Rite Aid Corp (RAD) 2006 Q4 法說會逐字稿

At this time I would like to welcome everyone to the Rite Aid fourth quarter results conference call. (OPERATOR INSTRUCTIONS). At this time I would like to turn the call over to Mr. Kevin Twomey, Chief Financial Officer of Rite Aid. Please go ahead, sir.

Good morning everyone. We welcome you to our fourth quarter conference call. Mary Sammons, our President and CEO, is also on the call with me. Our agenda for today's call will be as follows. Mary will give an overview of our fourth quarter and cover the outlook for fiscal 2007. I will review the fourth quarter financial results for fiscal 2006, and provide specific guidance for fiscal 2007, and then we will take questions.

But before I begin, I would like 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 differ are described in our 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 a non-GAAP financial measure, adjusted EBITDA, is mentioned. The definition and purpose for using this measure is described in the Form 8-K we furnished the SEC this morning. The Form 8-K can be accessed through our website under the tab entitled, Our Company and Investor Information. You are also directed to consider other risks and uncertainties discussed in documents we file with the Securities and Exchange Commission.

Now that we have covered the administrative aspects of the call, let's begin. Mary?

Good morning everybody. And thanks for joining us today to discuss our fourth quarter and year-end results. As you saw from the press release, we also reported our March same-store sales today, posting a strong 4.9% gain in pharmacy. This comes on top of the 2.5% increase in pharmacy same-store sales for the fourth quarter, and a slight improvement for all of fiscal 2006. We are pleased that our pharmacy sales have turned the quarter and script count is growing again.

Now let's talk about the quarter and year-end results. Excluding the tax benefit, net income declined both for the quarter and the year, due to an increase in LIFO, higher closed store and impairment charges, and in part to lower adjusted EBITDA. Excluding the extra week, adjusted EBITDA was flat quarter over quarter, but declined year over year. Lower pharmacy sales the first half of the year and higher SG&A expenses as a percent of sales in the first three quarters contributed to the decline.

While these results are not as strong as we had hoped, we believe the investment we have made in staffing the stores to improve customer satisfaction, ramping up our real estate department for our new store growth program, and additional marketing and labor expenses related to the Medicare prescription drug benefit will pay off down the road.

Same-store sales for the fourth quarter increased 2.5%, with pharmacy same-store sales as I said before, growing at the same rate. We saw positive script count growth even with the milder cough, cold and flu season in most of the country as compared to last year.

Ongoing benefits from our tactical marketing and operating plan in priority markets, our senior loyalty program, Living More, emphasis on health and wellness programs and services like in-store health clinics, and the launch of Medicare Part D all contributed to the increases.

In fact, the number of senior Medicare Part D scripts we filled in January and February was above our forecast, a sign that our comprehensive marketing programs, including our partnerships with United Healthcare, Aetna and Humana positioned us well for the launch. Our pharmacists deserve a giant ground of applause for what they had to go through to fill prescriptions during the first weeks of the program when the health plans didn't answer many of their phone calls, and there was no insurance information on many seniors who had enrolled.

Fortunately the program is running a lot more smoothly after many of us in the industry sat down to work through the problems with Health and Human Services Secretary Leavitt and Dr. McClellan at CMS.

Pharmacy gross margin was up slightly in the quarter, even with the negative impact of the lower reimbursement for Medicare prescriptions. New generic prescriptions dampened pharmacy comp by 138 basis points, while the percentage of total generic generics dispensed increased 347 basis points for the quarter, and 386 basis point for the year, saving money both for patients and payors.

We have set our goals for generic dispensing even higher for fiscal 2007 to take advantage of the substantial number of new generics expected to come to market the second half of the year.

On the front-end, same-store sales continued to increase with a 2.5% gain in the quarter, contributing to the 2.6% increase for the year. Core drugstore was solid even though cough, cold and flu categories suffered from a milder flu season in January and February. Other OTC categories, health and beauty care were strong. And vitamins posted could gains because of our GNC department. Valentines was a large contributor to seasonal sales, while this years later Easter had a dampening effect on February results. Effective promotions, competitive assortments and targeted marketing programs to support our health and wellness positioning with a focus on diabetes in December and January, and healthy heart in February all aided results.

Once again, consumables posted strong gains for the quarter. And private brand sales were up quarter over quarter as well as year over year as we launch a record number of new private-label SKUs.

A significant event in the quarter as mentioned in our press release was notification by the U.S. Attorney's Office that it has ended its investigation into Rite Aid related to the business practices of former management under former CEO Martin Grass. As you know, three years ago we made a $20 million non-cash accrual in light of potential liability against Rite Aid that could have resulted from this investigation. And we are extremely pleased that the U.S. Attorney has closed it without any penalty to the Company.

We are also pleased that we made significant progress on our key strategic growth initiatives during the fourth quarter and during the year. We finished fiscal 2006 with 76 new and relocated stores, and 173 remodels. And are in good shape to open 125 new and relocated stores we have targeted for this year. All of our new and relocated stores will be Customer Worlds, and the remodels will carry elements of the design that continues to get rave reviews from our customers.

Our customer satisfaction scores improved significantly in fiscal 2006, both in the pharmacy and the front-end, with the knowledge level of the pharmacists, timeliness of filling prescriptions, and availability of associates overall improving the most. Customer complaints are down substantially, and we have set our goal significantly higher for this year.

Our aggressive pursuit of prescription file-bys continued as part of our initiative to gain new Rite Aid customers. Scripts purchased increased by 66% year over year, with even better retention of both customers and pharmacy staff. We also increased our number of limited networks with third-party payers, bringing the patients to our pharmacies.

Our new operational structure under COO Jim Mastrian was completed in the fourth quarter, as we added 16 new regional Vice Presidents of Pharmacy. Our new structure positions us well for the new, year. And we expect to see improved operations, higher customer satisfaction, increased associate satisfaction and better execution of Company programs as a result.

Fiscal 2006 also marked a significant increase in the number of health and wellness offerings and services to support our health and wellness platform, another one of our key strategic growth initiatives. We opened 130 new GNC vitamin departments in the quarter, bringing the total to 1,155, with GNC departments now in more than one-third of our stores. And we expect to open another 115 in fiscal '07. We also expanded the home health care category to target the aging population with products like wheelchairs, canes, and electric scooters for mobility, and products enhancing bath safety, all with excellent results.

The in-store health clinics that opened in Rite Aid stores in the Portland, Oregon area in November have attracted thousands of patients with the prescriptions written by the nurse practitioners a significant contributor to script count growth in that market. We intend to expand this concept and are also exploring similar ventures in other markets.

And our health and wellness marketing programs with a different focus on each quarter, allergies, vitamins and nutrition, diabetes, and healthy heart were so successful that we have added two more health conditions to the program, skin care and weight management.

Our partnerships with well-respected organizations like the American Academy of Allergy, Asthma and Immunology, the American Diabetes Association, and the American Heart Association reinforced the positioning of our pharmacists as experts on health and wellness.

Our Living More program with nearly 2 million senior members continues to give us a competitive advantage with this market, and positively impacted our launch of Medicare Part D. Rite Care, our medication and therapy management program in conjunction with physicians at the University of Pittsburgh, has seen hundreds of patients since its inception last June, and created a scalable replicatable model for MTM for future expansion.

And we have increased our immunization program with pharmacists in 350 of our stores now able to provide adults with basic immunizations, and have plans to increase that number to 600 stores this year.

Going forward from our focus remains the same. We have formed six critical priority teams headed by members of our executive management team focused on growing pharmacy sales and prescription count, increasing front-end sales, improving customer and associate satisfaction, managing expenses, operational execution, and recruiting and retaining pharmacy talent. These teams are charged with developing and expanding initiatives to improve our business and deliver value to our shareholders.

Now let's talk about guidance for fiscal 2007, which is included in our earnings release. We have considered several major developments that will impact retail pharmacy in fiscal 2007 in developing our guidance. We included what we believe will be an overall positive impact of Medicare Part D on pharmacy sales, of the new generics expected to come to market in the second half of the year impacting both sales and margins, and estimated a range on how much new Medicaid reimbursement rates starting in calendar 2007 might negatively impact pharmacy results.

In closing, we remain optimistic about the business of retail pharmacy, our store growth programs, and the initiatives we have underway to deliver value in the future. Even though our results came in at the low end of our fiscal 2006 guidance, we finished the year with positive momentum, and have built a plan to continue accomplishing our strategic goals and objectives.

I will now turn it back to Kevin. Kevin.

Before we begin with a detailed review of the operating statement, let's make some general notes. First, we have changed the classification of certain expenses and have attached to this release quarterly operating statements that reflect the reclassifications for both fiscal 2006 and fiscal 2005. We made the reclassifications in order to give a more transparent view to gross profit, and facilitate comparisons with others in the industry.

Generally speaking, we reclassified occupancy expense out of cost of goods sold and into SG&A, or selling, general and administrative expense. Further, we reclassified product handling costs out of selling, general and administrative expense and into cost of goods sold.

The second general item to note is the fourth quarter and fiscal year we have just completed included the results of an extra week. We estimated the extra week contributed approximately $15 million of adjusted EBITDA.

Third, the fourth quarter and the year included a non-cash, 1.231 billion, or $1.82 per diluted share, income tax benefit, related to adjusting income tax valuations allowances for deferred income tax assets. The fourth quarter also includes the reversal of a $20 million, or $0.01 per diluted share, accrual that was established in fiscal 2003 related to the U.S. Attorney's investigation of prior management's business practices. The investigation of the Company was closed in the fourth quarter, with no fine to the Company, and the accrual was no longer necessary.

Let's now talk through the operating statement. Revenues for this quarter, which had 14 weeks, were 4.77 billion compared to 4.34 billion last year, which had 13 weeks in it. This was an increase of 430 million. The revenue increase was primarily due to the extra week and the 2.5% increase in same-store sales, partially offset by a lower number of stores.

The increase in same-store sales was the same for both pharmacy and front-end. Pharmacy same-store sales increased 2.5%, and front-end same-store sales increased 2.5%. Our initiatives for improving customer satisfaction, especially in the pharmacy, along with the programs Mary mentioned, and the prescription file-bys continued to gain traction.

We had slight positive prescription comp growth in same stores for the quarter. The 2.5% pharmacy same-store sales increase was negatively impacted by a milder cough, cold and flu season when compared to last year, continued safety concerns on the part of customers for the anti-arthritic and hormone replacement categories of drugs, and lower reimbursement rates primarily for Medicare Part D prescriptions.

Our new and relocated store program is building momentum. We opened 7 stores and relocated 33 stores during the quarter. Most of these openings occurred near the end of the quarter. The new and relocated stores opened during the quarter were not significant contributors to revenue this quarter, but as momentum builds and time passes, the new and relocated store program continues to gain momentum and will be a significant contributor to revenue growth and same-store sales growth.

Gross profits were 1.275 billion, or 26.71% of revenues for this quarter, versus 1.217 billion, or 28.03% of revenues for last year. The current quarter included a LIFO charge of 9.4 million versus a credit of 36.2 million in last year's quarter. The LIFO charge increase was due to the effect of higher product inflation and higher inventory levels. Excluding LIFO, this quarter's gross margin was 26.91% of revenues compared to 27.20% of revenues last year, or a decrease of 29 basis points.

The 29 basis points decrease in FIFO gross margin can be explained primarily in two pieces. There is a positive component, an 11 basis points increased contribution from pharmacy gross profit. The lower reimbursement rates, especially for Medicare Part D prescriptions, were offset by an increase in generic prescriptions, mix and slightly reduced pharmacy shrink.

The negative component in gross margin was a 49 basis points decrease in front-end gross margin -- gross profit contribution. Although front-end sales were higher than last year, the gross margin rate for front-end was lower due to a higher mix of sales on ads. Although we did not change our promotion program, customers purchased more product on promotion.

Selling, general and administrative expenses for the quarter decreased as a percent of revenues by a 41 basis points compared to the prior year. The current quarter included the 20 million accrual reversal related to the U.S. Attorney investigation we described earlier. Excluding that accrual reversal from the current year, SG&A as a percent of revenues was 24.67%. The prior year's fourth quarter also included favorable litigation settlement amounts of 12.1 million. Excluding those favorable litigation amounts from the prior year, SG&A expense as a percent of revenues was 24.93. So SG&A as a percent of revenues, after excluding these matters from both quarters, decreased 26 basis points.

The improvement was due primarily to the leverage we achieved from the increase in sales and the extra week of sales. In other words, our labor and benefit expense, for example, as well as other expenses -- areas were lower as a percent of revenues than last year.

The 26 basis points of improvement, even after a 10 basis point increase in occupancy expense from sale and leaseback of stores opened in prior years, and the new and relocated stores that opened this year, as well as a 4 basis point increase in the fees related to the accounts receivable securitization program.

Store closing and impairment charges were $18 million higher than last year's charge. We had more stores in the impairment calculation this year compared to last year. And we closed more stores in the quarter requiring a lease exit liability charge. A lot of that activity is related to our new and relocated store program.

Interest expense was 71.7 million for the quarter versus 69.9 million in last year's quarter. That increase is due primarily to the extra week. Cash interest expense was 66.3 million for this quarter versus 64.9 million last year, and non-cash interest was 5.4 million this year versus 5 million last year. The gain an asset sales was 2.6 million in the current quarter compared to a loss of 3.6 million in last year's quarter.

Regarding income taxes, as we described earlier, we recorded a 1.2 billion income tax valuations allowance adjustment related to deferred tax assets in the current quarter, and a 179.5 million income tax benefit also related to income tax valuations allowances adjustments to deferred tax assets in last year's fourth quarter.

Net income for the quarter was 1.246 billion compared to net income of 228.6 million last year. The increase in net income is primarily due to income tax benefit and the accrual reversal we have described earlier, along with the extra week. Other items to consider in your analysis of the change in net income are the negative impacts of a $45 million swing in the LIFO impact, and the $18 million increase in the closed store and impairment charge.

Net income per diluted share was $1.83 for the current quarter compared to $0.35 per diluted share for last year's fourth quarter. As I mentioned earlier, for the current quarter the income tax benefit had a $1.82 per diluted share impact, and the accrual reversal had a $0.01 per diluted share impact. The income tax benefit for the prior year had a $0.29 per diluted share impact.

Each quarter's diluted per share calculation included declared preferred stock dividends. And last year's fourth quarter included a redemption premium. Remember, preferred stock dividends and redemption premiums are not included in net income, but they are considered in calculating earnings or loss per share.

Adjusted EBITDA for this quarter was 181.4 million or 3.8% of revenues, an increase of 13.5 million from the prior year. The schedule attached to our press release reconciles our net income to our adjusted EBITDA. The increase was primarily due to the extra week and the operating leverage it improved.

Now let's turn to the cash-flow statement. Net cash provided by operations was 80.4 million this quarter versus a 5.5 million use of cash in last year's quarter. The 85.5 million increase is primarily due to the increase in adjusted EBITDA, the proceeds from the hurricanes insurance claims, and maintaining the level of utilization of the accounts receivable securitization program. These cash providers were partially offset by an increase in prepaid rent this year, which is due to the year ending on March 4 versus last year's ending on February 26.

Net cash used in investing activities for this quarter was 98.9 million versus 37.6 million for last year's quarter. The increase was primarily a result of capital expenditures being higher than last year, due to our expanding new and relocated store program, and the proceeds from sale and leasebacks being lower.

For the quarter we spent 96.6 million for property, plant and equipment, and 19 million for prescription file purchases, for a total of 115.6 million of capital expenditures in the quarter. During the quarter we opened 7 stores, relocated 33 stores, acquired 1 store, closed 18 stores, and remodeled 10. Also during the quarter, we completed the sale and leaseback of 3 stories for net proceeds of $7.5 million.

Net cash used in financing activities for this quarter was 10.6 million versus net cash provided by financing activities of 109.8 million for last year's quarter. The change is related to the difference in required maturity payments and the issuance in last year's fourth quarter of the 7.5% secured notes. Using cash provided by operations and the sale accounts receivable, we reduced total debt by $260 million during the year.

Liquidity continues to be strong. Our availability under the revolver is over 1.1 billion. At the end of year we had 534 million outstanding under our senior secured credit facility, which now consists solely of a 1.75 billion revolver. We also had outstanding letters of credit of 115.7 million at the end of the year. At the end of the prior year we had 449 million outstanding under our old senior secured credit facility consisting of the old term loan, which we paid off through the new revolver.

The 400 million accounts receivable securitization agreements continue to be a good source of liquidity. At the end of year we had utilized the securitization agreements for 330 million.

Regarding required maturities in fiscal 2007, we have choices and intend to be opportunistic. We may use the revolver or we may access the capital markets, or do both to fund the required maturities. Which specific funding sources we ultimately use will be depend on the market conditions and the economics during fiscal 2007 or beyond.

Finally, let's discuss guidance. We're providing guidance for fiscal 2007, which is a 52-week year. We are estimating fiscal 2007 sales to be in the range of 17.35 billion or 17.6 billion. Sales guidance is based on same-store sales estimates of 1.75% to 3.25%. We are estimating fiscal 2007 adjusted EBITDA to be in the range of 650 million to 725 million. Our guidance reflects the fact that fiscal 2007 is a 52-week year and will benefit from an increased number of new generic drugs, the timing of which is quite dynamic.

Fiscal 2007 guidance also reflects our estimates of the effect of the planned timing and number of new and relocated stores. We have included in our guidance the full year effect of reduced reimbursement rates and increased prescriptions from the new Medicare Part D drug benefit plan that was introduced in late fiscal 2006. Finally, we have included in our fiscal 2007 guidance estimates of the negative impact from the Medicaid reimbursement rate reductions.

We are estimating our net operating results to be in the range of a net loss of 5 million to a net income of 40 million, or a loss of $0.07 per diluted share to net income of $0.02 per diluted share. Attached to our press release is a table that reconciles our adjusted EBITDA guidance to our guidance for net income or loss.

Capital expenditures, before sale and leaseback proceeds, are estimated to be in the range of 450 to 500 million for fiscal 2007. We estimate sales and leaseback proceeds to range from 50 million to 100 million.

This concludes our prepared remarks. We're now ready to take questions.

(OPERATOR INSTRUCTIONS). John Heinbockel with Goldman Sachs.

A couple of questions. First, Kevin, can you walk through what would be the key variables between the upper end and lower end of your guidance range? And in particular, what would cause you to be -- as you model it -- what would cause you to be at the low end on that range at 650 or so?

I think that we mentioned those major variables as being, number one, the timing of the generics; number two, the prescription growth that we hope to continue to experience under Medicare Part D; and then last but not least, the timing of our new and relocated stores. Those are all -- and then --.

I would also add that just what will happen, or could happen, with the Medicaid changes that are expected for January, February, which both months are in our fiscal year, that is probably the main driver of having expanded the range.

There's a lot of moving parts. I guess I was just surprised where the low end came out, given that pharmacy is doing so well. I guess I was trying to gauge how conservative you are trying to be, particularly with the low end.

We do the best job we can of providing the guidance. And we believe that it was reasonable with what we have mentioned to have a wider range this year.

What type of lift are you guys getting on the relocated stores saleswise?

We're getting a very strong growth rate out of those stores. In fact, we are accomplishing what we put into the pro formas, and it is strong double-digit increases for both front-end and pharmacy.

Right now it is not significant. As we mentioned, an awful lot of the stores opened in fiscal 2006 happened in the latter part of the fourth quarter, and -- but they are going to continue to build.

We do not include them in our comp numbers. They have to go through a full year as a comp, whether it is a relo -- as just a non comp for a full year, whether it is a new store or a relocated store before they impact our comps.

All right. One final thing. Again, if we go back to the '07 guidance, give me some sense what you built in in terms of how much generic will affect pharmacy comp. Is it 100, 200 basis points? And how much do you think generic will lift pharmacy gross -- 50 or 100? Do you have a general sense of that?

As we have talked about before, we're not breaking down things like customer segment, and we're not also breaking down those pieces, and we haven't in the past, and we don't do that right now. Mary has told you that we made our best estimate, and there's a lot yet to be nailed down in that area.

You also know that I think we have said before that we believe we lead the industry in the percent of generics in our mix. And we're being very aggressive in terms of the percent of generic penetration that we expect to accomplish this next year. But Kevin is right in saying that a lot of it is due to -- will be connected to the timing of new generics entering the marketplace. And I think you know that that can vary, and we have done our best job of estimating when we think we will come into market.

Reade Kem with Banc of America.

This is actually Bill Reuter for Reade. I was wondering whether you guys had any comments or could comment upon whether you were benefiting in the Easter period from weaknesses as some of your competitors such as Eckerd’s?

We really do not focus on what is happening with our competitors in that respect. We really focus more on executing our marketing plans. We are expecting overall good Easter performance across the country. In some places they operate and some they don't.

Okay. A couple of housekeeping issues. Could you disclose what your cash rent was for the past fiscal year that just ended?

We didn't. But it is about $569 million for the full year or about $155 million for the quarter. That is about $15 million higher than last year.

Okay. Do you have any expectation for what your cash rent will be for fiscal year '07?

We're not giving specific guidance to that. It is going to be higher because of the new and the relocated store program, and it is specifically stirred into our guidance.

Meredith Adler with Lehman Brothers.

Guys, I have a questions for you. First, I just wanted to confirm that you're seeing a benefit, a positive sales benefit from Part D? And do you have a sense whether that is mostly dual eligibles, or do you think you were getting other kinds of customers as well?

We definitely are seeing a lift in sales frown Medicare Part D, but we're also seeing it from other segments of our business too. I do know that we have a fair amount of duel eligibles that came over, because we do run a higher percent of Medicaid business, I think, than most of our other competitors, so that would be a factor too that we have just generally speaking seen a lift in overall Medicare Part D business and the rest of our business.

That's great. You made a comment, which I just was wondering if you could repeat. You talked about something about limited networks. I wasn't quite sure what you said.

What I said was that we have continued to develop partnership relationships around network relationships. In some instances that has led to more what I would call limited networks, where we would have a preferred positioning within a network.

Okay. You did increase the closed stores in this past year. You say most of that is tied to relos. Do you anticipate very many closures going forward that aren't for relocated stores, or are you doing something like 2-for-1 relos where you close two and build a nice new big one?

No, we don't have like any goal 2-for-1, but what we do do in addition to a reloc, if a lease comes up as being -- it is going to cease to exist unless we renew an option, we go through a pretty rigorous analysis of that lease, and make a determination on whether that store really should be an ongoing part of what we're doing. And if it is in what I would call maybe a non-core area, we might make a decision to close that store.

Great. The new stores -- can I just ask one more question?

Sure.

The new stores, what is the expected maturity schedule for those stores? how quickly the think they will hit breakeven?

What we have said in the past that the relos are in -- so the news are three to five years mostly, and the relos are sooner than that, or had a faster maturity life to them, sometimes as early as two years.

Just one more housekeeping. The question about rent that was asked -- cash rent -- does that include rent on closed stores?

It does not. That is rent expense, which is net of sublease income, but does conclude the contingency rents. It is similar to the rent number in our footnote. So the closed store rent is flowing through the lease exit liability that is recorded at the time of the closure of the store. That cash outflow for closed stores is on an annualized basis running at about $35 million a year.

So the 569 doesn't include the 35 million?

That is correct.

Ed Kelly with Credit Suisse.

A question for you on your strategy of new store openings versus remodels, or new stores actually versus remodels. What percent of your store base now would you say you think needs to be remodeled? And then what is the give and take behind accelerating new store openings versus aggressively remodeling the existing store base?

I can tell you over the last five or so years we had spent most of our CapEx dollars on remodels. And we probably focused the hardest on what we needed to do on the West Coast. And a lot of our relocations planned over the next five years are on the East Coast, and in the Central area. We're going to continue to do remodels as we do new stores and relocations, but we believe the best investment overall is where we need to do a reloc, that is what we need to do.

It doesn't mean that if the relo is not going to take place for three or four years we might go in and do some kind of cosmetic remodel. But our best return overall is to be able to put in our full-size store with all the departments and have pharmacy really be our pharmacy that we believe is needed for the future. And sometimes that is difficult to do was just a remodel.

Then in terms of 2007 guidance, how would you view the core business if you were to take out some of the one off issues such as Part D, Medicaid reform, generics, excluding all that, how do you look at core business in terms of how it is going to do year-over-year?

I believe our core business is very strong and continues to get stronger on the -- whether it is pharmacy or front-end, because our core categories of OTC, health and beauty care, vitamins, all of which you would consider real core drugstore categories, have been performing very well for us. And so a lot of our strategic initiatives are geared to increase that for the future.

I mentioned in response to one of the earlier questions and in my comments that our prescription growth is coming, yes, from Medicare Part D, but also really from other segments within our business for pharmacy, and that is really important for us. And it is coming in -- it came in all divisions too in the month of March.

If I could add one other thing, when Mary is talking about the core business she is including our new and relocated store program as part of our core business, and as well as the prescription file activity that we're doing. And those programs are well on their way.

And then finally in terms of Medicaid and your assumptions for 2007, what have you assumed, if anything, in terms of higher dispensing fees that you're going to being able to get at the state-level, if any? And then how do you look at the prospects of that?

That dispense fee is probably one of the bigger unknowns. A lot of the lobbying effort there is in its beginning stages. There's still a tremendous amount of work going on right now, not just by us as a Company, but the industry collectively to get a better definition of really what AMP means. And that is going to the one factor that affects your Medicaid results. And then the dispensing fee variable will be on top of that.

But we have already started preliminary discussions with several of the states relative to the dispense fee issue. And frankly it will be very important for states to understand the need to look at the dispense fee issue, especially related to generics, because that is really -- continuing to drive generics is going to be critical to really reducing their overall health care cost.

John Ransom with Raymond James and Associates.

Could you update us on the status of your nascent efforts to get into the PPM business?

I think we mentioned several times over this past year that our PVM is not going to provide meaningful benefit to us until we have a few years of traction with it. We have really got our organization in place, have a lot of RFPs out there, and just beginning to really make some kind of statement with what we're doing there. So I think it is still premature for -- we have had much discussion on it.

I guess where I would challenge you a little bit is it seems like it is going to take probably five years before it would be meaningful. Why the build versus buy decision there?

Remember one of our reasons behind doing the PVM the way we did, it is really more of a pharmacy benefit administrator versus pharmacy benefit management company, and that we really want to put the benefit back to an our stores -- our pharmacies filling prescriptions. But it doesn't rule out also other initiatives around our PVM to strengthen it through some other strategic initiatives that I've got our people working on right now.

Okay. And then I guess my second question is, and I'm -- just probably every conference call you had a dumb question, so I get to be the dumb question. But could you remind us, as you look at your store base now, how does it break out between freestanding and non-freestanding? And how many -- what percentage of your stores now are where you want them to be from a physical location and infrastructure standpoint, and what stores do you still think you've got some legacy issues, either with layout or location or any of the above?

You asked in a lot of questions there. Freestanding is 54% of the store base. What else did you ask?

How many -- if the freestanding is 54, how many of your -- if you look at your total store count now, recognizing you put in a lot of money back into renovation, how many stores out there still do you think need some work, either in terms of their going to have to be relocated or significantly rehabbed?

I know that we still have at least 400 relos that we still plan on doing. And so then we would be looking at additional remodels around that. And then the new store growth is really targeted in what we identified as our most strategic markets, and we are well on our way there too.

Okay. And then the other thing as is was there a noticeable hit to your operating income -- I know you have made reference to it but -- when you transferred from -- the dual eligibles under the [CDPs] as you adjudicated through those claims were there space where you had a noticeable change in your generic reimbursement?

Just in overall reimbursement of Medicaid to Medicare you're experiencing a hit to margin.

Is that more concentrated on the generic side?

It would not necessarily -- no, because your AWP discount would also be higher on brands.

Is it the dispensing fee or is it just ingredient reimbursement were the biggest changes when you go from one to the other?

Primarily it is going to be on the cost of the product.

Karen Miller with Bear Stearns.

In your CapEx budget for 450 to 500 million, could you just break out how much you have to for file-bys, and if you still plan to be aggressive in this front?

Yes, let me give it to you sort of like in percentages so that you can take either the low end or the high end. But file-bys are about 10% of the total -- of the gross total. If you look at from a store -- investing in a store base perspective, it is -- store growth is about 45%, store improvements and remodels at 30%, scripts file-bys at 10%. And then everything else is 15%.

Great. Then just turning to your guidance for fiscal 2007, you talked a lot about the impact of generics and Medicare Part D in kind of the pharmacy side. Could you address a little bit what your expectations are for the front in terms of margins? I know you mentioned that part of the -- there was some pressure from people buying more on sale.

And then also secondly if you could just talk about where we should expect SG&A? I know you were stuffing up this year if you are pretty much -- if we should look at SG&A pretty much flat in terms of your staffing needs?

In response to the front-end margin question, one of the things that should be pointed out on, and especially the fourth quarter on front-end margins, is a lot of what you would call promotional sales were really clearing out seasonal kinds of products too. So that was part of what was included in promotional. We're starting this year really with a good outlook in terms of where we think front-end margins will finish for the whole year. We haven't really changed our promotional program, and we feel we have strong assortments. We have always had strong margins in the front, so I think we would still expect that going forward.

In terms of SG&A and staffing levels?

Staffing levels, we put a high-level focus on staffing just in general to make sure our stores are properly staffed to be able to deliver the right customer experience in the pharmacy and the front-end. We're going to continue to do that. We use a labor scheduling tool that really looks at the customer service aspects, as well as the job that needs to be it yet done. We're going to continue to keep our people focused on that.

We had additional burn this year really getting prepared for Medicare Part D. That is behind us, and things look pretty smooth relative to the transition programs that kicked in just over this last week or so. And unless something unusual comes up, I would expect our labor to be very manageable for this upcoming year.

In SG&A, the new SG&A is included -- it includes occupancy expense. And as I have said earlier to a specific question, it is going up. That is going to have a dilutive effect on the SG&A percent to revenues.

Thanks. That should help us in modeling. That is it for me.

Mark Wiltamuth from Morgan Stanley.

I just want to ask a little bit about what you have seen in your cash paying senior population. Have many of those switched over to Medicare Part D, and has that changed your cash mix?

Surprisingly, at least at initial blush, the cash paying piece has stayed fairly consistent. Maybe a little bit of deterioration, but pretty close to the percent of mix that it has always been.

As you're looking at your new store programs for the year ahead, what is the blend of new versus relos? And what do you think the net new store number is going to be?

The blend of new and relos this 2006 fiscal year was 25% new and 75% reloc. Now next year it is going to be 40% new and 60% relos.

How about a goal for net new stores for the year maybe?

We're not giving you the net new number. We're saying look about 125 new and a normal level of closed stores. In the past that has ranged from anywhere from 25 to 40 stores. So we should have net store growth.

We would expect to have (multiple speakers).

This would be the first time in five, six years.

Okay. It is there any way to quantify the margin drag from the new stores?

Sure there is. We're not going to split that out.

Steve Chick with JP Morgan.

I guess, Kevin, a question on occupancy costs. You had been giving us the drag up until now of what the thing has been on the quarters. I actually didn't catch if you had said what the drag was on this past quarter.

We did not give you a specific occupancy costs drag because of the reclassification now, and we just want it to be focused on in its entirety in the SG&A arena.

But I guess -- you have been saying the drag has been, say, what, 10 basis points as a percent of sales?

Yes, I did say within SG&A the occupancy expense was up 10 basis points in the quarter. Is that what you are --?

Yes.

In SG&A.

Yes, okay. I think --.

We have continued to do sale leasebacks too throughout the year, and would expect to continue to do that too, and that is going to increase the occupancy costs.

Okay, right. So I guess that is what I was looking for. I hadn't heard it. The drag that you have been giving us is the same. It sounds like it was 10 basis points for the quarter?

Yes.

And that is in SG&A. Okay. What does that look like in your forecast for next year -- that drag?

We're not giving you a specific forecast for rent expense, for example. We're just not giving it that specific.

Okay. I guess --.

We're not giving specifics with regard to gross margin or SG&A rate. The guidance is, as we have in the past, in totality the sales and the bottom line.

Okay. Well then the second question. Your operating cash flow is normally even with the AR securitization proceeds, a percentage below EBITDA. And so with your higher CapEx expectation next year and your lower AR proceed expectation, are you expecting to be a net borrower?

No, we expect to be able to keep our debt level at about where it is at. Because of the appetite for our properties in the sale and leaseback area and the strong cash flow coming from operations, we feel very confident of being able to execute our strategies.

I guess in the event that -- how flexible are the 125 stores, I guess? It looks like you kind of came a little short of your target this year. Are you pretty committed to these 125 stores, or is there a little flexibility like you saw this year heading into next?

Being a little bit short this year wasn't flexibility on my part, because I'm very committed to the number of stores we need to be opening. We really do have a goal of 125. Things can always come up that causes a store to fall over into another year, and you run into stores that take longer to get done or whatnot, but our pipeline is very well developed for this next year. And it is actually getting well developed for the year after, because we have to be far enough out that we can do stores.

We're very confident about that. So I'm not sure -- if you go back two years or so ago when we were just starting there was just a lot of unknowns, and we just don't have those now.

Our store growth program is -- an important strategic initiative for us is the fact that we weren't able to grow for a number of years. We have to in my mind get ourselves in the right position in a lot of key strategic markets over the near-term because we want to be able to grow marketshare.

That's fair. Two other questions if I could. Congratulations on your pharmacy trends for March. They look very good. Is this -- are we too aggressive to think that this might be a runrate to think about as we forecast out here? 4.9 was well above what I would have expected.

I think we have said -- I said in my remarks and Kevin said in his that we have been working on our initiative to build our pharmacy sales throughout the past several years. We're gaining traction on them, and we expect to continue to gain traction throughout the year. And we have really included that impact in our guidance.

Remember there is a couple of other things that are always -- have been existing in the past that we haven't talked about and that is your assumption with regard to inflation and the flow of it, as well as remember these Medicaid reimbursement rate cuts are coming in our fourth quarter. There's a lot of moving pieces. I would not take this month and go with a runrate.

Last thing, just on your schedule of your capital structure, Kevin, with the converts and the options to get to your diluted share count, I thought your option count was a little bigger. I guess you have 6.6 million of options -- outstanding options. Is there -- are those options that are just in the money, and how are you quantifying that number?

That is the treasury stock method, which says you only take those options that are in the money, and then with the proceeds have a net number. That is what that is. Yes, we do have more outstanding options, but they are not in the money.

Right. I guess if your stock price goes up, obviously, that number goes up too. Okay. Well, we can talk about it off-line.

Yes.

(OPERATOR INSTRUCTIONS). Meredith Adler with Lehman Brothers.

Just a quick question about the Medicaid cuts. I know you have got it forecast to impact you starting in the beginning of calendar '07. But do you think that there's any risk that any of those cuts come earlier? I have heard a little bit about that from [NATDL], NATDL and elsewhere.

We haven't seen that happening yet, but really states can do things just because of their own budget issues throughout the year, and that has always been part of our estimation on what would happen with pharmacy margins. So we would have estimated some effects from states taking just their normal kind of Medicaid action throughout this fiscal year.

[Michael Rothenberg] with [Mellab] Partners.

I am wondering if you can tell us what the incremental occupancy cost is from the sale leaseback transaction?

No, we just disclose full rent expense.

Can you tell us how many stores were sale leaseback?

In the quarter we had three.

And over the year?

I don't remember over the year, but I'll -- I have to get back to you. Why don't you call me?

Okay.

Operator, we're going to take one more question.

At this time there are no further questions. Mr. Twomey, are there any closing remarks?

No, thanks everybody for the interest and the time.

Thank you.

This concludes today's Rite Aid fourth quarter results conference call. You may now disconnect.