Rite Aid's Former Executives May Face Charges, Analysts Say
Camp Hill, Pennsylvania, July 12 (Bloomberg) -- Rite Aid Corp.'s former top executives may face charges of fraud and criminal activity for the accounting practices they used while leading the No. 3 U.S. drugstore chain, analysts and investors said.
``There is tangible evidence that the company cooked the books and it's not by a little,'' said John Ransom, an analyst at Raymond James Financial Inc. ``It's by a lot.''
Rite Aid yesterday said it overstated profit in fiscal 1998 and 1999 by more than $1 billion, the second time it restated earnings lower in the past 13 months. The company also said that losses in its fiscal first quarter and last year widened.
New management led by Chief Executive Robert Miller spent seven months and $50 million investigating Rite Aid's accounting, the results of which were turned over to the Securities and Exchange Commission and the U.S. Attorney's Office. The federal investigators are continuing probes begun in the past year, the company said. Rite Aid also will face shareholder lawsuits, analysts and investors said.
Those who may be liable for the accounting practices include Martin Grass, auditor KPMG International and Rite Aid's former board, analysts said. Chief Financial Officer Frank Bergonzi also could be named. Bergonzi announced his retirement in June 1999, three months after the accounting discrepancies first surfaced.
Grass and Bergonzi couldn't be reached for comment. KPMG spokesman Alec Houston declined to comment, saying the company was ``not a party to this new report.''
``Presumably, some of the former management will be spending a lot of time in court,'' said analyst Sheldon Grodsky of Grodsky Associates.
Rite Aid shares fell 1 5/8, or 21 percent, to 6 on the New York Stock Exchange. They've dropped 88 percent from a high of 51 1/8 in January 1999. In the two and a half years before its peak, the stock quadrupled as the company made acquisitions and opened stores to expand across the U.S.
Management
Miller, previously Kroger Co.'s vice chairman and chief operating officer, joined Rite Aid in December along with three other executives from Kroger's Fred Meyer chain. He took over for investor Leonard Green, who replaced Martin Grass after the son of Rite Aid founder Alexander Grass quit in October.
Rite Aid's former accounting firm, KPMG, resigned in November, saying it couldn't rely on management's statements. Deloitte & Touche LLP replaced them.
Rite Aid's problems come at a time when the Justice Department is getting tough on financial fraud, Ransom said.
``If the Justice Department gets interested in an SEC accounting case, it must regard the target as having a serious problem because they don't usually get involved,'' said former SEC general counsel Dan Goelzer.
Goelzer, now a partner with the Baker & McKenzie law firm in Washington, said Rite Aid faces severe SEC fines if the company is found to have ``knowingly and intentionally'' committed fraud.
These fines ``would be more serious still'' if Rite Aid executives were found to have manipulated earnings so they could personally profit by, for example, exercising stock options, Goelzer said.
Troubles
Rite Aid's troubles emerged in March 1999 when the company said fourth-quarter earnings would be less than expected. The company blamed the shortfall on increased costs to integrate numerous acquisitions.
The company added more than 1,300 stores through its purchase of the K&B Inc. and Harco Inc. chains in 1997 and its acquisition of Thrifty Payless Holdings Inc. in 1996. Rite Aid has about 3,800 stores.
Three months later, Rite Aid made its first restatement of earnings for fiscal 1997 to 1999 as the SEC reviewed its accounting practices.
After Martin Grass quit in October, Rite Aid received $300 million from Leonard Green & Partners, a firm that often invests in troubled companies. Green became interim chairman from Nov. 1 until December, when Miller took the helm.
Rite Aid postponed reporting earnings in January after Miller and Deloitte & Touche began reviewing its books.
Analysts and investors compared the accounting troubles to those at Cendant Corp., the New York-based marketing and franchising company behind Days Inn hotels. Three former executives, including its chief financial officer, pleaded guilty last week to participating in a scheme to inflate profits.
Restatement
Yesterday, Rite Aid said it lowered fiscal 1999 profit by $566.2 million and 1998's profit by $492.1 million.
The loss in the quarter ended May 27 widened more than fivefold to $237.5 million, or 92 cents a share. For the year ended Feb. 26, Rite Aid's loss from operations almost tripled to $1.12 billion, or $4.34 a share.
Rite Aid gave little information about its profit outlook on a conference call yesterday, causing many analysts and investors to lose confidence in the company.
``We just have to see how much they can do in their current situation,'' said David Dreman, chairman of Dreman Value Management, which owns about 5 million shares of Rite Aid, down from about 5.9 million at the end of March.
Earnings before interest, taxes, depreciation and amortization will have to come from increased sales because there are no costs to cut, said analyst Andy Wolf of BB&T.
In fact, costs may rise because Rite Aid has to add merchandise to its stores and may need to increase incentives to pharmacists, he said.
``The company is not going to make money for the foreseeable future,'' Wolf said. ``The valuation doesn't make sense either.''
Rite Aid's shares are more expensive than its rivals based on some measures. Rite Aid's enterprise value, which measures the takeover value of a company, is 20.1 times estimated EBITDA, after the sale of its PCS Health Systems Inc. unit. That's higher than Walgreen Co.'s 19.6 and CVS Corp.'s 11.2, Wolf said.
Rite Aid is the No. 3 drugstore chain by sales after Walgreen and CVS.
Jul/12/2000 18:28 ET
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