Rite Aid Corp (RAD) 2009 Q2 法說會逐字稿

Good morning. My name is Brandy and I will be your conference operator today. At this time, I would like to welcome everyone to Rite Aid's second quarter results conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session. (OPERATOR INSTRUCTIONS). Thank you.

Now I would like to turn the call over to Doug Donley, Chief Accounting Officer for Rite Aid. Mr. Donley, you may begin your conference.

Thank you, Brandy, and good morning everyone. We welcome you to our second quarter conference call. On the call with me are Mary Sammons, our Chairman and CEO, John Standley, our new President and Chief Operating Officer, and Frank Vitrano, our new Chief Administrative Officer and Chief Financial Officer. On today's call, Mary will give an overview of our second quarter results and I will discuss the key financial highlights and then we will take questions. But before we start I would like to remind you that today's conference call includes certain forward-looking statements. These forward-looking statements are made in the context of certain risks and uncertainties that could cause actual results to differ.

Also, we will be using a non-GAAP financial measure. The risks, uncertainties and definition of the non-GAAP financial measure along with the reconciliations to the related GAAP measure are described in our press release. I would also encourage you to reference our SEC filings for more detail. With these introductory remarks of mine, let's get started. Mary?

Thanks, Doug. Good morning everyone and thank you for joining us today. Today's call will be slightly different from our usual format in light of the new Management appointments that we also announced this morning. I'm pleased that John and Frank have been able to join us on the call today and I will talk more about them in just a few moments.

First, I will give an overview of our second quarter results. As you can see it was a challenging quarter in a difficult operating environment, but despite these challenges we continue to see results from many of our initiatives and the beginning of a clear turnaround in the sales of our acquired stores. We remain confident in the benefits of the Brooks-Eckerd acquisition including our expanded presence in key markets and the integration and conversion activities are almost behind us. We are currently putting the finishing touches on the last 25 minor remodels, which will take just a few more days. I just come back from visiting former Brooks-Eckerd stores in several markets and couldn't be more pleased with the results. Stores were clean and inviting, the decor upgrades look great, but most importantly, our pharmacy and front end associates were excited about their future prospects. With the integration behind us, we can now focus all of our energies on growing profitable sales.

We delivered positive cash flow from operations this quarter, marking solid improvement from the first quarter of this year. We strengthened our liquidity position by completing a $700 million refinancing and increasing the number of sale lease back transactions this quarter too. As a result, we have the financial flexibility we need to support our business plans while managing our debt. At the same time, we've developed a plan to improve cash flows by further cutting SG&A expense in the second half of our fiscal year. In this increasingly challenging economic environment, it's a given that we must manage our business responsibly while continuing to deliver the level of service our customers expect. We also expect to begin paying down debt at the end of fiscal 2009 using free cash flow to reduce the outstanding balance on our revolver. But even with this additional cost cutting, you'll see that we've lowered guidance because of current pharmacy sales trends and the weak forecast we're hearing from most economists from the second half of the year. Doug will talk more about our revised guidance later on the call.

Now let me get into more details about the quarter. We saw solid sales performance in our core stores in both front end, where same-store sales grew 3.6%, and pharmacy, even as pharmacy growth continued to slow. In fact, IMS Health latest forecast is now for only a 1 to 2% growth in both prescription sales and volume for the year across the industry. Our initiatives are helping us grow our scripts in spite of this industry slowdown, and on the front end, we kept a much better balance between markdowns and margins than we did last quarter. Front end same-store sales in our acquired stores decreased by 2.7% in the quarter, but turned positive for the month of August, while pharmacy narrowed the decline from the first quarter. We saw strong increases from these stores in both high margin private brand sales and generic dispensing, and core drug store categories like OTC and vitamins had positive gains.

I'm pleased to report that with only three days left in the month, we expect to report September sales that continue to show very positive sales trends in both the acquired and core stores, and we continue to expect total same-store sales in the acquired stores to turn positive in the third quarter. Looking more closely at pharmacy, same-store sales were flat for the quarter, reflecting a 2.8% increase in the core Rite Aid stores, and a narrowing decline to 4.6% in the acquired stores. Pharmacy gross profit rate improved, in large part due to the growth in generic dispensing, although new generics added 264 negative basis points impact on pharmacy sales in the quarter. Our core stores hit a record generic dispense rate of 68.4%, with the acquired stores catching up quickly at 66.6%. We have added to the acquired stores the education and marketing programs that continue to give Rite Aid the highest generic dispense rate in the industry.

The Brooks-Eckerd pharmacy same-store sales are also showing progress from the first quarter and have continued to improve in September. Customer satisfaction improved in the pharmacy in all of our stores but especially in the acquired stores as our associates work diligently to bring back customers. Customer complaints are also down across all stores, combining core and acquired stores under one field management structure, which we did earlier this year has really made a difference. We believe that moving pharmacy operations under our Executive Vice President of Store Operations, Brian Fiala, which we did at the end of the second quarter will also lead to more cohesive Management and better performance in the stores. We continue to attract the very important senior segment into our stores as our Living More senior loyalty program grew to more than 3.8 million members. We've had a lot of requests from younger seniors to join the program so we've lowered enrollment age from 60 to 55, opening the door to many more patients who on average take more prescriptions than any other demographic. Our continued push on pharmacy acquisitions is delivering exceptional results, and we've completed 25% more deals than at this time last year. Our retention rate remains high, and we've been able to entice many of the pharmacy staff to move over to Rite Aid along with the prescription files.

We've had such good results with our new Rite Aid Rx savings card in states like Michigan and California that next week we plan to launch it nationwide. The card, which offers substantial savings on generic and brand prescriptions, over-the-counter medicine and Rite Aid brand products is much broader than the $4 generic program, and it doesn't have a membership fee as some other cards do. We designed it to benefit patients with no or limited prescription insurance, but it's available to anyone who enrolls. The card is driving new customers to Rite Aid with its 400 generics at only $8.99 for a 30 day supply, and $15.99 for a 90 day supply, as well as 20% off all other generic and brand prescriptions. Our fill up fuel up, a very successful transfer program that rewards patients with a chance to win a year's worth of free gas continues to bring in new customers to Rite Aid. We've seen such great response to this kind of promotion that the national launch of our automated courtesy refill service, where our pharmacies automatically fillet prescription before it runs out for patients who sign on, includes a chance to win a hybrid car and $3,000 in gas gift cards. Response has been good even in just a few weeks.

We expect that expanding our compliance programs, targeted marketing programs to win back customers and continued focus on health and wellness initiatives like our recently launched caregiver program will also continue to improve our pharmacy results. Core drug store categories contributed to these positive trends, as did vitamins, especially our GNC vitamin department. GNC continues to be a powerful differentiator for Rite Aid, and we now have more than 1700 of them, including 386 being added to the acquired stores. Private brand sales were very strong in all of our stores, as customers continued to search for value, reaching 14% of front end sales for the core stores and 12.1% for the acquired stores, which was up significantly over the first quarter. The value of Rite Aid brands will be a continued focus of our marketing program in this tough economy.

While we saw softer back-to-school sales like other retailers, our team did a good job of managing inventory to sales expectations. Photo continued to be difficult as we continued the transition from Kodak to our expanded state-of-the-art photo offerings with Fuji Film, which is taking a few months longer than we originally expected. On our last call, I mentioned our increased focus on eCommerce initiatives to drive sales. One of these initiatives is the new Rite Aid online OTC store, which we have announced we will launch later this year. While the site will be powered by Drugstore.com, it will be managed, marketed and branded by Rite Aid. Most importantly we will own this database and be able to market directly to these internet customers, an important next step in our digital strategy. You may remember that up to now, our internet offering has been basically a link to Drugstore.Com. We'll give you more details on our new OTC store on the next call.

As many of you know, managing expenses has been a critical priority for us this year, and through our spend efficiency program, we've realized significant savings on non-retail purchases across the chain, but the growing uncertainty in this economy and the growing reluctance of customers to spend their dollars dictate that we tighten our belts further. Let me give you some more details in our plan to improve cash flows through additional cost reductions. First, we are going to operate more efficiently. That includes improving labor scheduling in the stores. We had a good system before but now we have a better one. We're going to make sure store hours match customer demand and shorten them where they don't. We're increasing efficiency in the distribution centers, and reducing administrative costs that don't impact the store level. Basically, we are putting our day-to-day expenses in line with the sales we expect. Of course we'll keep a close eye on our customer satisfaction scores to make sure we're still delivering a high level of service to our customers.

Second, we are cutting Capital Expenditures by about $50 million. These cost effect projects that would be nice to have but not necessary this year, and we're tightening budgets on projects in which we will invest. We continue to plan to open 85 new and relocated stores this fiscal year and continue to plan to remodel our stores that need it, and third, we will pursue additional sale and lease back transactions over the second half of the year. As you can see from our revised guidance, we now expect $200 million from sale and lease backs in fiscal 2009 compared to $150 million previously. With these cost reductions, along with the improvement in operating results we expect for the second half of the year, we expect to start paying down debt by reducing drawings in our revolver at the end of this fiscal year.

Now, I'll turn it over to Doug to cover the financial highlights. Doug?

I'll talk now about the numbers in detail. Revenues for the second quarter were $6.50 billion compared to $6.57 billion last year, a 1.1% decrease. Same-store sales increased 0.62% and were offset by the net reduction in store count of 58 stores. Total company front end same-store sales increased 1.9%. Gross profit was $1.78 billion, or 27.36% of revenues for this quarter, versus $1.79 billion or 27.23% of revenues for last quarter. The current quarter included a non-cash LIFO charge of $15.1 million, versus a $16 million charge in last year's quarter. The 13 basis point improvement in gross margin rate was primarily a net result of a 70 basis point increase in pharmacy gross margin, partially offset by 53 basis point lower front end gross margin, a 20 basis point increase in product handling, and distribution expense.

Selling, general and administrative expenses for the quarter increased as a percent of revenues by 89 basis points compared to the prior year. The increase is primarily due to the following. A 51 basis point increase in wages and benefits, a 26 basis point increase in occupancy expense, resulting from our new store program and our recent sale and lease back transactions, a 26 basis point increase in depreciation and amortization due to the Brooks Eckerd acquisition, prescription file purchases, and a new store program. The cost increases were partially offset by a 32 basis point reduction in integration expense. Adjusted EBITDA for the current year's second quarter was $215.3 million or 3.3% of revenues, a decrease of $46.2 million from the prior year, primarily due to the increase in our SG&A expenses. The schedule attached to our press release reconciles our net loss to our adjusted EBITDA. Store closing and impairment charges were $35.2 million higher than last year's charge. This was due primarily to more stores sold or closed.

Interest expense was $118.6 million for the quarter versus $123.2 million in last year's quarter. The decrease was primarily due to a shift in the debt portfolio to more variable-rate debt. That mix changed resulting in a lower combined interest rate. This is partially offset by the increase in debt that funded the acquisition and refinancing. Cash interest expense was $112.9 million for this year's second quarter versus $116.7 million last year and non-cash interest expense was $5.7 million this year versus a $6.6 million last year.

Regarding income taxes, the current year's second quarter had income tax expense. We did not recognize any income tax benefit for the pre-tax loss. In other words, the deferred tax assets related to pre-tax loss were fully reserved with a valuation allowance. The prior year's second quarter included income tax benefit because at that time, we were recording the deferred tax assets without any valuation allowance. Net loss for the quarter was $222 million versus $70 million last year. Net cash provided by operations was $96.1 million this quarter versus cash used in operations of $139.6 million in last year's second quarter.

A couple of comments about liquidity. Availability to the revolver increased to $549 million at quarter end compared to $530 million at the end of the first quarter. At the end of the second quarter we had utilized accounts receivable securitization agreements for $500 million. On September 16, 2009, we completed an amendment to the securitization agreements whereby commercial paper vehicle entities renewed their committment to fund the purchase of our pharmacy-related receivables until January 15, 2009.

The securitization agreements continue to be back stopped by standalone bank commitments through September 2010 that we can use for funding as commercial paper vehicle entities do not renew. As previously announced during the quarter, we completed refinancing of three notes and thereby removed any restrictions that they had on availability of the revolver. We had no significant required maturities in the foreseeable future. Our required maturities currently are less than $25 million for the next 24 months. In September 2010, the revolver and the $145 million term loan mature. When the time comes, we expect to be able to refinance them with some combination of revolver, term loan, or secured notes.

Now let's turn to guidance. We are estimating fiscal 2009 sales to be in the range of $26 billion to $26.5 billion. Same-store sales guidance which includes the Brooks-Eckerd stores starting June 2008 is 1.5% to 3%. We're estimating fiscal 2009 adjusted EBITDA to be in the range of $950 million to $1.025 billion. Our fourth quarter is expected to be our strongest quarter. We are estimating our operating results for fiscal 2009 to be a net loss between $445 million to $535 million or a loss between $0.56 to $0.67 per diluted share. Attached to our press release is a table that reconciles our adjusted EBITDA guidance to our guidance for net loss. Capital Expenditures before sale and lease back proceeds, which includes the continuing new and relocated store program and integration capital expenditures are estimated to be $550 million for fiscal 2009. We estimate sale and lease back proceeds to be $200 million.

Now let's go back to Mary.

Thanks, Doug. As I mentioned at the beginning of the call we're also taking steps to strengthen our management team in order to drive profitable growth at Rite Aid. First, we are very pleased that John Standley is returning to Rite Aid as President and Chief Operating Officer. John assumes the role of President from me, and the role of COO from Rob Easley, who will be leaving the Company to pursue other interests. Second, we are pleased that Frank Vitrano is joining the Company as our new Chief Financial Officer and Chief Administrative Officer. Frank assumes the CFO role from Kevin Twomey and the CAO position from Pierre Legault, both of whom are leaving the Company. We are combining the CFO and CAO positions in order to help us further improve operational efficiency. I want to thank Rob, Kevin, and Pierre for their dedicated service and contributions to the Company and wish them well in the future.

John and Frank will both report to me and bring Rite Aid an optimal blend of financial, operational, and turnaround experience that our Company needs at this juncture. John is a proven leader with a broad based financial background backed by hands-on operational experience over a 23 year career in the retail grocery and pharmacy industry. He returns to us from Pathmark Stores, Inc., a $4 billion food and drug retailer with a strong pharmacy business. John engineered and lead the successful turnaround and sale of Pathmark to A&P during his tenure as Chief Executive Officer and Board Director from August 2005 through 2007. Many of you will remember John from this time at Rite Aid several years ago. He has intimate knowledge of our Operations and earned broad respect throughout the Company during the six years he spent as our Senior Executive Vice President, Chief Financial Officer, and Chief Administrative Officer. He made significant contributions to Rite Aid, chief among which include, he was a key member of the team that helped turnaround our operating results earlier this decade. He also lead the design of our financial controls and was integrally involved in the development of our current information systems, real estate strategy, and compliance programs. He has worked closely with our banks, auditors and outside counsel.

Finally, John has served for the past few months in an advisory capacity to the Company and is therefore ready to hit the ground running. John would like to share a few brief words with you.

Thank you, Mary. First of all, I'd also like to welcome Frank Vitrano to Rite Aid. I'm very very excited to have Frank join us here. He's a very talented retail executive and played a great role at Pathmark helping us be successful so Frank, welcome aboard. Great to have you here. Mary I want to thank you for this opportunity. I'm very very excited to be here today and to join this great Rite Aid team.

Rite Aid has a tremendous amount of opportunity in front of it. I'm very excited to get involved and do what I can to help this Company be great and move forward. We have lots of things to do. Mary's touching on a lot of great things we have to work on and I really see a lot of success for us in the future so it's great to be here. Thank you, Mary.

Thank you, John. Really glad to have you back.

Great to be here.

I want to say a few words about Frank too. I have not yet had an opportunity to work much time with Frank ,but he is a really accomplished executive with strong track record, over 35 years at Pathmark, serving in a variety of positions. Most recently, he was President, CFO and Treasurer, reporting to John and was instrumental in the company's rebound and sale to A&P. His experience across a number of operating and financial disciplines from implementing cost savings initiatives to engineering debt and credit facilities will serve Rite Aid as well as we move forward. John and Frank forged a strong partnership at Pathmark which will enable them to begin working quickly in partnership with me to deliver results for the Company.

This is the right time for these changes as Rite Aid focuses on delivering strong value for shareholders, suppliers, and customers in a challenging business environment, with the integration of Brooks-Eckerd behind us and same-store sales in the acquired stores continuing to trend upward, the key task before us is to drive profitable growth. With John and Frank, we are bringing in seasoned executives who have proven they can work through challenging situations and achieve growth in value through a combination of operational excellence, committment to a high level of service, and effective cost management. It is even more important to do this now so we can best capitalize on the opportunities ahead for our business despite the difficult economic climate.

Before opening up the call for questions, I want to emphasize several key points in closing. First, the integration of Brooks Eckerd is now complete, enabling us to focus on growing profitable sales across all our stores. Second, sales trends in the acquired stores continue to move in the right direction, and we expect positive same-store sales from these stores in the third quarter. Third, with the completion of the debt refinancing in the second quarter, and our continued pursuit of sale and lease back transactions, we have the financial flexibility necessary to support our business plans. Fourth, we are taking prudent steps to operate even more efficiently as we navigate the challenging economic environment. Fifth, with expected continued improvement in our operating results and additional cost reductions, we anticipate that we'll be able to start paying down debt at the end of this fiscal year, and sixth, with this management team, Rite Aid can build on the foundation we have in place to sharpen our focus on invigorating sales, reducing costs and strengthening our overall financial position.

In summary, we believe we have the right strategy, right initiatives and the right executive team in place to create sustainable profitable growth and long term value for our shareholders. Now, we'll be glad to answer your questions.

(OPERATOR INSTRUCTIONS). Your first question comes from the line of Meredith Adler with Barclays.

Good morning. Welcome to the new folks. I have a couple of questions for you. Maybe could we talk a little bit about working capital? There was improvement this quarter a bit, but well I guess actually not for total working capital. There's improvement in payables. Could you talk a little bit about what you're doing to manage inventory and is there anything you can do with your payables which I think should have improved more this quarter.

Meredith, we have a pretty extensive overall working capital plan, really high focus on inventory itself is probably really the key driver in what we need to do and it is store based as well as distribution center based and really we expect a think a majority of that improvement to show up through the third and fourth quarters. Last year we built a lot of inventory in the third quarter as we set up the categories in the acquired stores and then took us a long time to work through the old inventory and so we have pretty aggressive numbers in the plan as we finish the year and one of the things that John already has zeroed in on is the fact that we believe there's probably significantly more working capital improvement possible even by year-end than we had in our original plans, and we'll probably share more of that as we move through the next quarter.

I think it's a really good point Meredith and a great opportunity for us and I think there's lots of things for us to work on to kind of get after it and I think we can make improvement there, so I think it's a good source of liquidity for us as we go forward.

Okay, and then I just have another question about slowing down your capital spending. You have obviously haven't given guidance for next year, but it seems to me that one of the opportunities with this Brooks Eckerd transaction was to do two-for-one relocations, to move two strip center stores into one much better corner location. Does that remain a priority for what other capital you do spend or are you going to be cutting back almost completely on relocation?

No, that's absolutely a priority. In fact, relocations will continue to be a key focus for us. Where we will cut back is probably on just the number of what you call net new stores because we have so many relocation opportunities and remember, we have just completed the refresh and remodel of about 1800 stores and we also next year have allocated capital spend towards that refreshing of core stores in a lot of these same markets so that the whole market presents itself in the sale way to customers. We were very prudent in how we really went back through our CapEx plan and making sure that again it was more the nice to have things that we took out versus the need to have.

And I think for next year we're going to continue to be really efficient with our capital.

Yes. And you really have to in today's environment until you see really a change in what's going on out there and we need to get the benefit out of what we've been investing and really keeping working on improving performance of the stores that we have.

I have one final question. What kind of comp do you need in the pharmacies at the acquired stores to be able to leverage the fixed cost, because clearly there's a limit to how much you can cut labor in those pharmacies. Are you very far from being breakeven in those pharmacies?

First, we're very careful relative to labor in the pharmacy too to make sure that we have the right level of pharmacists and technician help to really be able to take care of customers and support the script level. Important to remember that the acquired stores had high volumes of scripts and in fact that was one of the key positives that we really want to make sure that we protect on a go forward basis and grow because both Eckerd stores and Brooks stores actually did higher scripts per store than core Rite Aid stores, so during systems conversions, no matter how well planned they are and how well executed, you lose some customers during that transition and our competitors who are very active in going after those customers and so we are marshalling all resources to get those customers back and get the script base to where it needs to be to then start growing from there, and so we're really not doing anything that's going to negatively impact that pharmacy service.

Okay, thank you.

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

Hi, good morning.

Good morning, Ed.

Good morning.

Mary, could you provide us a little bit of detail on what's taking place in Eckerd in the pharmacy business, why comps are still down there and maybe what some of the issues have been and when you expect them to stabilize?

Again, Ed, I don't know if you heard my comments to Meredith, but I think our real focus is on getting customers back that we lost and if you go from quarter to quarter to quarter, we see improvement each quarter but they are still negative and they are improving at a slower rate than we would originally have expected but I think a lot of that is because you do lose a certain number of customers and their loss until you've really got the strategies well executed to get them back and that's where our focus is, and we still believe that those pharmacy sales will take a little bit longer than the front end sales to get positive but as we move through the end of the year, we would expect to be very close to that positive number.

Has the issue there really been centered around the integration and the upgrading of the systems and is that why you basically are losing pharmacy customers?

That would be the number one cause of it and the aggressive activities by our competitors to also get our customers, but we are being equally aggressive if not more so in initiatives to get them back now, and have a very well defined program around any of the declining script stores that really pulls in the operational initiatives that need to be in place, the Marketing initiatives and then the follow-up with those customers that we lost as well as the kinds of programs I described to get new customers for the pharmacy business, those are also fully deployed in all of our acquired stores too.

I think the great news here is the integration is done.

Yeah, it is. It's behind us.

So the pharmacists are largely digesting, have digested kind of what's happened here and I think from a service perspective, things have improved a lot over the last several months so we've made a lot of progress operationally kind of I think getting things back in order and being where we want to be. As Mary said, we have really good Marketing programs out there attacking this thing so we've got a plan in place to get there over the next couple months and by the end of the third quarter.

Okay. Can you discuss the opportunity to exit any underperforming markets or closing under performing stores, kind of similarly like you did in Las Vegas? Is there other opportunities out there like that?

That's part of our ongoing review, so we always have a list of stores that we would be working on to either improve or if we don't believe we can improve them just as over the first half of the year we closed a fair number of stores there that just weren't going to be able to pass the hurdle that they needed to, and we'll continue to keep evaluating them, and I think I've talked a little bit before about that we have what you call some non-core markets. There aren't a lot of them, other than the Las Vegas market that we divested earlier this year, we really have positive EBITDA contribution overall on a market basis but we would still look at some that we are not investing in if the opportunity came up and it was right, but it's a minimal number of Markets.

Okay. And then you had indicated that there's opportunity in working capital and inventory for the rest of the year, but the third quarter is typically seasonal build for you, so will you be drawing down on your revolver in the third quarter and how much do you expect that to be?

Well, we've built that into our plans and obviously that was a big consideration for us on making sure that we had the financial flexibility, but remember we built inventories so high last year because not only did we have the seasonal build, we had the build for putting all of the new planograms in the acquired stores and we had all of the old inventory from the acquired stores so even with a build in inventory, we feel very comfortable with where we are at on our draw on our revolver and our liquidity that's available even at the lowest point of need.

Okay, and just one last question in your capital spending, sort of how we should think about the next couple of years because you've brought your CapEx down from where you started at least your plan this year, you're increasing your sale lease backs, so your net spend is really not much. My guess is that the opportunity for sale lease backs next year is not quite as much, so potentially I guess we're talking about an increase in net CapEx but what is the level of CapEx that we should really be thinking about in terms of your business and what you need to spend in order to accomplish your goals of turning the business around?

Again, I think it's going to be very important to us in this kind of operating and economic environment that we be prudent with our CapEx spend and disciplined in what we spend because we want to really be able to pay down debt and not have as much draw on the revolver so we'll be balancing what we spend in CapEx against cash flow created by operations, and it just is so important to remember that we've just finished investing significant dollars in remodeling about 1800 stores. We've been opening new stores and relocating stores and we're going to continue that program but prudently.

So your feeling is a lower level of spend next year will not hinder you from improving the profitability of those acquired stores is what you're saying?

No, absolutely. In fact if anything it just focus more of our resources against the number one priority we have which is increasing profitable sales, getting our script business where it needs to be and continuing to grow front end business and start getting some of that productivity improvement that we know is out there.

Okay, thank you.

Your next question comes from the line of Lisa Gill with JPMorgan.

Hi, good morning. It's fully Mike Minchak in for Lisa. Just a couple more questions on same-store sales guidance. First, how much of the lower same-store sales guidance was related to the longer-than expected turnaround of the Brooks-Eckerd pharmacy sales versus the overall weakness in the economy, and then secondly, can you give us a sense of the level of conservatism included in that guidance? Within the overall same-store sales guidance as to whether the bottom end assumes a continuation of the current weak economic environment, or if things get dramatically worse from here?

We were very cautious in looking at the sales forecast and we want to make sure that we don't put a number out there that is high at this point to what we're either seeing or hearing about and we don't know what the holiday season will actually end up being but everything that you're hearing out there and reading out there says to be careful, so I think it's prudent to take it down. Probably the single business thing that's built in there though is a little bit longer time it's going to take to get the pharmacy script business to where we want it to be or need it to be for the acquired stores.

Great. Thanks and then just another follow-up. Can you give us a sense of your expectations around gross profit given the commentary you provided about the heavily promotional environment? Are you expecting to see continued increases in that going forward?

I think we've got a strong focus on continued to grow private brands, keep increasing generic penetration in pharmacy. We still have much more opportunity in the acquired stores, and that will help us relative to offsetting some of that pressure relative to just the promotional environment and we've really worked hard on the plans with our suppliers for being able to put more value items out there for our customers in terms of the front end and if you look at some of the programs that I talked about on pharmacy, a lot of those are to create additional volume in the pharmacies, grow the scripts per store per week and to get incremental business that would offset any say gross profit erosion that might be there so we feel overall pretty good about our ability to hold those gross margins.

Great. Thanks for the comments.

Your next question comes from the line of Mark Wiltamuth with Morgan Stanley.

Hi, good morning. Wanted to ask a little bit about the Wal-Mart $4 generic drugs. When this program first came out, I think most of us thought this would not be a big impact on the drug store industry because it was targeted more at cash paying customers and your business is more focused on insured customers but now that we've seen it spread out more to grocery stores as well, I'm curious if you think this is having an impact on the overall script trend for the industry and just how are you countering that with your prescription savings card?

Well, I Think as you had, when you saw this proliferation of these discount programs, I think as that grew, I think it did start impacting overall choices of where customers were getting their prescriptions, and you saw one of our competitors introduce a program of theirs that was also set to go after the same particular customer, and so we really started with a pilot in Michigan with our own Rx savings card and what we found was the result of that pilot were very encouraging because of the incremental script growth that we saw really helped relative to the impact on margins so we rolled it out to a couple more areas, a couple in the South, the Carolinas and then over to California, and continued to monitor results and based on the results have made the decision to roll it out everywhere, and I think it's just as the economy has worsened and people are paying more attention to where they spend their dollar having some kind of response to this was important to have and I believe we have a good response and our card is free for those who enroll where others can have a discount or have a charge, and we have attached more value to it by giving some broader based discounts on generics that aren't included on the program.

Okay. And you had mentioned in some of your earlier comments that you only have like I think it was $25 million in financing you need to do over the next 24 months. Give us the picture on what it looks like beyond that and what your plans are to address the financing beyond the 24 month window.

Well, we haven't spent a lot of time on that. That far out on the refinancing I think really our effort was on what we needed to do this past year which we took care of in the second quarter, earlier in the second quarter of completing the refinancing to remove those indenture restrictions. Really the major things that we have to work on over the next 18 months or so is the revolver.

Looking down the capital structure it's just not a lot and it comes off in the next period of time, not until 2013 so again, in the near term, there's just not a lot of refinancing to be done other than what Mary talked about, and what Doug talked about.

Okay. All right, thank you very much.

You're welcome.

Thank you.

Your next question comes from the line of John Heinbockel with Goldman Sachs.

Hi, guys. A couple issues wanted to drill down on. One is the consumer and the promotional intensity you mentioned. If you look at that intensity September, August, July, kind of yourselves and across the industry what's the trend been? Has it picked up, moderated, and then do you find the customer cherry picking you more because that's one of the things we've heard.

John, I think we have a better balance in our ads if you take a look at them from say the first quarter and that we're using items and categories more strategically to get a better balance and still get that customer in but not totally give away margin on that whole ad, and we've worked with what we're merchandising in the stores on ends to create more value for the customer when they are in the stores so we actually saw I think improvement there with what we did in Q2, and we'll keep on that and try to keep them balanced there but know that we have to do the right things to drive sales.

I mean I think the markdown trend is good actually from the first quarter to the second quarter.

And within the Second Quarter did it get better?

In terms of I'd say sales momentum and results, yes.

How about the markdown trend?

Markdown trend was very good across-the-board I'd say.

Okay, because it wasn't much trend beginning to end, kind of stayed pretty stable?

Yes, in fact I think as our initiatives to really do that balance relative to how we were using promotion to drive sales, I think we saw improvement as the quarter progressed and continue to see it in September and I mentioned that our September sales trends were almost through the month have continued to show that same kind of improvement so we feel good about what we're doing here.

Can you see any change in the consumer when it was July, August, or September, particularly in kind of the economic outlook has darkened a bit here. Have you seen anything or not really your consumer has not changed their behavior?

Well based on the sales results that we're seeing for the front end, I would say we're doing a good job of offering value and getting the customer in. Okay. Now if you look at the back half of the year, the EBITDA trends would have to improve to get you to sort of the mid point of your guidance. What's the biggest swing factor in the improvement first half to second? Is it mostly the expense line? Or do you think margins look better as well? Well we have absolutely a big focus on expense and driving really all costs out that we can during that time period, but doing it prudently. We also are going to continue I think working strongly on getting the sales that are there for us to get and as we see continued improvement in the acquired store sales trends which is going to keep strengthening for front end and keep improving to finally get in positive territory, on the scripts in those acquired stores, that's a big part of where we see the growth coming from.

That's really important, John. I think that improvement a little bit in the leverage situation on the costs as these results turnaround is really important as we look at the second half of the year.

So on the Eckerd side you think any positive comp would improve margin there? Is that fair?

It would help EBITDA margin absolutely.

Yeah, absolutely.

All right and then finally John, what are you going to spend most of your time on say the next three or four months ? Give me one or two priorities given where the business sits

Well I think this thing for us, John, is really going to happen in 5,000 stores and so I'm really excited to have the opportunity to just really dig in with Brian and John and all these guys to really dive into the day-to-day business to see what we can do to really connect with the consumer and to operate our business more efficiently. There's lots and lots of good stuff to work on and there's good stuff under way going on right now that helps the third quarter a little bit but really helps the Fourth Quarter and so I'm excited to kind of get involved in that stuff and see what we can do to push it along and bring it to fruition.

What I was going to say, how does the macro environment which you probably hadn't planned for it to be this tough, how is that kind of changed what you're prioritizing in the next couple of quarters?

Well you can see John what we're trying to do is be a little bit more conservative with the sales and that really helps you address that situation because if we go in with too aggressive a sales plan we tend to over spend on the expenses so really trying to tighten our revenue estimates and a much tighter range of what we think we're going to be and then you have to use that know help us be more efficient on the cost side of the business and Mary and the whole gang started doing that over the last several weeks that I've been here and have really got good initiatives under way and they start to hit again a little bit in the third quarter and we'll get it in the Fourth Quarter so what's changing about us is we realize the revenue base is where it is at this point and it will improve a little bit as we go through the rest of the year but we've got to make our cost structure work inside that revenue base and that's how we'll get there.

Okay, thanks. You're very welcome. Thank you.

Your next question comes from the line of Robert Willoughby with Banc of America Securities.

Good morning. You mentioned distribution center savings somewhere in the prepared remarks. Does that entail any fundamental change in your relationships with your primary wholesale drug distributer or is this moving shelves around at the various facilities you do have?

Well it does not involve McKesson. Really the distribution cross and Pharmaceuticals are really the smallest part of the distribution equation is really about the front end merchandise and we added facilities as we went through the Eckerd transaction so really trying to use our far ill its as efficiently as we can to make sure we're putting the right products through those facilities and looking at look how we're moving products between the warehouse and stores. These are really big opportunities for us to focus on. We tried to over deliver as we went through the integration. It was really important to provide as much support through the stores as we could, as we went through that process, but now we're to a point where we really get the opportunity to see how we can make the value out of all of the volume we added in the integration and we're really excited about that. I think the DC side of this thing is a great opportunity. We've got a good guy with Wilson Lester, and we'll really focus on this over the next couple quarters and make some progress.

And just my other question, it looks like your D & A guidance you've broken out in the press release is below the trajectory that you're currently on. Can you point to what causes that D & A number to drop off in the second half of the year?

It's mostly the weighted script files amortized because the amortized script files not only over a 10 year basis but also amortized them on an accelerated method so as you basically front end --

They amortize quickly at first and they have a bubble of script files that appear to be coming fully amortized as we move into the second half of the year.

And that with CapEx we've done over the last several years some of the computer equipment and lower amortization items will also rollout as well.

So a sequentially flat number then is the wrong assumption. We need to tweak that down a bit?

That's correct.

Okay. That's it, thank you.

You're very welcome. Thank you.

Your next question comes from the line of Tom O'Neill with Barclays High Yield.

Yes, good morning. Having shopped your Stores regularly, there's no question you offer great value proposition to consumers in the front end, given the weaker economy with consumers looking for more value what are you doing differently to get your message out there? Are you considering changing the mix between your circulars and other forms of advertising and if you could distinguish between the legacy Brook-Eckerd stores and the Rite Aid stores that would be helpful.

Well, we still put most of our effort into our circular in terms of getting our message to customers and then how our stores actually merchandise when you come in, and I think that applies equally to our acquired stores as it does to the core stores and we have a huge opportunity in the future to be able to get a lot more sales out of the front end than at acquired stores because one of the benefits we saw from the acquisition is that we had a 35% productivity improvement opportunity in those stores compared to the core stores in the same market, and you know with what we lost in sales last year, got to recover those which we've done and are showing nice improvement and then we can start growing towards closing that gap with our core stores so big opportunity. You know, we're also doing some things really with data mining and understanding our customer segmentation and best customers and market basket analysis to really help us in the future to be able to more precision target customers and what they need and as we get into this next year, we'll probably have more to share on what we're doing there too because it's a key strategy for us.

Okay, great. And just one other question. You mentioned the proceeds from sale lease back transactions will now be approximately $200 million for this year. Can you give us a ballpark figure on your capacity to do sale lease back transactions in future years, how much sort of unused capacity do you have there and then also given the current Real Estate market what changes if any are you seeing in terms of the economics related to the sale lease back transactions? Thank you.

Okay, I think I missed the end of the question but I'll hit the first part and maybe you could ask the second part again but in terms of our ability to do sale lease backs as it relates to new store relocated activity we can pretty much do things that come up so as long as we reinvest the proceeds in the business we pretty much have the flexibility we need there with no limitations. I think Chris is telling me we have a limitation in the indenture?

There's $150 million basket in the current indentures.

Okay.

So that's of the historically owned properties.

Right, right.

Okay, and then the second part of my question was, you know, given the real estate market right now, have the economics changed related to each sale lease back transaction?

Yeah, I'd say economics have changed. I mean, but again, there's still very doable and Chris, who sort of lead our effort here has been very successful in what we set out to do here and we continue to work on them just as John said.

Yeah, I think Real Estate is getting cheaper and financing is getting more expensive. That's kind of the blend of economics in the sale lease back today.

Okay. Well thank you very much.

You're very welcome. Thank you.

Your next question comes from the line of Carla Casella with JPMorgan.

Hi. You mentioned that the acquired stores expect to be positive in terms of the same-store sales this quarter. Would you say we should see that progressing throughout the quarter or you already are starting to see them comping positive?

No, we expect them to be positive really closer to the end of the quarter in total same-store sales. Again, due to the little bit longer time that it's going to take to get the prescription business where it needs to be. The front end is doing great relative to what our expectation is but we need a little more time on the pharmacy so towards the end of the Third Quarter.

And then some of the pharmacy in the stores, is part of that related, are they having a greater impact on the generics than Rite Aid because they were carrying or were pushing fewer generics in the past?

No. I don't think that. I really think it's what we talked about earlier that you lost a certain group of customers during the system conversions and through competitor activities and now that things are stabilized in the integration and all those activities are behind us, we really have full court press on getting those lost customers back and getting new customers.

Okay and you had mentioned they were doing a higher scripts per store than Rite Aid pre-acquisition. Did that actually fall below Rite Aid during the transition?

No.

Okay, just fell.

And then last question, on the cross savings going forward, have you begun any further negotiations with or do you think you have opportunity to negotiate with vendors for better volume pricing?

Well I think a lot of that was done back at the integration so I think it relates to the acquired stores, that's really a lot of the value we've gotten early on in the process. We're always working as hard as we can every day to get the best value we can from our vendor partners but I don't see any dramatic change or dynamic shift or anything like that going on in terms of that today.

Okay, great. Thanks a lot.

You're very welcome. Thank you for calling.

Your next question comes from the line of Reade Kem with Merrill Lynch.

Hello?

Hello. Sorry about that.

That's okay.

John, welcome back. I just had a quick question going back to the liquidity earlier. If you look in the second half of the year, could you tell us approximately what you think your minimum net availability will be in the course there?

I don't think, I'm trying to figure out if we traditionally done that in the past. It doesn't sound like we have, but we can tell you we're very comfortable with where we are from a liquidity position given where everything sits today. As Mary mentioned earlier we're building substantially less inventory this year for the holiday than we did last year which is a tremendous help so we think we're in pretty good shape.

Okay. Okay? Okay, and then my other question was just on comps. I was curious given the store pores that you've been doing and maybe inflation in the front end some of the front end whether that, how much that boosts comps, potentially poured stores might comp at 50% and would be my guess and I was just wondering if you could comment on that and help us understand that part of the guidance.

I'll make a quick comment and kick it to Mary. In terms of the poured stores they comp tremendously but unfortunately there's just not enough of them when you have 5,000 stores to make a huge dent in the comps so while it's certainly helpful in a broader sense when you average everything together it's not a significant driver of when we seen going on with the comps today, on an inflation side, obviously we do some work for LIFO provision and other purposes and we see a little bit of inflation in our numbers but we see the benefit of improved baskets and what not really out weighing the impact of the inflation.

And that really does answer it, both those are I think appropriate.

Thanks, good luck.

Thank you. Operator we'll take one more question.

Your final question comes from the line of Brian Hunt with Wachovia.

Thank you very much and John, welcome back. Frank I look forward to working with you again.

Thank you for calling.

No problem. My first question is on your distribution center expense targets. It seems like now that your systems are in place and all of the integration are at least the integration has been completed, there's a real opportunity to close some distribution centers. One, could you talk about the opportunity to consolidate, two, what type of working capital that could pull out of the system and then three, what is your cost savings target, when that transpires and I've got a follow-up.

Okay. Do you want to give me a hint on the follow-up or should I just dive in?

Just dive in. I don't want to give you too much at one-time.

So in terms of the distribution network, I men I think we need to evaluate that carefully. Obviously we have a fair number of DCs in the system sot extent there was some consolidation ability that would provide some savings but I don't think we're in a position right now to say we're quite far enough along in evaluation of that to announce that we're going to close distribution centers or anything like that today. In terms of working capital I think there is as we said to Meredith and others earlier I think working capital is a huge opportunity for us and I think I don't want to give exact guidance on it or something but I think hundreds of millions of dollars that we can work on here in terms of working capital and it directly relates to distribution center expenses. Obviously some of the challenges we have is we do have satellite facilities out there and other kinds of situations we're working through after the integration and so to the extent we can become a little bit more efficient with inventory and turn it a little bit better that effectively frees up square footage in distribution centers which reduces handling costs which obviously reduces expenses so we have a good opportunity to become a little bit more efficient through the I guess I'd say through the ordering and merchandising and warehousing process to really drive efficiencies in those facilities and it really takes all of us through the whole inventory process working together to kind of get at those dollars, but I think there's some real value there. I don't know if I answered your question or not.

No, you definitely beat around the bush.

Okay. What did I not answer? Do you want me to tell you we're going to close five distribution centers I can't do that today. I'm not there yet.

But that's definitely on the table?

It's definitely on the table. We're looking at it.

The first priority is where we've had to use excess space because of the inventory issues last year and just not being as efficient, bring that use down and then address the issue of the number of facilities.

Right. That's the key. I think like any of these things you want to get to value as quick as you can, it's there but you also have to be careful not to impact the service to our customers and destabilize the situation, so you go for the low hanging fruit first which is what we're doing and there's things we can do without closing a single distribution center that will bring significant value here and as we work our way through that then we start to move through some of the other issues once we see what the potential is.

And then my follow-up and this question has been posed before, but the environment has definitely changed, the multiples that are being tossed around for your California competitor are fairly high and there's a battle for that and there's going to be a winner and there's going to be a loser obviously in the situation. Do the multiples that are being tossed around and having a potential loser out there in this equation that once more stores in the West Coast market cause you to reevaluate being in the West Coast, given that your strength on the East Coast?

Our policy has always been not to really comment a lot on this subject. You always look at that question that comes up that we have very profitable business out on the West Coast. It's continued to grow and it's even grown in a difficult economic environment out there and we've made a lot of investment in it over the years, and there are some probably unique characteristics to the whole Long's transaction out there and how their valuation was determined, you know, PBM and a lot of owned real estate so you got to think about that when you think about the multiple possibility.

Okay. Thank you very much.

You're welcome. Thank you. Thank you, everyone for your interest. We may be a little slower on answering calls the rest of the day but we will certainly keep a record of anybody who calls and get back to you as quickly as we can with the response either Frank or John or myself, and or Doug and so please call if we didn't get to your question and you'll hear from us. Thank you again.

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