Rite Aid Corp (RAD) 2013 Q1 法說會逐字稿

Good morning. My name is Holly and I will be your conference operator today. At this time, I'd like to welcome everyone to the Rite Aid first-quarter fiscal 2013 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).

I would now like to turn today's conference over to Matt Schroeder. Please go ahead, sir.

Thank you, Holly, and good morning, everyone. We welcome you to our first-quarter conference call. On the call with me are John Standley, our Chairman, President and Chief Executive Officer; and Frank Vitrano, our Chief Financial and Chief Administrative Officer.

On today's call, John will give an overview of our first-quarter results and discuss our business, Frank will discuss the key financial highlights and fiscal 2013 outlook 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, including annual earnings and sales guidance, on our website, www.RiteAid.com under the Investor Relations information tab for conference calls. This guidance is a point-in-time estimate made early in the fiscal year. The Company expressly disclaims any current intention to update it.

This conference call and the related slides will be available on the Company's website until the next earnings call unless the Company withdraws them earlier and should not be relied upon thereafter. We will not be referring to the slides 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 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 can cause actual results to differ. These risks and uncertainties are described in our press release, in Item 1A of our most recent annual report on Form 10-K, and other documents we file or furnish to the Securities and Exchange Commission.

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. With these remarks, I would now like to turn it over to John.

Thank you, Matt, and thank you all for joining us this morning to review our fiscal 2013 first-quarter results. We continue to make strong progress thanks to a companywide focus on executing key sales initiatives, taking good care of our customers and operating more efficiently. As a result, we have now grown same-store sales and adjusted EBITDA for six consecutive quarters, and I would like to take this opportunity to thank our entire Rite Aid team for their hard work in driving these positive results.

During the quarter, same-store sales increased by 2.5% over the prior-year period, including a 2.7% increase in the front end and a 2.4% increase in the pharmacy. Prescriptions filled at same stores increased by 3%, which is primarily due to additional prescriptions resulting from the Walgreens-Express Scripts dispute.

Adjusted EBITDA for the quarter increased $11.3 million from the prior year's first quarter to $274.2 million. The increase in adjusted EBITDA was driven by our strong top-line results and an improvement in pharmacy gross margin, partially offset by a $20.9 million charge to settle certain class action lawsuits. The improvement in pharmacy gross margin was the result of new generic drugs that have come to market in the past several months, which have increased our generic drug penetration by over 3% to 79%. This improvement was partially offset by pharmacy reimbursement pressure.

The increase in our generic penetration combined with the expected future significant reduction in generic drug costs will cause our sales per script, and correspondingly, our pharmacy sales to decline for the remainder of the year.

Net loss for the quarter decreased by nearly $35 million compared to the prior-year period, an improvement driven by our higher adjusted EBITDA and decreases in depreciation and amortization expenses and lease termination and impairment charges. We also ended the quarter with over $1.1 billion in liquidity, giving us ample resources to operate our business.

In terms of key sales initiatives, our wellness+ customer loyalty program continues to be a game-changer. The number of active members, defined as those who have used their card at least twice in the past 26 weeks, was 25 million at the end of the quarter, an increase of 11% over the same period the previous year and consistent with last quarter.

Card usage continues to be strong, as members accounted for 75% of front-end sales and 69% of prescriptions filled in the first quarter, compared to 67% and 62% respectively in last year's first quarter.

Members continue to take advantage of the value we offer through the program, including both tiered discounts received by achieving various point levels and through product-specific +UP rewards. In fact, we issued nearly 14 million +UP rewards in the first quarter.

In the pharmacy, we continue to focus on delivering additional clinical services to more patients. Last year's flu vaccination program was very successful, and we were able to build on that success through our shingles vaccination campaign in the first quarter. We more than doubled our number of shingles vaccinations during the quarter due to our additional focus on this opportunity and increased availability of the vaccine from the manufacturer.

We are now shifting our focus to immunizations for children entering school, especially in terms of pertussis vaccinations. And soon, we will be ramping up this year's flu shot program. We expect to substantially grow this area of our business now that most of our pharmacists have had at least one full year of providing a variety of immunizations, and as more consumers become aware of how convenient it is to receive their vaccination from a Rite Aid pharmacist.

According to the New England Healthcare Institute, poor medication compliance leads to $290 billion in avoidable healthcare spending each year. At Rite Aid, we are using our new Rite Care Prescription Adviser to help our pharmacists conduct highly-focused discussions with patients who need help in improving their medication compliance. During the quarter, our pharmacists consulted with nearly 300,000 patients using this tool. We believe that one-on-one interaction with a pharmacist is an effective way to help patients understand the importance of taking their medications as prescribed.

Our store remodeling initiative is gaining momentum, as we continue to convert high-volume stores to our groundbreaking new Wellness format. For the quarter, we remodeled 143 stores and are on pace to reach our goal of completing 500 remodels during fiscal 2013. We had a total of 423 wellness stores by the end of the quarter and plan to have 780 by the end of the fiscal year.

Our Wellness stores are designed to help customers in their pursuit of health and wellness by offering hundreds of new wellness-related items and expanded clinical pharmacy services. By bringing this format to additional stores, we are increasing patient access to important services such as medication therapy management and diabetes care.

In addition, the unique interior design of these stores provides easier access to the pharmacy and enhances the overall shopping experience. We continue to see a positive impact on the front-end sales of these stores versus the chain.

We have now trained 680 Wellness ambassadors to work in our stores, and we are pleased with how these associates are providing a level of service that differentiates us from the competition.

As noted during our last call, we recently completed the conversion of more than 2900 items to our new Rite Aid brand architecture. During the quarter, customers continued to respond positively to our new package design and new brands. Private brand penetration increased to 17.9%, a 2.3% increase over the prior year's first-quarter penetration. Also in the quarter, we completed $9 million in prescription file purchases.

I'll turn it over to Frank to provide additional financial details on the quarter, as well as our revised outlook for fiscal 2013. But in summary, we are pleased with the progress we are making in our turnaround efforts and are working hard to ensure continued success as we move forward. Frank.

Thanks, John. Good morning everyone. As John mentioned, first-quarter sales and earnings were strong, reflecting good progress in our turnaround and the benefits of the various initiatives we've been working on, as well as new ESI business.

This is a sixth consecutive quarter of EBITDA and same-store sales growth. On the call this morning, I plan to walk through our first-quarter fiscal results, discuss our liquidity position, certain balance sheet items, our capital expenditure program, and finally update fiscal '13 guidance.

As previously reported, revenues for the quarter were $6.5 billion, which was a 1.2% increase to last year's first quarter. This was the fourth consecutive quarter of total revenue growth, reflecting the improvement in same-store sales and fewer store closings. In the quarter, we closed 15 stores and did not open any net new stores. On a year-over-year basis, we operated 52 net fewer stores.

Same-store sales increased 2.5% in the quarter, reflecting the positive impact of wellness+ and positive script count. Front-end same-store sales were up 2.7%, and pharmacy same-store sales were higher by 2.4%. Pharmacy same-store comp scripts were positive 300 basis points, primarily driven by the new ESI scripts.

Pharmacy same-store sales were positively impacted by strong script growth, but included an approximate 326 basis point negative impact from new generic drugs. We expect the negative sales impact of new generic drugs to increase throughout the year.

Adjusted EBITDA in the quarter was $274.2 million, or 4.2% of revenues, which was $11.3 million or 4.3% higher than last year's first quarter of $262.9 million, or 4.1% of revenues. The new incremental ESI script benefit in the quarter is estimated to be $15 million to $20 million. We believe we are getting our fair share of new ESI scripts.

The results also include a $20.9 million or $0.02 per share litigation provision in connection with a proposed settlement of 15 wage and hour class-action lawsuits.

The overall results were driven by favorable sales and script trends, improved gross margin trends and continued expense control.

Net loss for the quarter decreased to $28.1 million, or $0.03 per diluted share, compared to last year's first-quarter net loss of $63.1 million, or $0.07 loss per diluted share. The net loss improvement was driven by higher adjusted EBITDA, lower depreciation and amortization expense of $11 million and lower lease termination and impairment charges.

As part of the 2006 acquisition agreement, Rite Aid was indemnified by the Jean Coutu Group for tax liabilities related to any pre-acquisition-period tax audits of Brooks Eckerd. The IRS finalized its audit of Brooks Eckerd for all years ending up to and including the acquisition date of June 4, 2007, resulting in no tax payments. As a result, we recorded an income tax benefit of $60.2 million in the quarter related to the settlement of these pre-acquisition-period tax audits and recorded a corresponding charge in selling, general and administrative expenses for the reversal of an indemnification asset related to this matter from the Jean Coutu Group. The tax benefit and the corresponding SG&A charge had no impact on net loss, adjusted EBITDA or cash flow.

The Company also recorded a $17.8 million or $0.02 per share loss on debt modification as a result of the refinancings completed in the first quarter. You recall on the fourth-quarter call I commented that our guidance didn't include any provision for the Jean Coutu tax settlement or any refinancing. However, it is now included in our updated guidance. The litigation settlement and the loss on debt modification impacted net loss by $0.04 per share.

Total gross margin dollars in the quarter were $57.9 million higher than last year's first quarter and 58 basis points higher as a percent to sales. FIFO gross margin dollars were higher by $56.6 million, or 56 basis points, and adjusted EBITDA gross profit, which excludes specific items, primarily LIFO and the wellness+ revenue deferral, the details of which are included in the first-quarter fiscal '13 earnings supplemental information, which you can find on our website, was favorable to the prior year's first quarter by $56.8 million and 55 basis points as a percent to revenues.

Front-end gross profit was higher, and the rate was lower, driven by strong Rite Aid brand penetration, partially offset by high-tier discount investments related to wellness+ customer loyalty program. Pharmacy gross profit dollars and rate were both higher, with the benefit of new generics, partially offset by continued pharmacy reimbursement rate pressures.

Selling, general and administrative expenses for the quarter were higher by $102 million or 128 basis points as a percent to revenues as compared to last year. SG&A expense not reflected in adjusted EBITDA was higher by $56.3 million, primarily due to the reversal of the Jean Coutu tax-related indemnification asset previously discussed.

Adjusted EBITDA SG&A dollars, which excludes specific items, the details of which are again included on the first-quarter fiscal '13 supplemental information package, were higher by $45.5 million or 43 basis points as a percent to revenues. The increasing dollars primarily reflect the $20.9 million class-action lawsuit settlement, as well as a $9.1 million increase in holiday pay, as Memorial Day fell in the first quarter of fiscal '13, but was in the second quarter of fiscal '12. Without the Memorial Day shift and the class action lawsuit settlement, adjusted EBITDA would have increased 15.7% versus the 4.3% increase reported.

Turning to the balance sheet, FIFO inventory was $37.9 million higher than the first quarter of last year and $98 million lower than the fourth quarter of fiscal '12. Relative to the first quarter of last year, the increase reflects pharmacy brand inflation, as well as incremental store pharmacy inventory as a result of the new ESI scripts.

Our cash flow statement results for the quarter show net cash from operating activities in the quarter as a source of $364 million as compared to a source of cash of $385 million in last year's first quarter. Lower inventory and receivables, as well as the timing of accounts payable payments last year influenced the balance.

Net cash used in investing activities for the quarter was $75.7 million versus $48.4 million last year, and also includes proceeds from script file sales.

During the first quarter, we relocated two stores, remodeled 143 stores and closed 15 stores. We have now completed and grand reopened 423 Wellness remodel stores and expect to have 780 completed by fiscal '13 year-end. Front-end sales in the remodeled stores continue to improve above the chain average.

Now let's discuss liquidity. At the end of the first quarter, we had $1.151 billion of liquidity, including $102 million of invested cash. We had no revolver borrowing outstanding, and we had $125 million of outstanding letters of credit. Today, we are just under $1.2 billion of liquidity.

Total debt, net of invested cash, was higher by $12.5 million from last year's first quarter. Our leverage ratio, defined as total debt less invested cash over LTM-adjusted EBITDA, improved to 6.5 times from 6.9 times.

Now let's turn to fiscal '13 guidance. We are updating our guidance based on current sales trends, including continuation of existing incremental ESI script trends, benefit of the generic wave and generic cost controls, a challenging reimbursement rate environment and continued investment in our customer loyalty program to grow sales, as well as an increase in capital expenditures. The Company expects total sales to be between $25.3 billion and $25.7 billion and expects adjusted EBITDA to be between $950 million and $1.025 billion for fiscal '13.

Same-store sales are expected to be in a range from a decrease of 50 basis points to up 100 basis points, which reflects the anticipated negative pharmacy sales impact of approximately 600 basis points from new generic introduction compared to the 520 basis points in our original guidance.

Net loss for fiscal '13 is expected to be between $248 million and $103 million, or a loss per diluted share of $0.29 to $0.13.

Our fiscal '13 capital expenditure plans remain at $300 million, with $130 million allocated to remodels and $50 million for file buys. We are planning to complete 17 relocations and remodel 500 Wellness stores. We are not planning to complete any sale-leaseback transactions and we expect to be free cash flow positive for the year.

We expect to close a total of 50 stores, of which the guidance includes a store lease closing provision to close 15 stores, with the balance of the stores closing on lease expiration.

This concludes my portion of the presentation. I would now like to open the line up to questions. Holly.

(Operator Instructions) Ed Kelly, Credit Suisse.

Nice quarter, guys. You raised guidance by more than it seems really, right? Because you have this $21 million litigation settlement in here. So can you maybe just talk about what the bigger drivers of the upside are that caused you to do that?

What we said when we released guidance in the end of the fourth quarter was we thought we'd get to the higher end of the range based upon our ability to continue to receive and maintain the ESI scripts. Okay? And right now, we are continuing to expect to be able to retain the ESI scripts, and that drives us to the higher end of the guidance.

I think the other thing I would touch on too is we did a good job in the quarter on the pharmacy margin side, particularly on the cost side. And so we are continuing to work really hard to make progress with the new generics in the pharmacy margin and I think we saw some good benefit there that was encouraging also.

Any reason that you don't exclude the $21 million charge in the guidance? It is one-time, right?

You could go either way on that, Ed, honestly.

Okay. And then on the gross margin, you had nice gross margin this quarter. Can you maybe give us a little bit of color on how the generic benefit is playing out relative to your expectation and what it is telling us about reimbursement rates overall?

Reimbursement rates remain, honestly, very challenging in many different directions. It is still a very difficult reimbursement rate environment. I would say on the generics side, probably like I had mentioned, I think where we're probably a little better than I expected is I think on the cost side. We probably came in a little stronger or a little more efficient than we originally budgeted or forecasted when we built our plan. So I would say we are a little bit ahead on that side of the equation at the moment. And that is -- obviously, pharmacy margin was one of the drivers in this quarter.

The impact of the generics looks like it's probably going to double from here at some point this year, so we should think about the gross margin as more opportunity on that front the rest of the year as well, I think. Right?

Well, again, it is our expectation as we continue to take cost out that we will remain under reimbursement rate pressure. So as we've talked about all along, there is a give and a take on this thing, unfortunately.

If we were to exclude generics, the benefit from the incremental generics that were launched, do you think your gross margin would be flat, up, down?

I would say down.

You think it's down?

Flat to down.

Yes, flat to down.

Okay. And just last thing for you, on the Walgreens front, can you maybe talk a little bit about what you are doing to make sure that the WAG scripts that you are getting are sticky even if there is a settlement at some point? And also what you are doing to capture the potential incremental front-end spend. And not the incremental front-end spend that customer makes when they are filling the prescription, but the other times of the month, where maybe they are still going to Walgreens to do some other convenience-based trip that you potentially could capture at some point.

I think we are in a great position to capitalize on the opportunity here. Wellness+ is really designed to do just what we are trying to do here. So as we work with these customers and try and provide them great service, we are also trying to engage them with wellness+. If we get them into wellness+, they are earning points with their scripts, which gives them the potential earned discounts on the front end and really convert them from a pharmacy to a front-end customer, and hopeful encourage them to be a great, loyal customer with us going forward.

Okay. One quick thing before I go here. Can you just remind us -- the customer loyalty revenue deferral adjustment that is in the EBITDA, what exactly does that relate to again? I feel like I knew this at one point and --.

That relates to an accrual -- basically, a deferral of points that somebody earns when they are earning up to a point level. And then it's some revenue that -- when earning up to a point level, and then we would then have -- take that revenue when they are getting the discount. So what it basically does is it kind of smooths the person's purchases between -- or the revenue over the purchase stream between the time before and the time after they get to the tier level that they would get to.

Okay, thank you.

John Heinbockel, Guggenheim Securities.

A couple of things. Did I hear you right -- the ESI EBITDA benefit was -- did you say $15 million to $20 million?

Yes.

Okay. Why a range as opposed to an exact number? I'm curious.

It is not an exact science in terms of trying to identify what would be a true incremental new ESI customer, because there are some switches from period to period. So we tried to give you some -- kind of our best (technical difficulty) in terms of what we think it is going to be.

I think there is some judgment required in how much variable cost we apply.

When you look at the prior quarter -- and I know that was only two months -- but it looks like there was a little bit of a step-up sequentially. Is that cost -- incremental costs going away or something else?

We had some incremental advertising costs here in the fourth quarter related to that.

And we continue to gain some customers.

Right.

Is the $15 million to $20 million a decent run rate, assuming no settlement, until you cycle? Or do you think something -- for some reason it is not a good run rate?

I think that is probably representative.

Okay (multiple speakers).

When you look at -- have you been able to track the new ESI pharmacy patients, how many of those and what percent of those have signed up for wellness+ that become card members, or is that too hard to tell?

It appears to be sort of lining up with our broader numbers. So when we look at the penetration of transactions, it is approaching kind of where we are with the whole thing.

Okay. And when you think about wellness+ in this environment, particularly if you get to silver or gold, would think that value proposition would resonate more. How do you think about kind of stepping up either more the visibility of that going forward? And what do you do, if anything, -- do you sort of think you need to do something when Walgreen launches their card in September? Do you hold some spending back for that or no, not really?

We are not going to give away all of our secrets, John. Come on. But I think your first comment is a great one, and we are going to be out there continuing to explain to consumers the value of wellness+, the value of the tiered discount, the value of the +UPs, and tying the relationship of the front end of the store and the pharmacy together. That is really a very critical message. And I think there is still a lot of opportunity for us to continue to educate people about the value of this program.

And the last thing, you said wellness+ remodels are improving and generating comps better than the Company average. How do they compare to your plan? Are they basically on plan and how much better do you think they are? I know you have done a better job of clustering them and merchandising them. Do you think we can see hundreds of basis points of improvement from here?

I think we still have a solid opportunity to continue to grow sales in the Wellness stores. The trend is very positive. They are gaining traction. But we are not yet quite to our ROI projection levels.

Okay. Thanks.

Karen Eltrich, Goldman Sachs.

You mentioned that you expect to expand your flu shot program. Do you have a target for how many flu shots -- or how many immunizations you expect to administer next year? How much do you think you can increase that?

I don't think we have given a target yet for the year, but we would expect another year of very significant growth. It is a good target, and I don't know if we are going to give it out at some point or not -- probably not this morning. But we are expecting some very significant growth in flu shots again this year.

Great. And again -- of course I have to -- for wellness+, the topic of the day. As you talk -- you've expanded with the silver, gold and now the bronze. Have you found that to be effective? And with the additional benefits, are you finding good consumer response? And as you mentioned, you think there are ways that you can communicate this program better. Is that in store, is that media? What can we expect in terms of communication from you this year?

Some of both, but I think the folks -- you can see from the penetration numbers that the folks who are in our store are basically getting it and understand it, are working the program. So I think our opportunities to get out and attract additional customers with it, that really requires us to get outside the store to explain the benefits of the program.

What are you finding to be the average migration period for a person who signs up for the program and then reaches the various stages? And is that accelerating in any way?

I would tell you that we continue to see silver and gold customer accounts grow, which is not unexpected. As the timeframe of this thing continues to develop, that should be happening, and it is. So those customers are becoming a bigger part of our total, which is exactly what we want. We want more of those loyal customers. They are our best customers. I don't know if I have an exact average time for you off the top of my head.

Fair enough.

In terms of migration.

What about percentage of silver, gold, that are both using your front end and your pharmacy?

I feel like I'm being non-responsive here a little bit. But given what everybody else is doing and working on their programs, we are a little close to the vest with this, I know, but --

Okay. Is it increasing?

Yes, absolutely.

And what about reception to go Load2Card?

It is going well in test markets. And we are looking at that program very carefully, but it has been very warmly received.

Great. And final question, just getting back to generics, you said that the profitability is exceeding your expectations. How would you say it is doing relative to history?

I would say -- I don't know if I can answer that -- I guess fairly consistently, maybe a touch better. I mean, we used history to make our projection, so we are a little ahead of that. I guess that is probably the best way can answer that.

I would also tell you our contracts are constructed differently today than they may have been historically, so there are some other dynamics that are in play beyond just the normal factors.

And based on the data we've seen, it is fair to say that in the current quarter you've seen an acceleration of generic penetration?

Yes, generic penetration is up strongly.

That was very firm. I appreciate that. Great. Thank you.

The other thing I would just mention there is that in addition to the penetration, as drugs that came out that were single-source become multi-source, their cost is going to go down dramatically and reimbursement rates will follow that down. And so we do have a fairly significant negative headwind on just pharmacy sales, even though profitability should be good in the back half of the year.

Sounds good. Thank you very much.

Carla Casella, JPMorgan.

I think I may have missed it. Did you say how many scripts that you are gaining on average per store from Express Scripts?

We didn't say. What we did say though, Carla, was in terms of the total increase in script count in the first quarter, it came primarily from ESI.

Okay. And then on the front-end side, are you seeing any change in the promotional environment for seasonal merchandise -- or margins, I guess, for the seasonal merchandise this year versus last?

Not that I would call out, I guess. It is always competitive. I don't think it is dramatically worse.

Okay. And it looks -- so EBITDA would have been $300 million, around, if we had excluded the Memorial Day pay and the settlement. Are the pay and the settlement both included in SG&A?

I'm sorry, Carla. What did you say?

(multiple speakers) pay and the settlement amount, were those (multiple speakers) SG&A?

Yes, they are included.

Okay. And then one question on reimbursement rate pressure. Does that move up in lockstep as you see generics grow, or is it something that is not tied specifically to generics?

It is -- a substantial part of it is tied to generics. Basically, as you would expect, generics cost less and we get paid less for generics. So one thing that will happen is if you look at reimbursement rate as a percent to total revenues, it definitely goes down just by virtue of an increase in the generic mix.

But in addition to that, as the generic drugs mature, their cost goes down and as their cost goes down, we also get paid less. So you have those two dynamics kind of working on our number right now.

Okay, great. And the wellness+ stores, is there any major concentration? Are you focused on markets where you've got more older stores that are underperforming stores or is it pretty much well spread?

It is spread out. Right now, it is probably in eight or 10 kind of our key markets, and we are focused initially on our best stores.

Okay, great. Thanks.

Bryan Hunt, Wells Fargo Securities.

John, or Frank, just to ask about generics in maybe a more direct manner with regards to your change in assumptions.

Don't do it. No, I'm just kidding.

Is your change in assumptions to 500 basis points to 600 basis points of dilution, is that because of increased penetration assumptions, or is it due to maybe a faster development of multi-sourcing and driving prices down faster?

Probably some of both, probably some of both. I would say generic penetration is very strong. And so that is kind of good news/bad news, I guess, as it relates to this number. But also, I think we have seen a little bit better cost environment than we probably initially expected.

Okay, great. And then looking at the ESI script counts, would you expect some stabilization in the growth rate in the upcoming quarters, and when does -- when do you annualize that?

I think the sheer growth of it has slowed down to some degree. I think we are approaching a more normal level, if you will. Although we are going to continue to fight to get as many customers as we can. So I think we are kind of near that point, Frank.

I agree, and we probably -- we will start cycling it really in the beginning or mid-December, is when we would start to cycling it.

And switching gears and looking at script file buys, we've seen significant inflation in the price per script in the last -- call it 24 months. Has that rate slowed, or are you looking at stable kind of sequential pricing on your script file buys?

Really -- at the end of the day, it really comes down to competition. It is how many people are bidding for a particular independent. And if there are two or three of the major chain guys that are bidding, or a couple supermarkets, that is what has primarily been the driver. I can't really say it is the inflation on the price of a script.

All right, so maybe a better way to ask it is -- is the competition for file buys, does that remain robust or has that been dialed back?

No, it's pretty strong.

And the price levels are still in that I guess 12, 15?

We didn't give a range, but really $10 to $20 is probably a good range to use.

All right. I appreciate your time. Thanks, gentlemen.

Emily Shanks, Barclays Capital.

My question firstly is around the litigation expense. And I was curious, when do you expect to pay the cash payment out? I recognize it is subject to court approval.

At this point, we do have to go through court approval. It will probably be in two payments, one probably late summer or so and then one in probably the end of the third, beginning of the fourth quarter.

Terrific. Thank you. And then my other question is just around the reimbursement rate environment, I know you've highlighted how it relates to generics, et cetera. But I was just curious how would you characterize the reimbursement rate environment? Are you seeing stability intra-quarter, and what is your outlook for that?

I think the reimbursement rate environment, I think it is going to stay very difficult. There is a number of moving parts. We have a lot of states, I guess, working on their reimbursement rates. Obviously, we have a substantial merger in the marketplace that is going to play out over time. There is always some amount of contracts up for renewal in our business.

So we continue -- we expect to continue to see reimbursement rate pressure. And I often look at it on a year-over-year basis, and on a year-over-year basis it is still declining.

Okay, great. Thank you.

Joe Stauff, Susquehanna.

Good morning, thank you. You've covered a lot of territory, but I just wanted to just clarify a few things. One, obviously the reimbursement pressure has always been a function of this industry. And your comments on it about it continuing to be challenging, is it kind of the same as or is it worsening?

I would say the same as.

Okay. And can you provide I guess an update just on the same-store trends for the remodeled stores, pre and post sort of the completion? Are you seeing a significant step-up in that same-store comp on those stores in particular? And how has that been tracking?

We've definitely seen an increased pre versus post, and we've also been measuring those stores against the rest of the chain, and those stores are exceeding the chain as well.

Got it. And then finally, there is obviously a lot of discussion on the higher profits in generics and so forth. But can you comment, I guess, just on your front-end opportunity? The tools that you are using, so to speak, to kind of convert what is your stickier traffic that appears in your pharmacy into front-end traffic is the Wellness program, remodels and advertising. How much, I guess, utility or effectiveness do you still have with these tools? Is there a lot more opportunity in terms of the leverage that they provide? Can you comment on that?

I would describe it this way, I think, and I don't -- in general terms. What we've done, I think, is put in a pretty powerful economic opportunity for a consumer to be a loyal customer with us and move between the front and the back of the store, either direction. Whether you are a good pharmacy customer or a good front-end customer, I think you are incented to try, right now, economically, to bring your business to us with the tiered discounts.

We've also used the +UP program to just try and drive additional footsteps into the store. The opportunity that we are working on right now is really using the information from this program to really get at where the incremental opportunities are. I think that is a substantial opportunity that we are very early in the stages of.

Got it. Thanks very much.

Karru Martinson, Deutsche Bank.

When you guys talk about profitability on generics exceeding expectations, the contracts being constructed differently, is this something that we should be looking at kind of normalizing this year, or would that be something that gets adjusted whenever those contracts come up for renewal or renegotiation?

It is -- I think it is -- the structure of those contracts are going to stay the way they are, and we've talked about this a lot. I do want to get this call going too far sideways here, but we have certain contracts that are more traditional contracts that on the new generic we tend to make a good amount of profitability during the exclusivity period.

We have other contracts that are structured in a way where we actually don't make as much during exclusivity period but make more of our profitability when the drug goes multisource. And we sort of ended up in a spot where we kind of have a blend of those two types of contracts. So that is sort of one piece of the puzzle.

But the other piece of the puzzle I think relative to what our expectations were is just there's probably been more opportunity on the cost side on some of these drugs than we expected when we did our original projection.

Now when you give the free cash flow positive guidance for the year, does that include the $20.9 million payment, or is that ex that?

It includes it, Karru.

Okay, it includes it. And you noted that both on the remodels and the wellness+ conversions, you are seeing better than store average. Is there any kind of granularity that you can provide there? Are you 100 basis points better, 50 basis points better?

It is more than 100, and we continue to the trajectory that is encouraging so far.

Given the success and the traction that you are getting there, is there an ability for you guys to ramp that program up, or do you feel you're kind of hitting the best conversion opportunities right now?

I think we are operating at the level that our organization can handle right now. I think we are doing what we are organizationally capable of.

You mentioned earlier, obviously there is M&A activity going on with Walgreens. Is that something that you guys have looked at as well, and kind of what is your view on that front?

We are very focused on the opportunity we have with our existing assets. That is our primary focus.

Thank you very much, guys.

Mark Wiltamuth, Morgan Stanley.

John, any update on the AMP situation, and maybe tell us how things are going with some of the states out there on reimbursement rates in Medicaid?

One of the probably steepest declines we've had over the last couple years has been in the Medicaid area. So there's a lot of states that are working on reimbursement rates and changing the way they come to market to us. So there has been a fair amount of activity there.

We see a number of states migrating towards managed Medicaid where they are actually using a PBM to take over their Medicaid business. So we have a fair amount of that activity going on. So there is a number of different sort of things happening that have made that business much more difficult over the last few years.

In terms of AMP, basically where we are right now is there is a process underway to formulate rules for AMP, and that process is ongoing. And right now, although CMS could implement AMP without those rules, it's our expectation that they won't. And so right now, it is still kind of in the formulation phase.

Okay. And looking over at the Walgreens and Alliance Boots deal, there is chatter that Walgreens is going to be able to do better on sourcing costs. Do you think this transaction in any way affects Rite Aid? Does it change your world at all?

I guess I would say if they somehow dramatically reduced their sourcing costs and took those savings to market to somehow lower price or something, yes, that would put pressure on us. But otherwise, I'm not sure I can point to something immediate.

Okay, and I guess a few comments here on that much of the 3% volume gain for prescriptions in the quarter was Express. I think last quarter you said it was around 2%. Is it still running in that range or is it almost close to the 3?

It is higher than the 2.

Okay. Thanks for the questions and congrats on the continued sequential progress.

Thank you very much. Appreciate it.

Mary Gilbert, Imperial Capital.

Just wanted to follow up on the gains that you've gotten for Express Scripts. I just wanted to confirm -- but you are thinking that it is pretty sticky, the gains that you have already gotten, and that is why we could get to the higher end of the range of guidance. Is that what you are saying?

No, I think we are saying the longer -- we don't know when the dispute might be resolved, so each quarter that goes by, we've gotten those scripts into our number and that is really why we are bringing up the low end of the range of the guidance. If the dispute ends, we know there is going to be a lot of these scripts at risk.

Okay. I thought maybe you changed your perspective on that. Okay. The other thing --

It will be a competition.

Okay. Second of all, with Walgreens coming out with their loyalty card, it sounds like you guys are working on an initiative to launch or look at another iteration program. Is that true?

We continue to evolve our program and continue to add features and functionality to it. We think is a great program. So yes, that is where we are.

Okay. Are you planning to launch something sort of right around that launch?

I think I said before, we can't give away all of our secrets.

Okay. The other thing that I just wanted to verify also, when you talked about the cost and the benefit you are getting on the gross margin side with the generic, it is the cost in the purchasing or is there something else that you --?

Yes, it was cost in the purchasing.

Okay, great. And then with regard to dark rent, where are we ending up this year?

Right now, we are forecasting, Mary, about $85 million.

Okay, great. And then do we see that dropping down to like $75 million, or how would we look at that looking out to next year?

I think assuming no more store -- or if we don't have a dramatic increase in our store closure activity, you've got a drop of about $5 million to $8 million a year.

$5 million to $8 million. Okay, perfect. And then with regard to free cash flow this year, is that number sort of in the zero to $50 million range or $50 million to $100 million?

I would say probably north of $50 million.

North of $50 million. Okay, and how should we look at working capital?

Probably has a slight use.

Slight use. Okay, great. Perfect. Thank you very much.

Holly, this will be our last -- we are going to take one more question and then we are going to be done.

Jason [Darisi], UBS.

It's Jason Darisi. Thanks for squeezing me in here. Just wanted to come back to the volumes that you are picking up from Express Scripts. How are -- in that $15 million to $20 million profit, what are you allocating to the front of the store, or is that literally just the pharmacy benefit?

That is the pharmacy benefit.

Okay. And then I guess in terms of -- you said you picked them up in terms of the wellness+ conversion sort of in line with the store at the beginning of the Q&A. How is their spend actually in the front of the store once they convert? Is that also in line or are they signed up, but not as active as the rest of your members?

The short answer is it looks like it is in line. The longer answer is it looks like some of these folks, some percentage of these folks, actually shop the front of our store before they became our pharmacy customer. So chew on that for a while.

Okay. And then I guess in general, just with the front of the store trend, is there anything that maybe you can point to that you feel like you can improve on here? It doesn't seem like the front of store is performing as well as it did at the start of the year and it has sort of faded. And I know there is some weather issues and timing issues. But is there anything you can point to to talk about that trend?

I think we are comping around some tougher numbers from last year, the last two months. So our two-year stacked comps are still pretty solid. Other than that, I hate to even talk about weather. So, that is probable the single big thing I could point to.

And then I guess in terms of the front of store gross margin, is there anything that you are doing there in terms of your markups or anything like that to either drive the sales further? Or are you just kind of holding steady and assuming that it is going to pick back up?

Really, we just continue to execute our programs. I think our results here over the last several quarters show I think we are working on the right things. So it's not really just only about a markdown in spend. We continue to try to improve the experience in the store. And again, as we talked about earlier, we are going to continue to push the value of wellness+ and what it means to customers.

And the other area that continues to seem to get traction with consumers is private-label. And so we are going to continue to show good value with our private-label program.

Just as a very last quick one, could you comment on the quarter if your front-of-store gross margin was up, down or flat?

The dollars were up and the rate was down.

Okay.

Okay, everyone, thanks for joining us, and we will talk to you soon.

Thank you for your participation in today's Rite Aid conference call. You may now disconnect.