Rite Aid Corp (RAD) 2004 Q3 法說會逐字稿

Good morning, my name is Kelly and I will be your conference facilitator today. At this time, I would like to welcome everyone to the Rite Aid third quarter results 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 period. If you would like to ask a question during this time, simply press star and then the number 1 on your telephone keypad. If you would like to withdraw your question, press the pound key. Thank you. Mr. Standley, you may begin your conference.

Thank you. Welcome to our third quarter conference call. On the call with me today are Mary Sammons, our Chief Executive Officer, Chris Hall, our Chief Financial Officer and Kevin Twomey, our Chief Accounting Officer.

Before we begin today, I would like to read the following regarding forward-looking statements. During today's call, forward-looking statements may be made. Such statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those expressed or implied in the forward-looking statements. Factors that could cause actual results to differ materially from those expressed or implied in such forward-looking statements include; our high level of indebtedness, our ability to make interest and principal payments on our debt and to satisfy the other covenants contained in our senior secured credit facility and other debt agreements, our ability to improve the operating performance of our existing stores, in accordance with management's long-term strategy, our ability to hire and retain pharmacists and other store personnel, the outcomes of pending lawsuits and governmental investigations, competitive pricing pressures, continued consolidation of the drugstore industry, the efforts of third party payers to reduce prescription drug reimbursements, changes in state or federal legislation of regulations, the success of planned advertising and merchandising strategies, general economic conditions and inflation, interest rate movements, access to capital and our relationship with our suppliers. Consequently, all of the forward-looking statements made during this call are qualified by these and other factors, risks and uncertainties.

Also, during today's call, non-GAAP financial measures are mentioned. The definition and purpose for using the measures are described in the form 8K we furnished to the SEC this morning. The form 8K can be accessed through our web site, under the; our company and investor info tabs. You're also directed to consider other risks and uncertainties discussed in documents we file with the Securities and Exchange Commission.

Our agenda for today's call will be as follows: Mary Sammons will give an overview of third quarter operations, I will review third quarter financial results and comment on our 2004 and 2005 guidance and then we will take questions. Mary?

Thanks, John. Good morning and thanks to everybody for joining us today as we discuss our third quarter results.

We're very pleased with our performance with a 10.2% increase in adjusted EBITDA and net income of $22.5 million compared to a loss of $16.4 million for the same period last year and, as you can see from our press release, we expect the positive momentum to continue. We've reaffirmed our guidance for fiscal '04 and forecasted a substantial improvement in our results for the next fiscal year.

Contributing to our results in the third quarter, were a healthy 6.4% increase in same-store sales, higher gross margins resulting in part from an increase in generic dispensing and strong contribution by the front end and continued leverage of our fixed costs. We also benefited from an increase in both front end and pharmacy sales in Southern California because of the grocery workers' strike. Pharmacy comp sales for the quarter rose 6.5% with script growth positive each month.

New generic dispensing growth dampened comps by 100 basis points but positively impacted margins and helped offset continuing declines in non-sedating antihistamines and hormone replacement therapies. Cycling the Claritin switch to OTC this month will lessen the impact going forward but the negative press still associated with HRT continues to cause gradual decline in the category. Our stores did not see a big benefit from the early flu season until late November since the initial outbreak was heaviest primarily in Texas and the mountain states.

During the quarter, we continued to make a significant investment in our initiatives to improve pharmacy sales, gross script count and build our pharmacies for the future. We aggressively supported our file buy program with both increased field and corporate resources and capital investments. We increased the number of file buys this quarter over last year by 300%, with an even larger number of deals expected to close in the fourth quarter. We are currently on track to more than double last year's total number of buys and have developed specific marketing plans for each of them to maximize retention.

In September, we launched our win back direct mail customer reacquisition program, which offers a front-end incentive for returning to Rite Aid. We now update our list of transferred or last customers weekly so we can target these customers quickly.

Initial feedback on the comprehensive diabetes initiative we launched in all stores in November has been positive and our diabetes web site provides a database for direct marketing to patients with diabetes. As part of our partnership with the American Diabetes Association, Rite Aid pharmacists will be the only pharmacists featured on their web site. The ADA also recently certified our diabetes education program in West Virginia, which means Medicare will now reimburse us for that program and will use it as a prototype in other states. We also kicked off a 50-store pilot project with Washington State Medicaid to demonstrate how including retail pharmacy in a disease state management program can reduce third party healthcare costs for chronic care. Programs like these not only enhance Rite Aid's image as a healthcare provider, they also help set the stage for additional reimbursement for cognitive services.

During the quarter, we continued building third party relationships and had discussions with several payers and DBMs about supplying 90-day scripts at retail. We will evaluate 90-day at retail programs on a case by case basis. We continued investing in technology to better support our pharmacists and our pharmacies.

We've taken a leadership position in the chain drugstore industry with e-prescribing, now available in more than 1,000 of our stores in 15 states and our new next gen pharmacy dispensing system, developed with the help of our store pharmacists, was expanded to 143 pilot stores during the third quarter, with a staggered rollout scheduled for all stores during the first half of next year. This new Windows-based system enhances quality assurance, improves work flow, enhances security and makes it easier to track orders. State-of-the-art pharmacy technology will not only help us deliver on our commitment of "ready when promised", it will also help us fulfill our commitment to "with us, it's personal", making it easier for the pharmacist to spend more quality counseling time each patient and it will help attract pharmacy students and pharmacists to join our Rite Aid team.

We also hosted a successful Dean's Education Conference with deans and directors from 74 pharmacy schools further strengthening our school relationship. This conference gives us the chance to reinforce with the schools the benefits of their students working at Rite Aid and provides valuable feedback on our recruiting and intern programs which have both produced great results this year. Our goal is to become the employer of choice.

We continue to deliver strong front end sales with comps increasing 6.2% for the quarter on top of industry-leading sales last year in the same quarter. Strong promotion, new items, new planograms and excellent store execution of both corporate and direct store programs all helped drive sales and our focus on growing private brand is really paying off. Private brand sales rose significantly, bringing year to date penetration to 11.1%, compared to 10.8% last year. We've added 161 new items to private bands so far this year with more than 70 additional SKUs in development.

Consumables continued to be strong, especially in food and beverage categories and households. These categories had some of the largest gains due to the grocery strike out west. Core drugstore business was excellent overall with strong growth in OTC led by gains in upper respiratory. Pain care, personal care, vitamins, diagnostics, diabetic and home healthcare also increased nicely. General merchandise performed well with double-digit gains in pet and electronics.

And in November, we launched our "Cat in the Hat" holiday marketing program in conjunction with the hit movie, adding excitement and differentiation to our merchandise assortment, presentation and add offers.

Cigarettes and tobacco continued to decline. Photo categories remain difficult, a trend seen industry wide. We continued additional digital upgrades to our photo department in the quarter and launched our chain wide digital advertising right before Thanksgiving. We now have digital capability in about half of our in-store labs and we expect sales to improve over the holidays as more customers count on us for digital processing.

In November, we conducted our first survey of all Rite Aid associates to learn how they feel about working at our company, as part of our customer satisfaction critical priority. As we said before, we believe that if we treat our associates right, they will treat our customers right, which will lead to improved customer satisfaction. We will use this feedback to determine where we've made progress and where we need to improve.

We also started development of a monthly store based customer satisfaction survey, which annually will poll more than 1.3 million customers who visit our pharmacies. We expect the survey to launch chain wide next spring.

On the expense side, SG&A was lower as a percent of sales as we leveraged fixed costs and gained traction on our containing costs initiatives, which include greater participation and online auctions for non-retail expense items. These savings allow us to invest more dollars in better staffing of our stores and more competitive store hours.

Inventory turns continue to improve in both front end and pharmacy and our inventory content is excellent as we enter the holiday season. Our shrink increased slightly for the quarter against a very low experience last year but still continued to run well below industry norms at less than 1% of costs. We have heightened our focus on the use of the shrink management tools we've developed over the past several years.

Looking at the 4th quarter, we expect the substantial flu outbreak that is now spreading to most parts of the country to continue to benefit both pharmacy and OTC upper respiratory, cough and cold sales, as we have seen in the first half of December. We also expect there to be a positive impact on generic dispensing from the generic introduction of the popular birth control pill, OrthoTricyclene in late December.

In January, we will launch our new specialty pharmacy program that we will market to physicians. With the program, we will now easily be able to accept and build for specialty prescriptions in all of our pharmacies.

As we approach the busiest weeks of the holiday selling season, we have strong promotions in place to compliment our strong product assortment. We will also repeat two post Christmas events that have been very successful for us in the past; Rite Aid brand Supervalue Days in January and our annual President's Day sale in February.

As I mentioned earlier, we have confirmed guidance for fiscal '04 and provided a preliminary outlook for fiscal '05. John will review these in his comments. The programs we've invested in this year, especially in the pharmacy, position us to continue to improve our performance and deliver shareholder value. We're already hard at work on our EBITDA achievement program initiatives for fiscal '05 which will continue to focus on growing sales, leveraging costs and delivering improved customer satisfaction.

We're very pleased with all our Rite Aid team has accomplished to date and are confident they will continue to deliver strong results and now, John will fill you in on a few more details for the quarter. John?

Thanks, Mary. Overall, we're very pleased with our third quarter results. Total revenues for the 13-week third quarter were $4.11 billion this year versus $3.87 billion last year. Revenues increased $234.6 million or 6.1% this year versus last year. We operated 3,386 retail stores at quarter end versus 3,411 stores at the end of last year's quarter, a net reduction of 25 stores or 70 basis points.

Same-store sales for the quarter were up 6.4% with pharmacy comparable store sales up 6.5% and front-end comparable store sales up 6.2%. Total comparable store sales for the quarter were positively impacted by approximately 40 to 90 basis points for the grocery strike in Southern California and pharmacy comparable store sales were negatively impacted 1% by an increase in generic sales mix.

Although increases in generic sales negatively impact comp store sales, they increase gross margins. Prescription sales accounted for 64.3% of total sales and third party prescriptions represented 93.4% of total pharmacy sales. Gross margins, which include occupancy costs, were $1 billion or 24.4% of revenues for the third quarter this year versus $919.1 million or 23.7% of revenues last year.

Including a noncash LIPO credit of $1.4 million this year and LIPO charge of $17.3 million last year, gross profits were $999.4 million or 24.3% of revenues this year versus $936.4 million or 24.2% of revenues last year, an increase of 15 basis points. FIFO gross margins were positively impacted by a larger percentage of generic drug sales versus branded drugs and better leveraging of larger of occupancy and depreciation and amortization expenses, included in gross margin, partially offset by a slight increase in shrink expense.

Selling, general and administrative expenses for the quarter decreased as a percent of revenues by 37 basis points compared to the prior year. Significant items impacting SG&A in the third quarter this year and last year include $5.2 million this year and $3.3 million last year of legal expenses incurred to defend prior management and to defend against litigation related to the business practices of prior management and $7.3 million this year and $6.6 million last year in favorable legal settlements.

SG&A in the third quarter improved 39 basis points from the prior year after adjusting both years for the significant items. This improvement is the result of lower payroll, as a percent to revenues, to the deleveraging of the fixed component of labor, lower depreciation and amortization expense resulting from a reduced store count and certain intangible assets becoming fully amortized and good cost control in our stores, distribution centers and the corporate office, partially offset by higher employee benefit costs.

Noncash stock compensation was $7.3 million this year versus $2.6 million in the prior year. We adopted FAS 123 at the beginning of the first quarter on a modified perspective basis to recognize the noncash cost of stock options granted to management. The prior year charge is the result of variable planned accounting on certain management stock options and divesting of restricted stock grants in the prior year.

Store closing and impairment costs were $4 million this year, which includes $3.1 million on the face of the operating statement and $900,000 of expense and cost to goods sold, representing the inventory liquidation cost. The prior year store closing and impairment costs totaled $10.4 million, including $7.5 million of inventory liquidation costs included in cost of goods sold and $2.9 million in expense on the face of the operating statement. Interest expense was $77.7 million for the third quarter versus $80.9 million in last year's third quarter. Cash interest expense was $72.5 million this year versus $71.6 million last year and noncash interest was $5.2 million this year versus $9.3 million last year. Noncash interest is lower than in the prior year because of lower debt issue cost amortization and the classification of the interest expense related to the closed store reserve as closed store expenses this year versus interest expense last year.

Adjusted EBITDA for the third quarter was $177.5 million or 4.3% of sales, an increase of $16.4 million over the prior year computed on a consistent basis. The schedule attached to our press release reconciles our net income to the adjusted EBITDA total. Net income for the quarter was $22.5 million or earnings of 3 cents per common share compared to a net loss of $16.4 million or a loss of 5 cents per common share last year. The earnings and loss per common share amounts include $8 million in the current year and $7.4 million in the prior year of accretion of declared preferred stock dividends that are not included in net income or loss.

Liquidity remained strong during the quarter, cash on the balance sheet at the end of the quarter was $274 million, operations generated $162 million of cash during the quarter, primarily due to a strong adjusted EBITDA and an increase in accounts payable, partially offset by increases in inventory. Expenditures for property plant and equipment were $39.7 million when we acquired $4.2 million of script files for a total of $43.9 million of capital expenditures.

During the quarter, we remodeled 63 stores and relocated two stores. Also during the quarter, the IRS completed it's examination of our amended tax returns for fiscal years 1996 through 2000. These returns have been submitted to the Joint Committee on Taxation for their review. Although we can't predict the outcome of the Joint Committee's review, certain previously recorded liabilities may be reduced as a result of the review when it is completed and we may be entitled to a tax refund.

We are confirming our adjusted EBITDA guidance of $700 million to $725 million for fiscal 2004. Attached to our press release is a table that reconciles our adjusted EBITDA guidance to our guidance for GAAP earnings. We are updating our GAAP earnings guidance to a range of $13 million of net loss to $15 million of net income for fiscal 2004. Sales are expected to be in the range of $16.5 billion to $16.7 billion for the year, based primarily on assumed same store sales growth of between 5.5% and 6.5%.

Cap ex is expected to be in the range of 170 to $190 million for fiscal 2004. This does not include the $107 million buyout of the synthetic lease, completed with the refinancing, that will be classified as cap ex on our cash flow statement.

We are also issuing a preliminary outlook for next year, fiscal 2005, which begins February 29, 2004. Based on our preliminary business plans, we expect sales in the range of $17.4 billion to $17.6 billion, the same store sales increase of 5.5% to 6.5% and net income of $112 million to $157 million. Adjusted EBITDA is expected to be in the range of $800 million to $850 million. We also expect capital expenditures to be in the range of $300 million to $325 million. Operator, we are now ready to take questions.

At this time, I'd like to remind everyone, in order to ask a question, please press star and then the number 1 on your telephone keypad. We will pause for just a moment to compile the Q&A roster. Your first question comes from John Heinbockel with Goldman Sachs.

John, can you tell us where we are on script buys, in terms of how many you made in the third quarter, how many you think you will make in the fourth and what's in the budget for next year?

In terms of where we're going, we're going to spend probably a little over $20 million this year for script buys for the full year, John.

Yep.

Next year's plan is to increase that to about $40 million. As Mary, I think, has mentioned previously, you know, we staffed up the script file department and substantially increased the rate of file buys that we're moving at right now so, we expect that's going to provide us some benefits next year in terms of our sales growth.

How many, wasn't your goal for the year, what, about 125 files? Is that right?

Yes, probably in that range and we're probably, I don't know, do you know the exact number is, Mary? We did 20 in the quarter, John.

Yeah but we have significantly more that are in the Q to wrap up for the fourth quarter, John.

Because I think probably year to date maybe you're about 60, so, this, you know, it is a big step up in the fourth quarter, correct?

Yeah, I think it's more like 50 or so, kind of on a year to date basis, John. We do have a lot in the pipeline for the fourth quarter, like I said, we will spend probably our whole capital plan.

Yeah, we did 20 in the quarter itself.

So, next year you're thinking 200 plus, then, something like that?

Right.

Yes.

And then when you look at your comp, the comp guidance for next year, is about the same as this year. When you breakdown front end and pharmacy, are you assuming the front end moderates and the pharmacy goes up or they will look much the same of this year?

It's a little bit of moderation in the front end and a modest improvement in pharmacy.

Modest, but no major changes?

No, not major changes, no.

And then finally, what, where do we stand with MediCal in terms of the, you know, 5% cut, you know, is that kind of, you know, a done deal, there is no hope to roll that back and then the possibility of other cuts coming down the road from, you know, in next year's budget?

John, we have actually factored the 5% cut into our forward projections, we're still attempting to set up discussion meetings with the new staff, but not a lot's happened there. So, an outcome any greater than that is still just a big question mark.

And so, the 5% is in your 8 to 850 for next year. So, I assume if you made some adjustments for, you know, some cost tweaking to offset the loss in gross?

We looked at all parts of our plan in order to determine where we'd be for the year, so, it's a combination of focusing on what we get in sales, margin improvement, cost containment, those three things are still there.

I mean, in doing our plan we are trying to give consideration about what we know about Medicaid plan changes but obviously those things are happening on the fly and we have to react, you know, in our business to those things. But, yeah, we've tried to give consideration to that in the preliminary business plans.

Okay. Thanks.

You're welcome, John.

Your next question comes from Eric Bossard with Midwest Research.

Good morning.

Hi, Eric.

Hey, on cap ex, the cap ex number increases a bunch next year. Can you remind us again of where that money is going, what that's going to be spent on?

Sure, I mean the big change, really, is the new store program. We are targeting to open 75 new and relocated stores next year. We've, I think as we previously announced we restarted our real estate program over the last, you know, quarter or so. We have substantially increased our staff, built a real estate network again, we had disbanded a lot of that in years past, we have started a pipeline building process and we've built a pretty good pipeline of stores for next year and we're, like I say, we're targeting 75 stores, it's kind of 50/50 between relocs and news and that's the biggest increase in the cap ex for next year.

You talk about 38 or whatever new stores gross. How many normal closings will there be next year, I guess I'm trying to get a sense of what the net store change might be in the quarter?

Other than the relocs, closures would be low, 20 or 30 stores, something along in those lines.

So in theory, sometime during next year you will have upped store count year-over-year slightly?

That's right.

And then secondly, on EBITDA, EBITDA growth this quarter was 10%, the guidance next year is EBITDA growth of 15%. Can you talk about what might have been different in the third quarter relative to next year that would allow EBITDA to grow faster next year than it showed up here in 3 Q?

Well, I think if you look at year-to-date I think we are going to end up this year it is right around 14 to 15% on a full year basis where we're guiding. I think, honestly, when we did our business plan for this year, we always thought this was going to be our toughest year-over-year comparison. Last year's third quarter was also a very good quarter. In general, there's nothing, you know, if if you look at the longer term growth trend we have this year, we're going to line up with that next year.

And, you know, the third quarter for us, which is September/October/November, usually are a little bit less in terms of overall results just by nature of how the calendar falls because we're on a different calendar year where we end February so our fourth quarter is generally much stronger and so is our first quarter.

So, the belief is that next year you can maintain the EBITDA growth that you've achieved this year?

Yeah, I mean in it terms of how it will spread out by quarter, that's something we will get into as we continue to update guidance as we go along. Will it be exactly 15% each quarter? It won't. That's, you know, how things kind of work.

Okay. Very good. Thank you.

Great, thank you.

Thank you.

Your next question comes from Lisa Cartwright with Smith Barney.

Hi, it's Elizabeth Lynn calling for Lisa.

Hi, Elizabeth.

Hi, I have a quick question on the 3Q results from last year. I might be missing something, but it looks like you restate stated sales last year by about $8 million.

And that's, Elizabeth, that's to conform with the different kinds of things that came out of that revenue recognition policy that was put in place last November.

So, that's EITF 216?

Yeah.

I wouldn't say they're restated, I'd say they're reclassified.

The sales?

Yeah. It's just moving around in classification on the income statement. It's not a restatement.

Okay, great. [ Laughter ]

We're touchy about that word around here.

I understand and then just a question on the guidance that you guys put out. Are you going to be giving any specific guidance for the full year tax rate or see any changes in the tax rate over the course of the year?

I think we've given you a full year estimate of income tax expense on the table.

That's correct.

Okay.

And basically, what we have going on is primarily state tax. You know can we have a large $2.6 billion of federal NOL of substantial income that we can generate for a long time, so in terms of trying to do effective tax rates, you know, it's best to kind of use your guidance and spread it out a little bit. It's a mixture of states and NOLs and things like that.

Great. Thank you very much.

You're very welcome.

Your next question comes from Mark Hudson with Merrill Lynch.

Hi, it's Monica filling in for Mark. Can you just sort of expand a bit on what you think are going to be the drivers of the EBITDA growth next year because a 15% growth in EBITDA implies that 20 to 50 basis point improvement margins. So, is it coming from gross margin, SG&A, a combination of both, if you can elaborate on that?

You know, the big fuzzy picture, kind of, it's what we're doing here. We are primarily growing our same-store sales base, which is allowing to us get more EBITDA dollars to the bottom line. We're leveraging the backstage facilities and the occupancy costs in the stores and other fixed costs, effectively and that is what is really s moving the EBITDA margin along here. That's the trend we expect to continue into next year. I don't think we see a huge increase in gross margins or something like that. It's really cost containment and continued growth of the same stores

And we will continue to make supply chain improvements which help take some expense out of the margin side and we'll address just our cost containment initiative as part of everything we do. I think it's everything working together to keep growing the top line and bring that more and more to the bottom line.

Would you assume any pressure on the gross margins coming from the pharmacy side next year as the generics sort of come off a bit and there is some outstanding issues with Medicaid/Medicare?

Well, as far as generics, I think we will see some increase in generics again next year compared to this year because we cycled through a lot of generics this year and so, I'd say that's still going to be a positive and we're very strong with generics in terms of utilization, I would consider us an industry leader. We're going to be fighting the battle of the Medicaids, just as everyone else, is and we factored those into our plans. And just a final question, where you expect D&A to be next year?

I've got it right on the table for you.

Great, thank you.

You're very welcome.

Your next question comes from Steve Chick with JP Morgan.

Hey.

Hi, Steve.

I got a few questions. I guess if we could start, I don't know if I caught, you know, the LIFO credit during the quarter, what was that related to, did you explain that?

It's basically, you know, when we build our plan for the year and as we book our LIFO amongst the quarters, we're really using an estimate and what we did in the third quarter is trued up the LIFO calculation, looked carefully at the inflation estimates. Which is what we have been doing at what we see is less inflation in certain categories, primarily in the pharmacy than we originally forecasted at the beginning of the year and even at the end of the first quarter and second quarter. So, we've reduced our estimate of LIFO expense for the year, which results in a credit for this quarter.

Okay. So you're seeing a little bit of lower or I guess you could say lower inflation within?

Within pharmacy.

Within pharmacy. Is that in branded drugs or generics, I guess generics.

Generics is a big part of it. Yeah.

Okay. So, as we, you know, I guess we, you know, heading into the next quarter, would the credit year-over-year be pretty similar to, like, are you on track to be pretty similar?

No, what will happen in the fourth quarter is that we will look a normal looking provision which is about $8 millionish, towards our estimate. Depending on the final calculation, that's subject to finalization of the actual LIFO detailed calculations.

Got you.

So, again, that's an estimate now that the guidance is based on and when we run the final calculations, we will get it adjusted slightly.

And inflation trends in the front end are pretty --

They've been pretty stable.

Pretty stable.

We've had some deflation going back about a year ago and it's just stayed fairly stable at this point.

Okay. Now, second thing... With the gross profit margin improvement I guess you said up about 15 basis points. Can you dissect that a little bit in terms of your trends with your pharmacy margins versus, you know, your front end margins and how front end gross margin pressures are trending I guess if youl back out the shrink impact?

I think in general, pharmacy margins are basically kind of flattening out on a year-over-year basis. That's what we expected to happen and that's what we planned for. Our front end margin is doing fine, it's up a little bit maybe over the prior year. Or maybe flattish and we also have, you know, fixed costs in there that we also leveraged effectively. In terms of raw margin rates, I'd say things are pretty steady. You know, we are making good leverage on the fixed costs we put in external margins.

Right, okay and so, I guess if you looked at kind of your front end promotional stance, sequentially and relative to where you were last year, are things pretty stable?

Yes, it stayed pretty much the same. We have not changed our page count. We really don't have any intention of doing that and our mix of kinds of items and price points is very similar. We keep adding enough new things in and creating new events to keep customers interested and I think, you know that allows to us work our own strategy.

Okay and how would you characterize the environment generally from others and competition, you know, on the front end, is the environment relatively stable, as well?

I'd say there's still, you know, pretty intense out there, people are putting a lot of pages out there. We're seeing more ROCs, and, you know, more midweek ads out, but I don't see anything a lot different than say last year at this time.

Yeah, I thought it was interesting that Walgreens had a five-hour ad on Black Friday or something like that. That was new for them, so.

We did not do that, you know, we've experimented with that in past years. You don't really get much other than, you know, you get a burst of sales in the hours, but customers leave the store to go to the next sale. You do better to have a little more extended sale that's more convenient to customers overall.

Okay. One other thing if I could. The Windows-based pharmacy system, can you walk us through, when are you installing that, when does it start and when do you expect it to end and just comment on the process, I mean, you know, when CVS went through installing Epic, I think they had some problems with that as they went along. Obviously you've added cushion into your--

Yeah, I think ours is probably that's a little bit, Epic is a different thing than what we're doing with the pharmacy system. But where we're basically at is that the new pharmacy system is in test in about 143 stores and it starts a rollout in January to February kind of time frame and then takes about 6 months from there to rollout across all the stores. In kind of rough timing.

In terms of what it is, it is a very exciting system, I think we're very, very pleased with it and the stores that are using it are very pleased with it. It is in fact, a Windows-based system so you understand some of the backstage functionality in terms of claims of adjudication and what not are not changing. This is really a front end system in terms of how it interfaces with the pharmacy, with the pharmacists and with the techs in the store and how they can manage the work flow and the process within the store. That's really the key to the whole thing.

It is a Windows-based system, just like you mentioned. It's got scanning, it's got biometrics on it, all kinds of stuff. It pretty neat, it's pretty good stuff. We think it's going to really allow pharmacists and techs to spend more time with customers and providing service than, you know, working the mechanics of filling out claims and that kind of stuff.

And Steve, we also, we really stretched out the pilot process so we worked enhancements into the pilot stores as we went through this past year and worked through any issues that came up so that at the point we start the rollout, we should be able to avoid a lot of the problems, I think, a lot of companies run into when they roll out a new system.

We will be able to run, to some degree, parallel as it rolls out. If, God forbid, there was a hitch of some kind, we could, you know, still operate. It's using other equipment, it's new equipment, as well. So, I think from a, you know, exposure perspective there isn't a lot there.

Okay.

From an upside perspective, it is nothing but opportunity.

Okay. Good and one last thing, I promise this will be last but can you make a comment on your thoughts about Walgreens released that they're not going to, or they're planning on not honoring any plans that want to do mandatory mail. Can you comment what your thoughts are there about that and if that's something you'd consider, as well?

Well, I think their stance is an important one for the industry because mandatory mail is not good for anyone except a PBM. It's really not good for a customer and the customer really ought to have choice and so it's up to pharmacies to really do their homework on being able to fill a 90-day script at retail and also, I think, you know, be believable to who they're working with on, you know, plan arrangements to, if there is some added costs to doing it at retail to get some reimbursement for it. But I think we made a good stance.

And so it sounds like you guys are, have the same stand or will be making the same stand.

Well, we don't have a PBM so we don't have this issue to deal with relative to whether, you know, we'll take on a plan like that that has mandatory mail, but if we were say working with a particular employer in an area on our own, we would evaluate that on a case by case basis as to whether it made sense and it would depend on the other elements of the plan arrangement.

Gotcha. Okay, thank you.

Thank you.

Your next question comes from Christina Bonney with CSFB.

Good morning, everyone.

Good morning.

First question was just with respect to the impact in the quarter that you saw vis-a-vis the strike in California, could you maybe comment on, you know, if you see that a lot of that business will be a permanent shift given what's gone on there and change in the overall environment?

Well, we're going to do everything we can to retain as many of those customers as we can. You know, with the, any of the pharmacy business that would have moved over the strike has gone on long enough that some customers have say refilled a script for a second time. So, we've done, really invested in effort to give them great customer service and the strike also gave us an opportunity to show customers maybe what our store was like for the first time since we've been doing a lot of remodels in Southern California, where some people may not have been back into the stores. We're going to work very aggressively to keep those customers.

And secondly, with respect to next year, you talked about your new and relocated stores. On the store closure front, could you give us a sense of what you see and foresee for fiscal 2005?

Yeah, I think I touched on it that we're probably looking at maybe 20 to 30 closures next year other than closures related to relocations.

Okay. And so in terms of --

That's an estimate. Obviously we're working in under performing stores all the time.

Right.

So...

Is it still about $50 million a year in terms of closed store costs?

It is a little lower at this point, but it's -- I don't know, high-40s.

Okay. And then finally on the working capital front, if you can give us a sense of, you know, what you foresee, you know, going forward there, any opportunities for improvement in fiscal 2005?

We've continued to be, you know, very focused on working capital. You know, what we think will happen is there will be some, as expected, build in receivables as we continue to grow our pharmacy business. We're going to work hard to try and offset that as much as we can with improvements in inventory but we might have some very small amount of working capital investment. We don't think it's going to be significant.

Okay. Great. Thanks very much.

Your next question comes from Meredith Adler with Lehman Brothers.

Hi, I'm sorry I missed the beginning of the call so this question might have been asked, but someone did ask about the impact of Medicaid on gross margin and the question was also about Medicare. And my own sense is that at least at this point, we're not seeing Medicare having a big impact or not likely to have a big impact. I was just wondering what your thoughts were on that?

As far as the Medicare, the actual Medicare new program won't kick in until 2006. So, in the interim we've got a drug discount card that we will be dealing with but if you think about it, we are already experienced with the drug discount cards in most pharmacies, us included, already offer, say, a senior discount. So, in some respects this will replace that and, you know, we're working through details of how we handle the card program offers now.

And I was wondering if you could comment on your experience with Medicaid this past year? I think CVS has said things weren't quite as bad in '03 as we expected but they're cautious for '04. I wondered if you had a similar experience or believe there's some chance that you'll be able to convince the states to cut things other than your reimbursement rates?

Well, I'd say I agree with what they said that we had good and bad experiences but we spent a lot of time and ever, too, in meeting with the different state Medicaid officials and even meetings with governors of states to help educate on the value of pharmacy in the equation and getting us to work with them on putting together a program that just doesn't save money at the expense of pharmacy and we have a pilot program, I mentioned in my comments, going on with the state of Washington on Medicaid to really help them be able to do a better job of disease state management so that they can save overall health costs and we're going to continue to do that because down the road that's the way that they're going to more effectively manage their costs and their programs and we will be able to handle the effect on the margin.

Great and just a follow-on to Steve Chick's question about mandatory mail. I wasn't quite sure about your answer. Are you looking at just whether a program, which might include mandatory mail, is unprofitable altogether in its entirety and that's how you make your decision? Because I thought Walgreens' comment was really about business they take at retail it really didn't have anything to do with the PBMs?

Well, I actually think a lot of their comment did have to do with their PBMs too and whether they would participate with plans that had mandatory mail. I think on mandatory mail, it isn't a good option for the customer and you have to, we have to make every effort we can to make it optional as to whether the customer does it through the mail or picks it up at the pharmacy.

Okay. Thank you very much.

You're welcome.

Your next question comes from Mark Waltimaat with Morgan Stanley

Hi, good morning. Mary, maybe you could talk just a little bit about what you've learned about your experience with the 90-day prescriptions and just how the economics look versus competing with the PBMs which, in many cases, have lower labor costs?

Well, one thing that we've done is we've actually held meetings with PBMs since we don't have one, to be able to develop for the future some additional 90-day programs. We do already fill some 90-day scripts through a couple of our programs and we do have, you know, a lower reimbursement but if you can also end up more scripts and a higher value on your script, you can end up coming out okay on that. We have to go through case by case. That's what the pharmacy services people are doing.

Okay, and if you could fill us in a little bit on how the process goes for negotiating the margins on the -- for the Medicare prescription drug benefit? It's fairly well believed that there's going to be a nice volume up tick for the industry but I think the margin question is still up in the air?

I don't -- yeah --

Mark, it is up in the air.

I don't think we know enough details yet about how everything's going to work on the prescription care. on the prescription program. So, I think we need to wait a little bit longer here.

Okay. And lastly, if you could just give us an update on how meaningful the flu season is going to be for you and is that more of a comp driver or is it comp plus margin mix?

Well, we're finally glad that there is a flu season, I don't like people to be getting sick personally, but, you know, this is probably the first year that there's really been such a strong start to the flu season and it started in a few areas in November and really picked up steam in December and I think it is expected to continue through into January and maybe February and it will, should have a positive overall effect on comps and on the margin, I think it should be okay on the margin side, too.

Okay, so those are higher margin products that are generally sold for combating the flu?

Well, flu usually can have a combination of flu, cough and cold so you can sell a mixture of products, both prescription and over-the-counter and I think that's where you get the extra benefit because you can end up with an overall larger customer sale because they may get a prescription and they may get OTC product, too.

I think if you sort of break it down a little bit, on the over-the-counter side, it's obviously very beneficial and you look at actual scripts related to flu, they can be probably a lower total value of script and the GP prescription can be a little bit lower than our average script, maybe. So, it will move margin dollars for sure,. Is margin rate going to go up? Probably not.

Okay, thank you very much.

Okay.

Your next question comes from Karen Miller with Bear Stearns.

Good morning. I'm wondering if you could talk a little bit about your new store program and would they be basically in the same regions or would you be expanding into new regions with some of the new stores?

Yeah, that's a great question, Karen. We're really very much focused on our existing markets. We are not planning any green fielding or movement into new markets at all. We really think that a new store or a relocated store, you know, obviously in an existing market, but a new store can get profitable much faster if it's in an existing market because you're going to leverage the infrastructure, the supervision, the advertising and other costs already in the marketplace.

We have lots of good opportunity to grow in our existing markets. We're in good markets today, that have that opportunity for us.

Secondly, could you comment on just some blurbs in the press that you might be interested in some of Eckerd's stores?

We're not going to do that. We're not going to comment on that. I appreciate the question but I don't think it's appropriate for to us do that.

Great. Thanks a lot. And one last question about a different subject. How much is outstanding on your term loan, please?

The term loan is $1,150,000,000.

Okay, so, no change.

Right.

Thank you very much.

Thank you, Karen.

Your next question comes from Leah Hartman with CRT Capital.

Good morning. A couple of follow-up questions on the bank line, was the full revolver available?

Yes, we have LCs outstanding about $400 million, but the full revolver is available.

Did you repurchase any bonds throughout the quarter?

We did not.

I noticed that the private series "A" preferred stock is off the balance sheet?

It's in other long-term liabilities.

It's moved up there?

Yes, it's an accounting pronouncement change, classification change.

Okay. I wondered about that. On the remodeling, can you give us an idea of the cost per store or maybe the cost per the smaller stores versus the larger stores?

Yeah, I would say just in kind of rough, round numbers, we probably spend sort of 250ish in the east coast right now for our remodel and probably 400ish in the west coast close to 450.

In your remodeling budget, is there a skew toward east coast versus west coast?

Well, we've been very, very focused on the west coast, we have done some east coast remodels but we have been very focused on the larger stores in the west and this year, I think we've pretty much finished those up. There may be another small batch next year. Maybe there's 100 or so left at this point and then, we're pretty much focused on the east and central from there.

Can you give us an idea of what kind of comps you're seeing in the remodeled stores?

I would tell you this, you know, a lot of our relo activity has really been designed to maintain, you know, our customer base and our image. We don't,when we do those we don't plan for, in our projections or build in a large sales increase. Having said that, our broader comps have improved and the remodel stores have followed the broader trends.

Okay. And on the store closure front, are you, do you look at a mix of leases running off versus the store just may have turned to, you know, less profitable than desired?

Yeah, I mean generally we have the ability to extend or negotiate, you know, additional lease term in most instances when a lease runs, so the majority of closures are, you know, not related to lease term expirations. We work, we have a report that gives us two or three years notice, we're at work on the issues before we get to them. I doesn't mean we can't lose a lease, we occasionally do but most of what you're looking at next year would be there f there's an under performing store is do we decide we can't fix it, we may close it. Like I said, that's kind of the 20 to 30 number total between those two issues.

And it looks like you have gotten a nice improvement in kind of the ratio of accounts payable to inventory. Is that kind of of just volume purchases, that they're giving you better terms from your vendors or you're aggressively?

No, you know I think it's kind of a weird thing in how it's played out. We brought in some seasonal merchandise early. We built inventory early in the second quarter but payables really did not follow it. Then we saw in the third quarter, payables started to catch up. I don't know if that was the mix of seasonal total inventory because we use LCs to buy some of that stuff or what but basically, where we sort of ended up was at a normal inventory and payables level at the end of the third quarter compared to the prior year.

Okay.

Okay?

Good luck during the next season.

Thank you.

Your next question comes from Jack Murphy with CSFB.

Good morning.

Good morning.

Most of my questions have been answered, but just as a follow-up on the openings. You said you're going to open them in existing markets but could you give us a sense of, you know, geography, if there's any, you know, bias toward any region and also, the same on closures and then finally, what you're seeing in terms of competitive openings, particularly versus Walgreens in California?

Okay. I guess I'll start at the beginning. In terms of the new store pipeline, it is kind of spread out. What we've done is basically focused on what we've identified there's about 30 key markets we're very focused on. Those are the markets where we're concentrating our new store and relocation efforts. Those are the New York's, the Los Angeles's, the Philadelphia's, the Detroit's, those kinds of things. These stores will be focused around the major metros. They are, of course, geographically across the country in terms of the way they're spread. In terms of, what was the second part of the question? I'm sorry.

Same question for closures?

For closures it's probably the same thing. It's really a cats and dogs kind of thing versus, you know, exiting a market if that's what you're asking. You know, what we're basically saying is there are probably some stores that we are working on that are under performers that we may make a decision to get out of next year. It would be a very small number of stores, but that would be, again, pretty spread out geographically. Okay?

Okay. And then competitive openings --

I think Walgreens has announced another 90 stores or so in Southern California.

In Southern California.

And CVS, you know, is obviously trying to develop a network of stores there. We, I think, held up in Southern California pretty well under the pressure so far and, you know, we expect to continue to do so.

Yeah, we've competed very effectively in Southern Cal with new competition.

Okay. Thank you.

You're welcome. Operator?

Your next question comes from Jeff Cobalar with Salomon Brother Assets.

Hi, Mary, you mentioned earlier about your script count being positive. Can you say is there any momentum in script count or is it consistent with the second quarter rate of change?

I think I commented that December has definitely shown momentum going forward to that really started to pick up in November because of the flu kicking in and yet, all the months of the quarter were positive. So, I'd say the momentum has definitely picked up even more.

Is any of it attributable to this September, win back the customer reactivation program?

I think it's a combination of all the different things we're doing and I would fully expect that we will continue to just keep building our script business as, you know, each of the different initiatives gets traction.

Can you describe the September program, how is it different than other programs you've had?

Our win back program?

Yes.

Really it's going through our database and identifying where the customer that should still be with us for a refill on a script, isn't. And really doing a direct mail piece to that customer, offering incentive to come back into our store via front end incentive. We're also exploring possible other ways of doing the same thing through direct calling of customers and really relying on the more personal interaction with the pharmacists or pharmacists in our call center.

Okay and then about the shrink, was there any special cause of the variance this third quarter?

You know, nothing that I can really point out, you know, our shrink has been well under control and we really began working on it several years ago, put lots of tools in place. But we did see in our third quarter, a slight increase in the shrink and no one thing in particular and so we just reinforced the need to use the shrink management tools because we intend to, you know, keep our shrink where it belongs.

Okay and then, John, you mentioned, you alluded to some potential tax refund. Can you throw any numbers around that?

I can tell you that we filed a tax return or tax returns that are now at the Joint Committee that basically would have generated a refund of $17 million and there would also possibly be some interest associated with that. That's more difficult to quantify because the IRS has audited these returns and probably moved some of the, you know, loss and income around by year, so I don't know exactly what the interest expense number is, earned interest income, right, I'm sorry.

Okay, thank you.

Your next question comes from Gary Giblin with CL King.

Yes, hi. I was wondering if you could comment on the pharmacy impact of the supermarket strikes because you talked mostly about the front end. Have you picked up prescriptions because the pharmacies are less active at the supermarkets and can you presumably retain them if people have switched prescription files?

Gary, we really gave the overall sales estimate for the strike and it was for both front end and pharmacy and I believe the response to one of the questions, I mentioned that some customers actually will have had a second fill on a script and so that gave us even another opportunity to keep that customer and it would be our intention to keep as many of those customers as we possibly can.

Uh-huh. Okay and are you getting increasing, you know, transfers of prescriptions as the strike continues on?

Yes, we --

An increasing number.

A lot of what it would have been transferred would have happened in really the early weeks of a strike or as somebody's prescription came due to be filled. So, there have been, you know, certain amounts each of the weeks and some stores are more effective than others. I think partly dependent on whether a pharmacist at a supermarket crossed over and worked in the pharmacy.

Okay. And have you seen the immediate impact on health and beauty care from that increased foot traffic or is that yet to come as people get used to your store?

Well, I think some of the bigger increase categories I mentioned were in the consumable category, the food-type items, beverages, liquor, categories like those that I think people were accustomed to buying in the supermarket. Those were probably the ones that I saw most affected. But some on everything.

It's all up.

Yeah, I mean, usually you have health and beauty care, I mean "X" the strike, you'd get health and beauty care increase along with foot traffic if you increased your customer counts. So, okay, great, thank you.

Okay. You're very welcome. Operator, this will be our last call, or our last question on the call.

Okay, your last question is from Luka Epolito with Chesapeake Partners.

Thank you. I wanted, you mentioned that you couldn't comment on Eckerd's but does that mean with tha with your balance sheet, which is now improving dramatically after some years of strain and, at times, outright distress, you're not ruling out possibly, a major acquisition?

What I think it means is we're just not commenting on M&A activity at all. We're not going to comment that.

Yes, it is our policy not to comment on speculation about that sort of thing.

But you're not ruling ruling it out, it would seem a fairly simple thing to do?

We're just not going to comment on it.

Okay, thank you.

Thank you, operator, very much. Thank you, everybody for listening in on the call. We appreciate your interest in our company. Happy holidays.

This concludes today's Rite Aid conference. You may now disconnect.