Rite Aid Corp (RAD) 2010 Q4 法說會逐字稿

Good morning. My name is Jennifer and I will be your conference operator today. At this time, I would like to welcome everyone to the Rite Aid fourth quarter fiscal 2010 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. I will now turn the conference over to Mr Matt Schroeder, Group Vice President, Strategy, Investor Relations, and Treasurer. Please go ahead, sir.

Thank you, Jennifer and good morning everyone. We welcome you to our fourth quarter conference call. On the call with me are Mary Sammons, our Chairman and Chief Executive Officer, John Standley, our President and Chief Operating Officer, and Frank Vitrano, our Chief Financial and Chief Administrative Officer. On today's call, Mary will give an overview of our fourth quarter results. Frank will discuss the key financial highlights and fiscal 2011 outlook. John will discuss our business. And then we will take questions.

As we mentioned in our release, we are providing slides related to the material we will be discussing today on our website, www.riteaid.com, under the Investor Relations information tab for conference calls. We will not be referring to them directly in our remarks but hope you will find them helpful as they summarize some of the key points made on the call.

Before we start, I'd like to remind you that today's conference includes certain forward-looking statements. These forward-looking statements are made in the context of certain risk and uncertainties that can cause actual results to differ. Also, we will be using a non-GAAP financial measure. The 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 remarks, I'd now like to turn it over to Mary.

Thanks, Matt and good morning everybody. Thanks for joining us today as we review our results for the fourth quarter and fiscal 2010, and provide guidance for fiscal 2011. As you can see from our release, it was a difficult quarter with mixed results. We improved front end margins as our team did a better job of managing seasonal inventory, buying down to match the decrease in demand for discretionary items that we've seen all year and once again, our team did a good job of controlling operating expenses. But these were not enough to offset lower sales, negatively impacted by a cautious consumer, and a cough, cold and flu season that started out strong in the third quarter but died out in the fourth. And, continued pressure on pharmacy margins. With everyone focused on healthcare costs, it's not surprising that we continue to see increased pressure on prescription reimbursement. Frank and John will discuss the impact in greater detail in just a few minutes.

As for fiscal 2010, last year was tough for all retailers as the economy and unemployment worsened as the year progressed. Despite these challenges, we made a lot of progress transforming our business throughout the year. We are much more efficient operators today, which will further benefit our bottom line when we start to see an economic recovery. Even though we held tight on expenses, our overall customer satisfaction rating improved every quarter as our associates continued to take great care of their customers. We delivered free cash flow for the first time in three years and started to reduce debt. And thanks to our working capital initiatives, we start the new fiscal year with a strong liquidity position, enabling us to make strategic investments in initiatives for long-term growth. These include the upcoming national launch of our customer loyalty program, called Wellness Plus, the training of additional immunizing pharmacists to get ready for the next flu season and a new private brand architecture to increase these higher margin sales.

You'll hear more details a little later from John who has done a great job leading the successful piloting of these growth initiatives, as well as launching our segmentation strategy to improve the productivity of our diverse store base. These accomplishments are just some of the reasons why, as we announced in January, that John will become CEO of Rite Aid at our annual meeting in June as I continue as Chairman. As I've said before, John brings the right combination of operational knowledge, hands-on management and financial orientation to successfully lead our Company for the future.

This morning we also gave guidance for fiscal 2011 which you can see from our release. We remain cautious about the overall economy with unemployment still around 10%, and under employment even higher, which also has a big impact on discretionary spending. We expect customers will continue to be focused on getting the best value for every dollar in a competitive retail environment. And we expect pressures on pharmacy to continue, as both private and government payers search for more ways to cut healthcare costs. Our guidance also includes investments we will be making in the programs designed for long-term profitable sales growth that I mentioned earlier. Our top priority this year is growing profitable sales.

Before I turn it over to Frank, let me just add a few comments about the recently passed healthcare reform. We expect the additional 32 million people who will be covered by health insurance in 2014 to be good for our business, as will the closing of the donut hole in Medicare part D, which begins with a $250 rebate this year, expands to 50% brand drug coverage in 2011, and is eliminated completely by 2020. We also expect that the additional fee for service opportunities for medication therapy management that are in the bill could benefit us long-term. The key will be making sure we are fairly reimbursed for those additional prescriptions and services and making sure our lawmakers understand the billions of dollars our pharmacists can save on long-term healthcare costs by making sure patients take their medicines correctly. Now, I'll turn it over to Frank. Frank?

Thanks, Mary and good morning everyone. Fourth quarter continued the challenging sales and margin trend experienced all year. On the call this morning, I plan to walk through our fourth quarter financial results, discuss our liquidity position and finally I will discuss our fiscal 2011 guidance.

This morning we reported revenues for the quarter of $6.5 billion, compared to $6.7 billion for the fourth quarter last year. The decrease in total sales was primarily driven by a reduction in total store count as well as soft front end and pharmacy sales. In the quarter, we closed 22 stores and year-to-date we closed 138 stores. On a year-over-year basis, we had 121 fewer stores. Same store sales declined 240 basis points, reflecting soft front end and pharmacy sales, with pharmacy scripts down 170 basis points. Front end same store sales were down 260 basis points, and pharmacy sales were lower by 240 basis points during the quarter, which reflects the economic environment and a weak cough and cold season. Pharmacy sales included an approximate 202 basis point negative impact from new generic drugs.

Adjusted EBITDA in the quarter was $205.1 million or 3.17% of revenues, $65.5 million below last year's fourth quarter of $270 million, or 4%. The results were driven by lower sales and lower pharmacy gross margin dollars, partially offset by lower SG&A dollars. SG&A dollars adjusted for non-EBITDA expenses were $35.5 million lower, but 33 basis points higher as a percent of sales as total revenues were down $245 million, quarter-over-quarter.

Net loss for the quarter was $208.4 million, or $0.24 per diluted share, compared to last year's fourth quarter net loss of $2.3 billion or $2.67 per diluted share. The decrease in net loss was driven by no goodwill impairment charge in the quarter, compared to the $1.8 billion non-cash goodwill impairment charge we took last year, as well as a non-cash lease termination impairment charge of $77 million this year, compared to $104 million in the same period last year, and lower income tax expense of $267 million. Without these non-cash charges, last year's fourth quarter net loss was $116.9 million or $0.14 per diluted share. Lease termination charge includes 10 stores for which we recorded a closing provision during the fourth quarter.

The LIFO charge of $44.1 million is lower than last year by $50.4 million. Last year we experienced higher front end inflation. Higher interest and securitization expense of $141.7 million, which is a $18.4 million increase over the $123 million last year, which resulted from the refinancing of our September 10 maturities. Non-cash interest, primarily debt issuance cost amortization and workers' compensation interest accretion, was $11.5 million. The total gross margin dollars in the quarter were $48.4 million lower than last year's fourth quarter, but higher by 22 basis points as a percent to sales.

FIFO gross margin dollars were lower by $98.8 million or 51 basis points. Front end dollar margins was favorable by $1.2 million, and 142 basis points, despite an $85 million sales decline and an increase in the percent of items sold on promotion. The improvement in front end margins reflects a $24 million reduction in seasonal promotional markdowns. Our pharmacy margin dollars were lower by $103 million or 1.43% of pharmacy sales, driven by lower third party pharmacy reimbursement rates, as well as lower Medicaid reimbursement rates, which are largely influenced by the AWP roll-back which went into effect in September of last year and is costing us approximately $1 million per week in reimbursement on Medicaid scripts. The lack of new generics and less benefits from generic price cost improvements have also impacted the numbers. The margin dollars shortfall was partially offset by lower distribution center costs and lower front end and Rx shrink. Product handling and distribution center expense as a a percent to sales was essentially flat to last year.

Selling, general and administrative expenses for the quarter were lower by $58 million or 6 basis points higher as a percent to sales as compared to last year. SG&A expenses not reflected in adjusted EBITDA were lower by $22.8 million or 27 basis points, primarily driven by lower depreciation and amortization and the proceeds of a generic drug litigation settlement in the prior year. Adjusted EBITDA SG&A dollars which excludes specific items, the details of which are included in the fourth quarter fiscal 2010 earnings supplemental information, which you can find on our website, were lower by $35.5 million or 33 basis points higher as a percent of sales. This reduction in dollars reflects the various cost saving initiatives that we have implemented over the last 12 months as well as store closings. The SG&A improvement was driven by better labor control and lower field controllable costs including utilities and supplies, corporate expenses were also lower. As I mentioned on the third quarter earnings call, we began to cycle the various expense initiatives that we introduced in the fourth quarter of fiscal 2009, and it was more difficult for us to fully offset the gross margin shortfall with SG&A reductions as we have been able to do in the last three quarters.

As previously mentioned, our liquidity remains strong as a result of the various working capital initiatives and lower capital expenditures. As compared to the fourth quarter of fiscal 2009, FIFO inventory was lower by $186 million, of which 60% is due to the initiatives and the balance is due to net -- to store closings. FIFO inventory decreased $297 million from the third quarter, reflecting normal seasonal sell-through. Our cash flow statement results for the quarter show net cash from operations -- net cash from the operations in the quarter as a use of $100 million, as compared to a source of $325 million in last year's fourth quarter. Prepaid rent, interest expense, as well as the timing of purchases and accounts payable payments at the end of the quarter influenced the balance. Year-to-date, net cash provided by operating activities was a use of $325 million of cash, which reflects the $555 million repayment of the accounts receivable securitization facility. Our days payable outstanding in the quarter was 22 days, which compares to 23 days in the same period last year. Net cash used in investing activities for the quarter was $36 million versus $54 million last year. This reflects our proactive plans to trim CapEx. It also includes proceeds from script file sales and the proceeds of an online auction of surplus property which netted us about $10 million during the quarter. Year-to-date net cash used in investing activities was $120 million.

During our fourth quarter, we opened one new store, relocated one store, remodeled one store and closed 22 stores. Our cash capital expenditures were $63.4 million. For the full year, we opened 17 new stores, relocated 41, remodeled eight, and closed 138.

Now let's discuss liquidity. At the end of the fourth quarter we had $945 million of total availability, including $936 million under the credit facility, and $8.5 million of invested cash. We had $80 million in revolver borrowing outstanding under our $1.75 billion senior secured credit facility with $159 million of outstanding letters of credit. Today, we have $1.2 billion of liquidity. Total debt, including accounts receivable securitization from last year, was lower by $189 million.

Now let's turn to our fiscal 2011 guidance. We developed our plan based on current trends and a continued difficult economy. The Company expects total sales to be between $25.2 billion and $25.6 billion, and expects adjusted EBITDA to be between $875 million and $975 million for fiscal 2011. Same store sales are expected to be in a range of a decrease of 1% to positive 1% over fiscal 2010. Net loss for fiscal 2011 is expected to be between $355 million and $570 million, or a loss per diluted share of $0.41 to $0.65. Our fiscal 2011 capital expenditure plans was increased to $250 million, with a $50 million allocation for file buys. We're not planning to complete any sale leaseback transactions in the year. We expect to be cash flow -- free cash flow positive for the year, and we also expect to close a total of 80 stores.

The adjusted EBITDA guidance includes the start-up cost and discounts associated with the chain-wide rollout of the Wellness Plus customer loyalty program. In addition to those costs, general accepted accounting principles require us to defer a certain portion of the revenues generated by customers as they qualify for their tiered discount benefit. A silver member must earn 500 points, while a gold member must earn 1,000 points. Once a Wellness Plus member qualifies as a silver or gold member and begins to use their tiered discount, we're permitted to recognize the deferred revenues as income to offset a portion of the tiered discount. Within each customer qualification and discount use period, which can span multiple calendar years and fiscal years, the net impact of these adjustments has no effect on the income statements, as the entries will net to zero over time. Included in our net income guidance is a Wellness Plus deferral provision range of $30 million to $40 million, which covers fiscal 2011. Fiscal 2012 will have an additional charge to reflect the full 12-month qualification period.

Our bank credit facility has a fixed charge coverage ratio test which increases from 1.05 to 1.10 beginning in the first quarter of fiscal 2011. The impact of which would limit our ability to access the last $150 million under our facility. Given our range of guidance, we may be restricted during the course of the year. Based upon our liquidity position, which we expect to remain strong throughout the year, we do not expect this restriction to have any impact on our business. Finally, we have not factored in any impact of the recently passed healthcare law. However, I can tell you that the Company does not have any significant post retiree prescription exposure. That completes my portion of the presentation. Now I'd like to turn it over to John.

Thank you, Frank. It was a very challenging quarter but a productive fiscal year, with a number of exciting initiatives launched that will bear fruit over the next couple of years. Before I get into this year's accomplishments and next year's business plan, I would like to make a couple of comments about the quarter.

The fourth quarter was a difficult quarter for us, from a sales and pharmacy margin perspective, but we did a good job managing expenses and improving front end margin and we saw sales improvement in March. Both front end and pharmacy sales were impacted by very soft flu season, bad weather and generally weak economy. As announced this morning, March front end sales improved significantly with front end same store sales increasing 1.8% versus the 2.6% decline last quarter. In March we saw a significant improvement in almost all of our core HBC and beauty categories and many of our consumable categories. Front end sales benefited in the range of 50 to 75 basis points due to an earlier Easter this year. Script count declined 1.3% in March, a modest improvement from the fourth quarter decline of 1.7%, but a good improvement from February's 3.4% decline as we are almost done cycling the impact of flu on prior year script count.

As Frank and Mary both mentioned, front end margin improved in the quarter due to a much better job this year managing seasonal inventory, although we do see some additional sales opportunities for next year. Improvements we have made to our regular inventory management processes, including lower cost on reverse logistics, also helped front end margin. Pharmacy margin declined 142 basis points in the quarter which more than explains our year-over-year decline in fourth quarter EBITDA. The decline is primarily due to less gross profit for new generics and lower reimbursement rates on both brand and generic drugs. New generic profitability declined because there were fewer new generics and this year's new generics had less margin than last year's. Brand Medicaid reimbursement was impacted by the AWP rollback and generic drugs that were new last year were heavily matched by government and managed care payers this year. We made some progress reducing generic costs although we continue to see some cost increases on single source generics but unfortunately, reimbursement rate reductions far outweighed our cost reductions. Generic penetration did increase by 2.9%, 2.94% in the quarter, but a good portion of that was due to a decline in brand drugs that was not offset by generic conversion. We did see continued strong growth in our Rx Savings Card with total members reaching $5.1 million during the quarter.

We continued to do a good job with SG&A, reducing SG&A dollars by $35 million compared to last year. As a percent to sales, we saw a little bit of reversed leverage, but did a pretty good job holding the line in a difficult sales environment. Store and administrative labor costs as well as store expenses were all well managed in the quarter. Unfortunately, and unlike the last few quarters, our improvement in front end margin and good work with SG&A were more than offset by our pharmacy margin decline. Although the quarter was difficult, there were some significant accomplishments in fiscal 2010 including the completion of the refinancing of $2.5 billion of near term maturities, giving ourselves time and liquidity to execute our turnaround.

We reduced our SG&A expenses by over $240 million for the year, by becoming a much more efficient operator. We developed and testing our Wellness Plus customer loyalty program, that will roll out chain-wide early this fiscal year. We launched our segments initiatives, including different operating models for different types of stores which will allow us to grow sales and become more efficient over the next few years. We reduced our FIFO inventory investment by $186 million. We completed a new pharmaceutical supply agreement which reduced our branded drug costs. We grew our script count for the year in comparable stores by 81 basis points. As I mentioned earlier we grew our Rx Savings Card enrollment to 5.1 million members. We made our distribution network more efficient by rationalizing the network and improving operations. We reduced our debt by $189 million, and we improved our liquidity to $1.2 billion as of yesterday.

Looking forward to fiscal 2011, I'm very excited about the initiatives we have under way, especially our Wellness Plus card based customer loyalty program. Wellness Plus has been in test markets, four test markets since last October. Over 50% of front end sales and 40% of scripts in the test markets are now on the card and consumer research tells us that the program has been very well received. If we extrapolate enrollment from the test markets to the entire chain, we should expect that we will have in the range of 15 million to 20 million members enrolled in the program at maturity. The information this program is providing us has already validated our assumption about the value of loyal customers, and our program is uniquely designed versus other retail programs to attract and retain loyal customers through tiered rewards with increasing levels of front end discounts and health benefits based on the dollar amount of front end purchases and the number of scripts filled. The program will roll out chain-wide early in fiscal year with the largest marketing expenditure that we have made in several years. This program should really help us grow front end and pharmacy sales as it gains traction throughout the fiscal year.

We will continue to roll out our segmentation based initiatives in 2011. While there is still significant segmentation based cost saving opportunities for our low volume and high volume stores, like the best ball opportunity, we will also focus on the merchandising and sales growth opportunities. From a merchandising perspective we'll be working on the low volume stores, urban stores and health and wellness stores. We will also add 105 new GNC departments in existing stores. From a segmentation sales growth perspective, Wellness Plus will really help us attack those stores where we are underpenetrated on either the front end or the pharmacy.

Another exciting initiative for fiscal 2011 is the expansion of our immunization program. We will increase the number of Rite Aid immunizing pharmacists from 2,000 in fiscal 2010 to over 6,000 in fiscal 2011, which will give us a strong presence in most of our major markets. A very important initiative this year is the rollout of our new private brand architecture that will occur throughout this fiscal year and into next year. The new architecture will include the following new brands. Rite Aid pharmacy will be the new brand for health products. Renewal will be the new brand for beauty products. Pantry will be the new brand for food and certain consumable products. Home will be the brand for house hold goods. Tugaboos will be the brand for baby and Simplify is our new price fighter brand. All of our existing private brand products, with a few exceptions, will be migrated over time to these new brands with new, more contemporary packaging. This new brand architecture combined with strong promotional support, good price positioning and continued development of new items will help us grow private brand sales and meet the needs of today's consumer.

Our continued focus on improving customer service should help us grow sales this year. In addition to our ongoing store level initiative, which allows us to track and improve customer service on a store by store basis, we are working on improving in stock conditions, primarily around advertised items and planogram changes. We also have an initiative underway called project simplification that is helping our associates find better, more efficient ways to operate our stores, which should help improve conditions and help them provide better customer service. A big focus area will obviously be pharmacy margin.

It will be a soft year again for new generics based on what we know today, particularly in the first half. But in the second half, new generic profitability will be much closer to fiscal 2010. It is important to note that often new generics come to market unannounced, so we will probably get some help along the way. On the reimbursement rate side we will continue to work with our managed care providers to try to find some relief. We are working very hard on the purchasing side, looking for opportunities to lower our generic cost, and we have the benefit of our new supply agreement with McKesson, which will help us with our brand cost. Because there were fewer new generics in fiscal 2010, we are expecting some moderation in reimbursement rate reductions.

The other big thing we will do to improve pharmacy profitability is grow script count by continuing to improve customer service, growing our Rx savings program, purchasing script files and attracting and retaining high value pharmacy customers. Which takes us right back to why Wellness Plus is so important. Ultimately, if we can differentiate ourselves with pharmacy service and Wellness Plus, then we can gain some leverage with managed care because employers will request that Rite Aid be included in their networks in order to obtain our services and Wellness Plus benefits for their employees.

In terms of cost savings, the segmentation and project simplification initiatives that I've already mentioned will help us to continue to successfully manage and reduce our cost. In addition, our indirect procurement group will help us reduce the cost of merchandise and non-merchandise purchases. For the year, we are expecting our initiatives are worth about $340 million of EBITDA, most of which will be offset by cost increases, and pharmacy reimbursement rate reductions which is why the midpoint of our EBITDA guidance is flat to last year. Included in our cost increases are the expenses that we will incur to roll out Wellness Plus. Of this year's $340 million in initiatives, approximately $100 million is from our segmentation goal of $550 million. We estimate that we obtained $150 million of the segmentation goal in fiscal 2010, leaving us with a $300 million opportunity after this year's savings are achieved. With that, we are now ready to take questions.

(Operator Instructions) We'll pause for just a moment to compile the Q&A roster. Your first question comes from Bryan Hunt with Wells Fargo Securities.

Good morning.

Good morning,.

Thank you for all the detail. I was wondering, when you look at your segmentation opportunity for 2010, where do you feel like the biggest opportunities are and could you talk about, again, what you achieved in 2009 from segmentations, and where the biggest gains were -- came from?

Sure. We'll start with fiscal 2010, or calendar 2009. We made our -- probably our biggest gains in really working with our low volume stores. We made significant kind of structural changes in the way we operate those stores and there were significant cost savings and increases in profitability in those stores. If you exclude the pharmacy margin impacts. So we made a ton of headway there. We also started to make some progress in our higher volume stores with our best ball initiative, but we still have a lot of ground to gain there.

Where some of the biggest segmentation opportunities are still at are related to sales. I think we talked a lot about, we have group of stores that are underpenetrated either on the front end or the pharmacy and this is where Wellness Plus really matches up nicely with where the opportunity is in segmentation. Because it really provides us some powerful information to work with the situation where maybe we have a strong front end and a weak pharmacy or vice versa, to really see if we can connect with the consumer that's already coming to that store and get the rest of their business. So that's where there's I think a really huge opportunity coming up for us. Obviously, we've got to get Wellness Plus rolled out. We've got to get -- get it engaged and that will take a good part of the year to do but that will be part of the segmentation this year.

In addition to that, there are still cost saving opportunities that come out of segmentation. There's still some work to do with our lower volume stores that we're very focused on. So we've got that, and there's some merchandising opportunities where we're really segmenting stores, not just by the kind of stores that we have, but by the customers that the store has. So I think when you stir all those things together we still see a lot of opportunity with our segmentation based initiatives.

As a follow-up, looking at Wellness Plus and where you tested it, what type of tangible benefits did you receive in terms of sales momentum and profitability enhancements?

I think the --

Were the give-aways in terms of improved volumes and what you're giving back to the consumer, did those give-aways eat away on the margin generated from excess sales? And that's my last follow-up, thanks.

What I would tell you right now is that the margin on a rate basis in the Wellness Plus markets is very consistent with where it was before we rolled it out. In terms of sales growth, initially we didn't see a lot of sales growth. I think we're starting to get a little bit of momentum in those markets today.

There's a couple of dynamics to this thing. First of all, the way the card program works, you do need the card to get our other discounts. So there's some savings that occurs on the markdown line but you need the card to qualify for ad discounts and other discounts that we have in the store. That really gives us money to invest with our loyal customers. The second aspect is that our vendor partners have really kind of jumped onto this thing and are going to support this program and that's also going to provide us additional monies to invest in sales growth. So I think as the thing plays out over time, what you're going to see is that it's going to give us the opportunity to, again, really connect with that loyal customer and attract more loyal customers and we're going to have some savings that are created by the program and some additional vendor funds to invest and we're going to use all that to really try and attack sales.

Thank you for your time.

You're welcome. Thank you.

Your next question is from Meredith Adler with Barclays Capital.

Hi, thanks. Couple questions. I'd like to start just talking a little bit about reimbursement rates in generics and maybe you could just talk again about kind of what the impact of -- I think you talked about [Mack] coming very quickly and that you also weren't seeing the kinds of reductions in generic costs that you had been seeing, I guess in part because there are just fewer generics but maybe you could talk about that a little bit.

Sure. I think there's a couple of different dynamics that are moving around here inside the pharmacy margin. A year ago in the fourth quarter, we had fairly strong profitability from new generics and new generics give us gross profit that really subsidize's, quite frankly, poorer reimbursement rate on other drugs. It all balances out at the end of the day to give us the margin that we have. As our new generic profitability has declined year-over-year, we have less profit from new generics this year. We have seen reimbursement rates that are equal to or exceed reimbursement rate declines that we've had had last year. So we no longer have as much profitability from new generics to help subsidize those reimbursement rate reductions, so that's a big factor that's impacting our margins today.

On top of that, while we did make some substantial savings on the cost side, we also saw some cost increases and so there are some generics that actually kind of went backwards and became single source, couple of big ones in particular that cost us a lot of money, and so the combination of those dynamics has really put a lot of pressure on pharmacy margin. Then you have the AWP rollback where with Medicaid scripts we really didn't get made whole and that cost us some money in the quarter as well and you start stirring all those things together and you get the kind of difficult answer that we got this quarter on the pharmacy margin.

And would you say that all the commercial payers made you whole on the A&P rollback?

For the most part. There were a couple that didn't but 99% of them did.

And then you made a another comment about with the new loyalty program you think that will create excitement amongst employees and that will give their employers a reason to include you in their networks. Has that been an issue or do you get lower reimbursement because for some reason Rite Aid is not as popular?

I don't know what everybody else's reimbursement rate is. My goal is to improve my existing reimbursement rate. I'm not aware that my reimbursement rate is worse because we are not popular, because I think we are popular. We have millions and millions of customers and obviously we do a lot of business.

The issue for us is to try and gain more leverage with the managed care pricing. And I think the way we do that is providing the best service that we can at retail and having a very compelling offering. That creates demand. Demand works its way backwards up through the supply chain and hopefully encourages PDMs to want to have us in their networks, which I think they do, but creates more demand for that which hopefully in the long run gives us more leverage to demand things to be included. That's where we need to get to. Because the pricing equation today doesn't seem to be working that good for us.

Switching gears a little bit, you had a initiative this past year to address real estate costs for some of your most underperforming stores. Could you just comment about how that went and what you're thinking about those most underperforming stores. You closed over 100 this year and you're talking about 80 this coming year, but I think there were more than that you were addressing real estate costs on.

Meredith, it's Frank. Initially we looked at a population of about 500 stores that kind of fit that build, that they were underperforming stores and we were looking at a number of different ways in order for us to kind of turn around the profitability, some of which was operational. But we also looked at the other expenses on the P&L, one of which was obviously what we were paying in rent and we embarked on an effort to go back to our landlords and look for rent concessions. And we were able to achieve rent concessions in about 200 locations which will have -- again, our annual rent is just over $1 billion so it's not going to have a huge impact on $1 billion number, but we're going to get savings here of $20 million to $25 million.

Okay. Great. And have the profitability, all the initiatives in total, reduced the number of stores that are underperforming at this point?

I would say yes to that. There's always going to be a group of stores that are kind of on the list, if you will, and again, there's a lot of reasons why you get on the list. Maybe some recent sales performance, could be some competitive hits, whole host of reasons.

Pharmacy margins.

Pharmacy margins. We're continuing to monitor kind of a group of stores here. We do it on a quarterly basis, to see what's the most -- the best way to address some of the shortcomings and the profitability of that store. My ultimately would lead to a closing and we do have a provision in our guidance today to close up to 80 locations.

Okay. Great. I'm sorry. Just one final question about pharmacy file buys. Did you buy any files in fiscal 2010? Sounds like you're going to spend about $50 million next year.

Yes, we did. We probably spent about -- in file buys, we probably spent about $10 million to $11 million.

Okay. Great. Thank you very much.

Your next question is from Carla Casella with JPMorgan.

Hi. One question on the Wellness Plus program. How much of the SG&A cost do you expect to be for that program?

We didn't give you that number. We'll talk about it on a postmortem basis, but we're not going to signal ahead what we're doing.

Okay. And then the vendor partners you talked about, it sounds like that's going to reduce your advertising budget as you get your vendor partners just to spend some of that for the Wellness Plus program. Is that correct?

You said reduce our advertising budget. They're going to invest to support price and other promotions to drive sales. Okay. And then one housekeeping item. Did you -- how much of your $1 billion in rent is for dark stores?

Our ongoing dark store -- the cash on the dark stores is about $100 million, but that's not in the rent expense.

Okay.

We accrued up that liability.

Okay. Great. That's helpful. And then I don't think you disclosed the capacity that you have to issue additional first or second lien debt or any debt that would be senior to the first and second lien debt.

Carla, this is Matt. We basically don't have any additional capacity to issue secured debt if you assume a full draw on a revolver.

Okay. That's what I thought. And then do you have a -- you mentioned you expect to generate cash flow for 2011. Do you have a debt reduction target or a leverage target?

We haven't -- we clearly do expect to generate some free cash flow and the use of that is to pay down debt. We haven't necessarily disclosed the number yet.

Okay. And then just one last question, following up on Meredith's question on the gross margins. I guess if you looked at one generic drug in particular, does the margin trend over time, has that changed in this environment? I guess I'm saying, does generic margins come out lower than they were initially and decline faster? Is that what's going on?

Yes.

Okay. And that's -- some of that should continue, correct?

Yes.

Okay. Great. Thank you.

You're welcome.

Your next question comes from the line of Karru Martinson with Deutsche Bank.

Good morning. In terms of the pharmacy reimbursement rates, do you still feel the full year impact is going to be about $52 million from the AWP rollback in September?

Yes, it's right in that range.

Okay. And then for the quarter, what was the weather impact from the snow storms that rolled through kind of the northeast and the Mid-Atlantic?

I don't know if we quantified an exact number, but if you look at February sales, they were pretty tough and a good portion of that was driven by weather. Our business is a little different than the supermarket business. Where some of us were a few years ago, everybody shows up before the storm and they buy up and you move the sales around. Our business is a little bit more of a convenience business. A lot of markets, you lose it and you don't get it back. It's a little different that way.

If you look at February, we basically went back and looked at the three or four storms that we had on the east coast, if you took out the day before, the day of and the day after the storm and reran it, it probably impacted the front end same store sales in the month of February, probably 200 basis points. So it was pretty significant.

Okay. Now, the guidance range that you have given, it's fairly wide guidance range. The last couple of years we've gone back and revised those numbers. What's your confidence level with the guidance as you kind of look out for the year?

I'll tell you, I feel very good about where our retail business is and if you look at this last year, had pharmacy margin been more stable we probably would have exceeded the guidance that we gave. And that's going to be the same challenge that we faced this year. The volatility in our number right now is really driven around the pharmacy margin number. I'm excited and confident that we're going to continue to make great progress here with our retail business. It's really what's the pharmacy profitability going to be. A little bit of the unknown for us is we don't always have visibility into what we're going to get reimbursed. It's a difficult thing to get insight into, so that's why we have a range around this and that's what we're sort of fighting as we go through the year.

With that reduced kind of visibility on a pharmacy margins going forward, do you still feel the valuation of the script file, that's still in the 10 to 20 per script range?

That's a great question. We're kind of staring at that too. I think we've got to kind of see how things develop this year. We're working really hard on the cost side and I think we're going to make so progress there and that may restore the profitability of the value of the the script that's declined a little bit this year, but we've got to see how that plays out.

Just lastly, we've seen some large acquisitions take place in the market. Kind of what are your thoughts on going forward in terms of your network, both east coast and west coast, and kind of the competitive pressures as new people enter into markets?

We're excited about the network that we have and our challenge is to make that network work. Having said that, and we've said it a thousand times before, we're going to do what makes sense and what's right for all of our stakeholders. So that's our plan.

Thank you very much. Appreciate it.

Your next question is from Mary Gilbert with Imperial Capital.

Good morning. Could you give us an idea of how we should look at working capital for this year? Are there opportunities to generate cash? Where are you in your supply chain and your efficiencies?

Mary, in terms of from a working capital perspective, we still think there's opportunities for us to take additional inventory out of the system. We're targeting somewhere around $100 million to $110 million of additional inventory that we can take out of the stores and/or distribution centers.

For this year?

For, yes, this coming year, Mary.

Okay. So we should look at working capital as being a source of cash. And then just following up on the dark rent of $100 million, I thought that number was coming down by about $10 million annually. So I was thinking -- and I thought it was going to be somewhere around $11 million for this year, so I was thinking it was going to be somewhere around 89.

What happens is you do have a -- from year to year, it declines as we kind of roll -- as the lease payments roll off, but as you recall, we did add 138 stores into the reserve, so that kind of offset the decline.

Okay. So in looking at fiscal 2011, we're still looking at $100 million cash impact from dark rent?

Correct.

Okay. That's very helpful. And then in looking at some of the initiatives that you're working on this year, the investment that you're making, and the $340 million EBITDA opportunity that you're talking about, is this something that we'll see in fiscal 2012?

I think we'll get -- our goal is to get the 340 in this fiscal year. The challenge that we face is there are some cost increases to offset and really what's going to happen in the pharmacy margin are the two kind of things that are offsetting that in the guidance.

Okay.

We think there are significant initiatives for 2012. There's still a big chunk of our segmentation that we'll get in 2012 and some other things that we're working on that will help in 2012 as well.

Based on that, do you think we could get to over $1 billion particularly with the tailwinds from new generics?

That's a good question. We're going to probably at some point give guidance for 2012. That is a real positive in 2012 that's going to help us on the pharmacy margin side, so that -- I'm hopeful that's going to be a good year, but I don't think we're ready to give guidance on it yet.

One last thing. What should we be thinking on and what are some of the critical issues coming out of the healthcare bill and what the impact could be for Rite Aid?

Well, I think if you think about, Mary, what's happening with getting 32 million more people insured in 2014, obviously we think that will be good for the business long-term. That doesn't happen for a few years here. The biggest positive impact for us. There are a few things that happen right away, where you've got the $250 credit to help close the -- start closing the donut hole this year and you have the 26-year-olds getting to stay on their parents' policies. So those are small things that will help this year but the big win is really three years from now.

The other sort of not totally known impact is what's going to happen with AMP going in. We know that it will be definitely a hit to reimbursement compared to what we are experiencing today. But it's much better than what was going to happen to pharmacy if the whole DRA had gone into effect, that the injunction stopped. But that we won't know fully the impact until the CMS gets the rules established for the manufacturers reporting their AMPs to be able to come up with the average weighted AMP. I think the language in the House bill was certainly the best in terms of the language out there for pharmacy, at the no less than 175% of the average weighted AMP and we expect that, at the earliest, that would come into play end of September, October 1, but potentially longer than that. It all depends on how long it takes them to write the rules. I think Frank or John mentioned in their comments that we don't really have any negative impact from the whole pension issue, so that's a positive for us.

Great. Thank you very much.

Operator, we'll take one more question.

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

Thanks and good morning. It's actually Mike Minchak in for Lisa. Just a couple quick questions here. First, on the pharmacy reimbursement issue, you mentioned pressure from both private payers and Medicaid. If we exclude the impact from the A to B fee change, on a relative basis are you seeing more pressure from the Medicaid side or the private payer side?

On a percentage basis, I would say it's pretty challenging on both sides. Medicaid on the generic side we saw a number of federal upper limit go into effect in the last year, particularly related to the new generics last year. So we saw a very big percentage decline in reimbursement from Medicaid in the last year. For managed care obviously it's substantially more dollars and is much more impactful to our margin and we've seen pressure on that side as well. So it's really on both sides.

Secondly, in terms of the same store sales guidance, what are you sort of baking into those expectations regarding flu for next year. Are you expecting more of a similar to flu season to this year, meaning a relatively weak one, or sort of more of a normalized flu season?

Kind of more of a normalized flu season.

Okay. And then finally, you talked about your plans on the new private label architecture. Where do you currently stand in terms of penetration and where do you think it could ultimately go and over what time frame?

I think for the fourth quarter we were at 15.3% was our penetration of private label. I personally believe there's still another 100 to 200 basis points here of pharmacy margin penetration for us to get over the next year or two.

Thanks for the comments.

Okay.

We're done. Okay. Thank you very much. We appreciate it. And we'll talk to you soon.

Thank you, ladies and gentlemen. This does conclude today's conference call. You may now disconnect your lines.