Rite Aid Corp RAD
Q2 2013 Earnings Call Transcript
Transcript Call Date 09/20/2012

Operator: Good morning. My name is Kimberly and I will be your conference operator today. At this time, I would like to welcome everyone to the Rite Aid Second Quarter Fiscal 2013 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. Mr. Matt Schroeder, you may begin your conference.

Matt Schroeder - Group VP, Strategy, IR and Treasurer: Thank you, Kimberly, and good morning everyone. We welcome you to our second quarter conference call. On the call with me are John Standley, our Chairman, President and Chief Executive Officer; Frank Vitrano, our Chief Financial and Chief Administrative Officer and Ken Martindale, our Chief Operating 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 2013 outlook, and then we will take questions.

As we mentioned on our release, we are providing slides related to the material we will be discussing today, including annual earnings and sales guidance on our website, www.riteaid.com under the Investor Relations Information tab for conference calls. This guidance is a point-in-time estimate made early in the fiscal year. The Company expressly disclaims any current intention to update it.

This conference call and the related slides will be available on the Company's website until the next earnings call unless the Company withdraws them earlier and should not be relied upon thereafter. We will not be referring to the slides directly in our remarks, but hope you'll 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. These risks and uncertainties are described in our press release in Item 1A of our most recent Annual Report on Form 10-K and other documents we file or furnish to the Securities and Exchange Commission.

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.

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

John T. Standley - Chairman, President and CEO: Thank you, Matt, and thank you all for joining us this morning to review our fiscal 2013 second quarter results. We are pleased with our results for the quarter as we continue to make significant progress in our turnaround efforts. We had continued strong growth in front-end same-store sales and prescription count. We've also grown adjusted EBITDA and same-store prescription count for seven consecutive quarters, thanks to our chain-wide focus on executing key sales initiatives, operating more efficiently and providing a superior customer experience.

Our adjusted EBITDA was $218.7 million for the quarter, an increase of $34.4 million or 19% year-over-year. We also decreased net loss by $53.5 million compared to the second quarter of last year. Loss per share improved from $0.11 per share in the prior year second quarter to $0.05 per share this quarter. Same-store sales were flat due to a 1.4% increase in front-end offset by a 0.7% decrease in the pharmacy.

Prescriptions filled at same stores increased 4% over the prior year period, which includes the benefit of additional prescriptions resulting from the Express Scripts, Walgreen’s dispute. A key trend during the quarter was the impact of new generic medications. This waiver of generics has negatively impacted top line pharmacy sales by approximately 750 basis points. This is compared to a negative impact of approximately 148 basis points during last year’s second quarter.

At the same time, these new generics are having a positive impact on pharmacy gross margin, which has been a key driver for increasing adjusted EBITDA. Our generic penetration grew to nearly 80% during the quarter, a 4% increase over last year’s second quarter, and we continue to work diligently to contain generic drug purchasing costs.

Another key development was the continued success of our flu immunization program. Since flu shots arrived in our stores in late July, our teams have done a great job of reaching out to our customers and communities to promote how convenient it is to get a flu shot at Rite Aid.

We are already well ahead of last year's pace, and our goal is to administer 2 million flu shots this year compared to nearly 1.5 million last year. Our pharmacy and store teams are highly engaged in their communities, raising awareness of our flu shot program. We also will be supporting our flu immunization efforts with a comprehensive marketing campaign that includes TV and radio ads.

Our wellness+ customer loyalty program continues to have tremendous impact on our business. At the end of the quarter, we had approximately 25 million active members defined as those who have used their card at least twice in the past six months. This represented an 8% increase over the prior year, while total active members have remained consistent with the end of our first quarter the number of gold and silver members are most valuable and most satisfied customers continues to increase.

Card usage continued to be strong as well as wellness+ members accounted for 74% of front-end of sales in the second quarter compared to 69% in the prior year period. Members also accounted for 68% of prescriptions filled up from 67% in last year’s second quarter.

We believe that our award winning wellness+ program continues to be the most robust customer loyalty program offering in our industry, providing customers with an unparalleled combination of wellness and savings benefits. We continue to find new ways to make this innovative program even better. Earlier this month, we launched a new feature that loads +UP Rewards directly to the card of wellness+ members who earned them. This new Load2Card feature is an added convenience for members who no longer have to remember to bring receipts back to the store to redeem their +Ups.

We will continue to strengthen wellness+ in order to attract new customers while keeping it fresh and relevant for our most loyal shoppers. We also have an extensive marketing campaign plan for the second half of the year that reinforces the incredible value that our wellness+ program provides. Also in the second quarter, we continued to convert additional stores to our innovative new wellness store format. We converted 147 stores during the quarter and we now have a grand total of 571 stores. We remain on page to convert about 500 stores during the fiscal year which will increase our total to 781 wellness stores. We now have 815 trained wellness ambassadors to work in our stores and are pleased with how these associates are providing a level of service that differentiates us from the competition. We continue to see a positive impact on our front-end sales and new stores compared to the rest of the chain.

The wellness store format is another area of our business that we are constantly looking to refine. We’ve recently made significant enhancements to the format, which are reflected in a recently remodeled wellness store, located in Harrisburg market. This remodeled store features new interior decor, additional wellness items and unique merchandising presentations. We are receiving tremendous feedback from customers. It’s the latest example of how this innovative store format will continue to evolve as we look to deliver the right mix of products, services and convenience to our customers.

Our new and improved Rite Aid brand architecture continued to gain traction in the second quarter as customers take advantage of the value offered by private brand items. Private brand penetration was 18.4%, an increase of (1.2%) over the prior year period. Also during the quarter, we completed $11 million in prescription file purchases.

As we look forward, maintaining the new patients we receive due to the ESI, Walgreens dispute will certainly continue to be a top priority. Enrolling these patients into the wellness+ program has been a key focus for our store teams. We believe that the tremendous value we offered through the program will give our customers a compelling reason to keep their business at Rite Aid.

As we work diligently to continue to provide a superior customer experience for all of our customers and patients, we are also implementing a comprehensive and targeted communication plan to reinforce the full value that we offer, including wellness+ and an outstanding neighborhood pharmacy experience.

Before I wrap up, I’d like to acknowledge that we recently celebrated our company's 50th anniversary on September 12th. We are commemorating the significant milestone by hosting 50 Acts of Wellness, in major Rite Aid market across the country to recognize Rite Aid’s long-standing tradition of providing personal healthcare services, health and wellness products and community partnerships.

We launched our special RA50 campaign here in the Harrisburg PA market last week, by hosting a wellness fair for state employees for capital. Rite Aid associate teams also visited the Harrisburg public schools and restock the nurses offices throughout the district with wellness and first aid supplies.

At Rite Aid, we are proud of our strong tradition of providing personal service and supporting health and wellness in the communities we serve. We think RA50 campaign is a perfect way to thank the many communities that have helped us grow throughout the years.

With that I'll turn it over to Frank, but I’d just like to say that I'm proud of the hard work that our entire Rite Aid team continues to put forth as we look to deliver a one-of-a-kind drugstore experience to our customers and patients. Frank?

Frank Vitrano - Sr. EVP, CFO and CAO: Thanks John. Good morning everyone. As John mentioned, second quarter front-end sales, script growth and earnings were strong, reflecting good progress in our turnaround and the benefits of the various initiatives we have been working on as well as new ESI business.

This is seventh consecutive quarter of EBITDA growth and we continue to grow our front-end sales and pharmacy scripts. On the call this morning, I plan to walk through our second quarter financial results, discuss our liquidity position, certain balance sheet items, our capital expenditure program, and finally, update fiscal ’13 guidance.

Previously reported revenues for the quarter were $6.2 billion, which was $40 million or 65 basis points lower than last year’s second quarter. The decrease was primarily due to higher percent of generic sales.

In the quarter, we closed nine stores and did not open any net new stores. On a year-over-year basis, we operated 54 net fewer stores. Same-store sales were flat in the quarter, reflecting a positive impact of wellness+ and new ESI business offset by much higher generic penetration rate.

Front-end same-store sales up 140 basis points and pharmacy same-store sales were lower 70 basis points. Pharmacy same-store comp scripts were positive 400 basis points, primarily driven by new ESI script growth. Pharmacy same-store sales were positively impacted by strong script growth, but included an approximate 750 basis points negative impact from new generic drugs. We expect the negative sales impact of new generic drugs to increase even further in the third quarter.

Adjusted EBITDA in the quarter was $218.7 million, or 3.5% of revenues, which was $34.4 million, or 19% higher than last year’s second quarter of $184.3 million, or 2.9% of revenues.

Overall results were driven by favorable front-end sales, script growth and improved gross margin trends, partially offset by higher SG&A.

New incremental ESI adjusted EBITDA benefit in the quarter is estimated to be $18 million to $22 million. We continue to believe we received our fair share of new ESI scripts.

Net loss for the quarter decreased $38.8 million or $0.05 loss per diluted share compared to last year’s second quarter net loss of $92.3 million or $0.11 loss per diluted share. The net loss improvement was driven by higher adjusted EBITDA, a lower LIFO charge of $11.2 million, lower lease termination and impairment charge of $7.3 million as well as lower depreciation and amortization expense of $6.7 million.

Total gross profit dollars in the quarter were $61.5 million higher than last year’s second quarter, and 116 basis points higher as a percent of sales. FIFO gross margin dollars were higher by $50.2 million, or 98 basis points.

Adjusted EBITDA gross profit which excludes specific items primarily LIFO and the wellness+ revenue deferral, the details of which are included in the second quarter fiscal ’13 earnings supplemental information, which you can find on our website was favorable to the prior year second quarter by $47.9 million and 94 basis point as a percentage of revenues.

Front-end gross profit was lower, driven by higher tier discount investments related to the wellness + customer loyalty program and higher ad markdowns, partially offset by strong Rite Aid brand penetration.

Pharmacy gross profit dollars and rate were both higher due to script count growth and the benefit of new generics partially offset by continued pharmacy reimbursement rate pressure.

Selling, general and administrative expenses for the quarter were higher by $14.4 million or 40 basis points as a percent to revenues compared to last year. Adjusted EBITDA, SG&A dollars, again which excludes specific item, the details of which are included in the second quarter earnings supplement information package were higher by $13.5 million and 37 basis points as a percentage of revenues. The increase in dollars reflects wage and benefit increases, as well higher labor costs associated with incremental pharmacy hours for the added script volume and costs associated with the wellness remodel program, partially offset by lower holiday pay as Memorial Day fell in the first quarter of fiscal ’13 within the second quarter of fiscal ’12. Without the Memorial Day shift, adjusted EBITDA would have increased 13%.

Turning to the balance sheet, FIFO inventory was $91.9 million lower from the second quarter of last year and $88.2 million lower than the fourth quarter of ’12. Relative to the second quarter of last year, decrease reflects more generic inventory which is valued at a lower cost and inventory reduction initiative.

Our cash flow statement results for the quarter show net cash from operating activities in the quarter as a use of $32.9 million as compared to a use of $131 million in last year’s second quarter.

Higher payable this year, as well as higher inventory last year influenced the balance. Net cash used in investing activities for the quarter were $72.7 million versus $49 million last year and also includes proceeds from script file sales.

During the second quarter, we relocated four stores, remodeled 147 stores and closed nine stores. We have now completed and grandly opened 570 wellness remodel stores and expect to have 780 completed by fiscal ‘13 yearend. Front-end sales in the remodeled stores continue to improve above the chain average.

Now, let’s discuss liquidity. At the end of the second quarter we had $1.05 billion of liquidity. We had no revolver borrowings under our $1.175 billion senior secured credit facility with $125 million of outstanding letters of credit.

Today, we have $1.256 billion of liquidity. Total debt net of invested cash was lower by $32 million from last year’s second quarter. Our leverage ratio defined as total debt less invested cash over LTM adjusted EBITDA improved to 6.2 times from 7.1 times.

Now, let’s turn to fiscal ‘13 guidance. We are updating our guidance based on current sales trends and SG&A cost increases, the benefits of new generics, a challenging reimbursement rate environment, continued investment in our customer loyalty program to grow sales, as well as a function that we will retain a portion of the ESI scripts.

We also expect to incur additional cost to retain the ESI business. The Company expects total sales to be between $25.1 billion and $25.4 billion and expects adjusted EBITDA to be between $965 million and a $1.025 billion for fiscal ‘13.

Same-store sales are expected to be in a range from a decrease of 100 basis points to increase of 25 basis points, which reflects the anticipated negative pharmacy sales impact of approximately 650 basis points from new generic introductions and continued reimbursement rate pressure.

Net loss for fiscal ‘13 is expected to be between $196 million and $69 million, or a loss per diluted share of $0.23 to $0.09.

Our fiscal ’13 capital expenditure plan remains at $300 million, with $140 million allocated to remodels and $50 million to file buys.

We are planning to complete 13 relocations and remodel 500 wellness stores. We expect to be free cash flow positive for the year. We expect to close a total of 50 stores of which the guidance includes a store lease closing provision to close 20 with the balance of the stores closing on lease expiration.

This completes my portion of the presentation. I’ll now open the lines for questions. Thank you.

Transcript Call Date 09/20/2012

Operator: John Heinbockel, Guggenheim Securities.

John Heinbockel - Guggenheim Securities: So on the new wellness+ prototype, I guess you would call it, what is the cost and how would the expected front-end lift compare to the older version?

John T. Standley - Chairman, President and CEO: Well, the prototype cost more as prototypes usually do, and I think after we engineer it down it will probably still be more expensive than the current prototype store. So we may not use it in every location that we do a wellness store in. In terms of the sales lift, we’re having in (one storage on) and that’s comping very well. So we would expect that it is going to get a better comp than what we’re getting in the existing wellness store.

John Heinbockel - Guggenheim Securities: So is the idea to do this in higher volume, higher potential stores?

John T. Standley - Chairman, President and CEO: It is. We’re going to probably stratify the locations that we’re remodeling a little bit based on some different criteria and it will go in some locations, but not all and then I think there’ll be variations of it that are working through the rest of the wellness stores.

John Heinbockel - Guggenheim Securities: Is there a way to spend a little less – to spend a little more on the high potential location, spend a little less on the other ones and get a better return?

John T. Standley - Chairman, President and CEO: That’s basically the idea.

John Heinbockel - Guggenheim Securities: Secondly, if I think about your guidance, I don’t know if you want to say, but imbedded in that is one assumption for ESI retention. Do you have an idea?

John T. Standley - Chairman, President and CEO: Frank, I’ll let you handle that.

Frank Vitrano - Sr. EVP, CFO and CAO: John, the range – it's a $60 million range and basically what we're saying here is on the low end of the range, we're expecting to retain less of the ESI customers and probably have a higher reimbursement rate, see higher reimbursement rate pressures and to the high end of the range is an expectation here that we're going to retain a pretty good portion of those ESI customers, as well as see better impacts from new generics. That's basically the range, we're not going to, pin point a number for you, but that's kind of the spread.

John Heinbockel - Guggenheim Securities: Then, as I recall, I don't there is change – the litigation charge from the first quarter is included as a negative to that guidance, is that right?

Frank Vitrano - Sr. EVP, CFO and CAO: It's included in our guidance, that's correct John.

John Heinbockel - Guggenheim Securities: Then finally, the ESI benefits, is there an indirect benefit in there from – are you including the front-end purchases they make and then if they signed up to be silver and gold customers, becomes silver and gold customers, the benefit you get from that or is just purely the pharmacy benefit?

John T. Standley - Chairman, President and CEO: They are in our run-rate John, so that reflected in our guidance the way they have been behaving. That's our – what we built our expectations around in the guidance.

John Heinbockel - Guggenheim Securities: So it's largely pharmacy, but there is little front-end in there as well.

John T. Standley - Chairman, President and CEO: Yeah, there is front-end benefit.

Operator: Matthew Fassler, Goldman Sachs.

Matthew Fassler - Goldman Sachs: Two questions, first of all, as we look at the penetration of wellness+ relative to front-end and relative to script growth, if I'm reading my numbers right, this was the first period when you have, actually not the very first period, but I think there was a sequential decline in front-end penetration and in script growth for the first time in a while. How do you think about the maturation curve of this programs and are there ways for you to extract economic benefits from ongoing penetration, if these numbers are sort of hitting their (quartile)?

John T. Standley - Chairman, President and CEO: I think the program is two plus years into, 2.5 years into, I think it is maturing. We are out, I think we are going to be out aggressively, continuing to explain the benefits of the program to try and attract new customers with it. It’s definitely helping us retain existing customers. You can see comp store sales have behaved very well here both front-end and pharmacy and we definitely have a very significant opportunity to continue to work with our existing customers to grow their relationship with us.

Matthew Fassler - Goldman Sachs: Then second question, you addressed reimbursement to some degree. Can you give us your updated thoughts on where you think that is heading and in particular are you seeing reimbursement pressure move directionally in any way with generic penetration, which is clearly or seems to be surprising to the upside and having a very nice impact on our profitability?

John T. Standley - Chairman, President and CEO: I think we’re going to continue to see reimbursement rate pressures coming from a variety of different directions, we got a lot of government things going on that could impact us and the third-party business remains very competitive. I think as the newer generics mature, they are going to continue to be under pressure as their cost decline and our challenge is to make sure we keep our costs as low as we can as those rates come off.

Operator: Karru Martinson, Deutsche Bank.

Karru Martinson - Deutsche Bank: When we look at the ESI gains that you have now, you have two quarters here running around 20 million. So the total if we were looking at it, it would be about $80 million benefit right now if you were to retain everybody, correct?

Frank Vitrano - Sr. EVP, CFO and CAO: Yes.

Karru Martinson - Deutsche Bank: Then, when we look at the year ago flu season, that was with the warm winter, those are soft season, correct?

John T. Standley - Chairman, President and CEO: Yes, I think it was generally a – it was a very late season I will tell you that, and probably softer, yes.

Karru Martinson - Deutsche Bank: Then when we look at the wellness+ certainly recognizing two and a half years, we are kind of hitting the maturation point, but do you feel when you look at kind of like the wallet spend of your members, what’s the opportunity to increase that going forward?

John T. Standley - Chairman, President and CEO: Well, that's really what we think is kind of the untapped opportunity for us in the program. We’ve been working hard to develop those relationships with customers and develop our ability to understand those relationships and appeal to the needs of our customers, but we’re still very early in that process, and so we have a lot of work to do. So we think that's one of our very large ongoing opportunities as we look forward.

Karru Martinson - Deutsche Bank: Just lastly, certainly an expensive capital structure for parts of it that were put in very different times in your history, some of that has become callable. What's the mindset here for you guys will address your capital structure going forward?

Frank Vitrano - Sr. EVP, CFO and CAO: We are always kind of looking at what’s happening. Obviously, in the first half of the year, we completed two transactions. We don't have anything coming due now to ‘16 from a first and second lien perspective. And that’s really something that we are looking at what the rate we think we can get versus what the core premium is going to be. Obviously that does step down next year. Those are some of the things that we are looking at and thinking about. With regard to Tranche 2 Term Loan, again, that comes due in June 14 and that’s something that we’ll look to address probably at the beginning of next year.

Operator: Carla Casella, JPMorgan.

Carla Casella - JPMorgan: One just housekeeping item. Your LIFO forecast for the year still $60 million to $90 million. I didn’t see any change there.

Frank Vitrano - Sr. EVP, CFO and CAO: No, it isn’t. It’s $40 million to $70 million, Carla.

Carla Casella - JPMorgan: Okay. Then, now that we’ve had generics ramping up for a few months now, can you just talk about the generic pricing cycle and if you’re seeing any change? I think on the last few calls you’ve been talking about the best profitability coming in the first six months of the generic. Is that still the same, or is that shortening or lengthening at all?

John T. Standley - Chairman, President and CEO: Yeah, we haven’t – I think that didn’t come from us. What we have tried to explain the folks is that because of some contract structures we have, our generic profitability is probably a little more evenly spread across the first year. So we have some contracts that are more profitable in the first half of drugs lifecycle and somewhere it’s more profitable in the second half, I think, on the contract structure and we kind have a blend of contracts that sort of even it out over time and that seems to be remaining fairly consistent.

Carla Casella - JPMorgan: Okay. Great and then…

John T. Standley - Chairman, President and CEO: I don’t know it that was helpful or not.

Carla Casella - JPMorgan: Yeah, I know that is. Thank you for clarifying. Then on Walgreen, we saw the $25 gift card to get people come back into the store. You mentioned marketing up in the back half. I’m sorry, mentioned marketing for that competition in the back half. Are you increasing the marketing budget or just shifting it from one thing to another? I’m just trying to clarify what the marketing in the back half is for and whether it’s going to be up or not, is it wellness+ focus, is it more focused on attracting that customers.

John T. Standley - Chairman, President and CEO: It's really focused on a couple of different. It is up in the back half, were going to out with our flu program and so we're making some investments from a marketing perspective there. We've talked a little bit about the maturation of wellness+ and so we're going to be out really trying to make sure everybody understands how wellness+ works and the value of it as we think it is the strongest program in the marketplace. Then, obviously, we're going to do we need to do to protect our business from competitive threat. We will be marketing budget is up and we will be out there in the back half of the year.

Carla Casella - JPMorgan: Can you then quantify how much is going to be up?

John T. Standley - Chairman, President and CEO: No. It is included in our guidance.

Operator: Mark Wiltamuth, Morgan Stanley.

Mark Wiltamuth - Morgan Stanley: I wanted to ask on the reimbursement rate pressure issue, you kind of alluded to that in your sales guidance little bit there. Has anything been changing there, because in the past it sounds like that environment was at least stable?

John T. Standley - Chairman, President and CEO: I think that one factor I know reflected in the guidance Frank is just, this is very strong generic penetration and the deflationary impact is probably a little greater than we expected. Some of that mix and some of that is just reimbursement rate pressure. I wouldn't say there is any dramatic change in the environment, but it’s just a continued sort of tightening that we feel in our business.

Mark Wiltamuth - Morgan Stanley: Just to add a little bit to the generic commentary. Where do you think we are in terms of being in the peak period of margin and how long does that extend as we roll through the generic, the generic wave? Because it sounds like the volumes of generics are still coming to be greater in the second half.

John T. Standley - Chairman, President and CEO: Yeah, most of the big launches were actually in the first half of the year. We got a couple of stragglers that are coming in the back half, but when you think about the way they sort of waterfall out, we're going to clearly see some good benefit in the back half of this year. I think into the beginning part of next year, but as we get into the later part of next year that's when there is probably going to slow down quite a bit in terms of the impact.

Mark Wiltamuth - Morgan Stanley: You are talking about fiscal years or calendar years there?

John T. Standley - Chairman, President and CEO: Our fiscal years.

Mark Wiltamuth - Morgan Stanley: As you are look into that Express customer base that you’ve retained so far, what percentage of the Express customers are on the wellness+ program?

John T. Standley - Chairman, President and CEO: It’s very similar to the total program in terms of the penetration that we achieved.

Mark Wiltamuth - Morgan Stanley: At this point, does it look like the battle for those Express customers is more one along the lines of loyalty card activity or do you think there is going to be anything in store terms of discounting?

John T. Standley - Chairman, President and CEO: I feel there will be lot of different activity, as I am not sure which way this is all headed, we will have to see how it sort of develops. For us, we believe in the strength of our program and getting people enrolled and getting engaged with the program and providing them value to the program is really a direct way that we can communicate with our patients and our customers. We think that's for us important part of the whole thing.

Mark Wiltamuth - Morgan Stanley: You’ll probably communicate directly with those that are Express customers, is that fair to say?

John T. Standley - Chairman, President and CEO: We communicate directly with all of our customers, but we will be thinking about those Express customers quite a bit.

Operator: Edward Kelly, Credit Suisse.

Edward Kelly - Credit Suisse: Few questions for you, we maybe start off with a gross margin. On the front-end, maybe talk a little bit about the decline in the front-end related to the investment in the loyalty card, and exactly what’s going on that front? What is that investment related to? Does any of it pertain to new Walgreens customers?

John T. Standley - Chairman, President and CEO: So I think on the front-end there is a few different factors that impacted gross margin. Obviously, when you look at the year-over-year increases that we see in the penetration on the loyalty card, that's reflected in the tiered discounts. So you have that showing up in the gross margin numbers as the program is maturing on a year-over-year basis. So that’s piece of it. Clearly, as we brought more customers in for the program and grew it towards in totality, that grows the tiered markdown as well. There were slightly higher ad markdowns and some other discounts in the quarter as well, and some other factors in the front-end gross margin, but those are the big components.

Edward Kelly - Credit Suisse: Then could you maybe give us a little bit more color on how you end up retaining Walgreen’s scripts, maybe start with how sticky do you think these scripts will be just naturally to start? What are some of the things that you can do to ensure that you keep them? What do you think you’ll see from Walgreens other than $25 gift cards and a lot of advertising?

John T. Standley - Chairman, President and CEO: I certainly can't comment about Walgreen, what Walgreen is going to do. That’s a great question for Walgreens. They are great competitor. I know they are going to work hard to do what’s right for their business. What we are doing is, we are communicating with our customers and patients through wellness+, trying to engage them in the dialog we’ve communicated with them in the pharmacy, we’ve communicated with them through some other means and we’ve provided, I think, a great value offering for those patients. I think we’ve worked really hard to provide great service over the last several months. We hope the combination of those things will encourage those patients to stick with us.

Edward Kelly - Credit Suisse: One of your competitors, not name Walgreens, is optimistic about the amount of scripts that (build end) up keeping. Is that a fair way to characterize how you think about? That’s how I’m working out, but are you optimistic, are you pessimistic, I mean I (are you down like), how should we think about it?

John T. Standley - Chairman, President and CEO: We’re working really hard, and we’re going to do our best to keep all the patients we can. So we feel good about what we’re going to do, and hope we can retain a good portion of these patients. I know we’re getting a lot of questions around how much you’re going to retain or how do you feel about it. One thing that's a little bit different than us compared to some of our other competitors is we are going to provide you monthly report card, monthly sales, you’re going to see exactly what’s going on, which is why we don’t feel as much pressure to probably put a stake in the ground here. You’re going to see how it evolves as it plays out.

Edward Kelly - Credit Suisse: How long do you think it’s before we have a report card on it? Do you think by the end of year a lot of that movement that’s going to take place happens, or is it longer than that?

John T. Standley - Chairman, President and CEO: I would think that’s a reasonable timeframe to see kind of how thing shake out. Again, I don't know what Walgreens will do. So let's see how it sort of plays out.

Edward Kelly - Credit Suisse: Do you have any sense as to how many plans will continue to exclude Walgreens? I mean we know that DoD is there. I mean not naming names, but do you know what other contracts that are going to be along those same lines?

John T. Standley - Chairman, President and CEO: We do, but that's really a question for Express Scripts. For Walgreens, I don’t think I can answer that question contractually, but …

Edward Kelly - Credit Suisse: Is it a material number?

John T. Standley - Chairman, President and CEO: I’m a little nervous going there.

Edward Kelly - Credit Suisse: Come on John.

John T. Standley - Chairman, President and CEO: I’m pretty sure I’m going to get a call. I think I’ll not do that.

Edward Kelly - Credit Suisse: Last question for you on the – just getting back to the gross margin in the pharmacy, if we didn’t have this pickup in generics, what do you think the gross margin in the pharmacy we’ll be going right now, because I heard the term reimbursement (right pressured) numerous times on the call, clearly that's a longer term issue, but I was just curious as to, if we didn't have the wave right now, what would the gross margin in pharmacy look like?

John T. Standley - Chairman, President and CEO: We would probably be down. Having said that, I don't know if some of the reimbursement things that are gone on would be as aggressive as they are if we didn't have the new generics, it's hard to split the two apart, little bit, because I think it's obviously been a lot of discussion around who should benefit from the profitability of new generics, right?

Operator: Karen Eltrich, Goldman Sachs.

Karen Eltrich - Goldman Sachs: You mentioned penetration trends with and the wellness+ gold, silver. What are you seeing in terms of frequency of shopping as well as average check-in and how does that compare to the company average?

John T. Standley - Chairman, President and CEO: They are much more frequent, we see about half of those gold and silver customers every week. The basket sizes in total are 40% to 50% larger than the non-wellness members, so it is a significant factor. They are clearly our best customers and they (indiscernible) very highly and make a good portion of our sales.

Karen Eltrich - Goldman Sachs: Are you seeing that trend upwards generally as people get more familiar with the program?

John T. Standley - Chairman, President and CEO: We are.

Karen Eltrich - Goldman Sachs: Great. You’ve talked a lot about the wellness remodel programs, one thing we haven't heard about for a while is the discount format, is that still in the cards, how does the return and if so, how does the return on capital for remodels compare?

John T. Standley - Chairman, President and CEO: That's still on the cards, those stores are actually doing pretty well. Probably like most organizations, we're kind of focused on the wellness format right now, so we slowed down the efforts on the value stores and really shifted a lot of our energy into the wellness format, which will continue to be the case for the next year or so. We are continuing to work with a little bit and you'll hear us talk about some additional concepts probably over the next couple of quarters as we have a couple of newer things, we’re going to bring to the marketplace, probably in the next six to nine month.

Karen Eltrich - Goldman Sachs: Final question, following up on the increase in marketing. How is that going to split between digital print media, and again you’ve had the loyalty card for couple of years, you’ve built quite a data base, how much can you exploit that?

John T. Standley - Chairman, President and CEO: Well, that opportunity I think as we said is very significant for us, but we are pretty young in that process and building capabilities as we go, but I think there is a lot of opportunity for us to continue to build those relationships with our customers. In terms of the spending in the back half, I don’t really want to break it out per se, but we are going to make an appropriate investment for the things that we want to do.

Karen Eltrich - Goldman Sachs: So safe to say, that you’ll be touching all three years?

John T. Standley - Chairman, President and CEO: Yes.

Operator: Steven Valiquette, UBS.

Steven Valiquette - UBS: Your current contract with the primary drug wholesalers expires in April of 13. I guess assuming that you have not negotiated the new contract yet, just curious is this something that you plan to negotiate directly with McKesson on the renewal or you considering doing a full RFP with all major wholesalers for this go round?

John T. Standley - Chairman, President and CEO: We are working through that process right now. I think we’ll have more to talk about another couple of months, right.

Steven Valiquette - UBS: Just the way that you approach it though, is there a change in your policy or approach and the way you are negotiating this one versus what you’ve done previously or..?

John T. Standley - Chairman, President and CEO: No. We generally use an RFP process and that’s consistent with where we are now.

Operator: Joseph Stauff, Susquehanna Financial Group.

Joseph Stauff - Susquehanna Financial Group: Two questions, are you able to give us a breakout in terms of the percentage of gross profit quarter that came from your front-end versus pharmacy?

John T. Standley - Chairman, President and CEO: Frank, I think you gave these numbers.

Joseph Stauff - Susquehanna Financial Group: I am sorry, I think I missed it there.

Frank Vitrano - Sr. EVP, CFO and CAO: What we said was that front-end was down, front-end gross profit was down, and that pharmacy was up and the total GP increase was $48 million.

Joseph Stauff - Susquehanna Financial Group: I am sorry, did you give the split versus the two buckets.

Frank Vitrano - Sr. EVP, CFO and CAO: We did not. We did not quantify it.

John T. Standley - Chairman, President and CEO: We said the increase came out of pharmacy.

Frank Vitrano - Sr. EVP, CFO and CAO: Increase was virtually all pharmacy, front-end was down.

John T. Standley - Chairman, President and CEO: So that kind of should get you to where you want to go.

Joseph Stauff - Susquehanna Financial Group: Just to kind of zoom out quickly, the headwind from generic for the year, obviously, you are guiding to about 650 basis points. I think you started the year around 500. Can you just talk about some of the drivers that as you reconcile the generics and why it’s so much stronger than anticipated, obviously, for you and for your competitors, what is driving that just generally do you think?

John T. Standley - Chairman, President and CEO: I think versus our expectation, I would say cost have been – we are seeing some lower cost than we expected, which led to lower reimbursement rate, not necessarily lower profitability, but lower reimbursement rate. That combined with pretty solid penetration maybe slightly higher than we expected those two factors have increased the deflationary impact versus our original expectation.

Operator: Jason De Rise, UBS.

Jason De Rise - UBS: Yes, Jason De Rise, UBS. Just thanks for also taking my question. I know (indiscernible). So he obviously did the drug side, I’ll do the retail side. In terms of the gross margins, obviously, we’re talking a lot about the generics and then the competition on the front-end. Do you think your gross margin percentage is going to be up or down versus Q2 in the back half of the year?

Frank Vitrano - Sr. EVP, CFO and CAO: We really expect it to be up.

Jason De Rise - UBS: Then in terms of the phasing, in Q3, you did say that the generics were going to accelerate. I guess, if you go back to the guidance, they’re going to fade a bit in Q4, what is the impact of that if it starts to rollover?

John T. Standley - Chairman, President and CEO: I think what we are really talking about was into next year. There’re some conversation about where we were in the generic wave. We feel pretty good about the impacts for this year and how to play out through this year, but we see it slowing down next year. (calls ends abruptly)