One day after the abrupt resignation of Rite Aid Corp. Chairman Martin L. Grass and the company's disclosure that it had inflated profits by $500 million over three years, industry experts said Grass' departure was necessary to gain the confidence of investors.
"Obviously, with all the problems, someone had to take the blame for it. It was a way to put the past behind them and rebuild credibility," Glenn S. Curtis, an analyst at InsiderTrader.com, said of Grass' ouster. "Someone had to go down, and he was the likely candidate."
The stock market reacted to the news with zeal. Shares in Camp Hill, Pa.-based Rite Aid, the nation's No. 3 drugstore chain, rose 18.8 percent yesterday in heavy trading, shooting up $1.4375 to close at $11.8125.
Some 8.1 million Rite Aid shares changed hands, more than double the three-month daily average.
That followed an announcement after the close of trading Monday that provided few details about Grass' departure or about the $500 million the company expects in restatements.
Rite Aid, which also announced that leveraged buyout specialist Leonard Green is putting in $300 million for a 9.7 percent stake in the company, would not address Grass or the company's accounting problems.
Messages left for Grass at his home were not returned.
Timothy J. Noonan, the Rite Aid chief operating officer who was appointed interim chief executive officer, and other Rite Aid executives also did not return calls seeking comment.
Green, whose bid to revive the struggling Hechinger hardware store chain was unsuccessful, was traveling and could not be reached yesterday.
Howard Davidowitz, chairman of New York's Davidowitz & Associates Inc. retail consulting firm, said Grass had to leave in order to restore investors' confidence. "My opinion is that [board members] did what they had to do," he said. "The business has been demolished."
"I think with the $500 million restatement it was cut and dried, they had no choice. Any board would have done the same thing," said Mark Millman, president of Millman Search Group Inc., a retail consulting firm in Lutherville.
Monday's announcement marked the second by the company in five months that involved the restatement of earnings for fiscal years 1997, 1998 and 1999. Earlier, Rite Aid had restated earnings lower by $23.5 million for those years.
KPMG LLP, Rite Aid's accounting firm, according to the company's filings with the Securities and Exchange Commission, also declined to comment on Monday's events. Because of "client confidentiality, we don't discuss matters involving our clients," said John Fidler, a spokesman for KPMG.
The re-evaluation of Rite Aid's earnings was prompted by an SEC review of the company's statements when it filed documents in December for a $650 million debt offering.
Joseph Grundfest, a professor of law and business at Stanford University who has studied corporate accounting practices, said it would be premature to draw conclusions about Rite Aid's financial management.
"Why were there restatements?" he said. "What were the causes? You can have restatements that are relatively technical, and you can have restatements that are the consequence of nefarious conduct."
The company faces several shareholder suits alleging that it made misrepresentations that caused the stock to trade at inflated levels.
"It's not just yesterday or today," said Stuart J. Gruber, an attorney with Philadelphia-based Berger & Montague, which has been appointed co-lead counsel in cases against Rite Aid. "It's over the last few months that there have been a number of adverse news releases."
Gruber said the company's announcement will expand shareholders' complaint against Rite Aid. "We will be adding new allegations based on the more current news," he said.
In addition to the class action claims, the Florida attorney general's office accused Rite Aid in September of "racketeering and civil theft" and said the chain systematically overcharges consumers for prescriptions. A spokeswoman for that office said the attorneys handling the case were attending a conference and unavailable for comment.
Retail consultants said Rite Aid's problems grew largely from its aggressive expansion strategy under Grass, 45, who took control of the company from his father, founder Alex Grass, in 1995.
Under Grass' leadership, Rite Aid swallowed up smaller drugstore chains such as Thrifty PayLess to add more than 1,000 stores, most of them in the West; bought PCS Health Systems Inc., the nation's largest pharmacy-benefits manager; opened hundreds of drive-through pharmacies; and courted new business on the Internet and from customers looking for alternative medicines.
Rite Aid acquired the Thrifty PayLess chain for $2.3 billion in 1996, giving it more than 1,000 additional stores and a new Western territory.
Between February 1995 and August 1999, Rite Aid closed 2,177 stores, relocated 1,133 and opened 670 new stores. It now has about 3,800 stores.
Davidowitz said Rite Aid's troubles are especially significant because the drugstore industry in general is doing well.
"Everyone is booming, booming, except [Rite Aid]. It's very strange," Davidowitz said. "They went crazy, they over-leveraged the company. Management had so many things going on, the company got out of control, and that's reflected in the earnings restatements."
Steven J. Valiquette, an analyst at Warburg Dillon Read LLC in New York, agreed that Rite Aid grew too fast, but he said the earnings restatements were, more than anything else, an outgrowth of the way the company handled its store closings and relocations.
Rite Aid closed stores that had three or four years left on the leases, then wrote off those lease payments as one-time charges, he said. Its competitors typically closed stores with less than a year left on the leases, then treated the charges as a routine cost of doing business.
"Auditors are saying [to Rite Aid], 'You can't do that, you have to treat it as an operating expense,' " Valiquette said. "That's why there's a $500 million restatement. They almost tricked themselves."
Rite Aid must sell its unprofitable stores and get rid of a large portion of its $4.5 billion in debt to turn things around and remain a viable company, analysts said.
The sale of PCS could help Rite Aid shed some of its obligations. Rite Aid bought PCS from Eli Lilly & Co. for $1.5 billion in January but said earlier this month that it is looking for someone to buy all or part of the subsidiary.
"There will be selling off of some properties and holdings, such as the PCS division, to reduce debt and get back to a smaller, leaner organization," Millman said. "They have a good branding name and a good customer following. They just took on too much debt."
The Associated Press contributed to this article.