Rite Aid Corporation (NYSE:RAD) Credit Suisse 31st Annual Healthcare Conference Call November 9, 0000 4:25 PM ET
Company Participants
Heyward Donigan – CEO
Matt Schroeder – CFO
Conference Call Participants
Albert Rice – Credit Suisse
Albert Rice
Hi, everyone. I’m A.J. Rice, the Health Care Services Analyst at Credit Suisse. And we’re very happy to have up next in our presentation, I’ll do a fireside chat with Heyward Donigan, the Chief Executive Officer; and Matt Schroeder, the Chief Financial Officer at Rite Aid. Thank you guys for participating again this year.
Question-and-Answer Session
Q – Albert Rice
Maybe just might be helpful just to get a broad update on the company’s broad strategy. I’m sure there are people in the room and on the webcast that probably haven’t looked at Rite Aid in a while and are looking for a refresher. So maybe I’ll just give you an open-end question like that, if that’s okay?
Heyward Donigan
Of course. Thank you. Thanks for the opportunity. A lot of people forgot our original strategy because COVID rounded out. And so just as a reminder, I’ve been with the company for 3 years. And we had our first Analyst Day in 20 years back in the beginning of 2020, literally a day before the whole country got shut down. And so we are excited to get back to business with COVID as opposed to getting back to business without COVID. It’s more of a living with COVID thing.
But just a reminder, we’re a pharmacy services company. We are doubling down in the pharmacy business. It’s a $1 trillion marketplace. And just a reminder of the assets that we have to participate in that $1 trillion market. We have a mail order pharmacy, a specialty pharmacy, a company called Health Dialog. We have Laker adjudication platform, which is a platform for Pharmacy Benefit Management companies, including our own. We have Elixir Insurance Part D business. We have a PBM business.
And then we have what most people think of as our whole company, but isn’t and that is a retail pharmacy business, which includes both retail pharmacy and a front-end retail experience. So we’re creating a modernized, updated pharmacy services platform that includes all of those assets. And if you think about the 3 pillars of our strategy, it is promoting the pharmacist as the most trusted health care adviser in our communities and in the health care ecosystem who engages with consumers more than any other health care professional in America.
If you go see your doctor, if you even have one, you see them once a year. I’m on the older side, and I only see my doctor twice a year. But I see or talk to or engage with the pharmacist almost every other month. And so leveraging that care connector in our health care communities. Pharmacy is a highly skilled profession. I don’t know whether people know this, but it’s a 6-year profession — 6-year schooling.
And many do a whole full round in the hospital. So no one knows prescriptions medication and can help you with medication more than a pharmacist. And I was trying to convince people that this was important back in March of 2020, and then poof, the whole world now knows how important pharmacies are and pharmacists are to health care in America. In fact, pharmacists in the retail pharmacies delivered more vaccines than any other professions.
So we were hands down the people who did the majority of the vaccines in the United States. So in order to fulfill the promise of pharmacists, we have to get them to be able to have the time to practice the medicine of pharmacy as opposed to count pills and cash that went out at the register. So we’ve undertaken over the last 5 years, significant efforts to free our pharmacists up to take work out of the pharmacy. We have a central fill facility that serves 900 of our pharmacies and does all the maintenance medications for them and then ships them 5 times a week to the actual pharmacists.
So it’s freeing up the pharmacist to be the providers of health care and the engager with consumers like nobody else. And now we have so many more tools and so much more visibility to do that. The second thing is that we needed to redo our brand. It’s an iconic brand that needed to be freshened up. We have a new logo, and we did all of the exteriors of our stores, and we redid our brand for our Pharmacy Services segment. We changed out 75% of the merchandise in our retail pharmacy. So if you don’t know this, this is a really important statistic. We worked off $180 million worth of inventory. We reset 75% of the merchandise in our stores is new, better for you, on trend, fun, healthy, environmentally sustainable products to help our customers thrive.
And we also have — when I first got to the company, frankly, we barely had digital. I mean digital wasn’t — it was a big thing for me because I came from the digital technology company. So to me, I was using Zoom, and I was digital all day all the time. But Rite Aid had a long way to go and was barely at square one. So we went from 0 to 100 almost overnight because we had to. We had to launch riteaid.com, whole new website, relaunch the digital Elixir experience. We had to — we ended up engaging with 3 different delivery partners Instacart, DoorDash and Uber Eats. And we’ve grown our digital business just in this quarter, 70% over last quarter.
And — but now we’re really talking about digital engagement with the pharmacist. So put the pharmacist in your pocket on your phone, bring the pharmacist with you wherever, engage with the pharmacists via Zoom, via chat or in store. And so that’s the beginning of our digital journey. And then finally, Elixir, our pharmacy services company. It’s being the dominant mid-market PBM and a high-growth specialty mail order and — company and also leveraging Laker to do SaaS as a software offerings for other PBMs.
Albert Rice
Okay. Okay. And you mentioned you’d laid this out at the Investor Day just before the lockdown. Obviously, this year, not only are we still sort of trying to come out from the whole COVID crisis, but we’ve had now inflation. And we also have some chatter about a slowdown in the economy. Has that had any impact on how you think about the strategy and where we go from here?
Heyward Donigan
Our strategy really hasn’t changed. We’re — we’ve launched our advertising campaign now that we would have done 2 years ago, but we just got drowned out by COVID. So it was kind of a waste of money at that time. COVID really accelerated our business plan, and we’ve just moved from one crisis to another. The crisis of COVID was very good to our company, very good for our pharmacists. We save lives and continue to do so, and COVID is not going away. Because 75% of our business is prescriptions, fulfilling life-saving and life-enhancing medications.
Most people are covered by either insurance, whether it’s government or commercial. And people are still getting the prescriptions, and that business is not affected by inflation. However, we did reduce our guidance by $10 million on both ends because we are anticipating a slowdown in consumer purchasing, and that’s our caution in that regard.
Albert Rice
Okay. And with the inflation comment, there’s been a lot of discussion about supply chain. Is that anything on the supply chain that’s been an issue for your front-end inventory at all or not really?
Heyward Donigan
Well, supply chain was a big problem about 9 months ago. We were in the high 80% in stock. We’re now in the mid-range of the 90s. We have 2 areas of supply chain that we’re dealing with right now. One is upper respiratory, everybody is having a problem. If you go to any store and look for Robitussin, it’s not easy to find. And the other has been our private label rollout. For some reason, cotton is hard to get. But those are really only our 2 remaining issues.
Albert Rice
I’m jumping around a little bit here, but you mentioned flu, and I’m not sure that I had that on my list originally, but every presentation we’ve done in the last 2 days, flu keeps coming up because people are chatting about it more. We haven’t had a normal flu season in a couple of years. Are you seeing — and what does a normal flu season look like to you? It’s early. Are you seeing maybe indications we might even have above-normal flu season?
Heyward Donigan
Matt?
Matt Schroeder
Yes, I think — thanks, A.J. very early in the season, but I think there’s a couple of factors you can point to that lead us to believe that we’re going to have a pretty strong flu season this year. Certainly, a lot stronger than the last 2 years and something that probably is comparable to some of our stronger flu seasons pre-COVID. These indicators, which you’ve probably heard others referenced at least a couple is certainly flu in the Southern Hemisphere is very strong.
We’re — our markets are in the Northeast, in the Rust Belt and on the West Coast, but you are seeing in some of the Southern states really a real uptick in flu now. You see stories coming out of Texas of some hospitals being almost at capacity for flu. And then in our numbers, we’re seeing a very high rate of Tamiflu prescriptions so far in the year, high compared to what we would see at this time in the year and other years. So very early to call it, but the indicators are pointing to it’s going to be a pretty robust flu season.
Albert Rice
And a normal step up, I don’t know what normal is again, but would that be meaningful on a quarterly impact for you?
Matt Schroeder
Particularly in the fourth quarter. It’s meaningful in 2 places. One is acute scripts and the other is in OTC. And actually, you could go back to a couple of quarters ago when there was no flu season and see the negative impact on the downside in our numbers in our fourth quarter for a couple of years ago.
And I think we’re going to — again, you see that in both parts of the business. OTC is particularly important on the front end because it’s a pretty high-margin product. So, yes, I think, again, early to call it. And certainly, our guidance contemplates a more normal flu season in the last 2 years. But every indication is it’s going to be pretty robust.
Albert Rice
Yes. To that point, I guess, we’ve had some comment that first half versus second half, there’s a meaningful step-up that you’re anticipating. Can you give us some help, I mean maybe part of it is flu, but bridging from what you saw in the first half to where you — how you hope to achieve the second half outlook?
Matt Schroeder
Yes. I would point to 3 things, A.J. One is, we expect to do about 3 million flu immunizations this year, and the vast majority of those are in the second half of the year and flu immunizations compared to other scripts are very lucrative. They’re about — our gross profit dollars per script for flu immunization is about $25 a script. The second piece is the flu impact for scripts and OTC that we talked about, particularly in the fourth quarter.
And the third is we’ve had some pretty intense cost reduction initiatives this year, store closures, reducing labor costs, looking at kind of reducing advertising costs, particularly in circulars, indirect procurement type savings, reduction in SG&A at Elixir because of a downturn in lives. And a lot of — some of those initiatives, particularly the closed stores were ones that have a staggered impact and they are more heavily weighted to the back half of the year. So those are really the 3 main drivers that drive the meaningful step-up in the back half, particularly in the retail side of the business.
Albert Rice
And I know post the last quarter, the stock’s come under a little bit of pressure. What has been the area of focus that maybe has driven that and gets you to step back and say, what do you think The Street is sort of missing about the Rite Aid story and the opportunity there?
Heyward Donigan
Well, I think a couple of things, and then I’ll let Matt answer. Number one, I — we always have expected a second quarter to be a slow quarter because of the seasonality of the business. I think we could have done a better job helping everyone understand that seasonality is back. Now I think — because the last 2 years have been completely different than what a usual quarter-by-quarter cadence would be for a pharmacy company. So we’re almost kind of more back to normal than we were. And — so the second quarter for us was always planned to be and expected to be weak, not just on pharmacy because no one’s really sick at that time of the year other than the occasional COVID illness that keeps circulating.
But we also — there’s no big seasonal event in front end, our Elixir’s results were really strong. So I think there was that — I think there is this still kind of concern about how could the third and fourth quarters be so much stronger. For us, that gets back to seasonality. And then I think also some confusion over why the Elixir impairment. And so you can comment on.
Matt Schroeder
Yes. We did take an impairment charge for Elixir in the second quarter, really driven by an anticipated reduction in lives into next year. And we are still a long way away from pulling together the plan for next year and having kind of a guidance for next year, but the accounting rules around impairment are when you see an indicator that leads you to believe that there can be pressure in the business, you have to book an impairment charge.
And the lives reduction is really driven by 2 things. One is the loss of a sizable health care plan client, and the other one is reduction — a planned and anticipated reduction in our Medicare Part D business that are better driving that as well. I think the other things that The Street, that investors maybe missing and are focused on at least is, one, what is a trajectory look like in the business in, some call it, a post-COVID world, I would — we would call it an endemic COVID world. But what does that trajectory look like?
And candidly, it’s — we think through the strategies, hey, we’re laid out around driving adherence in the pharmacy, growing the pharmacy business efficiencies we can drive in rolling out a private label in front end and a host of other things. We have a path to kind of cover that COVID benefit. But certainly, I can understand the concern about the ability to cover that benefit as vaccines go down and just the uncertainty around what happens.
And then the other thing I think that kind of ties to the impairment charge on Elixir. And what does that mean for the business going forward? And just looking past the loss in lives, we picked up almost 100,000 lives at Elixir in the next year’s selling season. It’s the best selling season we have in 3 years. We’ve locked up our largest health plan client for another 3 years.
We’ve improved margins significantly at Elixir through really good network management, good network contracts and a rebate aggregation agreement has gotten off our own paper and really driven more rebate value. And between those drivers, I think there’s certainly more to come as we move through the year and then give guidance for next year, but there’s a path for us to grow this business in an endemic COVID world.
Heyward Donigan
Yes, I think, just one more thing in that is because of COVID, we were unable to leverage our pharmacy teams to do the clinical work and the adherence work that we really believe has significant upside. We’re back doing that work now, and we’re showing meaningful results. We also — our whole digital team got waylaid because we had to do the vaccine schedule by — for the government. And that was an every week almost a year deal.
So there’s been a significant distraction from our ability to execute on our key growth targets, and I think we’re back on track.
Albert Rice
Okay. Okay. I know when Cigna bought Express Scripts a few years back, there was sort of a perception that maybe that made room for some of the midsized PBMs to step up. I don’t know if I really can perceive that, that has played out that way. When you think about your niche in the market with employers that are particularly the sweet spot for Elixir, how would you describe that? And maybe talk about where you see the competitive landscape on the PBM side at this point?
Heyward Donigan
Sure. So if you look at the big business — bigger business, the big 3; Optum, Express Scripts and Caremark, they control 85% of the business. But if you look at the middle market, which is our target, which is employers 1,000 to 10,000, smaller health plans under 500,000, health systems and Taft-–Hartley labor business. That’s $150 billion opportunity and the big 3 only play in 65% of that. So there’s a significant step down in their participation.
And the interesting thing is there are not that many competitors. It’s us, it’s Navitus and it’s MedImpact. And then Prime has largely been serving the blues. So we don’t really compete against them, and we do have a partnership with them on the aggregation business for rebates. And then it’s a real step down again — the — then you have in terms of scale and size, you’ve got Maxor, who uses our Laker adjudication platform, WellDyne. And then Capital Rx and [PRx] who are smaller, and they are largely outsourcing almost all their functionality.
So when you think of any business that’s $150 billion in size, you would expect more sort of scaled competitors. So I was mentioning to many of you in our one-on-ones that we had a national practice leader meeting with all the big consulting firms this week — 2 weeks ago in Philly, our new collaboration center. And we had the largest group of national practice leaders in pharmacy show up to our event than any other PBM. And I think it’s because we’re new, we’re exciting, and they really want more competition. Competition for the consultants is good for them, it’s for their clients.
So they’re rooting for us. And we are on the precipice, I think of — we’ve had a very strong selling season. I think we’re on the precipice of really making a difference. So I would say we’re large enough to scale and small enough to be nimble.
Albert Rice
Okay. When you think about your offering, and I should know this, but do you have your own mail and do you — what about specialty? What do you do there?
Heyward Donigan
We have our own specialty pharmacy. We have over 100 LDDs and we have capacity. So we’re actually talking about — we are actually bidding on and talking to people about using our specialty pharmacy, not just us using our specialty pharmacy. We have a mail order pharmacy, same thing. We’re about to launch mail order as a service for people who want to use us for fulfillment. And then we have Laker, the adjudication platform. So it powers all of the benefits eligibility and claims adjudication. So we have — and we also have a discount savings card adjudication platform. So we actually power GoodRx and CVS’ discount cash card business.
Albert Rice
Interesting. Okay. You said you had a robust selling season. There’s some discussion about ebbs and flows in the very large group selling and people saying, “Hey, I don’t want to disrupt my employees, so maybe I won’t go out to full RFP maybe give us a little flavor for what’s happening in more of your middle market customer base. And yes, your retention, your wins and any comments along those lines.
Heyward Donigan
There’s no doubt that this past year we had a significant amount of proposal activity, and we came in either first or second in almost all of the important target markets and prospects that we had, mostly they stayed with the incumbent. So there is a little bit of a COVID fog people. They’re just exhausted. They don’t really want to upset their employees if they don’t have to. So for us to sell 100,000 new members was actually a pretty big deal for us. And I think that’s why I’m more optimistic next year.
Now on the other hand, it did help us because we retained a lot of business. So it always goes one way or the other in the market. So I think we — the reason that we won business is there are people who’ve been wanting to make a change. They really like — we’ve come in almost in all the big bids that we had. We — and many of them, we came out head-to-head on price and #1 on value proposition on a qualitative side of the business. We do have a very strong value proposition in Medicare and Medicaid Health Plan business.
And so we do win our fair share of that. And we’re now starting — the most recent wins have been an employer 1,000 to 10,000. And that’s where this margin play comes from because there’s less competition and higher margins.
Albert Rice
Any — I mean, we’ve heard some of the bigger guys talk about 340B and volatility in that, what have you guys — have you experienced any impact on your business this year?
Heyward Donigan
On the retail pharmacy side?
Albert Rice
Well, I mean, I guess, CVS reports it in the PBM side, so I don’t know where you report it or where you show it…
Heyward Donigan
I would say there’s an opportunity for us to support 340B plans with Elixir as a line of business, and it’s something that we are looking into and developing…
Albert Rice
So historically, you haven’t been active in that market…
Matt Schroeder
We have not. We have not. We don’t have a lot of contracting pharmacies in the retail on the 340B side and it’s something that to Heyward’s point, we see a real opportunity in the Elixir. So for us, it’s more of just an upside because we’re not that heavy into it right now.
Albert Rice
Okay. All right. Maybe just pivot over to the retail for a few minutes. Maybe what are the biggest challenges to show improvement from here on the retail side and the trajectory of the business there?
Heyward Donigan
Well, I think — you mean on the front end versus the scripts?
Albert Rice
I guess. Yes.
Heyward Donigan
So the front-end retail, which is products is where we’ve had the biggest challenge, frankly. So we’ve gained script growth. We’ve got strong script comps and we’ve gained market share over the last quarter. But front end, we’ve done really well on margins. So we are 250 basis points improved in margin quarter-over-quarter on front end. I’ll let Matt explain why in a minute. So we’re very pleased with that. We’ve done a really good job of managing through inflation, putting aside the cost on inventory. We are in a much better out-of-stock position and we are rolling out our new private label packaging brands and marketing campaigns, and we’ll have all the SKUs in, it looks like by the end of the year.
And obviously, great timing because of the economy. We have just had a very hard time getting new people to visit the stores. And I think a lot of that is because we’re not in the consideration set because we haven’t done advertising. So everyone knows about us for vaccines, but doesn’t necessarily think about us for front end and hasn’t necessarily understood how many great new products we have. So we’re getting the word out now.
Our new advertising campaign was kicked off a couple of weeks ago. It’s — there’s no wrong way to live at Rite Aid. And if you haven’t seen it, it’s — I think they’re really cool ads, getting great reviews. And in fact, our equity — brand equity has gone up over the last quarter. And that means our consideration — people’s consideration to buy at Rite Aid has gone up. We have a long way to go though, and it’s been disappointing. I remain optimistic, but it is definitely our sore spot at this point. You want to just talk about the loyalty?
Matt Schroeder
Yes. I think that in the brief description is we went from — with our change in loyalty program this year, we went from a tier discount program to more of a point-of-sale program. And as part of that going to that point-of-sale program, really leaned into getting more data from customers, getting e-mail addresses, trying to engage digitally and have really more of a direct contact with the customers.
By going to getting rid of the tier discount program, we actually are able to also eliminate a lot of markdowns, which has driven the margin improvement that Heyward talked about. And I think between that margin improvement and then leaning into the rollout of the brands over the rest of the year, I think we have a lot of — and then continuing to focus on nonproductive SKUs, I think we have a lot of opportunity not just to obviously grow sales, which it’s the most important thing, but continue to have more productive sales and improve our margins on the front end.
Albert Rice
And clearly almost every area of health care, there’s been discussion about labor and the cost trend. Where are you at in getting your labor force? Where it needs to be in terms of minimum wage and all that stuff? And are you — any meaningful restriction on hours because you can’t get labor for some stores or not really?
Heyward Donigan
Well, I would say, first of all, when — at the height of the labor crisis and everybody was raising their wages, we were very cautious. We were already paying an aggregate of a minimum wage. I was very worried about getting over our skis, making commitments on wages that we couldn’t walk back — and I’m very glad we did not get over our skis because I think a lot of people are regretting that.
Now we’re facing another problem, and it’s not general labor it’s actually our turnover for our company in our key categories like technology in Elixir and corporate are actually — turnover is going down. But we have one problem, and I think we — any pharmacy company shares this, and that is pharmacy — pharmacists.
So the pharmacists are exhausted. They’re burned out. They have been working so hard for the last 2 years and there are pharmacists who are exiting the pharmacy business. And that — it’s kind of like nursing. So it’s — the nurses are exhausted, stressed out of their minds and they’re seeking more work-life balance. And it’s really busy in pharmacies right now. I mean, they — I think they thought they were going to get a break. COVID’s done. And now they’ve got COVID again and flu and RSV and all the prescription volumes are going up which is great for business, but tough for them. So that’s why we’re trying to get this work out of the stores because we’re not going to — I don’t think throwing a lot of money at this makes sense.
I think you’ve got to get the pharmacist to have a better life balance — work-life balance. So what we’re doing — and we have to fulfill our customers’ needs and delight our customers. So we’ve taken like the last hour in some stores and gone dark. In other word, we shut down for customers, but the pharmacists are still working the medication. And we’ve given them a half an hour break every day, and we’re bringing in SWOT teams and taking certain work out of the stores, just to give them some relief.
Albert Rice
That’s interesting. Yes. So it sounds a lot of lingering issues. I know the company has highlighted adherence as an area of opportunity. Did you see adherence drop in the pandemic because I think you talked about a 1% increase in adherence could be a $20 million boost to gross profit. Is there something underlying those comments that you’re focusing on?
Heyward Donigan
Well, we — when I first came to the company, I knew we were behind on adherence. And then, of course, all hell broke loose. And people hoarded up on medications the first year of COVID, and then there was a big drop in adherence the second year of COVID. So the number started moving around. So this year, we said, “All right, we’re going to implement 3 or 4 programs to go after that $80 million adherence opportunity that we have in gross profit.” And it is — the $80 million is the 4% behind we are in adherence relative to the other drug channel.
And just in the last few months, we’ve enrolled 2.3 million members in Auto Courtesy Refill, which is automatic refills on their maintenance medications so that they don’t have to miss a refill, bother to ask for a refill. We’ll call the doctors, we’ll automate the refill, we’ll deliver it to your house. We’ll sync the medications up so that you get them all at once. And so that’s been a great program. Just in the last few weeks, I’ve gotten data that shows meaningful improvements in adherence just for that cohort — and we’re enrolling another 40,000 each month.
And one of the things that was interested, many of you in the audience, they’re — every time we met with someone pretty much, they said, “Oh, I know this company who’s doing really interesting work around adherence and personalized programs.” And these are the kinds of partnerships that we’re engaging with now is upstart companies that are really good at personalized outreach to customers about adherence.
And then I think the third tranche of that, and you’ll appreciate this, given your health care background is adherence is worth a lot of money to us. But the most important thing is it keeps people alive, it helps them stay healthy and keeps them from going to the hospital or getting readmitted. And I don’t know whether you all know this, but you know hospitals get — they don’t get reimbursed for Medicare if a readmission occurs within 90 days. 35% of readmissions to a hospital for Medicare recipients is because they don’t take their medications appropriately.
So we had a program that we’re relaunching called [Meds and Beds] and really going after that opportunity to save a person a readmission in a hospital, $50,000 or more.
Albert Rice
We’re running out of time. But let me just ask you about capital structure real quick. Where you’re at with that? I know you tendered for some bonds recently. I want you to make some comments on that.
Matt Schroeder
Sure. So I think certainly, ultimately paying down debt, delevering and addressing our capital structure is of pretty critical importance. I would point out that our leverage ratio at the end of the year, I would expect it to be in the low 5s. We have a target of getting down to about 4.5% at the end of fiscal 2025. The reason for the tender on the 2025 notes is they are the earliest debt maturity that we have. And actually, our credit facility is due in mid-2026. But there’s a springing maturity ahead of that.
So by tendering for these bonds, taking advantage of the market conditions, reducing amount of these bonds outstanding, I think, really helps put us in a place where it just gives us even more runway to address our strategic initiatives. And even with that tender, I still expect we had $1.3 billion of liquidity at the end of the second quarter, expect to have more than that by the end of the year even with the tender. So it gives us the flexibility and the runway we need to be successful.
Albert Rice
Okay. Well, I really appreciate Rite Aid participating. Heyward and Matt, thanks so much. And next up in this room will be [indiscernible].
Matt Schroeder
Thanks A.J.
Heyward Donigan
Thanks A.J.
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