By Paul Gunther and Seth Crystall
It has been recently reported that Rite Aid Corporation (Rite Aid) is preparing for a possible bankruptcy filing with Kirkland & Ellis as restructuring counsel and Kroll Restructuring Administration as claims agent. On 29 August S&P Global Ratings, citing upcoming debt maturities, poor operating results, potential opioid litigation liability and an unsustainable capital structure, lowered the company’s credit rating to CCC- from CCC+. On the heels of these recent events, at least some of Rite Aid’s creditors also appear to be gearing up – it has been reported that a group of the company’s secured bondholders are working with Paul Weiss and Evercore regarding a restructuring.
Given that Rite Aid appears to be heading towards a Chapter 11 filing, in this article, the Debtwire legal analyst team discusses what a potential Chapter 11 restructuring could look like along with a review of Rite Aid’s history, operations, and capital structure. We provide an overview of the opioid litigation that has engrossed the company and explain how other companies have settled their opioid liabilities both in and out of bankruptcy court. Finally, we discuss the company’s restructuring options and how it may try to resolve its own opioid liabilities.
Company background and operations
Rite Aid opened its first store as Thrif D Discount Center in Scranton, Pennsylvania in 1962. The company changed its name to Rite Aid Corporation and became a publicly traded company in 1968. Over the years the company has acquired several other pharmacy chains. In 1996 the company expanded to the West Coast and Gulf Coast regions by acquiring Thrifty PayLess Holdings, Harco, Inc, and K & B Inc. In 2006, the company bought Eckerd Pharmacy and Brooks Pharmacy. In 2015, the company acquired pharmacy benefit manager (PBM) Envision RX (now Elixir).[1] Most recently, in 2020, the company purchased Bartell’s Drugs.
As reported by Rite Aid in its 2022 Form 10-K (2022 10-K), in 2018, Rite Aid sold 1,932 stores to Walgreens. Per the company’s fiscal year (FY) 1Q24 10-Q (1Q24 10-Q), as of 3 June, Rite Aid operated 2,284 retail pharmacy stores in 17 states. The 2022 10-K states that during FY 2023 the company filled 250 million prescriptions and that through Elixir the company provides pharmacy benefits and services to over 1 million members across the country. The company currently has its corporate headquarters in Philadelphia, PA.
Rite Aid notes in the 2022 10-K that it operates in two segments, a retail pharmacy segment, which consists of Rite Aid, Bartell Drug Company, and Health Dialog Services Corporation, and a pharmacy services segment, consisting of Elixir. In addition to dispensing medications, the retail pharmacy segment offers health care services. According to the 2202 10-K, in FY 2023 prescription drugs accounted for over 71% of sales, with front-end merchandise such as over the counter medications, health and beauty aid, cosmetics, food and beverage, and household items constituting the remaining 29%. The company’s retail sales breakdown by product class for FY 2023 was as follows.
Source: Rite Aid 2022 10-K, at 8.
The company’s biggest competitors in the pharmacy retail segment are Walgreens, CVS, Kroger, Walmart and Target, among others.
According to the 1Q24 10-Q, the pharmacy services segment, through Elixir, provides PBM services such as mail delivery services, a specialty pharmacy, network and rebate administration, claims adjudication, pharmacy discount programs, prescription discount programs and Medicare Part D insurance offerings.[2] That filing states that as of 3 June, Elixir represented approximately 1.5m persons, including approximately 300,000 people through Medicare Part D. Per the 10-Q, the company will depart from the Individual Medicare Part D Insurance market as of 1 January 2024. The company’s biggest competitors in the pharmacy services segment are CVS Caremark, Express Scripts, OptumRx, and mid-market PBMs.
Rite Aid’s capital structure
As of 3 June, Rite Aid’s total outstanding funded debt was USD 3.376bn. The company has a credit agreement, dated as of 20 December 2018 (Credit Agreement), for which Bank of America N.A. (BOA) serves as administrative and collateral agent. Pursuant to the third amendment to the Credit Agreement, dated 1 December 2022, the company has a USD 2.85bn first lien senior secured revolving debt facility with USD 1.6bn outstanding (Revolving Facility) and a first lien senior secured first-in last-out term loan (FILO Facility) with USD 400m principal amount outstanding. Both the Revolving Facility and the FILO Facility have a maturity date of 20 August 2026, with a springing maturity date if the company does not repay or refinance its 7.5% notes due 1 July 2025 before 1 April 2025.[3]
The company has issued two sets of second lien senior secured notes – 7.5% notes due 1 July 2025 with an outstanding principal amount of USD 320m and 8% notes due 1 November 2026 with an outstanding principal amount of USD 850m (Second Lien Notes). The Bank of New York Mellon Trust Company, N.A. serves as trustee and notes collateral agent for the Second Lien Notes.
The company has also issued 7.7% unsecured, unguaranteed senior notes due 15 February 2027 with an outstanding principal amount of USD 186m. Another set of 6.875% notes due 15 December 2028 has an outstanding principal amount of USD 2m. US Bank serves as trustee for the 7.7% notes and BMO serves as trustee for the 6.875% notes.
The company’s capital structure as of the end of fiscal 1Q24 is summarized below:
Recent financial performance
In fiscal 1Q24, Rite Aid experienced a net loss of USD 306.7m (or a loss of USD 5.56 per share), compared with a net loss in fiscal 1Q23 of USD 110m (or USD 2.03 per share). According to the company’s 1Q24 10-Q, this was “primarily” due to a write down of Elixir goodwill due to the performance of Elixir insurance’s individual Part D plan and its decision to leave the individual Part D market. Other factors, according to the company, were lower gains on asset sales, higher interest expenses and a decline in adjusted EBITDA.
Debtwire recently reported that Rite Aid has been experiencing revenue and EBITDA declines, with the company’s pharmacy services segment experiencing an average decline of 12% year-over-year (YoY) during the last nine quarters. For fiscal 1Q24, on a YoY basis, the company had a revenue decline of 6% (to USD 5.7bn) and a decline in EBITDA[4] of 8% (to USD 92m). The USD 362m decline in revenue in 1Q24 over 1Q23 was largely attributable to a drop in insurance drug plan membership and the loss of a large commercial client. Despite the decline in revenue, the company’s gross margin expanded 95bps to 20.8%, while the EBITDA margin remained flat at 1.6%. Per the company’s 1Q24 Form 10-Q, as of 3 June, the company had USD 1.15bn in liquidity, comprising USD 135.5m in cash and USD 1.041bn in borrowing capacity under the Revolving Facility.
Furthermore, per the Debtwire credit report, the company trades at a higher EV/NTME EBITDA multiple than its industry peers – 9.3x for Rite Aid and 6.2x for its peers – and operates at a slimmer NTME EBITDA margin – 1.6% (net leverage 9.0x) for Rite Aid and 5% for its peers (net leverage 4.3x):
The Debtwire credit report includes two methods of valuation – (i) a multiple of EBITDA and (ii) a liquidation. In a multiple of EBITDA scenario, using NTME adjusted EBITDA of USD 359m as a base case, and an EV/EBITDA multiple of 6.0x, at this midpoint the first lien Revolving Facility would receive a full recovery. The FILO Facility would receive an 84% recovery and would thus be the fulcrum security. In contrast, in the base case scenario of a liquidation analysis the Revolving Facility and the FILO Facility both receive a full recovery. The Second Lien Notes would receive a 43% recovery and be the fulcrum security. In either scenario, the unguaranteed notes and the equity would receive no recovery.
According to the Debtwire next generation site, as of 22 September, Rite Aid’s 7.5% second lien notes and 8% second lien notes traded at USD 60.18 and USD 59.9, respectively. From 26 September 2022 to 22 September 2023, the prices on the company’s 7.7% senior notes fell to USD 10.59 from USD 68.87, and prices on its 6.875% senior notes fell to USD 10.85 from USD 58.20. During the same period, the company’s share price declined to USD 0.59 from USD 6.50.
Industry trends
In its 2022 10-K, Rite Aid identifies several risk factors related to the company’s financial condition and its operations. With respect to financial condition, the company notes that it is highly leveraged and dedicates a substantial portion of its cash flow to debt service. The company further highlights that prescription opioid lawsuits could negatively impact liquidity. With respect to operational risks, the company observes that its sales productivity level falls short of its competitors.
In the 2022 10-K, the company identifies several larger trends that have affected the profitability of the company’s retail pharmacy segment. Third-party payors,[5] including Medicare Part D plans and state-sponsored Medicaid agencies, have changed the eligibility requirements of participants and reduced reimbursement rates and the number of participants, which can affect sales and margins and reduce profitability. The company also says that it faces increased competition from new digital pharmacies who seek to bypass third-party payors and sell (mostly generic) prescription drugs directly to consumers. Furthermore, according to the 10-K, the sale of less expensive generic drugs has impacted overall revenues and same store sales. Additionally, says the company, the rate of pharmacy sales has been “negatively impacted” by “a decline in new blockbuster drugs, drug safety concerns, higher copays, and an increase in the use of generic [] drugs.”[6] Finally, the company notes in the 10-K that there has been an increasingly demanding state and federal regulatory environment.
Rite Aid’s opioid litigation
In addition to declining revenue, Rite Aid faces a multitude of lawsuits relating to its sale of opioids. The suits have been filed by state and local governmental units, Native American tribes, hospitals, third-party payers and individuals. More than 1,000 of these lawsuits have been transferred to a multi-district litigation pending in the US District Court for the Northern District of Ohio.[7] The company says in the 2022 10-K that it is also a defendant in a significant number of cases in state court that have not been transferred to the multidistrict litigation. The theories of liability proposed in these lawsuits include negligence and public nuisance.
In March 2023, the US Department of Justice (DOJ) filed a complaint against the company alleging that Rite Aid dispensed opioids without lawful prescriptions in violation of the Controlled Substances Act and that the company sought reimbursement for those prescriptions in violation of the False Claims Act. The federal government seeks recoveries for unjust enrichment and payment by mistake.[8]
The company faces potential litigation liability in several other lawsuits unrelated to opioids, including a qui tam litigation alleging violations of California’s Medicaid program and consumer class actions. The company is also a defendant in overcharging litigations, and in one such litigation an arbitrator awarded USD 122.6m to Humana, Inc for alleged overcharging. A separate litigation brought by Blue Cross/Blue Shield plans in several states alleges that Rite Aid overcharged pharmacy benefit managers.
Recent pharmacy opioid settlements
Recently, several other pharmacy chains have settled some of their opioid liabilities outside of bankruptcy proceedings. In November 2022, CVS Health, Walmart and Walgreens all announced settlements of opioid claims brought by state, local and Native American tribal governments. CVS Health agreed to settle all such claims against the company for approximately USD 5bn. Walmart agreed to pay USD 3.1bn for its liabilities. Walgreens agreed to settle its opioid claims for approximately USD 4.95bn. These settlements do not release claims brought by private individuals and businesses.
The three settlements are structured to allow governmental units and Tribal Nations to “opt-in” and to elect to receive an allocation of settlement funds in exchange for releases. 85% to 95.5% of the settlement funds are to be used for opioid-remediation efforts (including treatment and mitigation), and 70% of the funds are to be used for future remediation efforts. The settlements also require changes in the pharmacies’ operational policies with respect to dispensing medications, compliance, monitoring and data sharing. More information regarding these opioid settlements, including copies of the settlement agreements, are available at the website nationalopioidsettlement.com.
The recent treatment of opioid liabilities in Chapter 11
As noted, the pharmacy settlements do not resolve private claims. Other companies have elected to file Chapter 11 to achieve a more comprehensive resolution of their opioid-related liabilities, including personal injury claims. These companies include pharmaceutical manufacturers Purdue Pharma LP (Purdue), Mallinckrodt plc and Endo International.
In the Purdue case, the debtors’ plan of reorganization provides for the creation of an opioid master disbursement trust and the channeling of opioid-related claims to separate trusts for each of the various categories of plaintiffs asserting opioid-related claims, including non-federal governmental units, Native American tribes, hospitals, third-party payors, and direct personal injury claimants.[9] The debtors’ businesses would be transferred into a new private public benefit company whose ultimate owners would be two opioid abatement trusts – a national opioid abatement trust (NOAT) for non-federal, domestic government claims and a trust for Native American tribe claims (TAFT). The new company would develop opioid reversal and addiction treatment medications and develop non-opioid drugs to create additional value for the trusts to address the opioid epidemic.[10]
Purdue’s owners, the Sackler family, have agreed to contribute USD 4.325bn pursuant to the plan in exchange for non-consensual third-party releases of claims against them. The US Trustee has appealed confirmation of the Chapter 11 plan, in particular the plan’s third-party releases. The US Supreme Court has agreed to hear the appeal and stayed consummation of the plan pending the appeal.
Mallinckrodt’s Chapter 11 plan in its first bankruptcy case similarly provides for the channeling, pursuant to an injunction, of all opioid-related claims to several opioid trusts and the discharge of those claims against the debtors. Like the Purdue plan, the Mallinckrodt plan creates a national opioid abatement trust (MDT II) to distribute cash payments to separate sub-trusts. These trusts include (i) NOAT and TAFT trusts for claims asserted by states/municipalities and Native American tribes, respectively (with funds to be used to abate the opioid crisis), (ii) third-party payors, (iii) hospitals, and (iv) personal injury claimants. The MDT II also pays cash directly to the federal government on account of the latter’s opioid-related claims.[10] The trust was funded with current and deferred cash payments, including an initial payment of USD 450m, warrants, causes of action held by the debtors related to opioid claims and insurance rights. Although the plan included third-party releases, it was confirmed on 3 February 2022.
A little more than a year later, on 15 June, reorganized Mallinckrodt missed interest payments on its first and second lien notes. The company also repeatedly deferred a USD 200m payment to the MDT II. On 28 August 2023, due to self-described “enterprise insolvency and forecasted inability to meet their debt and settlement obligations, ” the company filed a “Chapter 22” bankruptcy case with a restructuring support agreement in hand to reduce its funded debt obligations to USD 3.6bn from USD 1.75bn. More relevantly, the company plans to reduce its remaining opioid settlement obligations to USD 250m, down from USD 1.275bn under the previously confirmed plan. As part of the recoveries for opioid claimants the new plan of reorganization also would give the MDT II contingent value rights to purchase 5% of the reorganized company’s ordinary shares for MDT beneficiaries.
Although it has not yet filed a Chapter 11 plan, Endo International has entered into a restructuring support agreement with an ad hoc group of first lien creditors that contemplates a sale of the company by way of a USD 5.9bn credit bid. The first lien creditors would provide funding for separate trusts created for public, tribal, and private opioid claimants.
Rite Aid’s restructuring options
If Rite Aid elects to reorganize in a Chapter 11 proceeding, the restructuring would have to address both its outsized debt load and its opioid liabilities as have Mallinckrodt, Purdue and Endo. According to the Debtwire credit report, the company needs to reduce its debt by approximately USD 1bn to reach a point where it generates free cash flow. It also needs to address the springing maturities on the Revolving Facility and the FILO Facility. The company could seek to relieve itself of these obligations through a confirmed Chapter 11 plan. Based on the Debtwire credit report, the fulcrum security could be either the FILO Loan or the Second Lien Notes, and in a financial restructuring the holders of those instruments could receive the equity in the reorganized company. Potential candidates to provide exit financing might be found in the company’s large pool of Credit Agreement lenders.
However, even if Rite Aid is successful in reducing its debt load, it appears that a financial restructuring may be insufficient to set the company on a profitable path. In its 2022 10-K, Rite Aid states that in addition to the fact that some competitors are better capitalized, the company has other structural disadvantages. The company highlights that it is smaller in size and less diversified than some competitors. It also says that some of those competitors are expanding into Rite Aid’s markets and can exercise greater leverage due the vertical integration of their healthcare, insurance, PBM operations and retail operations. With respect to the PBM business, the company gives “no assurance” in the 10-K that it can compete with the larger, more established PBMs.
Given these structural disadvantages, the company may need to look at an operational restructuring in addition to a financial restructuring. The company states in the 2022 10-K that it already commenced this process beginning in FY 2019. Since then, the company has been engaged in the process of rationalizing its SKUs, updating its merchandise assortment, closing stores, reducing administrative expenses and implementing a performance acceleration program. The company could continue these processes in Chapter 11, with the added benefit of being able to reject any onerous leases and free itself of further financial commitments under them (with the exception of paying lease rejection damages).[11]
If a financial and operational restructuring prove insufficient, another option could be to sell the company to a larger rival such as CVS or Walgreens. As noted, in 2018 Rite Aid sold 1,932 of its stores to Walgreens for USD 4.375bn. In a bankruptcy sale a purchaser could obtain Rite Aid’s assets free and clear of all existing liabilities, including opioid liabilities. As in the Endo case, the purchaser(s) might provide funding for trusts to address the opioid claims.
Opioid liability restructuring
A Chapter 11 restructuring for Rite Aid would enable the company to address its opioid liabilities more comprehensively than in an out-of-court restructuring. As an initial matter, given the company’s recent revenue declines, debt load and thin operating margins, the company might not have sufficient funds to pay outside of bankruptcy what can be massive opioid-related liabilities. And unlike the other pharmacies that have settled government opioid claims outside of bankruptcy, Rite Aid has not been profitable. Furthermore, as already noted, the CVS, Walgreens and Walmart settlements only addressed state, local government and Native American tribe liability, but not liability to private entities and individual plaintiffs. Rite Aid would have to address these liabilities as well.
A Chapter 11 filing would benefit Rite Aid by centralizing all the opioid lawsuits in one forum. As noted, the company has not only transferred over 1,000 lawsuits to a multidistrict litigation in an Ohio federal court, but also faces a significant number of cases in state courts. In addition, the company is defending the DOJ claims for violations of the False Claims and Controlled Substances Acts. It would be more economical, and more efficient, for the company to address all these disputes in the bankruptcy court.
If Rite Aid files for Chapter 11, it could look to the bankruptcy settlements of the pharmaceutical manufacturers as a guide to resolve its own opioid liabilities. It could create a structure for settling claims that utilizes a combination of a channelling injunction and a series of trusts that would resolve claims brought by the various governmental and non-governmental actors who have asserted claims against the company. The trusts for the governmental claims could be used to further opioid remediation efforts.
The company might also want to look to the non-bankruptcy settlements in which the pharmacies agreed to pay a stream of settlement payments to three separate funds – a state fund, a subdivision fund, and a remediation accounts fund to be used for future opioid remediation efforts – as well as devised a means for allocating payments to the various government entities. In those settlements, the pharmacies also agreed to institute changes to their management of opioids, including having independent departments oversee legal compliance, granting greater independence to pharmacists in dispensing prescriptions, and instituting monitoring and data share programs with respect to suspicious activity. Similar changes by Rite Aid might be part of the consideration for any settlement.
Another benefit to Rite Aid of restructuring in bankruptcy is that it would provide more certainty regarding the company’s opioid liability to individual claimants. For opioid-related personal injury claims, the company could create a trust (or trusts) to oversee distributions to harmed individuals. An administrator could oversee the trust and determine the eligibility of claimants to receive distributions and could also contain processes for appeals. By channelling all such claims to the trusts, the debtor would eliminate the uncertainty presented by individual court cases and by jury verdicts.
Ideally, Rite Aid would want to enter bankruptcy with a restructuring agreement with as many of the plaintiff parties as possible. It may be more likely, given the differing widely disparate parties and claims, that it will use the bankruptcy process to try to reach consensus on the terms of a plan, as did both Purdue and Mallinckrodt. Either way, the Debtwire legal analyst team will provide continuing coverage of any out-of-court and in-court developments regarding the company’s restructuring.
Paul Gunther is a former practicing restructuring and litigation attorney. Prior to joining Debtwire as a Legal Analyst, Paul practiced in the New York offices of Dentons US LLP, Salans LLP and Mayer Brown LLP. He has represented various constituencies in high-profile restructurings.
Any opinion, analysis or information provided in this article is not intended, nor should be construed, as legal advice, including, but not limited to, investment advice as defined by the Investment Company Act of 1940. Debtwire does not provide any legal advice and subscribers should consult with their own legal counsel for matters requiring legal advice.
------------------
Endnotes
[1] PBMs are third parties that act as intermediaries between drug manufacturers and insurance providers. Among other things, they devise formularies (lists of drugs covered by an insurance plan), create pharmacy networks, negotiate rebates with manufacturers and process insurance claims. The three largest PBMs, which cover the vast majority of the market, are CVS Caremark, Express Scripts and OptumRx (UnitedHealth Group).
[2] Medicare Part D is a federal prescription drug program available through private plans to people who have Medicare Part A or Part B.
[3] The parties listed as lenders in the third amendment to the Credit Agreement are BOA, Wells Fargo Bank; Capital One; BMO; Fifth Third Bank; MUFG Bank Ltd.; PNC Bank; Truist Bank; ING Capital, Citizens Bank; TD Bank; The Huntington National Bank; First-Citizens Bank & Trust Company; U.S. Bank (US Bank); UBS AG, Stamford Branch; Siemens Financial Services; Webster Bank; Keybank; New York Community Bank; Atlantic Union Bank; and Cathay Bank.
[4] “EBITDA” is earnings before interest, taxes, depreciation and amortization.
[5] Third-party payors are entities that pay for part or all of an individual’s prescription drug bill and include insurance companies, government entities and self-insured employer plans.
[6] 2022 10-K, at 7.
[7] In re Nat. Prescription Opiate Litig., Case No. 17-MD-2804 (N.D. Ohio 2017).
[8] U.S. ex rel. White et al. v. Rite Aid Corp., et al., Case No. 1:21-cv-1239 (N.D. Ohio 2021).
[9] The plan also settled criminal and civil claims brought by the federal government in exchange for a criminal forfeiture judgment of USD 2bn, to be offset by up to USD 1.775bn for distributions under the plan to the non-federal government and tribal entities.
[11] Separately, the plan also provides for a USD 260m settlement of the federal government’s claims that the company violated the False Claims Act in connection with its sale of Acthar, among other settlements.
[12] As of 4 March 2023, the company leased 2,221 of its drugstores and owned 88.
