Rite Aid Corporation (RAD) Earnings Call Transcript & Summary

Good morning, everyone, and welcome to Rite Aid Corporation Retail Shareholder webcast. My name is Byron Purcell, the vice President, Investor Relations. And on the call with me today are Matt Schroeder, Executive Vice President and Chief Financial Officer; and Heyward Donigan, President and Chief Executive Officer. And now I'm going to turn it over to Heyward.

Thanks, Byron, and thanks, everyone, for joining us for our first annual virtual retail shareholder webcast event. And I am speaking to you from home and can't promise you that my cat won't make an appearance. So in the world of Zoom and virtual work today, really happy that we're able to engage with you in this new and exciting way. I do want to make some really brief introductory remarks, and then I'm going to address questions that you sent to the IR Department as indicated in the instructions in the alert that went out for this event several weeks ago. So if you forgot to send in your question or have additional questions, you can e-mail them now to us at investor@riteaid.com. We are so grateful for the support from our retail shareholders. And you represent a very significant portion of our overall equity holders. And we're excited about the launch of our greatly expanded retail IR program. We are investing significant additional time and resources to make sure you are well served. As a part of this effort, we are launching the following items: a newly launched dedicated retail Investor Relations web page, and we're conducting this retail shareholder virtual event today that provides the same format, access and attention that our professional investors get at financial conferences. We think this is critical since our retail shareholders are not able to participate in the professional conferences. We just launched a StockPerks loyalty program that allows users to earn benefits just for being a Rite Aid shareholder. It's very easy to sign up, and we hope you will. And we will be using StockPerks to choose 1 lucky retail shareholder to visit the New York Stock Exchange Trading Floor and will be hosted by our VP of IR in late 2022. And lastly, we're going to be adding educational video clips on our retail IR page to help educate and frankly simplify some complex topics in our business. And the business of pharmacy and healthcare is complicated. And that will be in addition to quarterly video shareholder letters. So now I'd like to shift to our business. So as you know, we had a strong FY 2022 and our first quarter '23 fiscal year showed good growth on scripts, continued administration of vaccines for COVID, a nice rebound in EBITDA at Elixir from our last quarter and strong SG&A controls as we are well on our way to a goal of achieving over $170 million in annualized cost savings. This quarter, last quarter, we beat consensus, raised revenue guidance for the year and reaffirmed our EBITDA guidance. Now I'm going to be very frank with you all. and I acknowledge the things that you all know. When I came to the company and as I considered coming to this company, Rite Aid had $3.35 billion of net debt outstanding with $1.8 billion of that debt due in 2023 over 6x levered. There had been 2 attempted acquisitions. One, Walgreens was not approved by the FTC and the other, Albertsons, the shareholders rejected. I also knew when I came to the company that the front-end business had been declining for many years, and I saw with my own eyes, the stores and signage and merchandising was in a deteriorating state. And Elixir, a very exciting opportunity, which was then EnvisionRxOptions, had not been integrated in any way, neither the assets within EnvisionRxOptions nor between EnvisionRxOptions and Elixir. That being said, I decided to take the risk to join the company because I believed and I still maintain that belief that the pharmacy business overall is a strong, growing and important business in America. And that Rite Aid as a smaller regional pharmacy, let's be clear about that, we are not national. At a mid-market national PBM has the right to win in its target markets. The pharmacy business we compete in is a $400 billion business and growing. The pharmacy business in its totality is over $1 trillion. And I'm not the only one bullish on the pharmacy business. Look at all the new entrants, Amazon, Roman, Cuban, Capsule, just to name a few. As I said, the pharmacy business is a strong, growing and important business in healthcare in America. It's an important component of care for almost all Americans who use some form of medication or who are getting life-saving vaccines. And Rite Aid has exciting and important pharmacy assets to compete in this business. These assets include our PBM; our specialty pharmacy; our mail-order pharmacy; our Retail Pharmacy; our Medicare Part D business; Laker Software, our adjudication PBM platform business; and Elixir Savings, which is a platform for Cash Card businesses and, of course, and finally, Health Dialog. That means we don't need to acquire more companies to fulfill our strategic plan. Our strength as a company, including these assets is our ability to be nimble, innovative and relevant to our target markets, whether it's our PBM whom consultants are now saying we are positioned to win and are winning business or our specialty pharmacy who is the 14th -- we are the 14th largest specialty pharmacy distributor in America. And we are winning in our specialty pharmacy business, new limited distribution drugs. And then, of course, our Retail Pharmacy whose volumes on scripts are up across the board. So I know many of you asked, that Heyward, how do we accelerate our path to a profit? Well, the first thing is that our net debt today is $2.35 billion, which is down $1 billion since when I started with the company. And because our teams, Matt and Byron, who are on the phone today or the Zoom today, we're opportunistic. They refinanced our debt, and we have no debt due until 2025. And we have $1.8 billion in liquidity. Do we need that liquidity for big M&A activity? Not really because, as I mentioned before, we have all the assets right now that we need to compete. But will we use liquidity opportunistically if we think it's going to build enterprise value for our company? It's something we will consider, but very carefully. The challenge that I have as a CEO is that we still have debt and that debt requires $200 million worth of cash to service every year. And that debt does restrict us from doing some things that our shareholders might like to see, for example, paying dividends or stock buybacks. So that being said, I am laser-focused with my team on growing EBITDA, reducing costs and generating free cash flow. So to grow our EBITDA, we need to deepen our share. We will continue to show strong growth in pharmacy scripts driven by adherence, clinical services and immunizations. Also, we must show inroads in our front-end sales. And that's an area that, frankly, has been challenging for us, I admit. But we do feel confident about our plan forward. And I encourage you to check out our new advertising campaign that appeals to our core customer. Frankly, COVID did have an impact on our ability to grow front end. We grew front-end sales because of COVID and vaccines and hoarding but it did impact our ability to develop the brand equity that we were hoping to develop in the Rite Aid markets during that time. So we're relaunching our advertising campaign, really excited about it. We've also launched our new and improved digital marketplaces, and you may not know this, but we are one of Amazon's top 100 marketplaces in their entire ecosystem. Rite Aid launched Buy Online, Pick Up in Store. And you might notice in some of our stores, our designated parking spaces for our [indiscernible] service. We're also embarking on important new work to accelerate our earnings growth in our specialty pharmacy business. We also need to expand, and we're excited to open 5 new small-format stores this year in new markets that are contingent to the ones we have today and starting with Virginia and New York. And many of you have asked and if you don't know about Thrifty is, the best ice cream ever. Have we done as well as we could have done with that leveraging that brand nationwide? No, we have not. And we have plans to. Encourage you to buy and enjoy Thrifty ice cream, spread the world -- spread the word. We have plans to roll this out nationwide and expand our reach of this valued and beloved brand, more to come. And we are creating new businesses, direct-to-consumer, white label mail order and over-the-counter mail order programs for health plans. And on SG&A and costs, we're well on our way to reducing expenses by over $170 million just this year. And our work continues as we leverage lean, modernize our technology and improve our customer experiences. We expect more efficiencies in future years. So there's a lot of work for us to do to build on our strengths to achieve our ultimate potential. I also have great confidence that we have the right team in place to be able to deliver the results we need. In order to allow the most amount of time to address your key questions, this is going to conclude my prepared remarks, and I'll ask Byron to begin the Q&A session. The format of this is going to have Byron read your questions and then Matt and I will respond accordingly. Since there are so many similar questions, we've grouped duplicates together in order to remove the duplication and be able to cover as much ground as possible. So Byron, for you.

Thank you, Heyward. Okay. We have some initial questions that came in. Why are you reaching out to retail shareholders now? Are you trying to turn the stock into a meme stock like GameStop is?

Well, first of all, I've been very passionate about our retail shareholders. Many of them are friends of mine and many of you I have yet to have the pleasure of meeting with. I get e-mails every day from many retail shareholders. I wish that I had done this earlier and so no time better than now. And I don't want to become a meme frenzy stock. I want the stock to be valued in its own right according to our results and our potential. And I think that, that's the message that we're here today to help communicate.

Why did you ask for questions beforehand, do you have something to hide?

I have very little to hide. We are a public company, however. And so I have to be judicious in the information that I portray, but I am open to any and all questions. I get very tough questions every day from retail shareholders, and I try to answer all of them.

Next is a very popular question on the message boards and coming into IR, are we going bankrupt?

I am very confident in the future of this company. I mentioned that the debt is not due until 2025. We have contingency plans. If we were not to get a good financing deal in place, we have $1.8 billion in liquidity. And so while we can never say never, I am very confident in our plans, and I think we have a good runway to -- and contingency plans to the future of this company. And Matt, if you want to add anything else?

Thanks, Heyward. I would just reiterate what you said. We have -- at the end of the first quarter we have $1.7 billion in liquidity. We have no debt due until 2025. We have a very supportive group of creditors and bondholders. We've got great support from our vendor partners. So as Heyward said, no one can predict the long-term future, but there are no plans to file bankruptcy. There's no need to have such plans and we're focused on growing the company.

The next group is all around the debt. So Matt get ready. There's going to be a lot coming your way. How did Rite Aid acquired so much debt?

Yes. It's really something that -- it's a debt load that unfortunately, we've carried for many years, and it's over time as we've grown the company, we've grown the company through debt. And there's really 3 major transactions historically, I would point to. Winding back the clock for quite a few years. First one was the purchase of Thrifty PayLess, about 1,000-store chain on the West Coast back in the late 1990s. Another big purchase was the purchase of the Brooks, Eckerd Stores that we did back in 2006. And then we did utilize debt to purchase EnvisionRxOptions, which we have now is the backbone of our pharmacy benefit management company, Elixir. And those were 3 transactions at all were financed via debt and contributed to the debt load. I would also point out that one transaction that we did do in the past, the reduced debt was we did sell about 1,932 stores of Walgreens back in 2017, which actually reduced our debt load by about $4.4 billion at the time. And as Byron -- as Heyward said, we continue to focus on generating free cash flow to pay down our debt. And that is along with investing back in the business, really our top priority from the standpoint of stabilizing the company and improving shareholder value.

So when do u started -- when do you expect to start reducing the debt load?

Well, as Heyward said, we're doing it. I mean, we had well over $3 billion of debt back when Heyward started the company. We ended last year at about $2.7 billion of net debt. We expect to generate free cash flow to pay down debt this year as well. We've said that publicly and in our investor calls and definitely expect to do that. And so we are already reducing the debt load. And as we execute on our business strategies and grow the company, execute on cutting costs, I expect over time, the reduction in that debt load to accelerate.

Next question. I want to know what the plans are for the CMS receivable? Are they going to use it to buy down debt? Rite Aid could purchase back long-term bonds at a steep discount right now?

Well first thing long-term bonds back at a steep discount is a great idea, and we actually did it a couple of months ago. And we actually struck at a pretty good time, honestly, and that was probably a little bit of luck from the standpoint at the time we did the tender and the discount we captured, but we used $150 million of revolver borrowings couple of months ago to buy back $193 million worth of bonds. So we actually reduced our debt by $43 million just by that transaction alone. But maintaining strong liquidity is really important as well. And so my -- one of my main jobs as CFO is to strike that right balancing act between how we use our capital, how we invest in the business and how we take advantage of opportunistic things like buying back the bonds at a discount but also maintaining that strong liquidity that gives investors and partners of ours confidence in the business. So the long-winded kind of conclusion to this question is when we do securitize and finance this year's CMS receivable, we would use that to basically pay down borrowings in the revolver and maintain our strong liquidity position.

The next group of questions are going to start getting in the stock, and this one blends pretty well into it. Would you issue stock to pay down debt?

I'll jump in. The answer is we would certainly consider it. We wouldn't do it at this price. At this price, it would be too much of a discount to where we think the value of the stock could get to. And honestly, too much of it be at a price that would dilute the existing shareholders to a level that would be probably more detrimental to shareholders than the debt benefit would be. But there probably is a price at some point in the future where we would strongly consider issuing stock to pay down debt because companies value us using what they call our enterprise value, which is basically in simple terms, the EBITDA that we generate or that analysts expect us to generate times a multiple of that EBITDA equals your enterprise value and then enterprise value is both your debt load and your equity value. So the more debt that we can pay down, the more that enterprise value gets allocated to equity value, which would cause the stock price to go up, which is why at the right price, we would consider using stock as currency to pay down debt.

Is there any chance that you can buy back some of your undervalued stock? I understand CapEx and debt reduction is critical, but if buybacks are limited, why not speak to lenders about stock buybacks.

Yes. I think I would start this answer with where I ended the last one, which is the discussion around enterprise value. So if you think about how analysts and investors assign value at our company, again, they take a multiple of EBITDA and come up with a total enterprise value, which is a combination of our debt level and our stock level. So if we use our -- when we use our cash to pay down debt, we push more of that enterprise value to equity value, which increases the value of the stock. And in my mind, that's going to be more accretive to equity holders than taking money that we could use to pay down debt and use it to buy back stock. So a company like ours that's north of 5x levered, we need to be focused on paying down debt and reinvesting to grow the business. And if we do those things, equity value will come. But those are the places we need to be thinking about from the standpoint of capital allocation.

Along the same lines, has there been any discussion about a dividend that would significantly increase shareholder interest and increase share price and market cap for future investments in market share?

Yes, I think I kind of covered off on the reasons why it's so important to use our cash to pay down debt or reinvest in the business, so I won't repeat myself. The other thing I would say that both from a dividend and stock buyback standpoint, there are covenants in our credit facilities and our bond indentures that limit the amount of cash that we can use to do those types of things. So until our debt structure is different, those are things that are not going to be on the table.

Okay. The next topic is stock shorting. Why do we have shorts in share price manipulation?

Yes. So first of all, as fellow shareholders, and I am a shareholder as is Heyward, as is Byron. We don't like short selling. We want to see investors that are interested that believe in the company and are interested in the long-term growth of the company. Having said that, taking a short position in the company is a perfectly legal transaction that somebody can do, if they want to enter into a contract that basically bets against the company's ability to grow at share price or keep the share price where it is. I firmly believe that the way that we combat short selling is to prove the short sellers wrong and to deliver our business initiatives, grow our revenue, grow our EBITDA, pay down our debt, drive our equity value up and make a short seller regret that they took a short position. That's how we combat short selling is by delivering results. And from our standpoint as a management team, that's where our focus is.

This question you already addressed, but I want to read the entire question. Have you considered employing some common approaches to dampening the aggressive short play? The Board can approve a resolution to at times during their buyback shares. Also by managing your CapEx spend with some variability, you can occasionally show stronger surprise quarterly earnings.

Yes. Well, first of all, Byron, I know you're reading the question as it came in. Our capital expenditure spend has nothing to do with our earnings. Our capital expenditure spend is really -- is a component of our cash flow. And there are times where we will tighten up on capital expenditure spending or expand capital expenditure spending different than what our plans are at the beginning of the year based upon how we see the year projecting and the need to generate free cash flow to pay down debt. So that is something where we do watch the CapEx spend very carefully. However, we also need to be cognizant that there are a lot of investments that we need to make in this company for us to be successful. As far as a resolution of buyback shares, I think I covered that already. I firmly believe -- and I know Heyward firmly believes that the best use of our capital is to invest in a bit -- our cash is to invest in the business and pay down debt. That's how we grow value using it to buy back shares in the environment we're in right now, when there's just so much good we can do from paying down debt and investing in the business. I think would be a shortsighted play. It might -- I can't say what impact it would have on our stock in the near term, but it's my firm belief it would be a bad play in the long term.

Last one of this topic, have you engaged the SEC in regarding stock manipulation as it pertains to Rite Aid? Can you speak to any action or lack thereof on the part of the SEC? If any action taken, can you speak to the results?

So I think we reached out years ago on this topic. And we've talked to firms in the past that come to us and say that they can do surveillance on short selling. And if we engage them, they'll be able to hunt down illegal short sellers and stop. And then honestly, every time we grow with these firms, there's just not a lot under the covers candidly. And so again, I think some of this is a matter of focus on where do we spend our time and where do we think our time is important. And my focus, Heyward's focus, Byron's focus, the management team's focus is on growing the company, paying down debt, investing in the business, and that's how we ultimately defend the company against shareholder -- short sellers, excuse me, and support our shareholders. Doing kind of a little bit of chasing around for illegal short sellers again, I haven't seen a proven way where you can find and really -- this activity and at the end of the day, you beat a short seller by beating expectations and driving your stock price above the short term.

I have a couple of questions that came in concerning the stock price. Why is George Hill still erroneously reporting and making wild predictions regarding our stock? Have you requested Deutsche Bank provide another analyst and if not, why?

Well, let me just first start by saying that I think he has brought up a couple of important things that I think are worthy of discussion. One is that his concern was whether we could cycle through the loss of all the COVID benefits and continue to be a stand-alone company with the debt service we have. And we had over $200 million worth of COVID benefit last year and that is not going to evaporate, but it will significantly diminish. And I think as you can see from our guidance, we believe we continue to have a strong company without the peak of COVID benefit because there were so many things that got hurt for us during the period of COVID. We had higher costs. We had no acute medications. We had a drag on front end. We had a lull in Elixir proposals. And so we were doing well before COVID. And we knew we could do well after COVID. But that's clearly been a general concern. And then shortly thereafter, George also said, well, I guess am reinvigorated about the opportunity with Elixir because, like many others, they saw the sale of Magellan's pharmacy benefit management business to Prime at a very nice multiple. So that caused him to reflect on the positives. So I think an analyst has their right to their view, and our job is to continue to show that we can outperform expectations.

Why don't you publicly defend the stock price? Why don't you say we believe we are worth x amount per share?

Well, first, I'll say I bought $200,000 worth of stock at over $14. So you can -- you know what my point of view is on the stock. I thought that was a very cheap price at the time. And I remain very bullish about the future of this company, which translates into a strong stock price in my mind.

Now we're switching to cost reductions. Could you speak to field wages at your stores and where you are offsetting cost -- excuse me a second. And where are your offset cost reductions planned to hold and improve the margin line?

Let me just start and Matt can weigh in, but I am really proud of the way that we handled the last year and beyond in terms of our balance between making sure we had competitive wages in the market, our ability to manage labor during the middle of the peak of the labor crisis for retail pharmacy companies, and our ability to manage through that year without overinflating wages in a way that we would regret. But in a way that we were able to both give people a good, fair and competitive wage and improve the productivity of our workforce to offset at least some of the wage increases. So we are in a very strong position. We did not have to shut many of our stores and ours because of the labor crisis. We got through the hotspot, which was around January. And certainly, it was impacted us in terms of customer satisfaction in some of our markets. But we've crested through that peak. We have only a couple of hotspots right now. And we've done a really good job, I think, of balancing the competitive wage, the improvements in productivities in our stores and our ability to keep our stores open and grow our scripts. So Matt, you may have some more details.

Thanks, Heyward. Yes. the headwind we have from a wage increase in our company is about a $45 million headwind this year, and we're more than offsetting that from SG&A through initiatives like closing stores, reducing our back office costs, purchasing improvements, even field overtime reductions and other types of productivity initiatives that we have in the stores. And those are the things that are going to drive us to a $170 million cost reduction in this year over last year, and that's even after -- and that's even after absorbing that wage increase.

Rite Aid evolved as a much larger footprint. Do you feel you've adjusted your corporate SG&A cost structure to match your smaller profile?

Matt?

Yes. I think we have. And there's places certainly where we've adjusted the corporate SG&A cost structure. As we talked about, I think, earlier in the year, as we broke down the benefits of $170 million, we're looking at $40 million reduction in admin costs year-over-year. There does get to a point where you need a certain amount of back-office people to run the operations that you have both at the retail operations, also the PBM operations regardless of the number of stores that you have. But we've done a lot of work on spans and layers. We've done a lot of work to flatten the organization. We've done a lot of work to take out really make the leadership team a more efficient structure. Look at the beginning of the year where we eliminated -- we talked publicly about eliminating some very key executive positions. And we're going to continue to be very rigorous about looking at the spans and layers of control and what I would call the more kind of expensive headcount in our structure and making sure that we are being as efficient as possible while still be on the support of our operations.

Besides the corporate SG&A, what other cost savings initiatives are being done to improve EBITDA?

Well, I'd say the biggest one is the store closure program we've done over the past year. We've closed 145 nonprofitable stores. It's going to generate an EBITDA benefit of -- we targeted $60 million, it's going to be north of $60 million in EBITDA for the year. We're also looking at store labor efficiencies. We're being really thoughtful about how we look at advertising and starting to reduce the amount of expense we put into circulars, which is very costly and not as targeted and saving money there and then reinvesting some of that in more targeted digital marketing, which we think -- which is much more efficient and then really looking at supply purchasing and also indirect procurement as other levers to drive toward that $170 million cost reduction target.

And I'd also like to comment on Elixir. We integrated Elixir's backroom operations between Elixir and Rite Aid. That is almost fully complete. We also are now integrating all of the platforms and processes across these 2 Elixir PBMs that work, we call Project Fusion is underway and will afford us significant efficiencies going forward and also improved client service. And I also want to comment that our work on lean continues and continues -- has and continues to generate hundreds of millions of dollars' worth of savings. So more to come on the Elixir front as well.

Next group involves the retail stores. Why are there so many empty shelves? And why do you cover them with blue and green cardboard?

Well, that was a transition period when we were changing out 75% of our merchandise to healthy, better-for-you, higher inventory turn merchandise that people want to buy. So more and more, you're going to see those boxes and cards disappearing from the stores. But you also realize, as we all do, that we have had, as everyone else has, significant out-of-stock issues. Not so much now. We are over 92% in stock right now. But during the time that we were going through the merchandise reset and COVID, we also happen to have large out-of-stocks. And we wanted that customer experience to be something other than just a white shelf that was empty.

Were you expanding your own brands to Rite Aid brands and how much do they benefit us?

I am super excited about own brands. Let me just say, first of all, as you know, that own brands is a significantly higher margin than our branded products. So our branded products, let's say, 30% owned brands, let's say, 55%. But what's really exciting is that we are launching an entirely refreshed, new wholesale grouping of own brand products. So we are launching new baby products, new pet products, consumables, health and beauty and the list is long. The one thing I will say is, as we have rolled out over 500 SKUs of our new, own brand products this year, we're going to be launching another -- I think it's about 1,500 during the course of this calendar year. We have had some issues with supply chain. This is where we've had more out of stock and supply chain issues than the national brands. So that has slowed us down. But watch for new marketing campaigns. We are seeing improved penetration. The SKUs are rolling out new packaging, new names, new look and feel, tested and really well received, not only by our target customer in an environment where inflation is going to, for sure, drive people to own brand purchasing. But what's really cool is that we are -- we tested really well in our own brands packaging and brand against the actual national brand corollary. So more to come on that. I think it's very exciting. This is a marketplace now in a market -- in an environment with inflation where people want that own brand option, but they want that own brand option to be a quality option and they want it to be an appealing option for our target customer. So 500 out and more to come.