Jun 28, 2007
TRANSCRIPT SPONSOR
Executives
Kevin Twomey - CFO Mary Sammons - Chairman, President & CEO Jim Mastrian - COO Pierre Legault - CAO
Analysts
Meredith Adler - Lehman Brothers Ed Kelly - Credit Suisse John Ransom - Raymond James Mike Maguire - FTN Midwest Research Carla Casella - J.P. Morgan Karen Miller - Bear Stearns Reed Kim - Merrill Lynch
Operator
Good morning. My name is Stacy and I will be your conference operator today.
At this time, I would like to welcome everyone to the Rite Aid First Quarter 2007 Conference Call (Operator Instructions). Thank you.
Mr. Kevin Twomey, Chief Financial Officer for Rite Aid, you may begin your conference.
Kevin Twomey
Thank you, Stacy, and good morning, everyone. We welcome you to our first quarter conference call.
Mary Sammons, our Chairman, President, and CEO; Jim Mastrian, our Chief Operating Officer; and Pierre Legault, our Chief Administrative Officer are also on the call with me. Our agenda for today's call is pretty straightforward and will be as follows.
Mary will give an overview of our first quarter and a brief update on our Brooks Eckerd's integration. I will then review the first quarter financial results and cover guidance, which includes the Brooks Eckerd's operations, and then we'll open it up for questions.
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 could cause actual results to differ.
Also we will be using a non-GAAP financial measure. The risks, uncertainties, and the definition of the non-GAAP financial measure along with a reconciliation to the GAAP measure are described in more detail in our SEC filings.
So with that in mind, let's get started. Mary?
TRANSCRIPT SPONSOR
Mary Sammons
Thanks, Kevin. Good morning, everyone, and thank you for joining us today.
As you can see from our press release, we had a good first quarter. We continued to improve our business at the same time we focused on closing the Brooks Eckerd acquisition, which we did on June 4th, and got ready for a smooth integration.
I'll give you an update on the progress we've already made on transitioning our 1,850 new stores into Rite Aid, but first let's talk about our results. We had a profitable first quarter with adjusted EBITDA up year-over-year.
We grew both pharmacy sales and script count and had solid sales gains in margin improvement on the front-end. Expense management was strong throughout the quarter, even with higher occupancy expense from new and relocated stores negatively impacting SG&A.
We're now three years into our new store development program and our new and relocated stores are delivering strong sales results. Same-store sales for the first quarter increased 2.3% with pharmacy sales up 2.7% and prescription count up about 1%.
Medicare Part D prescriptions increased to nearly 15% of our total pharmacy sales. Although the impact on our same-store sales was much less than what we experienced in last year's first quarter shortly after the launch of the program.
We continue to successfully target senior customers. Our Living More senior loyalty program grew to 2.7 million members in the quarter and we have marketing initiatives to double that number this fiscal year.
Customers in our newly acquired stores will be able to sign up starting next month. The introduction of new generics had a negative impact on our pharmacy sales.
591 basis points this quarter, up substantially over last year and last quarter, but a positive impact on pharmacy margins, especially as our generic dispense rate climbed to 64.1%. Even though we lead the industry in this measure, we believe we still have plenty of room to grow when you look at the more than 30 billion in brand drugs that are expected to come off patent in the next two years.
Now that we have the purchasing power of more than 5,000 stores and recently completed a very successful bid process with our generic manufacturers, we expect the positive impact of generics on pharmacy margins will continue to grow. Our aggressive prescription file buy program contributed to our pharmacy sales increase and will contribute even more in future quarters.
We completed more than 40 deals in this quarter and have substantially more scheduled for the balance of the year. We are now starting to realize the benefit from the pipeline our acquisition group worked so hard to fill last year.
File buy purchases this quarter were also additionally positively impacted by the long swap we completed in April, which included file buys as well as stores and strengthened our market position in Washington and Oregon. Both our file buy retention rate and return on investment are significantly higher year-over-year.
We also continued to pursue new regional opportunities for in store clinics during the quarter and are in negotiations on multiple partnerships. We expect to announce one of these in the next few weeks.
You'll remember that we believe partnering with local and regional organizations that already have a reputation for providing superior healthcare in a community will deliver the best, most sustainable results. As for the front-end, same-store sales increased 1.6% with good margin improvement.
Despite a weaker allergy season, OTC performed well, health and beauty was up significantly, and vitamins continued to post strong gains especially in our GNC Living Well department. We now have almost 1,300 GNC departments in our stores and plan to add several hundred more this fiscal year including to some of our newly acquired stores.
Once again, private brand growth was excellent increasing to over 13% of front-end sales, and summer seasonal got off to a great start. While photo continues to be a negative contributor to same-store sales, we are controlling our photo expenses better and are in the process of developing tactics to drive incremental sales in margin from this category, including broadening our online offering.
Along with increasing profitable sales, we made good progress on our other critical priorities this quarter. As I said at the start of my remarks, our team continued to manage expenses well, including store labor, and at the same time, we saw some of our biggest increases in customer satisfaction ratings we've seen to date, in both the pharmacy and the front-end.
Our initiatives on improving customer satisfaction are working. We also continue to improve operational execution in our stores, which plays a big part in improving the shopping experience.
We're very excited about yesterday's announcement that Brian Fiala has joined our team as Executive Vice President of Store Operations. After 24 years of managing stores and rising through the ranks at Target.
He will report to our COO, Jim Mastrian, who has been looking for the right person for this position for some time. We're looking forward to benefiting from Brian's talent and expertise.
As for store growth, we remain on track to open our targeted 125 new and relocated stores this fiscal year. Some of them may even be in our new states.
Speaking of our new states let me give you a quick update on the progress we've already made on our integration plan. As we've said for months now, we were ready to hit the ground running as soon as the Brooks Eckerd acquisition closed and we did.
In the last three weeks the events triggered by the closing happened as expected. Rite Aid coming soon banners are now up in almost all of the Brooks and Eckerd stores.
Integration of the first distribution center is nearly complete and we expect to connect this DC to the Rite Aid distribution network early next week. We're on target to complete the integration of all six new DC 's by the end of the second quarter.
Our first health condition marketing program, this one on summer skin care is already in all of the acquired stores. Rite Aid private brand has started shipping to the stores and we begin our common advertising circular program next month, with heavy emphasis on those items.
As I said earlier, our Living More senior loyalty program will also be introduced in our new stores next month. We started work on the pilot stores and have already successfully converted systems and two of them near our home office.
Systems were replaced overnight virtually without a hitch, and any minor issues that surface were quickly fixed. Associates describe their training as nearly flawless.
Those two stores are now in the minor remodel, remerchandising phase and while it's only been a few days, we're on schedule to complete them in the planned time frame. After this phase is completed in these two stores, we'll move on to the other pilot stores, wrapping up the number until we complete all the pilot stores by the end of the second quarter.
It's exciting and encouraging to talk with our new associates in the pilot stores and see their excitement and enthusiasm for the changes coming. At the same time we're focusing on the pilot stores we're also continuing to get ready for rolling out the systems conversion to all stores.
We expect to start in September and complete by the end of Fiscal 2008. We're currently equipping some 58 training centers to provide training for our store associates starting 60 days before their stores scheduled conversion, and we'll welcome all of our new associates from Brooks Eckerd with open houses next month where they will get more information on their new company and our conversion plan.
All 44,400 of these associates will be converted to our payroll system next week. As you can see, we've made a lot of progress in the last three weeks, and we're feeling very good about our integration plans.
We're also feeling very good about the initiatives we have in place to improve our base business at the same time we executed smooth integration. As we said before, profitably growing pharmacy sales and prescription count, increasing profitable front-end sales, improving associate and customer satisfaction, operational execution, and spend management continue to be our critical priorities for Fiscal 2008.
These initiatives will benefit both core Rite Aid stores and the newly acquired stores. Before I turn it over to Kevin I want to make one other comment.
There's been a lot written about Medicaid reimbursement and the definition of AMP in the last few days. After the Center for Medicare and Medicaid Services CMS announced a delay in implementing the cuts managed by the Deficit Reduction Act.
While we don't know what the out final regulations will look like, we do know that our industry has worked very hard over the past month trying to convince CMS, Congress and the State that retail pharmacy deserves a much higher reimbursement for dispensing Medicaid prescriptions. That effort has resulted in several government agencies including the Department of Health and Human Services issuing reports demonstrating that the current AMP definition will not even cover acquisition costs for the most widely dispensed generic drugs and in 250 members of Congress, contacting CMS to protest the way AMP is currently being defined.
We won't slow our efforts because implementing AMP has been delayed. We will continue to try to convince CMS to change the definition to make it fair to retail pharmacy and are evaluating legislative options if they won't.
We'll also continue working on the states to increase dispensing fees so that we'll be able to serve our Medicaid patients. As for what impact this delay will have on Rite Aid, as our release indicates, we are maintaining our current guidance.
We believe we set our ranges wide enough to accommodate the benefit from the delay. I'll now turn it over to Kevin.
Kevin Twomey
Thanks, Mary. Before I get into any detail, I want to remind everyone that the closing on the Brooks Eckerd's acquisition was on the Monday after our first quarter close.
Accordingly, the first quarter results and financial position are all pre-acquisition. Our guidance for fiscal 2008 and forward-looking statements do, of course, include the acquisition.
Let's talk through the operating statement. Revenues for this quarter were $4.46 billion compared to $4.34 billion last year.
That was an increase of $121 million or 2.8% increase. The increase was driven primarily by a 2.3% increase in same-store sales that Mary mentioned.
Pharmacy same-store sales increased 2.7%, which was driven primarily by a 0.9% increase in prescriptions. Our mix of generic prescriptions continued to increase.
During the first quarter, all generic prescriptions were 64.4% of total prescriptions, which was 489 basis points higher than last year's first quarter. We expect this increasing trend to continue.
New generics had a negative 591 basis point impact on pharmacy sales during the quarter, which was higher than the previous quarters negative 416 basis points impact on pharmacy sales. We did see some weakness in the allergy season and continued to anniversary the inception of the Medicare Part D program.
Our growth initiatives such as our focus on customer satisfaction, prescription file buys, marketing to Medicare patients, our senior loyalty program and the new and relocated store program continued to produce results. We expect prescriptions to continue to grow.
Front-end same-store sales increased 1.6%. We had solid positive contribution from almost all of our core categories.
The photo category continued to be a negative contributor. Our customers purchased more items that were on promotion in this years first quarter when compared to last years first quarter.
We did not change our promotion program. Our customers simply purchased more items on promotion.
We continue to believe our initiatives for improving customer satisfaction and our new and relocated store program along with our consistent promotion program with a focus on health conditions, senior citizens, and core categories will grow our front-end sales. Gross profit was $1.22 billion or 27.43% of revenues for this quarter versus $1.18 billion or 27.30% of revenues for last year.
Gross profit dollars increased due to the sales increase and an improvement in our gross margin rate. The current quarter included a non-cash LIFO charge of $9.3 million versus $8.9 million in last years quarter.
The LIFO charge increase was due primarily to the effect of higher product inflation. Excluding LIFO, this quarter's gross margin rate was 27.64% of revenues compared to 27.51% of revenues last year, an increase of 13 basis points.
The 13 basis points increase in consolidated FIFO gross margin rate consisted primarily of a 27 basis point positive contribution from front-end, partially offset by a 12 basis points negative contribution from pharmacy. The 27 basis point positive contribution to consolidated gross margin rate from front-end was due primarily to three factors.
One, our ability to maintain our gross margin rate when faced with cost increases. Two, an improvement in shrink.
And three, better contribution from photo. The 12 basis point negative contribution to consolidated gross margin rate from pharmacy was the net result of several factors.
Our Medicare Part D business is a larger part of all prescriptions. It was approximately 14.8% of pharmacy sales for the current quarter compared to 11.2% last year.
We did not obtain the typical reductions in generic costs we normally negotiate during the quarter because of some pushback from vendors due to the successful generic bid process we conducted related to the Brooks Eckerd's acquisition. The lower costs for the generic products from the bids became effective on June 4, the closing date of the acquisition.
There's also the benefit from an increase generic prescriptions from new generics as well as from dispensing more existing generics, which was partially offset by the withdrawal of three significant generics. Clopidogrel, Albuterol, and oxycodone ER.
We continued, of course to experience reimbursement rate pressures. And the last factor I want to mention is we did not experience as much of a benefit in pharmacy shrink as we had the previous year.
The prior year we had made tremendous progress, because of various initiatives and this year, the progress is at what I would call a more normal level. None of the expected gross profit improvement from the Brooks Eckerd's acquisition is included in the first quarter.
Also, we have several other initiatives that are expected to improve our pharmacy gross profit. We expect pharmacy gross profit to continue to grow; however as we grow our pharmacy business, including prescriptions from the Medicare Part D program, pharmacy gross margin rate will continue to be pressured.
Let's move on then. Selling, general, and administrative expenses for the quarter increased as a percent of revenues by 27 basis points compared to the prior year.
25 basis points of the increase was due to $11.2 million of acquisition related expenses in the current quarter, whereas the prior years quarter had none. By excluding the acquisition related expenses, SG&A as a percent of revenue between the quarters increased 2 basis points.
The increase was the net result of a 17 basis point increase in occupancy expense, because our new and relocated store openings. Partially offset or mostly offset by 15 basis points of improvement from general and broad based expense control.
We're confident in being able to continue our broad based expense control efforts. We also intend to continue to develop our new and relocated store program.
This means occupancy expense will continue to grow. Until the sales growth from the new and relocated stores has a chance to mature, occupancy expense as a percent of revenues will be greater than the previous years comparable period for a few more years.
Continuing on down the operating statement then, store closing and impairment charges were $8.6 million lower than last years charge. This was due primarily to a lower impairment charge in the current quarter.
Interest expense was $68.7 million for the quarter versus $69.3 million in last years quarter, the decrease was primarily due to less non-cash interest expense. Cash interest expense was $64.1 million for this quarter versus the same amount last year, and non-cash interest expense was $4.6 million this year versus $5.3 million last year.
Gain on asset sales was $4.2 million in the current quarter versus a loss of $0.8 million in last year's quarter. The increase is primarily due to a favorable insurance settlement.
Regarding income taxes, it was a benefit for the current quarter. The current first quarter benefit was $1.3 million compared to last years first quarter income tax expense of $4.7 million.
This year’s quarter tax benefit included adjustments for several uncertain tax positions that were favorably concluded. Net income for the quarter was $27.6 million compared to net income of $11.0 million last year.
The increase was the result of all the items I just described. Income per diluted share was $0.04 per share for the current quarter compared to income of $0.01 per diluted share for last year's first quarter.
Each quarters diluted per share calculation included declared preferred stock dividends. You'll remember that preferred stock dividends are not included in net income but they are considered in calculating per share amounts.
Also remember the weighted average shares in the calculation do not include the 250 million shares we issued on the Monday after the first quarter end for the Brooks Eckerd's acquisition. Adjusted EBITDA for this quarter then was $192.8 million or 4.3% of revenues, an increase of $12.4 million from the prior year.
The increase was primarily due to the increase in revenue and the resulting increase in gross profit and gross margin rate along with good expense control. The schedule attached to our press release reconciled our net income to our adjusted EBITDA.
Now let's turn to the cash flow statement. Net cash provided by operations was $186.3 million this quarter versus $121.8 million in last year’s quarter.
The $64.5 million increase was primarily due to the increase in adjusted EBITDA, an increase in the net proceeds from the accounts receivable securitization program, insurance proceeds, and an increase in accounts payable, which is related to acquisition related activities. Net cash used in investing activities for this quarter was $1.359 billion versus $62.0 million for last year’s quarter.
The increase was primarily due to an increase in restricted cash balances. At the end of the quarter, we issued notes before we closed on the Brooks Eckerd's acquisition and deposited the proceeds from the notes into escrow or restricted cash accounts.
The increase in cash used in investing activities is also the result of capital expenditures being higher than last year because of our new and relocated store and prescription filed buy programs. For the quarter we spent $117.5 million for property, plant and equipment, $13.8 million for prescription file purchases for a total of $131.3 million of capital expenditures in the quarter.
During the quarter we opened six stores, relocated seven stores, acquired seven stores, and closed 14 stores. We also remodeled 15 stores during the quarter.
The acquired stores and closed stores reflect the store swap transaction we announced earlier with Longs. Also during the quarter there were capital expenditures of $5.3 million related to the Brooks Eckerd Acquisition.
Net cash provided in financing activities for this quarter was $1.178 billion versus cash used of $24.8 million for last year's quarter. The current quarters cash provided in financing activities was primarily due to the notes we issued for the acquisition of Brooks Eckerd's, the proceeds of which were placed in restricted cash accounts.
Liquidity continues to be very strong. Our availability under the revolver is over a billion.
At the end of the quarter, we had $261 million outstanding under the $1.75 billion senior secured revolving credit facility. We also had outstanding letters of credit of $123.8 million at the end of the quarter.
The $400 million accounts receivable securitization agreements continue to be a good source of liquidity. At the end of the quarter we had utilized the securitization agreements for $380 million.
Total debt at the end of the first quarter increased $1.154 billion since the beginning of the fiscal year, and advances from the sale of accounts receivable increased by $30 million. The combined balances at the end of the first quarter increased $1.184 billion since the beginning of the fiscal year.
The increase was due to the issuance of the notes for the Brooks Eckerd's acquisition. The combined balances at the end of the first quarter net of the cash in escrow decreased $48 million since the beginning of fiscal year.
Throughout fiscal 2008 we will have on average approximately a billion available for additional borrowings under the revolver. Finally, let's discuss guidance.
We are confirming our guidance previously given for fiscal 2008. Fiscal 2008 sales including the acquired operations are expected to be in the range of $25.3 billion to $26.0 billion.
Same-store sales guidance, which does not include the acquired stores, is 3.8% to 5.8%. We're estimating fiscal 2008 adjusted EBITDA to be in the range of $1.0 billion to $1.125 billion.
Our guidance includes acquisition related cost savings of approximately $155 million. We're estimating our operating results for fiscal 2008 to be a net loss between $47 million to $129 million or a loss between $0.11 to $0.23 per diluted share.
The net loss estimates include acquisition related integration expenses of approximately $145 million. Attached to our press release is a table that reconciles our adjusted EBITDA guidance to our guidance for net loss.
Capital Expenditures before sale and lease back proceeds, which includes the continuing new and relocated store program and integration capital expenditures are estimated to be in the range of $825 million to $875 million for fiscal 2008. We estimate sale lease back proceeds to be approximately $100 million.
This concludes our prepared remarks. Stacy we're now ready to take questions.
Operator
(Operator Instructions) Your first question comes from the line of Meredith Adler.
Meredith Adler - Lehman Brothers
Meredith Adler. Hi, guys.
I was wondering if we could talk just a little bit about the front-end. I think this is the second quarter that we've seen customers buying more product on ad, and I'm trying to figure out whether you folks think that's economically related, you know do you have one, if you look at your data, do you think there's a lot of cherry picking going on, just trying to understand that better.
Mary Sammons
Yes, Meredith, actually, I think we have a very rational promotional program. We've never really relied on what I call cherry picker kind of customers.
We saw that trend on customers buying more promotional products throughout all of last year. I'd say at least three of those quarters I believe I commented on it, but it's not like give away kinds of things.
They are just buying more economically and I think it's undoubtedly related to their economic condition and the cost of fuel, et cetera. So we try to give great value in our circulars so we also make sure that we're delivering value to our business too.
Meredith Adler - Lehman Brothers
Okay, great. And I'd like to talk just a little bit about occupancy costs and maybe just the performance of the newer stores.
I know you've said they're doing well. How do they compare with your expectations?
Are they in line, are they beating expectations?
Mary Sammons
They are doing very well against our expectations. We measured them on an ongoing basis, do our report card on them by year because we track them in groups based on when they open too so that we can see the relative strength based on just the number of stores and areas we're putting them in but they're performing very well and meeting the objectives that we had for them and we're very aggressive in the objectives we set.
Kevin Twomey
We monitor those very closely, Meredith. If for no other reason than to make sure that our decision-making process doesn't need any changes and so far we're very, very pleased.
Meredith Adler - Lehman Brothers
That's great. And just turning to the acquisition, I was wondering whether you have any more information about overlapping stores and what your plan will be to rationalize the store base and then any more thoughts about distribution consolidation or is that still really far out in terms of decisions?
Mary Sammons
Well, on the store piece of it, we really spent a lot of time going through the opportunities that are there and really have most of our decisions made there and our developing of the plans and the timetable. Most of those will start up slightly later in the year because most of them require where it's a pore over will require a remodel of the store, especially pharmacy, that's taking the new business.
We want to make sure the store can handle it so we've scheduled those out. The distribution centers will actually come later.
We're going to spend the first 90 days getting all the DC's integrated to our network and then we will begin the process of looking out towards the future but don't expect to make any decisions on that until much later in the year.
Kevin Twomey
Meredith as you recall, when Mary answered the question last quarter, we said we had approximately 200 pairs of stores that we're looking at and we have narrowed that down probably around 150, but we now are putting down the specific plans. It's just that we don't quite know the timing yet.
Meredith Adler - Lehman Brothers
Okay, great. Thank you very much.
Operator
Your next question comes from the line of Ed Kelly.
Ed Kelly - Credit Suisse
Good morning.
Mary Sammons
Hi, Ed.
Ed Kelly - Credit Suisse
Mary, could you discuss the addition of Brian in a little bit more detail, specifically what does he bring to the table, why is he a good fit? Obviously he's coming from a strong organization.
Mary Sammons
Well, we're really pleased with adding Brian to our team. We spent considerable time really looking for the right person to fill this spot because it is a key role, and with our focus on customer service as well as running a strong operation, we think someone with the kind of background that Brian has brings just what we need to that position.
He's held increasingly strong roles at Target, including overseeing the stores when they first started putting pharmacies into the stores so he also understands what that requires, and how Target goes about merchandising their stores, their approach to creating the right kind of customer space, their emphasis on associates, they call customers guests. He brings just the right kind of background to really, I think make our operation that much stronger for the future.
Ed Kelly - Credit Suisse
Great. And does his addition free up a lot of time from you and I guess also from Jim and is that time then just more time that you can really spend on the acquisition?
Mary Sammons
Well, certainly it will help the whole process, having really great people in these key spots, we all have plenty of work to do so it does give us I think all of us more time to keep focusing on making this integration and conversion as successful as possible because it means so much to increasing shareholder value for the future.
Ed Kelly - Credit Suisse
And is your management team now set or are you still looking for help in additional areas?
Mary Sammons
I think we're overall in good shape relative to our team, but we're always on the look out for great people to be able to add to the team.
Ed Kelly - Credit Suisse
Okay, and Kevin, I wonder if you could just provide some clarity on the comment that you made on generics. Did you not get the acquisition rates that you would typically get because of something with the deal or are you saying that you're not getting the acquisition cost saves yet?
Mary Sammons
Yes, let me give you an answer there. Our team, our pharmacy services team has always been very strong at negotiating cost decreases relative to generics, and I think we've put a lot of effort into the bid process.
It's been highly successful, and we intended or expected that it was going to close sooner, and so I think we probably lost a little bit of momentum there for a few months in the negotiation in that interim time period, and vendors aren't going to give you anymore than they feel like they have to, and we are pretty aggressive on the bid process.
Kevin Twomey
So, Ed, if you will the net reductions in cost savings amount has been nailed down. It was just that slippage.
Remember, we were waiting and waiting for the FTC, and as a result, we gave the vendors an opportunity to kind of posture themselves that I think did some damage to the first quarter and just the normal processes.
Mary Sammons
But we should more than get that back as we move through the second and third quarters.
Ed Kelly - Credit Suisse
Okay. And then just lastly for you, what are your thoughts on owning a clinic versus partnering up, given that Walgreen’s now owns one as well?
Mary Sammons
We still feel that the strategy that we talked about before is the right one. When you are looking at this business, you really want to build something sustainable for the future and when you partner with someone who is local and well known healthcare provider in the area, they know the area, the people that live there know them.
They understand what's required in staffing these clinics and believe me, that's going to be an issue that anybody in this business is going to have to be looking out for because there's as much a nursing staff shortage as there is a pharmacist shortage, so I think in part, our strategy of partnering with people that know how to do this and have great experience in the communities that they live in is the right one and there are plenty of local opportunities and they may take a little longer to build what needs to get done there but it will be a lot more sustainable as we move forward.
Ed Kelly - Credit Suisse
Great. Thank you.
Operator
Your next question comes from the line of John Ransom.
John Ransom - Raymond James
Good morning.
Kevin Twomey
Good morning.
John Ransom - Raymond James
I had a couple of questions. I think negative 2% comps the last quarter, the last month they were public, could you comment on those comps and what your outlook was for why they were behind the industry?
Thanks.
Mary Sammons
Well, I think there was already some discussion off to the front-end in their conference call that they weren't getting necessarily shipped all of their private brand products so they had some issues there, and I think that's something that we'll quickly correct in the stores. We've already started shipping our private brand product into the stores and as we move through the pilot process, we're not going to be sitting still on the other front-end products that needs to go into all of the stores, so I mentioned that we're going to be starting a common ad next month and so that means we're going to have a lot of our products going into those stores.
Yes, and as far as pharmacy goes, yes, their sales were I think a little softer than we had expected but we really believe that the initiatives that we have been working on and that we will continue to work on are going to begin to change the momentum there too. And we're looking at things like file buys for these stores already.
We've already started that process. We're going to be putting them on our senior Living More program this next month, and we just I think believe that we've got the right set of initiatives to get the momentum changed for them.
Pierre Legault
Maybe I can just add, this is Pierre who is speaking, as Mary mentioned the issue we have had on brand name product but also on the other brand products some supplier were maybe not shipping the quantity we were expecting so we had some issue there as well.
John Ransom - Raymond James
Okay, thank you very much. A couple other things.
Back in ancient times, you guys used to say that generic gross profits per script were I think about 45% higher than branded. Just given the shift to Part D now that that's 15% of your scripts and given the kind of load dispensing fees that we're seeing, have the generic gross profit dollar economics changed or is it still in that relative range?
Kevin Twomey
The gross margin rate, when we take all of the prescriptions and divide it into the pharmacy sales and put them in the brand buckets versus the generic buckets, John, the gross profit per script continues to be 50% or more greater than the pharmacy. All the moving pieces we're still seeing that.
John Ransom - Raymond James
That's the dollar per script, not the margin but the dollar per script?
Kevin Twomey
Correct.
Mary Sammons
Yes.
John Ransom - Raymond James
Okay, great. That's helpful, and just a couple other things.
Kevin, what is a good number to use not only for fiscal '08 but an annualized interest and depreciation number pro forma for the deal? Thanks.
Kevin Twomey
The depreciation, well, I'm a little hesitant to give you the depreciation number beyond the guidance we've given, John, because I haven't finished the purchase price accounting allocation yet.
John Ransom - Raymond James
Okay.
Kevin Twomey
So unfortunately, I'm not going to be that much help to you and to follow-up on that, if I were really, really good at forecasting the LIBOR rate because remember the term loan and the revolver are a function of LIBOR rate, out into the future I could give you a number too so you know the pieces that we added to debt, right? You just have to make your best estimate with regards to what's going to happen to LIBOR for the term loan and the revolver and of course you saw the two new notes.
John Ransom - Raymond James
Well, I guess we can certainly forecast LIBOR. I guess the question will be what is the non-cash amortization piece of the interest cost given the cost ended up put in place?
Maybe we can take that--?
Kevin Twomey
It will be very similar to what it is now.
John Ransom - Raymond James
Okay. So about 20 million bucks I think?
Kevin Twomey
Yes.
John Ransom - Raymond James
Okay, about $20 million, got it. And then finally this is my last question, I promise.
The OIG put out a report in June, worrying that the FUL calculation by CMS was actually below generic acquisition costs. I know a couple states that you operate in, New York, Pennsylvania specifically don't have a State MAC and don't reimburse based on acquisition cost but have the FUL backstop, is that something that concerns you or are we too worried about that and have you factored that the into your guidance for the year?
Thanks.
Kevin Twomey
Well, remember, generics is about 10.3% of our sales and so you're talking about, I'm sorry Medicaid, sorry, thanks, and so you're talking about two states out of that whole total.
John Ransom - Raymond James
Yes.
Kevin Twomey
So I'm not quite sure I understand the question as it relates to those two states, John, but we have certainly stirred in all of our business best estimates with regards to where we're going to land and we have assumed that the delay is not going to go beyond December 30.
John Ransom - Raymond James
Okay, well, I guess there are seven states that don't use MAC and also don't have cost based Medicaid reimbursement or didn't and so the FUL calculation was kind of a backstop and the OIG was concerned that the CMS essentially by using the lowest AMP as a basis had brought the FUL rate which is supposed to be a backstop actually below generic acquisition costs for over 20 of the 25 most commonly dispensed generics. I didn't know if you had seen that.
Mary Sammons
Yes, we have, and I mean, that certainly is something that the industry has used too in talking with Congress and in lobbying the whole effort because even our own independent surveys that were done through member companies and it showed exactly the same thing, that the cost to fill a prescription and you put that along with the cost being dropped to a level that really you're not buying at that cost for certainly the smaller players in the industry, it's just we can put a lot of small players out of business.
John Ransom - Raymond James
Right. And I guess there's talk that the CVS is trying to get another 10 to 15% discount out of its generic suppliers.
Your renegotiations with Brooks Eckerd's, is there any contracts we should think about in terms of what additional buying power that might occur to you or is that something you'd prefer to keep to yourself?
Mary Sammons
Well, we always are in the process of ongoing negotiations and we'll continue those same kinds of practices that we've been very successful in the past and we expect to continue to be successful.
Kevin Twomey
And John, we have said consistently that in the $225 million of net cost savings, remember it's made up of like about six major components, two of which are actually an increase in expense but anyway, the four positive items, the largest one is the $155 million worth of gross profit improvement and that is almost all generic purchasing.
John Ransom - Raymond James
Okay, thank you and a lot of hard work and congrats on getting the deal done.
Mary Sammons
Thank you.
Operator
Your next question comes from the line of Mike Maguire.
Mike Maguire - FTN Midwest Research
Thanks, good morning. Just a couple of quick follow-ups.
Kevin, it sounds like you answered the question on the pharmacy gross margin pressure is just somewhat of a timing issue given the delay in the deal close, but I thought I heard you conclude your comments with pharmacy gross margins will continue to be pressured. Was that just a specific comment about one issue or could you just help me clarify that?
Mary Sammons
Well, let me take a cut at this one too, Mike. Remember, I think pharmacy margins have been pressured the last couple of years, whether it's through third-party plans or what's happening with government having a larger share of control on pricing on prescriptions, and so whenever Medicaid reform does kick in, you know it's going to.
It's not going to be a positive for pharmacy gross margin rate and we deal all along with pressures on margins from other third-party plans. So I think it's not realistic to expect that you're not going to continue to deal with that.
That's what makes the importance of scale and being able to buy better and leverage your expenses and really get the most out of the stores and continue to push on generics are so important because you got to offset these pressures.
Kevin Twomey
And just a continuation of an existing trend, Mike, I did not intend to stir anything more or new that's unique.
Mike Maguire - FTN Midwest Research
Okay, and that was the basis of the question was no more than you had anticipated in your synergy numbers, et cetera?
Kevin Twomey
Correct.
Mary Sammons
That's right.
Mike Maguire - FTN Midwest Research
Okay, thank you. And then just most of my other questions were answered, just quickly on the synergy number store closing integration expense, the guidance for the remaining nine months of the fiscal year, could you just help me with potential timing is there any reason to assume that some of those numbers may kick in later in the year, fiscal Q4, substantially more than the prior quarters?
Kevin Twomey
Well, if you go down the items, Mike, it kind of, there is a different flow to the years by item. The first item is we have a web, a presentation on our website so in case everybody forgets where that is but there's a page out there and it shows the six items that comprise the $225 million of cost savings and expense reductions but bottom-line is that there is a different flow throughout the year for those.
The first and most significant one on that list is the gross profit improvement of $165 million. That's going to kick in right away.
The next one is the corporate administration reduction and that's directly tied to the store systems conversions which means it's going to be realized sort of like ratably throughout the year, but more backend loaded because the headquarters folks are doing a great job and we need them to be there until the store systems are completed. The third one is the advertising savings and that's going to be starting to kick-in in the second quarter but it won't be at its run rate until the third or the fourth quarter, and then the last one is of a positive and all these add up to $290 million, it's kind of a grab bag of a lot of different kinds of things that I'd have to say are more backend loaded and then the two negatives are the investment in labor and that's going to kick in right away, and then the last one is the dis-synergies or the lost EBITDA from our divestitures and that's going to kick in right away and out of all of those really the only one that we know anything more about is basically now that we know that we're disposing of 26 stores, our lost EBITDA instead of $15 million is probably going to be closer to $10 million.
Mike Maguire - FTN Midwest Research
Great. Thank you.
And final question, could you just give us if you're willing to do it the comp numbers at the acquired stores since their most recent public…?
Kevin Twomey
Well, first of all we don't comment mid month on any kind of same-store sales kind of progress and as a rule, not as a rule but as, we're trying to be as transparent as possible Mike, and we'll give you a sense of how the Brooks Eckerd store sales are doing once we get through at least a month and going forward, but we're not going to include them in the same-store sales until they have in fact either anniversaried the entire acquisition or and then also comment on whether or not they've been through the entire Phase II and Phase III process.
Mike Maguire - FTN Midwest Research
Okay, thank you.
Mary Sammons
Thank you.
Operator
Your next question comes from the line of Carla Casella.
Carla Casella - J.P. Morgan
Hi, it's Carla Casella, from JP Morgan. Your file buy program sounds like it's great, you're getting more access than we've seen in the recent past, would you say that's somewhat because are you seeing less competition or is it strictly because your own efforts to increase that campaign?
Mary Sammons
Well, we've been very aggressive in looking for them but so have our competitors. I think there are more opportunities and for a lot of the reasons that we've talked about with the pressures on pharmacy anymore so we'll continue to look for opportunities and we're very strategic with the ones that we do buy.
We make a point of trying to get the pharmacist in the pharmacy team because that's part of the success and even with the high standards we have for the ROI it has to pass and the retention rate that we base the purchase price on, we've been able to really put a lot through the pipeline and have a lot more in the pipeline.
Kevin Twomey
And I might add that we monitor the post-investment decision and we're very, very pleased with our targeted retention versus actual retention.
Carla Casella - J.P. Morgan
That's great. And are you seeing pricing on it and pricing on the script files seems to be just continually increasing.
Does that continue or are you seeing that leveling off?
Mary Sammons
No. I'd say you'll keep seeing it increasing, maybe not as fast as it did for awhile there but as long as there's competition for the files, you're going to see people who are looking to sell, looking for their best buyer.
Carla Casella - J.P. Morgan
Okay, and then on the 125 net, or new and relocated stores, is that net of closures or…?
Mary Sammons
No. That would be the total that we expect to open between new and relocated, but any that would be a relocated store, you're going to be getting out of the old facility so that would be netted out of that number.
Kevin Twomey
Yes. We're at a normal store closing like kind of level, Carla, subject to this we did have, I think it was six more that we considered closed as a result of the Longs transaction but in the normal level, it is around 25 to 35 a year.
Carla Casella - J.P. Morgan
Plus this year, you will have added to that the closures for the overlap stores?
Kevin Twomey
No, no, for the full year.
Carla Casella - J.P. Morgan
25 to 35 for the full year, but does that include the stores that you have to close because of the Longs Drug transaction?
Kevin Twomey
No, that does not include the 26 that we are disposing of.
Carla Casella - J.P. Morgan
Okay.
Kevin Twomey
And it does not include the, as we talked earlier, we still have not completed the conclusions with regards to those 150 pairs of stores that are in close proximity of one another.
Carla Casella - J.P. Morgan
Okay, great. Thank you.
Operator
Your next question comes from the line of Meredith Adler.
Meredith Adler - Lehman Brothers
Sorry, I want to follow-up on Carla's question just a little bit about file buys. Does the delay in the implementation of AMP or the discussion about higher dispensing fees make independence less likely to sell out or are they seeing enough pressure in other areas that they are still moving ahead?
Mary Sammons
I think there is pressure in the other areas but it may cause them to take a little bit longer to make their final deal if they think they have a few more months but if you're already in the process and what not, they've made a decision that it's time for them to get out of doing that. So we'll keep the pressure on.
We've got our team out there in full force, and even with a delay, you think about it, it's still coming. Medicaid reform is not going to go away, even if it comes out in a modified form, and so the pressure is still going to be there.
Meredith Adler - Lehman Brothers
Okay. And then I want to go back to the generic procurement.
You guys were using, talking about a bid process and I'm not sure maybe you've talked about it before but maybe you could elaborate a little bit on exactly what you did and kind of where it came out.
Mary Sammons
Well, our pharmacy service group took the approach of really doing a very focused bid process on really all of the generics that we carry where you have multiple suppliers and taking into account you could have had different suppliers supplying Brooks Eckerd and supplying Rite Aid, and made some that weren't supplying either but we did a bid process on all of them and it was highly successful. In fact, it's just one of the areas that we're very pleased with the result of where we're ending up relative to what our goal was.
Kevin Twomey
Meredith, if you recall when we first announced the deal, we estimated gross profit improvement of about $115 million and now it's $155 million and that $40 million delta came out of that process.
Meredith Adler - Lehman Brothers
And would you say that that $155 million includes the benefit of scale, not just comparing sort of contracts and getting the best because you've done a bid process, they're recognizing your scale. Is that fair to say?
Mary Sammons
Yes. That's one area where the scale definitely came into play because when you're doing something like a bid they're bidding on the total business, understanding that you've got this increased capacity.
Kevin Twomey
Where we don't have scale in our estimates, Meredith, is in bit more of the front-end part of our business and in particular, not the top tier vendors but the second and third tier vendors and there's nothing in there with regards to combining our two companies various contracts with McKesson.
Meredith Adler - Lehman Brothers
Okay. So you're talking about in the numbers you've given us you're excluding any scale benefits in the front-end, especially for second tier manufacturers if I'm understanding what you said and then also rearranging your contract with McKesson, right?
Mary Sammons
Yes, there's nothing in any of our numbers, yes.
Meredith Adler - Lehman Brothers
Okay, great. Thank you very much.
Operator
Your next question comes from the line of Karen Miller.
Karen Miller - Bear Stearns
Hi, good morning.
Kevin Twomey
Good morning.
Karen Miller - Bear Stearns
If we could talk about your cap spending plans a little bit, of the 125 new or relocated stores can you give us a break down of new versus relocated because as you've discussed for us before in previous conference calls, the relocated stores do pay back quite sooner than the new stores?
Kevin Twomey
It's about 50%, so about 62, 63 new and 62, 63 relo.
Karen Miller - Bear Stearns
And as we look out over the next couple years, you plan to keep that same ratio? 50/50?
Kevin Twomey
Well, the Real Estate process are 18 to 24 months kind of lead time, and if you sit back and logically think about it, relos are the most difficult. But also the ones that we try to always look at and take care of.
So I would say initially especially with the Brooks Eckerd's acquisition it's going to be more heavily weighted to relo, and when I say initially, the first couple years but then thereafter it will start to get more into the new, first three years really for relos because of the lead time.
Mary Sammons
And that makes the most sense too because it's going to be a lot better for us to be able to find a location where we can move that script files that already exists and get the pay back. So I fully expect after we get a few years out here that the ratio will shift even more towards relocation, but it's still important to do enough of the net new and the neighborhood you're not in that you keep growing your market share.
Karen Miller - Bear Stearns
Right and the new stores are basically already within existing markets; is that correct for your plan?
Mary Sammons
Yeah, that's correct.
Karen Miller - Bear Stearns
And then in terms of just your normal store closing run rate as well as the 26 stores you have to close because of merger, what are we looking at in terms of dead leases that you have to pay out?
Kevin Twomey
First of all, Karen, the 26 stores are sold.
Karen Miller - Bear Stearns
Okay.
Kevin Twomey
They are not closed in and like dark stores. They're sold, so they don't add to the dead store rent and the dead store rent number is about the same for base Rite Aid when you stir in Brooks Eckerd's empty stores rent with that you're looking at for fiscal 2008 probably rent around $60 million annual, now that's only got three quarters of Brooks Eckerd's in it.
So if you had a full year of Brooks Eckerd's you're looking at somewhere around $65 million.
Karen Miller - Bear Stearns
Okay. And do you see that declining over the next five years?
Kevin Twomey
Yes. Our Real Estate people have just done a great job of managing that portfolio and if you look back over the last five years and you can see that those rent payments that are in our closed store liability footnote that that rent just trends rate down.
And it's not just because of just necessarily our lease is expiring. It's because of our Real Estate people working that.
Karen Miller - Bear Stearns
And that $65 million that's run through the P&L on occupancy?
Kevin Twomey
No.
Karen Miller - Bear Stearns
Is that the right way to think about it? Where does it show up?
Kevin Twomey
It's in your cash flow statement but not in your operating statement and if you want to, Karen, call me off line and I can talk you through some of the accounting.
Karen Miller - Bear Stearns
Okay, great. That's helpful and then one last question.
I thought that Mary had mentioned that one of the priorities would be to reduce debt. Can you give us a timeframe of when we might see, expect to see some debt reduction, some of the free cash flow that would allow you to pay down some of your debt burden?
Mary Sammons
I think still our best use of dollars is to keep investing in our store base and I think Kevin and I both mentioned that the number we look at the hardest is our debt ratio, what’s the leverage ratio, but we believe we're going to generate enough free cash flow that we'll be able to put some of that against debt too and keep investing the majority in our store growth program.
Karen Miller - Bear Stearns
And would that be within the next fiscal year?
Kevin Twomey
Fiscal 2009 is what we've said, Karen, is where we're going to have operating cash flows greater than CapEx, not a lot, and as Mary said that to the extent that we're really generating more cash flow than we expect we're going to look for opportunities to invest in the store base rather than pay down debt especially as the leverage ratio continues to improve.
Karen Miller - Bear Stearns
Okay, great. Thanks a lot and I went into a local Eckerd's and it was looking really good.
Mary Sammons
Thank you. Operator we'll take one more question.
Operator
Your next question comes from the line of Reed Kim with Merrill Lynch.
Reed Kim - Merrill Lynch
Hi, good morning. Three things, just a couple quick ones, on the rent question, Kevin, could you give us what you recognize as rent expense for the quarter and then also help us understand what it's going to be like on a combined basis for the rest of the year?
Kevin Twomey
The rent expense for the quarter was $150 million approximately, and for the full year, which includes three quarters of Brooks Eckerd's, not a full year, it's going to be about $880 million.
Reed Kim - Merrill Lynch
Okay. And then a full annualized run rate with Eckerd?
Kevin Twomey
Probably closer to the $965 million range, so you're asking me to get out into fiscal 2009 but if you just said I have a full year of Brooks Eckerd's for all of fiscal 2008 that gives you some kind of dimension to what it would be.
Reed Kim - Merrill Lynch
That's fine, that's helpful. And then one integration question on the supply chain.
You mentioned things going well in terms of integrating the DCs, I was wondering if there are any plans on whether you could close perhaps a DC or two? And then also just a little more granularity, are stores on the East Coast now able to receive product from the DC's on either side of the chain, in other words can existing Rite Aid store receive product from an Eckerd DC, and how is that evolving?
Mary Sammons
Well, as far as DC rationalization, that will be a later decision. We'll are really begin looking at that more seriously towards the end of the year.
Our first priority is to get all of these DC's in the first 90 days able to really ship all of our product, and right now, the pilot stores are being serviced out of Rite Aid distribution center because we still haven't got a DC a Brooks Eckerd DC on our system, but as soon as we have the DCs on our system, they really can ship to any store.
Reed Kim - Merrill Lynch
Okay, great.
Kevin Twomey
And Reed, the DC if you will, functionality, sorry, Brooks Eckerd's DC will be able to ship to a Rite Aid store, to a Brooks Eckerd store by the end of our second quarter because Mary said that all DCs are going to be converted by the end of the second quarter.
Mary Sammons
And we've already done a lot pre-work relative to where it makes the most sense, say over the near term to be shipping what stores out of which DC and what product categories until you make the final decision as to where you're going to locate, have your DCs for the future. And there you have to get through your store rationalization process, you have to get through really sort of plotting in where your new store growth is going to happen so that you really understand where the best possible locations are for that network.
Reed Kim - Merrill Lynch
Great that's helpful. And the last one I wanted to ask was just on the gross margin front in terms of your front-end merchandise mix, how much of your vendor base have you talked to about possible newer pricing and more attractive pricing for you as you go forward and have larger scale, any help there would be appreciated?
Mary Sammons
I think we've had conversations with most of them now at this point.
Reed Kim - Merrill Lynch
Okay. And should we look at that as a possible contributor later on this year?
Kevin Twomey
We've said all along that in our cost savings and reductions what's not included is the vendor scale, but it's going to be very, very difficult to isolate that, but it definitely will become part of the gross margin rate going forward and rather quickly.
Mary Sammons
And it will be a positive obviously.
Reed Kim - Merrill Lynch
All right thanks a lot.
Mary Sammons
Thank you. Thank you all for being on the call.
Operator
This concludes today's conference call. You may now disconnect.
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