Restricted stock awards	236	205	223	205

Diluted weighted average number of shares outstanding	36,062	38,326	36,252	38,412

The computation of diluted earnings per share excluded 0.1 million and 0.3 million stock option shares for the 13 and 26 weeks ended July 31, 2008, respectively, and 0.1 million and 0.2 million stock option shares for the 13 and 26 weeks ended July 26, 2007, respectively, because their inclusion would have been anti-dilutive.

6. Merchandise Inventories

Merchandise inventories are stated at the lower of cost or market value. Cost is determined using the last-in, first-out (LIFO) method. The excess of current cost over LIFO values was $212.4 million as of July 31, 2008, $204.9 million as of January 31, 2008, and $200.9 million as of July 26, 2007. LIFO costs for interim financial statements are estimated based on projected annual inflation rates, inventory levels, and merchandise mix. Actual LIFO costs are calculated during the fourth quarter of the fiscal year when final inflation rates, inventory levels and merchandise mix are determined.

LONGS DRUG STORES CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

7. Goodwill and Intangible Assets

All of the Company’s goodwill, pharmacy prescription files and non-compete agreements are included in the retail drug store segment. Insurance licenses are included in the pharmacy benefit services segment.

The Company’s intangible assets other than goodwill include the following:


	Estimated Useful Lives	Gross Carrying Value		Accumulated Amortization			Net Carrying Value
				*Thousands*
As of July 31, 2008:
Intangible assets subject to amortization:
Pharmacy prescription files	3-10 years	$	29,540	$	(8,245	)	$	21,295
Non-compete agreements and other	4-5 years		755		(178	)		577

Total			30,295		(8,423	)		21,872
Intangible assets not subject to amortization:
Beverage licenses	N/A		5,625		—			5,625
Insurance licenses	N/A		4,853		—			4,853

Total			10,478		—			10,478

Total intangible assets, net		$	40,773	$	(8,423	)	$	32,350


As of January 31, 2008:
Intangible assets subject to amortization:
Pharmacy prescription files	5 years	$	27,811	$	(6,457	)	$	21,354
Non-compete agreements and other	5 years		675		(103	)		572

Total			28,486		(6,560	)		21,926
Intangible assets not subject to amortization:
Beverage licenses	N/A		5,445		—			5,445
Insurance licenses	N/A		4,869		—			4,869

Total			10,314		—			10,314

Total intangible assets, net		$	38,800	$	(6,560	)	$	32,240

Amortization expense for intangible assets with finite useful lives was $3.0 million and $1.9 million for the 26-week periods ended July 31, 2008 and July 26, 2007, respectively. Estimated future annual amortization expense of these intangibles is as follows (in thousands):


Fiscal year ending:
2009 (remainder of year)	$	3,033
2010		5,928
2011		5,879
2012		4,821
2013		1,812
Thereafter		399

Total	$	21,872

LONGS DRUG STORES CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

8. Debt

Debt consisted of the following:


	July 31, 2008		January 31, 2008		July 26, 2007
			*Thousands*
Revolving line of credit, variable interest (weighted average interest rate of 3.95% as of July 31, 2008), expires January 2012	$	192,000	$	167,000	$	73,000
Private placement notes, fixed interest rates ranging from 6.19% to 6.71%, mature at various dates through 2014		50,363		53,091		57,091

Total debt		242,363		220,091		130,091
Less current maturities		36,727		36,727		6,727

Long-term portion	$	205,636	$	183,364	$	123,364

The Company’s debt agreements contain customary restrictions, and the private placement notes also include various customary financial covenants. As of July 31, 2008, the Company was in compliance with the restrictions and limitations included in these provisions.

9. Commitments and Contingencies

Rankin v. Longs Drug Stores California, Inc. was filed in the Superior Court of California, San Diego County, in October 2004, and was subsequently certified as a class action. The lawsuit alleged that the Company’s employment application violated California Labor Code Section 432.8 by inquiring about criminal convictions within the last seven years, without providing an exception for misdemeanor marijuana convictions more than two years old. The plaintiff sought to recover statutory damages and attorneys’ fees for himself and all similarly situated individuals who applied for employment with the Company during the class period. Trial commenced on August 20, 2007 and concluded with a dismissal of plaintiff’s case by the court on September 26, 2007. The plaintiff filed a notice of appeal on December 4, 2007.

During fiscal 2007, the Company completed a self-audit of certain of its California drug stores located in three counties that was initiated at the request of the State of California, Division of Labor Standards Enforcement (“DLSE”). The audit related to compliance with California law relating to meal period requirements. The Company made compensatory payments resulting from this audit, which were not material, during fiscal 2007. The DLSE also requested that the Company conduct an audit related to meal period compliance for all of its California drug stores. The Company has agreed to a state-wide audit covering the three-year period from June 1, 2004, through June 1, 2007. At this time the Company cannot reasonably estimate the amount of possible payments that might be required as a result of an additional audit, if any.

On August 19, 2008, a putative class action titled Steamfitters Local 449 v. Longs Drug Stores Corporation, et al., was filed in the Superior Court of the State of California for the County of Contra Costa. The complaint in the action names the Company and its directors, and CVS Caremark Corporation, as defendants, asserting that the directors breached their fiduciary duties by failing to take steps to achieve a higher price in the proposed transaction with CVS described in Note 2 and in Subsequent Events. The complaint also alleges that the directors suffer from certain conflicts of interest, and that the Company and CVS have aided and abetted in the directors’ alleged breach of duty. The complaint seeks injunctive relief, including an order prohibiting the Company from proceeding with the CVS transaction until it adopts and implements procedures to obtain the highest possible price. The Company believes the action is without merit and plans to defend the case vigorously. There can be no assurance that the Company will be successful in our defense of this action. It is not known when or on what basis the action will be resolved.

In addition to the matters described above, the Company is subject to various lawsuits, claims and federal and state regulatory reviews and actions arising in the normal course of its businesses. The Company accrues amounts it believes are adequate to address the liabilities related to lawsuits and other proceedings that it believes will result in a probable loss if the loss can be reasonably estimated. However, the ultimate resolution of such matters is uncertain and outcomes are not predictable with assurance. It is possible that the matters described above or other proceedings brought against the Company could have a material adverse impact on its financial condition and results of operations.

LONGS DRUG STORES CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

10. Segment Information

The Company operates in two business segments: retail drug stores and pharmacy benefit services. These segments were identified based on their separate and distinct products and services, technology, marketing strategies and management reporting. Management evaluates the segments’ operating performance separately and allocates resources based on their respective financial condition, results of operations and cash flows. Inter-segment transactions and balances are eliminated in consolidation.

Pharmacy is the cornerstone of the retail drug store segment, complemented by such core front-end categories as cosmetics, over-the-counter medications, health and beauty products, photo and photo processing, and food and beverage items. As of July 31, 2008, the retail drug store segment operated 521 retail stores in the western United States, primarily under the names Longs, Longs Drugs, Longs Drug Stores and Longs Pharmacy. The retail drug store segment also operates a mail order pharmacy business.

The pharmacy benefit services segment, operated through the Company’s subsidiary, RxAmerica L.L.C., provides pharmacy benefit management services whereby RxAmerica contracts with third-party health plans, retail pharmacies and drug manufacturers to provide a range of services, including pharmacy benefit plan design and implementation, claims administration and formulary management. In addition, the pharmacy benefit services segment operates prescription drug plans under Medicare Part D as established by the Medicare Prescription Drug, Improvement, and Modernization Act of 2003.

The following tables summarize significant financial information by segment:


	For the 13 weeks ended				For the 26 weeks ended
	July 31, 2008		July 26, 2007		July 31, 2008		July 26, 2007
	*Thousands*				*Thousands*
Revenues:
Retail Drug Stores	$	1,201,468	$	1,195,591	$	2,421,113	$	2,380,602
Pharmacy Benefit Services		131,269		78,958		318,605		190,957

Consolidated Totals	$	1,332,737	$	1,274,549	$	2,739,718	$	2,571,559


Operating Income:
Retail Drug Stores	$	31,580	$	33,429	$	66,591	$	56,825
Pharmacy Benefit Services		14,902		10,858		19,428		15,432

Consolidated Totals	$	46,482	$	44,287	$	86,019	$	72,257

LONGS DRUG STORES CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)


	July 31, 2008			January 31, 2008			July 26, 2007
				*Thousands*
Total Assets:
Retail Drug Stores	$	1,628,030		$	1,668,948		$	1,598,812
Pharmacy Benefit Services		334,719			304,502			212,537
Inter-segment Eliminations		(50,044	)		(126,734	)		(73,734	)

Consolidated Totals	$	1,912,705		$	1,846,716		$	1,737,615

Consolidated total revenues include the following product and service types:


	For the 13 weeks ended				For the 26 weeks ended
	July 31, 2008		July 26, 2007		July 31, 2008		July 26, 2007
	*Thousands*				*Thousands*
Pharmacy sales	$	620,009	$	613,761	$	1,259,095	$	1,234,283
Front-end sales		581,459		581,830		1,162,018		1,146,319
Prescription drug plan revenues		110,873		65,670		277,990		162,228
Pharmacy benefit management revenues		20,396		13,288		40,615		28,729

Consolidated total revenues	$	1,332,737	$	1,274,549	$	2,739,718	$	2,571,559

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read together with our consolidated financial statements and the related notes. This discussion contains forward-looking statements relating to, among other things, matters set forth under “Cautionary Statement Regarding Forward-Looking Statements.” Our actual results and the timing of events could differ materially from those anticipated in these forward-looking statements as a result of many factors, including, but not limited to, those set forth in the following discussion, under “Cautionary Statement Regarding Forward-Looking Statements” and under “Risk Factors” in our Annual Report on Form 10-K for fiscal year 2008 and elsewhere in this Form 10-Q.

OVERVIEW

Longs Drug Stores Corporation is one of the most recognized retail drug store chains on the West Coast and in Hawaii. Over the past seventy years we have grown our operations to 521 stores as of July 31, 2008. We provide expert pharmacy services and a wide assortment of merchandise focusing on health, wellness, beauty and convenience.

We also provide pharmacy benefit services, including pharmacy benefit management and Medicare beneficiary prescription drug plans, through our wholly-owned subsidiary, RxAmerica L.L.C. RxAmerica has contracted with the federal Centers for Medicare and Medicaid Services (“CMS”) to be a prescription drug plan sponsor in all 50 states and the District of Columbia.

Our financial results for the first half of fiscal 2009 reflect the progress we have made on our initiatives to make Longs a stronger competitor and more profitable company. Our significant progress on our initiatives to improve the efficiency and productivity of our retail operations enabled us to increase our earnings and improve our retail operating margin, while managing increased growth and structural changes in the industry, and remain competitive in a difficult economic environment. We continue to pursue additional opportunities to improve the profitability of our core retail business by realigning and upgrading our store base, increasing our self-distribution of front-end merchandise, installing supply chain and other technology and improving our operations. Our consolidated results also reflect the continued growth of our pharmacy benefit services segment.

Subsequent Events

On August 12, 2008, we entered an Agreement and Plan of Merger (“Merger Agreement”) with CVS Caremark Corporation and their indirect wholly owned subsidiary, Blue MergerSub Corp. (together “CVS”). Pursuant to the Merger Agreement, and upon the terms and subject to the conditions thereof, CVS has commenced a tender offer (the “Offer”) to purchase all outstanding shares of our common stock at a price of $71.50 per share, in cash without interest (the “Offer Price”). Following the completion of the Offer, Blue MergerSub Corp. will merge with and into the Company (the “Merger”), with the Company surviving the Merger as a wholly owned subsidiary of CVS. At the effective time of the Merger, any remaining outstanding shares of our common stock not tendered in the Offer, other than shares owned by CVS or any direct or indirect wholly owned subsidiary of CVS or us, will be acquired for cash at the Offer Price.

The closing of the Offer is subject to the satisfaction or waiver of a number of customary conditions, including among others, the expiration or termination of applicable waiting periods under the Hart-Scott-Rodino Antitrust Improvement Act of 1976 and the holders of at least two-thirds of the outstanding shares of our common stock on a fully-diluted basis tendered such shares in the Offer. The Merger Agreement contains certain termination rights for each of CVS and us, and if the Merger Agreement is terminated under certain circumstances, we may be required to pay CVS a termination fee of $115 million and/or reimburse CVS for its out-of-pocket transaction-related expenses up to $10 million.

RESULTS OF OPERATIONS

Revenues


	For the 13 weeks ended						For the 26 weeks ended
	July 31, 2008			July 26, 2007			July 31, 2008			July 26, 2007
	*Dollars in thousands*
Retail drug store sales:
Pharmacy sales	$	620,009		$	613,761		$	1,259,095		$	1,234,283
Front-end sales		581,459			581,830			1,162,018			1,146,319

Total	$	1,201,468		$	1,195,591		$	2,421,113		$	2,380,602

Pharmacy benefit services revenues:
Prescription drug plan revenues	$	110,873		$	65,670		$	277,990		$	162,228
Pharmacy benefit management revenues		20,396			13,288			40,615			28,729

Total	$	131,269		$	78,958		$	318,605		$	190,957

Total revenues	$	1,332,737		$	1,274,549		$	2,739,718		$	2,571,559

Retail drug store sales:
Total sales growth over previous year		0.5	%		2.9	%		1.7	%		3.6	%
Same-store sales growth (decline)		(1.1	)%		1.0	%		(0.1	)%		1.5	%

Pharmacy sales growth		1.0	%		5.2	%		2.0	%		5.7	%
Same-store pharmacy sales growth (decline)		(0.6	)%		1.8	%		0.0	%		2.4	%
Pharmacy as a % of total retail drug store sales		51.6	%		51.3	%		52.0	%		51.8	%
% of pharmacy sales covered by third party health plans		94.5	%		94.8	%		94.5	%		94.9	%

Front-end sales growth (decline)		(0.1	)%		0.6	%		1.4	%		1.5	%
Same-store front-end sales growth (decline)		(1.6	)%		0.3	%		(0.1	)%		0.7	%
Front-end as a % of total retail drug store sales		48.4	%		48.7	%		48.0	%		48.2	%

Pharmacy benefit services revenues:
Prescription drug plan revenue growth (decline) over previous year		68.8	%		(4.5	)%		71.4	%		7.4	%
Pharmacy benefit management revenue growth over previous year		53.5	%		102.0	%		41.4	%		62.7	%

Thirteen Weeks Ended July 31, 2008 versus Thirteen Weeks Ended July 26, 2007

Retail Drug Store Sales

Retail drug store sales were $1.20 billion, a 0.5% increase over the second quarter of fiscal 2008, with same-store sales decreasing 1.1%.

Pharmacy sales increased 1.0% in the second quarter of fiscal 2009 over the second quarter of fiscal 2008, with same-store pharmacy sales decreasing 0.6%. We estimate that generic utilization unfavorably impacted our same-store pharmacy sales by approximately 2.8 to 3.0 percentage points in the second quarter of fiscal 2009. We expect that generic utilization will have a reduced effect in the second half of fiscal 2009 as the rate of new generic introductions declines and we begin to cycle some of last year’s introductions. In addition, a reduction in cold, flu and allergy prescriptions, primarily due to the impact of the switch of the prescription allergy medicine Zyrtec to over-the-counter status, unfavorably impacted our same-store pharmacy sales by approximately 1.4 to 1.6 percentage points in the second quarter of fiscal 2009. The decrease in same-store pharmacy sales was mitigated in part by continued increases in average prescription prices.

Front-end sales decreased 0.1% in the second quarter of fiscal 2009 from the same quarter last year, with same-store front-end sales decreasing 1.6%. Our front-end sales performance is affected by overall economic conditions, including growth and unemployment, especially in California, our primary market. We expect these factors to contribute to a difficult sales environment in the short term. Longer term, we expect our front-end sales to increase as a result of growth in the number of our stores and our continued efforts to expand and enhance our assortments of merchandise in our core categories of health, wellness, beauty and convenience, which now represent over 90% of our front-end sales.

Pharmacy Benefit Services Revenues

Pharmacy benefit services revenues were $131.3 million in the second quarter of fiscal 2009, a 66.3% increase over the second quarter of fiscal 2008. Prescription drug plan revenues increased 68.8% to $110.9 million in the second quarter of fiscal 2009 primarily due to growth in the number of Medicare beneficiaries served to over 450,000 in this plan year, almost double the number served in the second quarter of fiscal 2008. Prescription drug plan revenues include fixed monthly premiums paid by beneficiaries and CMS, as well as a CMS risk share component. The fixed monthly premiums are recognized on a straight-line basis over the coverage period. The risk share component is variable, depending on drug costs, and can cause revenues to fluctuate from period to period. Pharmacy benefit management revenues increased 53.5% to $20.4 million in the second quarter of fiscal 2009 due to growth in our existing client base and the addition of new clients.

Twenty-Six Weeks Ended July 31, 2008 versus Twenty-Six Weeks Ended July 26, 2007

Retail Drug Store Sales

Retail drug store sales were $2.42 billion, a 1.7% increase over the first half of fiscal 2008, primarily due to new store growth, with same-store sales decreasing 0.1%.

Pharmacy sales increased 2.0% in the first half of fiscal 2009 over the first half of fiscal 2008, with same-store pharmacy sales remaining flat with last year. Same-store pharmacy sales were favorably impacted by continued increases in average prescription prices, which increased due to pharmaceutical cost inflation and the continued introduction and utilization of newer and more expensive drugs. These increases were offset by increased generic utilization and a reduction in cold, flu and allergy prescriptions, primarily due to the impact of the switch of the prescription allergy medicine Zyrtec to over-the-counter status, which unfavorably impacted our same-store pharmacy sales by approximately 1.1 to 1.3 percentage points in the first half of fiscal 2009.

Front-end sales increased 1.4% in the first half of fiscal 2009 from the first half of last year, with same-store front-end sales decreasing 0.1% due to overall economic conditions, partially mitigated by our ongoing merchandise strategy focusing on our core categories.

Pharmacy Benefit Services Revenues

Pharmacy benefit services revenues were $318.6 million in the first half of fiscal 2009, a 66.8% increase over the first half of fiscal 2008. Prescription drug plan revenues increased 71.4% to $278.0 million in the first half of fiscal 2009 primarily due to growth in the number of Medicare beneficiaries served to more than 450,000 in this plan year, almost double the number served in fiscal 2008. Pharmacy benefit management revenues increased 41.4% to $40.6 million in the first half of fiscal 2009 due to growth in our existing client base and the addition of new clients.

Gross Profit


	For the 13 weeks ended						For the 26 weeks ended
	July 31, 2008			July 26, 2007			July 31, 2008			July 26, 2007
Retail drug store gross profit (thousands)	$	320,200		$	314,473		$	645,568		$	618,425
Retail drug store gross profit margin		26.7	%		26.3	%		26.7	%		26.0	%
LIFO provision (thousands)	$	4,000		$	2,000		$	7,500		$	5,000

Prescription drug plan gross profit (thousands)	$	14,373		$	11,496		$	18,401		$	15,558
Prescription drug plan gross margin		13.0	%		17.5	%		6.6	%		9.6	%

Thirteen Weeks Ended July 31, 2008 versus Thirteen Weeks Ended July 26, 2007

Retail Drug Stores

Retail drug store gross profit was 26.7% of retail drug store sales in the second quarter of fiscal 2009, compared with 26.3% in the second quarter of fiscal 2008. The increase was primarily due to higher generic utilization and improved inventory management, partially offset by changes in the sales mix reflecting increasing price sensitivity among consumers.

Our LIFO provision, which is included in the cost of retail drug store sales, was $4.0 million and $2.0 million in the second quarter of fiscal 2009 and fiscal 2008, respectively. The increase was primarily due to higher net inflation compared with last year, especially on

front-end merchandise. The LIFO provision fluctuates with inflation rates, inventory levels and merchandise mix. We estimate LIFO costs for interim financial statements based on projected annual inflation rates, inventory levels and merchandise mix. We calculate actual LIFO costs during the fourth quarter of the fiscal year when we determine final inflation rates, inventory levels and merchandise mix.

Prescription Drug Plans (Pharmacy Benefit Services Segment)

Prescription drug plan benefit costs relate only to prescription drug plan revenues. Revenues generated from pharmacy benefit management services are reported net of reimbursements to participating pharmacies.

Prescription drug plan gross profit was 13.0% of prescription drug plan revenues in the second quarter of fiscal 2009, compared with 17.5% in the same period last year. The decrease was primarily due to more competitive bidding for the calendar 2008 plan year. We expect to serve approximately 450,000 Medicare beneficiaries during the 2008 plan year, which is almost double the number served last year, and we expect our revenues and operating income to increase from the additional business. However, due to margin compression associated with our bids to increase enrollment, we expect our gross profit and operating margins will be lower in fiscal 2009 than last year.

As a result of the Medicare Part D benefit design, the Company incurs a disproportionate amount of prescription drug plan benefit costs early in the contract year. For example, as of January 1, 2008, for most of its plans the Company is responsible for approximately 67% of a Medicare beneficiary’s drug costs up to $2,510, while the beneficiary is responsible for 100% of their drug costs from $2,510 up to $5,726. The Company is responsible for 15% of a beneficiary’s drug costs above $5,726. As a result of this program design, we expect prescription drug plan gross profit to be greater in the second half of our fiscal year as compared with the first half of the year.

Twenty-Six Weeks Ended July 31, 2008 versus Twenty-Six Weeks Ended July 26, 2007

Retail Drug Stores

Retail drug store gross profit was 26.7% of retail drug store sales in the first half of fiscal 2009, compared with 26.0% in the same period last year. The increase was primarily due to higher generic utilization and improved inventory management, partially offset by changes in the sales mix reflecting increasing price sensitivity among consumers.

Our LIFO provision, which is included in the cost of retail drug store sales, was $7.5 million and $5.0 million in the first half of fiscal 2009 and fiscal 2008, respectively. The increase was primarily due to higher net inflation compared with last year, especially on front-end merchandise.

Prescription Drug Plans (Pharmacy Benefit Services Segment)

Prescription drug plan gross profit was 6.6% of prescription drug plan revenues in the first half of fiscal 2009, compared with 9.6% in the same period last year. The decrease was primarily due to more competitive bidding by prescription drug plan sponsors in the second year of the Medicare prescription drug benefit resulting in lower premiums as we expanded our prescription drug plans to all 50 states.

Operating and Administrative Expenses

Operating and administrative expenses were $307.4 million, or 23.1% of revenues, and $617.0 million, or 22.5% of revenues, in the second quarter and first half of fiscal 2009, respectively, compared with $295.0 million, or 23.1% of revenues, and $581.3 million, or 22.6% of revenues, in the second quarter and first half of fiscal 2008, respectively. The flat expense rate compared with last year reflects increased leverage on higher revenues, offset by increased new store activity and soft retail sales growth.

Provision for Store Closures and Asset Impairments

The provision for store closures and asset impairments of $0.6 million in the second quarter and $0.8 million in the first half of fiscal 2009, and $0.4 million and $9.6 million in the comparable periods of fiscal 2008, primarily includes lease-related costs, net of estimated sublease income, related to the disposition of seven stores in California initiated in fiscal 2008. Five of the store locations have been sold or sub-leased and the remaining two are being actively marketed. Additional charges or gains related to this disposition of stores may be incurred as a result of changes to management’s current estimates and assumptions regarding the disposition of the remaining store locations. The timing of future charges and gains related to this disposition are subject to significant uncertainty including the variability in future vacancy periods and sublease income. Costs related to the disposition of 23 stores in Washington, Oregon and Colorado are included in discontinued operations. See “Discontinued Operations” below for further information.

Net Interest Expense

Net interest expense was $2.6 million and $5.1 million in the second quarter and first half of fiscal 2009, respectively, compared with $1.5 million and $3.0 million in the second quarter and first half of fiscal 2008, respectively. The increase was a result of higher average borrowings.

Income Taxes

Our effective income tax rate was 37.3% and 37.5% in the second quarter and first half of fiscal 2009, respectively, compared with 39.9% and 39.7% in the second quarter and first half of 2008, respectively. We expect that our effective income tax rate for the full 2009 fiscal year will be approximately 38%.

Discontinued Operations

In fiscal 2008, we closed all of the 23 stores located in Washington, Oregon and Colorado pursuant to a plan approved by our board of directors. These stores are reported in discontinued operations in our statements of consolidated income in accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets.

During the first half of fiscal 2009, we recorded after-tax income from discontinued operations of $0.5 million, compared with an after-tax loss from discontinued operations of $2.1 million for the first half of last year. Results from discontinued operations for the first half of fiscal 2009 primarily included adjustments to our reserve for closed stores as a result of changes to our estimates and assumptions regarding the disposition of closed store locations. During the first half of fiscal 2008, we incurred pre-tax costs of $10.7 million for lease-related costs net of estimated sublease rental income and $3.3 million for employee severance, offset by pre-tax gains of $17.8 million on the sale of store properties and related assets, related to the 23 stores located in Washington, Oregon and Colorado. Net operating losses related to these stores for the 26 weeks ended July 26, 2007, were $7.3 million pre-tax, for a total net loss from discontinued operations of $3.5 million pre-tax ($2.1 million after tax).

Twenty of the store locations reported in discontinued operations have been sold or sub-leased and the remaining three locations are being actively marketed. Additional charges or gains related to this disposition of stores may be incurred as a result of sales of property or changes to management’s current estimates and assumptions regarding the disposition of the remaining store locations. The timing of future transactions and charges related to this disposition are subject to significant uncertainty including the variability in future vacancy periods, sublease income and the timing of property sales.

LIQUIDITY AND CAPITAL RESOURCES

General

Our primary sources of liquidity are operating cash flows and availability on our line of credit. We use cash to provide working capital for our operations, finance capital expenditures and acquisitions, repay debt, repurchase shares of our common stock and pay dividends.

We have a secured $400 million revolving line of credit with a syndication of banks, which expires in January 2012 and accrues interest at LIBOR-based rates. Borrowings on this line of credit are secured by inventory, accounts receivable and certain intangible assets. As of July 31, 2008, borrowings of $192.0 million with a weighted average interest rate of 3.95% were outstanding on the secured line of credit. The secured revolving line of credit agreement contains customary restrictions but no financial covenants and no limitations on capital expenditures or share repurchases if availability of credit remains above a minimum level. Borrowings on the line of credit do not require repayment until the expiration date but may be prepaid without penalty. We pay a commitment fee of 0.25% per annum on the unused portion of the line of credit.

Additionally, as of July 31, 2008, we had $50.4 million in outstanding privately placed promissory notes. These notes, which mature at various dates through 2014, bear interest at fixed rates ranging from 6.19% to 6.71%, and are secured on the same basis as the secured revolving line of credit. The notes include penalties for repayment prior to their scheduled maturities. Current maturities of $36.7 million as of July 31, 2008 constitute regularly scheduled principal payments due in the next twelve months, the majority of which will be paid in the third quarter of fiscal 2009.

The privately placed promissory notes contain various customary financial covenants and restrictions. Failure to comply with these covenants and restrictions, or with the restrictions included in our secured revolving line of credit, could result in higher interest costs and potentially accelerated repayment requirements, and could affect our liquidity. As of July 31, 2008, we were in compliance with the restrictions and limitations included in these provisions.

We believe that cash on hand, together with cash provided by operating activities and financing capacity, will be sufficient to meet our working capital, capital expenditure and debt service requirements beyond the next 12 months.

Operating Cash Flows

Net cash provided by operating activities was $120.4 million in the first half of fiscal 2009, compared with $77.8 million in the first half of fiscal 2008. The increase in our net operating cash flows in fiscal 2009 from fiscal 2008 was primarily due to improved net income, lower merchandise inventories and higher cash flows in our pharmacy benefit services segment resulting from a calendar change in the timing of benefit payments to our pharmacies relative to our fiscal calendar. These increases were partially offset by receivable growth, primarily in our pharmacy benefit services segment, and a change in the timing of income tax payments as a result of new federal regulations.

Investing Cash Flows

Net cash used in investing activities was $65.3 million in the first half of fiscal 2009, compared with $59.2 million in the same period last year. During the first half of fiscal 2009 we opened or acquired thirteen new stores, including nine small pharmacies and four full-service retail drug stores, and closed two stores. Fiscal 2008 cash flows include $19.8 million of proceeds from the sale of property, primarily related to the disposition of 30 stores.

Financing Cash Flows

Net cash used in financing activities was $55.2 million in the first half of fiscal 2009, compared with $21.7 million in the first half of fiscal 2008. Our financing activities primarily consist of long-term borrowings and repayments, repurchases of common stock, dividend payments, proceeds from the exercise of stock options, and Medicare Part D subsidy receipts and disbursements.

Financing cash flows include prescription drug plan disbursements covered by CMS, including reinsurance payments and low-income cost subsidies, net of amounts received from CMS for these payments. Differences between receipts and payments for these amounts depend on the timing and extent of the related claims from beneficiaries. In the first half of fiscal 2009, our payments for these claims exceeded reimbursements from CMS by $30.4 million, compared with $5.9 million in the first half of fiscal 2008. Final settlement of the outstanding balance with CMS is made subsequent to the end of the plan year.

Our borrowing levels on our revolving line of credit fluctuate based largely on the levels of our cash flows from operations, capital expenditures, Medicare Part D subsidy receipts and disbursements, and stock repurchases. There were net borrowings of $25.0 million on our revolving line of credit during the first half of fiscal 2009, compared with net borrowings of $8.0 million in the same period last year. We also made regularly scheduled principal payments of $2.7 million on our private placement notes in the first half of both fiscal 2009 and 2008. We are scheduled to make additional principal payments of $36.7 million on our private placement notes in the next 12 months, the majority of which will be paid in the third quarter of fiscal 2009.

We repurchased 1,000,000 shares of our outstanding common stock in the first half of fiscal 2009 at a total cost of $39.3 million. In the first half of fiscal 2008, we repurchased 555,000 shares at a total cost of $30.0 million. We repurchased these shares under various programs authorized by our board of directors, the most recent of which was authorized in November 2007. Under this program, we are authorized to repurchase additional shares of our outstanding common stock for a maximum additional expenditure of approximately $117.1 million through February 2011. Any future repurchase of our common stock will be made in open market transactions from time-to-time depending on market conditions and the availability of funds.

Our board of directors makes decisions about the declaration of quarterly dividends based on, among other things, our results of operations and financial position. We paid regular quarterly dividends totaling $10.1 million and $10.6 million in the first half of fiscal 2009 and 2008, respectively.

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

Our major market risk exposure is changing interest rates. We use debt financing in combination with operating cash flows to support capital expenditures, acquisitions, working capital needs, dividend payments, share repurchases and other general corporate purposes. Our revolving line of credit, on which $192.0 million in borrowings were outstanding as of July 31, 2008, bears interest at LIBOR-based rates, and therefore, an increase in interest rates could increase our interest expense. A 10% change in interest rates (40 basis points on our floating-rate debt as of July 31, 2008) would have an immaterial effect on our earnings and cash flows and on the fair value of our fixed rate debt. We do not currently undertake any specific actions to cover our exposure to interest rate risk, and we are not currently a party to any interest rate risk management transactions. We have not purchased and do not currently hold any derivative financial instruments. Depending on the interest rate environment and subject to approval by our board of directors, we may make use of derivative financial instruments or other interest rate management vehicles in the future.

Item 4.

Controls and Procedures

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

As of July 31, 2008, the end of the period covered by this quarterly report, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective and adequate to provide reasonable assurance that material information relating to the company would be made known to them on a timely basis.

There have been no changes in our internal control over financial reporting that occurred during the quarter covered by this quarterly report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II – OTHER INFORMATION

Item 1. Legal Proceedings Rankin v. Longs Drug Stores California, Inc. was filed in the Superior Court of California, San Diego County, in October 2004, and was subsequently certified as a class action. The lawsuit alleged that our employment application violated California Labor Code Section 432.8 by inquiring about criminal convictions within the last seven years, without providing an exception for misdemeanor marijuana convictions more than two years old. The plaintiff sought to recover statutory damages and attorneys’ fees for himself and all similarly situated individuals who applied for employment with the Company during the class period. Trial commenced on August 20, 2007 and concluded with a dismissal of plaintiff’s case by the court on September 26, 2007. The plaintiff filed a notice of appeal on December 4, 2007.

During fiscal 2007, we completed a self-audit of certain of our California drug stores located in three counties that was initiated at the request of the State of California, Division of Labor Standards Enforcement (“DLSE”). The audit related to compliance with California law relating to meal period requirements. We made compensatory payments resulting from this audit, which were not material, during fiscal 2007. The DLSE also requested that we conduct an audit related to meal period compliance for all of our California drug stores. We have agreed to a state-wide audit covering a three-year period from June 1, 2004, through June 1, 2007. At this time we cannot reasonably estimate the amount of possible payments that might be required as a result of an additional audit, if any.

On August 19, 2008, a putative class action titled Steamfitters Local 449 v. Longs Drug Stores Corporation, et al., was filed in the Superior Court of the State of California for the County of Contra Costa. The complaint in the action names the Company and its directors, and CVS Caremark Corporation, as defendants, asserting that the directors breached their fiduciary duties by failing to take steps to achieve a higher price in the proposed transaction with CVS described in Note 2 and in Subsequent Events. The complaint also alleges that the directors suffer from certain conflicts of interest, and that the Company and CVS have aided and abetted in the directors’ alleged breach of duty. The complaint seeks injunctive relief, including an order prohibiting the Company from proceeding with the CVS transaction until it adopts and implements procedures to obtain the highest possible price. The Company believes the action is without merit and plans to defend the case vigorously. There can be no assurance that the Company will be successful in our defense of this action. It is not known when or on what basis the action will be resolved.

In addition to the matters described above, we are subject to various lawsuits, claims and federal and state regulatory reviews and actions arising in the normal course of our businesses. We accrue amounts we believe are adequate to address the liabilities related to lawsuits and other proceedings that we believe will result in a probable loss if the loss can be reasonably estimated. However, the ultimate resolution of such matters is uncertain and outcomes are not predictable with assurance. It is possible that the matters described above or other proceedings brought against us could have a material adverse impact on our financial condition and results of operations.

Item 1A.

Risk Factors

If our planned acquisition by CVS is not consummated, our business, results of operations and the market price of our common stock could be adversely affected.

On August 12, 2008, we announced that we had entered into a Merger Agreement with CVS pursuant to which CVS and Blue MergerSub Corp., a subsidiary of CVS, have commenced a tender offer at an offer price of $71.50 per share to acquire all of the outstanding shares of our common stock. Under the terms of the Merger Agreement, if at least 66 2/3rds percent of our shares are tendered and the other conditions to the Offer are satisfied, Blue MergerSub Corp. must promptly purchase all of the tendered shares. Following completion of the tender offer, Blue MergerSub Corp. will merge with and into the Company and we will become a wholly-owned subsidiary of CVS, thus ending our existence as a standalone publicly-traded company. The announcement and pending completion of the terms of the Merger Agreement, the tender offer and the merger could have an adverse effect on the our business generally, our customer relationships and operating results, and our ability to retain employees, including key employees.

In addition, in the event that the conditions to the completion of the tender offer and the merger are not satisfied, including the receipt of regulatory approvals, or an event, change, or other circumstance occurs that could give rise to the termination of the Merger Agreement, the tender offer and the merger may not be completed.

We expect to incur substantial costs in connection with the tender offer and the proposed merger, including legal fees, financial advisory fees and other related costs. If the tender offer and the merger are not completed due to certain circumstances specified in the Merger Agreement, we also may be required to pay CVS a termination fee of $115.0 million, plus expenses, up to a maximum of $10.0 million. Further, if the tender offer or the merger is not completed, we may experience negative reactions from the financial markets and our customers, suppliers and employees. For example, during the pendency of the transaction we will incur substantial integration costs, our employees and management will likely be distracted, it may be difficult for us to attract new retail and PBM customers and we may not be able to successfully enter into new leases or modify or extend our existing leases. As a result, if the tender offer and the merger are not completed, for the foregoing and other reasons, it may be difficult to pursue and obtain our previously announced strategic initiatives and goals.

Each of the factors described above could materially and adversely affect our business, results of operations and the market price and trading volume of our common stock. In particular, if the tender offer and the merger are not completed for any reason, the market price of our common stock will likely decline, to the extent that the current market price reflects the market assumption that the tender offer and the merger will be completed or the market’s perceptions as to the reasons why the tender offer and the merger were not completed.

Restrictions on the conduct of our business prior to the completion of the tender offer and the merger may negatively impact our results of operations and our competitive position.

We are subject to certain restrictions under the Merger Agreement on the conduct of our business prior to the completion of the merger, including, among others, not exceeding a certain amount in capital expenditures, not making acquisitions other than those contemplated by the Merger Agreement, not entering into contracts exceeding a certain amount and other matters. These restrictions may prevent us from pursuing attractive business opportunities that may arise prior to the completion of the merger that could be favorable to our operations and our shareholders. As a result, if the tender offer and the proposed merger are not completed, our results of operations and competitive position may be adversely affected.

Other than the risk factors set forth above, there have been no material changes from risk factors previously disclosed in the Company’s Annual Report on Form 10-K for the year ended January 31, 2008.

Item 4.

Submission of Matters to a Vote of Security Holders

Our Annual Meeting of Stockholders was held on May 28, 2008. At the meeting, stockholders voted upon the following actions:

1.	Election of Directors


	For	Withheld
Leroy T. Barnes, Jr.	32,954,123	1,153,936
Murray H. Dashe	32,976,955	1,131,104
Evelyn S. Dilsaver	33,125,231	982,827
Donna A. Tanoue	33,118,782	989,276

The four nominees who received the greatest number of votes (all of the above individuals) were elected to our board of directors, and will serve as directors until our 2009 Annual Meeting of Stockholders and until his or her successor is elected and qualified.

The other directors whose terms of office continued following the Annual Meeting of Stockholders are:

Warren F. Bryant

Mary. S. Metz

Anthony G. Wagner


		For	Withheld	Abstained	Broker Non-Votes
2.	Proposal to ratify the retention of Deloitte & Touche LLP as our independent registered public accounting firm for the fiscal year ending January 29, 2009.	33,546,060	356,609	295,389	—

	The retention was ratified.

Item 6.

Exhibits

(a)

EXHIBITS


Exhibit No.		Exhibit Name
2.1		Agreement and Plan of Merger, dated as of August 12, 2008, among CVS Caremark Corporation, Longs Drug Stores Corporation and Blue MergerSub Corp., is incorporated herein by reference, as previously filed with the Commission on August 18, 2008, as Exhibit 2.1 to Form 8-K.

3.1		Amended Bylaws of Longs Drug Stores Corporation, dated August 11, 2008, is incorporated herein by reference, as previously filed with the Commission on August 18, 2008, as Exhibit 3.1 to Form 8-K.

10.1		Form of Personal Identity Theft Protection Reimbursement Agreement between the Company and directors and certain employees *

10.2		Amended and Restated Employment Agreement, effective as of August 12, 2008 by and between Longs Drug Stores California, Inc. and Warren F. Bryant, as previously filed with the Commission on August 18, 2008, as Exhibit 10.1 to Form 8-K.*

10.3		Amended and Restated Form of Agreement for Termination Benefits in the Event of a Change in Corporate Control, effective as of August 12, 2008 by and between Longs Drug Stores California, Inc. and Executive Officers, as previously filed with the Commission on August 18, 2008, as Exhibit 10.2 to Form 8-K.*

31.		Certification of the Chief Executive Officer and the Chief Financial Officer of Longs Drug Stores Corporation, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. **

32.		Certification of the Chief Executive Officer and the Chief Financial Officer of Longs Drug Stores Corporation, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. **

*	Indicates a management contract or compensatory plan or arrangement.

These certifications are being furnished solely to accompany this quarterly report pursuant to 18 U.S.C. §1350, and are not being filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and are not to be incorporated by reference in any filing of the Company, whether made before or after the date hereof, regardless of any general incorporation language in such filing.

SIGNATURES

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


				LONGS DRUG STORES CORPORATION (Registrant)

		Date: August 26, 2008		/s/ S. F. MCCANN
				(S. F. McCann)
				Executive Vice President, Chief Financial Officer
				(Principal Financial Officer)

		Date: August 26, 2008		/s/ R. L. CHELEMEDOS
				(R. L. Chelemedos)
				Senior Vice President—Finance, Controller and Treasurer
				(Principal Accounting Officer)

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LONGS DRUG STORES CORP 10-Q