March 4: Looking Up--Maybe (Forbes Mag on Rite Aid)
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Looking Up--Maybe
Brett Nelson, 03.04.02
Bob Miller brought Rite Aid back from the dead. Now he must get the drugstore chain off of life support.
At 55, Robert Miller was ready to retire. He had just spent eight years reviving the Fred Meyer supermarket chain before selling it to Kroger. Then in October 1999 he heard from his old lieutenant David Jessick, the former vice president of Fred Meyer. Jessick had been asked to hunt for a rescue artist for Rite Aid, the sputtering $14 billion (sales) drugstore chain based in Harrisburg, Pa. Would Miller be interested in tackling another turnaround?
It was a tough sell. Rite Aid (nyse: RAD - news - people), then with 85,000 employees and 3,800 stores in 30 states, had a liquidity crisis, shareholder suits, underfed stores and fed-up suppliers. Oh, there was also an accounting scandal that led to investigations by the Securities & Exchange Commission and, later, the U.S. Attorney in Pennsylvania. Chief Executive Martin Grass had resigned; three years of earnings were restated, lopping off $500 million. Between January and October, Rite Aid's shares fell from $50 to $10.
Jessick made the case: Although a heavy debt load made Rite Aid's bottom line dismal, the stores were capable of operating profitably. The chain, Jessick argued, was generating operating income (net before depreciation, interest and taxes) of $700 million a year. Postpone capital expenditures and that would be more than enough to cover debt service on $4 billion of bonds and capitalized leases. There was also $2.5 billion in short-term bank debt, but Miller could pay that off by selling assets. After visiting a few stores, Miller took the job.
What followed was one of the most grueling corporate restructurings in the retail industry. While Rite Aid now has enough cash to run stores and meet obligations through 2005, the turnaround is by no means complete. Miller faces a tough challenge from more efficient competitors like CVS and Walgreens. Worse, managed care companies are curbing reimbursements for prescription drugs, which account for 62% of Rite Aid's revenue. Says Miller: "We still have a lot of work to do."
But a little less than on that Sunday night in December 1999, when Miller landed in Harrisburg. He brought in the old Fred Meyer gang, including Jessick, now 48, and then went about scaring up cash to keep the shelves filled. Selling assets to pay off the bank debt, much of it due within a year, was tougher than Miller had expected. Rite Aid had a stake in newly hatched Drugstore.com worth $700 million on paper, but the shares were locked up until June. Not long before, it had paid $1.5 billion for a pharmacy benefit manager (a company that haggles over drug prices on behalf of medical insurers); J.P. Morgan, which led a syndicate in the bank loans, was trying to sell that unit but couldn't get a decent price.
Despite Jessick's initial analysis, the books understated Rite Aid's financial ills. To get a clearer snapshot, Chief Financial Officer John Standley, 38, started tracking daily cash receipts and disbursements. It appeared that the company would run out of cash any day. After a few weeks, Jessick started to crack. "Dave was in a catatonic state," says Mary Sammons, head of operations. Jessick blamed himself for getting all of them into this mess. He felt so low, he says, "Bob had to call me from his mom's funeral to jack me back up."
The pressure peaked in January 2000. Third-quarter numbers were owed to the SEC and the books were still in disarray. Standley and Jessick wouldn't consider signing the report; indeed, they had to do another restatement. If Rite Aid didn't report, the company would be in technical default on its debt unless it could get waivers from lenders. "They were a hostile mob," says Jessick. Bankers at J.P. Morgan and Salomon Smith Barney made a rash of calls and got the waivers. On Jan. 11, the filing date, Rite Aid announced it would suspend financial reporting until July. The stock fell 26% to $7.90; the 5.25% notes due in 2002 fell to just 58 cents on the dollar. "We had to save this thing," says Miller. "I didn't want to work for a bunch of distressed-bond holders."
Standley sent his wife and two kids to Los Angeles for two months while he often worked through the night, gaining 30 pounds from countless chili dogs. He hired 200 accountants on top of the 150 in-house bean counters. They had seven months to recreate three years of payments and invoices from records stored on hard drives, computer tapes and paper files. They counted inventory at 1,200 stores.
Miller and Jessick looked for more capital. Citibank, a big lender in J.P. Morgan's syndicate, found a way to lend another $1 billion by letting Rite Aid pledge more of its assets without breaking any clauses in its bond indentures. Citi's new senior-secured loan would mature on Aug. 1, 2002.
One slight wrinkle. Rite Aid had to convince the syndicate to extend maturities on $2.5 billion in debt, and its bondholders to push back another $470 million in notes, until after the Citibank loan was due. The banks were enraged: They had already agreed to a yearlong extension when Rite Aid announced its first restatement and now would have to wait two more years to get paid, if ever (S&P had just downgraded the company's debt to CCC+ from BBB-). If just one bank balked, the deal would fall through and Rite Aid would surely go bankrupt.
To nail down commitments, Miller and Jessick hit the road for six weeks in the spring of 2000, calling on banks and bondholders. They harped on the 12% annual growth in pharmacy sales since 1995. They promised to marshal assets so that the banks would be ahead of the bondholders. J.P. Morgan exchanged $200 million of debt for equity. By mid-May all lenders were on board.
A valiant but wasted effort if Standley didn't file those overdue financials by July 11. That day, at 5:02 p.m., Rite Aid announced its restatement. The press release had typographical errors; the document Jessick read from during the conference call was taped together. The new numbers erased an additional $1.1 billion of earnings in 1999 and 1998. More depressing: Rite Aid's $250 million in operating income wouldn't support its $6.7 billion in debt. The next day the stock closed at $6.
Thanks to the Citibank loan, Miller at least had some cash to run the stores. A day later he had the promise of more--the pharmacy benefit operation would be sold for $1 billion, $675 million of it in cash. Weeks later, Miller and company celebrated the refinancing at Sparks Steak House in Manhattan. After the meal, Chad Leat, head of global lending at Citibank, presented Miller with a plastic magician's wand, saying: "This is what you're going to need over the next couple of years."
Sammons toiled to get the stores humming again. Desperate for profits, Grass had jacked up prices on nonpharmacy items. "Our own people weren't shopping here," Sammons says. She slashed prices on Rite Aid's 1,500 top-selling items by 20%, closed underperforming stores, remodeled others, adjusted the product mix by location and paid angry suppliers.
But Miller could hear the debt bomb ticking. Citibank's new plan called for restructuring $3.2 billion in debt: A new $1.9 billion loan, due in 2005, would come from a new Citi syndicate; the rest from a patchwork of debt exchanges, private placements, and new stock and bond offerings. Eight months later the deal was done. Every bank in the Morgan syndicate got paid off, leaving just $288 million in notes and $140 million in amortization on Citi's new loan due before 2005. Those 5.25s of '02 now trade at 96 cents.
Rite Aid's Lazarus act will end up costing some $200 million in fees to bankers and accountants. And while debt holders may be singing, shareholders are stinging. Since June 2000 Rite Aid has increased its share base 56%; Miller may have to issue even more new stock to pay for a $155 million shareholder settlement, further diluting the stock. In the nine months to Dec. 31, 2001, Rite Aid lost $570 million on sales of $11.1 billion; it also posted its first quarterly decline in operating income since Miller took over two years ago. Shares have sunk to a recent $2.50.
"We weren't expecting the bump to be quite that big," says Christopher Gouskos, president of Textron Financial's commercial lending division, which committed $20 million to both Citibank syndicates.
Miller is keeping a tight grip on capital expenses--only 0.8% of sales, versus 4% at the competition. But there's room to grow internally: Rite Aid's sales per square foot at its 3,520 stores are $350, roughly half what Walgreens and CVS do. The long battle continues, but for the moment Miller can breathe a little easier. Says he: "We don't have to ask the controller every morning if we have any cash."
© 200[2] Forbes.com
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