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FOXMEYER WILL DO $ 500 MIL. WITH PHAR-MOR THIS YEAR; DEEP- DISCOUNTER CONTRACT REPLACES DEPARTING KMART; FOXMEYER GOING PUBLIC AGAIN, NII SPINS OFF 30%

Executive Summary

FoxMeyer is on a pace to do over $ 500 mil. in business with the Phar-Mor deep discount chain in the company's current fiscal year (ending March 31, 1992). According to a close look at the wholesaler's current business profile in a July 12 "red herring" prospectus, Phar-Mor quickly has emerged as the linchpin to FoxMeyer's growth. The Pittsburgh- based discounter generated almost 19% of FoxMeyer's total sales (or $ 133.7 mil.) in the wholesaler's most recent June 30 quarter. During the fiscal year ended March 31 of this year, FoxMeyer's business with Phar-Mor reached $ 423.2 mil., representing just short of 15% of FoxMeyer's total sales ($ 2.9 bil.). Phar-Mor was FoxMeyer's largest customer, buying almost $ 60 mil. more from the wholesaler than the number two customer, Kmart. FoxMeyer signed a five-year, $ 2.8 bil. agreement with Phar- Mor in 1990 ("The Pink Sheet" Aug. 6, 1990, p. 16). The current sales levels indicate that FoxMeyer is still in an accelerating phase in the contract period. The average annual sales to Phar-Mor ought to be close to $ 600 mil. to reach the five-year target. Phar-Mor's well-publicized blitz of the deep-discount sector and its ambitious store opening program (120 new units planned for 1991 and 1992) describe an attractive prospect for the wholesaler. Phar-Mor recently raised $ 125 mil. from an affiliate of Lazard Freres to help finance its continued growth; the Lazard Freres affiliate also contributed $ 75 mil. to some of the chain's initial investors through the repurchase of "certain of [Phar- Mor's] existing equity securities." The Phar-Mor business is fortuitous for FoxMeyer since its position as a key supplier to Kmart is on the downturn. The prospectus, for a 9 mil. share common offering, discloses that Kmart downgraded FoxMeyer from a primary supplier to a secondary supplier as of May of this year. FoxMeyer's business with Kmart dropped to 10% of the previous year's level in May and June. In addition to cultivating the Phar-Mor business, FoxMeyer is scrambling to add other new customers to replace the loss of the Kmart sales. "As a result of the reduction in sales to Kmart," the prospectus notes, "the company has intensified its efforts, both at the senior management and distribution center levels, to attract new business from existing and potential accounts." FoxMeyer just recently has weathered the defection of another big customer. During the company's fiscal 1990 (ended March 31, 1990), its business with Wal-Mart dropped precipitously: from $ 160.5 mil. in FY 1989 to $ 66.7 mil. in 1990. The wholesaler maintains that the Wal-Mart experience is good preparation for the changes in the wake of Kmart's departure. The loss of the Wal-Mart business was offset, FoxMeyer said, by increased business with other chains. In fiscal 1991, the company had three major segments of distribution sales: $ 1 bil. to chains (up from $ 850 mil. the year before); $ 980 mil. to independents (up from $ 901 mil.); and $ 585 mil. to hospitals and institutions (up from $ 459 mil.). Approximately 87% ($ 2.5 bil.) of FoxMeyer's total sales in 1991 were pharmaceuticals. For the first quarter of FY 1992, sales to chains were $ 228 mil. (about on a level for last year's full-year total). That flat level reflects the loss of the Kmart business. The loss is also evident in lower gross margins in the most recent quarter: gross margin slipped to 6.5% from 7.3%. The lower gross margins may be sign of dealing with Phar-Mor, which has made much of its image of pushing down costs from suppliers. FoxMeyer's volume buying business (purchasing in bulk ahead of price manufacturer increases) apparently also has been growing significantly. The segment of the business in which that operation is included contributed almost $ 100 mil. in sales in the first quarter compared to $ 248 mil. for all of last year. The decision to go to the public market for financing despite the bad news of the loss of the Kmart business is indicative of the confluence of two key factors: (1) the apparent continuing pressure from the new dominant group at FoxMeyer's parent, National InterGroup (NII), for a quick cash return from the wholesale drug business; and (2) the confidence of the NII management in the appeal of FoxMeyer's recent profit turnaround. As one of the first moves following the victory of Centaur Partners in the struggle for control of NII last summer, FoxMeyer was put up for sale at an indicated asking price of between $ 475 mil. and $ 525 mil. After about seven months of trying to find a buyer, NII took FoxMeyer off the market at the end of March ("The Pink Sheet" April 1, T&G-1). The new public offering is designed to funnel about $ 148 mil. (or all of the anticipated proceeds of the stock placement) to NII. FoxMeyer's board already has approved motions to pay dividends to NII after the placement equal to 75% of the money raised (or about $ 113 mil.). The other $ 37 mil. earmarked for NII will pay back an unsecured, demand promissary note held by the parent firm. In early July, NII retired $ 37 mil. of $ 47 mil. outstanding on a revolving credit line. FoxMeyer apparently paid back the other $ 10 mil. The credit line had no outstanding balances as of July 10. FoxMeyer has a $ 135 mil. revolving credit facility. NII will continue to own 70% of the company's outstanding stock after the offering. The $ 148 mil. pricetag for 30% of the business calculates roughly to the target sale price of $ 500 mil. The offering price does not discount the 30% share for being a minority holding. The spinoff price for 30% of the business compares to the $ 235 mil. price for purchase of the whole business just over five years ago in February 1986. The current offering is being managed by Paine-Webber and A. G. Edwards. With its debt reduced after the offering to under $ 7 mil., FoxMeyer says its plans to devote major spending to (1) "capital expenditures in connection with the upgrading of the company's management information system capabilities [estimated at $ 30 mil. over the next three years] and its warehouse automation program [$ 5 mil.-$ 7 mil. over the next three years(BRACKET)"; (2) "the establishment of new regional distribution centers"; and (3) potential acquisitions. FoxMeyer reports that "no substantive acquisition negotiations by the company are currently pending." The company is currently relocating its Beaumont, Texas distribution center to San Antonio. That project should be complete by the end of this calendar year. The next planned project is the opening of a Middle Atlantic region distribution center by March 1993. The firm has 11 distribution centers currently. It boasts that "net sales generated by its distribution centers are among the highest in the industry." In the 12 months ended March 31, FoxMeyer said its "average net sales per distribution center were $ 244.1 mil. and average net sales per square foot were $ 2,002." FoxMeyer's profit improvement is more dramatic at the net earnings line than in operating profits. In the most recent quarter, for example, after-tax earnings were up more than 52% to $ 7.1 mil. compared to the first quarter of fiscal 1991. Operating earnings were up at a more modest 11% pace in the same comparison periods. An extraordinary charge for the accounting change for retirement benefits cut almost $ 2 mil. from the first quarter net last year. In both years, FoxMeyer benefited from substantial loss carryforwards: almost $ 2 mil. in the first quarter of each of the last two fiscal years and nearly $ 12 mil. in all of fiscal 1991. The wholesaler has over $ 100 mil. in net operating loss carryforwards through 2006. About $ 65 mil of the carryforwards, however, are going to be passed on to parent NII to offset a gain from a sale of one of NII's other businesses, Permian Oil, on June 30.

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