Rite Aid Corporation (RAD) Earnings Call Transcript & Summary

Hello, everyone. I'm A.J. Rice, the health care service analyst at Credit Suisse. We're very pleased to have up next presenting Rite Aid. Rite Aid is obviously a leading player in the retail pharmacy and PBM industry. Participating for the company today is Heyward Donigan, CEO; Jim Peters, Chief Operating Officer; Matt Schroeder, Chief Financial Officer; and Trent Kruse, Head of Investor Relations. Thanks again for participating, everyone. Heyward, I thought I'd maybe just turn it over to you and maybe give a few opening comments, and then I've got plenty of questions to follow up. I always should let people know that to the extent they want to e-mail questions, I will try to ask those as I can on their behalf. So Heyward, you want to make a few opening comments about the current state of affairs, and then we'll follow up with some questions.

Great. Thank you so much. Thanks for having us. We really appreciate it. And I guess we're a little over 2 years into my tenure at Rite Aid, and it's been a hell of a 2 years. It kind of feels like 10 years, to be honest. And we launched our Analyst Day strategy overview last 2 -- March right before the whole world shutdown. And it feels like that was a long time ago, but it really was only about 18 months ago. So we really are early days into our RxEvolution. And of course, the pandemic has impacted us probably as much as any organization in America. The pharmacy chains really have been on the forefront of this from day 1. We've remained open. We barely even shut stores for even hours during this whole pandemic, and we both were on the forefront of providing necessary medications, whether it be through our mail order facility, our specialty pharmacy or our retail stores throughout the pandemic. And of course, we were one of the first, if not the first, to launch a testing site in the United States, which is really kind of funny to think about how novel that was at the time. And we were out in the parking lot with PPE, which was almost impossible to find. And now, of course, we've evolved to a very, very big drive-through testing business. And of course, the vaccines, first, the vaccines, and I actually was looking at my phone the other day. And I saw a picture that I had taken of a Moderna vile because at the time, that was the most exciting thing to see in the world was a vile of a vaccine. And of course, now we're into boosters and we're into children and third shots. And well, our strategy has not changed. It is a little different from the other pharmacy chains in that we are doubling down exclusively on the pharmacy business. So I call it pharmacy with a capital P, meaning that we are in a myriad of different pharmacy businesses, only one of which is the retail pharmacy. And so people tend to think of us as a retail pharmacy. And of course, we are. If you look at our business, we're, let's call it, $11 billion in retail pharmacy revenue, $8 billion in our PBM business and almost $6 billion in front end. So we tend to talk about front end a lot, but our business is really pharmacy. Front-end has really been restructured to support or help you get thriving business in the pharmacy. So when we talk about pharmacy, we are a mail order pharmacy of some size in our PBM business, but we also use mail order in a myriad of different ways to support our overall business. We are a specialty -- we have our own specialty pharmacy, and we have a retail pharmacy, but you can get your prescriptions via delivery, via drive-thru or via in-store. So we are very focused on new and differentiated ways to expand our prescription business, including we have a very healthy cash card business that we don't really always talk about, and it's growing substantially. So the pandemic actually propelled our strategy. It did not derail our strategy. And our core 3 goals as a company because, of course, we have a long way to go to get to the healthy company we want to be is to grow our business, mostly organically given our capital structure; two, drive cost efficiencies, and we've made significant progress, while still investing in the business; and to, of course, reduce our leverage ratio. So I think that sums it up. I'm very excited for our future. it's a crazy time right now given the labor market and the incredibly high volumes we're dealing with in store, in particular, because now acute medications are back. So it's a good problem, but it is a tough problem. I will say the labor market is really front and center, one of our challenges at this point. But we are really bullish. We are very excited about the role pharmacy plays for the future of health care and the outcomes of our customers.

That's great. That's great. That actually -- number of questions I could just ask off of pivoting off of that. One thing -- and you did spend a little time on the latest conference call talking about this is the repositioning, which you sort of alluded there, the front end of the store, and you're getting out of some product categories and you're trying to reposition more to that healthy living type of focus. How do you manage that transition and still maintain the revenue growth that you're wanting to be able to generate? Is that a hard thing to do as you transition out of some areas and add new product offerings?

Well, we've had actually very, very good success. We have finished the reset of our merchandise. We changed about 75% of our merchandise last year. and -- or reset it, I should say. And Jim, why don't you comment -- Jim is in charge of all of the merchandising and brand work. Maybe you can just comment on some of the specific really good inventory turn and inventory reduction numbers that we've had.

Sure. Yes. To your question, A.J., it's a very, very challenging problem to address. But that's been addressed by us in the planning stages. So we didn't wholesale change merchandise overnight. We've recalculated from a timing perspective to understand what SKUs we're going to change, when we're going to change them and what the economic impact of those category changes would be. So actually, by that planning process, we've been able to see beauty health increase substantially, almost double digits even since our last conference call. And so we feel that we're in a very strong spot because of the way that we rolled out and cascaded these changes. Our inventory turns are higher than they've been in at least 5 years. So up to a 3x inventory turn. And from an inventory perspective, $180 million. of inventory benefit as a result of that rationalization. Now it's not without challenge, but we continue to -- we've got a team that hungers and thirst for challenge. We're -- I'd probably say we're a turnaround team, and that's not just the people on this call. That's people who joined the company who want to make change. And we recognize we've got to make change very deliberately and surgically. So far, it's been very positive.

We've also reduced our working capital time tied to inventory by $180 million last year, and we believe that we can get a very sizable continued reduction in inventory while at the same time, showing the highest level of inventory turns in the recent history of the company. And on top of that, we are now challenging our suppliers. We want product that nobody in the retail drug chain has, and in some cases, big-box either. So we challenged our suppliers. We want to be the forefront of on trend and a new and innovative product for our target growth customer, which is women between the ages of 29 and 45 -- or 25 and 49. Sorry, I got that wrong. But while still really supporting our other core customer who's a little bit older, I'll put myself in that category. So really, really strong results, and we're only getting started.

I think I would say on that, A.J., is there's a couple of kind of numbers you look at to judge the success on what we're doing so far in the merchandising transformation and it is a journey. But with the reduction in inventory of the $180 million last year and probably another $100 million that we're looking at this year, with the improvement in turns, we're actually still growing sales in the front end to your stack basis. And you've got to look at a 2-year stack because the pandemic in the first part of last year was just so lumpy on the front end. But I think last quarter, we were up about 3.5% on a 2-year stack basis in front-end sales even with some of these changes that we're navigating through. So I think that bodes well for the direction we're going, and it shows that consumers are responding positively to the merchandising changes that we're making. So to get the comp sales increase even with a planned reduction in inventory, I think, shows we're moving in the right direction here.

On the -- and I know there's a variety of reasons why you're making that transition, but when you think about things like revenue per square foot or margins, are these products enhancing that? Or are they about the same with the types of things you're exiting?

I'll start. I would say, first of all, revenue per square foot is one way to look at. Our shelf productivity is actually up about 20%, which is another kind of metric to look at from the standpoint of how productive are we being with the merchandise that we have. The items we're getting out of, I would say, by and large, are lower merchandise items than the ones we're focusing on. OTC is typically a higher-margin business. Beauty drives good margins. Consumables drives good margins. So now there's other factors that play in such as how much you going to mark down an item and how much you're going to put on promo and all those things. But in general, we would expect margin expansion on a rate basis to come out of this strategy.

Okay. Continuing on the retail side, the company has benefited from COVID vaccines as have all of the major pharmacy players and testing over the last few quarters. Obviously, we hope that the COVID dynamic winds down. But what is your thought as you think about the next few quarters next year On vaccination rate, testing rate? Obviously, we've got the booster. We've got the commentary around potentially pediatric vaccinations. Do you think those will happen in your type of format? Do you think we'll see some of that in other -- more of the pediatric -- pediatrician's office? And how about just the idea that you've touched people that maybe you didn't touch before and your ability to retain those as customers? Maybe make some comments on that.

Yes. A couple of things, and then I'll let Jim and Matt weigh in. First of all, I'll start with the last part, which is we have converted over, I think, it's 450,000 customers to move their scripts to us since they have actually gotten a vaccine from us. So it's not a huge number, but it is an indication of people having a really good experience and deciding to shift their prescriptions to us. I think there's no doubt that this is the peak vaccine season over the next couple of months that we aren't likely to see this incredible activity all at once next year. And so we have not only flu shots, so this is flu season still and we have the boosters and some people are still actually getting their first vaccine, which is good news as these mandates are rolling out. And now we've got the kids. And I don't think we have any evidence yet whether the pediatricians will be the primary benefactor of that or the pharmacies. It's a little early. And while the media is talking about how important the pediatricians are, we saw in the last wave of vaccines, we are -- the drug channel is still a very significant distributor of these vaccines. And so I think we all probably understand that this is not going away, that COVID is not going to disappear. So it is my personal belief system that COVID will continue in some form for the foreseeable future. And like flu, it will -- there will be ongoing vaccines required for those that want them. And interestingly enough, these vaccines are more effective than the flu vaccine. So you might actually see more people getting a COVID vaccine than even a flu vaccine. And so the other really great news, and I honestly think this is the greatest news of all since the early vaccine news, and that is these treatments because you can get COVID when you've been vaccinated. That is for sure. And so now they've got remdesivir, which is highly effective from everything we can tell, which is readily available now. And these 2 pills, which I have practiced the pronunciation about 20 times, and I still can't pronounce them, the one that -- one from Merck and one from Pfizer that look to be highly effective. And that is obviously we will be now the beneficiary of distributing those drugs. They're even talking about us doing remdesivir. So we're trying to figure that out. So I think the volumes won't be like this year, but it's here to stay. And so we'll obviously -- Matt can comment on how we're modeling out our thinking on this.

Yes. I think, as Heyward said, continuing to see some very high volumes. We're up to now having done over -- just over 10 million COVID vaccines for the year. So continuing to see some pretty heavy volumes in the third quarter. To Heyward's point, we would expect certainly on an ongoing basis to see COVID vaccinations as something somebody gets I think as far as the cadence of how much of the boosters and the pediatrics falls into this fiscal year versus leaking in the next fiscal year for us with our fiscal year ending in February, it's still probably an open question, honestly. So I think probably a little more modeling and thought about the specifics around that when we get to the third quarter call in December. We're going to get the benefit. We just -- which fiscal year it's going to be in, I think, is still an open question.

Okay. Okay. I mean one of the perennial things we have to talk about on the retail side is the reimbursement headwind. It seems to be there every year, and then you work to offset it in a variety of ways. What are you seeing now? Has the pandemic lessened, increased, moderated that sort of reimbursement headwind that the industry has traditionally faced and anything to say about your ability to offset that? Has that improved for any reason? Or is that even more challenging today?

I'll start by just saying that the most intense reimbursement rate pressure was occurring when the PBMs thought we were going to get sold. And so that was really intense. And it has leveled off substantially since I joined the company for -- not because of me, but because the company is clearly moving forward, and we've made such great progress on our capital structure. So Jim, can you just comment on the status of the negotiations now?

Sure. Yes, all of our -- and this is probably something you already know, but all of our major Med D contracts are obviously done in June, including those with the big 3. They're fully executed for calendar year '22. With regard to our commercials, we're at the goal line and very shortly in a matter of days will be fully booked with the big 3. We've already got one. I think one is coming in today. And so 1 more of the big 3, probably done by the end of this week. So -- and that will take us through in 2 of those examples, 2 years, calendar year '22 and '23. And that's really been our emphasis is to negotiate multiyear deals, and we've been relatively successful with not only the big 3, but other midsized PBM. So from a cycle perspective, we have good visibility into how we're closing out these contracts in a positive way. With regard to your question about the rate pressure, I would say this that it's not just about rate and that was something that I think we inherited when we came to Rite Aid that the discussions from a Rite Aid perspective were always about negotiating hard line rates. And what we realized and are starting to see the benefits of is that we offer a lot of value to PBMs and regional health plans by working with them in collaborative ways that we've never worked with them before. So you think about how we can actually lower total cost of care, assist people and health plans and PBMs in adherence rates. We've, I think, shined up and shown to PBMs and health plans and frankly, have numerous contracts to show for it, how we can provide real value that helps to counteract the rate pressures that we see.

Yes. So it's really moved from a beat-up Rite Aid and extract every last penny from them to a partnership that is less about economics and more about creating overall value for the PBM's clients. And so while this always does remain one of our most significant risks as a company, it is not currently our most significant risk.

Okay. Okay. I want to -- before I forget, something you mentioned earlier in your opening comments, Heyward, the in-store percentage of prescriptions fulfilled versus drive-thru versus delivery. You have a -- I mean, I'm assuming the in-store is still the vast majority of that, but is there a sense of what percentage of prescriptions are fulfilled in those 3 ways and where that might go over time? And I guess one of the questions with that is I understand the appeal of the convenience for drive-thru and delivery. But do you lose anything on the foot traffic and the front-end store sale? Or do you make that up in other ways on those other 2 avenues?

Well, I'll let Jim comment on the percentages, I don't have them handy, but I will say delivery was something we didn't even have until the pandemic. So you're going to talk about something being propelled. And I can tell you for any prescription that I am on from a medication perspective, I have had delivered since the pandemic, and it's a really great service. I think that, yes, we do buy online, pick up in store, and we have multi-mix basket opportunity, both with the drive-through and how you can get things from the front end delivered. So we have made significant progress in trying to cut back that risk of just having the prescription without the front-end offering. So still a ways to go on that in terms of the convenience of those offerings. We have paused on buy online, pick up in store just because of the labor issues. We're trying to reduce the amount of friction in store. So I would say the bigger consideration that we're working through is that we see our customers and engage -- our pharmacists engage with our customers in ways they never happened before because that's a big part of our strategy is freeing up time for our pharmacists to engage with our customers around their total health and well-being. And we've made enormous progress in that and have measures to show that. So the one thing that we are thinking through is for those that don't come in store, how do we still allow for that pharmacy engagement through an omnichannel type engagement opportunities. So that in-store consultation, especially for people who are on chronic medications or who have chronic -- I'm sorry, maintenance medications or chronic illness or new and emerging illnesses that's really important. Jim, I don't know if you have the percentages handy or if you can comment.

Yes, I do. We haven't talked about actual delivery percentages. But what I would say is this, we have talked about the omnichannel offerings that we have that have seen substantial growth. So it's not just about delivery from store by courier. It's about online. It's about third-party e-commerce, which is more on the front-end side, third-party delivery. So our belief is that the better we can offer a service to our customers the way that they wanted at that time, the better. So I can say that the delivery itself is still a very small percentage of our business. It has grown substantially, as you might imagine, over the past year and much more substantially over the past 3 months where we've actually proactively sought to deliver and encouraged our customers to get script deliveries for us. So on the front end, third-party e-commerce is up 120% is what we announced as of the end of last quarter. And you have other mechanisms like third-party delivery, so Instacart and ScriptDrop. Those are up 20%. year-over-year. So we're still emphasizing -- we've gone from a company that resisted offering our customers anything except for the in-store 4-wall experience to a company whose philosophy is to actually engage with consumers in the way that they want. We believe that's going to create longer lifetime value for our customers.