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Rite Aid Pharmacy Pa

CAMP HILL, Pa. -- Rite Aid lowered sales, net income and adjusted EBITDA guidance for fiscal 2005 earlier this month, after announcing a 2 percent same-store sales increase for the second quarter ended Aug. 28.

Even after the lowered guidance, however, Rite Aid plans to increase its EBITDA from last year--on a total dollar basis and as a percentage versus total earnings.

"We are lowering our fiscal 2005 guidance as a result of slowing pharmacy sales growth and third party reimbursement rates that are trending lower than we had anticipated," stated Mary Sammons, president and chief executive officer of Rite Aid. Third-party reimbursement rates are being impacted negatively by a growth in generics utilization, Sammons said, though that will bode well for the chain in the long term. "We will continue to look to grow the generic component; we'll just continue to be really aggressive on the cost side, too, and pay careful attention to what's happening on the reimbursement side.

"Payers are taking additional steps to slow health care spending, and mandatory mail programs have increased," Sammons added, noting in an analyst conference call that the United Auto Workers decision to mandate mail order in January progressively has siphoned Rite Aid's pharmacy sales in its central division. "Our guidance reflects the fact that we believe we are still going to see an impact [from mandatory mail order programs] through the rest of this year.

Although Rite Aid could not pinpoint the exact number of prescriptions lost by the UAW mandatory mail decision, in August those locations that were filling UAW prescriptions "did a little over 2 percentage points worse on their pharmacy sales growth than did the rest of our stores that don't fill UAW prescriptions," noted John Standley, senior executive vice president, chief administrative officer and chief financial officer at Rite Aid. And that impacted almost a third of the chain's store base.

Mandatory mail order is a challenge that the entire chain pharmacy industry is looking to solve, noted Sammons, who is also chairman of the National Association of Chain Drug Stores. "As retail gets more competitive with its ability to fill 90-day scripts, which is high on everybody's agenda, and makes that available as an option ... we should make some headway."

But the loss of UAW prescriptions is not the whole story behind Rite Aid's restatement of earnings guidance, Standley observed. "When you take that and couple that with the reimbursement rate issue, that really brought us to where we are today ... you really have to put the two together to get where we are today, he said. "Mary and the rest of the management team feel very strongly, it is important that we not get into a slash-and-burn mentality here. We need to continue to invest in [the stores and staffs]."

"Despite these challenges, we believe that we have both short-term and long-term initiatives in place to improve our current situation and position us for future successful growth," Sammons said.

She expressed hope that the chain's recently announced ad campaign, as well as a stepped-up initiative to shore up pharmacy share in the chain's key markets, will help quell the slowdown in pharmacy sales. "We have recently started an aggressive pharmacy-customer acquisition program in priority markets, capitalizing on the Eckerd transition, as well as running prescription transfer incentives, Sammons noted.

Indeed, several marketing programs currently under way--including programs that target teens, seniors and Hispanics--are expected to help drive sales in both pharmacy and the front end through the rest of the year, Sammons said. "[These pro grams] give us plenty of strength through the rest of the year," she said. We will also complete our digital rollout by mid-November and can be even more aggressive in marketing the value of digital development to our photo customers."

The new guidance will not result in the chain pulling back from its capital expenditure guidance, however, Sammons stated. That commitment could top out at a level of $325 million.

The company said it expects sales to be between $16.9 billion and $17 billion, with same-store sales improving 2.8 percent to 3.3 percent, compared with previous guidance of $17.1 billion and $17.3 billion, with same-store sales improving 3.8 percent to 4.9 percent.

Net income for fiscal 2005 is expected to fall between $122 million and $150 million (between 16 cents and 22 cents per diluted share).

Analysts surveyed by Thomson First Call had expected earnings of 28 cents per share for the year on revenue of $17.4 billion.

And adjusted EBITDA is expected to be $770 million to $800 million, compared with previous guidance of $800 million to $850 million.

"Our liquidity remains strong, and our bank financing remains strong at this time," Standley remarked. "Overall, while we are disappointed with our short-term earnings, we believe that we are continuing to do the things that are necessary to make Rite Aid a successful company for all of our stakeholders in the long run."

Comp pharmacy sales increased 2.1 percent over the second quarter, and front-end same-store sales increased 1.8 percent.

Rite Aid's adjusted EBITDA

Fiscal Year                        EBITDA *

2000                        1.4% ([dagger])   $185.2
2001                        2.5%              $363.8
2002                        3.0%              $451.3
2003                        3.9%              $622.9
2004                        4.3%              $722.3
2005E previous guidance     4.8%              $825
      updated guidance      4.6%              $785

* EBITDA figures in millions

[dagger] percentage of adjusted EBITDA versus total sales

Source: Rite Aid analyst presentation

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