Rite Aid Corp. teetered on the brink of ruin more than two years ago after an accounting scandal led the company to wipe away $1.6 billion in profits.
Employee morale was in the gutter, supplier relationships were in tatters, angry shareholders were suing, and federal regulators were poring over the books.
A mountain of debt -- almost $7 billion -- was crushing the company. It was largely the legacy of Martin L. Grass, who as chief executive officer had gone on an acquisition spree in the mid-1990s only to be forced out and later indicted.
Now under new management, the No. 3 drugstore chain is regaining its footing having endured the kind of corporate catharsis that many companies -- from Enron Corp. to WorldCom Inc. -- are just beginning.
Analysts said the new management team has done a good job of dealing with the legacy left by Grass and other former managers. But the company still has far to go as it squares off against Walgreen Co., the No. 1 drug chain, and second place CVS Corp.
"I think they have their work cut out for them in a pretty competitive retail environment and a pretty competitive drugstore retail environment," said Stephen C. Chick, a retail analyst with J.P. Morgan Chase & Co. in New York City. "I think execution is pretty big, and demonstrating that the problems of the past aren't necessarily structural."
Led by Chairman and CEO Robert G. Miller, the chain embarked on its recovery program by installing new managers, closing unprofitable stores and negotiating with lenders for more breathing room.
Miller revamped the management structure, moving senior vice presidents from company headquarters near Harrisburg, Pa. to regional offices closer to the stores they supervise.
Since arriving in December 1999, Miller has been shoring up Rite Aid's balance sheet through the billion-dollar sale of its pharmacy benefits subsidiary and refinancing maneuvers that have pared its debt to $4 billion.
"Even though I would not say we're not highly leveraged, we're certainly leveraged [at a point] where we can manage now," said Miller, who previously turned around Fred Meyer Stores Inc., enabling the grocery chain to be sold in 1999 to Kroger Co., the nation's top grocer.
Signs of progress are showing up in Rite Aid's results. Sales have grown steadily, from $11.4 billion in fiscal 1998 to $15.2 billion in fiscal 2002, which ended March 2.
In the 2002 fiscal year, Rite Aid slashed its annual loss nearly in half from fiscal 2001 -- to $828 million from $1.6 billion. In the first quarter this fiscal year, it posted its first profit in five years -- $2.6 million -- as a result of asset sales and a tax benefit.
"They've been improving margins," said Diane Shand, a director in Standard & Poor's corporate rating division in New York. But Rite Aid is "still very highly leveraged, and their operating performance is still significantly below its peers," she said.
S&P;'s rating of Rite Aid's corporate debt is a single "B with a positive outlook," a highly speculative grade with a lot of risk.
Shand said Rite Aid's operating performance has improved under its new management and that if the progress continues, its credit rating probably would be upgraded.
The company's stock price continues to languish, closing Friday at $2.03 after trading at more than $50 before the accounting problems surfaced in late 1999.
Rite Aid amassed much of its debt after Grass embarked on an ambitious expansion program having wrested control of the company from his father, company founder Alex Grass, in a boardroom coup in 1995.
Under Martin Grass, Rite Aid bought Thrifty Payless Holding Inc., a West Coast pharmacy chain, for more than $2.2 billion in stock and debt. Thrifty and other chains bought by Grass raised the number of Rite Aid stores to 3,800 increasing the company payroll to 85,000.
The acquisitions, which also included the $1.5 billion purchase of PCS Health Services, a pharmacy benefits manager, from Eli Lilly & Co., put pressure on the balance sheet.
Revelations of accounting irregularities surfaced in October 1999, and Grass, then a resident of Baltimore County, and others were ousted, or soon left the company, leaving it on the verge of bankruptcy.
Last month, Grass and two other former Rite Aid officials were charged in a 37-count indictment alleging they manipulated the company's earnings, inflated its financial statements and personally profited from the scheme.
Although the indictments spotlighted Rite Aid's troubled past, they were accompanied by some relief. The Securities and Exchange Commission announced that it had resolved its investigation into Rite Aid's accounting practices and would not seek to penalize the company.
"That the company's not getting fined, all things being equal, that's good news," said Sheldon Grodsky, director of research of Grodsky Associates Inc. in South Orange, N.J. "They're going after the former officers rather than trying to inflict more pain on the shareholders."
Miller said, "Two years ago, we had lots of problems. ... Our job has been to look forward, not backward."
Rite Aid is focused on reducing debt, controlling costs and wringing profits from its stores, Miller said.
One key milestone was a huge refinancing in June last year that helped reduce debt by more than $2.5 billion, to the current $4 billion, and pushed back the due date on a big portion of that to 2005 and beyond.
Rite Aid also has access to a $500 million line of credit, which it hasn't used because the company's cash flow has improved, Miller said.
But Rite Aid's leveraged balance sheet means the company can't afford to open many new stores. The consequence, analysts said, is that the company will have limited ability to compete as rival chains expand.
"Rite Aid is still a major player, still a force in the industry," said Eric Bosshard, research director of Midwest Research in Cleveland. "But they're not able to be as aggressive as they could if they had a very good balance sheet."
Robert Goch, a fixed-income analyst with Miller Tabak Roberts Securities LLC in New York, says company officials are "are limited in their capital, in respect to [opening] new stores, and that puts them at a comparative disadvantage."
Instead, Rite Aid is spending what money it has on sprucing up stores through what it calls "paint and powder" programs. Under Miller, the company has shed about 300 stores and had 3,454 as of June 1.
Mary Sammons, Rite Aid's president and chief operating officer, said more than 50 percent of Rite Aid's stores are new or have been relocated within the past five years. "We're investing most of our capital dollars on remodels" over the next few years, she said.
Rite Aid has allocated most of this fiscal year's $110 million to $120 million capital budget to store upgrades and relocations, Sammons said.
A recently remodeled store in Glen Burnie is the chain's prototype. It has a drive-through window, an in-store GNC vitamin center, one-hour photo processing and a more-efficient pharmacy configuration.
The chain has 67 stores in the Baltimore area and 143 in the state. Sammons said Rite Aid is first in the Baltimore market in terms of market share.
Rite Aid has 37 stores in the city, compared with 26 for CVS and nine for Walgreen. CVS, which has been expanding aggressively, has more stores statewide than Rite-Aid does, 164.
Rite Aid also has a distribution center in Perryman in Harford County that employs 1,200 and feeds merchandise to about 770 stores in seven states and the District of Columbia. It is one of eight such centers across the country.
One way chains try to gain market share is by buying prescription files from other chains or independent drugstores that close.
Rite Aid plans to spend about $20 million on prescription file acquisitions this year.
"It's a very fast return on investment as long as you're well equipped to take care of the extra customers whose files move over to your store," said Rite Aid spokeswoman Karen Rugen.
More than 60 percent of Rite Aid's sales come from prescription sales. The sales have kept pace with the increase being experienced by the industry.
And with the baby boomer population approaching retirement age, retail drug sales are expected to help pharmacy sales grow 10 to 12 percent a year, some analysts said.
According to the National Association of Chain Drug Stores, prescription drug sales rose 13 percent last year, from $145.6 billion in 2000 to $164.1 billion.
The number of prescriptions is expected to soar 33 percent over the next three years to about 4 billion by 2005, and the number of pharmacists in retail stores is expected to remain almost stagnant at fewer than 140,000 nationwide, a trend that could inhibit store openings, some experts said.
"The number of prescriptions will grow due to new drugs and an aging population," said Mary Ann Wagner, vice president of pharmacy regulatory affairs for the National Association of Chain Drug Stores in Alexandria, Va. "Whether that will translate into additional profits for pharmacies is unclear."
Rite Aid and other chain drugstores also face increased competition from discounters such as Wal-Mart Stores Inc., supermarkets and mail-order companies.
Sammons said Rite Aid is putting together a marketing program that will lure pharmacy customers into other parts of the store.
The company has also introduced more of its private label merchandise -- such as hair-care products -- in hopes of luring customers with better deals and improving profit margins, Sammons said.
The goal of these initiatives is to increase non-pharmaceutical sales, which have been lackluster for many drugstore chains because of Sept. 11 and the recession.
Rite Aid's non-pharmaceutical sales have slowed in recent months, but the chain is still beating Walgreen and CVS in a two-year comparison, said retail drugstore analyst David Rodgers of McDonald Investments in Cleveland.
Miller and Sammons said growth potential in the pharmacy sector is sufficient for Rite Aid to keep pace with the competition, even with Walgreen planning to nearly double the number of its stores to 6,000 by 2010.
"If you look at the pharmacy pie, the whole pie is growing tremendously," Miller said. "The chain drugstore is keeping up with our sector. Our job is to make sure we're prepared to handle our growth in our existing stores."