Rite Aid Corp (RAD) 2015 Q3 法說會逐字稿

Good morning, my name is Angie and I will be your conference operator today. At this time I would like to welcome everyone to the Rite Aid third-quarter earnings 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. Mr. Schroeder, you may begin your conference.

Thank you, Angie, and good morning, everyone. We welcome you to our third-quarter conference call. On the call with me today are John Standley, our Chairman and Chief Executive Officer; Ken Martindale, our President and Chief Operating Officer; and Darren Karst, our Chief Financial Officer.

On today's call John will give an overview of our third-quarter results and discuss our business. Ken will give an update on some of our key initiatives. Darren will discuss the keys financial highlights and fiscal 2015 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. These slides include annual earnings and sales guidance. These slides are provided on our website, www.riteaid.com under the investor relations information tab. This guidance is a point in time estimate and 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 calls 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. Also included in our slides are the non-GAAP financial measures of adjusted EBITDA gross profit and adjusted EBITDA, SG&A and the reconciliations of those measures to their respective GAAP financial measure.

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

Thanks, Matt, and thank you all for joining us to review our results for the third quarter of fiscal 2015.

A key highlight was our 5.4% increase in total same-store sales which was driven by a 4.5% increase in same-store prescription count. Continuing the trends we have seen throughout the year, our script count was fueled by higher utilization in Medicaid expansion states and the success of our various pharmacy initiatives. We also benefited from an increase in flu shots administered during the quarter.

As we generated topline momentum, we also did a good job of managing expenses to effectively leverage our sales increase and drive gross profit. These factors helped us to achieve net income of $104.8 million and adjusted EBITDA of $332.8 million, both of which are solid increases over the prior year period.

As you know, one of our most important initiatives of the year has been our conversion to a new drug distribution and purchasing process with McKesson which is providing us with purchasing efficiencies and direct to store delivery for all our pharmacy products. As reported during our last earnings calls, all stores and our four pharmacy distribution centers were converted to this new distribution process by early in the third quarter. With all of our stores receiving direct to store delivery five days a week, we expect it to generate working capital benefits and improved in-stock positions to better serve our customers. These benefits were in line with our expectations during the third quarter.

In addition, our new purchasing agreement yielded savings during the quarter. These purchasing savings in addition to our higher pharmacy revenue helped fuel our increase in pharmacy gross profit.

We continue to face significant reimbursement rate pressure. However, we were able to mitigate this pressure during the quarter. We expect that this reimbursement rate pressure will continue to pose a challenge heading forward and are working hard as a team to meet this challenge head on.

Based upon our stronger than expected performance for the quarter, we have raised our guidance for the year.

As we concentrate on our day-to-day operations and providing outstanding service to our customers, we are also highly focused on transforming Rite Aid into a growing retail healthcare company while continuing to pursue opportunities for long-term growth. A key part of our strategy is to expand our healthcare offering to provide a higher level of care to the communities we serve. We made significant progress in this area during the third quarter as we continue to strengthen our portfolio of health and wellness services.

Two great examples are the Quit for You smoking cessation program and our initiative to add HealthSpot stations to select Rite Aid stores and Ken will share more details about those programs during his remarks.

Meanwhile our initiative to add RediClinics to Rite Aid Stores is gaining tremendous momentum. We have opened our first RediClinics in Philadelphia and Baltimore and will be announcing additional openings in the near future. In many instances we are leveraging our highly successful Wellness Stores to create an even more engaging overall customer experience. We are really excited about this opportunity to deliver yet another convenient layer of healthcare support to the communities through RediClinic.

As we continue to expand our healthcare offering, we are also making tremendous progress with our store development program. Our team is doing an excellent job of executing our Wellness Store remodels as we build up our real estate pipeline to support our relocation and new store initiatives over the next several years.

At this time I would like to turn it over to our President and Chief Operating Officer, Ken Martindale, who has additional information regarding our key initiatives. Ken?

Thanks, John, and thanks everyone for joining us on the call this warning.

In the third quarter, we achieved excellent results with many of our long-standing initiatives while launching new programs to further strengthen our position as a convenient destination for health and wellness.

As John mentioned earlier, our long-term strategy centers around the continued expansion of our healthcare offering so that we can deliver a higher level of care to the communities we serve. A great example of how we are expanding our efforts around immunizations as we continue to grow this area of our business. We have exceeded three million flu shots for the year and we continue to work diligently to engage our patients as we educate them about the value of this convenient health and wellness service.

Beyond flu shots we believe that raising awareness about other immunizations represents a great opportunity to help protect the health of the communities we serve and demonstrate our value as a health and wellness provider. To capitalize on this opportunity in the third quarter we launched a comprehensive offering of tools and resources known as Vaccine Central.

Through Vaccine Central customers can visit riteaid.com or any Rite Aid store and take a comprehensive immunization evaluation that helps determine their specific vaccination needs. Customers can also use Vaccine Central to track their personal immunization history and access educational resources. Customer response and engagement through Vaccine Central has been very positive thus far and we believe that this program further demonstrates how committed we are to actively working with our customers to keep them well.

Another key addition to our portfolio of wellness services is our Quit for You smoking cessation program. As discussed on last quarter's conference call, this free program leverages the counseling skills of our pharmacists to help customers develop and complete a personalized quit plan. We have been pleased with the customer engagement thus far as well as how this program empowers our pharmacists to provide additional care beyond prescriptions.

In January, we will launch further enhancements to Quit for You in time for the New Year's quit season including personalized text message support for quick tips and positive affirmations. We're also enhancing our online support available at riteaid.com by adding video tutorials, a quit calendar and an evaluation tool to identify a customer's best nicotine replacement therapy option.

Another exciting initiative announced in the third quarter is our agreement to bring private walk-in HealthSpot stations to select Rite Aid stores in three Ohio markets in the near future. Through these conveniently accessible health stations, customers will be able to use videoconferencing and interactive medical devices to connect with medical professionals and be treated for common health conditions. A key benefit is that most insurance plans will be accepted for these appointments.

Adding HealthSpot stations serves as a natural extension to our existing suite of health and wellness services and offers a convenient solution for accessing quality healthcare in a professional setting.

As John mentioned earlier, we have added our first RediClinics to Rite Aid stores to further expand the level of care that we can provide to our customers. We currently have 18 RediClinics open in our Philadelphia and Baltimore markets and we will open our first RediClinics in Seattle in the next few months. By early spring we expect to have 35 RediClinics opened in these three markets. As we add clinics to the Rite Aid stores, we also plan to open additional locations in Texas where RediClinic is already a leading provider of convenient care services.

As you can see, we are making excellent progress with our strategy to introduce new programs that further expand our healthcare offering. At the same time, we are making great progress with existing programs that continue to help grow our business and strengthen our unique brand of health and wellness.

We remain very focused on our ongoing Wellness Store remodel program. During the quarter we achieved a significant milestone as more than a third of our entire store base now operates as a Wellness Store. At the end of the third quarter, we had a grand total of 1529 Wellness Stores. These stores continue to outperform the rest of the chain in terms of same-store front-end sales and script count and we continue to work with our supplier partners to pilot innovative merchandising solutions that deliver an engaging customer experience.

Another key to our wellness format is the higher level of service provided by more than 2000 wellness ambassadors. As we move forward, we are also expanding the level of service that we can provide in the beauty category. We now have 50 Wellness Stores with expanded beauty departments that feature a broader selection of prestige brands and specially trained beauty advisors. Much like our wellness ambassadors, our beauty advisors are positioned to further engage customers and they achieve this through product demonstrations, helpful tips and personalized service.

Our customers continue to respond positively to our offering of private brand products with private brand penetration increasing to 18.5% during the quarter. Looking to 2015, we are focused on harnessing the same innovative spirit that has fueled our success with Wellness Store merchandising initiatives to create a world-class private brand that delivers quality and value to the consumer.

We have continued to aggressively pursue opportunities to expand our script file buy initiative. During the third quarter, we completed $39.6 million in file buys and these acquisitions are making positive contributions to our script count performance. Based on our third-quarter activity and expectations for the balance of the year, we have increased our file buy target from $90 million to $100 million.

To sum it up, our key initiatives continue to deliver strong results while positioning us to deliver a more comprehensive and engaging health and wellness experience. We look forward to building on this success heading forward by further expanding our portfolio of services to deliver an even higher level of care to the communities that we serve.

At this time I will turn it over to our Chief Financial Officer, Darren Karst, who will provide additional details about our financial results. Darren?

Thanks, Ken, and good morning, everyone. Our third-quarter results reflect strong script count and front-end trends, improvements in gross profit, good cost control, and continued progress on our business initiatives. Gross profit was improved from last year's third quarter due to a lower LIFO charge and cost reductions from our purchasing arrangement with McKesson, but that was partially offset by continuing reimbursement rate pressure.

On the call this morning I will walk through our third-quarter financial results, discuss our liquidity, certain balance sheet items, our capital expenditure program and finally, review our updated fiscal 2015 annual guidance.

Revenue for the quarter was $6.7 billion which was $335 million or 5.3% higher than last year's third quarter. The increase was primarily due to higher pharmacy sales. Overall same-store sales increased 5.4% in the quarter which was driven mostly by a higher pharmacy script count. Front-end same-store sales increased by 1.6%. Pharmacy same-store sales were higher by 7.2% which included an approximate 228 basis point negative impact from new generic drugs. Pharmacy same-store script count was up 4.5% reflecting higher utilization in Medicaid expansion states and an increase in flu shots.

Adjusted EBITDA in the quarter was $332.8 million or 5% of revenues which was $50.5 million higher than last year's third quarter of $282.3 million or 4.4% of revenues. The current quarter's results were primarily driven by improved sales and gross profit offset in part by higher SG&A which was also the result of higher sales.

Net income for the quarter was $104.8 million or $0.10 per diluted share compared to last year's third-quarter net income of $71.5 million or $0.04 per diluted share. The increase was driven by the $50.5 million improvement in adjusted EBITDA and a lower LIFO provision partially offset by an $18.5 million charge for the early redemption of our 10.25% senior secured notes that were due October 2019. This loss on debt retirement had an impact of $0.02 per diluted earnings per share for the current quarter.

The prior-year diluted earnings per share were negatively impacted by $0.03 due to the redemption of the Company's Series G and H preferred stock in the prior-year third quarter.

Income tax expense relates to certain state income taxes.

The lower LIFO charge was primarily the result of a partial LIFO liquidation resulting from the decrease in pharmacy inventory levels which reduced the effect that inflation otherwise had on our LIFO charge. Total gross profit dollars in the quarter were $122.6 million, better than last year's third quarter and 42 basis points higher as a percent of revenues.

Adjusted EBITDA gross profit, which excludes specific items, was favorable to the prior-year third quarter by $103.4 million or 12 basis points as a percent of revenues. Pharmacy gross profit dollars were higher and margin rate was flat. Pharmacy gross profit was positively impacted by our increased prescription count and negatively impacted by continued reimbursement rate pressure which we were able to offset through purchasing efficiencies.

We continue to expect to see margin pressure from reimbursement rate reductions in the fourth quarter. Front-end gross profit dollars were flat to the prior year and rate was unfavorable. Adjusted EBITDA gross profit was also favorably impacted by additional revenues from Health Dialog and RediClinic which were acquired earlier in the current year.

Selling, general and administrative expenses for the quarter were higher by $60.1 million, but 39 basis points lower as a percent of revenues compared to last year. Adjusted EBITDA SG&A dollars which exclude specific items were higher by $52.9 million but 41 basis points lower as a percent of revenues compared to last year as we were able to leverage the increase in sales through our various expense control initiatives. The increase in dollars was driven in part by incremental operating costs related to our acquisitions of Health Dialog and RediClinic with payroll and benefit costs related to our higher sales volume driving the balance of the dollar increase.

FIFO inventory was lower than the third quarter of last year by approximately $255 million driven by a reduction in pharmacy inventory resulting from our transition to direct store delivery from McKesson. Our cash flow statement for the quarter shows a net source of cash from operating activities of $112 million as compared to a source of $247 million in last year's third quarter with working capital timing differences driving most of that difference.

Net cash used in investing activities for the quarter was $166 million versus $97 million last year. During the third quarter, we remodeled 103 stores, we expanded one store, we acquired six stores, we relocated three stores and we closed six stores. At the end of the third quarter, we had completed and grand reopened 1529 Wellness Stores.

For the third quarter, front-end same-store sales in our Wellness Stores that have been remodeled in the past 24 months were approximately 321 basis points higher than our non-Wellness Stores and script growth in these stores was 278 basis points higher.

Now let's discuss liquidity. At the end of the third quarter, we had $944 million of liquidity. Our liquidity has decreased by $184 million year-over-year due primarily to the fact that in October we used borrowings on our revolving credit facility to fund the early redemption and payment of the full $270 million of our 10.25% senior secured notes. We had $780 million of borrowings outstanding under our $1.8 billion revolving credit facility and had $71 million of outstanding letters of credit.

Total debt net of invested cash was lower by $91 million from last year's third quarter. Our leverage ratio defined as total debt less invested cash over LTM adjusted EBITDA improved to 4.4 times from 4.5 times as compared to last year's third quarter.

In December we launched a financing transaction to reprice and upsize our revolving credit facility. We expect to increase the amount of the facility to $3 billion and to use the additional proceeds to repay the $1.15 billion of first lien term loans that are currently outstanding. We expect this transaction to close in early January and expect annual interest savings of approximately $20 million as a result.

Now let's turn to the current year guidance. Based on our results for the third quarter, we are raising our guidance for the full year. Our guidance reflects our current expectations for continued reimbursement rate pressure and the benefits from the McKesson purchasing arrangement as well as the anticipated benefits of our wellness remodel program, customer loyalty program, and other initiatives to grow sales and drive operational efficiencies.

We expect the current competitive environment to remain promotional. Our guidance for the remainder of the year also reflects the cycling of a favorable reimbursement rate adjustment that benefited last year's fourth-quarter margin and was related to a decision by California to exclude certain drugs from a retroactive Medi-Cal reimbursement rate adjustment.

We expect a working capital benefit of approximately $250 million as a result of the McKesson agreement. We expect script growth to benefit from the Affordable Care Act, favorable demographics, file buy acquisitions, growth in immunizations and other initiatives. We expect total sales to be between $26.25 billion and $26.4 billion and adjusted EBITDA to be between $1.275 billion and $1.305 billion for fiscal 2015.

Same-store sales are expected to be in a range from an increase of 3.75% to 4.25% including an anticipated negative pharmacy sales impact of approximately 208 basis points from new generic introductions and continued reimbursement rate pressure. We expect a range of net income of $315 million to $370 million and earnings per diluted share to be in a range of $0.31 to $0.37.

The range of guidance is primarily driven by our same-store sales range and pharmacy margin expectations.

Our fiscal 2015 capital expenditure plan is to spend approximately $525 million with approximately $250 million related to remodels and approximately $100 million for file buys. We are planning to open three new stores, acquire eight stores, complete 16 relocations and remodel 450 Wellness Stores in all of fiscal 2015.

We expect free cash flow to be in a range of $325 million to $375 million for the year including the benefit of lower pharmacy inventory and the acquisition of RediClinic and Health Dialog. We expect to close a total of 33 stores of which the guidance includes a store lease closing provision for 15 of those stores with the balance of the stores closing upon lease expiration.

This completes my portion of the presentation. And I would like to now turn it back to John. John?

Thank you, Darren. Before we open the phone lines for questions, I would like to thank our 90,000 Rite Aid associates for their great work during the quarter and their continued dedication to ensuring that our key initiatives and new programs lead to a stronger customer experience in our stores.

Looking ahead we will continue to focus on strengthening our position as a convenient destination for health and wellness by delivering innovative services that have a positive impact on the health of our patients. We believe that this strategy provides the best opportunity to fuel long-term growth while meeting the healthcare needs of the communities we serve.

That concludes our prepared remarks for this morning. We will now open the phone lines for questions.

(Operator Instructions). Lisa Gill, JPMorgan.

Good morning. Darren, can you help me to understand the McKesson, the one-time where you talked about it in the second quarter, what reversal you saw here in the third quarter? Just trying to figure out the run rate as we go into the fourth quarter around the McKesson relationship and those one-times that you called out last quarter.

We've taken a little bit harder look at that and I mean the reality is there wasn't much impact in this quarter in terms of a reversal and at least at this point we don't see much impact in the fourth quarter either.

So do you expect that -- the run rate that you are seeing to continue and we won't see a reversal, is that --?

I think that is accurate, yes. So it is kind of a second-quarter event.

And what has changed from your point of view in the second quarter to now around the relationship and the run rate?

Lisa, this is John. I think a couple of things. Obviously we had to do a fair amount of estimating to lay this whole thing out across the fiscal year in terms of inventory turns and valuation allowances and how they would reverse themselves through the numbers. And we moved to some debt net accounting in terms of how we are purchasing so we moved some allowances into inventory. So we had a lot of things moving back and forth through this whole process as we made the transition.

So based on the way things shook out in the third quarter, we feel like what we saw in the third quarter is more of what our typical kind of run rate experience is going to be with McKesson and that is what our expectation will be in the fourth quarter as well.

Okay, great. It looks like reimbursement was a little bit better in the quarter but John, you did say you continue to see significant reimbursement rate pressure. As we think about the fourth quarter, will there be more pressure come 1-1-2015 as contract terms change?

Yes.

Okay, so we would expect that obviously for the month of December maybe similar to what we saw in this quarter but two out of the three months for the next quarter you will see increased reimbursement pressure. Is that the right way to think about it?

It is, yes.

Okay, great. Thank you.

Edward Kelly, Credit Suisse.

Hi guys, good morning. I wanted to just ask you about the third quarter and then how this plays into guidance. But Q3 obviously was better than what the market expected, it seems like it is better than what you expected as well given that the guidance came back up. Could you maybe just provide a little bit more color around the areas that surprised you on the upside and what the real drivers of the improved guidance at this point?

I think probably a few things. One, the top line of our business remained strong so we had good volume in the quarter both in script count and front-end same-store sales. I think we did a nice job on the gross profit line in both pharmacy and honestly in front-end parts of our business. And in the pharmacy, we continue to work very closely with McKesson to implement the program so we saw I think good improvement and strength in terms of what we are doing with McKesson. We've continued to work hard every day on the reimbursement rate issue.

On the front-end side again, we had solid volume on the front-end which helped and then we were able to do a really good job on the SG&A side quite honestly to leverage all that to get it to the bottom line. So it came from a number of different areas throughout the business. It was a pretty solid operating quarter for us.

Okay. And then just to confirm on the McKesson side, you expected this $40 million benefit I guess in the second half that is not coming through. So as we think about your guidance, the improvement in EBITDA actually I guess is even better than what it appeared since that is not rolling through now. Is that a fair way to think about it? I just want to confirm that.

I'm not sure -- I'm a little -- maybe somebody else can help me sort of pick up the thread. We did see some one-time benefit in the second quarter as we changed our accounting to deal with the way we are purchasing from McKesson. We thought there might be some flip back from that in the third quarter which there was not. And we also thought there might be some impact in the fourth and we are not expecting that either.

So I think what you see is that the third quarter reflects a good benefit from the McKesson relationship. That is clearly one of the drivers that had a significant impact on the quarter.

Yes, now clear, got you. And then the last question for you, I don't know John at this point or Darren, if there is any thoughts on next year. I know it is kind of early for that but at the end of the day there are some puts and takes to the business next year.

Lisa asked about reimbursement rate pressure, clearly we are going to see some of that but that is kind of normal. Is there anything else here that you could maybe help us as we think about next year and things that we should be contemplating?

I think reimbursement rate will -- as you said, it is a normal part of our business but it will continue to be a factor next year. I think we are still digesting a lot of rate pressure that has fallen along behind the previous generic wave and we will see some of that roll into next year. So that is going to continue to be a factor.

We are going to continue to work very closely with McKesson on the purchasing side to continue to be an efficient provider and be a good partner with all of our PBM and other healthcare plans that we work with on that side. We are going to see maybe a little bit of a pickup here potentially depending on how Nexium plays and some other -- a couple of other new generics.

We are going to see a little bit better new generic environment for next year on the script count side. It will be interesting to see what year two looks like in a lot of states that had Medicaid expansion, if it will continue to grow. There's probably some decent chance of that. We have at least one other state, Pennsylvania, where we think Medicaid is going to roll and expansion is going to roll on January 1. So that will be helpful.

There are a couple of plans that we were in this year that we are not in next year that maybe cost us a little bit, maybe 1% or 1.5% of script count growth. And we have more Wellness Stores coming, more clinics and more exciting initiatives that we are going to be rolling next year so we have got some give and take but I would say overall we remain positive and focused.

Great, thank you.

George Hill, Deutsche Bank.

Good morning, guys, and thanks for taking the question. John, maybe can you provide a little bit more color? It sounds like in certain pockets of the business you got some reimbursement relief. I guess can you talk a little bit about that and maybe either by script type or by payer type and maybe kind of just tell us where the little bit of the relief there came from?

Well, relief is a strong word. I'm not sure what that means. Again, there is always a lot of dynamics in reimbursement rate. There are contracts that are renewing all the time. So some are better than others and can impact the numbers one way or the other. There is always again the mix of business and all those kinds of things going on in any given quarter. So I think this quarter was a fairly good one for us in terms of some of the things that we worked on but not sure I can answer you any better than that.

Okay, then maybe just a quick follow-up. Some of your competitors have pretty aggressive preferred networks strategies in Medicare D for the start up of 2015. Are you expecting that to have any share impact on you guys from a script perspective or is there anything that you guys plan to do to answer that? I know that you guys aren't as aggressively participating in the preferred networks?

I think it is a combination of really two things on preferred networks. There are some that we are in, probably three or so this coming year. There are a few that we looked at it and we just couldn't come to terms to get there financially. And there's a lot of others where we weren't invited to the table. So you have that kind of component of it.

There are a lot of preferred networks out there this year. I think there are probably more than last year for sure and so we will just have to see what the financial impact is on us related to that as we get into the year. We have great programs like wellness65+ that are really designed to help us combat those kinds of thing so we will just have to get into it a little bit and sort of see how it goes here.

But you guys aren't like hearing the filter up from these stores that patients are trying to transfer scripts out ahead of the benefit design changes?

Not yet.

All right, thank you.

Mark Wiltamuth, Jefferies,

Just on Nexium, what are your thoughts right now on timing and are you expecting it to be a sizable initial impact or is it going to be more into fiscal 2017 on the boost you get from margins?

I think the timing is just a little bit hard to figure out right now. We will probably have to reach a solid conclusion about that when we give guidance but we are continuing to gather information and look at it. There are some dates that are being floated around out there but it has been difficult to peg because it has slipped several times. I guess I'm a little hesitant to get out there with a date at this point until -- probably until we button down guidance for next year.

As it stands right now, it is going to depend on how it comes to market. Right now it looks like it is an exclusive. Whether that plays out that way or not just depends I guess on a number of different factors. But in which case we will get probably -- it just depends on when it falls because we will go through a period of time where it is a little less profitable and then it will become much more profitable. So if it happens earlier in the year, which is still a possibility, then by the end of the year, we will be seeing some good profitability from it. If it happens later in the year, it probably pushes in more of the financial impact into fiscal year 2017.

Okay. And then the other wildcard is I guess the magnitude of the McKesson savings. Obviously the first half of the year you are still going to have easier year ago comparisons to show but then in the second half you will start lapping some of the improvements you are seeing in these results you just posted today. Is there a building of savings that is going to be happening so you could still see year-over-year gains in the second half of the year?

I think there is, yes. That is what we are looking to do. We are working through honestly the bid process right now and so again as we get into next year and give guidance I think we will have some visibility into how that process is playing out. But we are working very closely with McKesson right now on next year's drug cost.

Okay. So you think within the next quarter or two you will know roughly where you are going to be on costs?

We will have much better insight. We are always driving every day to lower costs but a big chunk of it we will know.

Okay. And the $40 million that was discussed here that is not going to be reversing here in the second half, do you think that ends up being a factor in 2016 or not?

No, I think we are past it.

Okay, thank you very much.

Robert Jones, Goldman Sachs.

Thanks for the questions. Just a follow-up on McKesson and obviously this is the first full quarter you had with the McKesson relationship. I'm wondering if you can give any more perspective on just how much that contributed to the improvement, the noticeable improvement in gross margin?

And just to follow-up on the previous question, it was my understanding that you would benefit as McKesson's pricing improved and obviously we have seen them now close the Celesio deal, they have brought on Omnicare. How does that factor into the benefit that you will see as you go through next year?

It should help us. The more volume we put through this process I think the better it is going to be for all of us. Those are all exciting developments that should help us. Both McKesson and Rite Aid I think become more efficient purchasers in the marketplace so we are pretty excited about that. So that helps.

So we really shouldn't necessarily then think of this as a run rate of savings that you experienced from McKesson?

I think the way to think about it is every year I have been here we have always found a way to purchase a little better than the year before and that is our expectation that those trends will continue. And reimbursement rates will inevitably come down to some degree over that same period of time and the balancing act that we always talk about is trying to get costs and reimbursement rate to line up.

Got it. Look, I know you guys have been peppered on the reimbursement question but if I think back to last quarter, John, it sounded like there were some renewals up in the air at that point. Are those discussions still ongoing or do you have any more comfort or visibility into any major specific contracts that would affect fiscal 2016?

There are significant contracts that renew during fiscal 2016 like there is in any year.

Any more comfort relative to last quarter?

No. It is the same. I guess what I try to get across to everybody is there is a fairly constant level of activity at any point in time on reimbursement rates.

Okay, thanks.

That is the best way that I can answer it.

John Heinbockel, Guggenheim Securities.

So a couple of things. Just am I right in assuming the change in guidance from last quarter to this? I don't know if you might say the bulk of it but a lot of that was just not having the offset to the $40 million, is that -- that has got to be a large piece of it, right?

Maybe a little bit of it, John, but I think we did much better than we expected with on the McKesson side. One of the factors -- again we talked about script count has been strong so I think it was a largely driven by a much better operating performance.

Okay, when you think about the January 1 resets or rate changes --.

I guess, John, the other comment I would make on this $40 million, it wasn't our expectation that it would be fully offset by charges. We just didn't think that the net impact of it was going to be material to the fiscal year. So I think a lot of people said based on our comments last quarter maybe got to the conclusion that it was 40 and 2 so it is going to be 40 and 3 and 4, which honestly was never our expectation. We just thought the net of it wasn't going to be very material to the fiscal year. And so that is kind of what we were talking about.

And when I looked at the January 1 resets, is that more Medicare D commercial -- commercial be more than Medicare D?

It is some of both. We have some commercial contracts on January 1 and we have Medicare D on January 1.

But one not more than the other?

It is a bunch of both.

And then tying that in, when you think about Rite Aid being on this back side of the generic wave, generally speaking, when do you think we see a peak in reimbursement pressure or maybe a trough in pharmacy margin? It sort of seems like close to the timing of Nexium; it might be third quarter of next year. It is sometime in the early second half of next year, is that fair?

That is pretty close.

(multiple speakers) And then lastly, just to transition to the front-end, so you said front-end margins were down a little bit. Where do you think that goes from the perspective? It looks like a lot of guys, some of your competitors are kind of going in different ways but the notion that front-end gross profit dollars is really critical, you don't get a lot on spending front-end gross profit dollars on promotion. Is this kind of a temporary dip down or do you think this is more secular?

John, it is Ken. I think on the front-end margin, it was probably not indicative of a good run rate. We took some fairly big markdowns when we repositioned our tobacco and cigarettes to expand smoking cessation and that was one of the big hits that we took. I think going forward we are just going to be a lot smarter about the markdowns. It is going to be a long process but we are going to have to move those markdowns from the circular to a more personalized delivery and so I think we are just going to spend them a lot smarter. So if anything I think there might be some long-term upside but overall I don't think it is a big shift. I don't think the negative that you saw is going to be indicative of where we are.

Okay, thank you.

Ross Muken, Evercore ISI.

Good morning, gentlemen. Maybe just talk a little bit about where you think we are in the real estate transition? And then in general as you think about these sort of improving comps and what you have done on the remodels, etc., how are we seeing various trends at some of the legacy stores versus maybe some of those which you have revamped over the last 12 or 24 months?

I think like anything you would expect that we get the biggest bang right after we do them. We see a reasonably good tail on comps but clearly the stores that we are now four years old, they are running substantially less than the ones that we are doing today. I think Darren gave you some numbers on the stores that we have opened or remodeled in the last 24 months. We are very bullish on the progress that we are making in these stores and we think the remodels continue to get better and the consumer continues to react appropriately.

I guess my question is more so if we think about some of the underperforming stores or the more challenged stores as market growth improves overall, is that enough even if we are not seeing the revamp to sort of improve the profitability of that part of the fleet or are we seeing the bigger outsized changes where we are getting the comp bump on the remodel and then we are also getting the improved overall underlying market?

I think the non-remodeled stores if this is your question, they continue to grow with the overall Company. So if the Company -- if we post better comps, those stores are moving with it but they clearly don't perform as well as the remodeled stores. I think we have said before one of the strategies is to ramp up these relocations so as we do that we will be taking a lot of those underperforming stores that we still have the fleet and repositioning them to a better location which we think will help the topline a lot.

Great, thanks.

Charles Rhyee, Cowen and Company.

Thanks for taking the question, guys. Darren, maybe if I can go back to your comments about the LIFO charge real quick. I think you made if I heard you correctly part of the reasons for the lower than expected LIFO, you were kind of dipping into your LIFO layers and that offset some of the inflation that you saw.

First, did I hear that correctly? And then second, how much longer does that play out now that you have kind of transitioned to the McKesson agreement and afterwards how should we think about the LIFO charge as we maybe go into fiscal 2016?

You did hear that correctly. The reduction in inventory has sort of offset most of whatever inflation effect there would be. So I think going forward there will be some LIFO charge. We still have some opportunity I would say particularly on the store side. What we have done so far is largely taken out distribution center inventory. So there is still some opportunity to take out some more inventory next year on the store side. So we could still see some of that offsetting activity next year as well.

So as McKesson has gone to the direct store delivery for you guys, are you still carrying some excess inventory then at the store level? Could you maybe size that for us a little bit, how much you think we could still take out?

The answer is yes, we still are maintaining the inventory. I don't think we are prepared to size that at this point. We are still doing some work around that and sort of developing plans to address that.

Okay, great. Maybe on two other things that, Ken, you talked about was sort of Vaccine Central and the smoking cessation as well as beauty advisors. Do you have any metrics on what kind of impact that is driving in terms of any kind of sales metrics or maybe a flow-through to the pharmacy desk?

We do have metrics, we really haven't released them and probably won't on an initiative by initiative basis. But I think clearly we are seeing some benefit. The one that we have been in the longest is the wellness ambassadors. We started rolling them out four years ago when we did these things and we are now -- we've got 2000 of those people on the floor. And one of the areas where we really see an impact, for example, is with flu shots because they are on the floor and they are engaging our customers and they are also out in the communities engaging businesses.

So we wouldn't keep doing it, we are pretty excited about the early read on the beauty advisors. We are being a little more selective on those but we are trying to strategically put people against initiatives that we think we can get a return and so far the early read is really positive.

Great. Maybe the last question, around the clinics, do you have a target for the number of clinics you are expecting sort of either -- I guess you have really just gotten started but maybe in a year or two years, where do you think you will be in terms of the RediClinics or HealthSpot kiosks?

Right now we are targeted by early spring, we should have 75 clinics running between the ones that we have in Texas in the (technical difficulty) stores and the ones that we are opening in these first three markets. I think that is pretty much on target with what we told you guys we would do and we are going to aggressively expand from there.

Okay, great. Thanks, guys.

Steven Valiquette, UBS.

First, congratulations on these phenomenal results. I definitely couldn't have dreamed up better results myself.

Now for fiscal 4Q, I definitely hear what you are saying on the pharmacy reimbursement changes going into effect for January 1, 2015. But I do just want to check the box on some of the positive contributors for fiscal 4Q as well when thinking about sequential EBITDA. I guess for me there's four things that stick out right now. First is that flu prevalence is now up year-over-year, we obviously just got generic Celebrex approved, you should still get a decent holiday boost sequentially in fiscal 4Q versus fiscal 3Q. And then again, I think to myself that with McKesson getting operational control of Celesio, I would think that you guys might get some better generic COGS sequentially in 4Q tied to that unless it is too early.

But I guess the question is do you agree that all these should be helpful factors when thinking about sequential EBITDA ramp in fiscal 4Q?

We have got a seat for you right here at the table, there's a chair for you right here. I think those are all good. I would just caution a little bit and it is really for McKesson to talk about in terms of Celesio. This is a fairly recent event for them to get to domination there and so I know they are working hard on that. But I don't know exactly what that timing is yet. I think the fourth quarter might be a little bit premature for us to see that benefit. But I do think that for fiscal year 2016, that is hopefully a boost for us. So that one may be a little bit premature but I think all those other items that you mentioned are all helpful in the fourth quarter.

Okay, and then just quickly one of your competitors also talked about that anniversarying of that favorable adjustment related to the California Medicaid. Is there any way to quantify that just for that delta year-over-year for you guys? Is it greater than or less than let's say $15 million year-over-year as far as that tough comparison you have there?

I don't think that we have disclosed that number but it is greater than $15 million. It is probably in the $25 million to $30 million range.

Okay, that is helpful. Perfect. Okay, thanks.

John Ransom, Raymond James.

I am going to demonstrate my keen math skills. If you look at last year, your sequential EBITDA was up about $74 million, this year the implied guidance has it down about $23 million. So there is roughly a $97 million change in the sequential picture. Is all of that contract resets because it seems like there are a lot of good guys as we just talked about going into the fourth quarter? So should we think about then a $100 million swing per quarter and contract rates offsetting all of the good stuff?

I am not sure I got the math on that but I'm going to take a stab at it.

So you had $282 million of EBITDA and it went to $356 million from November to February. February is usually your strongest quarter of the year. This year your implied guidance has EBITDA down by $23 million so instead of being up by $76 million it is down by $23 million. I'm just saying that is a $100 million quarterly swing. Is all of that just saying we are getting a $400 million rate reset on an annualized basis starting the first day of the fourth quarter?

Got it. So I guess we can reconcile in any number of different directions. So I will take a stab at a couple of different directions with Darren supervising me closely.

So if we take a look at the fourth quarter of last year and try and reconcile from there one thing to understand is that we did have the retroactive California adjustment in the fourth quarter of last year. So if you take that into effect and looked at our guidance I think the higher end of our guidance has us pretty much onto last year's EBITDA number. So we would be basically at the high end sort of flattish to last year.

When looking from the third quarter current run rate today to the fourth quarter in terms of the guidance again the high end of the guidance has us kind of in line with where we are in the third quarter. We do have some plan changes that go into effect in January and February which we have talked about, which is normal. But given that it is late in the bid cycle for us, we tend to have less room to offset those and so as our bid comes to completion at the beginning of the fiscal year, we normally pick up a little momentum back on the cost side in the gross margin. So I think those are some of the big, larger dynamics that are rolling through the number.

I have no idea if I answered your question but that is probably be best I can do.

So just looking at your numbers, they jump around quite a bit from quarter to quarter. I'm thinking, for example, February of last year to May and then of course this quarter, which was above our expectation. Should we, it seems to me like a lot of things in your business are relatively constant like reimbursement pressure and script trends and what have you. Is the difference that in a quarter were you don't get a gigantic generic inflation surprise that you produced a quarter like this or is it more complicated than that?

There are just so many more factors than that. I mean if we walk across the volatility of those numbers in the first quarter, we were in a massive transition to move from self distribution to McKesson which we believe had a pretty negative impact on our numbers. In the second quarter I think we really started to recover from that. We did have some adjustments that came off the balance sheet that we've talked about. I think in the third quarter things are kind of settling down a little bit and we think we are at a more normal run rate right now on the cost side. And in the fourth quarter what we see is just because of January plan changes some additional reimbursement rate again. That is really the broader trend that I think you've got to follow across the fiscal year.

Are you seeing any flattening out or maybe even relief on the generic inflation side? Do you think that fever has peaked or do you think it is just too early to tell?

I think if you look at our results for this quarter, what we've basically said is that essentially our gross margins on a rate basis is pretty flat to the prior year. So if you kind of think about the fact that we had reimbursement rate pressure, that inherently implies that we did a better job than the prior year on the purchasing side. That is kind of what you get to. So when we talk about generic inflation, yes, we have generic inflation on certain items but we were able to offset that inflation with reduction on other items or by working on those specific items that had inflation in this particular quarter.

But it has become a little bit of a day-to-day battle and a challenge that we work on all the time. So that is kind of the dynamic that you have there but clearly I think you see an environment change where there are certain generic manufacturers that feel they have more pricing power in the marketplace and they are trying to exert it. That is not a trend that I expect to go away anytime soon.

Okay. Just lastly, if we think about -- and I'm going to make up a number -- let's say that you can steadily grow your scripts say 3% a year. You are doing better than that now. Given the mix shift, there is some mix shift from higher margin so let's say some of that is coming from Medicare D and Medicaid so it is not going to have the GP. But in general if you're growing your scripts 3% a year, what kind of gross profit numbers should we think about? In other words, let's say that is 10 million scripts a year that you are growing, is that a $10 GP, a $12 GP? How do we think about that growth in terms of a good guy?

I don't know that we have given any GP per script numbers out and probably wouldn't be a good idea for us from a competitive standpoint to do that.

So I mean I think you can look at our overall margin rates and use those to try and estimate some impact of topline growth. And we will be --

(multiple speakers)

Your peers have talked about a $65 ASP and a low 20s gross profit. So does that mean -- I'm assuming you're not too far off from something like that?

Yes, you know, I'm not sure about those numbers honestly but what we will do is give guidance next quarter so --.

Okay. Thank you.

Meredith Adler, Barclays.

Thanks for squeezing me in. Two questions. There was a comment very early on I think in your prepared remarks about working with payers to maybe lessen the pressure on reimbursement rates. I wonder if there is any specific -- I don't know, tools or things that you have to be doing for patients that would give you better reimbursement rates? How do you negotiate that?

We want to be a great partner with payers and I'm not sure I said we have any particular secret sauce -- I think is a term that was recently used on that front. But obviously we are very focused on taking care of patients. We are very focused on compliance and adherence and have a number of tools that we use to drive that. And I do think that is becoming more important over time to payers as they look at the impact of compliance on their business and their ability to manage cost and provide good service to their customers.

So what we do inside that store is very, very important I think to our success long-term and managing those relationships. Because at some point it will not just be about the lowest cost provider, it is really going to be about did the patient get the therapy they needed and we think we are doing a great job in our stores delivering that and are going to continue to enhance the services that we provide.

And is there some relationship between reimbursement and your success at adherence?

Not today. Not today, but I think there will be over time.

And then my other question is you do have some interesting things going on in terms of wellness, the wellness ambassadors, all the smoking cessation efforts, the HealthSpots. Do you see those things as being important for making you more connected to healthcare and of course the RediClinics too over the long term? Do you see yourselves moving beyond being a retailer and actually positioning yourselves to be working closely with health systems and physician groups?

The answer to that is clearly yes and the best example we have today is Rite Aid Health Alliance which we didn't spend a lot of time on this call but we are now in seven pilot projects across the country with large health plans directly integrated into their healthcare models for chronic and polychronic patients. So that just shows you how connected we are getting into healthcare delivery in our stores and I think if you look at broader trends, we really believe that in the long term healthcare delivery is going to be a retail driven model and it is going to be driven by consumer choice. And we are developing our brand and how consumers and patients think of us and connecting ourselves into the healthcare marketplace and delivering services in our stores. So that is clearly a direction that we are headed in.

Great, thank you.

Thank you everyone for joining us this morning. We greatly appreciate it and we will talk to you soon. Happy holidays.

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