Matt Schroeder - Group Vice President, Strategy and IR John Standley - President and CEO Frank Vitrano - CFO and CAO

Emily Shanks - Barclays Capital Lisa Gill - JPMorgan Karen Eltrich - Goldman Sachs Karru Martinson - Deutsche Bank Bryan Hunt - Wells Fargo Securities Meredith Adler - Barclays Capital Andrew berg - Post Advisory Group Carla Casella - JPMorgan

We welcome you to our second quarter conference call. On the call with me are John Standley, our President and Chief Executive Officer; and Frank Vitrano, our Chief Financial and Chief Administrative Officer.

On today's call, John will give an overview of our second quarter results and discuss our business. Frank will discuss the key financial highlights and fiscal 2011 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 on our website, www.riteaid.com, under the Investor Relations Information tab for conference calls. We will not be referring to them directly in our remarks, but hope you will find them helpful as they summarize some of the key points made on the call.

Before we start, I'd like to remind you that today's conference 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.

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 is described in our press release.

I would also encourage you to reference our SEC filings for more detail. With these remarks, I'd now like to turn it over to John.

Thanks, Matt. It was a very busy quarter for us, and I'm very pleased with the progress we're making on our key initiatives as well as improving our balance sheet.

Our wellness+ card-based loyalty program is going great. Our immunization program is ramping up, and we're moving forward with our segmentation-based initiatives.

Before I get into the specifics about the initiatives, I have a couple of comments about the second quarter results, which Frank will go through in detail in just a few minutes. As expected, our SG&A increased this quarter because of a shift in the timing of Memorial Day holiday, expenses to rollout wellness+ and the cost to expand our immunization capabilities, which altogether reduced adjusted EBITDA by $26 million.

Comparable store front-end sales declined 90 basis points due to softness in our seasonal and general merchandize categories, but our core drug store categories performed well. September front-end same-store sales are improving and are expected to be in the range of negative 50 to negative 75 basis points.

Script count declined 2.1% in the quarter due to growth of 90-day scripts, maturation of the Rx Savings Card and cycling some H1N1 benefit in the prior year. Script count improved month-to-month during the quarter, and in September, it is expected to be similar to our August number.

The year-over-year decline in Pharmacy margin was substantially less this quarter versus last year's second quarter. Distribution expenses were 1.48% of sales, lower than last year's, thanks to our continued focus on improving distribution efficiency.

FIFO inventory was $70 million less than last year's second quarter. We had $1.1 billion of liquidity at the end of the quarter, giving us the flexibility to invest in the future growth of our business.

We reduced debt by $158 million compared to last year's second quarter, and we completed the refinancing of our revolving credit facility and Tranche 4 Term Loan, reducing our interest expense by about $13 million annually and extending the maturities. Even though comparable adjusted EBITDA is down slightly after taking into account $26 million related to the holiday, pay shift and growth initiatives, the core business performed well with continued good cost control and solid gross margins.

We continue to operate more efficiently with reductions in many of our retail operating expenses year-over-year and believe there are more opportunities to further reduce operating cost throughout our company. With a low sales momentum, we'll improve our results, which is why the investments we made in our growth initiatives this quarter are so important.

We're working on the right things. Enrolment in our tiered reward loyalty program, wellness+, launched nationwide only five months ago, is already exceeding our expectations.

We had more than 22 million members last week and now expect to have more than 30 million members by the end of the fiscal year. Card usage has been strong.

56% of our front-end sales and 52% of prescription sales came from wellness+ members last week. The script count number grows to 58% of all scripts filled using wellness+ if you eliminate New York and New Jersey where giving points for prescriptions is not allowed.

We've also seen encouraging results from the pilot markets where script counts, which were running behind the chain before the program, are now running 70-plus basis points ahead of the chain. Front-end basket size for wellness+ members is 40% higher than for non-members, and it gets better as you move up the rewards levels.

At the Plus level, the lowest level, the average front-end basket size was 46% larger than non-members; at Silver, 88% larger than non-members; and at the top level Gold, 78% higher than non-members. And remember, Gold members got a 20% front-end discount, while Silver members got a 10% discount.

We believe wellness+ has been so well received because it's different from other retail loyalty programs. To attract and retain customers and patients, we offer increasing levels of front-end discounts and health benefits based on the dollar amount of front-end purchases and number of scripts filled.

Gaining a better understanding of our shoppers through wellness+ will help us capture some of the significant sales growth opportunities that we identified in our segmentation analysis. Overall, we're very pleased with the results of wellness+ so far.

During the quarter, we also made good progress with our segmentation initiatives, especially with our new merchandizing strategies for low-volume stores. We now have 37 value stores where we are testing various degrees of a new merchandize planogram designed to build business in lower-volume stores.

These stores have 9,000 fewer SKUs than our traditional drug store, are lower values, are larger dollar shop, are lower priced and have similar and a smaller add than our traditional drug stores. The good news is that these stores are showing strong front-end sales growth.

Our goal is to improve the productivity in these stores by combining the new merchandizing program with a modified distribution model, and if successful, evaluate whether the model can be expanded to other low-volumes stores in the chain. In addition to our value store test, you may have seen our recent announcement that we are going to test 10 Sav-A-Lot Rite Aid combo stores in Greenville, South Carolina.

We have a licensing agreement with Sav-A-Lot to add their limited assortment food store concept to the front in these 10 existing Ride Aid stores which will continue to be owned and operated by us. The front-end will carry Sav-A-Lot products of about 1,300 SKUs as well HBC products provided by Ride Aid with emphasis on our private brand.

Our pharmacies will operate as usual. The Sav-A-Lot portion of the store will have a full grocery shop, including prepackaged meat, produce and dairy, and will be up to 40% cheaper than traditional supermarkets.

The 10 stores remain opened during construction. The first store will be completed next week with the remainder completed by the end of October.

We chose these stores in Greenville, because they have solid pharmacy business, but we need stronger sales on the front-end. This new co-branded concept presents a unique opportunity to increase front-end sales in this market.

We also completed our immunization training this quarter. We now have over 7,000 immunizing pharmacists at more than 3,000 stores ready for flu season.

And in addition to the flu vaccine, we will provide all immunizations allowed by state regulation. Our shops are competitively priced.

And while it is still very early considering there is no H1N1 scare this year, we have already more than tripled the number of shops our pharmacists administered at this time last year. Because of H1N1, flu season peaked early in October and November last year.

This year, the CDC is forecasting a more typical timing with peak season being in December and January. During the quarter, customers continued to search for value with our private brand penetration increasing to 16.2% compared to 15.3% last year.

We expect this consumer behavior to continue even if the economy improves. And we expect continued rollout and we'll continue the rollout of our new private brand architecture in the second quarter.

Our program includes 250 new items this fiscal year with all new packaging and as a refresher the following brands: Rite Aid Pharmacy for health products, Renewal for beauty, Pantry for food and certain consumables, household goods, Tugaboos for baby, and our price fighter brand Simplify. We have now converted 136 items into these brands and expect to have about 2,200 items in these new brands within the next 12 months.

Even though we've just started the rollout, we're getting great response from our customers and expect that with strong promotional support, good price positioning and continued development of new items, we'll continue to grow private brands sales, improve margin and meet the needs of today's customer. As I said earlier, we're working on the right things.

Margins are stabilizing and our drug store categories are performing better. I'm pleased with the way our gross initiatives are progressing and our continued ability to reduce cost and improve efficiency.

I'm excited about our various segmentation tests and what they might mean for the future. Our financial position has improved with strong liquidity, lowering interest expense, extended debt maturities and our ability to continue to reduce debt while at the same time making good investments for future growth.

As you can see, we're working hard to improve our performance. Now I'll turn it over to Frank.

As John mentioned, we saw a solid progress in the second quarter with our various operating initiatives despite some sales challenges. We also saw our Pharmacy margins continue to stabilize.

On the call this morning, I plan to walk through our second quarter financial results, discuss our liquidity position and certain balance sheet items. I will also provide a capital expenditure update and discuss the cost associated with our wellness+ loyalty card rollout.

Finally, I will review our revised fiscal '11 guidance. This morning, we reported revenues for the quarter of $6.2 billion compared to $6.3 billion for the second quarter last year.

The decrease in total sales was primarily driven by a reduction in total store count as well as a decline in same-store sales. In the quarter, we relocated five stores and closed 20 stores.

On a year-over-year basis, we had 65 fewer stores. Same-store sales declined 150 basis points with sales trends improving each month.

Pharmacy scripts were down 210 basis points, primarily impacted by 90-day scripts and H1N1 comparisons to last year. Front-end same-store sales were down 90 basis points and Pharmacy same-store sales were lower by 180 basis points during the quarter.

Pharmacy sales included an approximate 195-basis-point negative impact from new generic drugs. Adjusted EBITDA in the quarter was $181.2 million or 2.9% of revenues, which was lower than last year's second quarter of $216.5 million or 3.4% of sales.

The results were impacted by $26.2 million or $0.03 per diluted share for cost associated with the rollout of the wellness+ customer loyalty program, expenses related to the expansion of our immunization capabilities and the shift in holiday pay with respect to the Memorial Day holiday from the first quarter last year to the second quarter this year, as well as lower sales partially offset by improving gross margin. Net loss for the quarter was $197 million or $0.23 per diluted share compared to last year's second quarter net loss of $116 million or $0.14 per diluted share.

The increase in net loss was driven by $44 million or $0.05 per diluted share charge on debt modification related to the recently completed refinancing and lower gross profit dollars due to lower sales. The lease termination charge in the current period included 12 stores for which we recorded a closing provision of $11.1 million during the second quarter.

The LIFO charge of $20.5 million compares to $14.8 million last year in increases due to higher than planned Rx inflation. Interest expense and securitization cost of $139.7 million was $3.2 million lower than last year's interest and securitization cost.

Non-cash interest, primarily debt issuance cost, amortization and workers' compensation interest accretion, was $11.7 million. Total gross margin dollars in the quarter were $49.6 million lower than last year's second quarter or 12 basis points as a percent of sales.

Adjusted EBITDA gross profit dollars, which excludes specific items including LIFO and the wellness+ deferral revenue charge, the details of which are included in the second quarter fiscal '11 earnings supplemental information which you can find on our website, were lower by $29.1 million due to lower sales but 23 basis points higher than last year. Adjusted EBITDA gross profit front-end margin rate was stronger in the quarter.

Pharmacy margins were lower by 13 basis points of Pharmacy sales driven by lower third-party Rx reimbursement rates as well as lower Medicaid reimbursement rates, which were largely influenced by the AWP rollback which we fully cycle this month. The 13-basis-point quarterly unfavorable variance improved from the 45-basis-point decline in Pharmacy margin we saw in the first quarter of this year.

The Pharmacy margin pressure has stabilized here in the second quarter fiscal '11, as we cycle the more significant MAC-ing of new generics which occurred last year. The margin dollar shortfall was partially offset by lower distribution center cost driven by the closure of two distribution centers and reduced and realigned trucking routes.

Product handling and distribution center expense as a percent of sales was lower than last year. Selling, general and administrative expenses for the quarter were higher by $19.2 million or 36 basis points as a percent of sales as compared to last year.

SG&A expenses not reflected in adjusted EBITDA were lower by $25 million or 34 basis points, primarily driven by lower depreciation and amortization and securitization cost from the accounts receivable facility reported last year as SG&A. Adjusted EBITDA SG&A dollars, which excludes specific items the details of which are also included in the second quarter fiscal '11 earnings supplemental information, were higher by $5.8 million or 71 basis points higher as a percent of sales.

This is the first increase in SG&A dollars in the past six quarters driven by a number of factors, including a comparison to last year's second quarter which was $90 million lower than the second quarter in the previous year. Two factors relate to our growth initiatives, mainly a $13 million advertising expense related to the startup of our wellness+ loyalty card.

And secondly, we incurred $4.2 million in training cost in the second quarter associated with our pharmacist immunization program, which we mentioned on the first quarter call. The third factor was something I also pointed out on the first quarter earnings call, and that was the timing of the Memorial Day holiday which favorably impacted our store level non-work holiday payroll cost in the first quarter by some $9 million as these costs were incurred in the second quarter of fiscal '11.

As I previously mentioned, these three items totaled $26.2 million. Incremental to those three items was a $17.3 million increase over last year in our workers' compensation and general liability cost due to a less favorable claims experience recorded in this year's second quarter as compared to last year.

You should also note in last year's third quarter, we recorded a $37 million favorable workers' compensation and general liability adjustment that we will cycle in the third quarter of this year. We continue to believe there are opportunities to reduce our cost in the future through operational efficiency and cost controls as part of Project Simplification and the various segmentation initiatives.

Another example of cost saving opportunities is the decision we announced last week to further rationalize our distribution center network. We announced plans to close our own New York distribution centers which will be completed early next year.

You will recall last year we closed distribution centers near Atlanta, Georgia and Bohemia, New York, as part of an ongoing review of our distribution center network. The size, age, condition and infrastructure of the 38-year-old Rome facility was a key factor in our decision.

The strong liquidity position benefited from the various working capital initiatives and spending capital wisely. As compared to the second quarter of fiscal '10, FIFO inventory was lower by $70 million.

FIFO inventory increased $60 million from yearend fiscal '10 due to normal seasonal trends. Our cash flow statement results for the quarter show net cash used in operating activities in the quarter as a use of $5.8 million as compared to a use of $147 million in last year's second quarter.

Our days payable outstanding in the quarter was 26.4 days. This compares to 24.2 days in the second quarter of fiscal '10.

The increase was influenced by favorable generic pharmacy terms. Net cash used in investing activities for the quarter was $37.3 million versus $26.9 million last year.

Last year, we received $6.5 million in sale leaseback proceeds. During our second quarter fiscal '11, we relocated five stores, remodeled one and closed 20 stores.

Our cash capital expenditures were $42.2 million of which $4.8 million was for script file buys. Now let's discuss our liquidity position.

At the end of the first quarter, we had $1.082 billion of total liquidity, including over $1 billion available under our credit facility and $51 million of invested cash. We had zero revolver borrowings under our $1.175 billion senior secured credit facility with $143 million of outstanding letters of credit.

Today, we have $1.037 billion of liquidity. Total debt, net of invested cash, was lower by $158 million from last year's second quarter and $220 million lower than the fourth quarter of '10.

Now let's turn to fiscal '11 guidance. Our guidance is based on current trends.

We have revised our guidance and now expect total sales to be between $25 billion and $25.4 billion as a result of the first six months sales trends. We have also narrowed our adjust EBIDA to be between $875 million and $950 million for fiscal '11.

We expect same-store sales to be in the range of negative 150 basis points to flat over fiscal '10. And net loss for fiscal '11 is expected to be between $400 million and $590 million loss or a loss per diluted share of $0.46 to $0.67.

The change in net loss reflects lower interest expense in part due to the recently completed refinancing more than offset by a $45 million provision for loss on debt modification. Our fiscal '11 capital expenditure plan remains at $250 million with $50 million allocated for file buys.

We expect to open three net new stores and relocate 30 stores. We are not planning any sale leaseback transactions, and we expect to be free cash flow positive for the year.

The guidance includes a total of 80 closures, half of which include a store lease closing provision with the balance of stores closing upon lease expiration. The adjusted EBIDA guidance includes the startup advertising and supply cost and discounts associated with the chain-wide rollout of the wellness+ customer loyalty program.

The advertising and supply costs for the program are estimated to be $32 million with $26.5 million incurred in the first half of the year. In addition to these costs, Generally Accepted Accounting Principles require us to defer a certain portion of revenues generated by customers as they qualify for their tiered discount benefit.

A Silver member must earn 500 points, while a Gold member needs to earn 1,000 points. Once a wellness+ member qualifies at Silver or Gold and begins to use their tiered discount, we are permitted to recognize the deferred revenue as income to offset a portion of the tiered discount.

Within each customer qualification and discount use period, which could span multiple calendar years through fiscal periods, the net impact of these adjustments have no effect on the income statement as the entries will net to zero over time. Included in our net income guidance is a wellness+ deferral provision range of $30 million to $40 million, which covers fiscal '11.

Fiscal '12 will have an additional charge to reflect a full 12-month qualification period. This completes my portion of the presentation, and I'd now like to open the lines for questions.

Operator, we're ready for the first question.

John, I was hoping you could give us a little color around your comments that are in the press release talking about sales in the core drugstore category has started to strengthen. Can you just give us color on how you define it and what you're seeing?

Sure. Basically what I'm talking about there are HBC and beauty categories.

Have done substantially better last quarter, so far this month as well. So we probably saw kind of more broad-based sales issues going back a few quarters, whereas now I think some of the core categories appear to be stabilizing and growing.

Where we're still fighting it a little bit is really in our seasonal categories and general merchandize. Those are really the categories that we've got to kind of get going here.

And I think our sales have come around quite a bit.

And do you think that strength is from the private label introductions that you were talking about?

Honestly I think it's just we're getting a little better in terms of execution. I think it's probably, maybe the consumer is reacting a little better to some of the things that we are doing promotionally with wellness+.

Ken, do you think you'd add to that?

No. I think that's pretty accurate.

And then Frank, just one question around the loyalty card revenue deferral. We should just think of that as essentially a non-cash hit to revenue.

And then over time the actual cash flow that you effectively lose would just be reflected in gross profit margins?

That's correct.

And then, also, my follow up question is, around the warehouse closure, I know you spoke to it in your prepared remarks. Are there more to come?

And then can you speak at all to what savings do you expect to see around this particular closure?

In terms of the distribution network, we're continuing to evaluate the network over time and look at it carefully to make sure we've got the right balance to this. In terms of the savings, Frank, it's going to be high single digits I guess.

High seven-digit single digits.

This is actually (Steven Gregory of Mandalay Research). Couple of questions.

About two months ago in the Wall Street Journal, there was an article written regarding e-commerce is going to reshape how companies like yourself, the chains, they way they do business for their customers. John, where can you provide us some color on the call today is, what is your e-commerce vision going forward over the next couple of years and how do you plan to take us there?

In terms of e-commerce, there are a number of things that we are doing in terms of I guess customer communication. I guess I pointed out initially, it's hard to, especially in the pharmacy side of our business be able to communicate with customers about the status of their scripts, whether it's through text messaging, improvements to our website or other types of communication.

I think that's really critical on the pharmacy part of our business. In terms of where we are headed from an e-commerce perspective, I'll turn to Frank Vitrano.

I think we are going to continue to leverage the relationship that we have with drugstore.com and build that out further, and clearly using the internet as a communication vehicle with our customers. And they are engaging very heavily.

On the Rite Aid online stores, how do you guys have the ability to introduce promotions so you can now react to customer trends? That way, customers can find your site more effectively and buy your products with much easier ease.

Again, we are still leveraging the relationship that we've got with drugstore.com, and we are expanding that relationship. We've been talking to them recently about ways to do that.

We are probably not ready to actually disclose our strategy there, but we are going to continue to leverage the drugstore.com relationship that we have. And obviously they've got a very robust platform.

John, what are your goals that you'd like your total sales to be from a percentage of total sales from e-commerce going forward? What's your big objective that you'd like to achieve?

I don't think we have a huge number for that honestly. I mean, what's going to kind of make or break us is our continued execution at retail.

That's where we think the success in the near term is for us, and that's our primary focus. We are going to continue to improve our website; we are going to continue to communicate with customers electronically, and we are working on our social networking skills.

Those are the basic platforms what we think are a success.

Are you guys looking at mobile right now, managing app for Google or Android, what have you?

Absolutely.

And when are you planning to launch something like that to let all the customers on the call know what you're planning on doing?

We'll announce it when we are ready to go down that road.

Can you provide some more color on that? I mean your sales are down pretty dramatically, and now your stock has fallen off a cliff.

What can you provide some color that you are going to do to turn around the company you had brought on board? A couple of years ago we turned around the company.

What can you tell us what are you going to do to get that stock up clearly as a dollar? I mean what are you going to do to get the stock up?

We are going to improve our retail operations. We are going to focus on our opportunity areas.

We are going to grow wellness+. We are going to become a more efficient operator.

We are going to improve customer service. Those are the key components of our strategy.

And we are going to grow in the healthcare arena.

So e-commerce is not really one of your biggest visions?

I think e-commerce is a key arrow in the quiver of the things that we are working on, but it's not the only strategy that we have.

And where would you like the percentage of total sales to be? Where are you now?

What are your percentage of total sales coming from like, for instance from drugstore.com and your Rite Aid online store?

Fairly small percentage of our total business. We are really more of a bricks and mortar retailer today than we are an e-commerce company.

So that's not going to really change that type of vision?

I think it will change modestly over time, but I don't see a dramatic shift in our business in the near term to become suddenly a very large e-commerce player. What we have is a great network of 4,700 stores across the country and we've got to leverage that asset.

That's what's really going to make our success. And we are going to have e-commerce as a convenience and a growth vehicle.

But I think the primary strategies that we have are really driven around our bricks and mortar business.

Final question. You mentioned social; what are you guys doing in that area and how's it impacting your bottom-line?

This is Ken, just so you can tell the difference between Ken and John.

We recently brought up Facebook and Twitter. We're really dabbling at it.

Obviously we're being very, very careful because as you know, the social space is a two-edged sword. And so we're using it as a vehicle to communicate to the consumers, and we're really just starting to leverage that asset very early.

I just had a couple of questions around the reimbursement environment. I think that you made some comments earlier that you're finding that the pharmacy overall reimbursement is stabilizing.

Can you maybe just talk a little bit about what you're seeing as far as stabilizing? Is it more from the government payers, from the commercial payers?

And then secondly, can you maybe just talk about what you have in your expectations around AMP?

Sure. In terms of the reimbursement rates, the stabilization is probably more from third party payers than it is from government payers.

Although they're both better than they were, probably more improvement on the third party payer side. And a big part of what's driving that quite frankly is the lack of new generics a year ago.

We're not seeing a lot of that through the second year; sort of big macking that goes on into the generic materials, because we didn't have a lot of new generics a year ago. So that's one of the key factors that I think is helping us stabilize the pharmacy margin right now.

In terms of AMP, we don't have anything in guidance for it per se. We don't really have a good sense yet of what the impact of AMP is going to be.

And we don't think it's going to show up I think right now until probably our next fiscal year in terms of timing. I mean, you never know on this thing but that's kind of the way it feels right now.

We're kind of waiting to see some data from the government to somewhat help us kind of understand what the AMP looks like. As soon as we get that kind of information we'll be able to provide some clarity and color on what we think it will do in terms of margin impact.

And then I guess, just my final question would be that your comments around flu that you've tripled the number of vaccines that you've given than last year. Have you given any indication as to how many vaccines you'll do this year?

We've said I think previously that we're shooting for 1 million shots this year.

And do you think they'd go exceed that?

I don't actually know the answer to that question. I think we're kind of around where we thought we would be at this point.

And the triple number, it's early, and we didn't shoot that many in the last year. So we're making good progress.

I'm pleased with where we're at, but we got to kind of see how it develops here.

And then, as the person comes in for that flu shot, are you seeing that they're picking up incremental items or are they just coming in, getting the flu shot and walking out the door? Are you seeing additional foot traffic around that flu shot?

Yes, we think we are, but again it's a little bit early. I have a better sense here probably through the next quarter kind of what happens with it.

Our belief is that people, based on some data we looked at from IMS is that people who get flu shots can be converted to our customer. That's why we thought it was so important to have that available for our customers and to potentially get some new customers with it.

Both the Supervalu and the lower cost sourcing have a lot of potential. How quickly could you roll those out, if successful, and how would you differentiate in the store base?

Which one would be the low price and which one would be a Save-A-Lot?

My guess is, the answer on this thing is probably likely to be some combination out of the two scenarios. The Save-A-Lot Rite Aid combo, there's more involved to convert a store to that sort of combined format than there is with our value kind of concept store.

So that has a bit more lead time on it. So it would take us longer to make a significant number of those stores.

And if we decided to significantly ramp it up, I think we'd be able to engineer the process a lot more than we did in the test scores because you're rolling doing 10. So if we were going to do a lot of them, I think we could come back to you and say, hey, it works and we're going to expand this thing and here's how we think it could kind of work.

But until we kind of get a sense for it, I'm hesitant to tell you we could make so many in x period of time because we kind of need to see how it sort of goes.

And what about for the value concept?

Value stores can be done fairly quickly. In two weeks or so a store can be converted.

The cost is not gigantic for it. So we could potentially expand that fairly rapidly.

We would have to have the internal resources to do that. But that probably could move a lot quicker than a riding Save-A-Lot could.

And at our conference you mentioned you were starting to see a spread between the wellness+ stores cum store performance versus the whole chain. Can you maybe quantify what kind of spread you're seeing?

Well, the thing that we're kind of watching most closely, pharmacy, and what we saw over the last month is that the wellness+ stores that were in the pilot outperformed the rest of the chain by about 70 basis points on the script count growth. It feels like it's starting to get some traction.

Well, all my e-commerce questions have been answered. But a focus on the guidance here.

What are some of the assumptions you guys are baking into the guidance? What are you expecting from a macro trend and what's your confidence level in the guidance you had given?

Well, the big thing that really I think was reflected in adjustment in comp end of the guidance this morning is really sales, and that's really the key for us right now. We're very focused on the top-line.

We've got to get some sales momentum into this thing. And so that's always the hardest thing to predict and forecast, but I feel good about the things that we're working on.

I feel good about some of the internal metrics that we are looking at. Obviously none of us are satisfied until we get total sales growth where we want it to be.

So in terms of the confidence and the guidance, based on where we sit today I feel pretty good about it and will just have to see how kind of sales progress here as we work our way through the year.

And when you look out at your store base you're closing 80 stores, but how many of your stores do you feel are negative on a four wall basis and kind of what's the closure outlook going forward?

There are probably a couple of 100 stores here that are not profitable. There is always a group that are not profitable, the ones that we look at on a fairly regular basis.

And Brian Fiala and the Ops teams continue to look at those under-performing stores in looking at ways for us to improve the overall profitability. But that's something, Karru, that we continue to monitor and that's part of the 40 stores that we did decide to close this year that were under-performing stores.

On the Medicaid reimbursements, just so we're clear, we anniversary that reduction in the reimbursements here in September. That's about 1 million bucks, would be correct?

That was on the brand side. Yes.

And then in terms of the script buys, how are we looking on that pipeline? You guys had historically said that that was something that was still in the ramp up process?

We are continuing to do that dedicating some additional resources on the ground, knocking doors on the independents, continuing to search for profile buys in and around surrounding our existing stores.

And just lastly, on those scripts, are you still kind of valuing those in the $10 to $20 per script range?

Yes. That's still pretty much the range, Karru.

I was wondering if you could just talk about, since you mentioned the AWP and you're cycling it, what AWP cost you over the last year on a profitability basis?

It was $52 million, about $1 million a week.

And then second, looking at the distribution center you're closing, is that an owned facility, and if it is what do you believe it's worth if you are to list it?

There's actually three buildings up there that kind of make up this complex. Two of them are leased facilities, one is an owned facility.

And the owned facility is probably worth $4 million to $5 million.

And if you are a potential buyer listening.

Next question, if you look at the conversions to the Save-A-Lot stores down in the South Carolina market, the 10 you are doing. Why that concept as opposed to your own value food offerings that you've developed around your low volume stores?

And then along with that question, what is the cost of conversion to the Save-A-Lot?

I think what we're trying to do here is sort of step back a little bit. As we do have a group of underperforming stores that we've been focused on.

And we're really kind of marching down a couple of different roads. At the same time, we've been working on our own kind of value concept that's really focused in on traditional kind of drug store categories, a little bit more consumables.

I'm feeling about the Save-A-Lot concept is, it's a very deeply discounted broader food offering and based on some of the work that we did, we think that could have real appeal to the customer base that we have around these stores. So we see it as kind of another opportunity to kind of drive some volume through some of our lower volume client stores.

And I think it's a pretty interesting format and concept and could fit well with a lot of the demographics that we have around some of our lower volume stores.

Advantages, it's already up and running. I mean there's a name out there.

There is a brand, there's 1,200 Save-A-Lot's out there today.

And could you give us an idea, frank, what the cost conversion is?

Yes, it's about $600,000 to do a full conversion, that would include all of the refrigeration equipment and fixtures and what not.

And if you're to look at your store network and the demographics around your store network, I mean how many of your stores do you feel like you could roll a Save-A-Lot out into?

If it works. I think if it works, I think there could be a significant number of stores it just might work in.

It could be a good concept for us. And I'll just made a comment too, Supervalu have been a great partner in this thing, it's been just fantastic to work with and it really helped us kind of bring this thing to live fairly rapidly here.

And my last question. There was a few large packaged food companies report this week, it sounds like you're starting to see some inflation and less promotional dollars from the packaged food companies.

Are you all starting to believe that you'll see some inflation in the front-end of the store next year at this point? Or is that kind of pie in the sky?

I'm not sure I have enough clarity into it to tell you one way or the other at this point. Maybe we get a little further into this year.

We haven't seen yet, doesn't mean it's not coming, but we haven't yet seen a lot of inflation I think on the front-end, based on we do a little LIFO calculation and that kind of stuff. So it's a little bit of wait and see, I think for us.

And that's probably something we need to talk about again next quarter as something starts to develop.

This is (inaudible) in for Mark. I was wondering if you could talk a little bit more about the sales trends in the September, how much of that, the improvement is being driven by the front-end versus and may be the flu shot and for a month.

That kind of gives you two numbers, front-end right now we said is kind of tracking in minus 50 to minus 75. So it continues to get kind of incrementally better, kind of gradually here.

In terms of where we're running on pharmacy, we're pretty much, from script count perspective in line with last month. So although we're starting to administer some flu shots, it's not a real material number yet to script count.

And when did the benefits from H1N1 last year peak for you guys. I mean did you get a lot of that in September?

Some in September, but really it shows up October, November.

So October is going to be much more difficult?

October, November will be much more challenging as it relates to H1N1.

I guess the second question is a little bit more on pharmacy gross margin outlook from here. Obviously you've seen stabilization in that over the past few quarters.

I was wondering if you can maybe talk going forward given that there isn't likely to be as many new generic introductions before Lipitor in the back half of '11. Could you see pharmacy margins up at all before Lipitor?

I guess what would you say is the likelihood of margins being up?

I would love to see margins up, that's a trend I haven't seen for quite a while because there tends to be some general erosion all the time on it. So I don't think we'll see pharmacy margins up.

There's some consolidation sort of on the PBM managed care side of the business that could potentially have some negative implications to us. Like you said, there's not a lot of new generics, there aren't a lot of second year generics kind of getting max.

So, its always hard to kind of dial in a little bit. We need to see what happens through the selling season and what kind of prices we get back from some PBM share, kind of based on some of those things.

Right this moment, things are a little better than they have been.

And I guess just last in, let's say there are no generic introductions? What do you think is sort of an annualized run rate for pressure on gross margin, from PBM's and maybe other pairs just on a yearly basis?

Well, can we give a number what we're down this quarter, kind of year-over-year, for pharmacy margin.

For the quarter, we're down 13 basis points.

So I would say something like that there is always a little bit of pressure on it. And again it's going to depend a little bit on some dynamics we don't control obviously, which is what the PBM's are doing in their selling season.

Right now, when you kind of look at that number there's not a lot of new generics per say, there is a few. There aren't a lot from the prior year that were sort of digesting.

So, we're kind of in this period where there's not a lot of that kind of activity in number.

I've got two questions for you. First just to clarify something that was said a minute ago about H1N1.

When you said that it peaked in October, November, were you talking about the flu shot, the vaccines that you gave out or actually the illness?

Tamiflu. We were talking about Tamiflu scripts.

Okay. And then I'd like to just ask a little bit more about this arrangement with Supervalu.

I'm sorry I did miss a little bit of the call, so, who approached who on this idea? And I'm just kind of curious about how they are thinking about this?

Did they see this as an important growth area for them if it works?

I think, I got to be real careful about putting words into somebody else's mouth here. We identified the opportunity here on our side.

We reached out to them, had a conversation with them. They, I think, were very much interested in it and it's kind of gone from there.

And they have been fully engaged in this, extremely supportive. And from our perspective, seemed very excited about it.

But, I think you need to talk to them, kind of what it means to them and kind of where they're going.

That's fair. Just another question about generic reimbursement rates and generics in general.

Are you continuing to see the penetration of generics increase even though we really don't have a lot of new generics right now?

We are. That's a great point, I mean, we're 300 basis points or something year-over-year in generic penetration.

So it continues to be strong. Part of it is there is some erosion on the brand side.

So the mix, that's kind of a mixed number, and that's one of the things we've been kind of looking at too because we're trying to make sure we understand. Is it all people who are switching from brand to generics or do we have some erosion in our brands business, may be driven by the economy or other factors.

And then I actually have one final question about changes in the rules about FSA. Somebody just asked me this question and I really wasn't too aware of it.

But it sounds like for certain over the count medication to get this refunded through your medical account, you would have to get a prescription from a doctor. Have you guys heard about this and what do you think the impact is on your business?

This is Ken, Meredith. I don't know that we know exactly what the impact is going to be but that is correct.

There will be less OTC products that will be covered by FSA's, no question, because you are going to require a prescription.

But you could get some movement back to the pharmacy side because people will have better coverage or they will get some coping.

I get that could be the case. But it seems like what's going to happen is some of the stuff people bought on the FSA is just not going to get.

It's probably what happens.

Just a follow up on the flu shot issue in immunization. You said you are 300% accretion for your last year.

Can you actually give a quantity for that and any tangible benefits you're seeing on the front end?

I don't know. I think we got to be careful about throwing around numbers week to week on this thing.

And I cannot give you a tangible, its early enough that I can't give you a tangible number on the front end per say for that. I think we will be able to get some color in on that as we get further into it.

Despite that you do feel like it's definitely driving all the traffic into the store?

I think it will as we get into it further. I think it'll be helpful.

Operator, we'll take one more question.

You may have said this in the beginning, I may have missed it. Did you give the total number of stores that you have now in that kind of low volume store category?

37 stores right now.

And then the 100 that are underperforming, are any of those in that 37?

Well, I think it's kind of a couple of hundreds is what we kind of said. And there is probably a few of them in there.

And in addition to kind of underperforming stores, we have kind of a lower-volume group, and those are the ones we think that have the real potential to work with this concept. Maybe they'd get some additional volume on the front-end.

And then where is your drugstore ramp today? Or was it expected to be for 2011?

About $100 million.

And then when does that start to work its way down?

Assuming nothing gets added to it, it leads down $5 million to $8 million a year

Thank you all very much for participating in the call. We appreciate it and we'll talk to you next quarter.

Thank you.