Rite Aid Corp (RAD) 2016 Q2 法說會逐字稿

Good morning. My name is Keyla, and I will be your conference operator today. At this time, I would like to welcome everyone of to the Rite Aid second-quarter FY16 earnings call.

(Operator Instructions)

Thank you. I will now turn the call over to Matt Schroeder.

Thank you, Keyla, and good morning, everyone. We welcome you to our second-quarter conference call. On the call with me this morning is John Standley, Chairman and Chief Executive Officer; Ken Martindale, Chief Executive Officer of Rite Aid stores and President of Rite Aid Corporation; Frank Sheehy, Chief Executive Officer of EnvisionRx; and Darren Karst, Chief Financial Officer.

On today's call, John will give an overview of our second-quarter results, and discuss our business. Ken will give an update on some of our key initiatives, Frank will provide an update on EnvisionRx. Darren will discuss the key financial highlights and FY16 outlook, and then we will take questions.

Starting with this quarter, we're reporting our business in two distinct segments. Our retail pharmacy segment consists of Rite Aid stores, Rite Aid clinic and Health Dialog, while our pharmacy services segment consists of our newly acquired PBM, EnvisionRx.

As we mentioned in our release, with are providing slides related to the material we will be discussing today. These slides include annual earnings, revenue and sales guidance. These slides are provided on our website, www.riteaid.com, under the Investor Relations 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 will find them helpful, as they summarize some of the key points made on the call.

Finally, 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 file or furnish to the Securities and Exchange Commission.

Also, we will be using a non-GAAP financial measure, adjusted EBITDA. 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 measures.

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 second-quarter results for FY16. The second quarter was pivotal for Rite Aid, as we finalized the acquisition of EnvisionRx, and worked as a team to accelerate Rite Aid's transformation into a retail healthcare company.

In addition to the acquisition of EnvisionRx, we also made other significant investments in our business in the second quarter. Including refinancing a portion of our debt, building RediClinics in more locations, converting additional Rite Aid stores to our wellness format, and continuing the launch of our new wellness+ with Plenti coalition loyalty program. We are excited about these investments, because while they're having a short-term impact on our results, they are also absolutely critical in positioning Rite Aid for long-term growth.

Adjusted EBITDA for the quarter was $346.8 million, compared to $364.2 million last year. When taking into account last year's $40 million benefit related to our transition to a new drug purchasing and delivery arrangement with McKesson, adjusted EBITDA increased by $22.6 million.

The increase was due to $33.2 million of adjusted EBITDA generated by Envision. This was partially offset by a decline in retail pharmacy gross margin, due to lower pharmacy reimbursement, which was in turn partially offset by lower drug purchase costs.

Net income for the quarter was $21.5 million, compared to $127.8 million for last year's second quarter. The decline in net income resulted primarily from the cycling of the previously mentioned prior-year benefit related to our McKesson agreement, costs related to our debt refinancing, and incremental interest expense, amortization expense, and transactional costs related to the Envision acquisition.

Darren will walk through these items in more detail in a few minutes. Revenue for the quarter increased by 17.5% to $7.7 billion, compared to $6.5 billion for the prior-year period.

As I alluded to earlier, our completion of the Envision acquisition represented a key milestone in our efforts to significantly expand our health and wellness offering. And deliver unique and integrated pharmacy offerings in the healthcare marketplace.

During the second quarter, Envision made positive contributions to our performance. Delivering results that were in line with our expectations, and is having a strong selling season.

During today's call, EnvisionRx CEO, Frank Sheehy, will join us to provide additional details about this segment of our business. I would just like to add that we remain very excited about the opportunities these combined entities represent. And we are in the process of evaluating the best ways to leverage all of our healthcare assets, so that we can continue to grow as a retail healthcare company heading forward.

We also remain highly focused on further expanding our RediClinics, as we strive to deliver a higher level of care in our local communities. During the quarter, we also announced our eighth partner, Reliance ACO, based in Southeast Michigan. As we grow our Rite Aid health alliance program to provide comprehensive care to patients with chronic health conditions.

Finally, we announced some executive appointments during the quarter. Designed to help Rite Aid drive growth and efficiencies as we enter a new chapter for our business.

This included the promotion of Ken Martindale to the newly created position of CEO of Rite Aid stores, as he retains his role as President of Rite Aid Corporation. Ken is a proven leader with a deep understanding of our business, and we look forward to leveraging his talents to help us continue our positive momentum.

With that said, I'll now turn it over to Ken for an update on our key initiatives.

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

Our key initiatives continue to play an important role in providing our customers and patients with an engaging and differentiated experience that drives growth throughout the retail pharmacy segment. In the second quarter, we continued to focus on educating our customers about the unique value offered by wellness+ with Plenti. Which is part of the first coalition loyalty program in the United States.

Through this ground breaking loyalty offering, customers continue to enjoy the tremendous benefits of wellness+. While also having the ability to earn Plenti points, and redeem them for savings at Rite Aid as well as other Plenti partners.

We continue to experience strong membership growth. Through the end of the quarter, we enrolled 17.6 million customers, and our Plenti partners have enrolled millions more throughout the coalition. In addition, more than half of all store transactions at Rite Aid now involve a wellness+ with Plenti card.

We've also been highly successful in converting our gold and silver wellness+ members to the enhanced program. More than 86% of gold members and 74% of silver members are now enrolled. Overall, we are pleased with the initial results of wellness+ with Plenti, and look forward to building upon the great work that our Rite Aid team has done to successfully launch the program.

Our wellness store initiative continues to drive growth, and deliver a unique and engaging customer experience. During the quarter, we completed 119 wellness remodels, three relocations, and two net new stores.

We now have a grand total of 1,859 wellness stores, which represents 41% of our entire chain. In addition, wellness stores continue to outperform non-wellness stores in terms of same store front-end sales and prescription count.

With flu season right around the corner, we are now aggressively promoting flu shots as we look to raise awareness about this convenient health service. Last year, our pharmacists administered a Company record 3.2 million flu shots, and we look forward to working as a team to continue growing this area of our business.

In addition to wellness ambassador engagement with our local companies regarding flu shot clinics, we're supporting our efforts with a comprehensive marketing campaign that includes national broadcast media. We're also highly focused on leveraging the flu shot season as an opportunity to promote pharmacy services like Vaccine Central, and the additional types of vaccinations that we offer on a state by state basis.

We continue to look for new ways to leverage our convenient retail locations, and expand access to quality healthcare services. During the quarter, we launched a tele-health pilot by opening health spot stations inside 25 Rite Aid pharmacies in Ohio.

We also added one RediClinic in the Philadelphia market, and another four RediClinics in the Seattle market. We now operate 35 Rite Aid RediClinics and 70 total clinics.

We continue to experience steady growth in our clinic business. And as cough, cold and flu season approaches, we are excited to have our RediClinic and health spot locations in place so that we can better serve these communities.

During the quarter, we began accepting mobile payments. Such as Apple Pay, Google Wallet and the just released Android Pay in all of our stores nationwide.

We are also accepting tap and pay credit and debit cards, and have the technology in place to accept a variety of mobile payment options as they come to market. This enhancement has been well received by our customers, especially those who are highly engaged in utilizing mobile technology.

As you know, we're actively working to strengthen our portfolio of private brands. In the second quarter, we introduced two new innovative product lines. This includes the first 150 items in our Big Win brand, which offers budget-friendly value on high quality consumable items, as well as 40 items in our new Dream House brand, which offers indulgent yet affordable treats.

These launches represent a significant step towards our goal of creating a world-class private brand portfolio that will deliver superior value, quality and innovation to our customers. Meanwhile, our overall private brand offering continued to deliver strong results, with penetration increasing to nearly 18.8%, more than 40 basis points higher than last year's second quarter.

Finally, we had another strong quarter in terms of our prescription file buy program. We completed $29.2 million in file buys, and we're on pace to invest the $100 million we've allocated for this program in 2016.

To sum it up, we are pleased with the progress that we're making with our key initiatives. As we look to differentiate Rite Aid as a convenient destination for health and wellness in our local communities.

At this time, I will turn it over to EnvisionRx CEO, Frank Sheehy, for a additional details about the performance of EnvisionRx in our second quarter. Frank?

Thank you, Ken. And thanks again to everyone for joining us on today's call.

Let me first say that we are very excited to officially be part of the Rite Aid family. We believe that joining the Rite Aid team will provide us with a more competitive value proposition, and help us further expand our growing base of clients and members. Today, I will provide an update on the pharmacy services segment that consists of EnvisionRx financials from June 24, the date of the acquisition's closing, through the end of the fiscal quarter.

We are pleased with the results, which reflect Envision's continued strong momentum in the PBM market. Revenue for this segment for the quarter was $1.1 billion, and total gross profit dollars for the quarter was $61.8 million resulting in adjusted EBITDA for the quarter of $33.2 million.

I would like to comment briefly on our current PBM selling season for the 2016 plan year. We are seeing positive response across all lines of commercial PBM business. And, in particular, Envision's ability to deliver on a variety of operating models including pass-through and traditional.

While already completing nearly 95% of our client renewals for 2016, I'm pleased to report Envision is having a successful year with projected wins adding approximately 700,000 net new lives. Not including a still active fourth quarter calendar 2015 pipeline.

I would also like to touch briefly on our individual Medicare PDP. We have received the preliminary 2016 benchmark results from CMS. Envision insurance will retain 14 of 34 CMS regions, which compares to 24 regions in 2015. With the annual Part D bidding process becoming increasingly price competitive, we are maintaining a focus on acquiring low income subsidy and chooser members at a premium and profit levels that ensure the continued delivery of attractive benefits and satisfying service.

While we are decreasing in geographies and anticipate a reduction in covered lives of approximately 65,000, we still expect to have over 300,000 individual PDP lives in 2016, increased membership in the Rite Aid retail footprint, and stable profitability compared to 2015.

As our core PBM business grows, added opportunities are created for our Envision mail and specialty pharmacies. With specialty drugs expected to comprise 50% of all prescription spending by 2018, our specialty pharmacy is being embraced by more clients. And has seen a 37% increase in monthly prescription volume over the past six months.

The Envision partnership with Rite Aid enables access to an increased number of limited distribution drugs and continues to help improve the value of our pharmacy offer.

Overall, the Envision success in the marketplace continues to be driven by the fact that plan sponsors are looking for a PBM that will partner with them to keep drug costs down, while still providing the prescription coverage and service their employees and members expect. As a full service PBM with the operational flexibility to provide more customized client programs, as well as added opportunities to further leverage our relationship with Rite Aid, we expect to see continued positive performance.

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

Thanks, Frank, and good morning, everyone.

On the call this morning, I will walk through our second-quarter financial results, discuss our cash flow, liquidity, certain balance sheet items, our capital expenditure program and finally review our FY16 guidance.

Revenue for the second quarter was $7.7 billion, which was an increase of $1.2 billion or 17.5%. Adjusted EBITDA was $346.8 million or 4.5% of revenues. Net income was $21.5 million or $0.02 per diluted share versus net income of $127.8 million or $0.13 per diluted share in last year's second quarter. The decrease in our net income was driven by several of the investments that John referenced in his opening remarks, which I will discuss in more detail in a few minutes.

Retail pharmacy segment revenue for the quarter was $6.6 billion, which was $125 million or 1.9% higher than last year's second quarter. The increase was due to higher front end and pharmacy sales.

Overall, same store sales increased 2.1% in the quarter. Front end same store sales increased by 0.3%, and pharmacy same store sales were higher by 2.8% which included a negative impact of approximately 223 basis points from new generic drugs.

Pharmacy same store script count was up 0.2% which reflects a slowing of our script growth trend versus the prior year, as we are cycling the benefit of last year's strong Medicaid expansion. We expect same store script growth comparisons to continue to be difficult for the next several months, as we continue to cycle last year's Medicaid expansion. Retail pharmacy segment adjusted EBITDA in the quarter was $313.6 million or 4.7% of revenues. Which was $51 million lower than last year's second quarter adjusted EBITDA of $364.2 million or 5.6% of revenues.

Recall that last year's second quarter results were favorably impacted by a pharmacy margin benefit of approximately $40 million related to the transition to our drug purchasing arrangement with McKesson. Without this item in last year's results, adjusted EBITDA for the retail pharmacy segment decreased by approximately $11 million, which was driven by a reduction in gross margin primarily due to lower pharmacy reimbursements versus the prior year.

Total retail pharmacy segment gross profit dollars in the quarter were $34 million lower than last year's second quarter, and 106 basis points lower as a percent of revenues. Adjusted EBITDA gross profit was unfavorable to last year's second quarter by $33 million or 105 basis points as a percent of revenues. Pharmacy gross profit dollars and rate were unfavorable to the prior year due to the cycling of the $40 million item from last year, that I discussed earlier, and lower pharmacy reimbursements. Which was partially offset by purchasing efficiencies, resulting from our arrangement with McKesson and higher script volumes. Front-end gross profit dollars and rate were flat to the prior year.

Adjusted EBITDA gross profit was also favorably impacted by lower distribution costs. Retail pharmacy segment SG&A expenses for the quarter were higher by $38 million, or 11 basis points, compared to last year's second quarter. Adjusted EBITDA SG&A dollars were higher by $17 million, but 18 basis points lower as a percent of revenues compared to last year's second quarter 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 payroll and benefit costs, and higher occupancy expenses.

The pharmacy services segment had revenues of $1.1 billion. Gross profit of $62 million, or 5.8% of revenues, and adjusted EBITDA of $33.2 million or 3.1% of revenues. Envision is off to a very good start, as their results were in line with our expectations. As Frank discussed earlier, the 2016 selling season results have been positive, both in new business and client renewals.

Net income for the quarter was $21.5 million or $0.02 per diluted share compared to net income of $127.8 million or $0.13 per diluted share in last year's second quarter. Keep in mind, our comparisons are not consistent because the current year's effective income tax rate was 43%, as compared to 13% last year, which predated our reduction in our deferred tax asset valuation allowance that occurred in the fourth quarter of FY15. That difference would have lowered last year's EPS by $0.04 per diluted share.

As I said earlier, the decrease in our net income was driven by several investments in our business that we made during the quarter. We incurred a $33 million loss on debt retirement in the quarter related to the early call and redemption of our 8% first lien notes. These notes were refinanced with incremental availability under our revolving credit facility, which will result in annual interest expense savings of approximately $30 million. Depreciation and amortization expense increased by $17 million, related to the acquisition of Envision and $9 million related to our capital spending on our retail store base over the past year.

Interest expense was $14.5 million higher than last year's second quarter due to incremental interest expense of $27.6 million on our recently issued acquisition related 6 1/8% unsecured notes, offset by savings from our revolver financing that we completed earlier in the year. Net income for the quarter was also negatively impacted by $9.6 million in acquisition-related expenses associated with our purchase of Envision. Taken together, the additional expenses related to the acquisition of Envision and our financing activity accounted for $0.05 per diluted share.

Our cash flow statement for the quarter shows a net use of cash from operating activities of $26 million, as compared to a $122 million source of cash in last year's second quarter. Our current year cash flow activity reflects a normal seasonal inventory build. While last year's operating cash flow benefited from a reduction in pharmacy inventory in our distribution centers, as we began to transition to the new McKesson agreement. Net cash used in investing activities for the quarter was $1.9 billion, which included $1.78 billion related to the purchase of Envision. Excluding the Envision acquisition, net cash used in investing activities was $156 million versus $120 million last year.

During the second quarter, we remodeled 119 stores, relocated 3 stores, acquired 2 stores, closed 9 stores, and opened 5 clinics. At the end of the quarter, we had completed and grand reopened 1,859 wellness stores. For the second quarter, front-end same store sales in our wellness stores that have been remodeled in the past 24 months were approximately 350 basis points higher than our non-wellness stores. And script growth in these stores was 130 basis points higher.

Now let's discuss liquidity. At the end of the second quarter, we had approximately $1.2 billion of liquidity. We had $2.45 billion in borrowings outstanding under our $3.7 billion revolving credit facility, and $71 million of outstanding letters of credit. Total debt net of invested cash was $7.4 billion. Our leverage ratio, defined as total debt less invested cash over LTM adjusted EBITDA and pro forma for a full year of Envision results, was 5.2 times. Our goal is to reduce our leverage ratio to the level it was prior to the acquisition of Envision over the next couple of years.

Let's now 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, file buy acquisitions, and other initiatives to grow sales and drive operational efficiencies.

We expect total revenues, which include PBM revenues, to be between $30.8 billion and $31.1 billion. And adjusted EBITDA to be between $1.36 billion and $1.44 billion for FY16. We expect total drugstore sales to be between $26.7 billion and $27 billion.

Same store sales are now expected to be in a range from an increase of 1.5% to 2.5% given the cycling of last year's Medicaid expansion benefit, and current sales trends. Our same store sales guidance also includes approximately 347 basis points of anticipated negative pharmacy sales impact from new generic introductions.

We expect a range of net income of $125 million to $195 million, and earnings per diluted share to be in a range of $0.12 to $0.19 per diluted share. Our net income and earnings per diluted share guidance reflects incremental amortization related to the newly acquired assets of Envision.

Our purchase accounting work is not yet complete. But based on our preliminary estimates, we expect amortization expense to be higher than Envision's historical amortization expense, which was the basis of our early estimates. While this incremental amortization expense is more than we initially estimated, we still expect the acquisition of Envision to be accretive in FY17 on a cash EPS basis, adjusted for deal related amortization. Our net income and EPS guidance is net of estimated income tax expense of between $90 million and $135 million. However, we still expect our annual cash income taxes to be in a range of $10 million to $20 million as we will continue to be able to utilize our $3.1 billion federal tax NOL carry-forward to offset taxes that are currently available. The range of guidance is primarily driven by our same store sales range and pharmacy margin expectations.

Our FY16 capital expenditure plan is to spend approximately $665 million with approximately $95 million related to new and relocated stores, $235 million related to wellness remodels, and approximately $100 million for script file buys. We're planning to open or acquire 18 new stores, complete 27 relocations, and remodel 400 wellness stores in FY16. Our capital expenditure assumptions also includes a CapEx spend of $15 million related to EnvisionRx.

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 of these stores, with the balance of the stores closing upon lease expiration.

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

Thank you, Darren. Before we open the phone lines for questions, I'd just like to thank our nearly 90,000 associates for the great work they've done in delivering an outstanding experience for customers and patients, and supporting our growth as a retail healthcare Company.

Our Rite Aid family now includes nearly 4,600 stores and wholly owned subsidiaries that offer health coaching and analytics, clinical care, and a compelling suite of pharmacy benefit management services. We look forward to working as a team to fully leverage these capabilities to deliver value and innovation in the healthcare marketplace, and drive long-term growth for Rite Aid.

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

(Operator Instructions)

The first question comes from Robert Jones of Goldman Sachs.

Thanks for the questions. I guess as we think about guidance, the EBITDA outlook looks largely unchanged. Maybe could you talk about whether there has been any change to your expectations specifically about the contribution from Envision? And I guess with that, I'm just curious on the core business, any change to your outlook on EBITDA for the balance of the year?

I think we're pretty much in line with our original expectations. Obviously, the top line has been a little tougher than we anticipated coming into the year. I think reimbursement rates have lined up with our expectations so far. We've done a very good job on the purchasing side. And that's really helping us I think weather a little bit of our script count challenge at the moment. And we've been pretty good on the SG&A so far. So I think that's really what's driven our ability to hang in on there on EBITDA with a little bit tougher top line.

Got it. And I guess just a follow-up. Moderating generic inflation obviously a big focus across the supply chain. I recall last year the greater than expected inflation created some issues for you guys earlier in the fiscal year last year. Can you just remind us what the impact is to the business as we see generic inflation moderating?

I think we tend to look at it more directly on our ability to purchase drugs at a lower cost, or whether we have a cost increase that we have to absorb. So I think we've, again, had a pretty good year on the purchasing side, which is helping us on the pharmacy margin. And our expectation is that we're going to continue to make progress for the remainder of the year. I don't think I answered your question very well, but that's the way we think about it.

Understood. Thank you.

The next question is from [Lisa Gill] of JPMorgan.

Thanks very much, and good morning, everyone. I just want to go back to the same store sales. Obviously, cycling through Medicaid expansion.

But either John or Ken or Darren, can you maybe just give us some indication as to what changed? Is it just that it dropped off more quickly than you anticipated? Did you have something in your expectations for conversion of scripts from Envision moving into your stores in that initial guidance that you gave us?

I think that's a longer term opportunity for us, Lisa. That's going to take some time for us to build those kind of programs and put them in the marketplace. As it relates to Envision, we're really focused on organic growth. I've got to tell you, Frank and his team are really delivering on that front right out of the gate. We're really excited about the progress they've made.

I think as we look at our business, I think one area we knew we were going to be a little bit challenged coming into the year was on the Medicare side. We are not participating in a large number of those preferred Part D networks. I think the area that maybe surprised us a little bit more right now is we are a little bit soft in our commercial business. I think that's a trend that started in the first quarter. We talked about that, it continues today. That's probably where I see the biggest difference right now.

There's probably, out of the gate, maybe a touch slower on flu and cough and cold in both the front end and the pharmacy, but that will probably pick up as we go here. So some of that probably comes back over time.

And so do you feel like that the new same store sales guidance that you're giving which is down about 150 basis at the midpoint is conservative? Or do you feel like that's something that --?

We do our best, based on the information we have, we make it as accurate as we can.

Okay. Just a follow-up question. Frank, I'm happy to talk about PBM, and just had a question here. As we look at the 700,000 net new lives, is there a way that you can either talk to us about how many scripts you currently have, expectation around script growth that you'll see going along with these 700,000 lives? Are they commercial? Are they managed care? How do we think about those incremental lives that you're adding to the book?

Sure. We're really pleased because the growth has come across multiple segments. We've had growth in managed care plans, including managed Medicare plans as well as in mid-market, small business growth.

And the growth has come across both our historical Envision transparent pass-through PBM, as well as through our traditional spread model PBM, MedTrak. So we're seeing growth across all the various market segments, and we're really pleased with the organic growth, as John mentioned.

Okay. Is script count a number that you'll think about giving us going forward? I noticed that today you didn't talk at all about scripts, but rather gave us revenue, gross profit and EBITDA.

We'll look at it, Lisa.

Okay. That would be great. Thank you.

The next question is from Ross Muken of Evercore ISI.

Good morning, guys. Maybe to start out, I know you've started to touch on it as it relates to reimbursement. There's obviously been a lot of noise in industry from Walmart, Kroger and others. Obviously, different players have different timing of contract renewals and the like. But what else has developed this year that you've seen in industry and as you've talked to your peers and looked at how things have played out. What's been different I guess than maybe a six month ago assumption?

And as you think about now with Envision how that maybe can give you some relief on some of those items, and with some of the programs you're running. And as you better understood the PBM business model as a whole, has that made you smarter relative to the reimbursement discussion, and how do you see that manifesting itself?

So there's a lot in that one, I guess. But this is, and I think it's one of the reasons we started guidance where we did for the year, this is going to be a tough reimbursement rate year for us. And I think we talked about that pretty openly as we established that guidance. But it is in line with our expectations so far. So it has put pressure on our earnings, but it is what we expected and we tried to manage our business accordingly.

It is a very competitive marketplace. I think the Part D marketplace probably continues to drive the whole marketplace. As those rates continue to come down over time, they seem to bleed into the commercial space and I think that's the leader of the decline in rates over time here.

We also continue to see what we think is growth in limited networks on the commercial side. We think those are starting to gain more traction. It's still not a predominantly large piece of our commercial business, but a growing piece of our commercial business. So I think those are some dynamics that continue to drive rates in the negative direction. I'm not sure, what was the rest of that question? What else did you want me to --?

And now that you have the PBM asset in house, you get to better understand how the other side of the trade looks at it. How has that made you smarter as you think about your next set of negotiations and the like?

I don't know if I can point to anything specific. We do have some firewalls in place that prevent any particulars about rates and those kinds of things moving back and forth. I think conceptually, though, we are just getting a better understanding overall of the PBM industry.

And our focus has been, and continues to be, a great partner. We want to work with our PBM partners. They're essentially our customers at the end of the day, so we want to deliver great service to them. We want to be a differentiator in the marketplace, and I think that's how we need to continue to go to market. And as we learn more about Envision and its business, we understand how important that is, that execution at the retail level is, to really help Envision and other PBMs be successful in what they're trying to do.

That makes sense. And maybe strategically, obviously, there's been a lot of change in the market last probably 36 months. As you think about your priorities, obviously, you're executing against Envision right now, but you saw what CVS did with Target. There's a lot of opportunities on the PBM side to roll up. I think you did a small deal in the MedTrak side in the quarter. How do you think about, from a strategic set perspective, how you're prioritizing where you're going to push the asset next, and where capital's going to go from an M&A standpoint?

Sure. I think we'd love to have the opportunity to continue to grow our store network, obviously. So we are constantly reviewing opportunities that exist there, trying to figure out if anything makes sense for us. We're looking very carefully with Frank at the kinds of opportunities that make sense for his business, but we do have to live within the confines of our capital structure.

So I wouldn't -- those are the constraints with which we have to live by. So specialty is also interesting to us. We've picked up a nice, a really nice specialty business here with Envision. But I think there might be some opportunity over time to add some capabilities and depth to that business that could be exciting for us.

Great. Thank you, guys.

You're welcome.

The next question is from George Hill of Deutsche Bank.

Good morning, guys. Thanks for taking the question. We've all seen the generic drug price slow down, but has it provided much of a margin opportunity for you guys? [It wouldn't seem] that it has. Are we seeing the pace of change of reimbursement catch up with underlying cost changes, is that accelerating? Is there a way to capitalize on the price of the underlying cost of goods or is that eroding?

There is. As costs on the generic side in particular, as cost comes down, because cost seems to never go down on the brand side. But as costs go down on the generic side, that's clearly beneficial to us the way the vast majority of our PBM contracts are constructed. So that is good for us.

However, as you're [thinning], what tends to happen if you get a contract renewal date, I think rates have gone down for the last 15 years. Because then those cost savings tend to get passed through to ultimately to the clients and customers in the marketplace. So that's how the business works. And that's a cycle of life, if you will, on the generic side of the business.

And then maybe just a quick follow-up. Can you give us any color on how rate discussions for calendar 2016 are starting to look?

I think we've said for calendar 2016, it's early. But we're optimistic that it may not be quite as deep as this year was, but we still have a lot of work to do to probably have a full answer on that.

Okay. Thank you.

Next question is from John Heinbockel of Guggenheim Securities.

So on the PBM, two things. Maybe can you talk about the dialogue you're having with potential healthcare health plan clients, and how fruitful you think that might be, when that might start to pay off?

And then if you look at the 700,000 net lives, is there a way to put a revenue number around that? Could that be $500 million to $750 million of net revenue or something in that ballpark?

Sure. Well, I think first, I think our conversations with health plans have already started to bear some fruit. And actually, the growth that we've talked about is made up by more than 50% by health plan wins. I think the health plan market is really looking for an alternative with a PBM that can provide high touch service to its members, a nimble, flexible platform that helps them to compete in their marketplace. And a business model that can align incentives in how we work with them, whether it's to structure a retail network or how it's to design their formulary. So we're already resonating in the marketplace with the message that we have there, and have had some nice success this year. And we continue to think regional health plans is a key growth opportunity for Envision going forward.

To the second part of your question about the revenue. We'd expect the revenue on the business that has been won for 2015 going into 2016 to be north of the $700 million that you mentioned.

Okay. And then secondly for John, more strategically, it makes sense that some of the weakness here in comp scripts [write] and front end, it looks transitory. When you guys sit back and question, is it completely transitory?

Is it something else in the market that might be changing? I don't know if it's you if think about real estate, but how do you get comfortable that it's all transitory? And six, seven months from now we're going to be back closer to where we were a year ago?

We've obviously putting our Company through a lot of change. So we've got a lot going on here that we're working our way through. On the front end, I feel very confident that as Plenti continues to gain traction and we continue to renovate stores and do the things that we do, that that business will recover over time from some of what we've got going on right now.

On the pharmacy side, I do think that it's a balancing act that we do between where we want to be with reimbursement rates, and how many different kinds of more aggressive networks we want to be in. And we're probably paying a little bit of a price for some of our conscious decisions to manage margin a little bit here. I think that's the balancing act we continue to look at and work our way through, and so I think that's a dynamic we've got to continue to manage.

Okay. Thank you.

You're welcome.

The next question is from Edward Kelly of Credit Suisse.

Good morning, guys. John, could you provide a little bit of an update on what you're seeing on the remodel side from a comp perspective, traffic, has it changed much at all? How that's performing relative to expectations?

I'm going to let somebody else answer a question. Ken.

It's been pretty consistent with what we've seen over the last couple years. We're still seeing very good traction on the front end, right out of the gates, once we get the remodel done.

And the scripts tend to follow behind that, and consumer reaction seems to be very good and we're pretty happy with the results. So I would say it's very consistent with what we've seen over the last couple years.

And then, John, you mentioned not participating in preferred networks as one of the headwinds here. As you think about going into next year, how's your thought process there evolving? How much of an opportunity is it for you? Because you don't have a national footprint from a [store face], so can you be a bigger participant there if you want to be?

I think if we wanted to be, I think we could. There are still some networks that are just never offered to us. That's the way the industry works.

But I think there are some others that -- we do have strong regional presence in many markets. Where I think it's really -- it's a bit of a tradeoff between rate and access that we've got to continue to grapple with.

Last question. There's obviously been a lot of question about reimbursement rates, and we are hearing it from other players in the industry. I don't think anybody's really asked the question as to why has this year been tougher. I know every year it's kind of tough, but what is it about the current year that's making it tougher? It seems like for everyone.

I think for us, I think what we've talked about a little bit is -- and I think someone talked about it earlier. We saw a lot of benefit coming through the large generic wave the prior couple of years, and it just takes a while for rates in the marketplace to catch up to that. And I think that's what we've been digesting here, and that trickles into this year.

Does scale at all help with --

Yes.

It does, right?

Yes, it does. I think what our arrangement I think with McKesson has clearly helped us drive down costs, and helped us gain some efficiency in our distribution model.

What about scale at retail though?

I think scale at retail, where it's probably maybe most significant. Because I think on the purchasing side, on the drug side, I think we have scale. If you took how we purchase drugs and compared it I think to maybe where our two largest competitors are, when you combine our volume with everything that McKesson is doing globally, I think we stack up pretty nicely and we should be competitive on that front I think going forward.

Where we're a little weak is we have holes in the network. So where we would maybe be a little bit stronger, maybe we'd be if we had a more complete store network, which is something we continue to try and figure out a little bit.

Thank you.

The next question is from Steven Valiquette of UBS.

Thanks. Good morning. So I have a couple of the PBM too, actually you guys -- you already kind of answered as far as the revenues for next year. But I guess when you think about the $700 million plus of revenue, that implies mid-teens revenue growth just from those new lives. And then presumably, you'll get some organic revenue growth on the base book and from specialty as well.

But to frame all that, should we assume potentially 20% plus type growth within that PBM organically for next year, and really for the next few years? Is that the right ballpark to think about that asset? Thanks.

I think we're a little early to give you long-term guidance on it. But I think some of the points you make are good ones. We're having a great selling season. We're excited to continue to work with the specialty asset, specialty company that's inside of Envision. So we have a great opportunity here, but I don't think we're ready to peg some numbers for you yet.

And with some of the additional biotech drug coming out, the PCSK9 inhibitors, et cetera, does the specialty asset within Envision have leverage to some of those new drugs, and the PCSK9s in particular?

Yes, we expect that we will have access to those drugs going forward. Of course, it's going to be key on how we help our clients manage expenses as it relates to those drugs. So while those drugs could make sense, certainly for some patients, for some members, we want to make sure we have the appropriate processes in place to make sure they're getting to the right members so not to drive up the costs of our plan sponsors.

Okay. Got it. All right. Thanks.

The next question is from Karru Martinson of Deutsche Bank.

Good morning. When you guys look at getting leverage back to your earlier targets of where you were prior to the acquisition, do you feel that that keeps you out of the markets to add the bolt-ons or perhaps larger acquisitions? Or do you feel that the debt markets [doing that] are still there and supportive of your structure?

Again, I think we are going to work within the confines of the capital structure that we have. We think we made the right decision to acquire EnvisionRx. It was the right way to deploy the capital that we had available.

And so our focus will be on our core -- on our two core businesses now to invest in things that fit onto that. But it's clearly going to be smaller within the confines of our capital structure.

And when we look at the second half of the year, a number of other guys have talked about benefit from lower gasoline prices, a stronger, healthier consumer heading into the holidays. What are you seeing differently in terms of those front end sales?

I don't know that we're seeing a whole lot of impact. A lot of our business is convenient business, people live close to our boxes. And so I think the consumer, hopefully with the lower gas prices, will be a little more optimistic in spending in general. But I don't know that we see a big bump from lower gas prices. Overall, the front end has been fairly consistent, and we're looking forward to a reasonably good holiday season right now.

Thank you very much, guys. Appreciate it.

The next question is from Charles Rhyee of Cowen.

Thanks for taking the question, guys. First, I wanted to ask about the -- on the PBM side, I think I saw some news come across. Envision made a couple small acquisitions in the last couple months. Did that have any benefit to the current quarter, or is that something we'll see a little bit later? And if you could maybe help size some of that contribution.

I don't think it was significant for the current quarter. They were fairly small bolt-ons. The one thing I think that was very important about it is it added some geographic scope to us. It was a lot of East Coast business. Frank, you may have --

Again, I don't think they're significant. Certainly not immediately in size, but they do give us a presence on the East Coast for our MedTrak organization. And as we look to expand MedTrak, which we do think is a key part of our growth strategy to have the traditional model expanding into a national model. I think that will pay significant long-term dividends for us, and that was the basis behind these small acquisitions.

Okay. Were they -- was any contribution from them included in that 700 net new lives that you mentioned earlier?

No, that would be -- those acquisitions would be additive to the 700,000 lives that I mentioned earlier.

Okay. Great. And then I just had a question back about the new same store sales guidance. Just kind of tying together some of the comments you've made to previous questions. It sounds like some of this is really less market related and more how you want to manage promotion and margin versus traffic. Is that the right way -- am I understanding that correctly?

I think that's a little bit of an impact on the pharmacy side. Ken, on the front end it's --

I don't think that's probably the case on the front end. I would say the promotional environment is pretty similar to what it's been, and our position promotionally is pretty similar to how it's been.

We're still seeing some maturation with Plenti as customers get used to it. And we're looking forward to Plenti paying some pretty good dividends as customers do get more accustomed to how it works.

With Plenti, is it an issue where if I'm a Plenti member but from one of the partner companies, is it that I'm not fully aware yet of how the Rite Aid rewards program works? So is that just an education process to get them to understand how the purchasing level breaks, and if they get better discounts?

Yes, I think they probably are not going to really understand that until they start shopping with us. Because Plenti doesn't educate anybody on our wellness+ tier structure. So I think initially, it's more just getting people used to the concept of a coalition loyalty program. Because in the United States, people really aren't used to earning points in multiple places and being able to redeem them. So there's that education.

And we are seeing some new customers come in that signed up at our partner locations. And we think that over time, we'll be able to convert those folks and that there will be some education. But right now, it's really just getting people used to how to shop with a coalition loyalty program.

Great. Sorry, my last question for Darren. I think you had mentioned earlier there was -- you were accelerating deal related amortization. Can you go over those comments again, and why would that be the case?

It's early, so we're working through purchase accounting for the transaction right now. It looks like the valuation of our customer relationships are going to be a little bit higher than what they had been for Envision, and the amortization is going to be a little more accelerated. So it's creating a little more amortization expense, deal amortization expense.

Okay. Great. Thanks.

Next question is from Carla Casella at JPMorgan.

Hit the mute button, Carla.

Hello, can you hear me?

Yes, we can now.

Sorry about that. I had to switch phones. One is just a housekeeping item. You mentioned the revolver draw. Can I just get the availability on it?

It was $1.2 billion.

Okay. And then have you provided -- your guidance for the year includes Envision for the portion of the year. It was included pro forma EBITDA as if it were included for the full year what you would be looking at?

In the slides we put out, we have a pro forma leverage calculation, Carla. So there we used $155 million, which is the midpoint of the $150 million to $160 million that we said it would do for 2015 when we announced the deal.

Okay. That's great. The rest of mine have been answered. Thanks

You want that to calculate the leverage, correct?

Exactly. Great, that's all I had. Thanks.

Keyla, we're going to take one more question, please.

The next question is from Mark Wiltamuth of Jefferies.

For Ken, if you could maybe talk about how your doing on that transition to Core-Mark for distribution of tobacco and some of those five front-end categories. Is it helping on costs? Is it helping on in-stock position? Maybe a little feedback on how the stores are transitioning with that.

I think they're doing pretty well, Mark. Obviously, when you make a major transition like that, there's a few bumps in the road. And we've experienced a few of those, but I think overall, it's gone well.

It helps us because it gives them some scale, and makes it a little easier for them to visit our stores more frequently. And it drops some of those costs for us on distribution. So overall, I think it's been good, it takes some inventory out of our system and we're pleased with the progress that we've made so far.

Okay. And has that taken any of the heat off your new distribution facility because you're not going to be doing tobacco there?

Not really. Tobacco is a fairly easy category to handle. But it simplifies things a little bit, because we don't have to worry about [stamping] the cigarettes and everything. So it doesn't really apply to that DC. It was really more of an overall network opportunity for us to leverage them, and give them a little more volume.

And for you is, it more of a cost of goods sold savings or are you doing better on in stock?

It helps our distribution costs substantially, and it should help our in stocks. But it's more really helping us on the supply chain side, honestly.

Okay. Thank you very much.

I want to thank everybody for calling in today. Appreciate your time, and have a good day.

This concludes the call. You may now disconnect.