Rite Aid Corp RAD
Q2 2011 Earnings Call Transcript
Transcript Call Date 09/23/2010

Operator: Good morning. My name is Chrystal and I will be your conference operator today. At this time, I would like to welcome everyone to the Rite Aid Second Quarter Fiscal 2011 Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. Thank you.

I would now like to turn the conference over to Mr. Matt Schroeder. Please go ahead, sir.

Matt Schroeder - Group VP, Strategy and IR: Thank you, Chrystal, and good morning, everyone. We welcome you to our second quarter conference call. On the call with me are, John Standley, our President and Chief Operating Officer and Frank Vitrano, our Chief Financial and Chief Administrative Officer.

On today's call, John will give an overview of our second quarter results and discuss our business. Frank will discuss the key financial highlights and fiscal 2011 outlook, and then we will take questions.

As we mentioned in our release, we are providing slides related to the material we will be discussing today on our website, www.riteaid.com under the Investor Relations Information tab for 'Conference Calls.' We will not be referring to them directly in our remarks, but hope you will find them helpful as they summarize some of the key points made on the call.

Before we start, I'd like to remind you that today’s conference call includes certain forward-looking statements. These forward-looking statements are made in the context of certain risks and uncertainties that can cause actual results to differ. Also, we will be using a non-GAAP financial measure. The definition of the non-GAAP financial measure along with the reconciliations to the related GAAP measure are described in our press release. I would also encourage you to reference our SEC filings for more detail.

With these remarks, I'd now like to turn it over to John.

John T. Standley - President and CEO: Thanks Matt. It was a very bust quarter for us and I'm very pleased with the progress we're making on our key initiatives as well as improving our balance sheet. Our wellness+ card-based royalty program is going great. Our immunization program is ramping up and we're moving forward with our segmentation-based initiatives. Before I get into the specifics about the initiatives, I have a couple of comments about the second quarter results which Frank will go through in detail in just a few minutes.

As expected, our SG&A increased this quarter because of a shift in the timing of Memorial Day holiday, expenses to roll out wellness+ and the cost to expand our immunization capabilities, which altogether reduced adjusted EBITDA by $26 million.

Comparable store front end sales decline 90 basis points due softness in our seasonal and general merchandise categories but our core drug store categories performed well. September front end same store sales are improving and are expected to be in the range of negative 50 to negative 75 basis points. Script count declined 2.1% in the quarter due to growth of 90-day scripts, maturation of the Rx savings card and cycling some H1N1 benefit in the prior year. Script count improved month-to-month during the quarter and in September is expected to be similar to our August number.

The year-over-year decline in pharmacy margin was substantially less this quarter versus last year’s second quarter. Distribution expenses were 1.48% of sales, lower than last year's, thanks to our continued focus on improving distribution efficiency. FIFO inventory was $64 million less than last year second quarter – I guess that's $70 million. Sorry.

We have $1.1 billion of liquidity at the end of the quarter giving us the flexibility to invest in the future growth of our business. We reduced debt by $158 million compared to last year's second quarter, and we completed the refinancing of our revolving credit facility in Tranche 4 term loan reducing our interest expense by about $13 million annually and extending the maturities.

Even though comparable adjusted EBITDA is down slightly after taking into account $26 million related to the holiday, pay shift and growth initiatives, the core business performed well with continued good cost control and solid gross margins. We continue to operate more efficiently with reductions in many of our retail operating expenses year-over-year and believe there are more opportunities to further reduce operating costs throughout our Company.

With the little sales momentum we'll improve our results, which is why the investments we made in our growth initiatives this quarter are so important. We are working on the right things.

Enrollment in our tiered reward loyalty program Wellness+ launched nationwide only five months ago is already exceeding our expectations. We had more than 22 million members last week and now expect to have more than 30 million members by the end of the fiscal year.

Cards usage has been strong. 56% of our front-end sales and 52% of prescriptions filled came from Wellness+ members last week. The script count number grows to 58% of all scripts filled using Wellness+ if you eliminate New York and New Jersey where giving points for prescriptions is not allowed.

We have also seen encouraging results from the pilot markets, where script counts which were running behind the chain before the program are now running 70 plus basis points ahead of the chain.

Front-end basket size for Wellness+ members gets 40% higher than for non-members and it gets better as you move up the rewards levels. At the plus level the lowest level, the average front-end basket size was 46% larger than non-members, and sliver 88% larger than non-members and at the top level gold 78% higher than non-members. And remember, gold members got a 20% front-end discount, while silver members got a 10% discount.

We believe wellness+ has been so well received because it's different from other retail loyalty programs. To attract and retain customers and patients, we offer increasing levels of front-end discounts and health benefits based on the dollar amount of front-end purchases and number of script fills. Gaining a better understanding of our shoppers through wellness+ will help us capture some of the significant sales growth opportunities that we identified in our segmentation analysis. Overall, we are very pleased with the results of wellness+ so far.

During the quarter, we also made good progress with our segmentation initiatives, especially with our new merchandising strategies for low volume stores. We now have 37 value stores where we are testing varying degrees of a new merchandise planogram designed to build business in lower volume stores. These stores have 9,000 fewer SKUs than our traditional drug store, a lot of values, a larger dollar shop, are lower priced and have similar – have a smaller add than our traditional stores.

The good news is that these stores are showing strong front-end sales growth. Our goal is to improve the productivity in these stores by combining the new merchandising program with a modified distribution model, and if successful, evaluate whether the model can be expanded to other low volume stores in the chain.

In addition to our value store test, you may have seen our recent announcement that we are going to test 10 Save-A-Lot Rite Aid combo stores in Greenville, South Carolina. We have a licensing agreement with Save-A-Lot to add their limited assortment food store concept to the front of these 10 existing Rite Aid stores, which will continue to be owned and operated by us. The front-end will carry Save-A-Lot products, about 1,300 SKUs, as well as HBC products provided by Rite Aid with emphasis on our private brand. Our pharmacies will operate as usual.

The Save-A-Lot portion of the store will have a full grocery shop, including pre-packaged meat, produce and dairy, and will be up to 40% cheaper than traditional supermarkets. The 10 stores remain open during construction. The first store will be completed next week with the remainder completed by the end of October. We chose these stores in Greenville because they have solid pharmacy business but we need stronger sales on the front-end. This new co-branded concept presents unique opportunity to increase front-end sales in this market.

We also completed our immunization training this quarter. We now have over 7,000 immunizing pharmacist at more than 3,000 stores ready for flu season and in addition to the flu vaccine, we will provide all immunizations allowed by state regulation.

Our shots are competitively priced and while it's still very early considering there is no H1N1 scare this year, we have already more than tripled the number of shots our pharmacist administered at this time last year. Because of H1N1 flu season peaked early in October-November last year, this year the CDC is forecasting a more typical timing with peak season being in December and January.

During the quarter customers continue to search for value with our private brand penetration increasing to 16.2% compared to 15.3% last year. We expect this consumer behavior to continue even if the economy improves, and we expect continue to roll up and we continue to roll out our new private brand architecture in the second quarter. Our program includes 250 new items this fiscal year, with all new packaging and as a refresher of the following brands; Rite Aid Pharmacy for health products, Renewal for beauty, Pantry for food and certain consumables, Home for household good, Tugaboos for baby and our priced Rite Aid brand Simplify. We have now converted the 136 items into these brands and expect to have about 2,200 items in these new brands within the next 12 months.

Even though we've just started to rollout, we are getting great response from our customers and expect that with strong promotional support, good price positioning and continued development of new items, we'll continue to grow private brand sales, improve margin and meet the needs of today's customers.

As I said earlier, we're working on the right things. Margins are stabilizing and our drug store categories are performing better. I am pleased with the way our growth initiatives are progressing and our continued ability to reduce cost and improve efficiency. I am excited about our various segmentation tests and what they might mean for the future.

Our financial position has improved with strong liquidity, lower interest expense, extended debt maturities, and our ability to continue to reduce debt, while at the same time make good investments for future growth. As you can see, we are working hard to improve our performance.

Now, I will turn it over to Frank.

Frank Vitrano - SEVP, CFO and Chief Administrative Officer: Thanks, John, and good morning, everyone. As John mentioned, we saw a solid progress in the second quarter, with our various operating initiatives, despite some sales challenges. We also saw our pharmacy margins continue to stabilize.

On the call this morning, I plan to walk through our second quarter financial results, discuss our liquidity position, and certain balance sheet items. I will also provide a capital expenditure update and discuss the cost associated with our wellness+ loyalty card rollout. Finally, I will review our revised fiscal '11 guidance.

This morning, we reported revenues for the quarter of $6.2 billion compared to $6.3 billion for the second quarter last year. The decrease in total sales was primarily driven by a reduction in total store count as well as a decline in same store sales. In the quarter, we relocated five stores and closed 20 stores.

On a year-over-year basis, we had 65 fewer stores. Same store sales declined 150 basis points, with sales trends improving each month.

Pharmacy scripts were down 210 basis points, primarily impacted by 90-day scripts and H1N1 comparisons to last year. Front end same store sales were down 90 basis points and pharmacy same store sales were lower by 180 basis points during the quarter.

Pharmacy sales included an approximate 195 basis point negative impact from new generic drugs. Adjusted EBITDA in the quarter was $181.2 million or 2.9% of revenues, which was lower than last year's second quarter of $216.5 million or 3.4% of sales.

The results were impacted by $26.2 million or $0.03 per diluted share for cost associated with the rollout of the wellness+ customer loyalty program, expenses related to the expansion of our immunization capabilities, and the shift in holiday pay with respect to the Memorial Day holiday from the first quarter last year to the second quarter this year, as well as lower sales partially offset by improving gross margin.

Net loss for the quarter was $197 million or $0.23 per diluted share compared to last year's second quarter net loss of $116 million or $0.14 per diluted share. The increase in net loss was driven by a $44 million or $0.05 per diluted share charge on debt modification related to the recently completed refinancing and lower gross profit dollars due to lower sales.

The lease termination charge in the current period included 12 stores for which we recorded a closing provision of $11.1 million during the second quarter. The LIFO charge of $20.5 million compares to $14.8 million last year. The increase is due to higher than planned Rx inflation.

Interest expense and securitization cost of $139.7 million was $3.2 million lower than last year's interest and securitization costs. Non-cash interest, primarily debt issuance cost amortization and workers' compensation interest accretion, was $11.7 million.

Total gross margin dollars in the quarter were $49.6 million lower than last year's second quarter or 12 basis points as a percent of sales.

Adjusted EBITDA gross profit dollars, which excludes specific items including LIFO and the wellness+ deferral revenue charge, the details of which are included in the second quarter fiscal '11 earnings supplemental information which you can find on our website, were lower by $29.1 million due to lower sales but 23 basis points higher than last year. Adjusted EBITDA gross profit front end margin rate was stronger in the quarter.

Pharmacy margins were lower by 13 basis points of pharmacy sales driven by lower third-party Rx reimbursement rates as well as lower Medicaid reimbursement rates, which were largely influenced by the AWP rollback which we fully cycle this month.

The 13 basis point quarterly unfavorable variance improved from the 45 basis point decline in pharmacy margin we saw in the first quarter of this year. The pharmacy margin pressure has stabilized here in the second quarter of fiscal '11 as we cycled the more significant (MACing) of new generics which occurred last year.

The margin dollar shortfall was partially offset by lower distribution center cost driven by the closure of two distribution centers and reduced and realigned trucking routes. Product handling and distribution center expense as a percent of sales was lower than last year.

Selling, general and administrative expenses for the quarter were higher by $19.2 million or 36 basis points as a percent of sales as compared to last year. SG&A expenses not reflected in adjusted EBITDA were lower by $25 million or 34 basis points primarily driven by lower depreciation and amortization, and securitization cost from the accounts receivable facility reported last year as SG&A.

Adjusted EBITDA SG&A dollars which excludes specific items the details of which are also included in the second quarter fiscal '11 earning supplemental information were higher by $5.8 million or 71 basis points higher as a percent of sales.

This is the first increase in SG&A dollars in the past six quarters driven by a number of factors including a comparison to last year’s second quarter which was $90 million lower than the second quarter in the previous year.

Two factors relate to our growth initiatives, namely a $13 million advertising expense related to the start-up of our wellness+ loyalty card; and secondly, we incurred $4.2 million in training cost in the second quarter associated with our pharmacist immunization program, which we mentioned on the first quarter call.

The third factor was something I also pointed out on the first quarter earnings call and that was the timing of the Memorial Day holiday which favorably impacted our store level non-worked holiday payroll cost in the first quarter by some $9 million as these costs were incurred in the second quarter of fiscal '11.

As I previously mentioned, these three items totaled $26.2 million. Incremental to those three items with a $17.3 million increase over last year in our workers' compensation and general liability costs due to a less favorable claims experience recorded in this year’s second quarter as compared to last year.

You should also note in last year’s third quarter we recorded a $37 million favorable workers' compensation general liability adjustment that we will cycle in the third quarter of this year.

We continue to believe there are opportunities to reduce our cost in the future to operational efficiency and cost controls as part of project simplification and the various segmentation initiatives. Another example of cost saving opportunities is the decision we announced last week to further rationalize our distribution center network.

We announced plans to close our own New York distribution centers which will be completed early next year. You will recall last year we closed distribution centers near Atlanta, Georgia and Bohemia, New York as part of an ongoing review of our distribution center network. The size, age, condition and infrastructure of the 38-year-old (grown) facility was the key factor in our decision.

The strong liquidity position benefited from the various working capital initiatives and spending capital wisely. As compared to the second quarter of fiscal '10, FIFO inventory was lower by $70 million. FIFO inventory increased $60 million from year end fiscal '10 due to normal seasonal trends.

Our cash flow statement results for the quarter show net cash used in operating activities in the quarter as a use of $5.8 million as compared to a use of $147 million in last year's second quarter.

Our days payable outstanding in the quarter was 26.4 days, this compares to 24.2 days in the second quarter of fiscal '10. The increase was influenced by favorable generic pharmacy terms.

Net cash used in investing activities for the quarter was $37.3 million versus $26.9 million last year. Last year we received $6.5 million in sale leaseback proceeds.

During our second quarter fiscal '11 we relocated five stores, remodeled one and closed 20 stores. Our cash capital expenditures were $42.2 million, of which $4.8 was for script file buys.

Now, let’s discuss our liquidity position. At the end of the first quarter we had $1.082 billion of total liquidity including over $1 billion available under our credit facility and $51 million of invested cash. We had zero revolver borrowings under our $1.175 billion senior secured credit facility with $143 million of outstanding letters of credits.

Today, we have $1.037 billion of liquidity. Total debt net of invested cash was lower by $158 million from last year’s second quarter and $220 million lower than the fourth quarter '10.

Now let’s turn to fiscal '11 guidance. Our guidance is based on current trends. We have revised our guidance and now expect total sales to be between $25 billion and $25.4 billion as a result of the first six months sales trends. We have also narrowed our adjusted EBITDA to be between $875 million and $950 million for fiscal '11. We expect same store sales to be in a range of negative 150 basis points to flat over fiscal '10 and net loss for fiscal '11 is expected to be between $400 million and a $590 million loss or a loss per diluted share of $0.46 to $0.67. The change in net loss reflects lower interest expense, in part due to the recently completed refinancing, more than offset by a $45 million provision for loss on debt modification.

Our fiscal '11 capital expenditure plan remains at $250 million, with $50 million allocated for file buys. We expect to open three net new stores and relocate 30 stores. We're not planning any sale/leaseback transactions, and we expect to be free cash flow positive for the year.

The guidance includes a total of 80 closures, half of which include a store lease closing provision with the balance of stores closing upon lease expiration. The adjusted EBITDA guidance includes the startup advertising and supply cost and discounts associated with a chain-wide rollout of the wellness+ customer loyalty program. The advertising and supply costs for the program are estimated to be $32 million, with $26.5 million incurred in the first half of the year.

In addition to these costs, generally accepted accounting principles require us to defer a certain portion of revenues generated by customers as they qualify for their tiered discount benefit. A silver member must earn 500 points, while a gold member needs to earn 1,000 points.

Once a wellness+ member qualifies as silver or gold and begins to use their tiered discount, we are permitted to recognize the deferred revenue as income to offset a portion of the tiered discount.

Within each customer qualification and discount use period, which could span multiple calendar years and fiscal periods, the net impact of these adjustments have no effect on the income statement as the entries will net to zero over time.

Included in our net income guidance is a wellness+ deferral provision range of $30 million to $40 million which covers fiscal '11. Fiscal '12 will have an additional charge to reflect a full 12-month qualification period.

This completes my portion of the presentation, and I'd now like to open the lines for questions. Operator, we're ready for the first question.

Transcript Call Date 09/23/2010

Operator: Emily Shanks, Barclays Capital.

Emily Shanks - Barclays Capital: John, I was hoping you could give us a little color around your comments that are in the press release talking about sales in the core drug store category has started to strengthen. Can you just give us color around how you define it and what you are seeing?

John T. Standley - President and CEO: Sure. Basically, what I am talking about there, HBC and beauty categories have done substantially better over last quarter, so far this month as well. So we probably saw more broad-based sales issues going back a few quarters whereas now I think some of the core categories appear to stabilizing and growing. Where we're still fighting in a little bit is really in our seasonal categories and general merchandise. Those are really the categories that we've got to kind of get going here and I think our sales have come around quite a bit.

Emily Shanks - Barclays Capital: Do you think that strength is from the private label introductions that you are talking about or…

John T. Standley - President and CEO: Honestly, I think it's just we are getting a little bit in terms of execution. I think it's probably maybe the consumers reacting a little better to some of the things that we are doing promotionally with wellness+. Ken, is there anything you’d add to that?

Ken Martindale - COO: No, I think that's pretty accurate.

Emily Shanks - Barclays Capital: Then Frank, just one question around the loyalty card revenue deferral. We should just think of that as potentially a non-cash hit to revenue and then over time the actual cash flow that you effectively lose will just be reflected in gross profit margins? Is that…

Frank Vitrano - SEVP, CFO and Chief Administrative Officer: That's correct.

Emily Shanks - Barclays Capital: Then also my final question is, around the warehouse closure, I know you spoke to it in your prepared remarks. Are there more to come and then can you speak at all to what savings you expect to see around this particular closure?

John T. Standley - President and CEO: In terms of the distribution network, we are continuing to evaluate the network over time and look at it carefully to make sure we've got the right balance to this. In terms of the savings, Frank, it's on a high single-digits I guess.

Frank Vitrano - SEVP, CFO and Chief Administrative Officer: High seven digit single-digits.

Operator: John Ransom, Raymond James.

Stephen Gregory - Mandalay Research: This is actually (Stephen Gregory of Mandalay Research). Couple of questions. About two months ago in the Wall Street Journal, there was an article written regarding e-commerce is going to reshape how companies like to sell, change the way they do business with their customers. John, what can you provide some color on the call today as what is your e-commerce vision going forward for the next couple of years and how do you plan to take us there?

John T. Standley - President and CEO: In terms of e-commerce, there is a number of things that we're doing in terms of, I guess, customer communication, I guess I'd point to that initially. We've worked hard to, especially in the pharmacy side of our business, be able to communicate with customers about status of their scripts, whether it's to text messaging, improvements to our website or other types of communication. I think that's really critical on the pharmacy part of our business. In terms of where we're headed from an e-commerce perspective – what's that? Well, I think we're going to continue to leverage the relationship that we have with drugstore.com built that out further. And we're clearly using the Internet as a communication vehicle with our customers and they are engaging very heavily.

Stephen Gregory - Mandalay Research: And on the Rite Aid online stores, how do you guys have the ability to introduce promotions that can now react to customer trends, that way customers can (find their site) more effectively and buy your products with much easier use?

John T. Standley - President and CEO: Again, we're still leveraging the relationship that we've got with drugstore.com and we're expanding that relationship. We've been talking to them recently about ways to do that. We're probably not ready to actually disclose our strategy there, but we are going to continue to leverage the drugstore.com relationships that we have, and obviously they've got a very robust platform.

Stephen Gregory - Mandalay Research: John, what are your goals that you'd like to – your total sales to be from – a percentage of total sales from e-commerce going forward? What's your big objective that you'd like to achieve?

John T. Standley - President and CEO: I don't think we have a huge number for that honestly. I mean, what's going to kind of make or break us is our continued execution at retail. That's where we think the success in the near-term is for us, and that's our primary focus. We're going to continue to improve our website; we're going to continue to communicate with customers electronically, and we're working on our social networking skills. But those are the basic platforms of what we think our success.

Stephen Gregory - Mandalay Research: Are you guys looking at mobile right now, for about, price an app for Google, Android what have you?

John T. Standley - President and CEO: Absolutely.

Stephen Gregory - Mandalay Research: When you plan to launch something like that, you'd let all of the customers on the call know what you're planning on doing?

John T. Standley - President and CEO: We'll announce it when we're ready to go down that road.

Stephen Gregory - Mandalay Research: Can you provide some more color on that? I mean, your sales are down pretty dramatically, right now your stocks are falling off the cliff. What can you provide – or add some color that you're going to do to turn around the company you've brought on board? A couple of years ago, they re-turned around the company what can you tell us that you're going to do to get that stock up fully at $1? I mean, what are you going to do to get the stock up?

John T. Standley - President and CEO: We're going to improve our retail operations. We're going to focus on our opportunity areas. We're going to grow wellness+. We're going to become a more efficient operator. We're going to improve customer service. Those are the key components of our strategy, and we're going to grow in the healthcare arena.

Stephen Gregory - Mandalay Research: So, your e-commerce is not really one of your biggest decisions even though…

John T. Standley - President and CEO: I think EBITDA-commerce is a key arrow in the quiver of the things that we are working on. That is not the only strategy that we have.

Stephen Gregory - Mandalay Research: Where would you like a percentage of total sales to be – I mean, where are you now? What are – your percentage of total sales coming from like partnership or drugstore.com and your Rite Aid online store?

John T. Standley - President and CEO: Fairly small percentage of our total business. We're really more of a bricks and mortar retailer today than we are an e-commerce company.

Stephen Gregory - Mandalay Research: So, that's not going to really change that type of decision?

John T. Standley - President and CEO: I think it will change modestly over time, but I don't see a dramatic shift in our business in the near term, should become suddenly a very large e-commerce player. What we have is a great network of 4,700 stores across the country and we've got to leverage that asset. That's what's really going to make our success. And we're going to have e-commerce as a convenience and a growth vehicle, but I think the primary strategies that we have are really driven around our bricks and mortar business.

Stephen Gregory - Mandalay Research: Final question, you mentioned social. What are you guys doing in that area? And how is it impacting your bottom line?

Ken Martindale - COO: This is Ken, just so you can tell a difference between Ken and John.

John T. Standley - President and CEO: We recently brought up Facebook and Twitter, we’re really dabbling it. Obviously, we’re being very, very careful because as you know the social – the social space is a two edged sword and so we’re using it as a vehicle to communicate to the consumers, and we’re really just starting to leverage that asset, very early.

Operator: Lisa Gill, JPMorgan.

Lisa Gill - JPMorgan: I just had a couple of questions around the reimbursement environment. I think that you made some comments earlier that you are finding that pharmacy overall reimbursement is stabilizing. Can you maybe just talk a little bit about what you are seeing as far as stabilizing is it more from the government payers, from the commercial payers? And then secondly, can you maybe just talk about what you have in your expectations around AMP?

John T. Standley - President and CEO: Sure. In terms of the reimbursement rates, the stabilization is probably more from third-party payers than it is from government payers. Although they are both better than they were, probably more improvement on the third-party payer side, and a big part of which is driving that, quite frankly is the lack of new generics a year ago. We’re not seeing a lot of that for the second year, sort of big MACing that goes on as the generic matures because we didn’t have a lot of new generics a year ago. So that’s one of the key factors that I think is helping cost stabilize the pharmacy margin right now. In terms of A&P, we don’t, we don't have anything in guidance for per say. We don’t really have a good sense yet of what the impact of A&P is going to be and we don't think it's going to show up I think right now until probably our next fiscal year in terms of timing. I mean, you never know on this thing, but that's kind of the way it feels right now. We're waiting to see some data from the government or someone help us understand what the A&P should look like. As soon as we get that kind of information, we'll be able to provide some clarity and color around what we think it will do in terms of margin impact.

Lisa Gill - JPMorgan: Then, I guess, just my final question would be that your comments around flu that you've tripled the number of vaccines that you've given in last year. Have you given any indication as to how many vaccines you’ll do this year?

John T. Standley - President and CEO: We've said I think previously that we’re shooting for 1 million shots this year.

Lisa Gill - JPMorgan: Do you think that you’ll exceed that or just given what you've seen in the early flu start season?

John T. Standley - President and CEO: It's early enough that I don't actually know the answer to that question. I think we're around where we thought we would be at this point and the triple number, it's early and we didn’t shoot that many in the last year. So we're making good progress. I’m pleased with where we’re at, but we’ve got to see how it develops here.

Lisa Gill - JPMorgan: Then as the person comes in for that flu shot, are you seeing that they are picking up incremental items or are they just coming in, getting flu shot and walking out the door? Are you seeing additional foot traffic around that flu shot?

John T. Standley - President and CEO: Yeah, we think we are but again it’s a little bit early. I have a better sense here probably then in the next quarter what happens with it. Our belief is that people based on some data we looked at from IMS is that people who get flu shots can be converted to our customer. That's why thought it was so important we should have that available for our customers and to potentially get some new customers with it.

Operator: Karen Eltrich, Goldman Sachs.

Karen Eltrich - Goldman Sachs: Both the SUPERVALU and the lower cost stores seem to have a lot of potential. How quickly could you role those out if successful and how would you differentiae in the store base which one would be the low price and which one would be a SUPERVALU co-brand? (indiscernible) sorry.

John T. Standley - President and CEO: My guess is, the answer on that thing is probably likely to be some combination of the two scenarios. They Save-A-Lot Rite Aid combo there is more involved to convert a store into that sort of combined format than there is with our value concept of store. So that has a bit more lead time on it. So it would take us longer to make a significant number of those stores and if we decided to significantly ramp it up, I think we would be able to engineer the process a lot more than we did in the test stores because you are willing to intend. So if we were going to do a lot of them, I think we could come back to you and say, hey, it works and we are going to expand the spending and here is how we think it could work. But until we get a sense for it, I am hesitant to tell you we could make so many in X period of time because we need to see how it goes.

Karen Eltrich - Goldman Sachs: What about to the value concept?

John T. Standley - President and CEO: The value stores can be done fairly quickly. In two weeks or so a store can be converted. The cost is not gigantic for it. So we could potentially expand that fairly rapidly. We would have to have internal resources to do that, but that probably could move a lot quicker than a Rite Aid Save-A-Lot could.

Karen Eltrich - Goldman Sachs: At our conference you mentioned you were starting to see a spread between the wellness+ test stores comp store performance versus the whole chain. Can you may be quantity what kind of spread you are seeing?

John T. Standley - President and CEO: Yeah, the thing that we’re watching most closely is the pharmacy and what we saw over the last month is that the wellness+ stores that were in the pilot outperformed the rest of the chain by about 70 basis points on script count growth. It feels like it’s starting to get some traction.

Operator: Karru Martinson, Deutsche Bank.

Karru Martinson - Deutsche Bank: Well, all my e-commerce questions have been answered. So, let's focus on the guidance here. What are kind of the assumptions you guys are baking into the guidance? What are you expecting from a macro trend and what's your confidence level in the guidance you've given?

John T. Standley - President and CEO: The big that really what I think was reflected and adjusted in the top end of the guidance this morning is really sales, and that’s really the key for us right now. We're very focused on the top line. We’ve got to get some sales momentum into this thing. So, that’s always the hardest thing to predict and forecast. But I feel good about the things that we’re working on. I feel good about some of the internal metrics that we're looking at. Obviously, none of us are satisfied until we get total sales growth where we want it to be. So, in terms of the confidence in the guidance, based on where we sit today, I feel pretty good about it, and we'll just have to see how sales progress here as we work our way through the year.

Karru Martinson - Deutsche Bank: When you look out at your store base, you're closing 80 stores, but how many of your stores do you feel are negative on a four-wall basis, and what's the closure outlook going forward?

Frank Vitrano - SEVP, CFO and Chief Administrative Officer: There is probably a couple of hundred stores here that are not profitable. There is always a group that are not profitable, the ones that we look at on a fairly regular basis. We continue – Brian Fiala and ops teams continue to look at those underperforming stores, and looking at ways for us to improve the overall profitability. But that’s something, Karru that we continue to monitor, and that’s part of the 40 stores that we did decide to close this year that were underperforming stores.

Karru Martinson - Deutsche Bank: Now, on the Medicaid reimbursement, just so we’re clear. We anniversaried that reduction in reimbursements here in September, that's about $1 million a week, correct?

John T. Standley - President and CEO: That was on the brand side, yes.

Karru Martinson - Deutsche Bank: And then in terms of this script buys, how are we looking on that pipeline, you guys had historically said something that was still in the ramp up process?

John T. Standley - President and CEO: We're continuing to do that, dedicating some additional resources on the ground, knocking doors on the independents, continuing to search for profile buys, in and around surrounding our existing stores.

Karru Martinson - Deutsche Bank: Just lastly on those scripts, are you still kind of valuing those into kind of the $10 to $20 per script range?

John T. Standley - President and CEO: Yes. That's still pretty much the range, Karru.

Operator: Bryan Hunt, Well Fargo Securities

Bryan Hunt - Well Fargo Securities: I was wondering if you could just talk about since you mentioned that AWP and you are cycling it. What AWP cost you over the last year on a profitability basis?

Frank Vitrano - SEVP, CFO and Chief Administrative Officer: It's $52 million, (about 1 million to each).

Bryan Hunt - Well Fargo Securities: Second, looking at the distribution center you are closing, is that an owned facility, and if it is, what do you believe it's worth if you were to list it?

John T. Standley - President and CEO: It's actually three buildings up there that kind of make up this complex, two of them are leased facilities, one is an owned facility and the owned facility is probably worth $4 million, $5 million.

Frank Vitrano - SEVP, CFO and Chief Administrative Officer: And the few potential buyers listening.

Bryan Hunt - Well Fargo Securities: Next question, if you look at the conversions to the Save-A-Lot stores down in the South Carolina market, the 10 you’re doing, why that concept as opposed to your own value food offerings that you've developed around your low volume stores? Then along with that question, what is the cost of conversion to the Save-A-Lot?

John T. Standley - President and CEO: So I think what we are trying to do here, sort of, step back a little bit, as we do have a group of underperforming stores that we have been focused on and we are really kind of marching down a couple of different roads. At the same time, we have been working on our own kind of value concept, that's really focused in on traditional kind of drug store categories, little bit more consumables in it. What's appealing about the Save-A-Lot concept is, it's a very deeply discounted broader food offering and based on some of the work that we did, we think that can have real appeal to the customer base that we have around these stores. So, we see it as kind of another opportunity to kind of drive some volume through some of our lower volume prime stores. I think it's a pretty interesting format and concept and could fit well with some, a lot of the demographics that we have around some of our lower volume stores.

Frank Vitrano - SEVP, CFO and Chief Administrative Officer: Advantage is, it's already up and running. I mean, there is a name out there, there is a brand, there is 1200 Save-A-Lots out there today.

Bryan Hunt - Well Fargo Securities: Could you give us an idea what the cost – Frank, the cost of conversion is?

Frank Vitrano - SEVP, CFO and Chief Administrative Officer: Yes, it's about $600,000 to do a full conversion that will include all of the refrigeration equipment and fixtures and what not.

Bryan Hunt - Well Fargo Securities: If you were to look at your store network and the demographics around your store network, I mean, how many of your stores do you feel like you could roll Save-A-Lot out into?

John T. Standley - President and CEO: If it works. I think if it works, there could be a significant number of stores that this might work in. It could be a good concept for us. I'll just make a comment too, SUPERVALU has been a great partner in this thing, they've been just fantastic to work with and it really helped us kind of bring this thing to life fairly rapidly here.

Bryan Hunt - Well Fargo Securities: And my last question. There was a few large packaged goods companies report this week. It sounds like you're starting to see some inflation and less promotional dollars for the packaged goods companies. Are you all starting to believe that you'll see some inflation in the front-end of the store next year at this point, or is that kind of pie in the sky?

John T. Standley - President and CEO: I'm not sure I have enough clarity into it to tell you one way or the other, at this point maybe we get little further into this year. We haven't seen yet; doesn't mean it's not coming. But we haven't yet seen a lot of inflation, I think on the front-end, based on we do the LIFO calculations and that kind of stuff. So, it's a little bit of wait-and-see, I think for us. That's probably something we need to talk about again next quarter, something starts to develop.

Operator: Mark Wiltamuth, Morgan Stanley.

Justin Van Vleck - Morgan Stanley: This is actually Justin Van Vleck in there for Mark. I was wondering if you could talk a little bit more about the sales trends in the September, how much of that – the improvement is being driven by the front-end versus, and maybe the flu shot improvement?

John T. Standley - President and CEO: I can't get two numbers. Front-end right now, we said is kind of tracking in minus 50 to minus 75, so it continues to get kind of incrementally better, kind of gradually here. In terms of where we're running on pharmacy, we're pretty much from script count perspective, in line with last month. So, although we're starting to administer some flu shots, it's not a real material number yet to script count.

Justin Van Vleck - Morgan Stanley: And when did the benefits from H1N1 last year paid for your guys? I mean, did you see a lot of that in September or…

John T. Standley - President and CEO: Some in September but really it shows up October, November.

Justin Van Vleck - Morgan Stanley: So, October is going to be a much more difficult…

John T. Standley - President and CEO: October, November will be much more challenging as it relates to H1N1.

Justin Van Vleck - Morgan Stanley: The second question is a little bit more on pharmacy gross margin outlook from here. Obviously, you've seen stabilization in that over the past few quarters. I was wondering if you can maybe talk going forward, given that there isn't likely to be as many new generic introductions before Lipitor in the back half of '11. Could you see pharmacy margins up at all before Lipitor? I guess, what would you say is the likelihood of margins being up?

John T. Standley - President and CEO: I would love to see margins up. That's a trend I haven’t seen in quite a while because there tends to be some general erosion all the time on it. So, I don't think we'll see pharmacy margins up. There's some consolidation on the PBM managed care side of the business that could potentially have some negative implications to us. Like you said, there's not a lot of new generics, there aren't a lot of second-year generics getting MACed. So, it's always hard to dial in a little bit but we need to see what happens through the selling season and what kind of prices we get back from some PBMs here based on some of those things. But right this moment, things are a little better than they've been.

Justin Van Vleck - Morgan Stanley: Just lastly, as you say there are no generic introductions, what do you think is an annualized run rate for pressure on gross margin from PBMs and maybe other peers, just on a yearly basis?

John T. Standley - President and CEO: Did we give a number what we're down this quarter year-over-year for pharmacy margins? Yeah, we're down. For the quarter, we were down 13 basis points. So, I would say something like that is always a little bit of pressure on it, and again it’s going to dependent a little bit on some dynamics we don't control obviously, which is what the PBMs are doing in their selling season. But right now, when you look at that numbers, there is not a lot of new generics per say, there’s a few. There aren’t a lot from the prior year that we’re sort of digesting, so we’re in this period where there is not a lot of that kind of activity in the number.

Operator: Meredith Adler, Barclays Capital.

Meredith Adler - Barclays Capital: I’ve got two questions for you. First, just to clarify something that was said a minute ago about H1N1. When you said that it peaked in October, November, were you talking about the flu shots that the vaccines that you gave out or actually the illness?

John T. Standley - President and CEO: We were talking about TAMIFLU strips.

Meredith Adler - Barclays Capital: Then I’d like to just ask a little bit more about this arrangement with SUPERVALU. I am sorry I did miss a little bit of the call, so who approached who on this idea? I am just curious about how they are thinking about this? Do they see this as an important growth area for them if it works?

John T. Standley - President and CEO: I think I’ve got to be real careful about putting words into somebody else’s mouth here. We identified the opportunity here on our side. We reached out to them, had a conversation with them. They, I think, were very much interested in it, and it’s kind of gone from there, and they have been fully engaged in this, extremely supportive and from our perspective, seemed very excited about it. But I think you need to talk to them what it means to them and where they are going.

Meredith Adler - Barclays Capital: There’s another question about generic reimbursement rates and generics in general. Are you continuing to see the penetration of generics increase even though we really don’t have a lot of new generics right now?

John T. Standley - President and CEO: We are, and that's a great point. I mean, we are up 300 basis points or something year-over-year in generic penetration. So it continues to be strong. Part of it, there is some erosion on the brand side. So the mix, that's kind of a mix number and that's one of the things we've been looking at too because we're trying to make sure we understand is that all people who are switching from brand to generics or do we have some erosion in our brand business maybe driven by the economy or other factors.

Meredith Adler - Barclays Capital: Then I actually have one final question about changes in the rules about FSAs. Somebody just asked me this question and I didn't really wasn't too aware of it but it sounds like for certain over-the-counter medications to get this refunded through your medical account you would have to get a prescription from a doctor. Have you guys heard about this and what do you think the impact is on your business?

Ken Martindale - COO: I don't know that we know exactly what the impact is going to be but that is correct. There will less OTC products that will be covered by FSAs, no question, because you are going to require a prescription.

Meredith Adler - Barclays Capital: But you could get some movement back to the pharmacy side because people will have better coverage or better – they will get some co-pay in this.

Ken Martindale - COO: I guess that could be the case but it seems like what's going to happen is some of the stuff that people bought on the FSA is just going to get. That's probably what happens.

Operator: Andrew Berg, Post Advisory Group.

Andrew Berg - Post Advisory Group: Just a follow-up on the flu shot issue immunization. You said you were 300% versus where you were last year. Can you actually give a (quant) for that and any tangible benefits you're seeing on the front end?

John T. Standley - President and CEO: I don't know. I think we’ve got to be careful about throwing around numbers which we (can't understand) and I cannot give you a tangible. It's early enough that I can't give you a tangible number on the front end per se for that. I think we will be able to give some color on that as we get further into it.

Andrew Berg - Post Advisory Group: So should I say you do feel like it’s definitely driving more traffic into the store?

John T. Standley - President and CEO: I think it will as we get into it further. I think it will be helpful.

Matt Schroeder - Group VP, Strategy and IR: Operator, we’ll take one more call, one more question.

Operator: Carla Casella, JPMorgan.

Carla Casella - JPMorgan: You may have said this in the beginning, I may have missed it. Did you give the total number of stores that you have now in that low volume store category?

John T. Standley - President and CEO: 37 stores right now.

Carla Casella - JPMorgan: Then the 100 that are underperforming, are any of those in that 37?

John T. Standley - President and CEO: It’s actually I think it’s kind of a couple of hundred is what we said and there is probably a few of them in there. In addition to underperforming stores we have the lower volume group and those are the ones we think have the real potential to work with this concept, maybe to get some additional volume on the front end.

Carla Casella - JPMorgan: Then where is your dark store rent today or where is it expected to be for 2011?

Frank Vitrano - SEVP, CFO and Chief Administrative Officer: Carla, about $100 million.

Carla Casella - JPMorgan: Then when does that start to work its way down?

Frank Vitrano - SEVP, CFO and Chief Administrative Officer: It bleeds down, assuming nothing gets added to it, it bleeds down $5 million to $8 million a year.

John T. Standley - President and CEO: Thank you all very much for participating on the call. We appreciate it and we’ll talk to you next quarter.

Frank Vitrano - SEVP, CFO and Chief Administrative Officer: Thank you.

Operator: This concludes today’s Rite Aid's second quarter fiscal 2011 conference call. You may now disconnect.