Rite-Aid posts lower profit, warns on earnings, but makes progress on debt

By Paul Deckelman

New York, June 23 - Rite Aid Corp. on Thursday reported a lower fiscal first-quarter profit than it turned a year ago, and lowered its full-year guidance for the current 2006 fiscal year. But the Camp Hill, Pa.-based drugstore chain operator - third largest in the United States behind Walgreen's and CVS - also reported that it continued to make progress on reducing its debt load and interest costs, and is in a comfortable liquidity position.

In fact, "we have a boatload of liquidity in the near term" is how the company's chief financial officer, John Standley, described its cash and borrowing availability situation on a conference call following the release of quarterly numbers. He noted that the company has an undrawn $950 million revolving credit line, and so does not have to pursue any transactions to raise cash at this time.

His comment came in response to an analyst's question about whether Rite Aid was contemplating any kind of asset sales to raise cash, outside of its ongoing program of sale-leaseback transactions for some of what are currently company-owned stores.

"What we're really interested in at this time is growing our company. We are investing in store growth, remodels [of existing stores], investing in our underlying system and trying to leverage our infrastructure. The business plan we are executing at this time is really turning into more of a growth model than anything else."

He specifically declined to comment on the speculation that Rite Aid, which operates some 3,400 stores in 28 states plus the District of Columbia, might be willing to entertain the sale of its West Coast operations to CVS, which is looking to enter those markets. The company's president and chief executive officer, Mary F. Sammons, added that "we are building in our strongest market and one of those really is California, so our goal is to grow this company" - presumably rather than sell off parts of it.

As of the end of the fiscal first quarter on May 28, Rite Aid had some $2.681 billion of long-term debt minus current maturities, about flat from the levels it had at the end of the 2005 fiscal year on Feb. 28. It did not release a comparable year-earlier long-term debt figure.

However, Standley told the conference call that interest expense for the just-ended first quarter totaled $70.9 million - down from $77.8 million a year earlier, "due to lower levels of debt and a lower cost to borrow under our new senior secured credit facility." Rite Aid entered into the $1.4 billion facility late last summer. The $950 million revolver and $450 million term loan each carry an interest rate of Libor plus 175 basis points - well below the facility they replaced (a $1.15 billion term loan at Libor plus 300 bps and $700 million revolver at Libor plus 350 bps).

Cash interest costs in the latest quarter were $65.9 million and non-cash costs $5 million, versus $72.1 million in cash costs and $5.7 million in non-cash costs a year ago.

As of the end of the quarter, there were no outstanding borrowings from the $950 million revolver, although the total amount of credit availability was $838 million, taking into account $112 million of outstanding letters of credit. The company's $400 million accounts receivable securitization agreement "continued to be an excellent source of liquidity," the CFO said, and as of the quarter's end, Rite Aid had utilized the facility for $150 million.

Standley said that during the quarter, the company had redeemed the $170.5 million of outstanding 7 5/8% notes when they came due in April.

After the end of the quarter, Rite Aid called its $150 million of outstanding 11¼% notes due 2008 at a redemption price of 105.625, plus accrued interest up to, but not including, the redemption date. Standley said that the source of the funds for the redemption, scheduled for July 15, would be primarily be cash available in its accounts receivable securitization facility, although "we may also utilize the revolver slightly." Rite Aid will incur a $9.1 million pre-tax charge in the second quarter, connected with this redemption.

Blames charges, taxes for lower earnings

Rite Aid reported net income for the quarter of $33.4 million (five cents per diluted common share), on revenues of $4.22 billion, down from the year-earlier first-quarter net income of $63.7 million (10 cents per share), on $4.24 billion of revenues.

The company blamed the decrease primarily on a $20.5 million decrease in adjusted EBITDA, a $15.5 million store closing and impairment charge - versus a $4.6 million credit in the year-earlier quarter - and an $8.9 million increase in income tax expense.

Same store sales - the key performance metric in the retailing industry - eased 0.3% in the quarter from year-earlier levels, with a 1.2% pharmacy sales decrease more than offsetting a 1.4% percent increase in front-end sales - sales of food and beverages, clothing items, toys, photo developing and other non-medicinal products. Prescription sales accounted for 64% percent of total sales, and third-party prescription sales represented 93.9% of pharmacy sales.

Rite continued to be impacted by the loss of pharmacy business, particularly in industrialized midwestern states like Michigan and Ohio, resulting from the United Auto Workers union's switchover last year of its prescription drug plan to a mail-only pharmacy benefits management system.

Ironically, Rite Aid - which in 2000 sold its Advance PCS pharmacy benefits management unit to Advance Paradigm Inc. to raise badly needed cash and allow the then-troubled drugstore company to focus its efforts on its retail store operation, is now going back into the PBM business; Sammons said that the company "is now able to provide pharmacy benefits management services to employers, health plans and insurance companies, under the Rite Health Solutions label. It is ramping up the operation with the recruitment national sales and marketing people, with a goal of having them in place by the fall.

Adjusted EBITDA amounted to $203.6 million (4.8% of revenues), down from $224.2 million (5.3% of revenues) a year earlier, due to an increase in selling, general and administrative expenses. The adjusted EBITDA decline was a factor in cash flow from operations for the quarter dropping to $172.8 million from $216.6 million a year earlier.

Lowers guidance

On the basis of the weaker quarterly results, Rite Aid announced lower sales, net income and adjusted EBITDA guidance for fiscal 2006. The company said it expects sales to be between $17.1 billion and $17.4 billion, down from previous guidance of $17.3 billion to $17.7 billion, and sees same-store sales improving between 0.5% and 2%, versus the earlier predictions of same-store sales improving between 1.4% and 3.4% from fiscal 2005 levels.

Net income for fiscal 2006 is expected to be between $31 million and $62 million (breakeven to five cents a share), down from previous guidance of net income between $45 million and $71 million (two cents to seven cents a share). Adjusted EBITDA is expected to be between $675 million and $725 million, compared with previous guidance of $700 million to $750 million.

Standley declined to give specifics about the likely level of free cash flow Rite Aid expects, or its anticipated use, although he did give a roundabout answer to an analyst's question. With cash interest expense expected in a "$250ish [million]" area and capital expenditures - formerly expected to come in between $350 million and $400 million - seen at just under $300 million on a net basis, "we'll generate some free cash flow here, and we'll have to figure out the best way of using it."

No contact with Icahn

While Rite Aid is trying to gain traction, management is apparently not worried by the recent news that billionaire investor - though some might say 'corporate raider' - Carl Icahn has taken a position in the company, even though Icahn is known to frequently try to shake up the management of companies in which he has invested, challenging them to do more to improve stockholder value - or else. Icahn was most recently involved in a boardroom coup d'etat against management at Blockbuster Inc. that resulted in him putting several directors on the company's board, and, at least temporarily overthrowing chairman John Antioco, although Antioco, with Icahn's approval, later rejoined the board in the interests of company harmony.

Asked by an analyst whether management had any take on the billionaire's involvement with Rite Aid, Sammons answered that "we know from the report that was filed with the SEC that one of his funds holds shares of Rite Aid - but it's fewer than 2% of the stock. We don't know if the fund still holds the stock, because they only have to file quarterly reports.

"He has not contacted the company - and we have not spoken with him."

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