Phar-Mor Inc. History

Address:

20 Federal Plaza W.
Youngstown, Ohio 44501-0400
U.S.A.

Telephone: (216) 746-6641

Private Company
Incorporated: 1982
Employees: 9,800
Sales: $1.5 billion (est.)
SICs: 5912 Drug Stores & Proprietary Stores

Company History:

Phar-Mor Inc. is one of the top ten deep discount drug store chains in the United States. The company rose to national prominence when, just seven years after it was founded, it catapulted to leadership of the deep discount drug retail segment. At its most prosperous, the chain boasted more than 300 locations in 34 states. In 1992, however, one of the largest corporate frauds in American history was perpetrated against Phar-Mor. As a result, the chain declared bankruptcy, cut its store locations by more than half, and was only beginning to show signs of emerging from the crisis in early 1995.

Phar-Mor came into existence as an affiliate of Pittsburgh-based Giant Eagle, Inc., a $1 billion, family-owned grocery chain with 50 locations. In 1981 Giant Eagle acquired Tamarkin Co., a privately owned grocery chain and distribution firm (later renamed Tamco Distributors Co.). Within a year, Giant Eagle heir David S. Shapira and former Tamarkin vice-president Michael J. "Mickey" Monus established Phar-Mor, Inc., an entry into the fast-growing deep discount drug segment.

The two businessmen seemed to confirm the adage that "opposites attract." The charismatic Monus developed a reputation for flamboyancy in the otherwise stuffy drug store industry--he reportedly traveled with an entourage by white limousine, for example. Shapira, on the other hand, was described as "a member of Pittsburgh's establishment" in an article appearing in Business Week in August 1992. Monus served as president of the new venture and Shapira as chief executive officer. Giant Eagle owned 50 percent of Phar-Mor, and real estate mogul Edward J. Debartolo, Sr., reportedly held a substantial equity interest in the new enterprise.

The deep discount segment of the drug store industry traces its history back to close-out shops that appeared during the Great Depression. The popularity of the concept waned when prosperity returned, but saw a resurgence during the recession of the 1970s. Consumers wanted quality goods at low prices, and they were willing to forgo ambiance, convenience, and selection to get them. Discount druggists kept overhead low and used specialized purchasing techniques to achieve economies that they then passed on to their bargain-hungry customers. Discounters rented older--and usually cheaper--retail spaces than their traditional drug store counterparts. They saved advertising dollars by making their own signs and product displays by hand. Most of these operations were led by independent owner/managers.

Purchasing techniques were key to the concept. In the late 1970s and early 1980s, deep discounters obtained merchandise strictly "on deal" from manufacturers, often settling for limited quantities of a product in exchange for discounts of 12 to 20 percent off wholesale prices. Buying stock "on deal" meant that these retailers carried a limited, often erratic, merchandise mix, but customers did not seem to mind, since deep discounters passed savings of 25 to 40 percent off suggested retail prices on to their customers. The retailers made up for their own lean margins with high volume, often achieving six to seven times more sales per square foot than their conventional counterparts. By the early 1980s, the competitive pressures brought by deep discounters, warehouse clubs, and other off-price concepts had begun to capture the attention of traditional retailers, including Giant Eagle, which launched Phar-Mor in 1982.

Phar-Mor used many of the techniques established by deep discounters, and additionally adopted a strategy that had helped make Wal-Mart a national phenomenon: "power buying," or placing the largest possible orders for merchandise in order to secure the best possible terms. Phar-Mor earned a reputation for hiring shrewd purchasing agents who were proficient at negotiating the best wholesale deals from vendors. Their high-pressure tactics sometimes strained supplier relations as well.

Competition intensified dramatically during the mid-1980s, as many mass marketers and independent entrepreneurs joined the deep discount segment. From 1985 to 1990, the overall number of deep discount drug stores in the United States and Canada more than doubled, from 313 to 700. Although a relative latecomer to the segment, Phar-Mor more than kept pace with the industry's rate of growth. By 1987 the chain had nearly 70 stores, and a year later it opened its 100th store. In 1990 Phar-Mor surpassed the 200-store mark, becoming the leader in the industry. As it grew, its merchandise mix expanded from prescription and over-the-counter drugs and health and beauty aids to include more general merchandise, including office equipment, sporting goods, apparel, videos, music, and frozen foods.

Writing for Discount Store News, analyst Arthur Markowitz noted the "symbiotic relationship" between power buying and rapid growth. In 1991, he asserted that "Phar-Mor needs an expanding base of stores to sell the huge quantities of merchandise it purchases. At the same time, the increasing number of stores has generated the growing need for vast amounts of goods purchased at the lowest possible cost." The company won financial support for this strategy from Corporate Partners, the investment arm of Lazard Freres & Co., when it sold the firm a 17 percent stake for $200 million in 1991.

In July 1992, chain President Michael Monus hosted what Tony Lisanti of Discount Store News called "an uncharacteristically high profile grand opening" of the 300th Phar-Mor store. While there, Monus announced a corporate goal of 340 store openings over the next five years. Even retail giant Sam Walton admitted that, of all his competitors, he feared the Phar-Mor juggernaut the most. But before the month had ended, the fears harbored by many of Phar-Mor's retail rivals evaporated in scandal.

To the shock of most observers and to the dismay of Phar-Mor creditors, investors, and suppliers, on July 31, CEO David Shapira accused Monus, Chief Financial Officer Patrick B. Finn, and two other high-ranking officials of plotting to defraud the chain of $10 million in cash and exaggerate the chain's earnings and inventories by hundreds of millions of dollars over the course of three years. A flurry of firings and finger-pointing ensued. Shapira fired Monus, his protege Finn, two other executives, and the chain's outside auditor, Coopers & Lybrand. Phar-Mor subsequently accused the accounting firm of a "grossly negligent, intentional or reckless failure to uncover a massive fraud perpetrated on Phar-Mor." The lawsuit--one of several scandals that tarnished the accounting firm's reputation in the late 1980s and early 1990s--sought compensatory and punitive damages. Coopers & Lybrand, in turn, sued CEO Shapira "for not catching the fraud," as well as Monus, Finn, Monus's father, and Jeffrey Walley and Stanley Cherelstein (two former Coopers & Lybrand accountants who had transferred to Phar-Mor). For their part, Finn and Walley confessed to the fraud, but implicated Monus as the ringleader.

His accusers traced Monus's problems to the 1987 foundation of the World Basketball League (WBL), a professional association for players under 6′7″ tall. Monus owned at least 60 percent of each of the WBL's ten teams, and was therefore responsible for that fraction of each team's expenses and losses. Milton Kantor, a fellow investor in the WBL, told Plain Dealer reporter James F. McCarty that each of the league's games averaged a $13,000 loss. Former Phar-Mor CFO Finn, federal investigators, and even Monus's co-owners in the WBL alleged that Monus had embezzled millions to cover the league's costs, and had conspired to inflate the value of Phar-Mor's inventory in order to garner executive bonuses and other financial advantages. Business Week characterized the WBL as "doomed from the start." Its August 1992 collapse coincided with revelations of the multi-million-dollar sham at Phar-Mor.

By mid-August, when anxious vendors began detaining shipments, Phar-Mor filed for bankruptcy protection under Chapter 11. By the end of the month, Shapira laid off over 1,000 employees and wrote off what he hoped were the total damages: $350 million.

At the same time, it became apparent that the entire deep discount drug category was in trouble. Aggressive pricing from conventional drug chains, supermarkets, and mass merchandisers undercut the discounters' price advantage. Over-expansion by the leading chains had saturated key markets. In an article in Progressive Grocer in February 1994, reporter Glenn Snyder placed the blame on strategies that had formerly been recognized as some of the keys to Phar-Mor's success: "excessive inventory, oversized new stores, and straying far beyond core merchandise into such areas as computers and sporting goods."

The company brought in Antonio C. Alvarez as interim chief financial officer and "turnaround chief" in August 1992. Alvarez, who prescribed efficiency, contraction, and a focus on profitable stores to cure the drug chain's ills, was promoted to president and chief operating officer that September. He quickly closed more than one-fourth of Phar-Mor's stores, reduced the payroll by about 20 percent, and negotiated with creditors to save the company $233 million. In February 1993, he was promoted to the chief executive office vacated by David Shapira, who moved on to the chief executive office at Giant Eagle. Alvarez brought in David Schwartz, who had recent experience revitalizing the Smitty's SuperValu grocery chain, based in Phoenix, as president early in 1993. Phar-Mor's new management team was able to win the financial support of creditors and convince suppliers to ship merchandise, but these measures did little to reverse declining sales and low morale.

In January 1993, a federal grand jury indicted Michael Monus on 129 counts of fraud. He was charged with one of the biggest swindles in the history of U.S. business: the suit accused him of defrauding Phar-Mor's investors of $1.1 billion and the chain itself of $11.1 million. A hung jury forced the presiding judge to call a mistrial in June 1994. A second grand jury brought more than 100 new charges against Monus within a month, but as of January 1995, the new case had not yet come to trial.

CEO Alvarez's operational reorganization continued apace with Phar-Mor's financial reorganization. By the end of 1993, the chain had closed or sold 167 of its 310 stores, slashed its employee rolls from over 25,000 to 9,800, and shed superfluous merchandise lines to concentrate on health and beauty aids, drugs, and food. The chain automated inventory procedures and expanded advertising and promotions to raise awareness that Phar-Mor was still in business.

In January 1995 Phar-Mor submitted a financial reorganization plan that proposed taking the chain public. Under the plan, Phar-Mor's senior secured creditors would receive 85 percent of the chain's common stock, up to $107 million cash (or more, depending on the outcome of litigation with Coopers & Lybrand and other parties), and $100 million in variable-rate notes. Unsecured creditors would receive up to $30 million cash and 15 percent of the chain's common stock. With this plan, the company expected that Alvarez would be elected chair and that David Schwartz would advance from president to CEO. An alternative plan was filed in April of that year, however, under which an investor group led by drugstore magnate Robert Haft would purchase 30 percent of Phar-Mor. Haft and his associates would purchase five million shares of the new company's stock from creditors, as well as 2.5 million shares directly from the company. Alvarez remained committed to Phar-Mor's potential to become a strong, financially healthy company. In a press release he noted "under either plan, Phar-Mor will aggressively pursue strategic new store openings.... We believe it is time for the company to emerge from Chapter 11 and focus solely on building a stronger company."

Phar-Mor Inc. History

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