Rite Aid Corp (RAD) 2006 Q2 法說會逐字稿

At this time I would like to welcome everyone to the Rite Aid second-quarter conference call. [OPERATOR INSTRUCTIONS] Mr. Twomey, you may begin your conference.

Thank you. Good morning, everyone and welcome to our second-quarter conference call. Mary Sammons, our President and Chief Executive Officer is also on the call. Our agenda for today's call will be as follows, Mary will give an overview of our second quarter. I will review the second-quarter financial results and comment on our fiscal 2006 guidance. And then we will take questions.

But before we begin, I would like to remind that you 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 differ are described in our fiscal 2005 Annual Report on Form 10(K) and our periodic reports such as the Form 10(Q) and 8K 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, a non-GAAP financial measure adjusted EBITDA is mentioned. The definition and purpose for using this measure is described in our Form 8(K) we furnished the SEC this morning. The Form 8(K) can be accessed through our website under a the tabs entitled "our company" and "investor info." You are also directed to consider other risks and uncertainties discussed in documents we filed with the Securities and Exchange Commission. Now that we have covered the administrative aspects of our call. Let's begin. Mary.

Thanks, Kevin. Good morning, everyone, and thank you for joining us today for our second-quarter conference call. Today, we reported a $1.6 million net loss and decline in adjusted EBITDA compared to the second quarter of last year, largely due to weakness in pharmacy sales. The good news is that pharmacy sales are improving. We reported solid gains on the front end and our overall same-store sales moved back into positive territory. Our sales are trending in the right direction.

A rise in occupancy cost due to an increase in the number of sale lease-back transactions year-over-year and an increase in SG&A as a percent of sales negatively affected our adjusted EBITDA comparisons. The benefit of more sale lease-backs is the additional capital they provide to invest in our store base. And our SG&A number reflects our commitment to the right staffing levels to support our customer satisfaction improvement goals, as well as enhanced pharmacy technician training to improve the customer experience. Hurricane Katrina, which I will talk about at the end of my remarks, was not a factor in our second-quarter results, as its major impact hit the Gulf Coast after the quarter ended.

Second-quarter same-store sales increased 0.5%. Pharmacy same-store sales declined 0.8% compared to last year's quarter, but improved over this year's first quarter. The largest geographic contributor to the weak pharmacy sales remains the central division, which has been impacted the most by the United Auto Workers mandatory mail plan and new store competition although we have started to see some improvement there. Dispensing of new generics stamp and comped by 187 points year-over-year while pharmacy gross profit was up due largely to these higher margin drugs. We continue to see substantial increases in our already high generic dispensing rates, up nearly 400 basis points compared to last year's second quarter and more than 70 basis points compared to the first quarter. This puts Rite Aid in an excellent position to capitalize on the 70 billion in new generics expected to come to market between now and 2010.

Continuing to contribute to weak pharmacy sales were drug safety concerns, OTC switches, and the impact of mail order on maintenance prescriptions, which we expect to slow as more plans see the advantage of 90-day prescriptions at retail. New store competition also had an effect, although we expect to minimize the impact going forward with strength in marketing plans to counteract competitive openings. On the front end same-store sells increased 3% positive in all divisions. Health and wellness OTC categories were strong as was beauty cares, consumables, and electronics. Seasonal increased double digits on excellent performance of our new autumn harvest selections and strong end-of-summer promotions. Private brand sales and penetration were also up year-over-year as we launched nearly 250 new SKUs during the quarter. We also opened 31 new GNC store within a store vitamin departments bringing the chainwide total to 1096.

While photo and film sales declined, digital sales again performed better than the overall category and over last year. We expect the new digital one-time use camera line and digital print-to-store online service we will launch shortly on the West Coast and roll out nationwide by the end of the fiscal year to further strengthen our position as a destination for digital photo services. During the quarter, we made substantial progress on our key strategic growth initiatives. Our store development program is on track to meet our goal of 80 new and relocated stores this fiscal year, and our pipeline for the future is filling nicely. We are also on target to complete nearly 200 remodels this year. Our customers continue to be very enthusiastic about our new store design.

Our customers satisfaction scores again improved in all key attributes that drive drugstore customer loyalty, especially in the pharmacy. Our customer complaints are down too, as our pharmacy associates have gained expertise using our new state-of-the-art pharmacy dispensing system. We completed a Six Sigma study of our instore pharmacy operations during the quarter analyzing work flow as well as systems, support, and capability. We got good marks on the system but identified opportunities to improve certain work flow procedures and compliance. We will have action plans in place in the next 90 days to improve these for even better customer service.

We got good news from our annual brand tracking study too. This study surveys our customers and our competition's customers about satisfaction. The feedback shows Rite Aid improved significantly in overall satisfaction during the last year. As part of our initiative to gain new customers, we completed 49 prescription file buys which puts us on target to meet our goal for the year.

We've named a General Manager of our new pharmacy benefit management company, Rite Aid Health Solutions. Promoting our Vice President of Clinical Services Greg Drew to the position. Greg has more than 20 years' experience in retail pharmacy, managed care, and clinical services. Under his leadership, Rite Aid Health Solutions will provide a low-cost alternative to mail order as well as deliver clinical programs that focus on plan members' health which also reduces health care cost. To bring more customers into our stores and support our health and wellness positioning, we announced a partnership with Take Care Health Centers to open nurse practitioners clinics in 10 of our Portland, Oregon area stores. We also opened our first Rite Care centers in some of our Pittsburgh area stores, which provide medication therapy management services for a fee in partnership with the University of Pittsburgh. In only a few months we have already conducted or scheduled hundreds of appointments for this important fee for services model.

Certainly one our most important initiatives to gain new customers, as well as maximizing existing customers is getting ready for the new Medicare prescription drug benefit. Starting in a few weeks, approved prescription drug plans, PDPs, and insurance companies will bring to market their offerings to seniors, and on November 15, seniors will start to enroll. And one source we know they'll turn to for information is their neighborhood pharmacist. To take advantage of this dramatic change in the pharmacy business, Rite Aid will participate in all approved plans and has established marketing partnerships with multiple insurance and managed care companies with a substantial number of senior members. These include Aetna, Humana, Coventry, and United Healthcare.

Our marketing plans, which vary by partner, include enrollment events in store, outreach event at senior centers and high concentration -- markets, co-branding of prescription cards, and participation in preferred pharmacy networks. While I am not going to give away all the details, we have developed our own marketing plan to promote the Rite Aid pharmacist as a key resource for seniors who need help understanding the new benefit, and we believe our successful Living More senior loyalty program which already provides special benefits and discounts to over 1.6 million seniors will give us the head start on being the pharmacy of choice for seniors and all Medicare beneficiaries enrolling in the new Medicare prescription drug plan.

Going forward, September sales which end this Saturday continue to improve. As of today we show positive increases in both pharmacy and front-end sales, and excluding the impact of Hurricane Katrina, trends in the central division are also moving in the right direction. We have put together a marketing and operational plan to win back customers that will run through the end of the year. We continue to keep our operations team focused on improving the pharmacy experience and we will continue to execute against our key strategic initiatives for growth which we believe will deliver long-term success.

Now let me give you an update on the impact of Hurricane Katrina on our stores which occurred at the start of our third quarter. The Monday after the hurricane, we had 109 stores closed in Mississippi, Alabama, and Louisiana, including 29 in the greater New Orleans area. But today, thanks to the yeoman efforts of our associates, we have only 24 stores closed, with 19 stores closed in the greater New Orleans area, 4 in Mississippi, and 1 in Mobile, Alabama. Although we are filling scripts out of trailers next to the closed Mobile, Alabama and one at the closed Mississippi stores. Some of those in the New Orleans area are expect to open in the next several weeks. Because of our business interruption and other insurance coverage, loss or damage from Katrina has not impacted our guidance.

I would like to take this time to say thank you to all of our associates in Mississippi, Alabama, and Louisiana. Associates who traveled from other states and members of our corporate staff who worked tirelessly to reopen our stores and serve our customers and everyone in need whether it be from a reopened Rite Aid store or a mobile pharmacy. My thanks also go to Rite Aid Corporate and field staff that helped establish and staff shelters for homeless Rite Aid associates. I would also like to thank Rite Aid customers and associates across the country who contributed to help the victims. To date, we have collected more than $1 million for the Red Cross from selling disaster relief coupons in our stores and a donation from the Rite Aid Foundation. We continue to ship truckloads of water, personal care products, diapers, and other necessities to various shelters in the three states. Our Katrina relief fund for our own associates also continues to grow as we receive donations from our colleagues around the country. Our sympathies goes out to all who have suffered loss because of Katrina. Now I will turn it over to Kevin. Kevin?

Thanks, Mary. Let's begin with the operating statement. Total revenues for this quarter were 4.13 billion compared to 4.12 billion last year or an increase of 8.6 million. The revenue increase for the quarter of 8.6 million is primarily due to the 0.5% increase in same-store sales that Mary mentioned. The improvement is primarily due to this quarter's positive front-end same-store sales of 3% ,pharmacy same-store sales declined 0.8% due to the continuing negative impact of factors we have described before, but it is important to note that pharmacy same-store sales are improving because of our improving customer satisfaction results.

Gross profits which are net of occupancy costs were 1.01 billion or 24.56% of revenues for this quarter versus 1.03 or 24.87% of revenues for last year. The current quarter included a noncash LIFO charge of 7.6 million versus a 0.8 million charge in last year's quarter. The LIFO charge increase is due to the effect of higher estimated product inflation. Excluding LIFO, this quarter's gross margin was 24.74% of revenues compared to 24.89 of revenues last year or a decrease of 15 basis points. The 15-basis-points decrease in FIFO gross margin can be explained primarily in two pieces.

The first piece is nine basis points from increased rent expense caused by the sale and leaseback of 54 stores since the second quarter of last year. After stores are sold and leased back, we incur rent expense whereas when the stores are owned, we incur depreciation and interest expense. The second piece of the FIFO gross margin decrease is four basis points from increased appreciation and amortization expense from our new or relocated stores. Pharmacy gross margin strength continued, but it was on a lower amount of sales. We had an increase in generic prescriptions as a percent of total prescriptions, and reduced inventory costs resulting from purchasing improvements. Lower reimbursement rates, however, partially offset these positive items. Front-end gross margins were negatively impacted primarily by increased promotional and seasonal markdowns and offset the pharmacy margin positive contribution.

Let's go on to selling, general, administrative expenses then. For the quarter, SG&A increased as a percent of revenues by 18 basis points compared to the prior year. The increase is primarily the result of higher salary and wage expense, advertising expense, and accounts receivable securitization fees all of which support our strategic initiatives. These negatives were partially offset by a decrease in self-insurance expense for workers compensation and general liability. The negatives were also partially reduced by an increase in litigation, settlement income, and lower depreciation and amortization expense. Noncash stock-based compensation expense is included in SG&A, and was 4.3 million this quarter versus 5.1 million last year. We expensed the fair value of stock options granted.

Moving down then. Store closing and impairment charges were 8.1 million this quarter versus 13.5 million in last year's quarter. The 5..3 million decrease is due to the decrease in the store lease exit charges compared to last year's quarter. The decrease was partially offset by an increase in the impairment charge caused by the number of stores impaired in the current quarter due to our relocated store activity.

Interest expense was $67.5 million for the quarter versus 76.5 million in last year's quarter, due -- and the decrease is due to lower levels of debt and a lower cost to borrow. This reduction is due primarily to the sale of accounts receivable under our accounts receivable securitization agreements and improvements in pricing in our senior secured credit facility amended last September. Cash interest expense was 62.6 million this quarter versus 71.6 million last year and noncash interest was 4.9 million for both periods. Loss on debt retirements was 9.2 million due to the early redemption of the 11.25% notes that occurred during the quarter. This reduced our interest expense in the current quarter and will reduce interest expense in future quarters.

We had a precash loss for this quarter resulting in a 2.2 million income tax benefit. Last year's quarter had pretax income and therefore income tax expense. The effective tax rate used this quarter is higher than last year's quarter, primarily due to the current year's recognition of certain deferred tax assets. Net loss for the quarter was $1.6 million compared to net income of 9.9. The net loss per diluted share was $0.03 compared to net income per diluted share of $0.00. This quarter's diluted per share calculation included $9.6 million of declared preferred stock dividend and a $5.9 million redemption premium or preferred shares that were redeemed during the quarter. This compares to a $8.5 million declared preferred stock dividend last year. Remember, neither of these items are included in net income or net loss, but they are considered in calculating earnings per loss or loss per share. The redemption of the preferred stock with an 8% dividend is replaced by a 5.5% preferred stock dividend that is mandatory convertible into common stock and this will benefit us.

Adjusted EBITDA for this quarter was 149.3 million or 3.6 of revenue -- 3.6% of revenues a decrease of 21.6 million from the prior year. The schedule attached to our press release reconciles our net loss or if you are looking at last year's quarter, net income, to our adjusted EBITDA total. The decrease in our adjusted EBITDA was due to the 9 basis points of decrease in gross margin I described earlier. That was due to increase rent expense related to our sale and leaseback of owned stores. The decrease in adjusted EBITDA was also due to the increase in selling, general, and administrative expenses that I described earlier.

Now let's turn to cash flow. Net cash provided by operations was 141 million this quarter versus 15.9 million last year. The 125.1 million increase is due to the sale of 140 million of accounts receivable under our securitization agreement. Net cash used in investing activities for this quarter was 34 million versus 46.1 million last year. The decrease is primarily the result of the 29.1 million of proceeds from sale and leaseback of 10 stores in the quarter. That decrease was partially offset by a 20.6 million increase in capital expenditures which is in accordance with our plan.

For the quarter, we spent $52 million for property, plant, and equipment and 15.4 million for prescription file purchases for total CapEx of 67.4 million in the quarter. During the quarter we relocated 9 stores, acquired 2 stores, closed 11 stores and remodeled 60 stores. Also during the quarter we completed the sale and leaseback of 10 stores for net proceeds of 29.1 million as I mentioned earlier. We are on target to achieve our goals for new and relocated stores and prescription file purchases for the year.

Net cash used in financing activities for this quarter was 152 million versus 63.1 million for last year. During the quarter, we redeemed the $150 million, 11.25% notes. Also during the quarter we issued 111.5 million of Series I preferred stock which has a 5.5% cash dividend and will convert to common stock in three years based on a formula. We use the proceeds from the Series I and some borrowings under our revolver to redeem all of the 123.5 million of the Leonard Green Partner Series F preferred stock. The redemption required a 5.9 million redemption premium. The Series F preferred stock had a dividend coupon of 8%.

Liquidity continues to be strong. At the end of the quarter we had 803.9 million available under our $950 million revolver. Availability is calculated using the 34 million in outstanding borrowings under the revolver and 112.1 million in outstanding letters of credit. The 400 million accounts receivable securitization agreements continued to be an excellent source of liquidity. At the end of the quarter we had utilized the securitization agreements for 290 million. Subsequent to the quarter we reached an agreement with our lead banks to amend the current senior secured credit facility which will further increase our liquidity. The amendment will primarily result in our paying off the term loan and going to an all revolver facility, increasing the size of the total facility by 350 million to give us a total revolver of 1.750 billion. Extending the term of the facility to September 2010, and taking advantage of the collateral and market conditions to reduce the cost of our borrowings by 25 basis points on interest and 12.5 basis points on commitment fees.

Now let's just quickly summarize about the hurricane. As Mary mentioned, it impacted initially 1096 of our stores primarily because of the loss of power. The 24 stores that are closed today Mary described in what states they are in and what we think the condition of them are. If you assume that the 24 stores are closed for the remainder of the year, they are not significant to our results of operations or financial condition even under those pessimistic set of assumptions. And let me reiterate what Mary said. We have adequate insurance for replacement value of the inventory, replacement value of fixed asset and for business interruption losses and expenses.

To wrap things up now let's talk about guidance. We are confirming guidance for fiscal 2006 which remember will be a 53-week year. We are estimating fiscal 2006 revenues to be in the range of 17.1 billion to 17.4 billion. Revenue guidance is based on same-store sales estimates of 0.5% to 2%. Pharmacy same-store sales will be positive in the last half of the year. We are estimating fiscal 2006 adjusted to EBITDA to be in the range of 675 million to 725 million. Adjusted EBITDA for the second half of the year will be impacted by increased occupancy expenses and normal seasonal product mix shifts. The second half of the year will also be impacted by seasonal increases in advertising expense and the operating expenses of the new and relocated stores coming out of the ground.

We are estimating our net income to be between 31 million and 52 million or a loss of $0.01 per diluted share to $0.04 of income per diluted share. Attached to our press release is a table that reconciles our adjusted EBITDA guidance to our guidance to net income. CapEx is estimated to be in the range of 350 million to 400 million for fiscal 2006, which includes those approximately 80 new and relocated stores that Mary talked about. CapEx estimates do not reflect proceeds from sale and leaseback transactions. As I said a moment ago, our guidance considers the impact of the hurricane. That concludes our prepared remarks and with that, we are ready to open the conference call to questions.

[OPERATOR INSTRUCTIONS] Your first question comes from the line of John Heinbockel.

Hey, I wanted to drill down just a little bit on both gross and your expense performance. Kevin, on the gross side, how did pharmacy gross performance compare this quarter to last. Because you sort of implied it remains pretty healthy in terms of year-over-year improvement. Did you see any mitigation this quarter versus last or not really much at all?

The strength in pharmacy margins continued, John. As I said sales -- sales base is lower and therefore its contribution to the consolidated gross margin is lower, but that's because of the sales.

Now with that -- you also mentioned that weakness in front-end gross offset the pharmacy strength. Am I right in taking away the weakness then in the front-end gross would have to be somewhat pronounced given the different size of the two businesses to bring that about, and was that a change versus last quarter?

John, I'll take that one. If you think about it, you definitely are going to have an imbalance between front-end and pharmacy sales because pharmacy is such a large a percent even if it is not trending as strongly. But in front-end during that quarter we did have -- I would say higher promotional markdowns as well as end-of-season markdowns and some of that could be definitely due to the economic situations out there, but we still have strong front-end margins. We've always had healthy front-end margins though.

The first-quarter strength in front end, John, if you recall we mentioned, was more in the area of reduced returns and damage expenses, and we didn't expect that to continue.

Okay. So -- so the whole story with respect to strength in generic, being a huge benefit to you guys, that seems like that is intact, that really did not change quarter to quarter?

No. In fact, I mentioned in my comments that generic improved in the second quarter over the first quarter, and we already had significant improvement in overall generics first quarter.

Okay. Now on the expense side, did you -- I know you referenced a few things in there, but it looked like the expense control was significantly better than it has been. Is there anything that you are doing on a ongoing basis, not just one-offs that's bringing that back or not really. It is just the one-offs so they are helping you on the expense side?

Well, on expenses overall, we have had containing expenses as one of our critical priorities over the last several years, and if anything, we will emphasize that even more going forward because there are areas where we need to invest dollars, and we want to be doing that aggressively, and we want to stay in other places. So it will continue to be a big bonus.

All right. One final thing. Your guidance sort of implies a nice pick-up in the back half of the year. What are you most optimistic about, about the second half versus the first, be it sales, pharmacy gross, expense control, what are you most enthusiastic about in the second half?

Number one, obviously is improvement on the pharmacy sales side. That's been our problem area. It's been where we have focused our primary focus, and we are seeing those sales improve even as we sit here today so.

Okay. Thanks.

Your next question comes from the line of Alexis Gold with UBS.

Hi, good morning.

Good morning.

Good morning.

Just a few questions. What are the insurance premiums associated with Katrina?

I am sorry, Alexis, what are the insurance what?

Premiums.

That's confidential information, and I am not sure I understand your question--.

Okay, I am just assuming for the insurance -- is that your business interruption insurance and your insurance on the stores that you probably have some premium you pay before you get coverage. So I didn't know --I know other companies I have spoken with it's in the $1 million range. I was just trying to get a sense for what that cost -- I know it is probably fairly minimal, but what the cost impact was?

Are you talking about our maximum deductible.

Right. Sorry I didn't--.

Well, this is a complicated area, but basically even after taking into consideration the different kinds of claims, plus the deductibles, remember, the coverage is inventory at replacement cost, which is retail, and the -- and the replacement of the -- of the fixed assets is greater than the net book value. That you are basically -- your cash flow is going to cover whatever you have to pay for anything else. So there is little or no impact on the operations other than the loss of the stores' contribution to EBITDA while they are closed.

Okay. Great. And then I think last quarter when you talked about Rite Aid Health Solutions, you talked about, really getting the National sales and marketing team in place by this fall. I know you've talked a little bit about the management there, but is that team in place at this point?

We are close to hiring the head of our sales portion of this. And we expect to be in good shape very shortly there. And we already have responded to a few what you call RSPs. So I would say we are up and running, yes, slowly, but getting to where we need to get.

Great. And earlier on in the call you talked about the work flow and systems. And just talked about having plans within 90 days. Are there costs associated with that? And is that built into your guidance at this point?

We take any expected costs into our forecast going forward, but what we are talking about here is really incremental improvements to how our work flow is working and where we station people and what they are doing at what point in the work flow process. So in terms of adding a lot of costs that is not really going to be an issue. It is what we do where in the process that will get the most attention.

Okay. And then just finally, I think July was the first month that we really saw the UAW anniversary. I know it's late in September and you have given us a sense that September looks pretty good, but as you look out to the next few quarters, I mean -- or the next couple of months, do you think that you -- do you actually see the benefit of that cycle?

Yes. If we were to separate out the stores that are most impacted by that UAW plan, we definitely see a significant swing backwards -- upwards in sales performance compared to where they were. So we definitely have cycled it looking at it on a piece of paper. We still have other mail preferred plans out there, and you have competition issues, but I mentioned that our results in the central division are showing some improvement now, and that's the area that was most impacted.

Great, thanks very much.

Your next question comes from the line of Karla Costella with JP Morgan.

This is actually Stephen Capatia for Karla. I was just wondering how much additional secured subordinated debt can you guys issue now?

Well, if the -- for our current senior secured credit facility, it is probably including -- so if you draw fully down on the revolver, it is somewhere around $250 million additional secured debt. As we change the existing revolver to the new one once that is over and if then you assume fully drawing down on that new revolver than essentially we would have no additional capacity for secured debt.

Thanks a lot. That's all I had.

Your next question comes from the line of Mark Husson with HSBC.

Yes, good morning. I want to ask a question about Medicare. Particularly when the switch-over happens in 2006, can you just talk about what your expectation for the shape of that business is? The eligibles come in. Presumably the Medicare plans will give you a slightly lower gross margin than Medicaid that may give you a higher generic penetration. What do you think you are going to see?

Well, Mark, we have done a lot of internal modeling on what we expect to happen when all of this occurs, and we built really effective plans to make the dual eligible conversion work more smoothly so that we don't have customer issues when that occurs. So we've got systems support in place to help that. And we believe it will be a gradual ramp-up on the other Medicare patients enrolling. We know who our own Medicare patients are, and so we can also have them place some plans to smooth that kind of transition, and, remember, we will be doing things with our marketing partners on the PDP side to also get some new incremental patients into our stores.

Mark, because the fiscal year ends in February, the January and February time periods by themselves will probably be a negative for us because of Medicare Part D's dual eligibles only. It is the dual eligible negative, the cash customer switch negative is not going to be offset by the pick-up in business we get from the uninsured and the other competitors in that short of a period of time. But as you spread out over time and get into fiscal '07, then it is a net positive.

But I think we all know that it is important to be getting incremental business out of this benefit because you do have a margin impact, and all of our plans are built around just that. That's why the partnerships are important. It's why the co-branding on cards with partners are important, and the steps we take in store are critical. So we expect to get incremental gain from what occurs here.

As far as I understand it, CMS is now saying that you can advise people what the best plan will be for them. But you can't actually sign them up. Is that how you understand the situation now? And if that's the case, how do you sort of get your claws into these people rather than just educating them and let them wander off and do their own thing.

Well, a lot of it is making sure they understand how the plans work, and now the partners can do a lot more in terms of sharing their plans, and a number the partnerships that we have formed are going to hold instore clinics or seminars with patients too, to help them understand what the offerings are. We would be precluded -- our pharmacists, from recommending any kind of plan, but since we are going to accept really all of the approved plans and then we have got the partners to help on really getting more plan information out, we've got, I think, every opportunity to gain new business here.

And just final question. When you do these marketing days, just say Aetna guys all show up in the store and set up a stand. Do they pay you rent for that space? How does that work?

No, they don't pay rent. We have got a partnership with them, and we do certain things. They have access to our seniors in our stores, and so that, in itself, is a real benefit to them.

Okay. Thank you.

Your next question comes from the line of Reade Kem with Bank of America Securities.

Thanks. Hey, Kevin, I missed the comment about the bank amendment. Can you just say how much -- by how much you've widened, if any, the baskets under which you can issue more notes, either secured or unsecured

Well, the existing revolver of 950 million plus the term loan of 450. So 1.4 million is going to go up to a 1.750 billion all revolver, so I am adding 350 million of capacity, if you will. And then that pretty much sucks up any capacity that I had with regards to additional secured debt.

Okay. And anything -- any change on the availability test whereby you could repurchase your bonds?

We are still in the process of nailing things down, but generally speaking we are just going to get more and more flexibility.

Okay. And that's obviously the priority is store development, not bond buybacks at this point.

That is our best use of capital, correct.

Okay. Thanks a lot.

Your next question comes from the line of Meredith Adler, Lehman Brothers.

Hey, guys. A couple of questions for you. There was a comment when you were talking about the gross margin in the pharmacy that one of the offsets to the positives from generics and other things was lower reimbursement rates. Could you just talk a little bit about what you are seeing in the reimbursement rate environment?

I think really over the last year, we have commented on the fact of lower reimbursements, and I don't see that -- that is -- that next step is going to go away. You've got even with what goes on in the state Medicaid plans a lot of changes on reimbursements that have had negative impacts. But we factor those into our overall forecasting too, and do a really good job of anticipating as best we can. There certainly could be other changes with what's being looked at as far as Medicaid reform and whatnot, but we do the best at forecasting with the information we have, and we will continue to update that as there might be any other changes.

What we experienced in the second-quarter, Meredith, was really nothing new or different from what we have been seeing.

And are you seeing those reimbursement rates tied to more limited networks? Is that something that is the trend? You are willing to take a lower rate to get a limited network?

There are definitely instances of that. We examined any opportunities there case by case, and it is really dependent on the ability to get more volumes of lives and prescriptions to cover really any hit on the margin itself, on the margin rate itself.

Okay. Another question I have with -- just when you talked a little bit about increased markdowns in the quarter. You talked about this front end, both higher promotional markdowns and then some end-of-season markdowns. Maybe you could comment a little bit about whether you are seeing any meaningful changes in the promotional environment. And then comment on whether you feel good about the condition of your seasonal inventory, is back-to-school all gone and no more issues with markdowns for that season?

Well, relative to promotional markdowns, Meredith, what I think we really see is customers are buying more on sale. They are responding more to promotion, and that really could be tied to the fact that dollars might be tighter for people overall because of higher gasoline prices, and just uncertainty out there. But we spend a lot of time examining how to make modifications and leverage what might be some better margin opportunities. And I know our category management team has already rereviewed any ads to make sure they have the right balance of promotional draw items to what you call your other items. And the other thing that I think gives me some optimism on -- in this area is that as the pharmacy sales improve, and your traffic increases too, you also have more opportunity for front-end sales there too. So I think that is another positive. I mentioned in my comments that we had a good start on our new autumn -- what you would call spring bridge offering -- I mean fall bridge offering that we put out there in the stores, and that's a positive sign that customers are willing to spend a little bit more on what you might call discretionary product.

Our sell-through on back to school is what we expected, Meredith. There's no residual in subsequent quarter kind of exposure.

Great. That's wonderful. Thank you very much

Your next question comes from the line of Steve Chick with JP Morgan.

All right, thanks.

Hi, Steve.

Hi. I have a few questions. It's been hit on a little bit, but with gross profit margins, I think that is the one component of the P&L that I would have guess wood have looked different this quarter, and I know you discussed the markdowns that you saw in Q2. What -- within your guidance, what are you anticipating the second half will look like for gross, and do you think we will see gross profit trends with generics being up year-over-year for that period?

Well, we expect generics to continue to grow in percentage of the mix of our prescriptions that it's continue from second -- second quarter from first, and I see no reason why that would change third to fourth either. That would be a positive. I think I mentioned that in the second quarter too, on the front end we introduced 250 new SKUs into our private brand assortment, that will also be a positive for margins on the front going forward, and feel real positive about our seasonal assortments for holiday and those carry strong margins too. So I -- and we're -- we're watchful of the promotional environment itself, and have already taken steps relative to ads to make sure that we are not over promotional.

Generally speaking, Steve, the third and the fourth quarters have a general seasonal characteristic to them that results in all else being equal, your gross margin rate being a little less. There is just not -- that is just a normal seasonal flow for us.

Also, Steve, when Kevin addressed the whole gross profit thing, he also discussed the -- part of the difference was the noncash LIFO charge this year versus last year which was very small in terms of impact per quarter.

And we're going to have -- and the increase in our rent expense from the new stores that are coming out of the ground in the last half of the year.

And there was some difference on the -- if you'd call it the product gross profit, but not what I would call significant.

All right. Okay. Okay. Second thing. You said your pharmacy same-store sales are positive so far for the month of September. I think -- can you speak to if that is actually better than what you had expected at this point, because I think it is a little better than what I was anticipating or at least this early on, and then just clarify if you had to -- maybe it is not that material, but did you have to adjust for any -- those 109 stores that were closed in your comments about sales? Or not?

Okay. First I would say we were fairly close to our estimate. Maybe slightly better than we would have forecasted for September, and on the pharmacy side, with or without the impact of the hurricane-affected stores, our pharmacy sales are positive.

And the only stores that will be excluded from the same-store sales calculation for September will be those that are closed. So we are not going to sit there and say, well, what if some of the 109 were in there or not. It will just be what it will be. But a closed store is a closed store and it is excluded from the calculation.

Okay. Great. That's helpful. Third, the -- Mary, can you just give us an update on the -- filling John Standley's spot as CFO and timing and what we can expect from that?

We haven't finalized everything yet, but I expect we will have some news to talk about later in October. I am very comfortable with where we are today with Kevin as acting CFO, and we are making good process forward, and we will have more to talk about in about a month.

Okay. I guess as you think about that position, I mean, obviously Kevin is very competent. Is it, -- would your turnaround and all -- the adding maybe new blood to Rite Aid, I guess, could be somewhat important and provide a different perspective. I mean can you -- is that in line with what your thought process might be? Or is it really just too early to tell.

Well, I think it is always good to have a mix of both tapping your internal talent and having external where it makes sense. I think you may have read we recently hired a new Senior VP of HR, he comes to us from the outside so we are not against external hires. In fact, if it makes sense and you find the right person, that's what you do, but you also take advantage of the talent you have inside too. So a mixture.

Okay. One last question if I could. It's -- your plan sounds pretty good on paper, and it seems like you are very slowly making some progress. Behind the scenes -- it's a pretty transaction-oriented environment especially in retail and your -- the equity market right now is valuing Rite Aid at merely 33% of sales or so which you could argue is inexpensive on that metric. What type of -- broadly, what type of discussions are happening maybe with the Board, and the -- what is the level of urgency and timing of what they really want to see out of you guys as you continue to make progress? Can you speak to that?

Our Board is very supportive of our strategic initiatives and our plans for the future and any discussions between us and the Board would be confidential.

Okay. Thanks, guys.

Your next question comes from the line of Ed Kelly with CFSB.

Good morning.

Good morning.

Your five-year goal is to open or relocate 800 to 1,000 stores. If you do 80 stores this year, you would need to do about 200 stores a year maybe the next four years. Do you have the real estate team in place currently to execute on this? And how many sites have you identified? And how confident are you that you will be able to get this long-term goal accomplished?

Well, like I mentioned, our pipelines for new store locations is filling up. We have a plan that ramps up year-over-year. We have staff to meet that plan. And we have particularly staffed up to identify our most strategically important markets first. So we feel good about the staffing and about where we are in the pipeline. We will probably provide additional guidance when we do our guidance for next year and talk about our plans, so -- but it is a ramp-up over the next five years.

Great, thanks.

Operator, we have time for one more call.

Okay. Your next question comes from the line of Christine Boni with CFSB.

Yes. Good morning, thanks for taking my call.

Good morning.

Just a couple of housekeeping items. Could you give us what the sale leaseback proceeds are year to date and if you are still on budget for 2005? Or for this fiscal year, I should say

The sale and leaseback proceeds for the year did you say, Christina.

Yes. You gave a number in terms of your budget for that. Are you still -- what you have done year to date.

For the year, it is going to be somewhere around 75 million to 100 million. Year to date, I think our sale leaseback proceeds are somewhat around 50 some million, 55 million or so.

Okay. 75 to 100 though for the year?

Right.

And just in terms of pro forma for the bank transactions, could you tell us what the availability would be on a pro forma basis given a larger facility? Do you have access to that total incremental value, the 350?

Yes, we do.

So that is all available today?

Correct.

Okay. And then finally, just on--.

My answer to that -- we are not done yet so--.

Right. I was just saying on a pro forma bases when it closes, if you looked at it you would have all that can be borrowed.

Yes.

Okay. And in terms of pharmacy script count, can you just give us a sense -- obviously the comp is improving, that's terrific, what you see as a goal or what do you see as a benchmark to when you can get script counts to be positive.

Well, we don't share the script count numbers. We really are focused right now on improving pharmacy sales, on gaining new customers, and as I mentioned, September is positive, and we expect positive trends to continue, and all of our initiatives really are built around that, and it -- well, proof is in the pudding so it will be in our results going forward.

Great. Thank you very much.

Thank you. Thanks, everyone for joining us.

This concludes today's Rite Aid second-quarter conference call. You may now disconnect.