IMAGE SOURCE: THE MOTLEY FOOL.

Rite Aid Corporation (NYSE:RAD)
Q1 2019 Earnings Conference Call
June 27, 2018, 5:00 p.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Good afternoon. My name is Christina, and I will be your conference operator today. At this time, I would like to welcome everyone to the Rite Aid Fiscal 2019 first quarter earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. If you would like to ask a question during this time, simply press * then the number 1 on your telephone keypad. If you would like to withdraw your question, press the # key. Thank you.

Matt Schroeder, Chief Accounting Officer, you may begin.

Matt Schroeder -- Senior Vice President, Chief Accounting Officer and Treasurer

Thank you, Christina. Good evening, everyone. We welcome you to our first quarter earnings conference call. On the call with me tonight are John Standley, our Chairman and Chief Executive Officer; Kermit Crawford, our President and Chief Operating Officer; and Darren Karst, our Chief Financial and Chief Administrative Officer. On today's call, John and Kermit will provide an update on the business, Darren will provide an update on our first quarter results, and then we will take questions.

As we mentioned in our release, we're providing slides related to the material we will be discussing today. These slides are provided on our website, www.riteaid.com, under the Investor Relations information tab. We will not be referring to them in our remarks, but hope you'll find them helpful as they summarize some of the key points made on the call.

Before we start, I'd like to remind you that today's conference call includes certain forward-looking statements. These forward-looking statements are presented in the context of certain risks and uncertainties that can cause actual results to differ. These risks and uncertainties are described in our press release, in Item 1A of our most recent annual report on Form 10-K, and other documents that we file or furnish to the Securities and Exchange Commission. Also, we will be using certain non-GAAP measures in our release. The definition of the non-GAAP measures, along with the reconciliation to the related GAAP measure, are described in our press release.

Also, included in our slides are the non-GAAP financial measures of adjusted EBITDA gross profit and adjusted EBITDA SG&A and the reconciliations of these measures to their specific GAAP measure. With these remarks, I'd now like to turn it over to John.

John T. Standley -- Chairman and Chief Executive Officer

Thanks, Matt, and thanks to everyone for joining us on the call this morning. Our first quarter results show continued progress in our retail pharmacy segment, while we continue to make operating investments in our pharmacy services segment to support growth. During the quarter, as we focused on taking great care of our customers and executing our stand-alone strategy, we also continued pursuing a tremendous opportunity to transform our business by combining with Albertsons to care a truly differentiated leader in food, health, and wellness.

This combination will enhance our scale and density to better compete in existing markets, give us access to new markets, significantly improve our omnichannel capabilities, and create the opportunity to achieve substantial cost synergies and revenue growth, all of which will strengthen our financial profile and position us to deliver compelling long-term value for customers and shareholders. We'll talk more about these compelling opportunities in just a few moments. Before we do, let's take some time to discuss our results for the first quarter.

Overall, our net loss from continuing operations was $41.7 million, compared to $36 million in last year's first quarter. Our adjusted net loss from continuing operations of $0.01 per share was consistent with our performance in the prior year period. Adjusted EBITDA from continuing operations for the quarter was $147.3 million, compared to last year's pro forma adjusted EBITDA of $160 million. For the purposes of comparing our results to the prior year, last year's pro forma number includes fee income that would have been earned if all stores sold to WBA had been supported under the TSA for that period.

Adjusted EBITDA for our retail pharmacy segment increased by $2.1 million, compared to pro forma adjusted EBITDA for last year. The improvement was driven by strong pharmacy gross margin and effective expense management. This is the second consecutive quarter that we've delivered adjusted EBITDA growth in our retail pharmacy segment. In our pharmacy services segment, adjusted EBITDA decreased $14.7 million, which was driven primarily by investments we made for growth in EnvisionRx Options. In terms of the selling season or EnvisionRx Options, we continue to have a strong pipeline of prospects and have gained some additional lives in our commercial book of business.

Medicare per diem enrollment remains strong and I am pleased to announce that we did submit a bid to reenter the California Medicare Part D market in Calendar 2019. During the quarter, we sold the last group of stores to WBA. The proceeds from the asset sale to WBA have enabled us to reduce our debt by approximately $4 billion. Our debt, net of outstanding cash, is currently at around $3 billion and as a result, our leverage ratio has substantially improved to 4.8X, using LTM-adjusted EBITDA compared to our pre-asset sale ratio.

Overall, we are pleased with the progress we're making as we implement our new strategy. In a consolidating and evolving marketplace, we are working hard to defend and improve our competitive position. At the same time, after carefully reviewing our strategic options, we believe we have a unique opportunity to further accelerate these efforts and significantly enhance our competitive position through the combination with Albertsons. By transforming our business from a strong regional pharmacy player to a Top 5 food and drug retailer, we will be even better positioned to deliver significant value.

On a combined basis, the company will serve over 40 million customers every week, with approximately 4,300 counters nationwide. We will have increased local market scale with highly recognizable brands to better compete in markets where scale matters. We will have a stronger presence in key existing markets with the No. 1 or 2 positions in 66% of combined metropolitan areas. We will have a best-in-class omnichannel platform, a strong loyalty program, and a portfolio of innovative and healthy own-brand products, all of which will allow pharmacy and grocery customers to shop where, when, and how they want.

We expect to realize $374 million in run rate cost synergies with $3.6 billion in incremental revenue opportunities. We will also have a strong and diversified cash flow that will allow us to reinvest in our business and de-lever faster than Rite Aid can on a stand-alone basis. All of these factors will enhance our ability to compete in the face of increasing competition, drug reimbursement rate pressure, and consolidation in our industry.

With that, I'd like to turn it over to our President and COO, Kermit Crawford, for an update on key initiatives and some of the areas we're most excited about in terms of potential combination with Albertsons. Kermit?

Kermit Crawford -- President and Chief Operating Officer

Thank you, John, and thanks to everyone for joining us today. In the first quarter, we continued making important progress as we implement various components of our strategy to set the stage for future growth and to deliver a higher level of personal care in the communities we serve. Although our same-store sales results were impacted by an earlier Easter, as well as a slow start for the allergy and summer categories, front-end sales trends returned to a more normal level in May.

We continued having success with many of our most critical initiatives. A great example is the successful relaunch of our award-winning customer loyalty program, wellness+ rewards, which was supported by a comprehensive marketing campaign during the first quarter.

Customers are responding very positively to this enhanced program, which has been simplified with an easier, three-step sign-up and the introduction of bonus cash, which has replaced Plenti Points. During the first quarter, transactions, earnings, and redeeming bonus cash more than doubled compared to Plenti Points for the same period last year.

Our best customers continue to be more engaged and carded transactions accounted for more than 75% of our first quarter front-end sales. This is helping us to further build our CRM database and create opportunities for increased personalization in our direct marketing initiatives. Also, we are continuing our evolution from print advertising to digital marketing, highlighted by a 15% reduction in print circulation compared to last year's first quarter, as we invested more to leverage the potential of our digital channels. Additionally, our mobile app unique user base continues to grow, with the number of prescription refills requested through the app increasing by 32% compared to last year's first quarter. Our omnichannel customers are also realizing the enhancements that we have made to our e-commerce business.

Our wellness+ rewards members enjoy all the same card benefits online and have access to an expanded assortment. To improve our customer experience, we have transitioned our e-commerce fulfillment from a third-party provider to our own distribution network, which has improved our fulfillment lead time, lowered costs, and allowed us to increase our online offerings by 25%.

Our Rite Aid on-brand offering continues to be a major point of emphasis to help drive front-end revenue and margin. Year-to-date, we've introduced 160 redesigned or new items with additional items in various stages of roll-outs or development. Most new items are in health, beauty, and personal care, with emphasis on our Daylogic personal care and Rite Aid Pharmacy OTC brands. We continue to see significant opportunity to increase our own-brand penetration and deliver value through a combination with Albertsons utilizing their own-brand expertise in items such as O Organics and Open Nature. Our own-brand program is one of the initiatives that support efforts to create tailored offerings that are specific to each local market.

Another example of this hyper-local approach is our new field leadership structure, which we implemented at the beginning of the fiscal year to better support Rite Aid's new retail footprint. This process involves redrawing our district and region boundaries, reducing the number of stores in each area, and empowering our leaders to lead both the front end and pharmacy. After more than 90 days, we are very pleased with the feedback we've received thus far.

Our new structure not only reduces SG&A, but also gives our leaders the ability to better support their teams and customers through more frequent store visits. We continue to see positive results from our innovative wellness store format, which features expanded health and wellness offerings, along with additional convenience such as drive-through pharmacy. With the 49 remodels we completed during the quarter, we now have nearly 1,700 wellness stores, which represent more than two-thirds of our entire store network. These stores continue to outperform the rest of the chain in terms of front-end, same-store sales and script count.

Providing an excellent customer experience continues to be a top priority. For the sixth consecutive quarter, we have improved our overall customer satisfaction compared to the prior year. In fact, overall customer satisfaction reached an all-time high in the first quarter of this year. In the area of pharmacy, reimbursement rate pressure remains a constant challenge, but we continue to see rates stabilize for a second consecutive quarter. Pharmacy gross margin increased compared to prior year, despite a slight underperformance in generic purchasing due to a more stable reimbursement rate environment. As we have stated before, identifying the best long-term option for effectively managing our drug purchasing costs continues to be a top priority.

In terms of script growth initiatives, we invested $13 million in file buys during the quarter, and we've allocated $60 million for the year. File buys are a tremendous opportunity to build our script volume, and we will continue focusing on making the most of these strategic investments. As a reminder, we will fully cycle significant plan exclusions by the end of the second quarter and therefore expect same-store prescription counts to be stronger in the back half of the fiscal year, which should also help improve front-end sales. We're also continuing our efforts to engage with payer partners and thanks to these efforts, we plan to increase our participations in Medicare Part D preferred networks in 2019. Developing these strategic partnerships with payers will continue to be a critical priority.

We also remain focused on our goal of being the trusted advisor for our pharmacy customers to better meet their changing healthcare needs. For us, this process starts with operational efficiently in the pharmacy to free up time for our pharmacists to provide a higher level of personal care. In previous calls, we've mentioned how capabilities like one-trip refills, automated courtesy refills, and text messaging alerts are helping us become more efficient, while also freeing up time for our pharmacists to provide additional services, such as medication therapy management, administering immunizations, and improving medication adherence.

As a result of these efforts, we saw medication therapy management grow equivalent to 24,000 incremental prescriptions in the first quarter. We have also seen a significant increase in the percent of 90-day prescriptions filled for patients with chronic conditions. After a very strong flu season, we turned our team's focus to non-flu immunizations, supported by an increased marketing effort. Through these efforts, non-flu immunizations more than doubled compared to last year's first quarter. Specifically, we saw strong growth in shingles immunizations due to the availability of a new shingles vaccine. The CDC recommends that healthy adults 50 years and older get two doses of this vaccine, separated by two to six months to prevent shingles and the complications of this disease.

Finally, Rite Aid and Health Dialog have teamed up to create a dedicated medication support team, which conducts outreach for non-compliant patients in an effort to improve medication adherence. We're excited, as the early results of this integrated effort have been very positive. The ability to further leverage Rite Aid's pharmacy expertise in our unique healthcare businesses in a merger with Albertsons makes this opportunity even more attractive, due to greater scale and increased presence in key markets, especially on the West Coast.

On our Fiscal 2018 fourth quarter call, we discussed our significant progress with Medicare Part D enrollment for our PBM, EnvisionRx Options. As of May, we have enrolled over 540,000 Medicare Part D lives. We anticipate steady month-over-month growth will continue through the remainder of the year, and that we will meet our goal of 600,000 enrolled lives in calendar 2018. Likewise, Envision's specialty revenue continues to grow in the first quarter. Specialty pharmacy continues to be an important opportunity in our go-forward strategy and we have seen strong growth in this key area of our business.

Commercial and third-party health plan sales continue to perform well, as we are in the middle of the sales season, with over 256,000 new lives already won. We have also secured several significant client renewals thus far in the selling season and are tracking toward retention rates in excess of 95%. Remaining client renewals are expected to be solidified in the new two to three months.

Beyond Envision, both RediClinic and Health Dialog continue to be key assets that give us a unique opportunity to deliver a higher level of care and support. With RediClinic, we continue to explore opportunities for joint ventures with healthcare systems in the communities we serve. As we've mentioned on previous calls, we see tremendous potential for RediClinic through a combination with Albertsons, as RediClinic is a proven performer in a grocery store setting.

We mentioned earlier how we're taking critical steps to further leverage Health Dialog in driving better health outcomes for Rite Aid patients. We continue to see great potential in utilizing the analytical capabilities of Health Dialog to deliver value in performance-driven paired networks, which will be critical heading forward. Before I turn it over to Darren, I also wanted to mention how we continue to be highly focused on working with our communities and other organizations to help address the epidemic of drug abuse and misuse that is plaguing our country. Through the company and the Rite Aid Foundation's efforts, we have taken several key steps to implement a comprehensive strategy to help address this issue, especially when it comes to opioid abuse.

Among other steps, Rite Aid has made Naloxone available at all of our more than 2,500 pharmacies. We also became the first drugstore chain to offer free dispose Rx packets to our patients, which gives them a safe way to dispose of leftover or unwanted prescriptions at home. We've also partnered with law enforcement to install nearly 300 safe medication disposal units in the communities we serve. Earlier this month, we launched our first in-store medication disposal units and we plan to install 100 additional units over the next year.

The Rite Aid Foundation has also joined forces with school districts and a leading technology innovator to bring online prescription drug abuse prevention programs to high school students in several of the key communities we serve. We know that we cannot solve this issue on our own, but we also know that as a leading pharmacy chain, we can take on a leadership role in helping to address this epidemic. We look forward to continuing these efforts by working closely with our neighbors, elected officials, and other organizations.

Thank you for your time. Now, I will turn it over to Darren Karst for more information on our financial results. Darren?

Darren Karst -- Senior Executive Vice President, Chief Financial Officer & Chief Administrative Officer

Thanks, Kermit, and thanks, everyone for joining us today. I will walk through our first quarter financial results, as well as recap our progress on the use of proceeds and bond redemptions related to the WBA asset sale.

As we discussed on our last call, as of March 27th, we had completed the sale and transfer of all 1,932 stores to WBA and received cash proceeds totaling nearly $4.2 billion. This amount does not include about $220 million that will be received after we sell three distribution centers to WBA sometime after September 1, 2018. The proceeds received to date have been used first to pay off all of our $970 million of term loans.

We also completed two excess proceeds offers, as required under our bond indentures, of $900 million and $700 million, which resulted in an aggregate repayment of approximately $55 million under our 9.75% notes due 2020, our 6.75% notes due 2021, and our 6.125% notes due 2023. Those offers freed up cash proceeds to allow us to call the remaining principal on our 9.25% notes, which we redeemed on April 12, and the remaining principal on our 6.75% notes, which we redeemed on June 25th. We've also permanently reduced our revolving credit commitments from $3.7 billion to $2.7 billion, to reflect our reduced borrowing requirements.

The receipt of proceeds and paydown of debt in the first quarter gave us a debt balance net of cash of about $3 billion as of quarter end, and a leverage ratio of approximately 4.8X trailing EBITDA. Our liquidity as of today, which reflects the recent borrowings we made under our revolver to redeem our 6.75% notes, is strong at $1.5 billion.

I'll now turn to a review of our first quarter results. Net income for the total company was $214.4 million, or $0.20 per share, versus a net loss of $75.3 million, or $0.07 loss per share in last year's first quarter. During the quarter, we recorded a gain of $269 million on the sale of 281 of the divested stores sold to WBA. Note that our quarterly operating results reflect the stores that remain as part of continuing operations. Revenues for the quarter were $5.4 billion, which was a decrease of $48 million from the prior year quarter or 0.9%.

Net loss from continuing operations was $41.7 million versus a net loss of $36 million in the prior year. The increase in net loss was due primarily to higher interest expense, lease termination and impairment charges, and transaction costs, partially offset by an increase in adjusted EBITDA. Adjusted net loss in the current quarter was $11.5 million, or $0.01 loss per share versus adjusted net loss of $9.2 million, or $0.01 loss per share in the prior year quarter.

Adjusted EBITDA was $147.3 million in the current quarter, compared to $136 million in the prior year quarter. Actual Fiscal 2018 quarterly results from continuing operations do not include $24 million of fees that would have been earned if all 1,932 stores sold to WBA were being supported under the TSA for the entire prior year period. When considering these fees, pro forma adjusted EBITDA would have been $160 million in the prior year quarter.

Adjusted EBITDA in our retail pharmacy segment increased by $26.1 million, versus our prior year actual results, or $2.1 million when compared to the prior year TSA pro forma adjusted EBITDA. In our pharmacy services segment, adjusted EBITDA declined by $14.7 million. Retail pharmacy segment revenue for the quarter was $3.9 billion, which was $75 million, or 1.9% lower than last year's first quarter, due to the impact of store closures and a decline in same-store sales. Same-store sales decreased 0.7% in the quarter. Front-end same-store sales decreased by 1.8% due to soft seasonal sales that were impacted by the timing of an earlier Easter and a slow start for our allergy and summer categories.

Pharmacy same-store sales decreased by 0.1%, with same-store script count down 1.5% on a 30-day adjusted basis, which was caused primarily by being excluded from certain pharmacy networks where we were able to participate in the prior year. We expect to cycle most of the impact of the pharmacy network exclusions in August of this year. Total retail pharmacy segment gross profit dollars in the quarter were $12.5 million higher than last year's first quarter and gross margin was 83 basis points higher as a percent of revenues.

Adjusted EBITDA gross profit was favorable to last year's first quarter by $12.3 million and 83 basis points better as a percent of revenues. The improvement in gross margin was primarily due to more stable reimbursement rates and year-over-year improvements in drug costs. Retail pharmacy segment SG&A expenses for the quarter were lower by $17.7 million compared to last year's first quarter, while SG&A rate as a percent of revenues increased by 7 basis points.

Adjusted EBITDA SG&A was $13.8 million better than the prior year, but 12 basis points worse as a percent of revenues. Our SG&A reflects the inclusion of TSA fee income from WBA in the current quarter, offset somewhat by increases in litigation charges and other operating expenses. The increase in SG&A rate was the result of negative expense leverage from reduced sales.

Retail pharmacy segment adjusted EBITDA in the quarter was $113.5 million, or 2.9% of revenues, which was $26.1 million higher than last year's first quarter adjusted EBITDA of $87.4 million. After adjusting the prior year EBITDA for the pro forma inclusion of TSA fees from WBA, retail pharmacy segment EBITDA improved by $2.1 million. Our pharmacy services segment had revenues of $1.5 billion, which was an increase of $29.5 million or 2%, primarily due to an increase in our Medicare Part D membership.

As we said on our last earnings call, we had a very successful 2018 Medicare Part D bid and continued to see strong enrollments this year. We are now covering over 450,000 lives and expect to grow covered lives throughout the remainder of the year, as we add enrollments throughout the course of calendar 2018. We've also had a good start in the commercial selling season, with over 250,000 lives won.

Adjusted EBITDA for the pharmacy services segment of $33.9 million was $14.7 million lower than last year's first quarter adjusted EBITDA of $48.6 million. Last year's adjusted EBITDA was a particularly strong quarter and so, in part, the current year variance reflects this difficult year-over-year comparison. The operating results for the quarter were impacted by margin compression in our commercial business and other operating investments, as we invest for current year and future growth. These investments are consistent with our strategy for Envision.

Our cash flow statement for the quarter shows a net use of cash from operating activities of $16.3 million, which primarily reflects timing differences and working capital, including a build in the current year CMS receivable in our pharmacy services segment, which was not funded by reinsurance as it was in the prior year. We expect the absence of reinsurance this year to continue to be a drag on working capital in Fiscal 2019.

Net cash used in investing activities for the quarter was $49.1 million versus $33.1 million last year. During the first quarter, we remodeled 49 stores and spend $13.7 million on file buys. At the end of the quarter, we operated 1,694 wellness stores within our continuing operations, which is almost 67% of the store base. We continue to be pleased with the performance of our wellness stores. For the first quarter, front-end same-store sales in our wellness stores that have been remodeled in the past 24 months were approximately 109 basis points higher than our non-wellness stores, and script growth in these stores was 249 basis points higher.

Turning to our outlook, we are confirming our Fiscal 2019 guidance today. Our guidance reflects our expectations for continued reimbursement rate pressure, albeit the reimbursement environment is expected to be more stable than in Fiscal 2018. We also expect generic purchasing benefits consistent with our historical experience and the continued anticipated benefits of our wellness remodel program and other initiatives to grow sales and drive operational efficiencies.

Key items that are expected to drive same-store sales include the cycling of plan exclusions in the second half of the year, clinical initiatives, and script file buys. As a result, we continue to expect the second half of the year to be somewhat stronger than the first half. Additionally, our guidance does not give effect to our pending merger with Albertsons. That completes more portion of the presentation and I'll now turn it back over to John to wrap up our call. John?

John T. Standley -- Chairman and Chief Executive Officer

Thanks, Darren. Before we begin taking questions, I'd like to thank our Rite Aid team for all of their great work during the quarter. We've been really aggressive in implementing the various components of our strategy and our team has done an outstanding job of executing these efforts. We've implemented a new field structure to support our new retail footprint, and we successfully transitioned our loyalty program to wellness+ rewards. We're completing file buys and additional wellness store remodels, and we're supporting stores we sold to WBA through the TSA, as we also pursue a tremendous opportunity to combine with Albertsons.

As we do all of this, our associates are working hard to support each other and deliver a great experience to our customers. Our team has really stepped up to help us make the most of the opportunities we have and we greatly appreciate their efforts. That concludes our prepared remarks for the call. We will now open the phone lines for your questions. Operator?