Frank G. Vitrano - Chief Administrative Officer, Chief Financial Officer and Senior Executive Vice President John T.

Standley - Chief Executive Officer, President, Director and Member of Executive Committee Matt Schroeder - Group Vice President of Strategy & Investor Relations and Treasurer

Karru Martinson - Deutsche Bank AG, Research Division John Heinbockel - Guggenheim Securities, LLC, Research Division Mary Ross Gilbert - Imperial Capital, LLC, Research Division Karen Eltrich - Goldman Sachs Group Inc., Research Division Carla Casella - JP Morgan Chase & Co, Research Division Justin Van Vleck - Morgan Stanley, Research Division John W. Ransom - Raymond James & Associates, Inc., Research Division Matthew Galati - UBS Investment Bank, Research Division Emily Shanks - Lehman Brothers Matthew J.

Fassler - Goldman Sachs Group Inc., Research Division Joseph Stauff - Susquehanna Financial Group, LLLP, Research Division Edward J. Kelly - Crédit Suisse AG, Research Division Bryan C.

Hunt - Wells Fargo Securities, LLC, Research Division

Thank you, Sandrel, and good morning, everyone. 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 2012 outlook, and then we will take questions. As we mentioned in our release, we are providing slides related to the material we will be discussing today, including annual earnings and sales guidance on our website, www.riteaid.com, under the Investor Relations Information tab for conference calls.

This guidance is a point-in-time estimate made early in the fiscal year. The company expressly disclaims any current intention to update it.

This conference call and the related slides will be available on the company's website until the next earnings call, unless the company withdraws them earlier, and should not be relied upon thereafter. We will not be referring to the slides directly in our remarks but hope you will find them helpful as they summarize some of the key points made on the call.

Before we start, I'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.

The definition of the non-GAAP financial measure, along with the reconciliations to the related GAAP measure, are described in our press release. With these remarks, I'd now like to turn it over to John.

Thank you, Matt, and thank you, everyone, for joining us this morning to review our fiscal 2012 second quarter results. I'm pleased to report that our results for the quarter demonstrate that our continued company-wide focus on taking better care of and meeting the needs of our customers is paying off.

We have increased same-store sales for 3 consecutive quarters as initiatives such as wellness+, immunizations and wellness store renovations help us become more relevant to today's consumer. In addition, we continue to run our business more efficiently and improve overall performance, evidenced by the fact that our adjusted EBITDA has also increased for 3 consecutive quarters.

While we will get more into the details of our second quarter results shortly, I want to start today by discussing some of the exciting new Rite Aid health and wellness initiatives we are just rolling out that uniquely focus on meeting customers’ needs in a dynamic and ever-changing health care environment and that we believe will help further Rite Aid’s top line growth as we move forward. Just last week, Rite Aid, in collaboration with OptumHealth, announced that we are bringing the latest in quality, convenient online health care to Rite Aid customers in the Greater Detroit area with the introduction of NowClinic online care services, which is now available inside select Rite Aid pharmacies.

NowClinic offers Rite Aid customers realtime access to convenient medical care, information and resources from doctors and OptumHealth nurses. Rite Aid and OptumHealth are the first to provide a virtual clinic in a retail pharmacy setting.

Earlier this month, we also joined the Diabetes Prevention and Control Alliance, and we'll support patients enrolled in the alliances program to help provide people with diabetes better control their condition. In-store pharmacists in select Rite Aid locations will consult quarterly with enrolled patients to evaluate their success adhering to prescribe diabetes regimens and to review patients’ test results for blood pressure, blood glucose and cholesterol.

This support is available now to program participants at select New York City Rite Aid stores in Brooklyn, Queens and the Bronx and is coming to select stores in Washington, D.C., in mid-October. And next week, we will also introduce in all Rite Aid stores our first wellness+ program extension called wellness+ diabetes, which will feature an exclusive collaboration with WebMD, a leading online consumer health information destination, to provide wellness+ diabetes members with a multifaceted free program that offers resources, management lifestyle tools and in-store savings to people living with diabetes and their caregivers.

In addition to these new health initiatives that demonstrate Rite Aid's continuing commitment to support the total health and well-being of our communities, we also have started the rollout of our new wellness store format with 40 wellness stores completed as of the end of the second quarter. As I mentioned on last quarter's call, research shows that with baby boomers aging and the high cost of health care, people are increasingly focused on staying well and living longer.

More responsibility is being placed on consumers to make health decisions, and they are actively seeking advice on how to make the right ones. Our new wellness format is all about empowering our customers in their pursuit of wellness.

Customers are telling us they like the look and feel of these stores, which offer expanded clinical pharmacy services, new health and wellness product offerings and our unique on-site Wellness Ambassadors who serve as a bridge from the front end of the store to the pharmacy. All Wellness Ambassadors are specially trained to provide customers with information on over-the-counter medications and vitamins and supplements, and equipped with special iPad technology to assist customers in making decisions based on their individual symptoms and needs.

Our customers have responded very favorably to this unique service and approach. And while the wellness stores will continue to evolve based on our learnings and customer feedback, the key elements of these renovations provide the foundation for our store renovation program in fiscal 2012.

During the quarter, wellness+ continued to gain traction, as I said, was one of the key factors contributing to our second quarter and same-store sales growth. We now have 44 million members enrolled in wellness+.

wellness+ members accounted for 69% of front-end sales and 66% of script count during the quarter. We have continued to increase the amount of Gold and Silver members that we have in the program, which is important because these customers continue to be our most valuable customers.

Similar to last quarter, almost 90% of these members shop both sides of the store, and almost 50% shop our stores every week, which means we are getting good frequency. More importantly, Gold and Silver members continue to have significantly larger basket sizes than nonmembers, with Silver members’ average basket size being 55% higher and Gold members’ average basket size being 128% higher.

In the pharmacy, we continue to see a much higher retention rate with members versus nonmembers, and members are a high percentage of our best patients. And our research tells us that wellness+ members are significantly more satisfied with Rite Aid than nonmembers, which is another good measure of how the program is working.

Our immunization program continued to be a top priority as we look to provide these vital services to more customers. By the time our flu immunization kicked off in August, we had trained over 11,000 certified immunizing pharmacists, giving us the ability to provide vaccinations at every Rite Aid pharmacy.

As of this week, we have given over 364,000 flu immunizations, which is significantly higher than the same time last year. And we are well on our way to doubling the amount of flu shots we did last year with a goal of 1.5 million.

In terms of our financial results during the second quarter, we saw continued improvements in overall sales trends with a total comp store sales increase of 2.2% for the quarter. Front end and pharmacy comp store sales were positive in all 3 months of the quarter.

Pharmacy sales results were driven by script count growth, even after taking into account the impact of 90-day scripts and brand drug inflation. Front-end sales results were driven by continued momentum from our wellness program, a strong summer seasonal performance and, at the end of August, by increased purchases due to customer anticipation of Hurricane Irene.

Same-store sales results for September softened due to the negative impact of Hurricane Irene on our results, once the hurricane actually hit early in September. We will be announcing September sales next Thursday.

Second quarter adjusted EBITDA increased $3 million to $184.3 million this year versus $181.2 million last year. Similar to last quarter and as expected, our continued investments in sales growth initiatives reduced second quarter front-end gross margin, but higher same-store sales and good cost control helped us grow adjusted EBITDA.

Pharmacy margin was down slightly about 14 basis points compared to prior year due to declining reimbursement rates. Adjusted EBITDA SG&A declined 46 basis points due in large part to another great effort from our store teams.

Net loss narrowed in the quarter due to reductions in depreciation expense, interest expense and a gain on debt repurchases in the quarter compared to charges related to debt refinancing activities in the prior-year quarter. Other key accomplishments during the quarter included a continued rollout of our new private brand architecture.

We now have 1,800 items converted, and we are on track to have 2,900 items in these brands this fiscal year. For the quarter, our private brand penetration increased to 17.2% from 16.2% last year.

We continue to acquire new customers through 8.4 million of prescription file purchases in the quarter and 16.5 million year-to-date. We also improved our in-stock conditions by making further process improvements to our ad forecasting.

Our Save-A-Lot Rite Aid stores still continue to show solid sales gains. However, margins in these stores have not been strong enough to take advantage of the sales increases.

We still like the grocery concept and think it can work in certain of our stores. We have not been able to create an economic model with SUPERVALU that makes sense for both parties, and therefore, we will not be expanding the Save-A-Lot format with them.

We will continue to run these 10 stores as Save-A-Lot Rite Aids. To sum it up, I'm very encouraged by the results so far from our sales and marketing initiatives on both the front end and in the pharmacy.

Our associates are doing a really good job of executing these programs and taking care of our customers, while at the same time, they continue to control costs and operate their stores efficiently. Frank?

Thanks, John. Good morning, everyone.

As John mentioned, second quarter sales and earnings results reflect benefits of the various initiatives we have been working on for the past 18 months. On the call this morning, I plan to walk through our second quarter financial results, discuss our liquidity position, certain balance sheet items, capital expenditure program and, finally, update our fiscal '12 guidance.

This morning, we reported revenues for the quarter of $6.3 billion, which was a 1.8% increase to last year's second quarter. This was the first increase in total sales in 13 quarters, reflecting the same-store sales increases and fewer store closings.

In the quarter, we closed 7 stores and did not open any net new stores. On a year-over-year basis, we operated 50 net fewer stores.

Same-store sales increased 2.2% in the quarter, reflecting the positive impact of wellness+ and positive script count. Front-end same-store sales increased 2.5%, and pharmacy sales were higher by 2%.

Pharmacy scripts were positive 10 basis points. Pharmacy same-store sales included an approximate 148-basis-point negative impact from new generic drugs and were positively impacted by inflation on brand drugs and an increase in 90-day scripts.

Adjusted EBITDA in the quarter was $184.3 million or 2.9% of revenues, which was a $3.1 million or 1.7% increase than last year's second quarter of $181.2 million or 2.9% of revenues. This is the third straight quarter of growth in adjusted EBITDA.

The results were driven by favorable sales trends and lower SG&A dollars. Net loss for the quarter improved to $92.3 million, an $0.11 loss per diluted share compared to last year's second quarter net loss of $197 million and $0.23 loss per diluted share.

The net loss improvement was driven by higher adjusted EBITDA, lower lease termination and impairment charges of $11.2 million, lower depreciation and amortization expense of $17.8 million, lower interest expense of $8.9 million and a $4.9 million gain on debt repurchases versus a $44 million charge related to refinancing activities in the prior year. Our LIFO charge of $20 million was flat to last year.

Lower interest expense of $130.8 million, compared to $139.7 million last year, is due to lower borrowing rates resulting from the 2 most recent refinancing events. Total gross margin dollars in the quarter were $10.3 million higher than last year's second quarter and lower by 30 basis points as a percent of sales.

FIFO gross margin dollars were lower by a similar amount. Adjusted EBITDA gross profit, which excludes specific items, primarily LIFO and the wellness+ revenue deferral, the details of which are included in the second quarter of fiscal '12 earnings supplemental information, which you can find on our website, was slightly favorable to the prior-year second quarter.

Adjusted EBITDA gross margin was 46 basis points lower as a percent of revenues than last year's second quarter. Front-end gross profit was lower due to the tiered discount investments related to the wellness+ customer loyalty program, fully offset by higher pharmacy gross margin dollars, despite continued pressure on third-party reimbursement rates.

Selling, general and administrative expenses for the quarter were lower by $23 million or 83 basis points as a percent to revenues as compared to last year. SG&A expenses, not reflected in adjusted EBITDA, were lower by $20.5 million, primarily due to lower depreciation and amortization expense.

Adjusted EBITDA SG&A dollars, which excludes specific items, again, the details of which are included in the second quarter supplemental earnings information, were lower by $2.5 million or 46 basis points as a percent of revenues. This reduction in dollars and rate reflects the various cost-saving initiatives, efficiency improvements and overhead reductions that have been implemented over the past 12 months, as well as sales leverage from the same-store sales increases.

This was partially offset by an $8 million increase in our self-insurance liability expense due to decline in the risk-free interest rates over the past 6 months. These liabilities are present valued to reflect the payout patterns.

Turning to the balance sheet. FIFO inventory was $75 million higher than the second quarter of last year.

The increase in inventory partially reflects initiatives to reduce out of stocks, whereby we increase the minimum stock quantities on certain items, as well as increase the amount of inventory for add items. We are still refining these inventory changes but believe these modifications will increase sales.

During the quarter, we've repurchased $50.5 million in safe value of debt maturities coming due in 2013 and 2015. These repurchases resulted in a $4.9 million gain, as we were able to repurchase the bonds at a discount to par.

We will also have interest expense savings related to these repurchases going forward as any borrowings under our revolver credit facility has a rate lower than the rate on the bonds that we repurchased. As we have said in the past, we plan to use our cash to both reinvest back into the business, as well as reduce our debt.

Our cash flow statement results for the quarter show net cash from operating activities in the quarter as a use of $131 million, as compared to a use of cash of $6 million in last year's second quarter. Higher inventory, as well as the timing of accounts payable payments at year end, influenced the balance.

Our days payable outstanding of 26.3 was consistent with last year. Net cash used in investing activities for the quarter was $49 million versus $37 million last year.

During the quarter, we relocated 5 stores, remodeled 35 stores and closed 7 stores. Our cash capital expenditures were $49.9 million.

We completed and grand reopened 40 wellness stores as of the end of the second quarter. We expect to complete a total of 300 wellness remodels in fiscal '12.

Although we are very early in the process, we are seeing improving sales results in the first group of remodeled stores. Now let's discuss liquidity.

At the end of the second quarter, we had $965 million of liquidity. We had $73 million revolver borrowings under our outstanding $1.175 billion senior secured credit facility with $139 million outstanding in letters of credit.

Total debt net of invested cash was higher by $47 million from last year's second quarter but lower from year end by $28 million. Now let's turn to fiscal '12 guidance.

As we have previously stated, fiscal '12 is a 53-week year, and our guidance reflects the extra week. The company is updating its fiscal '12 guidance to reflect the results of year-to-date trends and prospects for the balance of the year.

The company expects total sales to be between $25.8 billion and $26.1 billion and expects adjusted EBITDA to be between $825 million and $900 million for fiscal '12. Same-store sales are expected to grow in a range of plus 75 basis points to plus 200 basis points.

Net loss for fiscal '12 is expected to be between $495 million and $345 million or a loss per diluted share of $0.56 to $0.40. Our fiscal '12 capital expenditures are projected to be $250 million with $92 million allocated to remodels and other merchandising efforts and $50 million for file buys.

We are planning to complete 20 relocations and remodel 300 stores. The remodels will primarily be the wellness format.

As John mentioned, we do not expect to complete any more Save-A-Lot format stores beyond the original 10. We expect to be free cash flow positive for the year, and we expect to close a total of 60 stores, of which the guidance includes a store lease closing provision for 20 with the remaining 40 stores closing upon lease expiration.

Included in our net loss guidance is a wellness+ deferral provision range of $35 million to $45 million. This completes my portion of the presentation.

I’d now like to open the lines to questions. Operator?

Guys, a couple of things. I sort of want to drill down a little bit on the wellness+ remodels and where we are with the loyalty program.

First on the remodels, I don't know, I guess it's too early for you to specify a comp lift, but I guess you're satisfied with the -- the first 40 you're getting what you thought that you would get. Is that fair?

I think we're getting there, John. We still have some room for improvement, but I think we're out of the gate in pretty good shape.

We're going to continue to work with the merchandising and develop the concept, which we’ve said all along. And so I think we're making good strides here.

Do you think the -- where you are today and the $250 million that you're spending, is it about the right amount and the 40 are about what you'd want? Or can you dial that back a little bit in terms of expenditure and maybe get a little better return or $250 million is kind of where we are?

I think $250 million is probably where we are for now. I'm sure as we go forward, we'll continue to grind some cost out of it.

But I think for what we're looking out for this year, that's going to be in that range.

I know it's early for '13, but you lost some remodels this year because of timing. Is it the thought that -- I mean if I think about the $50 million rolling over to next year and then what you were going to do next year anyway, could you end up doubling the number of remodels next year from this year?

And is that a number the organization could handle?

I think we can do significantly more than we did this year. I don't know if it'll be quite double.

I think, John, probably a more realistic number might be like 500 or so, John.

Okay. And then with the Wellness Ambassador, do you look at an ROI on that or not really because it's someone who's there anyway and you were paying anyway, you're just reallocating labor?

So there really isn't a good way to calculate ROI on that person?

Kind of looking at in the context of the total renovation. So we're looking at the results post-renovation, including the cost of the Wellness Ambassador kind of stirred in.

That's how we're sort of thinking about it.

Okay. And then finally on the -- because you talked about the Gold customer, so they must be spending about $25 average ticket it sounds like.

Is there a lot of difference, I guess there is, before they qualify and after they qualify? I imagine in both cases it's above the average, but is it a lot more above that 128 after they qualify?

They're good customers getting to the Gold, and they continue to be good customers once their Gold, and I'm not touching that $25, just so you know. Nice try, though.

And then one final thing. Are we now at the point where SG&A dollars -- it would be difficult to reduce that year-over-year?

I mean, I thought this might be the quarter when dollars would be up year-over-year. But we have to be getting to a point where it's difficult to keep that number declining.

I mean, it gets tougher, obviously, each quarter and each year. We continue to remain optimistic that there's some things to work on to get some additional costs out of the system.

But it's definitely tightening up, for sure.

This is actually Justin sitting in for Mark. Just had a question.

There's been some comments from one of your competitors in the marketplace this week about the profitability of generics throughout the cycle. And I was wondering if you could comment, speaking generally, about whether or not you see greater gross profit dollars for generic during the exclusivity period, if the drug has an exclusivity period, than you do after that.

I mean, it just depends on what period of times you want to consider after and how you want to add up the numbers. I mean, an exclusivity period can be significantly profitable.

When it comes off the exclusivity period, the cost tends to go down, but it also to tends to get MAC-ed. So you have to kind of -- it's really a timing thing.

So the first few months, I would say right after exclusivity can be more profitable depending on the timing of when the drug gets MAC-ed.

So in general, though, if you were to look at that, I mean, on average I think most drugs have 180-day exclusivity period.

It really depends on how it's coming to market. Many of the generics will come multi-source right out of the gate.

So it just depends on how it's getting there but...

But generally speaking, for the period, do you see a step-up in profitably greater than after the drug’s been MAC-ed? Just because most people have been under the impression that the exclusivity period was more profitable for retailers.

But then, as I said, one of your competitors had said that it actually wasn't true and that the period after the exclusivity period when the MAC-ing started was actually more profitable on a gross profit dollar per script basis because the costs essentially fell faster than the reimbursements from the MAC-ing. So on average across all generic drugs, is there anything you could give us from a guidance perspective there?

Yes. I mean, again, what I would tell you is the exclusivity period is a profitable period for us.

After the exclusivity period ends and we go to a multi-source environment, our cost tends to come down faster than the reimbursement rate decline. So we tend to make some additional profitability.

But after some period of time, some number of months, usually it kind of turns the other way.

So there's kind of like 3 steps. There's...

Kind of is. That’s probably the best I could describe it.

I'm not trying to get you too sideways here but...

No, no, that's very helpful.

We're speaking in some broad generalities here.

Yes. No, of course.

I know that it fluctuates quite a bit. And then just one other maintenance item.

Could you disclose your GDR for the quarter?

Did we throw it out there? I don't know.

You have in quarters past, but it hasn’t been every quarter. I was just curious if you'd be willing to give it today.

Yes, we're kind of in the high 75, 76 range.

I was hoping that you could, Frank, just give us a little clarity around open market repurchases that you executed, and, specifically, if you could give us by tranche and then, secondarily, specify the 2015 maturities where the 8 or the 9 handles, please?

Sure. The $50 million, the lion’s share of what we repurchased was what came due in March of '15.

So $40 million of the $50 million was primarily targeted for March of '15.

Okay. Great.

And then just around the inventory per average store growth, I'm just curious, are you guys seeing any inflationary pressures in any of your categories?

Emily, there is some. As we look at kind of the increases in inventory that I mentioned earlier on the call, some of it is we make some conscious decisions where we're going to put some inventory back into the building in order to increase sales.

But also a piece of that is clearly due to some price increases that we've seen. And also we made some forward buy decisions on both the pharmacy side as well as the front end, which also contributed to the increase in the inventory there.

If you look at it from a kind of an inflation standpoint, on the front-end side, looking at kind of our LIFO index, if you will, it's kind of the metric for inflation for us, we're seeing about a 1% increase on the front end.

I have one question on wellness+ and then a couple of housekeeping. On wellness+, do you see a greater penetration of customers in markets where you have a #1 or 2 market share in that market?

Or is it actually helping you in some of the markets where you are #2, 3 or 4?

I think it's helping us across the board. So it's helped us all over the place.

Some it's in markets that are -- we're 1 or 2, but it's also helped in markets where we have lower shares, also.

Okay. And then given your store closing program, where do you stand in terms of dark store rent?

How much are you paying right now in dark store rent, and how much can that go up by year end from the store closures?

Right now, it's about $93 million, $94 million for the year is the projection now, Carla.

Okay. And it looks like you reduced your file buy forecast from $75 million down to $50 million.

Is that because of the funds are being allocated into the wellness remodels? Or there are not as many files out there available?

It seems it’s just taking us a little longer to get these things closed. We still are very actively out there looking to acquire them, but it's just taking us a little longer to close these things, which is why we pared it back.

We want to do as many of these as we can.

Okay. Did you say what the dollar amount of the file buys in the quarter was?

About $8 million, $8.5 million.

Okay. Great.

And then just one last. It sounds like you still have some appetite to buy back bonds in the market if you've got the free cash flow.

Is that correct?

We would look to do that opportunistically.

My first couple of questions relate to front-end gross margin. Just as you think about input inflation and how you've been processing that and how the consumers have been receiving it.

I mean, you want to comment again about inflation? I mean, it hasn't been super significant, right?

No. I mean, again, inflation rate right now is, again, like we said, about 1%, not seeing significant increases.

We're still being told that there'll be some price increases in the second half of the year, but we're not expecting anything extraordinary.

Got it. As you think about deferred revenue associated with the wellness+ program, it looks like the guidance implies that the trajectory continues to decline from here.

Have we seen the biggest dollar numbers there at this point?

Yes.

Okay. And then on store closing and impairment charges, just based on the second quarter number, which is well below where we were and your guidance for the year, just confirming this is slated to be very much a back-end loaded number?

Yes. Yes, it is Matt.

Remember a lot of that, too -- part of that number is the negative cash flow impairment number as opposed to store closing charge. And that impairment number will hit in the fourth quarter.

I just wanted to ask a follow-up on this generics question because the debate is really...

You guys are really tangled up on this thing.

Well, the debate has really been specifically around lipitor. So the question that I'd like to ask you is, is there anything about lipitor that would make it different than drugs historically that have been in exclusivity and not?

In other words, is there any reason that lipitor would, profitability-wise, the curve would not look similar to past drugs that have launched?

I mean, the only thing that I can touch on there would just be whether we're -- right now, it's our expectation that Ranbaxy is going to be in the market and come to market on time. So that's kind of what our thinking is at this point.

If that's different, then that could impact how it plays out.

Right. And assuming that Ranbaxy is in the market, we should assume that the exclusivity period for you will be good as it always is?

Yes.

I mean, and over time, you would get MAC-ed, and profitability will go down. Is that fair?

That's fair. Costs will come down also, but we'll be MAC-ed.

All right. So that's helpful.

And then on the generic wave, specifically, it's obviously been highly anticipated. I know you're not going to quantify what the benefit is going to be, but you've probably seen numbers.

Can you help us frame how we think about it? And do you think it will end up living up to expectations?

It's clearly been hyped up, right?

I hope it does. I mean, I think what we've tried to communicate to everybody is that the other piece of the puzzle for us is the reimbursement rates out of this thing, right?

So there's, clearly, going to be great cost savings here as these drugs come to generic. There's no question about that.

And I think the expectations about what those cost savings are going to be are probably very real, based on past history of what we've seen. The question that you have for us that we're not answering, because it's a little bit dynamic, is where is that all going to shake out in the different parties that participate in the business.

And that's something that we've got to work our way through.

Is that because you don't have great visibility on the reimbursement rates today on what they'll end up being next year on these drugs?

To some degree, that's true, and that's true because, in part, we're in discussions with people about how it will work.

And currently, how are things shaping up so far?

Okay. Again, we're working our way through it.

I don't think we're in a position to say or we would. I'm not trying to be cute, but it's just -- we're not there yet, and when we're there, we'll say.

Okay. Second question for you is on the wellness program.

Can you help us assess the net impact of this program so far on EBITDA? Obviously, it's helping sales.

There is an investment in the gross margin. When do we get to the point, if we're not there yet, where it's neutral to EBITDA?

And then how does it ramp over time? And what do you have to do to get it to ramp?

Well, it's definitely ramping. There's no question about that.

I mean, I kind of look at gross margin -- or gross profit dollars, so as kind of a way to think about this thing a little bit. And it's impacting, I think, both the front end and the pharmacy.

And so I kind of go to gross profit dollars. So we're digesting a lot of the markdowns and whatnot, actually, in our gross profit dollars today.

The cost of this thing is in the gross profit dollars, and you can see that as the wellness deferrals going down. Correspondingly, what's running through gross profit is going up.

So we're digesting the cost of this thing, and so it is a rate play. We're giving some rate in margin.

We're driving top line results. But at the end of the day, and it's a little tighter this quarter than it was last quarter, but at the end of the day, we are driving some gross profit dollars down the P&L.

So I'm sorry, so your net assessment is that it's been positive to date or positive at this point?

Positive in current results, I'd say. But there were some initial investments that we need to make a return on over time.

Yes. Okay.

And then just last question for you. Last question.

Can you comment on the implications for the industry of the Express Scripts-Medco merger as you see it at this point, assuming it goes through? Does this consolidation just solidify continued pressure on reimbursed rates over time?

It's certainly not going to help. I mean, I think obviously, it gives someone a fair amount of buying power in the marketplace.

So it is what it is.

I will not ask about life cycle of a generic. Could you frame up just your investment in a wellness store and what type of sales lifts you need to hit your return on targets?

Bryan, we're looking to invest about $250,000 per store. And what's included in that, there are some investments back in the pharmacy.

We put in a new consultation room, plus we might be -- some enlargement to the waiting area, as well as all the work that we do on the front end in terms of resetting the store and whatnot. So there is also some signage that's included in that.

That's what kind of tallies up to that $250,000 per. The way that we've kind of laid this out here, Bryan, is that we would've looked to get basically a 3% total store comp, okay, in order for us to get a 20% kind of return on our money.

Now obviously, some piece of this is -- there's some deferred CapEx that's kind of baked into these numbers. I mean, we haven't spent a lot of dollars, as you well know, in the stores for a period of time, but that's kind of factored into our thinking here.

I mean, if you think about a longer-term goal, where would you like to be in terms of the number of stores that you are -- or a percent of stores that are remodeled or new over a 5-, 7-, 10-year period?

Yes, I mean, ideally, we'd like to be in a position where we're new or remodeled in 5 years. Okay?

Get 100% of the chain. Is that realistic?

Probably no. But if over the next 2, 3, 4 years, we can incrementally increase our CapEx investment by $50 million or $100 million a year, I think we probably could get to 78% to 80% of the chain in the next couple of years.

And thinking about that goal and the CapEx you just mentioned, with this potential windfall from the generic wave, when you think about that, is your primary target of that excess cash flow remodels? Or is it debt reduction?

Or how would you weigh the use of cash?

I'll tell you, Bryan, I mean, for us that's kind of ongoing discussion. Obviously, we’d like to do both, okay?

And there'll be some balance between reinvesting back in the stores, which we obviously know we need to do. But we also need to start getting down the $6.2 billion worth of debt that we have out there.

It's not going to be something that we're going to make huge strides on, but we certainly need to start paying down some of that. So it'll be a give-and-take there, Bryan.

Right. And my last 2 questions, when you look at same-store sales, was there any geographic disparity when you look at how same-store sales played out over the quarter?

I'd tell you just generally and overall, same-store sales had just gotten a lot better across the whole chain. Clearly, there's always some markets that are outperforming other markets in any given week.

Sometimes there’s weather or this, that and other thing. But just in general, everything's gotten better.

Okay. And then lastly, when you think about the promotional environment, it seems like more retailers, not specifically speaking to the pharma area, just retailers in general, it seems like there's been a push towards more promotion as consumer spending has kind of softened here.

Are you seeing that increased level of promotion across your core competitive set? Or could you just talk about the environment in general?

Yes. I think it is still a pretty promotional environment, and I'd say it's probably up slightly maybe over the last couple of months in terms of activity.

Given that you guys have always been somewhat conservative with your guidance, what are you seeing in the second half here that gives you the confidence on the tightening here?

Current trends.

Well, yes, if you kind of look at the current trajectory, the last -- certainly the first 2 quarters here, we've exceeded prior-year numbers. So that's certainly factored into it.

We certainly recognize there's a 53rd week that's kind of baked into our numbers here. But I mean, the things that we're thinking about in terms of factoring into these numbers is same-store sales trends for the third and fourth quarter, where reimbursement rates are going to shake out here in the second half of the year.

Obviously, the timing of lipitor and a couple of the other ones that are going to come into the back half of the year and the investments that we're making in wellness+. I mean, those are probably some of the key factors that are kind of driving the guidance here.

Okay. And with the September comp weakness, just trying to get a sense of the magnitude that was kind of pulled forward with Hurricane Irene in terms of what our expectations should be.

Well, for the quarter, for the second quarter, it probably impacted us about 50 basis points because it was 150-basis-points impact in August.

Okay. And then in terms of when you're out in the market looking at script and file buys, is the valuation still pointing to a $10 to $20 per script valuation under your credit agreement?

Karru, it's still pretty much in that range. Maybe it's inching up a little bit, okay?

But still pretty much in that range.

For wellness+, what evidence are you seeing that you're gaining new customers with the program as you look at enrollment continuing to grow? And then within the program, you mentioned that you're successful in retaining your pharmacy customers.

What about converting that front-end customer to a pharmacy?

I'd say that's a bit more of a gradual process. Yes, I think the initial results from this thing I think show that we've really slowed down kind of defection or loss of customer in the pharmacy.

But in terms of acquisition, it's not been a huge factor. I think we're starting to get a little bit of that.

But I think it's still an opportunity for us. And obviously, the longer this goes, the more information and history we get to work with to try and really make investments to move customers around inside the store.

And that's kind of where we are at this point, I think.

And what about in terms of attracting a general new customer to the program overall?

Well, I think -- the enrollment I think is, in fact, a good indicator to look at that we continue to attract new customers with the program. And we kind of watch their behavior as they come in, and it seems like the number of Gold customers is growing and Silver.

And so I think that's a good sign.

Great. And one quick final question.

Can you give us private label penetration this year for this quarter and how it compares to last year?

I think it was 17.2 versus 16.2.

This is Matt Galati on behalf of Steve Valiquette. Just a little bit more clarification on the Hurricane Irene impact.

So the benefit to August is essentially a pull forward of revenue from September, and we should think that September revenue’s really going to be no different than that benefit from August?

Right. So August picked up 150 basis points, Frank said.

We gave a lot of that back, all of it pretty much, in the first week of September.

Okay. And then secondly, I was wondering if there's been evidence of any customer inquiries related to a competitor's ongoing negotiation or contract dispute with the PBM?

Say that again. I'm sorry.

I didn't get that.

Has there been any increase in inquiries from customers associated with a competitor's negotiations with the PBM?

No.

No.

You mentioned your pharmacy gross margins were down, I think, 14 basis points. Is there any -- 2 questions on that.

Is there any difference between what your branded margins were hit versus was what your generic margins were hit? And then secondly, I know July 1 was a Medicaid reset for a lot of states.

For most states, stimulus money ran out. Did you see any increased pressure from Medicaid in the 2 months of the quarter that it would have been in effect?

In terms of the brand and generic, I think it’s a little bit on both sides, honestly. And in terms of the impact since July 1, I guess we're going to double-check here, but I don't think it's been huge.

And just in terms of your pharmacy reimbursement, is it just -- instead of paying you AWP minus x, they're paying you AWP minus more than x? Or are you seeing more structural changes for cost plus or that sort of thing?

Or is it just -- is it bigger discounts of AWP or is it changes in the structure and how you pay?

Well, in terms of its overall impact, it's clearly reductions off AWP payments. There are some states that are doing some structural changes, so that's stirred into the number as well, but it isn't probably material at this point as what's going on in other parts of the business.

On the wellness remodels, geographically, where are those remodels occurring? Are they on the East and West Coast primarily?

Mary, they are. They're kind of -- right now, they're in 8 -- kind of in 8-key markets, both East Coast and West Coast.

Can you tell us which markets those are? I'm sorry, did you hear?

I'm sorry. We didn't hear the question.

Can you tell us what markets those are?

L.A., Seattle, Baltimore, Pittsburgh, Buffalo, New York, Philadelphia and Boston.

Okay. Great.

That's helpful. And then on the free cash flow, the magnitude of the free cash flow, is it in the $50 million to $100 million range?

It's probably -- I'll call it modestly positive, how's that?

Modestly positive. That sounds like less than $50 million.

Okay. And is that after considering the bond repurchases or before?

Before.

Before. Okay.

Got it. And then specifically, which issues were -- the actual issue that you repurchased and the size?

It was March of ‘15, Mary. That was predominantly what we've bought was the March of ‘15.

Okay. And that was the -- it was $40 million exactly, and then the rest were the 6 7/8 of '13?

'13 and then we actually bought a little bit of December '15.

Okay. Got it.

All right, that's helpful. And then how should we look at working capital changes, seeing that you're adjusting your inventory levels to have a better in-stock position.

And then it sounds like we have some modest inflation. How should we balance that net year-over-year?

Are we going to see cash generation or a net use in cash?

I think they're probably either flat or slightly some generation here. But I don't think it's going to be significant.

Talking about your capital allocation policy. I mean, can you give us a little bit more background in terms of -- you're clearly dialing down some of your CapEx expectations this year.

You bought back bonds. Obviously, it was a very powerful tool in terms of deleveraging.

Can you talk a little bit about how that balance act between reinvesting back in your stores, obviously, there is a fair amount of deferred CapEx there versus kind of your willingness to delever in the near term.

John wants to spend all the money on the stores. Frank wants to delever.

That's the dynamic tension that exists. But honestly, there were some change in plans, particularly, as it related to capital we put aside to invest in potentially Save-A-Lot stores or otherwise that we're not going to do.

So that quite frankly freed up some capital that Frank put to work.

But isn't the total number of remodels for the year generally coming down?

It is because those Save-A-Lots that we were going to do, those were -- we were calling those remodels.

Got it. And then just one quick one.

I mean, how do we think about just the accounting effect from your revenue deferral piece on the customer loyalty? It was around $6 million or $7 million in the quarter.

It's bounced around historically. Is it fair to assume that's going to be relatively consistent at that level?

Well, Joe, as membership levels start to flatten out, that deferral charge that we take is actually going to get smaller and smaller.

And do you think you're achieving that level, or do you think there's....

I don't know if we achieved it, but we're certainly getting closer.

Yes. Obviously, by the end of the year.

But the deferral that will be up there is probably going to be around $90 million or so. And in the outer years, it'll increase to the degree that our enrollment increases.

Okay. Well, I think that wraps it up here.

Appreciate everyone listening here, and we'll talk to you in the third quarter. Thank you.

Thank you for joining us.