Rite Aid Corp (RAD) 2016 Q1 法說會逐字稿

Good morning. My name is Nan and I will be your conference operator today. At this time I'd like to welcome everyone to the Rite Aid first-quarter FY16 earnings call.

(Operator Instructions)

Thank you. I would now like to turn the conference over to Matt Schroeder. Please go ahead, sir.

Thank you and good morning, everyone. We welcome you to our first-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 first-quarter results and discuss our business, Ken will give an update on some of our key initiatives, Darren will discuss the key financial highlights and FY16 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 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'll find they'll helpful as they summarize some of the key points made on the call.

Before we start, I'd like to remind you that today's conference 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 filed or furnished 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 these measures to their respective GAAP financial measure.

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

Thanks, Matt. And thank you all for joining us to review our first-quarter results for FY16. We are pleased with our results for the quarter as they reflect our continued progress in driving growth as we also make significant investments to accelerate our transformation into a retail healthcare company.

We increased same-store sales by 2.9% over the prior year period, which was driven by a 1.6% increase in same-store prescription count. But we are beginning to cycle growth that occurred in states that expanded Medicaid coverage in 2014. We continued to benefit from this trend in the quarter.

Adjusted EBITDA for the quarter was $299.3 million, an increase of $16.7 million compared to the prior year. This growth resulted from improvement in front-end and pharmacy gross profit, including the benefit of savings we generated through our drug purchasing arrangement with McKesson. It's important to note that adjusted EBITDA for the quarter was in packed by increased expenses related to strategic investments in key growth initiatives like adding RediClinics to Rite Aid stores and the launch of wellness+ with Plenti.

Net income was $18.8 million or $0.02 per diluted share compared to last year's first-quarter net income of $41.4 million or $0.04 per diluted share. The decline in net income resulted primarily from interest and other incremental pre-tax costs of $36 million or $0.02 per share on an after-tax basis incurred in connection with the Company's pending acquisition of EnvisionRx. These incremental costs were partially offset by an increase in adjusted EBITDA.

In terms of the acquisition of EnvisionRx, I'm pleased to report that we are making tremendous progress in gaining the required regulatory approvals and meeting the customary closing conditions that are needed to close the deal. Thanks to the hard work of the Rite Aid and EnvisionRx teams we expect to complete the acquisition by the beginning of July.

The closing will mark an important and exciting milestone in our journey to become a growing retail healthcare company. By combining EnvisionRx's PBM and pharmacy-related businesses with Rite Aid's retail platform and health services, we can create an integrated healthcare offering that delivers additional value and choice for planned sponsors, EnvisionRx patients and Rite Aid customers.

From Rite Aid's perspective the acquisition gives us a strong presence in some of healthcare's fastest growing segments, including specialty pharmacy and the Medicare Part D insurance market. Long term, this acquisition provides Rite Aid with a significant opportunity to drive additional traffic to our stores, integrate specialty pharmacy into parts of our retail network, and generate cost synergies that help deliver additional value for Rite Aid customers. Simply put, this acquisition will significantly expand our health and wellness platform and put us in a better position to compete in the evolving healthcare marketplace.

Becoming part of the Rite Aid team will also allow EnvisionRx to offer a more competitive value proposition. We are particularly excited about the opportunity to leverage Rite Aid health services, like RediClinic, Rite Aid Health Alliance, and coaching from Health Dialog to give clients additional tools to manage healthcare costs and drive positive health outcomes. We look forward to the completion of this acquisition so that we can begin creating the integrated healthcare platform that we have in mind. We hope to announce that news very soon.

At this time, I'd 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 today's call. We continue to make outstanding progress with our key initiatives, which have been the driving force behind our efforts to provide a differentiated shopping experience for our customers and deliver a higher level of care to the communities that we serve.

Perhaps the biggest news of the quarter was our successful launch of wellness+ with Plenti, which is part of the first coalition loyalty program in the United States. This enhancement to wellness+ allows our members to continue earning all of the terrific benefits that they've grown accustomed to over the past five years. In addition customers can now earn Plenti points in lieu of +UPs that can be redeemed for savings at Rite Aid and other Plenti partners. They can also redeem Plenti points that are earned at partner locations at their favorite Rite Aid store.

Our store teams have done an excellent job of engaging our customers and explaining the tremendous value offered by this groundbreaking program. To date, Rite Aid has enrolled more than 10 million customers and our Plenti partners have enrolled millions more throughout the coalition. Last week at Rite Aid our Plenti members accounted for two-thirds of the transactions that were tied to a loyalty card. It's worth noting that we have also had significant success in engaging our gold and silver members, our most valuable and loyal customers, in its enhanced loyalty offering.

We also launched an integrated marketing campaign to support the introduction of wellness+ with Plenti. We are leveraging cable television, network radio, traditional print, and a multi-platform digital strategy. Other Plenti partners are also supporting the program with aggressive marketing campaigns and we're excited about this opportunity to reach new customers. We are pleased with the initial positive customer response to wellness+ with Plenti and look forward to building upon our early success.

Our Genuine Wellbeing remodel program continues to produce strong results as we convert additional stores to this unique and engaging format. These stores include enhanced design, innovative merchandising concepts, expanded wellness product and service offerings, and a higher level of service through our more than 2,000 wellness ambassadors. By the end of the quarter we had a grand total of 1,741 wellness stores, which represents 38% of our chain. These stores continue to outperform the rest of the chain in terms of same-store front end sales and script count. Our plan for the fiscal year is to remodel a total of 400 stores to the wellness format as part of a broader real estate strategy that also includes 33 store relocations and 11 net new stores.

Also during the quarter we introduced Rite-Aid RediClinics to Seattle, our third market, and announced a joint venture with MultiCare Health System to support these locations. We currently have 30 Rite Aid RediClinics operating throughout the Greater Seattle, Philadelphia, and Baltimore/DC areas. We plan to open a total of 50 clinics throughout FY16, including additional locations in Texas where RediClinic is already a leading provider of convenient care clinic services. This would bring our total number of operating clinics to over 100.

Our highly successful immunization program continues to be a point of emphasis as our teams again prepare for another upcoming flu season by engaging with community organizations and businesses for potential flu shot clinics. We're also promoting our full offering of immunizations and leveraging our new Vaccine Central tool to raise awareness about the importance of vaccinations. In addition, we continue to be a convenient immunization destination for communities dealing with situations like the recent outbreak of pertussis in Washington State.

As part of our efforts to make our pharmacy experience more convenient, we successfully launched our new OneTrip Refills program during the quarter. Our patients can now sign up to receive all their monthly maintenance medications by making a single trip to the pharmacy. The program has been well received by our patients, and when combined with our existing service to send alerts via text message, e-mail, or phone when a prescription is ready to be picked up, it creates a more patient-friendly experience for our Rite Aid customers.

We continue to make important strategic investments to drive both short- and long-term growth. And one of our most successful efforts has been our prescription file buy program. In the first quarter, we completed $14.3 million in file buys, which continue to make positive contributions to our script count. We have allocated $100 million for file buys in FY16 and have the flexibility to increase that allocation based on market conditions.

Our portfolio of Rite Aid brands continues to generate positive results, with private brand penetration increasing to 18.2% for the quarter. Customer demand for private brand items continues to be high and we remain focused on our opportunity to meet this demand by creating a world-class private brand.

And, finally, a quick note about the Rite Aid Foundation's KidCents program. KidCents allows our wellness+ members to round up their purchases to the nearest dollar and donate the change to a charity of their choice. The program has been tremendously popular with both our associates and our customers.

During the quarter we were honored to join forces with an outstanding non-profit organization, Folds of Honor, which provides educational scholarships to families of fallen or disabled veterans. Through KidCents over the recent Memorial Day holiday we announced a $1.3 million donation to support this important and worthy cause.

To sum it up, our key initiatives continue to drive positive business results while positioning Rite Aid to be the customer's number one choice for health and wellness. We look forward to working as a team to advance these important programs and find new ways to differentiate Rite Aid from other retailers.

At this time, I'll 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 first-quarter results reflect continued strong script count and front end trends, improvements in gross margin over the prior year, continued progress on our business initiatives and good cost control, which more than offset our investments in clinic expansion and the launch of Plenti. On the call this morning, I'll walk through our first-quarter financial results, discuss our liquidity, certain balance sheet items, our capital expenditure program, and finally, review our FY16 guidance.

Revenue for the quarter was $6.6 billion which was $182 million or 2.8% higher than last year's first quarter. The increase was due to higher front end and pharmacy sales as well as incremental revenue contributed from RediClinic and Health Dialog. Overall, same-store sales increased 2.9% in the quarter.

Front end same-store sales increased by 0.6% due to higher levels of cough, cold and flu incidents and good performance in core drug store categories. Pharmacy same-store sales were higher by 3.9% which included a negative impact of approximately 165 basis points from new generic drugs.

Pharmacy same-store script count was up 1.6%, reflecting higher utilization in Medicaid expansion states and an increase in flu incidents. We are now cycling last year's strong Medicaid expansion benefit so our expectation is that script comp growth comparisons will become more difficult for the next several months.

Adjusted EBITDA in the quarter was $299.3 million or 4.5% of revenues, which was $16.7 million greater than the prior year's first quarter of $282.6 million or 4.4% of revenues. The current quarter's results were primarily driven by improved sales and gross margin, offset in part by higher SG&A.

Net income for the quarter was $18.8 million or $0.02 per diluted share compared to net income of $41.4 million or $0.04 per diluted share in the prior year's first quarter. Interest expense was $22.8 million higher than the prior year's quarter due to $18.6 million of interest expense on our recently issued 6-1/8% unsecured notes and $15.4 million of expense for bridge commitment fees. Both of these items are related to the pending Envision acquisition. Together, these two items represented an after-tax drag on earnings of approximately $0.02 per diluted share.

Net income for the quarter was also negatively impacted by increases in depreciation and amortization due to our increases in capital expenditure spending over the last year, and LIFO charges due to lower projected deflation on generic drugs versus last year. Total gross profit dollars in the quarter were $56.6 million better than last year's first quarter and 8 basis points better as a percent of revenues.

Adjusted EBITDA gross profit, which excludes specific items, was favorable to the prior year first quarter by $59 million, and 12 basis points favorable as a percent of revenues. Pharmacy gross profit dollars were favorable to the prior year due to increased sales, but margin rate was worse than the prior year due to reimbursement rate pressure which was partially offset by purchasing efficiencies resulting from our arrangement with McKesson.

Front-end gross profit dollars and rate were favorable to the prior year. Adjusted EBITDA gross profit was also favorably impacted by lower distribution costs as well as additional revenues from Health Dialog and RediClinic.

Selling, general and administrative expenses for the quarter were higher by $55.2 million and 14 basis points compared to last year. Adjusted EBITDA SG&A dollars, which excludes specific items, were higher by $42.3 million but 2 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 by increases in advertising and training costs of approximately $7.5 million related to the rollout of Plenti, incremental operating investments of approximately $4.5 million related to the rollout of additional in-store clinics, and payroll and benefit costs related to our higher sales volume.

Our cash flow statement for the quarter shows a net source of cash from operating activities of $368 million as compared to $240 million in last year's first quarter, with working capital timing differences driving most of the difference. Net cash used in investing activities for the quarter was $152 million versus $177 million last year. Note that last year's expenditures included $65 million for the purchase of Health Dialog and RediClinic.

During the first quarter, we remodeled 108 stores, expanded 1 store, relocated 2 stores, and closed 4 stores. At the end of the quarter, we had completed and grand reopened 1,741 Wellness stores. For the first quarter, front-end same-store sales in our Wellness stores that have been remodeled in the past 24 months were approximately 332 basis points higher than our non-Wellness stores, and script growth in these stores was 195 basis points higher.

Now let's discuss liquidity. At the end of the first quarter we had approximately $1.4 billion of liquidity which is an improvement of $143 million from the fourth quarter of FY15. We had $1.6 billion in borrowings outstanding under our $3 billion revolving credit facility and $69 million of outstanding letters of credit. We have the ability to increase the availability under the revolving credit facility to $3.7 billion if we use the proceeds to repay our 8% first lien notes, which we expect to do when they become callable in August 2015. We expect this refinancing of the 8% notes to provide an additional $30 million in annual interest expense savings.

In April 2015, we completed the issuance of $1.8 billion of guaranteed unsecured notes. The notes mature in April 2023 and have a rate of 6-1/8%. Proceeds of these notes, which are $1.77 billion net of bond issuance fees, are being held as invested cash to fund the cash portion of the Envision transaction. In May 2015, in accordance with the terms of our 8% convertible notes, the remaining $64 million that was outstanding under those notes were converted into 24.8 million shares of common stock.

Total debt net of invested cash was lower by $237 million from last year's first quarter. Our leverage ratio, defined as total debt less invested cash over LTM adjusted EBITDA, improved to 4.08 times versus 4.52 times as of the end of the prior year's first quarter. We expect our leverage ratio pro forma for a full year of Envision's results to increase to 5.2 times upon the closing of the transaction.

Now let's turn to our FY16 guidance. Our guidance reflects our expectations for continued reimbursement rate pressure and the benefits from the McKesson purchasing agreement, as well as the anticipated benefits of our Wellness remodel program and other initiatives to grow sales and drive operational efficiencies. We've updated our guidance to include the results of Envision, assuming that the transaction closes at the beginning of July 2015.

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 revenues, which include PBM revenues, to be between $30.7 billion and $31.2 billion. We expect total drug store sales to be between $26.9 billion and $27.4 billion and adjusted EBITDA to be between $1.35 billion and $1.45 billion for FY16. The EBITDA guidance increase is related to the inclusion of the operating results of Envision from July 2015 through the end of our fiscal year.

Same-store sales are expected to be in a range from an increase of 2.5% to 4.5%, including the anticipated negative pharmacy sales impact of approximately 350 basis points from new generic introductions and continued reimbursement rate pressure. We expect a range of net income of $150 million to $230 million and earnings per diluted share to be in a range of $0.14 to $0.22.

Our net income and EPS guidance is net of estimated income tax expense of between $97 million and $151 million. However, we still expect our annual cash income taxes to be in a range of $10 million to $20 million as we continue to be able to utilize our $3.1 billion federal tax net operating loss carry forward to offset taxes that are currently payable.

Our net income and EPS guidance also reflects the negative after-tax drag on earnings of approximately $32 million of pre-closing interest expense and acquisition costs related to the Envision acquisition and approximately $20 million of debt modification costs related to the refinancing of our 8% notes. Together, these non-recurring items represent an after-tax expense of $0.05 per diluted share. The range of guidance is primarily driven by our same-store sales range and pharmacy margin expectations.

I also want to remind you that in last year's second quarter our gross profit and EBITDA was favorably impacted by approximately $40 million resulting from the effect on inventory valuation related to our transition to McKesson last year. So, that one-time item represents a headwind for our second quarter this year. In terms of quarterly cadence, we generally expect the latter portion of the year to be stronger than the earlier portion.

Our FY16 capital expenditure plan is to spend approximately $665 million with approximately $105 million related to new and relocated stores, $225 million related to Wellness remodels, and approximately $100 million for script file buys. We're planning to open 11 new stores, complete 33 relocations, and remodel 400 Wellness stores in FY16. Our capital expenditure assumptions also includes a CapEx spend of $15 million related to Envision.

We expect free cash flow to be in a range of $300 million to $400 million for the year including the benefit of lower pharmacy inventory. We expect to close a total of 40 stores, of which the guidance includes a store lease closing provision for 10 stores, with the balance of the stores closing upon lease expiration.

This completes my portion of the presentation and now I'd like to turn it back to John. John?

Thank you, Darren. Before we open the phone line for questions, I'd like to thank our Rite Aid team for the excellent work they did during the first quarter. Looking forward, we are excited to continue positioning Rite Aid for long-term growth through our journey to become a retail healthcare company. We believe these efforts will help us not only better serve our customers but also deliver long-term value for our shareholders.

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

(Operator Instructions)

Your first question comes from the line of Robert Jones.

Thank you, good morning. Just two quick ones on guidance, John. It seems like the raise entirely from Envision in light of the strong fundamental performance in the first quarter, just curious any reason why not to think a little bit more positively fundamentally for the balance of the year.

And then, Darren, just one quick point of clarification. The $100 million for Envision included, does it include acquisition related costs? And how does that compare to the original expectation for the $150 million to $160 million of EBITDA?

I'll go first. In terms of guidance for the core Rite Aid business, I think we had a very good first quarter, very much in line with our expectations. We have a couple of tough quarterly comparisons coming up, the second quarter in particular, I think, as Darren talked about the cadence. So, I think guidance for the year still seems appropriate to us.

And on the second question, the $100 million does not include any acquisition costs. Those were below the EBITDA line. And the $100 million is basically right on target with what our original expectation was on an annualized basis.

Got it. And then, John, if I could just sneak one more in, a strategic question. In light of the recent CVS/Target news, was curious if you saw any similar opportunities out in the marketplace, whether it be on the big box side or maybe with even the grocery chain, or any other opportunities like that that you guys see out there.

I can't point to a specific opportunity. I'd tell you we're, again as I think we've said all the way along, very open-minded. Those kinds of opportunities would be interesting to us but I couldn't point to a specific one at the moment.

Got it. Thanks so much.

Your next question comes from the line of John Heinbockel with Guggenheim Securities.

Hi, John. First, the softness in comp scripts, I know it's largely, or I think it's largely, Medicaid related. So, is there anything you can do to try to spur some share -- it's not going to be demand -- but share in the short term? And then do you think, is it possible that the comp scripts go negative before they reaccelerate, or no, we're pretty close to a bottom here?

I think they might get a little softer before we're done because we're still in the ramp-up phase. When you look at the first quarter, although it probably decelerated a little bit as the quarter progressed, we still actually were net up in Medicaid scripts. So, a lot of our pressure early on here has been actually on the commercial side of the business. As we continue, as Darren says, to get to the period here over the next few months where the Medicaid continued to ramp comps get a little tougher until we cycle this thing probably around August or so. That's the hand-to-hand combat we have in front of us from a script count perspective.

But we're working on a lot of exciting stuff. We've got the remodels, we've got Plenti out there right now we're working very hard on, we're going to be out there with our flu shot campaign again this year pushing very hard. So, I think we've got some things to do to help us.

And then just on Plenti, I know that was going to be a little bit disruptive in the short term, actually maybe seems a little less so than I would have thought. Where are we with that? And then at what point does this really start to become a customer acquisition vehicle for people that are not wellness+ cardholders?

Hey, John, it's Ken. Where we are now obviously is pretty early. We're not even two months into this thing yet. But I think the response from the consumer has been very positive. We're excited about the relationships that we're developing with some of these other brands. So, out of the gates I think it's pretty positive.

You think back to when we launched wellness+, we built this whole thing around, really, our pharmacy business. And the great thing about Plenti is the way that we've structured this we've retained all of the benefits that traditionally our customers have had with wellness+ but now they're really pushing the +UPs into the Plenti opportunity, gives them a lot more value and a lot more flexibility.

It's going to take a little while to ramp and I think it's going to be much like what we saw with wellness+. It will be a gradual build. But I think we're pretty bullish on what we've seen so far.

Okay, thank you.

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

Thank you and good morning. I know you don't give quarterly guidance but just given the outperformance in this quarter, and then John, I heard you and Darren both talking about some of the headwinds in the back half, the $40 million last year that was beneficial from McKesson, can you maybe just help us understand, was, one, this quarter, did it come in better than your expectations? Or did we all model it wrong? And, secondly, as you look out to the back half of this year, are there things that are different than what we saw in the first quarter, setting aside the one-time benefit that you saw from McKesson last year?

I have a couple thoughts and I don't know if Darren or Ken if you want to jump in. I think, first of all, the first quarter was in line with our expectations. Darren's mentioned the $40 million. We have the reimbursement rate pressure that builds throughout the year but we also have Abilify and Nexium, which we think are going to be (inaudible) some time by the end of the year. And there is some value associated with those.

The way things cycle and play out, all the different factors through the numbers, I think, while we're not giving quarterly guidance we do think the second quarter is a tougher one, and we expect to see some strengthening as we go into the third and fourth quarter. That's as close as I want to get to any kind of quarterly guidance.

Okay. But, John, as you think about your business generally speaking, do you feel like there's anything that's changing, either from a reimbursement perspective, that you weren't anticipating, or anything else that we need to be focused on? Because, again, I thought that -- whether that was your expectation or not. And the first quarter, that was a really solid quarter here in the first quarter. And we understand what you talked a little bit about the headwind, but part of me has to believe that you're still being fairly conservative this year, or am I wrong?

We feel good about our guidance.

All right. Let me just ask a second question. That's more on the PBM side of things. It looks, as you said, you'll close Envision here at the beginning of July. Do you have any updated thoughts around how Envision has done, for example, in the selling season? Have they benefited from the potential opportunity of what they can bring, now that they're part of Rite Aid?

I think the answer is that Envision is performing in line with our expectations for the first part of their fiscal year. In terms of the selling season, their selling season honestly falls a little bit differently than you're seeing from the larger PBMs, in that smaller clients generally wrap up their process a little bit later in the year. So, we're still a little early in their selling season.

Anecdotally I would tell you that they have seen more RFPs come in the door since we announced this transaction. I think there's more visibility to Envision. But I think it's a little early for us to tell you the selling season is good, bad or indifferent.

Okay, great, thank you.

Your next question comes from the line of Charles Rhyee with Cowen.

Yes, thanks for taking the question here. Just following up on the Plenti program here, I think, Ken, you made the comment, you said something about two-thirds of transactions were from Plenti members. Is that mostly they were Wellness members that also are enrolled in Plenti?

Yes, let me clarify. Last week we had two-thirds of the loyalty transactions that went through our store. We always have a number of convenience related non-member transactions that go through. And obviously we don't have a lot of intelligence on those because those are just not tied to any card.

But of all of the cards that went through our front end and pharmacy last week, two-thirds of those transactions have been linked to a Plenti account. What that's telling you is that of the population of wellness+ members that came in the door, two-thirds of them have already linked to a Plenti account. So, we're moving them into the new program at a fairly good clip and we're pretty happy with that rate.

Can you tell, of those two-thirds, how many were just a Plenti member but not a Wellness member? In other words, getting to the earlier question, new customer acquisition from Plenti?

It's still very early, like I said, but we are starting to see some customers coming in that were signed up at our partners and we have not seen them before. So, we are starting to see some new customers come in the door.

Okay, great. And then a clarification, Darren. In the guidance, as well, I know we talked about some of the acquisition costs. Is the debt financing costs that's included that's in the guidance, as well? You're absorbing it in the guidance?

It is. You're talking about on the 8% notes, correct?

Yes.

It is.

Okay, great. Thank you.

Your next question comes from the line of Ross Muken with Evercore ISI.

Good morning, guys. As you spend more time thinking about Envision and maybe what it could do for you on the specialty front, how do you feel like Orchard could maybe get you deeper into that paradigm, which obviously has very good growth and would be a very strong add to the store in terms of a specialty retail program? What thinking have you done around different options for what that could bring you?

First of all, it brings us 45 more limited distribution drugs that we didn't have before. We had a small portfolio of limited distribution drugs. This really gets us into the business, honestly. So, we've gone from nowhere to somewhere overnight with this acquisition, so that's very exciting to us.

I think our opportunity with Orchard is to broadly expose it to the Rite Aid retail network. And we have some work to do on the contracting side to bring that to life. But that's a really big opportunity for us.

Today someone walks into one of our stores, we don't have the drug, we're sending them somewhere else. So, all of a sudden here is 45 more drugs that we can now refer a patient to our own specialty pharmacy. Before we can do that we need to make sure Orchard is fully contracted, which it is not today. So, we have leg work to do to get to that opportunity. But that is going to significantly expand our scope in terms of what we can do from a specialty perspective.

Orchard continues to add additional drugs. They had success recently bringing some additional new drugs into their portfolio. And, again, I think it's like the whole Envision opportunity. Attaching the Rite Aid brand to it is really raising the awareness of all of the things that Envision can do. We think there's good opportunity just to organically grow the Orchard specialty business, so we're really excited about it.

Great. And not to belabor the point but I've just gotten a lot of questions this morning on the comp cadence. We've obviously looked at the macro data and it is in line also a bit with what you are highlighting, at least on a near-term basis. As we think about post August what's needed to hit the annual guide, and you obviously gave a number of key drivers, if you had to not put numbers around it but then maybe from like a qualitative perspective give us a sense of where, of those various opportunities, you're likely to see the most up lift. How would you characterize the top one or two pieces that are going to drive that back to a more normalized level?

I'm excited about all of the things we're working on. But as it relates to our front-end business, and probably indirectly to our pharmacy, I think Plenti is going to just be really important to us as we get this thing rolled out, get our customers engaged with it, gain access to new customers. I think it's going to be just hugely exciting for us in the back half of the year.

We've still got -- Ken talked about it -- we're still very much engaged with customers, getting them enrolled, getting them up to speed on the program. There's still a lot of action in the stores around this thing. But as they, I think, get comfortable with it and begin to work with it, I think that's going to be a big opportunity.

There's a lot of action out there with our partners on television and what not. There's lots of other people signing up to issue Plenti points. They're not redeemers but there's a bunch of people who are getting into this thing. So, it seems like it's got a lot of momentum around it. I think that could really help us.

The renovations continue to do well. We're seeing good progress there. So, I think we've got a lot of good things going on that should hopefully build into some momentum into the back half. Ken, I don't know if you want to --?

I think that's right. This is a pretty big lift for us to move all these customers into the new loyalty program. But so far it's been good and I think this thing just continues to gain momentum as we get it rolled out.

Great, thank you.

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

Hi, guys. John and Darren, first question for you is just on the outlook. When we think about last year there was some volatility around the guidance, which for you guys is actually not really normal. My question for you here is, as you think about this year, it sounds like you feel good about the guidance, but do you feel like you've got maybe better visibility around things like reimbursements that have been, like last year, were more of an issue?

That visibility continues to improve, as the year gets shorter and we don't look out as far. Based on what we know today we feel like guidance is in the right range here. There's still lots of things that are going to happen throughout the year but based on where we sit today it's still our best view.

And then, John, just related to industry consolidation, there's been a lot of news in the marketplace, particularly around stuff that CVS is doing, but obviously you guys are on the move, too. The question really is, where do you think you stand today in terms of having the right pieces to compete long term? And where do you think over time you still may need to strengthen?

In the long run we'd certainly love to have more counters. I think that's a strategic opportunity for us as we look forward. So, we're continuing to go through ways to work on that. We're excited about Envision but it may be that there are some things that make sense over time to add to Envision to round it out in terms of its capabilities. But I think those are our primary focus areas.

We're putting a lot of capital back into our store base. We think that's important. The interaction in our stores is really critical to our strategy. The Wellness ambassadors, pharmacists, even our front-end associates, coaches from Health Dialog and things, clinics. So, we're really trying to focus on things that make that experience in the store really what we want it to be. I think those are the kinds of things we are going to focus on.

You didn't mention specialty, John. Is that included with Envision when you talk about that?

Yes, that's included with Envision. I think there are probably some things that over time make sense to tack on to Envision, and specialty would be a piece of that.

Great. Thank guys. Good luck.

Your next question comes from the line of George Hill with Deutsche Bank.

Good morning, guys. Thanks for taking the question. John, maybe just start off with, you talked a little bit about how script trends could get a little softer before they get better. Can you quantify or put any color around the impact of not participating in Med D preferred networks on script trends? And then I have a quick follow-up.

It's interesting. We are pretty, I'd say, flattish, maybe down just slightly in our Medicare business. So, so far in this fiscal year that has not been a huge factor. It hasn't grown a lot but it hasn't declined a lot either. It's down just slightly.

Its really been more, so far this year, a little bit more on the commercial side of our business where we felt some pressure. There's been a lot of talk about limited networks and those kinds of things and I think that's probably more where we've seen some pressure early on.

Okay. And then you rolled right into the second half of my question which was the commercial pressure that you mentioned earlier. It sounds like that's more volume as opposed to price. And I guess the volume pressure is preferred networks but could you qualify price pressure and if there's any concentration there?

When we talk about price pressure reimbursement rate is a constant pressure that we unfortunately deal with all the time, and that's reflected in our guidance. I think we've said anecdotally that last year was a pretty tough year and this year was a pretty tough year. Early on we think next year is shaping up a little bit better. It's still pretty early on that. But that's the cadence on reimbursement rate pressure. But clearly there is some limited networks that have proliferated out there and we think those are putting a little bit of pressure on us.

Appreciate the color, thanks.

Your next question comes from the line of Steven Valiquette with UBS.

Thanks, good morning. Just a couple of questions for me. I think, first, some of the data we track suggests that generic drug price inflation may have moderated a little bit during your May quarter sequentially and year over year. And just given the strength in your gross margins this quarter I'm wondering if you can read into that maybe as somewhat confirmatory that generic inflation may have moderated. So, I'm curious to get your perspective on that topic.

We continue to make progress working on generic drug costs. We made some progress last year. Obviously last year's first quarter was a little tough, but throughout the year. We continued to make progress in the first quarter this year. So, from our view, we continue to make good work there and some progress.

Okay. And then the second question, this one a little bit of a sensitive topic but when thinking about your May same-store sales, I think some investors perceived it as a little bit soft. I think I saw in some news articles that you had eight stores closed in the Baltimore area around some of the activity that took place there in late April and into May. I'm just curious, did that have any material impact on your same-store sales from May and your results for the overall May quarter. Just curious if that had any material impact.

It did not.

Okay, that takes care of that. Thanks.

Your next question comes from the line of Joe Stauff with Susquehanna.

Good morning. I just had a couple questions. In talking about your remodeling program, you'll be about 2,000 units at the end of this year, as you guided to. What is a realistic number in terms of the maximum that you would take it to? I understand it's likely not to be 100%. Would it be 70%? What's the right metric to think about as we think about your remodeling reinvestments?

I don't know that we've got a number out there. I think as you look forward to the 2,500 stores that will be out there that have not been remodeled, clearly there is a portion of those that will continue to burn off, stores we don't want to go forward with. But there's a big opportunity for us to relocate a lot of those stores,.

So, between remodels and relocations, I think that's how you have to look at it. I think we'll get 33 relocations this year and we're going to continue to relocate these stores as we go. Some of those stores we don't want to go forward with but as we relocate, the percentage of the stores will continue to climb. I don't know that we have a number out there right now that gives you the overall number where we're going to land long term.

Okay. And then could you outline the approximate overlap that you guys have in terms of your store front with Target and Target's and CVS's acquisition of those units, approximate overlap with that?

Honestly, they're in a bunch of markets we're not in. They are in all of our markets, to some degree, I think, just off the top of my head. But they are in a number of markets that we're not. I don't have a percentage for you or something.

Okay. Do you have a similar figure, just to remind me, with respect to the overlap of store units that you guys have also with Rite Aid?

Rite Aid's 100%.

Got you. Okay, all right, thank you.

Your next question comes from the line of John Ransom with Raymond James.

Good morning. Just a couple things. What is the -- and I apologize if I missed this -- script count assumption embedded in your guidance, both high and low?

I don't think we give an overall script count assumption in our guidance John.

I'm trying to get one, though.

Our sales range of 2.5% to 4.5% and that's all the specific metrics we give.

So did the script count in the first quarter track in line with your expectations then? Maybe that's another way to get at this.

Pretty close, yes.

Okay. So we're kind of in a 1 to maybe a 1 to 2 environment hopefully?

You're looking for a confirmation on that?

Sure. (laughter) Got to keep trying, right? And then the second question I have is you've stepped up your spending. As I look at your CapEx you're spending $400 million-plus a year on both remodels and file buys. Do you still get a 20%-ish ROI on that spending?

Yes, we generally do. We've said in the past on the remodels if we get a 3% compounded growth on the top line, we see a 20% return. And historically the file buys are very good strong returns, as well.

I think one caveat -- I'll just jump in there -- is there is certainly a portion of that CapEx that is maintenance. Some of these stores have not been touched in awhile so you get into some things that we would consider more maintenance.

Right. And along that line, going back to an earlier question, how many stores do you think you'll eventually, that are maybe tucked away in dead or dying strip malls that are sub scale, as you think about relocating -- and this is not a remodel, this is a store lift out and a new build -- but how does the return compare on those, just say straight remodels? And what's the approximate scope of opportunity to lift out some of these smaller sub scale stores?

I think the returns are better on a relo than they are on a remodel, generally because we usually see a more substantial sales lift associated with it. And as you would expect, there's a group of stores that are identified that we're working pretty hard on to try and find relocation opportunities for. But it's one of those things that's got to come together. You need a site, you have to be able to get access to the real estate and all those kinds of things. So, it's a process that takes time. That oftentimes could take a number of years to get a relocation site. We continue to operate some stores with the hopes that we will get it out to the right spot eventually somewhere in the lease cycle.

Okay. Thanks a lot.

Thank you very much. That concludes our call. We appreciate everybody for joining us today.

Thank you very much.

Ladies and gentlemen, this does conclude today's conference call. You may now disconnect.