Rite Aid Corp (RAD) 2005 Q4 法說會逐字稿

Good morning. My name is April and I will be your conference facilitator today. At this time, I would like to welcome everyone to the Rite Aid fourth quarter results conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer period. [OPERATOR INSTRUCTIONS] Thank you.

At this time, I would now like to turn the call over to Mr. John Standley, Chief Financial Officer for Rite-Aid. Please go ahead.

Thank you very much, April. Welcome to our fourth quarter conference call. With me are Mary Sammons, our President and Chief Executive Officer, and Kevin Twomey, our Chief Accounting Officer.

Before we begin today, I would like to remind you that today's conference call includes forward-looking statements. Actual results could differ materially from those projected in the forward-looking statements. The factors that could cause actual results to it differ are described in our fiscal 2004 annual report on form 10-K and our periodic reports on forms 10-Q and 8-K if any. 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, nonGAAP financial measures are mentioned. The definition and purpose for using these measures are described in the form 8-K. we furnished the SEC this morning. The form 8-K can be accessed via our Website under the 'Our Company' and 'Investor Info' tabs. You are 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 business results. I'll review the fourth quarter financial results and comment on our 2006 guidance. Then we'll take questions. Mary?

Thanks, John. Good morning, everyone. Thank you for joining us today to discuss our fourth quarter and year-end results. We recorded both a profitable quarter and a profitable year before taking into account the tax benefit. Adjusted EBITDA for the fourth quarter declined 22.6% primarily because of weaker sales. And adjusted EBITDA for fiscal 2005 was basically flat to the year before.

Sales continue to be negatively impacted by mail programs, particularly mandatory mail. We were up against tough year-over-year comparisons due to the substantial sales increases we saw in the last four months of fiscal 2004, because of the Southern California grocery strike. We expect this negative impact to lessen over the next few months since we have cycled the end of the grocery strike and will cycle the start of the major impact from the United Auto Workers mandatory mail program in June. It's important to note that approximately 1100 of our stores were impacted by this program. A larger exposure than any of our competitors.

Same-store sales declined 0.9% in the quarter. Pharmacy same-store sales declined 1.1% but pharmacy growth margin was up due to more sales of higher margin generics and continued purchasing improvement. New generic prescriptions dampened pharmacy comps by 204 basis points, while the percentage of total generics dispensed increased 381 basis points for the quarter. And more than 300 basis points for the year, saving money for both patients and payors. While we saw strong sales increases related to the pickup in coughs, cold, and flu in the latter part of the quarter, it wasn't enough to offset the decline in other therapeutic categories. The Vioxx recall and negative publicity on overall Cox-2 inhibitors, as well as psychotherapeutics had a negative effect on comps. And we continue to see slower sales of estrogen products and anti-histamines, even though the Claratin switch to OTC occurred more than a year ago.

During the quarter, we made progress on initiatives to improve our pharmacy business. We increased our pharmacy field management staff, adding more pharmacy development managers to oversee execution and customer service in our pharmacies. With the roll-in of our new pharmacy dispensing system completed, customer satisfaction scores improved in the fourth quarter, and will continue to focus on significantly improving the customer's experience in our pharmacies. Our goal is best-in-class. We continued our aggressive pursuit of prescription file-bys increasing the scripts purchased by 70% over fiscal year 2004. Retention of those scripts is improving and in the majority of the buys, we kept the pharmacy staff as well.

At the end of February, we launched 'Living More', a new senior royalty program specifically targeted to our pharmacy customers who are 60 and older. Enrollment is free and seniors receive discounts on prescriptions, vitamins, private brands and other front-end products, as well as our 'Living More' newsletter with health and wellness tips targeted to their health concerns. So far, the response is more positive than even we expected, and we've already enrolled nearly 1 million seniors. We added a compliance program for generic prescriptions, using our call center to remind customers when refills are due. Refilling prescriptions as the doctor ordered not only increases sales, it also maximizes the benefits of drug therapy and can save on long-term healthcare costs. We've also made substantial progress in negotiating [inaudible - audio break]

Ladies and gentlemen, this is the operator. Today's conference is scheduled to begin momentarily. Ladies and gentlemen, this is the operator. I apologize, but there will be a slight delay in today's conference. Please hold and the conference will resume momentarily. Thank you for your patience. [audio break - technical difficulties]

-- for the fourth quarter, 100% of our 1-hour labs were digitally enabled. During the quarter, our merchandising staffs prepared for a major cosmetic reset would start this month in all of our stores. Most notable changes would be the additions of a men's grooming center and a new spa section. We believe these new planagrams will help us continue to increase beauty sales. While our focus on managing expenses to help offset the impact of lower sales continues to be a priority, SG&A was up over last year as a percent of sales both for the quarter and for the full year, primarily because of store labor costs. We placed increased emphasis on pharmacy service and training. Corporate administration expenses were down as a percent of sales both for the quarter and the year.

Last quarter I told you our two new pilot stores with the new Rite-Aid format and design turned out great. Now I have the customer research to prove it. Almost 95% of the customers who visited the two stores in Akron, Ohio and [Cellarsburg], Indiana, said they were satisfied or highly satisfied with our new store design, pointing to the expanded merchandise offering, improved in-store navigation, and open feel of the pharmacy as big positives. Sales at both stores are the real proof. Increasing dramatically in customers saying they plan to increase their shopping trips and purchases in the future. Associates like the design, too, which may be part of the reason we also got high marks from store personnel.

Our store's development program is well under way, and we plan to open 80 new and relocated stores in fiscal 2006, as well as remodel 200 stores, and will add 100 new GNC store-within-a-store departments bringing our total GNC's to almost 1200 by year end.

Looking forward, our focus is not changing. Our #1 priority is growing pharmacy sales and scripts, and continuous improvement of the customer experience in the pharmacy is our most important initiative. We set tough goals for ourselves in attaining high customer satisfaction ratings. Right behind this are our initiatives to get new customers. Our commitment to our senior 'Living More' program, our health and wellness platform supported by strong health condition marketing, our managed care partnership efforts, our PBM initiative, and our follow-buy strategy.

We'll keep identifying strategies to increase our solid front end business, too, themed marketing events, targeted marketing capitalizing on the ethnicity of our stores, expanding our GNC store-within-a-store departments, and collaborative business planning with our suppliers. We'll also be very active in filling the pipeline for aggressive store development beyond fiscal year 2006, staying focused on our strategic markets.

As you saw from our release, the guidance we provided for fiscal 2006 is about flat with this year's results. It reflects the time it will take to stifle the negative factors that affected us in the second half of this past fiscal year, and also includes the impact of aggressively working our growth plan for real estate, file-bys, and costs associated with new business development. We remain confident that our business opportunity is great, and that our team is focused on the right priorities and initiatives to increase our market share, and deliver long-term shareholder value.

Now I'll turn it over to John.

Mary, because of a problem with the phone a couple of your comments were blocked out. Would you like to comment about compliance for generic prescription drugs and PBM efforts?

Okay. I'm sorry that that occurred. Let me repeat this for those that missed it.

This has to do with initiatives on our pharmacy sales. We added a compliance program for generic prescriptions using our call center to remind customers when refills are due. Refilling prescriptions as the doctor ordered not only increases sales, it also maximizes the benefits of drug therapy and can save on long-term healthcare costs. We've also made substantial progress in negotiating third-party preferred and limited networks, and are in discussions with potential partners on initiatives to take advantage of the new Medicare prescription drug benefit in '06. We're starting up our own pharmacy benefit management company with mail capabilities using a third-party to provide back office services, including claims adjudication and mail services. We've laid out our preliminary plan for developing our own internal national sales and marketing teams, and as we said before, PBM capability will give us a seat at the table, to compete for managed care plans and protect our market share. Thanks. John?

Okay, thank you, Mary. Total revenues, I'll just talk for a couple minute of fourth quarter results.

Total revenues for the 13-week fourth quarter were 4.34 billion this year compared to 4.40 billion last year for a decline of $56 million. We operated 3,356 retail stores at quarter end, versus 3,382 stores at the end of last year's quarter, a net reduction of 26 stores. Same-store sales for the quarter declined 90 basis points. Pharmacy comparable same-store sales declined 1.1% and front-end comparable store sales declined 50 basis points. Gross margins, which are net of occupancy costs were 1.12 billion or 25.8% of revenues for the fourth quarter this year, versus 1.09 billion or 24.8% of revenues last year. Current quarter included a noncash LIFO credit of $36.2 million, versus a credit of 5.5 million in last year's's fourth quarter.

Excluding LIFO, the fourth quarter gross margin was 25% of revenues this year compared to 24.6% of revenues last year, an increase of 33 basis points. LIFO gross margin was positively impacted by increased pharmacy margins partially offset by a slight increase in occupancy costs. Pharmacy margins were positively impacted by reduced inventory costs resulting from purchasing improvements, and more generic scripts as a percent of total scripts, partially offset by lower reimbursement rates.

Selling, general and administrative expenses for the quarter increased as a percent of revenues by 1.3% compared to the prior year. The increase is the result of higher wage, advertising and bad debt expenses, partially offset by lowered depreciation and amortization expense, and lower incentive compensation extension expense . Noncash stock based compensation expense, which is now included in SG&A was 4.5 million this year, versus 3.9 million in the prior year. We've spent the fair value of stock options granted.

Store closing and impairment costs were 24.4 million this year versus 21.8 million in last year's fourth quarter. Interest expense was 69.9 million for the fourth quarter versus 77.4 million last year's fourth quarter. Due primarily to lower levels of debt. Cash interest expense was 64.9 million this year versus 72.5 million last year, and noncash interest was 5 million this year versus 4.9 million last year. Adjusted EBITDA for the fourth quarter was 167.9 million or 3.9% of revenues, a decrease of $49 million from the prior year computed on a consistent basis. The schedule attached to our press release reconciled our net income to our adjusted EBITDA total.

Income before taxes was $49 million this year versus 58.1 million last year. Income tax benefit for the quarter was 179.6 million this year, versus a 1.3 million benefit last year. The increase in the amount of the tax benefit is due to the reduction of the valuation allowance for deferred tax assets. Net income for the quarter was 228.6 million or net income per diluted share of $0.35, compared to net income of 59.4 million or net income of $0.09 in last year's fourth quarter.

During the quarter, we issued, $120 million of series E preferred stock which has a 7% cash dividend, and will convert to common stock in 3 years based on a formula. We used the proceeds from the series E to redeem $118 million of the LGB preferred which included a $5.7 million redemption premium. The remaining balance of the LGB preferred, which was $339.2 million at year end, was divided into 3 equal traunches with new terms as follows. The series F preferred will have a dividend rate of 8% payable in stock and will be callable at any time. The series G preferred will have a 7% dividend payable in stock and is not callable for four years. The series H preferred has a 6% dividend rate and is not callable for five years. During the quarter, we issued 200 million of 7.5% senior secured notes due 2015. Proceeds from this offering will be used to pay the $170.5 million of 7.625 notes due April 15 2005.

For the quarter, we spent $70.4 million for property, plant, and equipment and $10.4 million for script file purchases for a total of $81 million of Cap Ex for the fourth quarter. During the quarter, we completed the sale and lease back of 15 stores for net proceeds of $40.4 million. During the quarter, we opened 4 new stores, relocated 4 stores, acquired 2 stores, and remodeled 18 stores, and closed 13 stores.

Fiscal 2006 will be a 53-week year. We're estimating fiscal 2006 revenues to be in the range of 17.3 to 17.7 billion, based on a same-store sales range of 1.4% to 3.4%, and 80 new and relocated stores next year. We are also estimating fiscal 2006 adjusted EBITDA to be in the range of 700 to 750 million, and our net income to be between 45 and 71 million. Attached to our press release is a table of reconciles of our adjusted EBITDA guidance, or our guidance for GAAP earnings. CapEx is estimated to be in the range of 350 to 400 million for fiscal 2006. CapEx estimates do not reflect proceeds from possible sales and lease back transactions, and net income and EPS estimates do not include the possible impact of future tax benefits.

Operator, we're now ready to take questions.

At this time, I would like to remind everyone if you would like to ask a question, please press star then the number one on your telephone key pad. We'll pause for just a moment to compile the Q&A roster.

Your first question comes from John Heinbockel, Goldman Sachs.

Can you just touch a little more on the PBM start-up, in terms of kind of timetable to get it up and running, to begin marketing to third-party plans, to get a mail order facility in place. Is that presumably something you're also going to do greenfield? And at what point will it take a few years for that to begin making a revenue impact,or can it happen more quickly than that? And what role will acquisitions play in getting some scale?

John, we're pretty close to announcing coming out with a press release on what we're doing and how we'll be doing it. So I really don't want to give out too many details until that's out, but we would expect to get our sales force in place some time by, I'd say, mid-year and this year's impact will probably be marginal, because you're just getting started, but what it will do is give us, like we said, a seat at the table to be able to be part of what needs to go on for our business and over the future, it could have, I think, really good impact for us in our key strategic markets.

How big do you need to be to be competitive? Do you need to be top 5 or top 10 in lives managed, or do you think doing it kind of organically that, you know, scale is not an issue?

Let me jump in here a little bit. I guess I'm going to tip our hand a little and probably get yelled at after this call, but we are, you know in substantive negotiations with a service provider, who will add all of the backstage functions here. So we're going to basically, you know, start up a PBM but we're already going to have a formulary adjudication process and mail-order facility at our disposal. So we'll come right out of the ground hot. What we would be doing is, you know, adding the sales force and whatnot to make this thing go. So --

are there lives attached to this business right now or no? That's --

No, we would be ramping it up on the life side from scratch, basically, but we would have an offering that we would think is competitive today, that we gain from the scale provided to us if we complete these negotiations successfully, that this person would already have.

Okay. Secondly, you know you're not going to give quarterly guidance, but can you give a little color on how back end loaded this year looks. Obviously you had a great quarter last year, that's going to be a tough compare. Is it really skewed, you know, quite back-end loaded or, you know, a little more balanced than that particularly as we get into the middle quarters?

I'd say it's a little more balanced than you would expect. Probably sales are going -- you know, are a challenge right now. We need to cycle some of these issues. First quarter has some seasonality in it. It has less holiday pay in it. It's become a bit of a stronger quarter seasonally. Than even fourth quarter was, you know, obviously this last year. So I think as has been our trend the last few years, the first quarter and fourth quarter are our strongest quarters generally. The middle two quarters will be the same [inaudible-background noise] And from the revenue line we'll fight the first couple of quarters pretty hard, I think, and we expect things to get better in the second half from a revenue perspective.

And that 1.4 comp, does that exactly line up with the 700 million of EBITDA? I would think if you do the 1.4 comp, you could probably do better than that.

We generally just try to put a comfortable range around both the sales and EBITDA. It's not rocket science. That's all it is.

Thanks.

Your next question comes from Mark Husson with HSBC.

Talk a little about generics. I think three-quarters ago, you had said the gross margins from generics was good and welcome were being attacked by being marked down more quickly than they had been in the past. Can you talk about whether that's still your experience. Also, in terms of your guidance, it looks like there is a very big generic bulge coming through in 2006. Have you included a big bulge in generics, and would it be fair to say your guidance includes gross margin still going up and SG&A going up at the same kind of rate?

We definitely expect to continue growing our generics and feel positive about their impact through this upcoming year. We still continue to see, you know, reimbursement pressures on them, however, our services team has done a great job, in terms of cost issues related to generics and we continue to do a great job at store level of increasing penetration. So that has helped our margin. It's impacted our sales results overall because of that, but it also improves, you know, our mix of what we're selling.

If you look at take a little bit of a right turn and look at the LIFO credit as an example. That's coming out of the generic side of the pharmacy business that's driving that. So what you see there is we're lowering our cost, right, which is creating an deflationary environment in the LIFO credit. At the same time, you have all of those PBMs and others out there who are looking at costs, survey costs and are adjusting reimbursement rates following along behind us, so it's a timing thing.

Have you increased the amounts of generics that you are sourcing directly? I think you had probably more of a --

We always pretty much source directly on generics all the way.

Next year, some of the numbers being bandied around are around $20 billion of potential generic substitutions out there. Is that the kind of number you are expecting?

I think that seems a little higher than what we have factored. Maybe some of those are late, so they would get into our next fiscal year or something.

Calendar 2006.

Okay. And then just switch gears slightly. You talked about being in extensive negotiations with a partner on the PBM side. We've seen CVS do a deal with a specialty insurer, and Walgreen do a deal with an HMO-type company, United Healthcare in order to become PDPs, under the new Medicare program. Do you have any ambition to become a PDP in multiple markets, and if so, is this person you are talking to going to be your partner for that as well?

We're not personally becoming a PDP, but we are also in discussions with certain parties to be able to do similar things to what our competitors have announced.

So is that just, you know, being the marketing arm of a plan, or are you going to get involved in it on the PBM side in terms of ministering the plan?

I think on the PBM side, we will ourselves be very new into the PBM effort, so I don't see us doing through our own PBM anything here at this point, but we are in very strong discussions with several players in this arena.

So that you can co-brand an efforts on the Medicare front?

Yes.

Okay. You are not participating to the full extent of your P&L account, you are participating on a rather more limited basis?

Everything is in a state of flux. You have our two biggest competitors out there with partners. You can see there are a lot of large PBMs who have not announced a limited network, as well as other insurance providers. So this thing's still bouncing around, I'd say.

Yeah. We fully expect to be a pharmacy provider in most PDP programs, and that's going to really allow us to capture our fair share of the Medicare market.

I don't think the limited network issue is a result, either though --

No one know which one senior citizens are going to prefer.

Right. And one final question, if I may. Is it -- could you just talk about the impact file-bys had on your comp store sales? Obviously you've done more than this year.

I think what's happening is the program is ramping up, you know, over time, and we need to continue to grow it, I think, to really have a large impact on our costs. So it's, you know, it's in those -- it's more than 10 basis points but probably less than 50 or something.

Great. Thank you very much.

Your next question comes from Meredith [Alder] with Lehman Brothers.

Meredith Adler. First I'd like to talk about whether the new pharmacy system you have in place helps the pharmacist more to penetrate generics? Is there something about that program? Because it looks like your penetration has been very good, or is it other things that you're doing?

No. Our old system has really great capability relative to prompting for generic also, and we continue to keep that capability in the new system. But what the new system gives us is more flexibility and just overall pharmacy dispensing. It also positions the pharmacist to be at the pickup area so that they are more available to have that face time with a customer, which we believe long term is where a pharmacy needs to make big improvement in the pharmacy experience.

What are you doing to drive generics at the store level?

Well, we have really a strong communications plan to our stores, relative to any new general near that's's coming out, but --

any other generic appliance program that's launching, that continues to push on it, but procedurally, I don't think we've changed.

Yeah.

We were in a high place to start with. We were focused and just generally plans have gotten more educated about it, payors, we've been successful in maximizing the opportunity.

If you look at any of the IMF data, we continue to lead our -- any of our competitors in terms of our generic efficiency and penetration, and we place the highest focus on it because it improves our value proposition and helps the margin.

And then I was just sort of curious. You did sound like the refill compliance program is only focused on generic drugs.

There was an existing program.

Basically what it is, is a lot of times you do compliance programs relative to working in partnership, say with a supplier. What this is, is an internal program which, you know, we are doing through our own call center on generics because we believe the opportunity is there to improve our business results by spending some of the resource ourselves to call those customers.

Okay, great. Then just two other quick questions. You talked about 80 new and relocated stores. What do you think the net change in the store base will be this coming year?

It's probably about 50/50 between those news and relos, so call it 40 net news. We probably closed 20 to 30 stores. So the net change isn't a lot.

Okay. And just finally --

It will be growth.

Right, yeah.

within, kind of, 5 years.

Finally just quickly, are you seeing any change in availability of pharmacy files for you to buy?

No, it's been pretty much the same all year. We're very aggressive on it. We've got a big team focused on it as well as our pharmacy supervisors.

It's a competitive market.

One of the things I think I mentioned on the last call and we're still doing that is we're really spending more time, too, looking at what I'd call small multi-chain independents where a lot of the effort has been on single file-buys. We're looking at some opportunities for five or six-store purchase.

Right. Thank you.

Your next question comes from John Ransom with Raymond James.

Good morning.

Hi, John.

What percentage of your generic revenues would you say are still AWP-based, both Medicaid and commercial?

The revenues?

Yeah. Is it still over 90%? In other words, Massachusetts has a WAC-plus pricing, for example an expensing fee, whereas most states and most plans still have an AWP-based price.

It's mostly AWP-based.

Now with some of the comments coming out of Congress about that and the kind of mismatch between AWP and costs, do you see, if you had to look out two years, do you think there will be a material change in the percentage of AWP-based pricing for generics?

I do believe that moving away from AWP-pricing model is very possible to happen. I think what's happening right now is as it company, we are personally doing educating of people that are looking at this issue, the legislators, et cetera and doing it in conjunction with any CDF's also, to make sure that the pricing model that ends up coming out of all of this discussion is one that fairly reimburses for cost to dispense, as well as product cost.

Do you have an example of where you were at AWP and went to WAC and kind of what the overall impact on your pharmacy gross margins were?

I couldn't give you that, honestly because I don't know that we've had a lot of that, that I could think of off the top of my head. Also remember, AWP minus on generics is fairly aggressive. Drugs are max.

Yeah. So for example, I mean, if you looked at your highest gross margins say versus your lowest, let's say Massachusetts might be at the lower end of your gross margin --

Where we have no stores.

I understand. Let's take your highest gross margins state versus your lower gross margin state today. Is there a huge swing factor between the two?

There are some differences I'd say, yeah. I'm not sure I could tell you percentage points or basis points over the phone.

Okay.

And this is in relation to the state Medicaid programs that your talking about?

Right.

There's variations by states.

Yeah, the states vary a lot. I think that was part of the issue that the federal government really was looking at because of understanding how much they were paying towards the total bill to the state.

Okay. All right. And I guess I'm very happy that you're starting the PBM obviously, perfect world maybe this could have been done sooner by all of the drug retailers. Talk about just generally, I guess the concern might be just starting to slug it out now, and making those calls on consultants and benefit managers. This seems like a five-year slog to even get on. Talk about the buy versus build decision here.

I think the issue for us is, even if we bought a smaller PBM, we would have a material market share and realistically, versus the Big 3, neither do Walgreen's or CVS, I think what's relevant here, is to have an offering for key discussions where we have a sense that somebody's considering mail order as an option, to go sit at the table with those folks as a quote, unquote, PBM, and be involved in the negotiations and we have a stab at it. That's really what this is about.

It is. Yeah, I agree with John. That's why it's also been important while we're doing this, too, to build good relationships with PBMs. I mean, it's an important component of our business strategy and we're going to keep doing that even if we get our PBM off the ground.

And do you see kind of doing what Walgreen's is doing, in terms of being a higher -- do you plan to keep retained rebates in your PBM? Or are you going to try to differentiate sharing 100% pass-through. Medco keeps 55%, or 44% of their rebates. Do you have a strategy of keeping less than that or how are you thinking about that?

We have defined our strategy. I don't know that we want to share it at this point, but we really want to be able to benefit our customers and our stores.

Yeah, I think I'll be honest, what's the revenue and how many years, we didn't start this thing up as a quote, unquote profit center, or a future source of giant revenue. We really started this up, to help drive our pharmacy script business.

Sure.

So what we want to do is be as competitive as we can on price, low cost, cut to the bone. We're not in it to generate a bunch of EBITDA for PBM. We're in it to drive scripts to our stores. That's what this is about for us. Don't look at this as a new entity that's going to generate some wild amount of revenues in EBITDA. It's not designed to do that.

I assume your PBM will cover 90 days at retail? [laughter]

It's going to do that.

Have some sound plan design, right?

Right. And okay. Well, again, good luck with that, and I'm glad you guys are getting started.

Thanks.

Your next question comes from Carla Casella with JPMorgan.

Hi. I know you did a successful secured debt financing earlier this year, how much more secured debt are you permitted to do under your existing covenants?

I think about 200 million today.

Okay. And then you did some sale leasebacks. How many more stores or square footage do you own at this point, so we can get an idea of how much more you can do in sale leasebacks?

I think it's about 200 stores.

I missed that, the secured debt availability we have is over 775 million. The 200 as it relates to unsecured.

Oh, okay. And then on the sale lease, you said you had 200 stores or 200 --

Yes, I'm sorry. About 200 owned stores left roughly in that range.

Okay. And do you think all of those are candidates for sale leaseback?

No, it's not our intention do that. Really, we were trying to get a little bit of capital to help fund the start-up of the new store program, as we're in the development stage now. Figure about half of the stores we're building today will be owned by us, we'll be developing them versus a, you know, developer, if you will. And so what we intend to do is do a sale leaseback on a go-forward basis on some portion of those stores that we own.

Okay. As you are building out, you'll fund some of it with sale leasebacks?

Yes.

Okay. Then the preferred stock, is there any plans in terms of timeframe when you would like to get out of all of the I guess, [Leonard Green group] stock?

We would like to continue to reduce the number of shares they have. It's not our intention at this time to use cash flow from operations to do that. We use an equity security to replace an equity security, if you will.

Right.

So I would, you know, from a bondholder perspective be looking at this as, you know, we have a need for liquidity to deal with the Leonard Green stock which we don't, at this time.

Okay.

So I think we'll continue to be opportunistic on it. As it makes sense to address it. But our focus is on, you know, obviously servicing our debt and growing our company first and foremost.

Improving our ratios.

Great. One last question. I think someone asked earlier about the variance of your guidance for '06. Is anything, or how much is related to vendor allowances and variance you get based on volumes?

None.

Okay.

Not really an issue for us.

That's all. Thank you.

Okay.

Your next question comes from Christina Boni, Credit Suisse First Boston.

Yes, good morning, everyone.

Good morning.

My first question, followup on mail order, can you give us some insight what you're seeing on the environment? Obviously many of these plans come up in the beginning of the year. Can you give a sense if you're seeing anything new there and obviously the PBM will give you an opportunity to address that.

I really haven't seen a lot going on new at this point in time. I think there were several months ago about some larger companies doing an alternative kind of strategy, which was their own in-house pharmacies. But the whole mail issue, I think will continue to be an issue that our industry has to deal with, and that's why it means we also need to put more emphasis on being able to improve the pharmacy experience, get involved in the disease state management, have our own PBM to have a seat at the table, and help on plan design, and keep working on our partnership relationships with the larger PBMs.

I think there's a couple of plans that will go down, I'm not sure I can put my finger on which ones they are, but it continues to be some level of activity.

And, you know, nothing of the magnitude of what we saw with UAW.

Right. Okay. With respect to the dispensing system, I know there was a little bit of disruption as you implemented that. As you look back at the stores that you first put on the system, are you seeing the benefits of those stores, and maybe give us some insight as some stores are further down the chain than others?

I think things are kind of settling down in our sense. You know, we went back and put some programs in place, went back to stores that were struggling, make sure that we did properly train them, and provide them the support that they need. We now see a very high level of compliance on the training side. We have some new tools to work with, some measurement tools that are available to us to measure how the stores are complying with the system, and how effective they are with it. We are using those tools to continue to focus on stores that may not be quite where they want them to be with the new system. So I think we have settled down the larger group of stores, and we have the ability to focus on those stores that are still not quite there yet.

And we measure our customer satisfaction ratings by store every single month. I mentioned in my comments that from third quarter to fourth quarter we saw a nice improvement in the overall ratings, and we're expecting to see that happen all through this year. We set ourselves very aggressive goals. This is one of our strategic initiatives. We think that's very important for our future success.

Very good. And just if you can just give us a little more granularity on the capital expenditure plan? Just make maybe you can break that out, in terms of new stores versus maintenance. Also, if you can give us the sense of what at this point are you committed to spend the full 350 or is there discretion within the number?

Part of the CapEx plan, I'm not going to pull out all of the specific components, Christina, but part of the budget probably $50 million of it or something is available to us for land banking purposes to build pipeline, you know, storage for the pipeline in future years. There's 20 to $30 million of budget that's for store-related equipment. We're going to start a program to replace registers over time, you know, we're going to start to replace our [SASI] registers with newer equipment. We're updating our script pro-machines. We have CapEx in there for that, photo equipment, you know, for digital upgrade kinds of things. File-bys is a component of it. Of course you have the resource and the remodels. Those will be the big baskets of it.

Okay, great. That's helpful. Thank you very much.

You're very welcome.

Your next question comes from Steve Chick with JPMorgan Chase.

Hey, John, just a question on the disparity, I guess, in the quarter between the EBITDA you're reporting and your operating cash flow. And my numbers I guess operating cash was negative for the quarter.

Yeah, we paid down the revolving -- excuse me. The accounts receivable securitization facility was paid down $184 million in the quarter, so adjusting for that cash flow was $181 million from operations.

Okay.

But if you do the squeeze, you are going to come out with cash flow from operations of -4 or something. If you add back the AR facility, which goes through cash flow from operations on the working capital line, if you put that back. We actually generated $181 million of cash flow.

Okay, I got you.

So we paid down debt effectively, or the AR facility

You did that AR facility, I guess, the third quarter.

That's right.

If I want to really compare operating cash to EBITDA?

You would take that out altogether. Out of the third quarter as well.

Okay, great.

If you go to the year same exercise, for the full-year cash flow there's 150 million draw on the AR securitization facility. So take that out and cash flow for the year is about 370. Add back interest expense, you are right on top of the EBITDA number.

That's helpful, thanks.

You're very welcome.

Your next question comes from Robert Summers with Banc of America Securities.

[Horace Saxley] and Westcott Rochette for Bob Summers Can you talk about the competitive environment now that Eckhardt has been under new management for 9 months now, probably stabilized. Have you seen a significant change in the way people are operating either Eckhardt or some of your other competitors in response to Eckhardt?

I really haven't seen anything that I would say is remarkable at all.

It seems --

business as usual.

Business as usual, I would say.

No disruption or, you know, more aggressive either way?

No.

Okay. And secondly, on 90-day retail, is that an option, you are going to pursue as you grow your PBM capabilities?

It would certainly be one of the things we would bring to the table in terms of plan design, yes.

We already have participation in limited networks.

Yeah. 90-day at retail is not a brand new concept. We've been offering that under certain plans, some fairly significant ones for a while. And, you know it's something that we look at on a case-by-case basis in terms of what we're going to do relative to the 90-day offering, and we're going to continue to do that apart from our own PBM strategy.

And as plans get more familiar with the offering, three to five years down the line, what percentage do you think that that would start to take of the overall to start to eat into some of the mail order?

I don't know that I've developed any number along that line yet.

What we're really focused on here is, for existing situation where's mail order becomes a threat is having the opportunity to be involved in a discussion by being at the table on the PBM bid process, and hopefully hang on to some, or a portion of all of that business. That's really what we're trying to do here.

Okay. Makes sense. One more question just as far as digital and photo capability, do you plan on increasing your in-store digital service? Where do you see that business going? Do you plan on increasing the digital capability, but then outsourcing the actual processing?

Well, we have, I think I mentioned in my comments that 100% of our 1-hour labs are now digitally enabled. That covers about 70% of our store base. We're going to continue to add some new digital capabilities to our offering, and we'll have news about that out probably over the next several months, and we'll continue to upgrade the equipment that we have. One of the things because we did a lot of this upgrading a little bit later. That puts us in better shape with what we've got there. We think it'll continue to grow as customers, I think, recognize the value of developing it in the store.

Thank you very much.

Your next question comes from Reade Kem with Banc of America Securities.

Yes, hi. I was wondering with the increased CapEx budget for the year where, if any, bond repurchases may fit into that equation, and whether you've done any since the end of the fiscal year?

Haven't done any since the end of the fiscal year, and really that's not our current focus. We have some near-term maturities to work with, and we're focused on those and we're focused on, you know, growing our Company at this point.

Okay.

Okay?

And I think I missed the comments maybe with the phone disruption, but did you mention with what your same-store script volume was, either for the quarter or the year?

You know, we generally don't give it out. We give you comp store pharmacy sales. I can give you ten reasons why we don't give it out, but we don't generally give it. I will tell that you inflation, as you saw from our LIFO credit, is very narrow at this point, that you get some fairly good sense of where we are by looking at our receipt, comp-store sales.

Actually, along those lines, given the 30 basis points gross margin improvement after adjusting for that credit. Did you say that was mostly on the pharmacy side, or are we seeing some perhaps benefit on the front?

It's pretty much on the pharmacy side.

Front-end margins have been pretty stable and they've always been, I think, fairly strong for us.

Is there additional opportunity there because it seems like relative to some of your peers there may be, you know, some opportunity for improvement there.

Front-end margin, I think really we've done a great job of really combining and needs to find ways to improve margin, like increasing private brand and the need to be competitive. I don't really see a lot of margin rate potential. We do a great job on strength management. We have done that over the last several years. So it's not like there's something out there from a cost standpoint that would improve the margin.

I think what would help our margins the most is obviously getting our sales going a little bit stronger.

Okay. And then in the wake of the, you know, the GM Walgreens situation, has there been any positive fallout for you out of that?

We have seen some positive from that and I would expect that to even get a little bit stronger.

Okay. Thanks.

It's Ron Phillis along with Reade. We had a broader question. We just jumped on so I'm not sure if our colleagues have asked this question. It seems intuitive to us that as the Eckhardt folks get their act together a little more, that could affect you or has affected you or will affect you. Is that something you can talk to us about in some degree of specificity?

I really haven't seen any effect that I would attribute to their operation.

I think we have pointed to some geographic kind of issues with UAW and the Southern California grocery strike as to where our sales issues have generally been. So I think you can get a sense from that, that so far it doesn't seem like the Eckhardt situation has impacted us. They could do anything in the future, who knows? I can't speculate about that, but so far, it doesn't seem to have been impactful to us.

Sorry, Reade, didn't mean to interrupt you.

That's okay.

Did you have any more, Reade?

I'm all set, thanks a lot.

Thanks guys.

Your next question comes from Andrew Ebersole with KDP Investment Advisors.

I was hoping you could provide a little more color on your same-store sales performance on a regional basis.

We generally don't, you know, go region by region across the country, primarily for competitive reasons and give that information out. I think, though, if you looked at a couple of the big issues that we talked about, first would be the Southern California grocery strike that's currently impacting three of our regions in the west. That's the benefit we got in the prior year from the grocery strike out there. Right. And if you look at what's going on there, we said, I don't know, Kevin, last year?

125 to 150 basis in the last year's quarter.

With the benefit. We figure if you take those stores and take them out of the calculation for this year, kind of the same thing, our comps would be 75 to 100 basis points higher, say.

If you look at UAW, which is really kind of in the central part of the country, we've said all along that that's impacting our comps, you know, 100 to 150 basis points in the pharmacy. So those are kind of the big regional things that are going on if that helps you any.

It is helpful. That suggests that your Eastern stores are comping positive?

Again, we're not giving regional results.

But we feel very positive about our east coast business.

Okay. Can you talk a little about the incremental costs that you are anticipating to incur to roll out your PBM initiative?

It is factored into our guidance and basically, you know, the way we've structured the thing, it deals with probably mostly personnel costs to ramp it up, is basically what it is. It's not tens of millions of dollars to get going because we are, you know, working with a service provider to help us, as we mentioned earlier. So it's not a giant number, but there is some cost in our 2006 guidance to recover --.

Kind of just a housekeeping item, what was your revolver availability at the end of the year after considering LOCs?

114 million of revolvers outstanding, with the letter of credit so. 950 minus --

-- so call it 836 million bucks.

Yes.

Thanks very much.

You're welcome. Operator, I think we'll take one more question then I think we're done.

Okay. Your last question comes from Alexis Gold with CIBC World Markets.

Can you just talk a little bit more about the 'Living More' program? I know you said a million members, sounds pretty quick to me. Can you give us a sense of how consumers are reacting to the Medicare changes anecdotally, and whether or not it seems you are going to be able to, maybe, you know, get a good handle on who would actually remain with the retail, rather than switch to mail order early on?

In terms of the program itself, I think we believed it was really important to improve our positioning with the whole senior population based on what's going to be happening with Medicare going forward. And that if we could really get more senior customers into our stores and our pharmacies that that would really help us when more of that volume becomes available in 2006. So basically, what our program does is provide a variety of benefits to the seniors that sign up anywhere from discounts on prescriptions currently to certain days during the month when they are going to be able to get savings off of all front end product.

We give a Rite Aid private brand discount every day. We have really a health condition marketing program as part of it, too, in that we provide a newsletter to them that's really based on the health condition that's most important to them, or of most concern to them, and they will be getting that quarterly. And just really gives us an opportunity to reach more seniors and build our base there and we feel really positive about it. Seniors obviously do, too, based on the number of signups we had.

And SG&A was up last year as a percentage of sales for the quarter and full year. Sounds like corporate was down. Can you give us a sense as to the magnitude of the decline in corporate and administrative costs?

I don't think we said corporate was down, I think it's flat to just very slightly down.

Okay.

We said depreciation and amortization expense is down. Corporate admin is down , I guess slightly in the quarter.

It is. We were up on store labor and I mentioned that we invested more in some really pharmacy service and training. And --

Okay.

129 basis points, Ended up for the fourth quarter.

Okay, you are crossing this out though. For the quarter, SG&A was up 130 basis points. That's what we said. Now we're looking at corporate, right? Corporate is better call it 10 basis points.

Okay, great.

Okay? Sorry.

Thanks very much.

Okay. I think we're done. Thank you very much for participating in today's call. Bye-bye.

Thank you.

This concludes today's conference call. You may now disconnect.