[RITE AID LOGO APPEARS HERE]
RITE AID CORPORATION
2000 ANNUAL REPORT
CONTENTS Page
Letter to Stockholders,
Customers and Associates........1
Management's Discussion and
Analysis of Financial Condition
and Results of Operations.......5
Quantitative and Qualitative
Disclosures About Market
Risk...........................17
Independent Auditors'
Reports........................20
Consolidated Financial
Statements.....................22
Selected Financial Data........71
Directors and Corporate
Officers.......................73
Change in Independent
Auditors.......................74
Investor Information...........74
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
This Annual Report includes forward-looking statements within the meaning of
the Private Securities Litigation Reform Act of 1995. These forward-looking
statements are identified by terms and phrases such as "anticipate,"
"believe," "intend," "estimate," "expect," "continue," "should," "could,"
"may," "plan," "project," "predict," "will" and similar expressions and
include references to assumptions and relate to the future prospects,
developments and business strategies of Rite Aid Corporation.
Factors that could cause actual results to differ materially from those
expressed or implied in such forward-looking statements include, but are not
limited to:
. Our high level of indebtedness and our ability to refinance our
substantial debt obligations which mature in August and September 2002;
. Our ability to make interest and principal payments on our debt and
satisfy the other covenants contained in our credit facilities and other
debt agreements;
. Our ability to improve the operating performance of our existing stores,
and, in particular, our new and relocated stores in accordance with our
new management's long term strategy;
. The outcomes of pending lawsuits and governmental investigations, both
civil and criminal, involving our financial reporting and other matters;
. Competitive pricing pressures, continued consolidation of the drugstore
industry, third-party prescription reimbursement levels, regulatory
changes governing pharmacy practices, general economic conditions and
inflation, interest rate movements, access to capital and merchandise
supply constraints; and
. Our failure to develop, implement and maintain reliable and adequate
internal accounting systems and controls.
Rite Aid undertakes no obligation to revise the forward-looking statements
included in information report to reflect any future events or circumstances.
The company's actual results, performance or achievements could differ
materially from the results expressed in, or implied by, these forward-looking
statements. Factors that could cause or contribute to such differences are
discussed in the section entitled "Management's Discussion and Analyses of
Operations and Financial Condition--Factors Affecting Our Future Prospects" in
the Annual Report included with this information.
October 2000
To Our Stockholders, Customers and Associates:
The last year has been a time of dramatic change for Rite Aid: change in
management, change in strategy and change in the way we operate our business.
It's been a time of tremendous challenge, but it's also been a time of
accomplishment as we completed a refinancing that breathed new life into the
company. We also have a team of hard-working, dedicated associates, committed
to making Rite Aid a strong and profitable company.
Fiscal 2000: A Turbulent Year
Fiscal 2000, which began in March of 1999, was a turbulent year. The
company's financial position continued to deteriorate; stores experienced
serious declines in customer traffic and revenues because of inventory
shortages, high prices and a reduced and erratic advertising campaign; and the
company announced the need to restate earnings for the past three years.
In December, the Board of Directors hired a new executive management team to
resolve these issues. We came on board as chairman and chief executive and as
president and chief operating officer. Also joining the team were Dave
Jessick, as chief administration officer and senior executive vice president
and John Standley, as chief financial officer and senior executive vice
president. The four of us arrived at Rite Aid with 94 years of combined retail
experience and a successful track record working together at the West Coast
retailer Fred Meyer, the nation's fifth largest food and drug retailer before
being acquired by The Kroger Company last year.
Why did we decide to take on the challenges at Rite Aid? We believed that
with the aging population and the ever increasing use of prescription drugs,
the pharmacy business offers more real growth potential than any other sector
in retail today. We saw the opportunity for Rite Aid to receive a payback on
the substantial investments made by the company over the last five years. And
we were confident that given time, Rite Aid could achieve industry average
EBITDA margins (cash flow).
With our modern store base, new distribution centers, strong brand name,
superior pharmacy technology, outstanding and talented associates and the
advantage of having all of our stores integrated into one network, we have
good reason to be optimistic.
What We've Accomplished So Far
In our first ten months, we focused on bringing stability to the company.
Working together with our associates, our lenders and our suppliers, we:
. Strengthened our financial position with a refinancing that provided
more than $600 million of new working capital to invest in our business
and extended a substantial portion of our debt maturities so that we
have no significant debt maturing before August, 2002. We've also taken
steps to reduce debt by more than $1 billion, including the sale of PCS
Health Systems, our pharmacy benefit management subsidiary, to Advance
Paradigm, Inc.
. Developed a plan for fiscally responsible growth, dramatically
curtailing former management's overly aggressive expansion plan that
included the acquisition of PCS, the acquisition of six separate
drugstore companies, the opening of 376 new and 727 relocated stores and
the closing of 818 stores in the last three years alone. Today nearly
2,000 of our stores are new and relocated in the last 4 years. While
we'll open 30 to 40 new and relocated stores a year for the next two
years, because they are already in the pipeline and make good financial
sense, we will focus primarily on increasing sales by investing in our
existing stores and restoring the profitability of our operations.
1
. Strengthened our management team by adding 17 new vice presidents and
senior vice presidents, most of whom we've worked with in the past, to
the talented group of senior managers already at Rite Aid, to give us
one of the strongest retail teams in business today. All members of the
former executive management team have left the company.
. Improved store operations by dramatically reducing out-of-stock
conditions, lowering prices on 1,500 key items, establishing an
effective 52-week advertising program, executing effective promotions,
working closely with our suppliers to resolve issues and reorganizing
our field management structure to better focus on the critical areas of
our business. And our customers are responding. To date, same-store
sales increases have been consistently higher since April, with gains on
both the East and West coasts and dramatic improvement on the front end.
. Delivered up-to-date financial statements, in a process that took seven
months, hundreds of accountants and $50 million to complete. As a
result, the Company is now able to provide accurate financial reports on
a timely basis.
We also continue to cooperate fully with investigations by both the
Securities and Exchange Commission and United States Attorney into certain of
the company's former accounting and financial reporting practices. We expect
the outcomes of these investigations will not have a significant effect on our
ability to carry out our turnaround plan.
Our Long Term Strategy
While we are excited about all that we have accomplished, we realize we
still have a long way to go and much work ahead of us. The restatements,
refinancing and the sale of PCS consumed much of management's time through the
first ten months of this year. With those issues behind us, we can now focus
100% of our time on what creates value for investors---running better
drugstores.
Attracting more customers and making our current shoppers more loyal
customers is a key component of our long-term strategy. So is empowering,
training and motivating our associates to take great care of those customers.
We believe that new products and services and excellent customer service will
distinguish Rite Aid from other drugstore chains.
To enhance our relationship with our customers, we will continue to improve
our advertising program and evaluate and adjust our pricing to be competitive.
We are also testing a new version of our Rite Rewards frequent buyer program
in additional markets as a prelude to a national rollout. We are adding
technology to more of our pharmacies to make it easier for both the customer
and pharmacist to fill a prescription.
Because our sales per square foot are lower than our competitors, we see
great opportunity in new and improved product offerings, like more GNC
vitamins shops and one-hour photo processing and expanded categories like
garden, domestics and bath. We have expanded our private label program because
private label products generate higher margins, differentiate us from the
competition and represent real growth potential. We also want to increase the
sale of generic prescription drugs, which provide the same medical benefits as
branded drugs, generate higher margins for us and save money for our
customers.
Our larger stores in both the West and the South present additional
potential for growth. We have seen double-digit sales increases from recent
low-cost remodeling and remerchandising of stores on the West Coast. We will
remodel and remerchandise approximately 80 of our larger stores before fiscal
year end and plan to revamp 100 to 150 more during fiscal 2002.
The morale of our workforce is improving. We've visited many of our stores,
talking to associates across the country. We've conducted feedback sessions
with key cashiers, pharmacy technicians, pharmacists, store and district
managers and established pharmacy advisory panels because who knows more about
our business--and what it takes to improve our business-- than the people who
serve our customers every day?
2
Our associates want to do a great job. They just need the tools to help them
do it. Our turnaround plan includes implementing programs that give them more
time to spend with customers, from electronic processing of returns to a new
ordering system that makes it easier to have advertised items in stock. We
will institute training programs to improve customer service and to educate
our associates about the products we offer. As anyone in retailing knows, the
road to success is paved with great execution--and a big part of execution is
proper training.
As part of our focus on customer service, we also will provide incentives to
our associates for delivering quality customer service as well as overall
recognition and reward programs. We are evaluating and will make necessary
adjustments to our compensation and benefit plans to be competitive. All of
these initiatives are based on the number one rule of great retailing: take
good care of your employees and they will take good care of your customers.
Our associates are fundamental to our success, and it's critical that we
invest in them.
Defining A New Culture
Because what a company stands for is as important as what it sells, we have
set a new mission and are defining a new culture at Rite Aid. Our mission is
"To be a successful chain of friendly neighborhood drugstores" with "our
knowledgeable and caring associates working together to provide a superior
pharmacy experience . . . and everyday products and services to help our
valued customers lead happier, healthier lives."
We have established Rite Aid core values that empower our associates,
recognize the valuable role suppliers play as our partners, pledge that we
will operate every aspect of our business with the highest level of integrity
and reinforce that we are focused and committed to the healthcare needs of our
customers.
One of those core values is that "we will always communicate openly,
honestly and accurately with our associates, suppliers and our stockholders."
That means that Rite Aid will have on-time, up-to-date accurate financial
reports.
Another is that "we are committed to consistently delivering value for our
investors." We realize that another dramatic change at Rite Aid in the last 18
months has been the change in the stock price. While, unfortunately, we can't
change history, we can have an impact on the future. Although many challenges
remain, we believe the steps we've taken and the initiatives we have planned
will improve sales during the second half of this fiscal year and
substantially improve sales and EBITDA (cash flow) during the next fiscal
year.
We thank all of our associates--in our stores and distribution centers, in
field management and in our headquarters--for their hard work, dedication and
commitment to making Rite Aid a success and recognize that one of our biggest
responsibilities is to provide a secure future for all of them.
We promise our customers that we will value them more and deliver more value
in our quest to help them lead "happier, healthier lives." We'll work hard to
appreciate them so that when they ask themselves "Do I like doing business
with Rite Aid?," the answer will be a resounding yes.
We deeply appreciate our lenders for their trust that we have what it takes
to get Rite Aid back on track, and we'll continue to work hard to deserve that
trust.
We appreciate our suppliers for sticking with us during trying times and for
their confidence in Rite Aid's people, potential and plan. We would never have
been able to accomplish what we have so far without them and look forward to
building mutually successful long-term relationships.
We also want to thank our Board of Directors, and we welcome Alfred Gleason
and Stuart Sloan who joined the Board this year. Both have demonstrated
excellent business judgement and the highest integrity in their very
successful careers; we are fortunate to have them help us steer Rite Aid into
the future.
3
We are focused on improving our business. We are committed to successfully
executing our plan. And to borrow from the theme of our recent annual
management and supplier conference, we believe we have "The People, The
Passion and The Power" to accomplish our goals.
Sincerely,
/s/ Robert S Miller
Bob Miller
Chairman and Chief Executive Officer
/s/ Mary Sammons
Mary Sammons
President, Chief Operating Officer
and Director
4
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
The Management's Discussion and Analysis of Financial Condition and Results
of Operations for the years ended February 26, 2000, February 27, 1999 and
February 28, 1998 presented below reflects certain restatements to Rite Aid's
previously reported results of operations for these periods. See note 25 of
the notes to consolidated financial statements for a discussion of these
restatements.
Overview
Management believes that the following matters should be considered in
connection with the discussion of results of operations and financial
condition.
Maturing Store Base. Since the beginning of fiscal 1998, Rite Aid has built
372 new stores, relocated 713 stores and closed 791 stores. These new and
relocated stores represent approximately 29% of Rite Aid's total stores at
June 30, 2000. The new and relocated stores opened in recent years are
generally larger, free standing stores with higher operating expenses than our
older stores. New stores generally do not become profitable until a critical
mass of customers is developed. Relocated stores also must attract additional
customers to achieve comparable profitability to the store that was replaced.
We believe that the period of time required for a new store to achieve
profitable operations is generally between two and four years. This period can
vary significantly based on the location of a particular store and on other
factors, including the investments made in purchasing prescription files for
the location and advertising. Our recent liquidity constraints have limited
our ability to purchase prescription files and make other investments to
promote the development of our new and relocated stores. We believe that our
relatively high percentage of new and relocated stores is a significant factor
in our recent operating results. As new management continues to implement its
long term strategy, it will scale back Rite Aid's new store construction
program and focus on making the operations of its existing base of new and
relocated stores profitable. Management believes that as these newer stores
mature they should gain the critical mass of customers needed for profitable
operations. This continuing maturation should positively affect Rite Aid's
operating performance in future periods. If we are not able to improve the
performance of these new and relocated stores it will adversely affect our
ability to restore the profitability of our operations.
Reclassification of Lease Obligations. In connection with the restatement of
Rite Aid's operating results for fiscal 1999 and 1998, certain store leases
that had previously been classified as operating leases have now been
classified as capital leases. As a result of this restatement, our property,
plant and equipment and total debt balances at February 26, 2000 were
increased by $964.9 million and $1,080.0 million, respectively. The change in
classification of these lease obligations will result in an allocation of
depreciation charges to cost of goods sold and selling, general and
administrative expense. In addition, a portion of the lease payments will be
included in interest expense.
Substantial Investigation Expenses. The company has incurred substantial
costs in connection with the process of reviewing, reconciling and restating
its books and records, the investigation of its prior accounting practices and
the preparation of its audited financial statements. Included in these
expenses are the costs of the Deloitte & Touche LLP audit, the investigation
by Swidler Berlin, assisted by Deloitte & Touche LLP and the costs of
retaining Arthur Andersen LLP to assist management in reviewing and
reconciling its books and records. Management currently estimates that these
costs will total approximately $50.0 million, of which $10.1 million was
incurred in fiscal 2000, $19.5 million was incurred in the first quarter of
fiscal 2001, and the balance is expected to be incurred in the second quarter
of fiscal 2001 and thereafter. Rite Aid anticipates that it will continue to
incur significant legal and other expenses in connection with the ongoing
litigation and investigations to which it is subject.
Dilutive Equity Issuances. In June 2000, Rite Aid completed a series of debt
restructuring transactions as described further below under "--Liquidity and
Capital Resources." In connection with these transactions an aggregate total
of 69,564,434 shares of Rite Aid's common stock were issued in exchange for
$462.6 million principal amount of outstanding indebtedness. As a result of
these exchanges, we expect to record an aggregate
5
loss on conversion of approximately $77.6 million in the second quarter of
fiscal 2001. In addition, pursuant to the conversion price adjustment and pay-
in-kind dividend provisions of the convertible preferred stock issued to an
affiliate of Leonard Green and Partners, L.P. in October 1999, 57,571,389
shares of Rite Aid common stock were issuable upon the conversion of such
preferred stock at June 30, 2000. Assuming these transactions had occurred on
February 26, 2000, the common shares outstanding would have increased from
259,927,199 to 385,582,755. In light of our substantial leverage and liquidity
constraints, we will continue to consider opportunities to use the company's
equity securities to discharge debt or other obligations that may arise. Such
issuances may have a dilutive effect on the outstanding shares of Rite Aid
common stock.
Accounting Systems. Following its review of the company's books and records,
management concluded that further steps were needed to establish and maintain
the adequacy of its internal accounting systems and controls. In connection
with the audit of the company's financial statements, Deloitte & Touche LLP
advised Rite Aid that it believed there were numerous "reportable conditions"
under the standards established by the American Institute of Certified Public
Accountants which relate to the company's accounting systems and controls and
could adversely affect the company's ability to record, process, summarize and
report financial data consistent with the assertions of management in the
financial statements. Management's long term strategy includes a comprehensive
plan to develop, implement and maintain adequate and reliable accounting
systems and controls which address the reportable conditions identified by
Deloitte & Touche LLP.
Sale of PCS. On July 12, 2000, the company announced that it had entered
into an agreement to sell PCS its PBM segment to Advance Paradigm, Inc. The
sale was consummated on October 2, 2000. Accordingly, the PBM segment is
reported as a discontinued operation for all periods presented in the
accompanying financial statements and the operating results of the PBM segment
are reflected separately from the results of continuing operations. The
estimated loss on disposal of the PBM segment, subject to closing adjustments
and final determination of fair value of the series A preferred stock and
warrants, is $334.8 million, which consists of an estimated loss on disposal,
transaction expenses, and estimated net operating income through the date the
sale is consummated. In the first quarter of fiscal 2001 ended May 27, 2000
the company recorded a loss of $303.3 million and in the second quarter ended
August 26, 2000, an additional loss of $31.4 million will be recorded due to
changes in estimates. Additionally, the company recorded an increase to the
tax valuation allowance and income tax expense of $146.9 million in the first
quarter of fiscal 2001.
Results of Operations
Consolidated Revenues
- -------------------------------------------------------------------------------
Years Ended
-----------------------------------------
February 26, February 27, February 28,
2000 1999 1998
------------ ------------ ------------
(dollars in thousands)
Sales............................... $13,338,947 $12,438,442 $11,352,637
Sales growth........................ 7.2 % 9.6% *
Same store sales growth............. 7.9 % 15.5% *
Pharmacy sales growth............... 15.6 % 18.2% *
Same store pharmacy sales growth.... 16.2 % 21.9% *
Pharmacy as a % of total sales...... 58.4 % 54.2% 50.2%
Third-party sales as a % of total
pharmacy sales..................... 87.8 % 85.4% 83.4%
Front-end sales growth.............. (2.6)% 0.8% *
Same store front-end sales growth... (2.2)% 6.6% *
Front-end as a % of total sales..... 41.6 % 45.8% 49.8%
Store data:
Total stores (beginning of
period)........................... 3,870 3,975 3,750
New stores......................... 77 163 132
Closed stores...................... (181) (330) (280)
Store acquisitions, net............ 36 62 373
Total stores (end of period)....... 3,802 3,870 3,975
Remodeled stores................... 14 155 84
Relocated stores .................. 180 331 202
- -------------------------------------------------------------------------------
* See "Selected Financial Data" for a discussion of Rite Aid's inability to
present comparisons to fiscal 1997.
6
The 7.2% growth in sales in fiscal 2000 was primarily due to the continuing
strong growth of our pharmacy sales, which more than offset a decline in our
front-end sales. Our revenues in fiscal 1999 grew 9.6% over the level in
fiscal 1998 as a result of strong growth in pharmacy revenues and a slight
increase in front-end sales. Growth in sales in fiscal 1999 also benefited
from full-year sales of $779.0 million from the Harco, Inc. ("Harco") and K&B,
Incorporated ("K&B") stores which contributed only $458.2 million of sales in
fiscal 1998 following their acquisition on August 27, 1997.
For fiscal 2000 and fiscal 1999, pharmacy revenues led sales growth with
same-store sales increases of 16.2% and 21.9%, respectively. Our pharmacy
sales growth continued to benefit from our ability to attract and retain
managed care customers, our ongoing program of purchasing prescription files
from independent pharmacies and favorable industry trends. These trends
include an aging American population with many "baby boomers", now in their
fifties, consuming a greater number of prescription drugs. The use of
pharmaceuticals to treat a growing number of healthcare problems and the
introduction of a number of successful new prescription drugs also contribute
to the growing demand for pharmaceutical products.
Front-end sales, which include all non-prescription sales, such as seasonal
merchandise, convenience items and food and other non-prescription sales,
decreased in fiscal 2000 from the prior year. Our front-end sales were
adversely affected by our elevated levels of out-of-stock merchandise in the
third and fourth quarters of fiscal 2000. Other factors adversely affecting
our front-end sales included the suspension by former management of our
newspaper advertising circular program and their decision to raise front-end
prices to levels that were not competitive. Fiscal 1999 front end sales
increased .83% over fiscal 1998, despite a 6.6% increase in same store front-
end sales in those stores which had been open more than one year. Same store
sales growth was driven by strong performance in health and beauty, photo,
seasonal and general merchandise categories. Total front-end sales remained
essentially flat as an increase in the number of closed stores and a decrease
in the number of acquired stores in fiscal 1999 resulted in a net reduction of
105 stores in operation at the end of fiscal 1999 compared to fiscal 1998.
Costs and Expenses
- -------------------------------------------------------------------------------
Years Ended
---------------------------------------
February 26, February 27, February 28,
2000 1999 1998
------------ ------------ ------------
(dollars in thousands)
Costs of goods sold................... $10,242,377 $9,411,600 $8,396,239
Gross margin.......................... 23.2% 24.3% 26.0%
Selling, general and administrative
expenses............................. $ 3,578,861 $3,195,794 $2,796,342
Selling, general and administrative
expenses as a percentage of
revenues............................. 26.8% 25.7% 24.6%
Gain on sale of stores................ $ (80,109) $ -- $ (52,621)
Goodwill amortization................. 24,457 26,055 26,169
Store closing and impairment charges.. 153,317 192,551 148,560
Interest expense...................... 528,159 277,634 209,152
Share of loss from equity
investments.......................... 15,181 448 1,886
- -------------------------------------------------------------------------------
Cost of Goods Sold. Gross margin was 23.2% for fiscal 2000 compared to 24.3%
in fiscal 1999. The decline in gross margin in fiscal 2000 from fiscal 1999
was attributable to the incurrence of substantial additional costs related to
our distribution facilities and increased store occupancy costs. We incurred
significant start-up costs in fiscal 2000 in connection with the new
distribution facility located in Perryman, Maryland and also in connection
with the processing of merchandise received from our stores for shipment back
to our vendors. These increased
7
costs were partially offset by a substantial credit to cost of goods sold
resulting from the receipt of vendor allowances following a restructuring of
the terms of certain vendor contracts. In fiscal 1999, prior to the
restructuring of the contracts, these vendor allowances were credited to
selling, general and administrative expense. Also partially offsetting the
increases in cost of goods sold in fiscal 2000 were improved store level
margins for front-end and pharmacy sales.
Gross margin declined to 24.3% in fiscal 1999 from 26.0% in fiscal 1998. The
decline in gross margin in fiscal 1999 from fiscal 1998 was a result of a
substantial decline in our pharmacy margins. A decline in occupancy costs in
fiscal 1999 was largely offset by increased costs related to our distribution
facilities.
Also negatively impacting gross margins in the periods presented was the
continuing industry trend of rising third-party sales coupled with decreasing
margins on third-party reimbursed prescription sales. Third-party prescription
sales typically have lower gross margins than other prescription sales because
they are paid by a person or entity other than the recipient of the prescribed
pharmaceutical and are generally subject to lower negotiated reimbursement
rates in conjunction with a pharmacy benefit plan. Pharmacy sales as a
percentage of total sales were 58.4%, 54.2% and 50.2% in fiscal 2000, 1999 and
1998, respectively.
The company uses the last-in, first-out (LIFO) method of inventory
valuation. The effective LIFO inflation rates were 1.01486% in fiscal 2000,
1.01594% in fiscal 1999 and 1.00909% in fiscal 1998 which resulted in charges
to cost of goods sold of $34 million in fiscal 2000, $36 million in fiscal
1999 and $7 million in fiscal 1998. The company has changed its method of
accounting for LIFO as of February 26, 2000. See "--Accounting Change."
Selling, General and Administrative Expenses. Selling, general and
administrative expense ("SG&A") was 26.8% of sales in fiscal 2000, 25.7% of
sales in fiscal 1999 and 24.6% of sales in fiscal 1998. The increase in SG&A
as a percentage of revenues in fiscal 2000 is attributable to a decrease in
vendor allowances following the restructuring of certain vendor contracts as
described above, increased accruals for litigation and other contingencies and
a significant increase in legal and other professional fees.
Store Closing and Impairment Charges. In fiscal 2000, 1999 and 1998, Store
closing and impairment charges include non-cash charges of $120.6 million,
$87.7 million and $76.4 million, respectively, for the impairment of long-
lived assets (including allocable goodwill) of 249, 270, and 252 stores. These
amounts include the write-down of long-lived assets at stores that were
assessed for impairment because of management's intention to relocate or close
the store or because of changes in circumstances that indicate the carrying
value of an asset may not be recoverable.
Store closing and impairment charges consist of:
Year ended Year ended Year ended
February 26, 2000 February 27, 1999 February 28, 1998
----------------- ----------------- -----------------
(in thousands)
Store lease exit costs.. $ 32,724 $104,885 $ 72,118
Impairment charges...... 120,593 87,666 76,442
-------- -------- --------
$153,317 $192,551 $148,560
======== ======== ========
During fiscal 2000, 1999 and 1998, we recorded charges for 224, 422, and 593
stores, respectively, for stores to be closed or relocated that were under
long-term leases. Costs incurred to close a store, which principally include
lease termination costs, are recorded at the time management commits to
closing the store, which is typically 90 days preceding the store closing
date, or in the case of a store to be relocated, the date the new property is
leased or purchased. We calculate our liability for closed stores on a store-
by-store basis. The future minimum lease payments and related ancillary costs,
from the date of closure to the end of the remaining lease term, net of
estimated cost recoveries that may be achieved through subletting properties
or through favorable lease terminations, are computed. This liability is
discounted using a risk-free rate of interest. The company evaluates these
assumptions each quarter and adjusts the liability accordingly.
8
Subsequent to the recording of lease accruals, management determined that
certain stores would remain open. Included in the amounts stated above were
impairment write-downs of $4.0 million for 6 stores in fiscal 2000 and $1.4
million for 3 stores in fiscal 1999, that were written down to fair value but
were not relocated or closed. Also, the company reversed charges of $10.5
million and $1.1 million in fiscal 2000 and fiscal 1998, respectively for
lease accruals previously established for those stores.
In fiscal 2000, Rite Aid recorded an impairment charge of $7.6 million for
long-lived assets in connection with its decision to close and sell the Ogden,
Utah distribution center. The facility was sold in March 2000.
Interest Expense. Interest expense was $528.2 million in fiscal 2000
compared to $277.6 million in fiscal 1999 and $209.2 million in fiscal 1998.
The substantial increase in interest expense in fiscal 2000 is due to higher
levels of indebtedness throughout the year. The level of our indebtedness
increased in fiscal 2000 primarily as a result of the $1.3 billion borrowed in
January 1999 under the PCS credit facility and the $300 million of demand note
borrowings incurred in June 1999 to supplement cash flows from operating
activities and to fund capital expenditures. The annual weighted average
interest rates on our indebtedness in fiscal 2000, fiscal 1999 and fiscal 1998
were 7.4%, 6.8% and 6.7%, respectively.
Income Taxes. We had a net loss in fiscal 2000, fiscal 1999 and fiscal
1998. Tax benefits of $26.6 million (including the benefit related to
cumulative effect of accounting change), $216.9 million and $28.1 million have
been reflected for fiscal 2000, fiscal 1999 and fiscal 1998, respectively. The
full benefit of the net operating losses ("NOLs") generated in each period has
been partially offset by a valuation allowance based on management's
determination that, based on available evidence, it is more likely than not
that some of the deferred tax assets will not be realized. We expect to file
amended tax returns and utilize the NOL's against taxable income in prior
years to the maximum extent possible. Approximately $147.6 million is
currently expected to be recovered through carryback claims of which
approximately $80.0 million had been received as of June 30, 2000. See note 12
of the notes to consolidated financial statements.
Discontinued Operations. Sales of the PBM segment, which includes the
company's Eagle managed care division, increased from $180.8 million in fiscal
1998 to $344.4 million in fiscal 1999 and to $1.34 billion in fiscal 2000. The
increase in sales in fiscal 2000 resulted from the acquisition of PCS on
January 22, 1999. The PBM segment generated net income of $9.2 million in
fiscal 2000 compared to net losses of $12.8 million and $20.2 million in
fiscal 1999 and fiscal 1998, respectively.
Liquidity and Capital Resources
Rite Aid has two primary sources of liquidity: cash provided by operations
and the revolving credit facility under our new senior secured credit
facility. We may also generate liquidity from the sale of assets, including
sale-leaseback transactions. During fiscal 2000 and the fiscal quarter ended
May 27, 2000, cash provided by operations was not sufficient to fund our
working capital requirements, which have included the substantial accounting
and legal costs incurred in connection with the review and reconciliation of
our books and records, the restatement of our financial statements for fiscal
1999, fiscal 1998 and the audit of our financial statements for fiscal 2000,
fiscal 1999 and fiscal 1998. As a result, we have supplemented our cash from
operations with borrowings under our credit facilities. Our principal uses of
cash are to provide working capital for operations, service our obligations to
pay interest and principal on our debt, and to provide funds for capital
expenditures.
Credit Facilities and Debt Restructuring
In June 2000, we completed a major financial restructuring that provided us
with additional liquidity, extended the maturity dates of a substantial amount
of our debt until at least August 2002 and converted a portion of our debt to
equity. These refinancing transactions are described below.
9
New Senior Secured Credit Facility. We entered into a new $1.0 billion
syndicated senior secured credit facility with a syndicate of banks led by
Citibank N.A., as agent. The new facility matures on August 1, 2002, and
consists of a $500.0 million term loan facility and a $500.0 million revolving
credit facility. We used the term facility to terminate our accounts
receivable securitization facility and repurchase $300.0 million of unpaid
receivables thereunder, to fund $66.4 million of transaction costs relating to
our financial restructuring and to provide $133.6 million of cash that will be
available for general corporate purposes. The revolving facility provides us
with borrowings for working capital requirements, capital expenditures and
general corporate purposes. Borrowings under the facilities generally bear
interest either at LIBOR plus 3.0%, if we choose to make LIBOR borrowings, or
at Citibank's base rate plus 2%. For additional information about the interest
rates applicable to our credit facilities, see "Quantitative and Qualitative
Disclosures about Market Risks" below.
We are required to pay fees of 0.50% per annum on the daily unused amount of
the commitment. Substantially all of our wholly-owned subsidiaries guaranteed
our obligations under the senior secured credit facility. These subsidiary
guarantees are secured by a first priority lien on the inventory, accounts
receivable, intellectual property and some of the real estate assets of the
subsidiary guarantors. Our direct obligations under the senior credit facility
are unsecured.
The senior secured credit facility contains customary covenants, which place
restrictions on the assumption of debt, the payment of dividends, mergers,
liens and sale-leaseback transactions. The facility requires us to meet
various financial ratios and limits our capital expenditures. These ratios and
capital expenditure limits are subject to adjustment if we sell PCS. These
covenants require us to maintain a minimum interest coverage ratio of .75:1
(.72:1 if PCS is sold) for the quarter ended August 26, 2000, increasing to
1.40:1 (1.40:1 if PCS is sold) for the four quarter period ending June 1,
2002, and a minimum fixed charge coverage ratio of .88:1 (.88:1 if PCS is
sold) for the quarter ended August 26, 2000, increasing to 1.20:1 (1.19:1 if
PCS is sold) for the four quarter period ending June 1, 2002. We also must
maintain consolidated EBITDA (as defined in the senior secured credit
facility) of no less than $104.0 million ($81.0 million if PCS is sold) for
the quarter ended August 26, 2000, increasing to $894.0 million ($720.0
million if PCS is sold) for the four quarter period ending June 1, 2002. In
addition, our capital expenditures are limited to $70.0 million ($64.0 million
if PCS is sold) for the fiscal quarter ended August 26, 2000, and to $265.0
million ($243.0 million if PCS is sold) for the four quarter period ending
June 1, 2002. As indicated, the sale of PCS was completed on October 2, 2000.
The facility provides for customary events of default, including nonpayment,
misrepresentation, breach of covenants and bankruptcy. It is also an event of
default if any event occurs that enables, or which with the giving of notice
or the lapse of time would enable, the holder of Rite Aid debt to accelerate
the maturity of debt equaling $25.0 million or more.
Our ability to borrow under the senior secured credit facility is based on a
specified borrowing base consisting of eligible accounts receivable and
inventory. At June 24, 2000, the $500.0 million term loan was fully drawn. We
had no outstanding borrowings under the revolving facility at June 24, 2000;
however, $39.8 million of the availability was being utilized to support trade
letters of credit.
Other Existing Facilities. We extended to August 2002 the maturity date of
our existing syndicated credit facilities, which consist of the RCF credit
facility and the PCS credit facility. Borrowings under the PCS credit facility
bear interest at LIBOR plus 3.25% and borrowings under the RCF credit facility
bear interest at LIBOR plus 3.75%. These credit facilities contain restrictive
covenants which place restrictions on the assumption of debt, the payment of
dividends, mergers, liens and sale-leaseback transactions. These credit
facilities also require us to satisfy financial covenants which are generally
slightly less restrictive than the covenants in the new senior secured credit
facility. The facilities also limit the amount of our capital expenditures to
$70.0 million for the quarter ended August 26, 2000, and to $265.0 million for
the four quarters ending June 1, 2002. Any net proceeds realized from a sale
of PCS must be applied first to reduce the outstanding balances of the PCS
credit facility and the related PCS exchange debt and then to reduce the then
outstanding balance of the RCF credit facility. The amounts repaid with the
proceeds of asset sales may not be reborrowed. The PCS credit facility
continues to be secured by a first lien on the stock of PCS and the RCF credit
facility continues to be secured by a first lien
10
on the stock of drugstore.com and a second lien on the stock of PCS. At
June 24, 2000 we had $1.9 billion of borrowings outstanding under these credit
facilities. These facilities are also guaranteed and secured as described
below.
Exchange Offers. In June 2000, we completed the exchange of $52.5 million of
our 5.5% notes due December 2000 and $321.8 million of our 6.7% notes due
December 2001 for an aggregate of $374.3 million of our new 10.5% senior
secured notes due September 2002. After the exchange, $147.5 million of the
5.5% notes due December 2000 and $28.2 million of the 6.7% notes due December
2001 remained outstanding. In connection with the exchange, we entered into a
forward purchase agreement to sell $93.2 million of our 10.5% senior secured
notes due September 2002 to certain financial institutions. The proceeds from
such sale will permit us to repay approximately $93.2 million of the 5.5%
notes due 2000 when they mature in December of this year. The remaining 5.5%
notes due in December 2000 and 6.7% notes due 2001 will be retired with Rite
Aid's general corporate funds.
Exchange of Debt for Equity and Exchange Debt. As part of our restructuring,
certain affiliates of J.P. Morgan, which had lent us $300.0 million under a
demand note in June 1999 and was also a lender under the RCF and PCS credit
facilities, together with certain other lenders under the two credit
facilities, agreed to exchange a portion of their loans for a new secured
exchange debt obligation and common stock. This resulted in a total of $284.8
million of debt under these facilities, including $200 million of the
outstanding principal of the demand note, being exchanged for common stock at
a price of $5.50 per share. We expect to record a gain on this exchange of
debt of $11.4 million in the second quarter of fiscal 2001. An additional
$274.8 million of borrowings under the facilities were exchanged for the
exchange debt, including the entire remaining principal amount of the demand
note. The terms of the exchange debt are substantially the same as the terms
of our RCF and PCS credit facilities and the interest rate is currently LIBOR
plus 3.25%. The lenders of the exchange debt have the same collateral as they
did with respect to their loans under the PCS and RCF credit facilities and
also received a first lien on our prescription files.
On June 26, 2000, we issued 17.8 million shares of our common stock in
exchange for $177.8 million in principal amount of our 5.25% convertible
subordinated notes due 2002. As a result of this exchange, we expect to record
a loss of approximately $89.0 million in the second quarter of fiscal 2001.
Synthetic Leases. As part of our restructuring, we amended our existing
guarantees of two synthetic lease transactions to provide substantially the
same terms as the terms of our RCF and PCS credit facilities.
Second Priority Collateral. In connection with modifications to the PCS and
RCF credit facilities, the exchange for exchange debt and the guarantees of
the synthetic lease transactions, substantially all of our wholly-owned
subsidiaries guaranteed our obligations thereunder on a second priority basis.
These subsidiary guarantees are secured by a second priority lien on the
inventory, accounts receivable, intellectual property and some of the real
estate assets of the subsidiary guarantors. Except to the extent previously
secured, our direct obligations under those facilities and guarantees remain
unsecured.
Commercial Paper. Until September 24, 1999, we issued commercial paper
supported by unused credit commitments to supplement cash generated by
operations. Since the loss of our investment grade rating in fiscal 2000, we
are no longer able to issue commercial paper. Outstanding commercial paper of
the company amounted to $192.0 million at February 26, 2000, $1,783.1 million
at February 27, 1999 and $400.0 million at February 28, 1998. During fiscal
2000, the reduction of commercial paper was achieved through borrowings on our
RCF and PCS credit facilities. All remaining commercial paper obligations were
repaid in March 2000.
The increase in commercial paper in fiscal 1999 was due to the acquisition
of PCS in January 1999, which accounted for approximately $1.5 billion of the
total outstanding commercial paper at the end of fiscal 1999. Offsetting the
increase were net proceeds received from the issuance of $700.0 million in
long-term debt in December 1998 and net proceeds from the issuance of $200.0
million dealer remarketable securities in September 1998. Reductions in
commercial paper during fiscal 1998 were achieved through the issuance of
$650.0 million of our 5.25% convertible subordinated notes in the third
quarter of fiscal 1998.
11
Debt Capitalization. The following table sets forth our debt capitalization
(in millions) at June 24, 2000, following the completion of the refinancing
transactions described above:
As of
June 24,
2000
--------
Secured Debt:
Senior secured credit facility(1).................................. $ 500
PCS credit facility................................................ 1,142
RCF credit facility................................................ 730
10.5% senior secured notes due 2002(2)............................. 374
Exchange debt...................................................... 275
Synthetic lease guarantees......................................... 31
Other.............................................................. 16
Lease Financing Obligations......................................... 1,112
Other Senior Debt:
5.5% notes due 2000................................................ 147
6.7% notes due 2001................................................ 28
6.0% notes due 2005................................................ 200
7.625% notes due 2005.............................................. 200
7.125% notes due 2007.............................................. 350
6.125% notes due 2008.............................................. 150
6.0% Drs SM due 2003............................................... 200
6.875% Senior debentures due 2013.................................. 200
7.7% notes due 2027................................................ 300
6.875% debentures due 2028......................................... 150
Subordinated Debt:
5.25% convertible subordinated notes due 2002(3)................... 650
------
Total Debt...................................................... $6,755
======
- --------
(1) Proceeds from the term loan portion of the senior secured credit facility
were used to repay the $300.0 million outstanding balance of our
receivables securitization facility, to pay approximately $66.4 million of
expenses in connection with the refinancing transactions and to provide
$133.6 million of incremental cash on our balance sheet. No borrowings
under the revolving credit portion of the senior secured credit facility
were outstanding at June 24, 2000; however, $39.8 million of availability
was being utilized to support trade letters of credit. The receivables
securitization facility was an off-balance sheet liability and, therefore,
was not included in the company's balance sheet in prior periods.
(2) Outstanding amount of 10.5% senior secured notes due 2002 at June 24, 2000
does not include $93.2 million of such notes which are held by a special
purpose subsidiary of the company and are subject to a forward purchase
commitment by certain financial institutions. The proceeds from the sale
of these notes will be used to retire an equivalent amount of the
remaining 5.5% notes due 2000 upon their maturity in December 2000. The
remaining 5.5% notes due 2000 will be retired with the company's general
corporate funds.
(3) Outstanding principal amount was reduced to $472.2 million with the
exchange offer for common stock consummated on June 26, 2000, pursuant to
which $177.8 million principal amount of these notes were exchanged for
common stock.
Net Cash Provided By (Used in) Operating, Investing and Financing
Activities. We used $598.8 million of cash to fund continuing operations in
fiscal 2000. Operating cash flow was negatively impacted by $501.8 million of
interest payments. Operating cash flow was also negatively impacted from an
increase in current assets and a decrease in accounts payable partially offset
by an increase in other liabilities.
In fiscal 1999, we generated $278.9 million of cash flow from continuing
operations. Operating cash flow was negatively impacted by an increase in
accounts receivable, and a decrease in accounts payable, which was partially
offset by a decline in inventory and an increase in other liabilities.
Fiscal 1998 cash flow from continuing operations of $622.9 million benefited
from a $283.6 million reduction of accounts receivable. This reduction
resulted from the sale of accounts receivable through our accounts receivable
securitization program. Operating cash flows benefited from the utilization of
accounts payable to substantially finance the increase in inventories.
12
Cash used for investing activities was $552.1 million, $2,709.2 million and
$1,050.3 million for fiscal years 2000, 1999 and 1998, respectively. Cash used
for store construction and relocations amounted to $573.3 million for fiscal
2000, $1,222.7 million for fiscal 1999 and $716.1 for fiscal 1998. In
addition, cash of $1,390.6 million was used to acquire PCS in fiscal 1999 and
$335.0 million was used to acquire K&B and Harco in fiscal 1998.
Cash provided by financing activities was $905.1 million for fiscal 2000,
$2,660.3 million for fiscal 1999 and $535.0 million for fiscal 1998. Increased
borrowings under our RCF and PCS credit facilities which replaced our
commercial paper program and the sale of $300 million of preferred stock were
the main financing activities during fiscal 2000. In fiscal 1999, we issued
commercial paper to finance the acquisition of PCS. Also during fiscal 1999
net proceeds were received from the issuance of $700.0 million in long-term
debt and $200.0 million of dealer remarketable securities. Through the
issuance of $650.0 million of convertible subordinated notes in fiscal 1998,
reductions in then outstanding commercial paper were made. Supplemental cash
provided by financing activities were proceeds received from store sale-
leaseback transactions of $74.9 million, $505.0 million and $323.8 million for
fiscal 2000, 1999 and 1998, respectively.
Capital Expenditures. Rite Aid plans to make total capital expenditures of
approximately $225.0 million during fiscal 2001, consisting of approximately
$139.0 million related to new store construction, store relocation and other
store construction projects. An additional $61.0 million will be dedicated to
other store improvement activities including the purchase of Script Pro
automated prescription dispensing machines and the purchase of script files
from independent pharmacists. Management expects that these capital
expenditures will be financed primarily with cash flow from operations and
borrowings under the revolving credit facility available under our senior
secured facility.
Future Liquidity. We are highly leveraged. Based upon current levels of
operations and expected improvements in our operating performance, management
believes that cash flow from operations, together with available borrowings
under the new senior secured credit facility and its other sources of
liquidity (including asset sales) will be adequate to meet anticipated
requirements for working capital, debt service and capital expenditures until
August 2002, when $2.6 billion of our indebtedness, including the revolving
credit facility under the new senior secured credit facility, matures. Our
ability to replace, refinance or otherwise extend these obligations will
depend in part on our ability to successfully execute our long-term strategy
and improve the operating performance of our stores. For a discussion of
factors that could affect our current assessment, see "--Factors Affecting Our
Future Prospects" below.
Accounting Change
In fiscal 2000, we changed our application of the LIFO method of accounting
by restructuring our LIFO pool structure through a combination of certain
geographic pools. The reduction in the number of LIFO pools was made to more
closely align the LIFO pool structure to store merchandise categories. The
effect of this change in fiscal 2000 was to decrease our earnings by $6.8
million (net of income tax benefit of $4.6 million) or $.03 per diluted common
share. The cumulative effect of the accounting change was a charge of
$27.3 million (net of income tax benefit of $18.2 million), or $.11 per
diluted common share. The pro forma effect of this accounting change would
have been a reduction in net income of $6.4 million, (net of income tax
benefit of $4.2 million) or $.02 per diluted common share, and $12.6 million
(net of income tax benefit of $8.4 million) or $.05 per diluted common share,
for fiscal 1999 and 1998, respectively.
Recent Accounting Pronouncements
In November 1999, the Staff of the SEC issued Staff Accounting Bulletin
(SAB) 101, "Revenue Recognition." This SAB sets forth the Staff's position
regarding the point at which it is appropriate for a registrant to recognize
revenue. The Staff believes that revenue is realizable and earned when all of
the following criteria are met:
. persuasive evidence of an arrangement exists;
. delivery has occurred or service has been rendered;
13
. the seller's price to the buyer is fixed or determinable; and
. collectibility is reasonably assured.
The company uses the above criteria to determine whether revenue can be
recognized, and therefore believes that the issuance of SAB 101 does not have
a material impact on the company's financial statements.
In June 1998, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards No. 133, Accounting for Derivative
Instruments and Hedging Activities (SFAS No. 133). This statement, which
establishes the accounting and financial reporting requirements for derivative
instruments, requires companies to recognize derivatives as either assets or
liabilities on the balance sheet and measure those instruments at fair value.
This statement, as amended, is effective in fiscal 2002. The company is
evaluating the effects that the adoption of SFAS No. 133 may have on the
consolidated financial statements.
Factors Affecting Our Future Prospects
Risks Related to Our Financial Condition
We are highly leveraged. Our substantial indebtedness may severely limit
cash flow available for our operations and could adversely affect our ability
to service debt or obtain additional financing if necessary.
As of June 24, 2000, Rite Aid had $5.6 billion of outstanding indebtedness
for borrowed money and $1.1 billion, of capital leases (including current
maturities but excluding letters of credit) and negative stockholders' equity.
As of the same date we had additional borrowing capacity under our revolving
credit facility of $460.2 million. On a pro forma basis, giving effect to the
debt restructuring transactions completed in June 2000, our earnings would
have been insufficient to cover our fixed charges for the year ended February
26, 2000, by $1.2 billion. Our earnings for fiscal 2000 included non-cash
charges of $697.8 million. Based on the indebtedness outstanding, at June 24,
2000 (and then current interest rates) our annualized interest expense would
be approximately $574.0 million. Our high level of indebtedness will have
consequences on our operations. Among other things, our indebtedness will:
. limit our ability to obtain additional financing;
. limit our flexibility in planning for, or reacting to, changes in our
business and the industry;
. place us at a competitive disadvantage relative to our competitors with
less debt;
. render us more vulnerable to general adverse economic and industry
conditions; and
. require us to dedicate a substantial portion of our cash flow to service
our debt.
A substantial portion of our indebtedness matures in August and September,
2002. Our ability to refinance this indebtedness will be substantially
dependent on our ability to improve our operating performance.
Approximately $3.7 billion of our indebtedness at June 24, 2000 will mature
in August and September 2002. In order to satisfy these maturing obligations,
we will need to refinance the obligations, sell assets to satisfy them or seek
postponement of the maturity dates from our existing lenders. Our ability to
successfully accomplish any of these alternative transactions will be
substantially dependent on the successful execution of our long term strategic
plan and the resulting improvements in our operating performance.
The interest rate on certain of our outstanding indebtedness is based upon
floating interest rates. If interest rates increase, our interest payment
obligations will increase.
Approximately $2.6 billion of our outstanding indebtedness as of June 24,
2000 bears an interest rate that varies depending upon LIBOR. If we borrow
additional amounts under our senior secured facility, the interest rate on
those borrowings will vary depending upon LIBOR. If LIBOR rises, the interest
rates on this outstanding debt also increases. An increase in LIBOR therefore
would increase our interest payment obligations under these outstanding loans
and have a negative effect on our cash flow and financial condition.
14
The covenants in our outstanding indebtedness impose restrictions that may
limit our operating and financial flexibility.
The covenants in the instruments governing our outstanding indebtedness
restrict our ability to incur liens and debt, pay dividends, make redemptions
and repurchases of capital stock, make loans, investments and capital
expenditures, prepay, redeem or repurchase debt, engage in mergers,
consolidations, asset dispositions, sale-leaseback transactions and affiliate
transactions, change our business, amend certain debt and other material
agreements, issue and sell capital stock of subsidiaries, make distributions
from subsidiaries and grant negative pledges to other creditors.
Moreover, if we are unable to meet the terms of the financial covenants or
if we breach of any of these covenants, then a default could result under one
or more of these agreements. A default, if not waived by our lenders, could
result in the acceleration of our outstanding debt and cause our debt to
become immediately due and payable. If such acceleration occurs, we would not
be able to repay our debt and it is unlikely that we would be able to borrow
sufficient additional funds to refinance such debt. Even if new financing is
made available to us, it may not be available on terms acceptable to us.
Risks Related to Our Operations
Major lawsuits have been brought against us and certain of our subsidiaries,
and there are currently pending both civil and criminal investigations by the
U.S. Securities and Exchange Commission and the United States Attorney's
Office. Any criminal conviction against the company may result in the loss of
licenses that are material to the conduct of our business, which would have a
negative effect on our financial condition, results of operations and cash
flows.
There are currently pending both civil and criminal governmental
investigations by the SEC and the United States Attorney concerning our
financial reporting and other matters. An investigation has also been
commenced by the Department of Labor concerning our employee benefit plans.
These investigations are ongoing and we cannot predict their outcomes.
Lawsuits have been filed against us, as well as certain of our past and
present officers and directors. Class action lawsuits have been filed in which
the plaintiffs allege numerous violations of the securities laws; we cannot
predict the outcome of these cases.
Suits in six states are outstanding alleging that our pricing practices
violated applicable consumer protection laws and racketeering laws. Cases
against us regarding consumer protection and racketeering allegations have
been dismissed in the state courts of Florida, Oregon and New Jersey and in
the federal courts in Alabama and California, but we cannot predict the
outcome of an appeal, if any, nor can we predict the outcome of any of the
other cases in other jurisdictions.
In addition, given the size and nature of our business, we are subject from
time to time to various lawsuits which, depending on their outcome, may have a
negative impact on our results of operations, financial condition and cash
flows.
We are substantially dependent on a single supplier of pharmaceutical
products and our other suppliers to sell products to us on satisfactory terms.
We obtain approximately 87% of our pharmaceutical supplies from a single
supplier, McKesson, pursuant to a long-term supply contract. Pharmacy sales
represented approximately 58.4% of our total sales during fiscal 2000, and
therefore our relationship with McKesson is important to us. Any significant
disruptions in our relationships with our suppliers, particularly our
relationship with McKesson, would make it difficult for us to continue to
operate our business, and would have a material adverse effect on our results
of operations and financial condition.
15
Several of our executive officers have joined Rite Aid recently. We cannot
assure you that management will be able to successfully manage our business or
successfully implement our strategic plan.
Since December 1999, we have hired a new management team, including Robert
G. Miller as chief executive officer and chairman. Our management team has
considerable experience in the retail industry. Nonetheless, we cannot assure
you that management will be able to successfully manage our business or
successfully implement our strategic business plan.
We are now depending on our new management team, and the loss of their
services could have a material adverse effect on our business and the results
of our operations or financial condition.
The success of our business is materially dependent upon the continued
services of our chairman and chief executive officer, Mr. Miller, and the
other members of our new management team. The loss of Mr. Miller or other key
personnel due to death, disability or termination of employment could have a
material adverse effect on the results of our operations or financial
condition, or both. Additionally, we cannot assure you that we will be able to
attract or retain other skilled personnel in the future.
We need to improve our operations in order to improve our financial
condition but our operations will not improve if we cannot effectively
implement our business strategy.
Our operations during the fiscal year ended February 26, 2000 were adversely
affected by a number of factors, including our financial difficulties,
inventory shortages, allegations of violations of the law, including drug
pricing issues, problems with suppliers and uncertainties regarding Rite Aid's
ability to produce audited financial statements. To improve operations, new
management developed and has been implementing a business strategy to improve
the pricing of products, provide more consistent advertising through weekly,
national circulars, eliminate problems with shortages of inventory and out-
dated inventory, resolve all issues with our vendors, develop programs
intended to enhance customer relationships and provide better service and
continue to improve our stores and the product offerings within our stores. If
we are not successful in our efforts to implement our business strategy, or if
our business strategy is not effective we may not be able to improve our
operations. Failure to improve operations would adversely affect our ability
to make principal or interest payments on our debt.
The additional unregistered shares of Rite Aid common stock that we issued
may depress the market price of Rite Aid common stock because we have agreed
to register those shares under the Securities Act to enable the holders of the
shares to sell them.
In connection with the refinancing of our debt, we agreed to register the
51,785,434 shares of Rite Aid common stock that we issued to our lenders under
its RCF credit facility, PCS credit facility and demand note. In addition, we
have agreed to register the 57,571,389 shares of Rite Aid common stock
underlying (as of June 30, 2000) the series B convertible preferred stock that
we issued in October 1999 and the 2,500,000 shares of Rite Aid common stock
underlying the warrant issued to J.P. Morgan Ventures Corporation in October
1999. The possible public sale of such large numbers of shares may have an
adverse effect on the market price of Rite Aid's common stock.
Risks Related to our Industry
The markets in which we operate are very competitive and further increases
in competition could adversely affect us.
We face intense competition with local, regional and national companies,
including other drug store chains, independent drug stores, Internet retailers
and mass merchandisers. We may not be able to effectively compete against them
because our existing or potential competitors may have financial and other
resources that are superior to ours. In addition, we may be at a competitive
disadvantage because we are more highly leveraged than our competitors. We
believe that the continued consolidation of the drugstore industry will
further increase competitive pressures in the industry. As competition
increases in the markets in which we operate, a significant increase in
general pricing pressures could occur which would require us to increase our
sales volume and to sell higher margin
16
products and services in order to remain competitive. We cannot assure you
that we will be able to continue to effectively compete in our markets or
increase our sales volume in response to further increased competition.
Changes in third-party reimbursement levels for prescription drugs could
reduce our margins and have a material adverse effect on our business.
We are reimbursed by third-party payors for approximately 87.8% of all of
the prescription drugs that we sell. These third-party payors could reduce the
levels at which they will reimburse us for the prescription drugs that we
provide to their members. Furthermore, if Medicare is reformed to include
prescription benefits, Medicare may cover some of the prescription drugs that
we now sell at retail prices, and we may be reimbursed at prices lower than
our current retail prices. If third-party payors reduce their reimbursement
levels or if Medicare covers prescription drugs at reimbursement levels lower
than our current retail prices our margins on these sales would be reduced,
and the profitability of our business could be adversely affected.
We are subject to governmental regulations, procedures and requirements; our
noncompliance or their significant change could hurt our business, the results
of our operations or our financial condition.
Our pharmacy business is subject to several federal, state, and local
regulations. These include local registrations of pharmacies in the states
where our pharmacies are located, applicable Medicare and Medicaid
regulations, and prohibitions against paid referrals of patients. Failure to
properly adhere to these and other applicable regulations could result in the
imposition of civil and criminal penalties and could adversely affect the
continued operation of our business. Furthermore, our pharmacies could be
affected by federal and state reform programs, such as health care reform
initiatives which could, in turn, negatively affect our business. The passing
of these initiatives or any new federal or state programs could adversely
affect our business and results of operations.
Certain risks are inherent in the provision of pharmacy services, and our
insurance may not be adequate to cover any claims against us.
Pharmacies are exposed to risks inherent in the packaging and distribution
of pharmaceuticals and other health care products. Although we maintain
professional liability and errors and omissions liability insurance, we cannot
assure you that the coverage limits under our insurance programs will be
adequate to protect us against future claims, or that we will maintain this
insurance on acceptable terms in the future.
Any adverse change in general economic conditions can adversely affect
consumer-buying practices and reduce our sales of front-end products, which
are our higher margin products.
If the economy slows down and unemployment increases or inflationary
conditions worry consumers, consumers will decrease their purchases,
particularly of products other than pharmaceutical products that they need for
health reasons. We make a higher profit on our sales of front-end products
than we do on sales of pharmaceutical products. Therefore, any decrease in our
sales of front-end products will decrease our profitability.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS
Rite Aid's future earnings, cash flow and fair values relevant to financial
instruments are dependent upon prevalent market rates. Market risk is the risk
of loss from adverse changes in market prices and interest rates. The
company's major market risk exposure is changing interest rates. Increases in
interest rates would increase the company's interest expense. Since the end of
fiscal 1999, Rite Aid's primary risk exposure has not changed. The company
enters into debt obligations to support capital expenditures, acquisitions,
working capital needs and general corporate purposes. The company's policy is
to manage interest rates through the use of a combination of variable-rate
credit facilities, fixed-rate long-term obligations and derivative
transactions.
17
The table below provides information about the company's financial
instruments that are sensitive to changes in interest rates. The table
presents principal payments and the related weighted average interest rates by
expected maturity dates as of February 26, 2000.
Fair Value
at
February 26,
2001 2002 2003 2004 2005 Thereafter Total 2000
------- ------- ---------- -------- ------ ---------- ---------- ------------
(dollars in thousands)
Long-term debt,
including Current
portion
Fixed rate............ $76,086 $29,879 $1,121,490 $200,678 $2,289 $1,553,816 $2,984,238 $1,959,252
Average Interest
Rate................. 6.43% 6.77% 7.46% 6.01% 11.86% 7.00%
Variable Rate......... -- -- $2,480,495 -- -- -- $2,480,495 $2,480,495
Average Interest
Rate................. -- -- 9.38% -- -- --
In June 2000, Rite Aid refinanced certain variable- and fixed-rate
obligations maturing in fiscal years 2001 and 2002 and entered into an
interest rate swap that fixes the LIBOR component of $500.0 million of Rite
Aid's variable-rate debt at 7.083% for a two year period. In July 2000, Rite
Aid entered into an additional interest rate swap that fixes the LIBOR
component of an additional $500.0 million of variable rate debt at 6.946% for
a two year period. As a result of these financing activities, Rite Aid's ratio
of variable rate exposure changed from 37.7% as of February 26, 2000 to 27.3%
as of July 10, 2000.
Our ability to satisfy our interest payment obligations on our outstanding
debt will depend largely on our future performance, which, in turn, is subject
to prevailing economic conditions and to financial, business and other factors
beyond our control. If we do not have sufficient cash flow to service our
interest payment obligations on our outstanding indebtedness and if we cannot
borrow or obtain equity financing to satisfy those obligations, our business
and results of operations will be materially adversely affected. We cannot
assure you that any such borrowing or equity financing could be successfully
completed.
As of June 24, 2000, Rite Aid had three credit facilities: the new $1.0
billion senior secured credit facility entered into on June 14, 2000, and the
RCF credit facility and PCS credit facility. In addition, it had fixed-rate
obligations in the amount of $4.0 billion and exchange debt in the amount of
$274.8 million. In March 2000, all remaining commercial paper obligations were
repaid. The ratings on these credit facilities and obligations as of June 24,
2000 were as follows: the $1.0 billion RCF facility: B by Standard and Poor's
and B2 by Moody's; the $1 billion senior secured credit facility: BB- by
Standard & Poor's and Ba3 by Moody's; the $1.3 billion PCS facility: B by
Standard & Poor's and B2 by Moody's; the fixed-rate obligations: B- by
Standard & Poor's and Caa1 by Moody's; and the exchange debt is not rated yet.
The interest rates on the variable-rate borrowings are as follows: the $1.0
billion RCF revolving credit facility: LIBOR plus 3.75%, the $1.0 billion
senior secured credit facility: LIBOR plus 3.00%, and the $1.3 billion PCS
facility and the exchange debt: LIBOR plus 3.25%.
Further downgrades of Rite Aid's credit ratings would not impact the rate on
the borrowings under the credit facilities. The interest rate on the RCF and
PCS credit facilities and the exchange debt is subject to a 0.50% per annum
increase if we have not received and applied $500 million of net proceeds from
asset sales by November 1, 2000 to reduce these obligations. As a result of
the application of the proceeds from the sale of PCS, the interest rate will
not be increased.
Changes in one month LIBOR affect Rite Aid's cost of borrowings because the
interest rate on Rite Aid's variable-rate obligations is based on LIBOR. If
the market rates of interest for one month LIBOR change by 10% (approximately
60 basis points) as compared to the LIBOR rate of 5.91% and 6.65% as of
February 26, 2000 and June 24, 2000, respectively, Rite Aid's annual interest
expense would change by approximately $14.9 million and $18.0 million,
respectively, based upon Rite Aid's variable-rate debt outstanding of
approximately $2.5 billion and $2.7 billion as of February 26, 2000 and June
24, 2000, respectively.
18
A change in interest rates generally does not impact future earnings and
cash flow for fixed-rate debt instruments. As fixed-rate debt matures,
however, and if additional debt is acquired to fund the debt repayment, future
earnings and cash flow may be impacted by changes in interest rates. This
impact would be realized in the periods subsequent to the periods when the
debt matures.
19
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of
Rite Aid Corporation
Camp Hill, Pennsylvania
We have audited the accompanying consolidated balance sheets of Rite Aid
Corporation and subsidiaries as of February 26, 2000 and February 27, 1999,
and the related consolidated statements of operations, stockholders' equity,
and cash flows for each of the three years in the period ended February 26,
2000. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits. We did not audit the consolidated financial
statements of PCS Holding Corporation (a consolidated subsidiary of Rite Aid
Corporation), which has been included in discontinued operations in the
accompanying consolidated financial statements, which statements reflect total
assets constituting 17% and 18% of consolidated total assets as of February
26, 2000 and February 27, 1999, respectively, and revenues of $1,264.7 million
and $104.3 million for the years ended February 26, 2000 and February 27,
1999, respectively. Those financial statements were audited by other auditors
whose report has been furnished to us, and our opinion, insofar as it relates
to the amounts included for PCS Holding Corporation, is based solely on the
report of such other auditors.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits and the report of the other auditors provide a reasonable basis for our
opinion.
In our opinion, based on our audits and the report of the other auditors, such
consolidated financial statements present fairly, in all material respects,
the financial position of Rite Aid Corporation and subsidiaries at February
26, 2000 and February 27, 1999, and the results of their operations and their
cash flows for each of the three years in the period ended February 26, 2000,
in conformity with accounting principles generally accepted in the United
States of America.
As discussed in Notes 1 and 26 to the consolidated financial statements, on
July 12, 2000, the Company announced that it had entered into an agreement to
sell its pharmacy benefit management segment. Accordingly, the pharmacy
benefit management segment has been reclassified as a discontinued operation
in the accompanying consolidated financial statements.
As discussed in Note 25 to the consolidated financial statements, the
accompanying consolidated financial statements have been restated.
As discussed in Note 5 to the consolidated financial statements, the Company
changed its application of the last-in, first-out ("LIFO") method of
accounting for inventory in 2000.
/s/ DELOITTE & TOUCHE LLP
Philadelphia, Pennsylvania
July 11, 2000
(October 2, 2000 as to the effects of the discontinued operation discussed in
Note 26 and as to the effects of the restatement discussed in the third
paragraph in Note 25)
20
Report of Independent Auditors
Board of Directors and Shareholder
PCS Holding Corporation
We have audited the consolidated balance sheets of PCS Holding Corporation and
Subsidiaries (the Company) as of February 27, 1999 and February 26, 2000, and
the related consolidated statements of operations, shareholder's equity, and
cash flows for the thirty-six days ended February 27, 1999 and the year ended
February 26, 2000 (not presented seperately herein). These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on
a test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used
and significant estimates made by management, as well as evaluating the
overall financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position
of PCS Holding Corporation and Subsidiaries at February 27, 1999 and February
26, 2000, and the consolidated results of their operations and their cash
flows for the thirty-six days ended February 27, 1999 and the year ended
February 26, 2000, in conformity with accounting principles generally accepted
in the United States.
/s/ Ernst & Young LLP
April 21, 2000
21
RITE AID CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands of dollars, except share amounts)
February 26, February 27,
2000 1999
(as restated, (as restated,
see note 25) see note 25)
------------- -------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents......................... $ 179,757 $ 84,522
Accounts receivable, net ......................... 152,035 71,928
Inventories, net ................................. 2,472,437 2,618,235
Refundable income taxes........................... 147,599 --
Prepaid expenses and other current assets......... 63,659 26,327
----------- -----------
Total current assets.............................. 3,015,487 2,801,012
----------- -----------
PROPERTY, PLANT AND EQUIPMENT, NET................. 3,449,594 3,328,499
GOODWILL AND OTHER INTANGIBLES..................... 1,311,123 1,463,443
OTHER ASSETS....................................... 242,899 260,658
DEFERRED TAX ASSET................................. 146,916 171,364
NET NON-CURRENT ASSETS OF DISCONTINUED OPERATIONS.. 1,743,828 1,753,475
----------- -----------
Total assets...................................... $ 9,909,847 $ 9,778,451
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Current lease financing obligations............... $ 25,964 $ 31,522
Short-term debt and current maturities of long-
term debt ....................................... 76,086 1,539,267
Accounts payable.................................. 854,062 1,135,220
Sales and other taxes payable..................... 33,662 32,963
Income taxes payable ............................. 111,804 107,896
Deferred income taxes............................. -- 29,675
Accrued salaries, wages and other current
liabilities ..................................... 803,895 700,712
Net current liabilities of discontinued
operations....................................... 390,053 115,872
----------- -----------
Total current liabilities......................... 2,295,526 3,693,127
----------- -----------
CONVERTIBLE SUBORDINATED NOTES .................... 649,986 649,991
LONG-TERM DEBT LESS CURRENT MATURITIES ............ 4,738,661 2,583,813
LEASE FINANCING OBLIGATIONS LESS CURRENT
MATURITIES........................................ 1,125,937 1,117,911
OTHER NONCURRENT LIABILITIES....................... 647,771 370,433
----------- -----------
Total liabilities................................. 9,457,881 8,415,275
----------- -----------
COMMITMENTS AND CONTINGENCIES (Note 22)............
REDEEMABLE PREFERRED STOCK ........................ 19,457 23,559
STOCKHOLDERS' EQUITY:
Preferred stock, par value $1 per share;
liquidation value $100 per share; 20,000,000
shares authorized: shares issued -- 3,082,500 and
0................................................ 308,250 --
Common stock, par value $1 per share; 600,000,000
shares authorized: shares issued and
outstanding-- 259,927,199 and 258,862,411 ....... 259,927 258,861
Additional paid-in capital........................ 1,292,337 1,370,005
Accumulated deficit............................... (1,421,817) (288,774)
Deferred compensation............................. (6,188) --
Accumulated other comprehensive income............ -- (475)
----------- -----------
Total stockholders' equity........................ 432,509 1,339,617
----------- -----------
Total liabilities and stockholders' equity........ $ 9,909,847 $ 9,778,451
=========== ===========
The accompanying notes are an integral part of these consolidated financial
statements.
22
RITE AID CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands of dollars, except per share amounts)
Year ended
-----------------------------------------
February 26, February 27, February 28,
2000 1999 1998
(52 weeks) (52 weeks) (52 weeks)
(as restated, (as restated, (as restated,
see note 25) see note 25) see note 25)
------------- ------------- -------------
Summary of Operations:
REVENUES............................. $13,338,947 $12,438,442 $11,352,637
COSTS AND EXPENSES:
Cost of goods sold, including
occupancy costs................... 10,242,377 9,411,600 8,396,239
Selling, general and administrative
expenses.......................... 3,578,861 3,195,794 2,796,342
Gain on sale of stores............. (80,109) -- (52,621)
Goodwill amortization.............. 24,457 26,055 26,169
Store closing and impairment
charges........................... 153,317 192,551 148,560
Interest expense................... 528,159 277,634 209,152
Share of loss from equity
investments....................... 15,181 448 1,886
----------- ----------- -----------
14,462,243 13,104,082 11,525,727
----------- ----------- -----------
Loss from continuing operations
before income taxes and cumulative
effect of accounting change ...... (1,123,296) (665,640) (173,090)
INCOME TAX BENEFIT................... (8,375) (216,941) (28,064)
----------- ----------- -----------
Loss from continuing operations
before cumulative effect of
accounting change................. (1,114,921) (448,699) (145,026)
INCOME (LOSS) FROM DISCONTINUED
OPERATIONS, including income tax
expense (benefit) of $30,903,
$(5,925) and $(10,885).............. 9,178 (12,823) (20,214)
CUMULATIVE EFFECT OF ACCOUNTING
CHANGE, net of income tax benefit of
$18,200............................. (27,300) -- --
----------- ----------- -----------
Net loss......................... $(1,133,043) $ (461,522) $ (165,240)
=========== =========== ===========
BASIC AND DILUTED (LOSS) INCOME PER
SHARE:
Loss from continuing operations.... $ (4.34) $ (1.74) $ (0.58)
Income (loss) from discontinued
operations........................ 0.04 (0.05) (0.08)
Cumulative effect of accounting
change, net....................... (0.11) -- --
----------- ----------- -----------
Net loss per share............... $ (4.41) $ (1.79) $ (0.66)
=========== =========== ===========
The accompanying notes are an integral part of these consolidated financial
statements.
23
RITE AID CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE FISCAL YEARS ENDED FEBRUARY 26, 2000, FEBRUARY 27, 1999, AND FEBRUARY
28, 1998
(In thousands of dollars, except per share amounts)
Accumulated
Preferred Stock Common Stock Additional Retained Other
------------------------- ---------------------------- Paid-in Earnings Deferred Comprehensive
Shares Class A Class B Shares Issued Treasury Capital (Deficit) Compensation Income
------ -------- -------- -------- -------- --------- ---------- ----------- ------------ -------------
BALANCE, MARCH 1,
1997
(As restated,
see note 25).... -- $ -- $ -- 129,347 $129,347 $(104,746) $1,371,361 $ 553,814 $ -- $(1,867)
Net income (As
restated, see
note 25)........ (165,240)
Other
comprehensive
income--
Minimum pension
liability
adjustment..... 1,080
Comprehensive
income.........
Stock options
exercised....... 404 404 9,293
Stock option
income tax
benefit......... 4,191
Stock grants..... 13 13 616
Bond conversion.. 5,875 5,875 196,777
Two-for-one stock
split........... 135,639 135,639 (135,639)
Cancel treasury
shares.......... (13,064) (13,064) 104,746 (91,682)
Cash dividends
paid on common
stock ($.4075
per share post
split).......... (102,715)
----- -------- -------- -------- -------- --------- ---------- ----------- ------- -------
BALANCE FEBRUARY
28, 1998 (As
restated, see
note 25)........ -- -- -- 258,214 258,214 -- 1,354,917 285,859 -- (787)
Net loss (As
restated, see
note 25)........ (461,522)
Other
comprehensive
income--
Minimum pension
liability
adjustment..... 312
Comprehensive
income.........
Stock options
exercised....... 633 633 8,603
Stock option
income tax
benefit......... 5,807
Stock grants..... 14 14 669
Bond conversion.. 9
Cash dividends
paid on common
stock ($.4375
per share post
split).......... (113,111)
----- -------- -------- -------- -------- --------- ---------- ----------- ------- -------
BALANCE FEBRUARY
27, 1999 (As
restated, see
note 25)........ -- -- -- 258,861 258,861 -- 1,370,005 (288,774) -- (475)
Net loss (As
restated, see
note 25)........ (1,133,043)
Other
comprehensive
income--
Minimum pension
liability
adjustment...... 475
Comprehensive
income.........
Issuance of
preferred
shares.......... 3,000 300,000
Exchange of
preferred
shares.......... (300,000) 300,000
Stock options
exercised....... 66 66 814
Stock option
income tax
benefit......... 243
Stock grants..... 1,000 1,000 7,250 (6,188)
Issuance of
common stock
warrants........ 8,500
Bond conversion.. 5
Dividends on
preferred
stock........... 83 8,250 (8,250)
Increase
resulting from
sale of stock by
equity method
investee........ 2,929
Cash dividends
paid on common
stock ($.3450
per share post
split).......... (89,159)
----- -------- -------- -------- -------- --------- ---------- ----------- ------- -------
BALANCE FEBRUARY
26, 2000 (As
restated, see
note 25)........ 3,083 $ -- $308,250 259,927 $259,927 $ -- $1,292,337 $(1,421,817) $(6,188) $ --
===== ======== ======== ======== ======== ========= ========== =========== ======= =======
Total
-----------
BALANCE, MARCH 1,
1997
(As restated,
see note 25).... $1,947,909
Net income (As
restated, see
note 25)........ (165,240)
Other
comprehensive
income--
Minimum pension
liability
adjustment..... 1,080
-----------
Comprehensive
income......... (164,160)
Stock options
exercised....... 9,697
Stock option
income tax
benefit......... 4,191
Stock grants..... 629
Bond conversion.. 202,652
Two-for-one stock
split........... --
Cancel treasury
shares.......... --
Cash dividends
paid on common
stock ($.4075
per share post
split).......... (102,715)
-----------
BALANCE FEBRUARY
28, 1998 (As
restated, see
note 25)........ 1,898,203
Net loss (As
restated, see
note 25)........ (461,522)
Other
comprehensive
income--
Minimum pension
liability
adjustment..... 312
-----------
Comprehensive
income......... (461,210)
Stock options
exercised....... 9,236
Stock option
income tax
benefit......... 5,807
Stock grants..... 683
Bond conversion.. 9
Cash dividends
paid on common
stock ($.4375
per share post
split).......... (113,111)
-----------
BALANCE FEBRUARY
27, 1999 (As
restated, see
note 25)........ 1,339,617
Net loss (As
restated, see
note 25)........ (1,133,043)
Other
comprehensive
income--
Minimum pension
liability
adjustment...... 475
-----------
Comprehensive
income......... (1,132,568)
Issuance of
preferred
shares.......... 300,000
Exchange of
preferred
shares.......... --
Stock options
exercised....... 880
Stock option
income tax
benefit......... 243
Stock grants..... 2,062
Issuance of
common stock
warrants........ 8,500
Bond conversion.. 5
Dividends on
preferred
stock........... --
Increase
resulting from
sale of stock by
equity method
investee........ 2,929
Cash dividends
paid on common
stock ($.3450
per share post
split).......... (89,159)
-----------
BALANCE FEBRUARY
26, 2000 (As
restated, see
note 25)........ $ 432,509
===========
The accompanying notes are an integral part of these consolidated financial
statements
24
RITE AID CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Income Taxes
Deferred income taxes are determined based on the difference between the
financial reporting and tax bases of assets and liabilities. Deferred income
tax expense (benefit) represents the change during the reporting period in the
deferred tax assets and deferred tax liabilities, net of the effect of
acquisitions and dispositions. Deferred tax assets include tax loss and credit
carryforwards and are reduced by a valuation allowance if, based on available
evidence, it is more likely than not that some portion or all of the deferred
tax assets will not be realized.
Recent Accounting Pronouncements
In June 1998 the Financial Accounting Standards Board (FASB) issued SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities." SFAS No.
133 establishes the accounting and financial reporting requirements for
derivative instruments and requires companies to recognize derivatives as
either assets or liabilities on the balance sheet and measure those
instruments at fair value. This statement, as amended, is effective in fiscal
year 2002. The Company is evaluating the effects that the adoption of SFAS No.
133 may have on the financial statements.
In November 1999 the Staff of the SEC issued Staff Accounting Bulletin (SAB)
101, "Revenue Recognition". This SAB sets forth the Staff's position regarding
the point at which it is appropriate for a Registrant to recognize revenue.
The Staff believes that revenue is realizable and earned when all of the
following criteria are met:
.Persuasive evidence of an arrangement exists;
.Delivery has occurred or service has been rendered;
.The seller's price to the buyer is fixed or determinable; and
.Collectibility is reasonably assured.
The Company uses the above criteria to determine whether revenue can be
recognized, and therefore believes that the issuance of SAB 101 does not have
a material impact on these financial statements.
Use of Estimates
The preparation of the financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
Significant Concentrations
During fiscal 2000, the Company purchased approximately 87% of the dollar
volume of its prescription drugs from a single supplier, McKesson HBOC, Inc.
(McKesson). If Rite Aid's relationship with McKesson was disrupted, the
Company could have difficulty filling prescriptions, which would negatively
impact the business.
2. Results of Operations and Financing:
During fiscal 2000, 1999 and 1998, the Company incurred net losses of
$1,133,043, $461,522 and $165,240, respectively, and during fiscal 2000 net
cash used in operating activities from continuing operations was $598,750. As
discussed in note 11, the Company obtained various loan covenant waivers
and/or modifications, and refinanced or extended maturity dates from certain
of its lenders. In addition, the Company obtained a new senior credit facility
in June 2000 (see note 24).
Since December 1999, management of the Company has taken a series of steps
intended to stabilize and improve the operating results of the Company's
retail drug segment. Management believes that available cash and cash
equivalents together with cash flow from operations, available borrowings
under the new senior credit facility and other sources of liquidity (including
asset sales) will be sufficient to fund the Company's operating
29
RITE AID CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
activities, investing activities and debt maturities for fiscal 2001. In
addition, management believes that the Company will be in compliance with its
existing debt covenant requirements throughout fiscal 2001. However, a
substantial portion of its indebtedness which will mature in August and
September 2002 will require the Company to refinance the indebtedness at that
time.
3. Acquisitions and Dispositions:
On March 3, 1999, the Company purchased 25 drugstores from Edgehill Drugs,
Inc. The purchase price was $24,454, net of cash acquired of $12. This
acquisition was accounted for under the purchase method of accounting. The
results of operations have been included in these consolidated financial
statements since the date of acquisition.
On August 27, 1997, the Company completed the acquisitions of Harco, Inc.
(Harco) and K&B, Incorporated (K&B). The combined consideration paid for these
companies was $335,014, net of cash acquired of $2,811 and was financed
through commercial paper borrowings. These acquisitions were accounted for
using the purchase method and, accordingly, the Company recorded the assets
and liabilities of Harco and K&B at the date of acquisition at their fair
values. The excess of the acquisition cost over the fair value of the recorded
assets and liabilities of $190,439 has been recorded as goodwill. The Company
has determined that the estimated useful life of the goodwill recorded with
the Harco and K&B acquisitions is primarily indeterminate and likely exceeds
40 years. Accordingly, the Company amortizes goodwill over the maximum
allowable period of 40 years.
In October 1996, the Company signed a definitive contract to sell for cash
of $450 each, plus the value of closing inventories, all of its 193 drugstores
in North and South Carolina to J.C. Penney Company, Inc. (Penney).
Subsequently, Penney contracted to purchase Eckerd Corporation (Eckerd), a
chain of 1,748 drugstores. In order to proceed with the Eckerd purchase,
Penney agreed with the Federal Trade Commission not to take possession of 130
of the Company's stores. In February 1997, the Company agreed to an amendment
to its contract with Penney whereby the Company operated the stores until
Penney could find another buyer, but transfer of the stores was designated to
begin no later than May 30, 1997. Penney arranged for another drugstore chain
to begin taking possession of the stores in May 1997. A pretax gain of $29,969
was recognized in fiscal year 1997 for the stores that transferred in that
year. Upon transfer of the remaining stores in the first quarter of fiscal
1998, the Company recognized an additional pretax gain of $52,621.
In September 1999, the Company signed a definitive contract to sell 38
drugstores in California to Longs Drug Stores California, Inc. (Longs). During
the third quarter of fiscal 2000, a total of 32 stores were transferred to
Longs. In October 1999, the Company agreed to an amendment to its contract
with Longs whereby the closing of two stores was postponed due to delays in
obtaining waivers for existing lease provisions related to the assignment of
leases to the buyer. These two stores were ultimately closed in March 2000 and
transferred to the buyer at that time. The remaining four stores which were
originally included in the purchase agreement were retained by Rite Aid. A
pre-tax gain of $80,109 was recognized in the third quarter of fiscal year
2000 for the stores that were transferred in that year. The gain on the sale
of the two stores transferred in March 2000 was recognized by the Company in
the first quarter of fiscal 2001.
4. Store Closing and Impairment Charges:
In fiscal 2000, 1999, and 1998 Store closing and impairment charges include
non-cash charges of $120,593, $87,666 and $76,442 respectively, for the
impairment of long-lived assets (including allocable goodwill) at 249, 270 and
252 stores. These amounts include the write-down of long-lived assets at
stores that were assessed for impairment because of management's intention to
relocate or close the store or because of changes in circumstances that
indicate the carrying value of an asset may not be recoverable.
30
RITE AID CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Store closing and impairment charges consist of:
Year ended Year ended Year ended
February 26, 2000 February 27, 1999 February 28, 1998
----------------- ----------------- ------------------
Store lease exit costs.. $ 32,724 $104,885 $ 72,118
Impairment charges...... 120,593 87,666 76,442
-------- -------- --------
$153,317 $192,551 $148,560
======== ======== ========
During fiscal 2000, 1999, and 1998, the Company recorded charges for 224,
422, and 593 stores, respectively, to be closed or relocated that were under
long-term leases. Costs incurred to close a store, which principally include
lease termination costs, are recorded at the time management commits to
closing the store, which is typically 90 days preceding the store closing
date, or in the case of a store to be relocated, the date the new property is
leased or purchased. The Company calculates its liability for closed stores on
a store-by-store basis. The future minimum lease payments and related
ancillary costs, from the date of closure to the end of the remaining lease
term, net of estimated cost recoveries that may be achieved through subletting
properties or through favorable lease terminations are computed. This
liability is discounted using a risk-free rate of interest. The Company
evaluates these assumptions each quarter and adjusts the liability
accordingly. The discount rates used to determine the liability were 6.60%,
5.22% and 5.59% at February 26, 2000, February 27, 1999 and February 28, 1998,
respectively.
Subsequent to the recording of lease accruals, management determined that
certain stores would remain open. Included in the amounts stated above were
impairment write-downs of $3,954 for 6 stores in fiscal 2000 and $1,408 for 3
stores in fiscal 1999, that were written down to fair value but were not
relocated or closed. Also, the Company reversed charges of $10,490 and $1,052
in fiscal 2000 and 1998, respectively, for lease accruals previously
established for those stores.
The reserve for store lease exit costs includes the following activity for
the fiscal years ended February 26, 2000, February 27, 1999 and February 28,
1998:
Year ended Year ended Year ended
February 26, 2000 February 27, 1999 February 28, 1998
----------------- ----------------- -----------------
Balance--Beginning of
Year................... $246,805 $191,453 $137,230
Provision for present
value of
noncancellable lease
payments of stores
designated to be
closed............... 58,324 94,404 90,697
Changes in assumptions
about future sublease
income, terminations,
etc. ................ (15,110) 10,481 (17,527)
Reversals of reserves
for stores that
management has
determined will
remain open.......... (10,490) -- (1,052)
Interest accretion and
changes in
interest rates....... (618) 10,877 13,489
Cash payments, net of
sublease income...... (66,099) (60,410) (31,384)
-------- -------- --------
Balance--End of Year.... $212,812 $246,805 $191,453
======== ======== ========
In addition to store closings, the Company has also closed or relocated
certain distribution centers in its efforts to consolidate operations and
implement its regional exit strategies. During the second quarter of fiscal
2000, management approved a plan to close its leased distribution center in
Las Vegas, Nevada and terminate all of its employees and accrued termination
benefit payments of $1,634 in the second quarter of 2000, with
31
RITE AID CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
the charge included in Selling, general and administrative expenses (SG&A) on
the consolidated statement of operations. Severance payments of $1,165 were
made during fiscal year 2000 leaving a remaining liability of $469 at
February 26, 2000, with additional payments made during fiscal 2001. The
operating lease for the distribution center was terminated in May 2000 at the
end of the lease term with no additional liability to the Company.
In the third quarter of fiscal 2000, management announced plans to close its
South Nitro, West Virginia distribution center in the summer of 2000. As a
result of this exit plan, the Company accrued termination benefits of $3,858 in
the third quarter of fiscal 2000 for all of the 480 employees with the charge
included in SG&A on the consolidated statement of operations. Subsequently, in
the fourth quarter of fiscal 2000 management decided to not close the facility.
However, prior to this decision the Company became obligated to pay $1,040 in
severance costs related to 102 employees. The Company paid $540 in the fourth
quarter of fiscal 2000 and the remaining $500 was accrued at February 26, 2000.
The remaining reserve of $2,818 was reversed to SG&A in the fourth quarter of
fiscal 2000.
In the third quarter of fiscal 2000, management approved a plan to close and
sell its Ogden, Utah distribution center. As a result of this exit plan, a
liability of $2,256 for termination benefits for 500 employees was recorded
through SG&A in the third quarter of fiscal 2000. Additionally, an impairment
charge of $7,600 for long-lived assets was recorded in the third quarter of
fiscal 2000. The facility was sold in March 2000.
During the second quarter of fiscal 1998, the Company closed its distribution
center in Ontario, California and terminated all of its 177 employees. The
costs associated with closing the California facility including termination
benefit payments of approximately $400 were expensed as they were incurred
during fiscal 1998. The termination benefits were determined through
negotiations with the union representatives and were largely based on years of
service and included some health insurance benefits. The facility was sold in
the second quarter of fiscal 1998 for its adjusted carrying value of
approximately $11,400.
In the fourth quarter of fiscal 1997, the Company committed to construct a
new distribution center near Baltimore, Maryland. The new distribution center
was scheduled to be completed in August 1998 and would replace the existing
distribution facility in Shiremanstown, Pennsylvania. The Pennsylvania
distribution center was scheduled to close and all of its 734 employees would
have been terminated in October 1998 when the Maryland facility was scheduled
to be fully operational. As a result of this exit plan, a liability of $3,425
for termination benefits was recorded in the fourth quarter of 1997 and charged
to SG&A expenses on the statement of income. The termination benefits were
determined through negotiations with the union representative and based on
years of service and included the continuation of health insurance coverage
after the termination date. As a result of subsequent negotiations with union
representatives, an additional liability of $4,000 for termination benefits was
recorded in fiscal 1998. The closure of the Pennsylvania facility was delayed
due to computer software problems encountered in opening the Maryland facility.
The Pennsylvania facility was closed in March 1999, and all payments related to
the liability were made in the first quarter of fiscal 2000.
5. Change in Accounting Method:
In fiscal 2000, the Company changed its application of the LIFO method of
accounting by restructuring its LIFO pool structure through a combination of
certain existing geographic pools. The reduction in the number of LIFO pools
was made to more closely align the LIFO pool structure to the Company's store
merchandise categories. The effect of this change in fiscal 2000 was a charge
of $6,840 (net of income tax benefit of $4,560), or $.03 per diluted common
share. The cumulative effect of the accounting change on periods prior to
fiscal 2000 was a charge of $27,300 (net of income tax benefit of $18,200), or
$.11 per diluted common share. The pro forma effect of this accounting change
would have been a reduction in income of $6,360 (net of income tax benefit of
$4,240) or $.02 per diluted common share, and $12,600 (net of income tax
benefit of $8,400) or $.05 per common share, for fiscal 1999 and 1998,
respectively.
32
RITE AID CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
6. Accounts Receivable:
During November 1997, the Company and certain of its subsidiaries entered
into an agreement to sell, on an ongoing basis, a pool of receivables to a
wholly owned bankruptcy-remote special purpose funding subsidiary (the funding
subsidiary) of the Company. The funding subsidiary is a distinct legal entity
that engages in no trade or business in order to make remote the possibility
that it would enter bankruptcy or other receivership and is consolidated for
financial reporting purposes. The Company and certain subsidiaries transfer all
of their accounts receivable (principally representing amounts owed by third-
party prescription payers) to the funding subsidiary for a beneficial interest
in the funding subsidiary. The funding subsidiary has sold and, subject to
certain conditions, may from time to time sell an undivided fractional
ownership interest in the pool of receivables to a multi-seller receivables
securitization company. The securitization company is free to pledge or
exchange its interests and the Company is not entitled to repurchase them. The
accounts receivable sold to the funding subsidiary which sold an undivided
fractional ownership interest to the securitization company have been
derecognized on the Company's consolidated balance sheet. Upon the sale, the
Company allocates its basis in the receivables between the interest sold and
the interest retained in relation to their relative fair values. The remaining
receivables, substantially representing retained interests of the Company and
certain of its subsidiaries in the funding subsidiary, continue to be carried
on the Company's consolidated balance sheet at the lower of their cost or
market value.
Under the terms of the agreement, new receivables are added to the pool as
collections reduce previously sold accounts receivable. The Company services,
administers and collects the receivables on behalf of the purchaser. Total
proceeds outstanding from the securitization of receivables as of February 26,
2000 were $294,140, representing an increase of $2,640 from the February 27,
1999 balance of $291,500. The additional proceeds received during fiscal 2000
were used to reduce outstanding commercial paper borrowings and are reflected
as operating cash flows in the accompanying consolidated statement of cash
flows. The Company recognizes no servicing asset or liability because the
benefits of servicing are expected to represent adequate compensation for the
services performed. Expenses of $18,052 and $15,532 associated with the
securitization program were recognized as a component of SG&A for the years
ended February 26, 2000 and February 27, 1999, respectively. In connection with
the Company's refinancing in June 2000 (see note 24) all borrowings under the
securitization program were repaid and the program was terminated.
The Company maintains an allowance for doubtful accounts receivable based
upon the expected collectibility of accounts receivable, including retained
interests in receivables sold. The Company recorded an allowance for
uncollectible accounts of $35,371 at February 26, 2000 and $30,296 at February
27, 1999. The Company's accounts receivable are due primarily from third-party
providers (e.g., insurance companies and governmental agencies) under third-
party payment plans and are booked net of any allowances provided for under the
respective plans. Since payments due from third-party payers are sensitive to
payment criteria changes and legislative actions, the allowance is reviewed
continually and adjusted for accounts deemed uncollectible by management.
7. Property, Plant and Equipment:
Following is a summary of property, plant and equipment at February 26, 2000
and February 27, 1999:
2000 1999
---------- ----------
Land.............................................. $ 733,979 $ 773,084
Buildings......................................... 1,010,133 867,119
Leasehold improvements............................ 1,262,590 1,123,608
Equipment......................................... 1,469,881 1,240,777
Construction in progress.......................... 85,484 242,743
---------- ----------
4,562,067 4,247,331
Accumulated depreciation.......................... (1,112,473) (918,832)
---------- ----------
Property, plant and equipment, net.............. $3,449,594 $3,328,499
========== ==========
33
RITE AID CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Depreciation expense, which includes the depreciation of assets recorded
under capital leases, was $326,873 in fiscal 2000, $269,184 in fiscal 1999 and
$250,151 in fiscal 1998.
Substantially all of the Company's owned properties on which it operates
stores are pledged as collateral under the Company's debt agreements. The
carrying amount of idle facilities is $113,454 and $153,517 at February 26,
2000 and February 27, 1999, respectively.
8. Investments in Fifty Percent or Less Owned Subsidiaries:
In July 1999, the Company purchased 9,334,746 of Series E Convertible
Preferred Shares in drugstore.com, an on-line pharmacy (the "investee"), for
cash of $8,125, including legal costs, and the Company's agreement to provide
access to the Company's pharmacy networks and insurance coverages, advertising
commitments and exclusivity agreements. Also in July 1999, each of the
Company's Series E Convertible Preferred Shares converted to one share of
common stock at the time of the investee's initial public offering
representing 21.6% of the voting stock immediately after the initial public
offering. The initial investment, which is recorded in Other assets, was
valued at $168,025, equal to the initial public offering price of $18 per
share multiplied by the Company's shares. The Company accounts for the
investment on the equity method because the Company has significant influence
over the investee resulting from its share of the voting stock, its right to
appoint one board member and a number of significant operating agreements.
Included in Other noncurrent liabilities is the unamortized portion of the
fair value of the operating agreements of $149,900 and is being amortized over
10 years, the life of the arrangements described above. The excess of the
initial investment value over the Company's share of the underlying equity of
the investee is $77,320 and is being amortized over 7 years. As a result of
the start-up nature of the investee, the Company recorded an increase to its
investment of $2,929 and a corresponding increase to equity in connection with
the sale of stock by the investee during fiscal 2000.
In June 1999, the Company sold its investment in Diversified Prescription
Delivery LLC, a provider of mail order prescription delivery services. The
sales price was $22,860 and resulted in a loss of $811. The investment was
accounted for on the equity method with a carrying amount of $23,671 at the
date of sale.
In February 2000, the Company sold its investment in Stores Automated
Systems, Inc. ("SASI"), a manufacturer of integrated point of sale systems.
The investment was accounted for on the equity method with a carrying amount
of $8,005 at the date of sale. The $8,805 sales price included cash and
forgiveness of payables, and resulted in a gain of $800.
The Company's share of undistributed earnings of fifty percent or less owned
subsidiaries accounted for on the equity method was $0 and $7,263 at February
26, 2000 and February 27, 1999, respectively.
9. Goodwill and Other Intangibles:
Following is a summary of intangible assets at February 26, 2000 and
February 27, 1999:
2000 1999
---------- ----------
Goodwill............................................. $ 920,241 $ 979,482
Lease acquisition costs and favorable leases......... 739,770 731,175
Prescription files................................... 136,434 99,032
Assembled workforce.................................. 51,021 50,033
---------- ----------
1,847,466 1,859,722
Accumulated amortization............................. (536,343) (396,279)
---------- ----------
$1,311,123 $1,463,443
========== ==========
34
RITE AID CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
10. Accrued Salaries, Wages, and Other Current Liabilities:
Accrued salaries wages and other current liabilities consist of the
following at February 26, 2000 and February 27, 1999:
2000 1999
--------- ---------
Accrued wages, benefits and other personnel costs...... $ 254,738 $ 326,166
Accrued legal and other professional fees.............. 168,643 53,929
Accrued interest....................................... 61,427 44,487
Reserve for lease exit costs........................... 42,413 48,528
Deferred rent.......................................... 53,987 47,664
Deferred income........................................ 44,339 56,262
Accrued property taxes................................. 44,490 44,271
Other.................................................. 133,858 79,405
--------- ---------
$ 803,895 $ 700,712
========= =========
11. Indebtedness and Credit Agreements:
Following is a summary of indebtedness at February 26, 2000 and February 27,
1999:
2000 1999
---------- -----------
Commercial paper borrowings under existing credit
facilities--5.2% and 5.5% weighted average rates in
fiscal years 2000 and 1999.......................... $ 192,000 $ 1,783,125
Revolving credit facility due 2002 (amended and
restated)........................................... 716,073 --
Term loan due 2002 (amended and restated)............ 1,300,000 --
Term note due 2002 (amended and restated)............ 272,422 --
5.25% convertible subordinated notes due 2002........ 649,986 649,991
6.70% notes due 2001................................. 350,000 350,000
7.125% notes due 2007................................ 350,000 350,000
7.70% notes due 2027................................. 300,000 300,000
5.50% fixed-rate senior notes due 2000............... 200,000 200,000
6.00% dealer remarketable securities due 2003........ 200,000 200,000
6.00% fixed-rate senior notes due 2005............... 200,000 200,000
7.625% senior notes due 2005......................... 200,000 200,000
6.875% senior debentures due 2013.................... 200,000 200,000
6.125% fixed-rate senior notes due 2008.............. 150,000 150,000
6.875% fixed-rate senior notes due 2028.............. 150,000 150,000
3.5% to 10.475% industrial development bonds due
through 2016........................................ 5,196 8,672
Other................................................ 29,056 31,283
---------- -----------
5,464,733 4,773,071
Short-term debt and current maturities of long-term
debt................................................ (76,086) (1,539,267)
---------- -----------
Long-term debt less current maturities............... $5,388,647 $ 3,233,804
========== ===========
In December 1999, absent a waiver the Company would have failed to meet
certain reporting covenants contained in its bank credit and loan agreements
and public debt indentures, in particular the filing of quarterly financial
information in a timely manner. As a result, the Company obtained waivers of
these reporting requirements. These waivers relieve the Company from the
reporting requirements until July 11, 2000 at which time the Company is
required to submit all delinquent reports. In particular, the Company must
submit quarterly financial information for the quarters ended November 27,
1999 and May 27, 2000 and the fiscal year ended
35
RITE AID CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
February 26, 2000. These waivers enabled the Company to continue accessing
funds under the credit arrangements and provided a stay from debt acceleration
clauses contained under both the bank credit and loan agreements and the
public debt indentures. Company management subsequently renegotiated all of
its bank credit and loan agreements (see note 24). Management believes that
they are in compliance with the covenants contained within these new
agreements.
As of February 27, 1999, the Company had a $1,000,000 unsecured revolving
credit facility, expiring in July 2001, to support its commercial paper
program and a $1,300,000 unsecured revolving credit facility, expiring in
October 1999, to support commercial paper borrowings to complete the
acquisition of PCS. In June 1999, the Company borrowed an additional $300,000
from one of its banks under a demand note. In September 1999, the Company
determined it was in default on certain financial covenants in the credit
agreements. On October 27, 1999, the Company's banks agreed to extend
$2,600,000 of its outstanding credit facilities. As a result, the due dates of
the $1,300,000 revolving credit facility scheduled to mature on October 29,
1999 and the $300,000 note that was due on demand were extended to November 1,
2000. The Company's $1,000,000 revolving credit facility, which was to mature
on July 19, 2001, was also amended and restated. Borrowings under the credit
facilities carry higher interest costs than commercial paper. The interest
rates under the Company's credit facilities are based on prime or LIBOR plus a
risk adjusted spread. As of February 26, 2000, borrowings under the $1,300,000
facility were at LIBOR plus 3.5%. Borrowings outstanding under the $1,000,000
facility and the $300,000 bank note were $716,073 and $272,422, respectively,
as of February 26, 2000 with interest rates at LIBOR plus 4.00%. Borrowings
repaid under these credit facilities cannot be re-borrowed. These borrowings
have financial and restrictive covenants that, among other things, restrict
the Company's ability to incur liens and debt, pay dividends, make redemptions
and repurchases of capital stock, make loans, investments and capital
expenditures, prepay, redeem, or repurchase debt, engage in mergers,
consolidations, asset dispositions, sale leaseback transactions and affiliate
transactions, change its business, amend certain debt and other material
agreements, issue and sell capital stock of subsidiaries, make distributions
from subsidiaries and grant negative pledges to creditors.
As described in note 24, in connection with a refinancing on June 14, 2000,
the Company extended the maturity date of all its bank debt to 2002. In
addition, $52,500 of the Company's 5.50% senior notes due December 2000 were
exchanged for new 10.50% senior secured notes due September 2002. Another
$93,200 of the 5.50% senior notes will be refinanced in December 2000 with
proceeds received from the sale of 10.50% senior secured notes due September
2002 through a forward purchase agreement. All bank debt and notes with
extended maturities are reflected as long-term debt in the financial
statements.
In connection with obtaining waivers of compliance with, and modifications
to certain of the covenants during the third and fourth quarters of fiscal
2000 and the subsequent extensions and restructuring described above, the
Company paid fees and transaction costs of $63,332. Additionally, the Company
issued three-year warrants to purchase 2,500,000 shares of common stock at
$11.00 per share.
The fair value assigned to the warrants was $8,500 and is being amortized
over the term of the associated debt instruments. Additionally, as part of the
restructuring, the Company entered into a financial advisory agreement for a
period of one year. The Company is making payments under the advisory
agreement of $2,000 per month. These costs are being amortized over the life
of the contract, which approximates the term of restructured debt agreements.
On December 15, 1998, the Company completed the sale of securities
aggregating $700,000. The sale of securities included $200,000 of 5.50% fixed-
rate senior notes due December 15, 2000; $200,000 of 6.00% fixed-rate senior
notes due December 15, 2005; $150,000 of 6.125% fixed-rate senior notes due
December 15, 2008; and $150,000 of 6.875% fixed-rate senior notes due December
15, 2028. Interest is payable semi-annually on December 15 and June 15.
Financing costs for each issue are being amortized over the period until the
maturity date.
36
RITE AID CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
6. Accounts Receivable:
During November 1997, the Company and certain of its subsidiaries entered
into an agreement to sell, on an ongoing basis, a pool of receivables to a
wholly owned bankruptcy-remote special purpose funding subsidiary (the funding
subsidiary) of the Company. The funding subsidiary is a distinct legal entity
that engages in no trade or business in order to make remote the possibility
that it would enter bankruptcy or other receivership and is consolidated for
financial reporting purposes. The Company and certain subsidiaries transfer all
of their accounts receivable (principally representing amounts owed by third-
party prescription payers) to the funding subsidiary for a beneficial interest
in the funding subsidiary. The funding subsidiary has sold and, subject to
certain conditions, may from time to time sell an undivided fractional
ownership interest in the pool of receivables to a multi-seller receivables
securitization company. The securitization company is free to pledge or
exchange its interests and the Company is not entitled to repurchase them. The
accounts receivable sold to the funding subsidiary which sold an undivided
fractional ownership interest to the securitization company have been
derecognized on the Company's consolidated balance sheet. Upon the sale, the
Company allocates its basis in the receivables between the interest sold and
the interest retained in relation to their relative fair values. The remaining
receivables, substantially representing retained interests of the Company and
certain of its subsidiaries in the funding subsidiary, continue to be carried
on the Company's consolidated balance sheet at the lower of their cost or
market value.
Under the terms of the agreement, new receivables are added to the pool as
collections reduce previously sold accounts receivable. The Company services,
administers and collects the receivables on behalf of the purchaser. Total
proceeds outstanding from the securitization of receivables as of February 26,
2000 were $294,140, representing an increase of $2,640 from the February 27,
1999 balance of $291,500. The additional proceeds received during fiscal 2000
were used to reduce outstanding commercial paper borrowings and are reflected
as operating cash flows in the accompanying consolidated statement of cash
flows. The Company recognizes no servicing asset or liability because the
benefits of servicing are expected to represent adequate compensation for the
services performed. Expenses of $18,052 and $15,532 associated with the
securitization program were recognized as a component of SG&A for the years
ended February 26, 2000 and February 27, 1999, respectively. In connection with
the Company's refinancing in June 2000 (see note 24) all borrowings under the
securitization program were repaid and the program was terminated.
The Company maintains an allowance for doubtful accounts receivable based
upon the expected collectibility of accounts receivable, including retained
interests in receivables sold. The Company recorded an allowance for
uncollectible accounts of $35,371 at February 26, 2000 and $30,296 at February
27, 1999. The Company's accounts receivable are due primarily from third-party
providers (e.g., insurance companies and governmental agencies) under third-
party payment plans and are booked net of any allowances provided for under the
respective plans. Since payments due from third-party payers are sensitive to
payment criteria changes and legislative actions, the allowance is reviewed
continually and adjusted for accounts deemed uncollectible by management.
7. Property, Plant and Equipment:
Following is a summary of property, plant and equipment at February 26, 2000
and February 27, 1999:
2000 1999
---------- ----------
Land.............................................. $ 733,979 $ 773,084
Buildings......................................... 1,010,133 867,119
Leasehold improvements............................ 1,262,590 1,123,608
Equipment......................................... 1,469,881 1,240,777
Construction in progress.......................... 85,484 242,743
---------- ----------
4,562,067 4,247,331
Accumulated depreciation.......................... (1,112,473) (918,832)
---------- ----------
Property, plant and equipment, net.............. $3,449,594 $3,328,499
========== ==========
33
RITE AID CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Depreciation expense, which includes the depreciation of assets recorded
under capital leases, was $326,873 in fiscal 2000, $269,184 in fiscal 1999 and
$250,151 in fiscal 1998.
Substantially all of the Company's owned properties on which it operates
stores are pledged as collateral under the Company's debt agreements. The
carrying amount of idle facilities is $113,454 and $153,517 at February 26,
2000 and February 27, 1999, respectively.
8. Investments in Fifty Percent or Less Owned Subsidiaries:
In July 1999, the Company purchased 9,334,746 of Series E Convertible
Preferred Shares in drugstore.com, an on-line pharmacy (the "investee"), for
cash of $8,125, including legal costs, and the Company's agreement to provide
access to the Company's pharmacy networks and insurance coverages, advertising
commitments and exclusivity agreements. Also in July 1999, each of the
Company's Series E Convertible Preferred Shares converted to one share of
common stock at the time of the investee's initial public offering
representing 21.6% of the voting stock immediately after the initial public
offering. The initial investment, which is recorded in Other assets, was
valued at $168,025, equal to the initial public offering price of $18 per
share multiplied by the Company's shares. The Company accounts for the
investment on the equity method because the Company has significant influence
over the investee resulting from its share of the voting stock, its right to
appoint one board member and a number of significant operating agreements.
Included in Other noncurrent liabilities is the unamortized portion of the
fair value of the operating agreements of $149,900 and is being amortized over
10 years, the life of the arrangements described above. The excess of the
initial investment value over the Company's share of the underlying equity of
the investee is $77,320 and is being amortized over 7 years. As a result of
the start-up nature of the investee, the Company recorded an increase to its
investment of $2,929 and a corresponding increase to equity in connection with
the sale of stock by the investee during fiscal 2000.
In June 1999, the Company sold its investment in Diversified Prescription
Delivery LLC, a provider of mail order prescription delivery services. The
sales price was $22,860 and resulted in a loss of $811. The investment was
accounted for on the equity method with a carrying amount of $23,671 at the
date of sale.
In February 2000, the Company sold its investment in Stores Automated
Systems, Inc. ("SASI"), a manufacturer of integrated point of sale systems.
The investment was accounted for on the equity method with a carrying amount
of $8,005 at the date of sale. The $8,805 sales price included cash and
forgiveness of payables, and resulted in a gain of $800.
The Company's share of undistributed earnings of fifty percent or less owned
subsidiaries accounted for on the equity method was $0 and $7,263 at February
26, 2000 and February 27, 1999, respectively.
9. Goodwill and Other Intangibles:
Following is a summary of intangible assets at February 26, 2000 and
February 27, 1999:
2000 1999
---------- ----------
Goodwill............................................. $ 920,241 $ 979,482
Lease acquisition costs and favorable leases......... 739,770 731,175
Prescription files................................... 136,434 99,032
Assembled workforce.................................. 51,021 50,033
---------- ----------
1,847,466 1,859,722
Accumulated amortization............................. (536,343) (396,279)
---------- ----------
$1,311,123 $1,463,443
========== ==========
34
RITE AID CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
10. Accrued Salaries, Wages, and Other Current Liabilities:
Accrued salaries wages and other current liabilities consist of the
following at February 26, 2000 and February 27, 1999:
2000 1999
--------- ---------
Accrued wages, benefits and other personnel costs...... $ 254,738 $ 326,166
Accrued legal and other professional fees.............. 168,643 53,929
Accrued interest....................................... 61,427 44,487
Reserve for lease exit costs........................... 42,413 48,528
Deferred rent.......................................... 53,987 47,664
Deferred income........................................ 44,339 56,262
Accrued property taxes................................. 44,490 44,271
Other.................................................. 133,858 79,405
--------- ---------
$ 803,895 $ 700,712
========= =========
11. Indebtedness and Credit Agreements:
Following is a summary of indebtedness at February 26, 2000 and February 27,
1999:
2000 1999
---------- -----------
Commercial paper borrowings under existing credit
facilities--5.2% and 5.5% weighted average rates in
fiscal years 2000 and 1999.......................... $ 192,000 $ 1,783,125
Revolving credit facility due 2002 (amended and
restated)........................................... 716,073 --
Term loan due 2002 (amended and restated)............ 1,300,000 --
Term note due 2002 (amended and restated)............ 272,422 --
5.25% convertible subordinated notes due 2002........ 649,986 649,991
6.70% notes due 2001................................. 350,000 350,000
7.125% notes due 2007................................ 350,000 350,000
7.70% notes due 2027................................. 300,000 300,000
5.50% fixed-rate senior notes due 2000............... 200,000 200,000
6.00% dealer remarketable securities due 2003........ 200,000 200,000
6.00% fixed-rate senior notes due 2005............... 200,000 200,000
7.625% senior notes due 2005......................... 200,000 200,000
6.875% senior debentures due 2013.................... 200,000 200,000
6.125% fixed-rate senior notes due 2008.............. 150,000 150,000
6.875% fixed-rate senior notes due 2028.............. 150,000 150,000
3.5% to 10.475% industrial development bonds due
through 2016........................................ 5,196 8,672
Other................................................ 29,056 31,283
---------- -----------
5,464,733 4,773,071
Short-term debt and current maturities of long-term
debt................................................ (76,086) (1,539,267)
---------- -----------
Long-term debt less current maturities............... $5,388,647 $ 3,233,804
========== ===========
In December 1999, absent a waiver the Company would have failed to meet
certain reporting covenants contained in its bank credit and loan agreements
and public debt indentures, in particular the filing of quarterly financial
information in a timely manner. As a result, the Company obtained waivers of
these reporting requirements. These waivers relieve the Company from the
reporting requirements until July 11, 2000 at which time the Company is
required to submit all delinquent reports. In particular, the Company must
submit quarterly financial information for the quarters ended November 27,
1999 and May 27, 2000 and the fiscal year ended
35
RITE AID CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
February 26, 2000. These waivers enabled the Company to continue accessing
funds under the credit arrangements and provided a stay from debt acceleration
clauses contained under both the bank credit and loan agreements and the
public debt indentures. Company management subsequently renegotiated all of
its bank credit and loan agreements (see note 24). Management believes that
they are in compliance with the covenants contained within these new
agreements.
As of February 27, 1999, the Company had a $1,000,000 unsecured revolving
credit facility, expiring in July 2001, to support its commercial paper
program and a $1,300,000 unsecured revolving credit facility, expiring in
October 1999, to support commercial paper borrowings to complete the
acquisition of PCS. In June 1999, the Company borrowed an additional $300,000
from one of its banks under a demand note. In September 1999, the Company
determined it was in default on certain financial covenants in the credit
agreements. On October 27, 1999, the Company's banks agreed to extend
$2,600,000 of its outstanding credit facilities. As a result, the due dates of
the $1,300,000 revolving credit facility scheduled to mature on October 29,
1999 and the $300,000 note that was due on demand were extended to November 1,
2000. The Company's $1,000,000 revolving credit facility, which was to mature
on July 19, 2001, was also amended and restated. Borrowings under the credit
facilities carry higher interest costs than commercial paper. The interest
rates under the Company's credit facilities are based on prime or LIBOR plus a
risk adjusted spread. As of February 26, 2000, borrowings under the $1,300,000
facility were at LIBOR plus 3.5%. Borrowings outstanding under the $1,000,000
facility and the $300,000 bank note were $716,073 and $272,422, respectively,
as of February 26, 2000 with interest rates at LIBOR plus 4.00%. Borrowings
repaid under these credit facilities cannot be re-borrowed. These borrowings
have financial and restrictive covenants that, among other things, restrict
the Company's ability to incur liens and debt, pay dividends, make redemptions
and repurchases of capital stock, make loans, investments and capital
expenditures, prepay, redeem, or repurchase debt, engage in mergers,
consolidations, asset dispositions, sale leaseback transactions and affiliate
transactions, change its business, amend certain debt and other material
agreements, issue and sell capital stock of subsidiaries, make distributions
from subsidiaries and grant negative pledges to creditors.
As described in note 24, in connection with a refinancing on June 14, 2000,
the Company extended the maturity date of all its bank debt to 2002. In
addition, $52,500 of the Company's 5.50% senior notes due December 2000 were
exchanged for new 10.50% senior secured notes due September 2002. Another
$93,200 of the 5.50% senior notes will be refinanced in December 2000 with
proceeds received from the sale of 10.50% senior secured notes due September
2002 through a forward purchase agreement. All bank debt and notes with
extended maturities are reflected as long-term debt in the financial
statements.
In connection with obtaining waivers of compliance with, and modifications
to certain of the covenants during the third and fourth quarters of fiscal
2000 and the subsequent extensions and restructuring described above, the
Company paid fees and transaction costs of $63,332. Additionally, the Company
issued three-year warrants to purchase 2,500,000 shares of common stock at
$11.00 per share.
The fair value assigned to the warrants was $8,500 and is being amortized
over the term of the associated debt instruments. Additionally, as part of the
restructuring, the Company entered into a financial advisory agreement for a
period of one year. The Company is making payments under the advisory
agreement of $2,000 per month. These costs are being amortized over the life
of the contract, which approximates the term of restructured debt agreements.
On December 15, 1998, the Company completed the sale of securities
aggregating $700,000. The sale of securities included $200,000 of 5.50% fixed-
rate senior notes due December 15, 2000; $200,000 of 6.00% fixed-rate senior
notes due December 15, 2005; $150,000 of 6.125% fixed-rate senior notes due
December 15, 2008; and $150,000 of 6.875% fixed-rate senior notes due December
15, 2028. Interest is payable semi-annually on December 15 and June 15.
Financing costs for each issue are being amortized over the period until the
maturity date.
36
RITE AID CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Net periodic pension cost for the defined benefit plans includes the
following components:
Nonqualified Retiree Health
Defined Benefit Pension Executive Retirement Benefits Plan
Plans Plan (PBM Segment)
------------------------- -------------------- --------------
2000 1999 1998 2000 1999 1998 2000 1999 1998
------- ------- ------- ------ ------ ------ ---- ---- ----
Service cost............ $ 8,505 $ 5,363 $ 5,015 $ 671 $ 514 $ 402 $693 $57 $--
Interest cost........... 5,851 4,091 3,559 1,497 1,424 1,350 252 22 --
Expected return on plan
assets................. (7,670) (5,117) (4,219) -- -- -- -- -- --
Amortization of
unrecognized net
transition
(asset)/obligation..... (160) (160) (160) 1,163 1,163 1,163 -- -- --
Amortization of
unrecognized prior
service cost........... 376 473 390 -- -- -- -- -- --
Amortization of
unrecognized net gain.. (182) (202) -- -- -- -- -- -- --
------- ------- ------- ------ ------ ------ ---- --- ----
Pension expense......... $ 6,720 $ 4,448 $ 4,585 $3,331 $3,101 $2,915 $945 $79 $--
======= ======= ======= ====== ====== ====== ==== === ====
Discontinued Operations
Included in the defined benefit pension plan data above is $3,434 of expense
related to the PBM segment for fiscal 2000. The expense associated with the
PBM segment for fiscal 1999 and fiscal 1998 is not material. Expenses related
to the Retiree Health Benefit Plan presented above are solely related to the
PBM segment. Employer contributions to the defined contribution plans for the
PBM Segment were $5,440 and $439 for fiscal 2000 and fiscal 1999,
respectively.
41
RITE AID CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The table below sets forth a reconciliation from the beginning of the year
for both the benefit obligation and plan assets of the Company's retirement
and health benefits plans, as well as the funded status and amounts recognized
in the Company's balance sheet as of February 26, 2000 and February 27, 1999:
Nonqualified Retiree Health
Defined Benefit Executive Benefits Plans
Pension Plans Retirement Plan (PBM Segment)
----------------- ------------------ ----------------
2000 1999 2000 1999 2000 1999
-------- ------- -------- -------- ------- -------
Change in benefit
obligations:
Benefit obligation at
end of prior year.... $ 86,908 $58,048 $ 21,891 $ 20,906 $ 3,433 $ --
Service cost.......... 8,505 5,363 671 514 693 57
Interest cost......... 5,851 4,091 1,497 1,424 252 22
Distributions......... (9,844) (6,097) (1,224) (650) (60) (5)
Purchase of PCS....... -- 23,537 -- -- -- 3,359
Change due to change
in assumptions....... (4,655) 1,486 (1,281) (50) -- --
Change due to plan
amendment............ 187 665 18,891 -- -- --
Actuarial (gain) or
loss................. 2,425 (185) (5,754) (253) 323 --
-------- ------- -------- -------- ------- -------
Benefit obligation at
end of year............ $ 89,377 $86,908 $ 34,691 $ 21,891 $ 4,641 $ 3,433
======== ======= ======== ======== ======= =======
Change in plan assets:
Fair value of plan
assets at beginning
of year.............. $ 93,366 $58,212 $ -- $ -- $ -- $ --
Employer
contributions........ 5,611 7,315 1,224 651 60 5
Actual return on plan
assets............... 20,544 13,727 -- -- -- --
Purchase of PCS....... -- 21,507 -- -- -- --
Distributions
(including assumed
expenses)............ (10,601) (6,744) (1,224) (651) (60) (5)
-------- ------- -------- -------- ------- -------
Fair value of plan
assets at end of year.. $108,920 $94,017 $ -- $ -- $ -- $ --
======== ======= ======== ======== ======= =======
Funded status........... $ 19,543 $ 7,109 $(34,691) $(21,891) $(4,641) $(3,433)
Unrecognized net loss
(gain)................. (21,532) (7,369) (5,972) 1,064 323 --
Unrecognized prior
service cost........... 1,808 2,752 18,891 -- -- --
Unrecognized net
transition (asset) or
obligation............. (339) (498) 12,790 13,953 -- --
-------- ------- -------- -------- ------- -------
Prepaid or (accrued)
pension cost
recognized............. $ (520) $ 1,994 $ (8,982) $ (6,874) $(4,318) $(3,433)
======== ======= ======== ======== ======= =======
Amounts recognized in
consolidated balance
sheets consisted of:
Prepaid (accrued)
pension cost......... $ 4,787 $ 4,551 $ (8,982) $ (6,874) $ -- $ --
Adjustment to
recognize additional
minimum liability.... -- 1,039 (22,836) (12,536) -- --
Accrued pension
liability............ (5,307) (3,596) -- -- (4,318) (3,433)
Pension intangible
asset................ -- -- 22,836 12,061 -- --
Accumulated other
comprehensive
income............... -- -- -- 475 -- --
-------- ------- -------- -------- ------- -------
Net amount recognized... $ (520) $ 1,994 $ (8,982) $ (6,874) $(4,318) $(3,433)
======== ======= ======== ======== ======= =======
42
RITE AID CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The amounts recognized in the accompanying consolidated balance sheets as of
February 26, 2000 and February 27, 1999 are as follows:
Retiree Health
Defined Benefit Nonqualified Executive Benefits Plan
Pension Plans Retirement Plan (PBM Segment)
---------------- ------------------------ ----------------
2000 1999 2000 1999 2000 1999
------- ------- ----------- ----------- ------- -------
Accrued benefit
liability.............. $(5,307) $(2,557) $ (8,982) $ (6,874) $(4,318) $(3,433)
Prepaid pension cost.... 4,787 4,551 -- -- -- --
------- ------- ----------- ----------- ------- -------
Net amount recognized... $ (520) $ 1,994 $ (8,982) $ (6,874) $(4,318) $(3,433)
======= ======= =========== =========== ======= =======
The accumulated benefit obligation and fair value of plan assets for the
defined benefit pension plans with plan assets in excess of accumulated
benefit obligations were $58,798 and $84,084, respectively, as of February 26,
2000, and $30,579 and $24,836, respectively, as of February 27, 1999.
The significant actuarial assumptions used for all defined benefit pension
plans were as follows:
Defined Benefit Nonqualified
Pension Plan Executive Defined Benefit
(Retail Drug Retirement Pension Plan
Segment) Plan (PBM Segment)
----------------- -------------- -----------------
Percentage 2000 1999 1998 2000 1999 1998 2000 1999 1998
---------- ----- ----- ----- ---- ---- ---- ----- ----- -----
Discount rate............ 7.25 6.75 7.00 7.83 6.95 6.93 7.80 7.80 --
Rate of increase in
future
compensation levels..... 4.50 4.75 4.75 3.00 3.00 3.00 5.90 5.90 --
Expected long-term rate
of return on
plan assets............. 9.00 9.00 9.00 9.00 9.00 9.00 9.00 9.00 --
Through its acquisition of PCS, the Company also assumed a retiree health
benefits plan that provides for certain health benefits at retirement for
covered employees. Healthcare cost trend rates were assumed to increase at an
annual rate of 6.5 percent in 1999 for participants under the age of 65, and
decrease one-half percent per year to 5.0 percent in 2002 and thereafter. For
participants over the age of 65, the rate was assumed to increase 5.0 percent
in 1999 and thereafter.
The assumed health care cost trend rates have a significant effect on the
retiree health benefits amounts reported. If these trend rates were to be
increased by one percentage point each future year, the accumulated post-
retirement benefit obligation would increase by 16.1 percent and the aggregate
service and interest cost components of the expense recognized in 2000 would
increase by 17.6 percent. A one percentage point decrease in these rates would
reduce the accumulated post-retirement benefit obligation by 13.9 percent and
the aggregate service and interest cost components of the expense recognized
in 2000 would decrease by 14.9 percent.
15. Leases:
The Company leases most of its retail stores and certain distribution
facilities under noncancellable operating and capital leases, most of which
have initial lease terms ranging from 10 to 22 years. The Company also leases
certain of its equipment and other assets under noncancellable operating
leases with initial terms ranging from 3 to 7 years. In addition to minimum
rental payments, certain store leases require additional payments based on
sales volume, as well as reimbursements for taxes, maintenance, and insurance.
Most leases contain renewal options, certain of which involve rent increases.
Total rental expense, net of sublease income, was $440,556 in 2000, $417,311
in 1999 and $365,082 in 1998. These amounts include contingent rentals of
$28,625, $32,960, and $30,720, in fiscal 2000, 1999 and 1998, respectively.
43
RITE AID CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The Company is a guarantor on certain leases transferred to third parties
through sales or assignments.
The Company leases certain facilities through sale-leaseback arrangements
accounted for using the financing method. Proceeds from sale-leaseback
programs were approximately $74,899 in 2000, $504,990 in 1999 and $323,803 in
1998.
The net book values of assets under capital leases and sale-leasebacks
accounted for under the financing method are summarized as follows:
February 26, February 27,
2000 1999
------------ ------------
Land............................................... $343,948 $328,610
Buildings.......................................... 570,604 541,710
Equipment.......................................... 86,348 77,453
Accumulated depreciation........................... (36,043) (20,391)
-------- --------
$964,857 $927,382
======== ========
Following is a summary of lease finance obligations at February 26, 2000 and
February 27, 1999:
2000 1999
---------- ----------
Sale-leaseback obligations accounted for under the
financing method................................. $ 944,805 $ 921,331
Obligations under capital leases.................. 207,096 228,102
---------- ----------
Total............................................. 1,151,901 1,149,433
Less current obligation........................... (25,964) (31,522)
---------- ----------
Long-term lease finance obligations............... $1,125,937 $1,117,911
========== ==========
Following are the minimum lease payments net of sublease income that will
have to be made in each of the years indicated based on non-cancellable leases
in effect as of February 26, 2000:
Financing obligation
under sale-leaseback
arrangements and
Capital Lease Operating
Fiscal year obligations Leases
----------- -------------------- ----------
2001........................................ $ 119,757 $ 448,580
2002........................................ 119,264 437,140
2003........................................ 116,687 419,024
2004........................................ 114,701 396,930
2005........................................ 114,701 379,860
Later years................................. 1,461,945 3,675,519
---------- ----------
Total minimum lease payments................ 2,047,055 $5,757,053
==========
Amount representing interest................ 895,154
----------
Present value of minimum lease payments..... $1,151,901
==========
16. Capital Stock:
In October 1999, the Company issued 3,000,000 shares of $100 par value 8%
Series A Convertible Preferred Stock for cash of $300,000. The shares have a
liquidation preference of $100 per share with preference over all existing
classes of preferred stock. The shares are callable by the Company beginning
October 2004 at the liquidation value plus a 5% premium. The shares accrue
cumulative dividends at 8% of the liquidation value of
44
RITE AID CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Net periodic pension cost for the defined benefit plans includes the
following components:
Nonqualified Retiree Health
Defined Benefit Pension Executive Retirement Benefits Plan
Plans Plan (PBM Segment)
------------------------- -------------------- --------------
2000 1999 1998 2000 1999 1998 2000 1999 1998
------- ------- ------- ------ ------ ------ ---- ---- ----
Service cost............ $ 8,505 $ 5,363 $ 5,015 $ 671 $ 514 $ 402 $693 $57 $--
Interest cost........... 5,851 4,091 3,559 1,497 1,424 1,350 252 22 --
Expected return on plan
assets................. (7,670) (5,117) (4,219) -- -- -- -- -- --
Amortization of
unrecognized net
transition
(asset)/obligation..... (160) (160) (160) 1,163 1,163 1,163 -- -- --
Amortization of
unrecognized prior
service cost........... 376 473 390 -- -- -- -- -- --
Amortization of
unrecognized net gain.. (182) (202) -- -- -- -- -- -- --
------- ------- ------- ------ ------ ------ ---- --- ----
Pension expense......... $ 6,720 $ 4,448 $ 4,585 $3,331 $3,101 $2,915 $945 $79 $--
======= ======= ======= ====== ====== ====== ==== === ====
Discontinued Operations
Included in the defined benefit pension plan data above is $3,434 of expense
related to the PBM segment for fiscal 2000. The expense associated with the
PBM segment for fiscal 1999 and fiscal 1998 is not material. Expenses related
to the Retiree Health Benefit Plan presented above are solely related to the
PBM segment. Employer contributions to the defined contribution plans for the
PBM Segment were $5,440 and $439 for fiscal 2000 and fiscal 1999,
respectively.
41
RITE AID CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The table below sets forth a reconciliation from the beginning of the year
for both the benefit obligation and plan assets of the Company's retirement
and health benefits plans, as well as the funded status and amounts recognized
in the Company's balance sheet as of February 26, 2000 and February 27, 1999:
Nonqualified Retiree Health
Defined Benefit Executive Benefits Plans
Pension Plans Retirement Plan (PBM Segment)
----------------- ------------------ ----------------
2000 1999 2000 1999 2000 1999
-------- ------- -------- -------- ------- -------
Change in benefit
obligations:
Benefit obligation at
end of prior year.... $ 86,908 $58,048 $ 21,891 $ 20,906 $ 3,433 $ --
Service cost.......... 8,505 5,363 671 514 693 57
Interest cost......... 5,851 4,091 1,497 1,424 252 22
Distributions......... (9,844) (6,097) (1,224) (650) (60) (5)
Purchase of PCS....... -- 23,537 -- -- -- 3,359
Change due to change
in assumptions....... (4,655) 1,486 (1,281) (50) -- --
Change due to plan
amendment............ 187 665 18,891 -- -- --
Actuarial (gain) or
loss................. 2,425 (185) (5,754) (253) 323 --
-------- ------- -------- -------- ------- -------
Benefit obligation at
end of year............ $ 89,377 $86,908 $ 34,691 $ 21,891 $ 4,641 $ 3,433
======== ======= ======== ======== ======= =======
Change in plan assets:
Fair value of plan
assets at beginning
of year.............. $ 93,366 $58,212 $ -- $ -- $ -- $ --
Employer
contributions........ 5,611 7,315 1,224 651 60 5
Actual return on plan
assets............... 20,544 13,727 -- -- -- --
Purchase of PCS....... -- 21,507 -- -- -- --
Distributions
(including assumed
expenses)............ (10,601) (6,744) (1,224) (651) (60) (5)
-------- ------- -------- -------- ------- -------
Fair value of plan
assets at end of year.. $108,920 $94,017 $ -- $ -- $ -- $ --
======== ======= ======== ======== ======= =======
Funded status........... $ 19,543 $ 7,109 $(34,691) $(21,891) $(4,641) $(3,433)
Unrecognized net loss
(gain)................. (21,532) (7,369) (5,972) 1,064 323 --
Unrecognized prior
service cost........... 1,808 2,752 18,891 -- -- --
Unrecognized net
transition (asset) or
obligation............. (339) (498) 12,790 13,953 -- --
-------- ------- -------- -------- ------- -------
Prepaid or (accrued)
pension cost
recognized............. $ (520) $ 1,994 $ (8,982) $ (6,874) $(4,318) $(3,433)
======== ======= ======== ======== ======= =======
Amounts recognized in
consolidated balance
sheets consisted of:
Prepaid (accrued)
pension cost......... $ 4,787 $ 4,551 $ (8,982) $ (6,874) $ -- $ --
Adjustment to
recognize additional
minimum liability.... -- 1,039 (22,836) (12,536) -- --
Accrued pension
liability............ (5,307) (3,596) -- -- (4,318) (3,433)
Pension intangible
asset................ -- -- 22,836 12,061 -- --
Accumulated other
comprehensive
income............... -- -- -- 475 -- --
-------- ------- -------- -------- ------- -------
Net amount recognized... $ (520) $ 1,994 $ (8,982) $ (6,874) $(4,318) $(3,433)
======== ======= ======== ======== ======= =======
42
RITE AID CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The amounts recognized in the accompanying consolidated balance sheets as of
February 26, 2000 and February 27, 1999 are as follows:
Retiree Health
Defined Benefit Nonqualified Executive Benefits Plan
Pension Plans Retirement Plan (PBM Segment)
---------------- ------------------------ ----------------
2000 1999 2000 1999 2000 1999
------- ------- ----------- ----------- ------- -------
Accrued benefit
liability.............. $(5,307) $(2,557) $ (8,982) $ (6,874) $(4,318) $(3,433)
Prepaid pension cost.... 4,787 4,551 -- -- -- --
------- ------- ----------- ----------- ------- -------
Net amount recognized... $ (520) $ 1,994 $ (8,982) $ (6,874) $(4,318) $(3,433)
======= ======= =========== =========== ======= =======
The accumulated benefit obligation and fair value of plan assets for the
defined benefit pension plans with plan assets in excess of accumulated
benefit obligations were $58,798 and $84,084, respectively, as of February 26,
2000, and $30,579 and $24,836, respectively, as of February 27, 1999.
The significant actuarial assumptions used for all defined benefit pension
plans were as follows:
Defined Benefit Nonqualified
Pension Plan Executive Defined Benefit
(Retail Drug Retirement Pension Plan
Segment) Plan (PBM Segment)
----------------- -------------- -----------------
Percentage 2000 1999 1998 2000 1999 1998 2000 1999 1998
---------- ----- ----- ----- ---- ---- ---- ----- ----- -----
Discount rate............ 7.25 6.75 7.00 7.83 6.95 6.93 7.80 7.80 --
Rate of increase in
future
compensation levels..... 4.50 4.75 4.75 3.00 3.00 3.00 5.90 5.90 --
Expected long-term rate
of return on
plan assets............. 9.00 9.00 9.00 9.00 9.00 9.00 9.00 9.00 --
Through its acquisition of PCS, the Company also assumed a retiree health
benefits plan that provides for certain health benefits at retirement for
covered employees. Healthcare cost trend rates were assumed to increase at an
annual rate of 6.5 percent in 1999 for participants under the age of 65, and
decrease one-half percent per year to 5.0 percent in 2002 and thereafter. For
participants over the age of 65, the rate was assumed to increase 5.0 percent
in 1999 and thereafter.
The assumed health care cost trend rates have a significant effect on the
retiree health benefits amounts reported. If these trend rates were to be
increased by one percentage point each future year, the accumulated post-
retirement benefit obligation would increase by 16.1 percent and the aggregate
service and interest cost components of the expense recognized in 2000 would
increase by 17.6 percent. A one percentage point decrease in these rates would
reduce the accumulated post-retirement benefit obligation by 13.9 percent and
the aggregate service and interest cost components of the expense recognized
in 2000 would decrease by 14.9 percent.
15. Leases:
The Company leases most of its retail stores and certain distribution
facilities under noncancellable operating and capital leases, most of which
have initial lease terms ranging from 10 to 22 years. The Company also leases
certain of its equipment and other assets under noncancellable operating
leases with initial terms ranging from 3 to 7 years. In addition to minimum
rental payments, certain store leases require additional payments based on
sales volume, as well as reimbursements for taxes, maintenance, and insurance.
Most leases contain renewal options, certain of which involve rent increases.
Total rental expense, net of sublease income, was $440,556 in 2000, $417,311
in 1999 and $365,082 in 1998. These amounts include contingent rentals of
$28,625, $32,960, and $30,720, in fiscal 2000, 1999 and 1998, respectively.
43
RITE AID CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The Company is a guarantor on certain leases transferred to third parties
through sales or assignments.
The Company leases certain facilities through sale-leaseback arrangements
accounted for using the financing method. Proceeds from sale-leaseback
programs were approximately $74,899 in 2000, $504,990 in 1999 and $323,803 in
1998.
The net book values of assets under capital leases and sale-leasebacks
accounted for under the financing method are summarized as follows:
February 26, February 27,
2000 1999
------------ ------------
Land............................................... $343,948 $328,610
Buildings.......................................... 570,604 541,710
Equipment.......................................... 86,348 77,453
Accumulated depreciation........................... (36,043) (20,391)
-------- --------
$964,857 $927,382
======== ========
Following is a summary of lease finance obligations at February 26, 2000 and
February 27, 1999:
2000 1999
---------- ----------
Sale-leaseback obligations accounted for under the
financing method................................. $ 944,805 $ 921,331
Obligations under capital leases.................. 207,096 228,102
---------- ----------
Total............................................. 1,151,901 1,149,433
Less current obligation........................... (25,964) (31,522)
---------- ----------
Long-term lease finance obligations............... $1,125,937 $1,117,911
========== ==========
Following are the minimum lease payments net of sublease income that will
have to be made in each of the years indicated based on non-cancellable leases
in effect as of February 26, 2000:
Financing obligation
under sale-leaseback
arrangements and
Capital Lease Operating
Fiscal year obligations Leases
----------- -------------------- ----------
2001........................................ $ 119,757 $ 448,580
2002........................................ 119,264 437,140
2003........................................ 116,687 419,024
2004........................................ 114,701 396,930
2005........................................ 114,701 379,860
Later years................................. 1,461,945 3,675,519
---------- ----------
Total minimum lease payments................ 2,047,055 $5,757,053
==========
Amount representing interest................ 895,154
----------
Present value of minimum lease payments..... $1,151,901
==========
16. Capital Stock:
In October 1999, the Company issued 3,000,000 shares of $100 par value 8%
Series A Convertible Preferred Stock for cash of $300,000. The shares have a
liquidation preference of $100 per share with preference over all existing
classes of preferred stock. The shares are callable by the Company beginning
October 2004 at the liquidation value plus a 5% premium. The shares accrue
cumulative dividends at 8% of the liquidation value of
44
RITE AID CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
the outstanding shares. Dividends may be paid in cash or additional shares and
have been paid in shares to date. In December 1999, the shares were exchanged
for Series B Convertible Preferred Stock with the same characteristics except
that each Series B share has voting rights equivalent to one share of common
stock. The terms of the shares provide that they are convertible into common
stock at an initial conversion rate of $11.00 per common share subject to
adjustment based on future declines in the quoted price or subsequent equity
transactions based on per share prices lower than $11.00. As a result of the
Company's equity transaction on June 14, 2000, further described in note 24,
the conversion price was subsequently adjusted to a conversion price of $5.50
per share. The resulting beneficial conversion feature of approximately $160.9
million (representing the difference between $5.50 and the market price of the
Company's common stock on the issuance date of the preferred stock), will be
accreted as a return on the preferred stock and will decrease earnings
available to common stockholders beginning in the second quarter of fiscal
2001.
At a Special Meeting of Stockholders held on February 22, 1999, an amendment
to Rite Aid's Restated Certificate of Incorporation was approved to increase
the number of authorized shares of common stock, $1.00 par value, from
300,000,000 to 600,000,000. Accordingly, the authorized capital stock of the
Company consists of 600,000,000 shares of common stock and 20,000,000 shares
of preferred stock, both having a par value of $1.00 per share. Preferred
stock is issued in series subject to terms established by the Board of
Directors.
On February 2, 1998, the Company effected a two-for-one stock split of the
Company's common stock to stockholders of record at the close of business on
January 20, 1998. The stock split increased the number of shares outstanding
by 135,640,000 shares. All share and per share amounts have been restated to
give effect to the stock split.
17. Redeemable Preferred Stock:
In March 1999 and February 1999, Rite Aid Lease Management Company, a wholly
owned subsidiary of Rite Aid Corporation, issued 63,000,000 and 150,000,000
shares of Cumulative Preferred Stock, Class A, par value $100 per share,
respectively. The Class A Cumulative Preferred Stock is mandatorily redeemable
on April 1, 2019 at a redemption price of $100 per share plus accumulated and
unpaid dividends. The Class A Cumulative Preferred Stock pays dividends
quarterly at a rate of 7.0 percent per annum of the par value of $100 per
share when, as and if declared by the Board of Directors of Rite Aid Lease
Management Company in its sole discretion. The amount of dividends payable in
respect of the Class A Cumulative Preferred Stock may be adjusted under
certain events. The outstanding shares of the Class A Preferred Stock were
recorded at the estimated fair value of $5,695 and $13,559 for the 2000 and
1999 issuances, respectively, which equaled the sale price on the date of
issuance. Because the fair value of the Class A Preferred Stock was less than
the mandatory redemption amount at issuance, periodic accretions to
stockholders' equity using the interest method are made so that the carrying
amount equals the redemption amount on the mandatory redemption date.
Accretions were $97 in fiscal year 2000 and $0 in 1999.
In March 1998, RX Choice, Inc., a wholly owned subsidiary of Rite Aid
Corporation (Rite Aid), issued 10,000,000 shares of preferred stock, par value
$0.01, with a liquidation preference per share of $1,000 per share. Granted to
the holder of each share of preferred stock was an option (Put Option) to sell
to Rite Aid all or any portion of the preferred stock held by the holder on
the date the Put Option is exercised. Each Put Option may be exercised any
time after March 25, 2003 and before March 25, 2004. In addition, Rite Aid has
an option (Call Option) to purchase from the holders of the preferred stock,
all or any portion of the shares of preferred stock upon the exercise of the
Call Option. The Call Option may be exercised by Rite Aid any time after
March 20, 2004 and before March 20, 2005. The preferred stock carries a
mandatory obligation to declare and pay preferential dividends at the rate of
7.70 percent per annum of the liquidation preference per share, payable
quarterly. As amended and restated, the articles of incorporation of RX
Choice, Inc. authorize the issuance of 10,000,000 shares of preferred stock,
of which 10,000,000 shares were issued in 1999. During 2000, the Company
repurchased and retired all of the shares at the redemption value of $10,000.
45
RITE AID CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
18. Earnings Per Share:
Basic earnings per share is computed by dividing income available to common
stockholders by the weighted-average number of common shares outstanding for
the period. Diluted earnings per share reflects the potential dilution that
could occur if securities or other contracts to issue common stock were
exercised or converted into common stock or resulted in the issuance of common
stock that then shared in the earnings of the entity. All share and per share
data have also been restated to reflect a two-for-one stock split distributed
to stockholders on February 2, 1998.
February 26, February 27, February 28,
2000 1999 1998
------------ ------------ ------------
Numerator for earnings per share:
Loss from continuing operations
before cumulative effect of
accounting change.............. $(1,114,921) $ (448,699) $ (145,026)
Accretion of redeemable
preferred stock................ (97) -- --
Dividends on preferred stock.... (10,110) (627) --
----------- ----------- -----------
Loss before cumulative effect of
accounting change attributable
to common stockholders......... (1,125,128) (449,326) (145,026)
Income (loss) from discontinued
operation...................... 9,178 (12,823) (20,214)
Cumulative effect of accounting
change......................... (27,300) -- --
----------- ----------- -----------
Net loss attributable to common
stockholders..................... $(1,143,250) $ (462,149) $ (165,240)
=========== =========== ===========
Denominator:
Basic weighted average shares... 259,139,000 258,516,000 250,659,000
Diluted weighted average
shares......................... 259,139,000 258,516,000 250,659,000
Basic and diluted loss per share:
Loss per share before cumulative
effect of accounting change.... $ (4.34) $ (1.74) $ (0.58)
Discontinued operations......... 0.04 (0.05) (0.08)
Cumulative effect of accounting
change......................... (0.11) -- --
----------- ----------- -----------
Basic and diluted loss per
share.......................... $ (4.41) $ (1.79) $ (0.66)
=========== =========== ===========
In fiscal 2000, 1999 and 1998, no potential common shares have been included
in the calculation of diluted earnings per share because of the losses
reported. At February 26, 2000, an aggregate of 109,640,439 potential common
shares related to stock options, convertible preferred stock, convertible
notes, warrants, stock appreciation rights and other have been excluded from
the computation of diluted earnings per share.
19. Stock Option and Stock Award Plans:
The Company reserved 22,000,000 shares of its common stock for the granting
of stock options and other incentive awards to officers and key employees
under the 1990 Omnibus Stock Incentive Plan (the 1990 Plan). Options may be
granted, with or without stock appreciation rights (SARs), at prices that are
not less than the fair market value of a share of common stock on the date of
grant. The 1990 Plan provides for the Compensation Committee to determine both
when and in what manner options may be exercised; however, it may not be more
than 10 years from the date of grant. The exercise of either a SAR or option
automatically will cancel any related option or SAR. Under the Plan, the
payment for SARs will be made in shares, cash or a combination of cash and
shares at the discretion of the Compensation Committee.
In November 1999, the Company adopted the 1999 Stock Option Plan (the 1999
Plan), under which 10,000,000 shares of common stock are reserved for the
granting of stock options at the discretion of the Board of Directors. Under
the 1999 Plan, stock options may be granted at prices that are not less than
the fair market value of a share of common stock on the date of grant.
46
RITE AID CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Following is a summary of stock option transactions for the fiscal years
ended February 26, 2000, February 27, 1999 and February 28, 1998:
Weighted
Average
Price
Per
Shares Share
---------- --------
Balance, March 1, 1997.................................. 12,168,650 $13.43
Granted............................................... 401,000 26.59
Exercised............................................. (771,500) 12.60
Canceled.............................................. (306,376) 12.89
---------- ------
Balance, February 28, 1998.............................. 11,491,774 13.96
Granted............................................... 4,054,000 32.74
Exercised............................................. (633,575) 14.58
Canceled.............................................. (241,500) 20.18
---------- ------
Balance, February 27, 1999.............................. 14,670,699 19.02
Granted............................................... 18,687,562 7.95
Exercised............................................. (64,650) 13.61
Canceled.............................................. (7,488,707) 14.60
---------- ------
Balance, February 26, 2000.............................. 25,804,904 $12.30
========== ======
For various price ranges, weighted average characteristics of outstanding
stock options at February 26, 2000 were as follows:
Outstanding Options Exercisable Options
---------------------------------- ---------------------
Remaining Weighted Weighted
Range of life Average Average
exercise prices Shares (years) Price Shares Price
--------------- ------ --------- -------- ------ --------
$ 5.38 5,855,308 9.70 $ 5.38 600,000 $ 5.38
$ 6.75 to $ 7.13 638,000 9.94 $ 6.94 -- --
$ 7.35 7,000,000 9.77 $ 7.35 388,889 $ 7.35
$ 7.44 to $ 9.25 3,059,416 5.82 $ 8.56 1,792,699 $ 9.22
$ 9.56 to $16.50 2,955,600 5.54 $13.85 2,481,450 $13.42
$16.63 to $23.00 2,871,000 7.35 $19.02 1,935,750 $17.16
$23.06 to $32.00 2,791,080 8.40 $29.29 132,000 $29.39
$32.06 to $48.81 634,500 8.61 $41.98 124,375 $43.89
---------------- ---------- ---- ------ --------- ------
$ 5.38 to $48.81 25,804,904 8.36 $12.30 7,455,163 $13.21
================ ========== ==== ====== ========= ======
47
RITE AID CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
position, results of operations and cash flows of the Company as well as
necessitate substantial additional expenditures to cover legal costs as it
pursues all available defenses.
The Company has also recently been notified that it is being investigated by
multiple state attorneys general for its reimbursement practices relating to
partially-filled prescriptions and fully filled prescriptions that are not
picked up by ordering customers. The Company is supplying similar information
with respect to these matters to the Department of Justice. The Company
believes that its existing policies and procedures fully comply with the
requirement of applicable law and intends to fully cooperate with these
investigations. The Company cannot, however, predict the outcome of these
investigations.
If any of these cases results in a substantial monetary judgment against the
Company or is settled on unfavorable terms, the Company's results of
operations, financial position and cash flows could be materially adversely
affected.
Other
In addition, the Company is subject from time to time to lawsuits arising in
the ordinary course of business. In the opinion of management, these matters
are covered adequately by insurance or, if not so covered, are without merit
or are of such nature or involve such amounts as would not have a material
adverse effect on the Company's financial condition, cash flow or results of
operations if decided adversely.
Vendor Arrangements
As of February 26, 2000, the Company had outstanding commitments to purchase
$140 million of merchandise inventory from a vendor for use in the normal
course of business. The Company expects to satisfy these purchase commitments
by fiscal 2005. Under the terms of a joint marketing agreement, the Company
and the vendor are each obligated to make contributions of $51 million to a
marketing fund to be used in connection with advertising and marketing of such
products through September 30, 2004.
Employment Agreements
The Company has employment contracts with its executive officers and various
other members of senior management requiring payment of minimum annual base
salaries and, in some cases, minimum target bonuses and other compensation
arrangements. The terms of the agreements are three years.
Employment agreements with four executive officers contain change in control
provisions that entitle each of them to receive three times the sum of their
annual base salary and annual target bonus amount. The executive officers will
also receive the total amount of contributions that would have been made to
the deferred compensation plan if they had been employed through the end of
their employment contract. All outstanding stock options shall become fully
vested and all restrictions on stock awards shall immediately lapse.
52
RITE AID CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
23. Interim Financial Results (Unaudited):
The information in this footnote has been revised from the information
previously reported to correct certain errors in annual and interim periods,
and to reflect the reclassification of the PBM segment as a discontinued
operation and certain other reclassifications. See notes 25 and 26.
Fiscal Year 1999
------------------------------------------------------------------------------------------------------
First Quarter Second Quarter
--------------------------------------------------- --------------------------------------------------
Restated As As Restated As As
Previously Restated Previously Restated
As Reported in for Further As Restated As Reported in for Further As Restated
Previously 2000 Form Restatement and Previously 2000 Form Restatement and
Reported(1) 10-K Adjustments Reclassified Reported(1) 10-K Adjustments Reclassified
----------- ----------- ----------- ------------ ----------- ----------- ----------- ------------
Revenues.............. $3,032,681 $3,086,505 $3,086,505 $3,030,237 $3,011,029 $3,057,095 $3,057,095 3,010,237
Costs and expenses
excluding store
closing and
impairment charges... 3,009,279 3,232,024 3,232,364 3,171,532 2,939,376 3,105,926 3,104,719 3,053,617
Store closing and
impairment charges... 74,300 57,134 57,134 57,134 63,604 31,244 31,244 31,244
---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------
Income (loss) from
continuing operations
before taxes......... (50,898) (202,653) (202,993) (198,429) 8,049 (80,075) (78,868) (74,624)
Income tax expense
(benefit)............ (25,221) (61,027) (61,161) (59,564) 3,961 (24,114) (23,637) (22,151)
---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------
Income (loss) from
continuing
operations........... (25,677) (141,626) (141,832) (138,865) 4,088 (55,961) (55,231) (52,473)
Loss from discontinued
operations, net of
tax.................. -- -- -- (2,967) -- -- -- (2,758)
---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------
Net income (loss)..... $ (25,677) $ (141,626) $ (141,832) $ (141,832) $ 4,088 $ (55,961) $ (55,231) (55,231)
========== ========== ========== ========== ========== ========== ========== =========
Basic and diluted
earnings (loss) per
share:
Loss from continuing
operations........... $ (0.10) $ (0.55) $ (0.55) $ (0.54) $ 0.02 $ (0.22) $ (0.21) $ (0.20)
Income (loss) from
discontinued
operations .......... -- -- -- (0.01) -- -- -- (0.01)
---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------
Net income (loss)..... $ (0.10) $ (0.55) $ (0.55) $ (0.55) $ 0.02 $ (0.22) $ (0.21) $ (0.21)
========== ========== ========== ========== ========== ========== ========== =========
- --------
(1) Financial data as previously reported in the Company's quarterly report on
Form 10-Q for the period ended August 28, 1999.
53
RITE AID CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Beginning in January 1999 the Company leased for $188 per year a 10,750
square-foot store in Sinking Springs, Pennsylvania, which it leases from a
relative of Martin Grass, the former Chairman of the Board and Chief Executive
Officer. The Company leases a 5,000 square-foot store in Mt. Carmel,
Pennsylvania, from a partnership in which Martin Grass is or was a partner.
The rent is $39 per year.
22. Commitments, Contingencies and Guarantees:
Legal Proceedings
This Company is party to numerous legal proceedings, as discussed below. The
Company has charged $232,778, $7,916, and $19,374, to expense for the years
ended February 26, 2000, February 27, 1999, and February 28, 1998,
respectively, for various pending and actual claims, litigation, and
assessments based upon its determination of its material, estimable and
probable liabilities in regard to the portion of these claims, lawsuits, and
assessments not covered by insurance.
In addition, as discussed below, an unfavorable resolution of certain of
these matters could materially adversely affect the Company's results of
operations, financial position and cash flows.
Federal investigations
There are currently pending federal governmental investigations, both civil
and criminal, by the SEC and the United States Attorney, involving the
Company's financial reporting and other matters. The Company is cooperating
fully with the SEC and the United States Attorney.
The U.S. Department of Labor has commenced an investigation of matters
relating to the Company's employee benefit plans, including its principal
401(k) plan which permitted employees to purchase Company common stock. Plan
participants held approximately 2.8 million shares at December 31, 1998 and
3.9 million shares at December 31, 1999. Purchases of Company common stock
under the plan were suspended in October 1999. The Company is cooperating
fully with the Department of Labor.
These investigations are ongoing and the Company is unable to predict their
outcomes. If the Company were convicted of any crime, certain contracts and
licenses that are material to operations may be revoked, which would have a
material adverse effect on results of operations, financial condition and cash
flows. In addition, substantial penalties, damages or other monetary remedies
assessed against Rite Aid could also have a material adverse affect on results
of operations, financial condition and cash flows.
Stockholder litigation
Rite Aid, its former chief executive officer Martin Grass, its former
president Timothy Noonan, its former chief financial officer Frank Bergonzi,
and its former auditor KPMG LLP, have been sued in a number of actions, most
of which purport to be class actions, brought on behalf of stockholders who
purchased Rite Aid securities on the open market between May 2, 1997 and
November 10, 1999. With one exception, the cases have been consolidated in the
U.S. District Court for the Eastern District of Pennsylvania, where plaintiffs
have filed a third amended compliant and have been given leave of court to
file a fourth amended complaint on or before August 10, 2000. Most of the
existing complaints assert claims against defendants under Sections 10 and 20
of the Securities Exchange Act of 1934, as amended, based upon the allegation
that the Company's financial statements for its 1997, and 1998 and 1999 fiscal
years fraudulently misrepresented its financial position and results of its
operations for those periods, among other allegations. Two actions also assert
claims against defendants under Section 18 of the Exchange Act and one action
asserts claims under the Florida Securities Act and Florida common law, all
based upon similar allegations.
50
RITE AID CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
If any of these cases were to result in a substantial monetary judgment
against the Company, or is settled on unfavorable terms, the Company's results
of operation and financial position could be materially adversely affected.
Certain of Rite Aid's former officers (Martin L. Grass, Timothy J. Noonan
and Frank Bergonzi), certain of its current and former directors (Alex Grass,
Philip Neivert, Franklin C. Brown, Leonard I. Green, Leonard N. Stem and Nancy
A. Lieberman), its former auditor, KPMG LLP, and Rite Aid as nominal
defendant, have been sued by Rite Aid stockholders derivatively on behalf of
Rite Aid in derivative actions brought in the U.S. District Court for the
Eastern District of Pennsylvania and the Chancery Court of the State of
Delaware. The derivative complaints purport to assert claims on behalf of Rite
Aid against the defendants for violation of duties asserted to be owed by such
defendants to Rite Aid, based upon allegations similar to those contained in
the complaints in the securities cases described above. The time for
defendants to respond to the derivative complaints has not yet run. Rite Aid
had made no determination yet as how it will respond to the derivative
complaints and is unable to predict the ultimate outcome of this litigation.
Drug pricing and reimbursement matters
Civil proceedings are continuing involving the Company's pricing-related
practices for prescription drugs. On September 22, 1999, the Florida Attorney
General filed a complaint against the Company in the Second District, Leon
County, alleging violations of the Florida Deceptive and Unfair Trade
Practices Act and the state RICO statute. The Company no longer operates any
retail drugstores in Florida. In essence, Florida asserted that the Company's
former practice of allowing its pharmacists the discretion to charge non-
uniform prices through the use of positive overrides for cash purchases of
prescription drugs was unlawful. The Company discontinued its use of this
policy in June 1998 throughout its retail drugstores. On February 18, 2000,
the reviewing Florida state court dismissed with prejudice the Florida
Attorney General's complaint. On May 5, 2000, the same court denied Florida's
motion to rehear the case and affirmed the initial decision on the merits, but
granted Florida's motion to amend its complaint to raise allegations
concerning other pricing practices relating to discounts and generic drug
price notices. On July 5, 2000, the Company filed a motion to dismiss the
amended complaint.
The filing of the complaint by the Florida Attorney General, and the
Company's press release issued in conjunction therewith, precipitated the
filing of purported federal class actions in Alabama and California and
purported state class actions in New Jersey, New York, Oregon, and
Pennsylvania. All of the class actions are based on facts essentially
identical to those contained in the Florida complaint and none specify
damages. The Company has asserted in court filings that its imposition of
positive overrides was a legitimate utilization of non-uniform pricing
similarly engaged in by many other sectors of retail commerce. The Company
filed motions to dismiss each of the uncertified class action complaints for
failure to state a claim for which relief could be granted. The Company's
arguments have prevailed in each of the cases in which a court decision has
been rendered thus far. On December 27, 1999, the United States District Court
for the Northern District of Alabama dismissed the federal RICO claims against
the Company with prejudice and the plaintiffs later filed an appeal with the
Eleventh Circuit. That appeal is currently pending. On May 21, 2000, an Oregon
state court judge granted the Company's motion to dismiss the purported class
action there with prejudice. On June 12, 2000, the United States District
Court for the Central District of California dismissed that case and on June
27, 2000, a New Jersey state court dismissed that class action there. Motions
to dismiss the state class actions in New York and Pennsylvania are currently
pending.
The Company believes that all of the positive override lawsuits are without
merit under applicable state consumer protection laws and/or state or federal
RICO statutes. As a result, the Company intends to continue to vigorously
defend each of the pending actions and does not anticipate, if fully
adjudicated, that any of the lawsuits will result in an award of damages
and/or civil penalties. However, such an outcome for each of the actions
cannot be assured and a ruling against the Company could have a material
adverse effect on the financial
51
RITE AID CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
position, results of operations and cash flows of the Company as well as
necessitate substantial additional expenditures to cover legal costs as it
pursues all available defenses.
The Company has also recently been notified that it is being investigated by
multiple state attorneys general for its reimbursement practices relating to
partially-filled prescriptions and fully filled prescriptions that are not
picked up by ordering customers. The Company is supplying similar information
with respect to these matters to the Department of Justice. The Company
believes that its existing policies and procedures fully comply with the
requirement of applicable law and intends to fully cooperate with these
investigations. The Company cannot, however, predict the outcome of these
investigations.
If any of these cases results in a substantial monetary judgment against the
Company or is settled on unfavorable terms, the Company's results of
operations, financial position and cash flows could be materially adversely
affected.
Other
In addition, the Company is subject from time to time to lawsuits arising in
the ordinary course of business. In the opinion of management, these matters
are covered adequately by insurance or, if not so covered, are without merit
or are of such nature or involve such amounts as would not have a material
adverse effect on the Company's financial condition, cash flow or results of
operations if decided adversely.
Vendor Arrangements
As of February 26, 2000, the Company had outstanding commitments to purchase
$140 million of merchandise inventory from a vendor for use in the normal
course of business. The Company expects to satisfy these purchase commitments
by fiscal 2005. Under the terms of a joint marketing agreement, the Company
and the vendor are each obligated to make contributions of $51 million to a
marketing fund to be used in connection with advertising and marketing of such
products through September 30, 2004.
Employment Agreements
The Company has employment contracts with its executive officers and various
other members of senior management requiring payment of minimum annual base
salaries and, in some cases, minimum target bonuses and other compensation
arrangements. The terms of the agreements are three years.
Employment agreements with four executive officers contain change in control
provisions that entitle each of them to receive three times the sum of their
annual base salary and annual target bonus amount. The executive officers will
also receive the total amount of contributions that would have been made to
the deferred compensation plan if they had been employed through the end of
their employment contract. All outstanding stock options shall become fully
vested and all restrictions on stock awards shall immediately lapse.
52
RITE AID CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
23. Interim Financial Results (Unaudited):
The information in this footnote has been revised from the information
previously reported to correct certain errors in annual and interim periods,
and to reflect the reclassification of the PBM segment as a discontinued
operation and certain other reclassifications. See notes 25 and 26.
Fiscal Year 1999
------------------------------------------------------------------------------------------------------
First Quarter Second Quarter
--------------------------------------------------- --------------------------------------------------
Restated As As Restated As As
Previously Restated Previously Restated
As Reported in for Further As Restated As Reported in for Further As Restated
Previously 2000 Form Restatement and Previously 2000 Form Restatement and
Reported(1) 10-K Adjustments Reclassified Reported(1) 10-K Adjustments Reclassified
----------- ----------- ----------- ------------ ----------- ----------- ----------- ------------
Revenues.............. $3,032,681 $3,086,505 $3,086,505 $3,030,237 $3,011,029 $3,057,095 $3,057,095 3,010,237
Costs and expenses
excluding store
closing and
impairment charges... 3,009,279 3,232,024 3,232,364 3,171,532 2,939,376 3,105,926 3,104,719 3,053,617
Store closing and
impairment charges... 74,300 57,134 57,134 57,134 63,604 31,244 31,244 31,244
---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------
Income (loss) from
continuing operations
before taxes......... (50,898) (202,653) (202,993) (198,429) 8,049 (80,075) (78,868) (74,624)
Income tax expense
(benefit)............ (25,221) (61,027) (61,161) (59,564) 3,961 (24,114) (23,637) (22,151)
---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------
Income (loss) from
continuing
operations........... (25,677) (141,626) (141,832) (138,865) 4,088 (55,961) (55,231) (52,473)
Loss from discontinued
operations, net of
tax.................. -- -- -- (2,967) -- -- -- (2,758)
---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------
Net income (loss)..... $ (25,677) $ (141,626) $ (141,832) $ (141,832) $ 4,088 $ (55,961) $ (55,231) (55,231)
========== ========== ========== ========== ========== ========== ========== =========
Basic and diluted
earnings (loss) per
share:
Loss from continuing
operations........... $ (0.10) $ (0.55) $ (0.55) $ (0.54) $ 0.02 $ (0.22) $ (0.21) $ (0.20)
Income (loss) from
discontinued
operations .......... -- -- -- (0.01) -- -- -- (0.01)
---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------
Net income (loss)..... $ (0.10) $ (0.55) $ (0.55) $ (0.55) $ 0.02 $ (0.22) $ (0.21) $ (0.21)
========== ========== ========== ========== ========== ========== ========== =========
- --------
(1) Financial data as previously reported in the Company's quarterly report on
Form 10-Q for the period ended August 28, 1999.
53
RITE AID CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Fiscal Year 1999
------------------------------------------------------------------------------------------------------
Third Quarter Fourth Quarter
--------------------------------------------------- --------------------------------------------------
Restated As As Restated As As
Previously Restated Previously Restated
As Reported in for Further As Restated As Reported in for Further As Restated
Previously 2000 Form Restatement and Previously 2000 Form Restatement and
Reported(2) 10-K Adjustments Reclassified Reported(2) 10-K Adjustments Reclassified
----------- ----------- ----------- ------------ ----------- ----------- ----------- ------------
Revenues.............. $3,122,930 $3,185,386 $3,185,386 $3,109,903 $3,565,260 $3,453,904 $3,453,904 $3,288,065
Costs and expenses
excluding store
closing and
impairment charges... 2,995,965 3,325,360 3,319,656 3,238,912 3,482,123 3,531,560 3,617,988 3,447,470
Store closing and
impairment charges... (7,298) 69,255 69,255 69,255 430 34,918 34,918 34,918
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Income (loss) from
continuing operations
before taxes......... 134,263 (209,229) (203,525) (198,264) 82,707 (112,574) (199,002) (194,323)
Income tax expense
(benefit)............ 53,705 (63,007) (60,753) (58,912) 9,139 (33,901) (77,315) (76,314)
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Income (loss) from
continuing
operations........... 80,558 (146,222) (142,772) (139,352) 73,568 (78,673) (121,687) (118,009)
Loss from discontinued
operations, net of
tax.................. -- -- -- (3,420) -- -- -- (3,678)
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Net income (loss)..... $ 80,558 $ (146,222) $ (142,772) $ (142,772) $ 73,568 $ (78,673) $ (121,687) (121,687)
========== ========== ========== ========== ========== ========== ========== ==========
Basic and diluted
earnings (loss) per
share:
Loss from continuing
operations........... $ 0.31 $ (0.57) $ (0.55) $ (0.54) $ 0.28 $ (0.31) $ (0.47) $ (0.46)
Income (loss) from
discontinued
operations .......... -- -- -- (0.01) -- -- -- (0.01)
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Net income (loss)..... $ 0.31 $ (0.57) $ (0.55) $ (0.55) $ 0.28 $ (0.31) $ (0.47) $ (0.47)
========== ========== ========== ========== ========== ========== ========== ==========
- --------
(2) Financial data as previously reported in the Company's annual report on
Form 10-K for the year ended February 27, 1999.
54
RITE AID CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
As of and for the fiscal As of and for the fiscal For the fiscal
year ended year ended year ended As of March
February 26, 2000 February 27, 1999 February 28, 1998 1, 1997
--------------------------- ------------------------- ----------------- -----------
Increase Increase Increase Increase Increase Increase
(decrease) in (decrease) in (decrease) (decrease) in (decrease) in (decrease)
retained results of in retained results of results of in retained
earnings operations(1) earnings operations(1) operations(1) earnings
------------- ------------- ----------- ------------- ----------------- -----------
Purchase accounting..... $ 11,032 $ -- $ 11,032 $ -- $ 11,032 $ --
Exit costs and
impairment of operating
and other assets....... (4,513) (19,596) 15,083 9,186 (8,800) 14,697
Accruals for operating
expenses............... 13,356 17,525 (4,169) (5,753) (725) 2,309
Property, plant, &
equipment.............. (22,165) 41,037 (63,202) (90,431) 33,411 (6,182)
Inventory and cost of
goods sold............. 260 260 -- -- -- --
Capital leases and sale
leaseback accounting... 3,884 (3,884) 7,768 7,768 -- --
Other................... (3,436) (2,809) (627) (627) -- --
Income taxes............ -- (22,520) 22,520 40,817 (13,967) (4,330)
-------- -------- --------- --------- -------- -------
Total .................. $ (1,582) $ 10,013 $ (11,595) $ (39,040) $ 20,951 $ 6,494
======== ======== ========= ========= ======== =======
- --------
(1) Represents the effects of the restatement on previously reported amounts
prior to the reclassification of the PBM segment as a discontinued
operation.
A description of the principal adjustments follows:
Purchase Accounting
The Company acquired Thrifty PayLess, Inc. in fiscal 1997 and Harco Inc. and
K&B Incorporated in fiscal 1998. Certain liabilities associated with these
acquisitions that had previously been established have been either reduced or
eliminated with a corresponding decrease in goodwill, to correctly reflect the
fair value of the assets acquired and liabilities assumed at the dates of
acquisition.
Exit Costs and Impairment of Operating and Other Assets
The restated financial statements reflect adjustments to appropriately
recognize charges related to store closures in the period in which the
decision, and ability, to close a store had been made. In addition, other
charges not related to exiting stores and gains from the sale of certain
assets that had previously been recorded as adjustments to the store exit
liability have been reflected as income or expense in the period in which they
were incurred or realized.
Adjustments have also been made to record impairment charges for stores and
other assets in the period in which the impairment occurred; and to change the
method used to evaluate assets for impairment from a market level to an
individual store level because this is the lowest level of independent cash
flows ascertainable for purposes of measuring impairment.
Accruals for Operating Expenses
The restated financial statements reflect adjustments to expense certain
operating costs in the period in which they were incurred and to record a
corresponding liability for those items not paid at the end of the period.
Such costs primarily consisted of payroll, vacation pay, incentive
compensation, executive retirement plans, scheduled rent increases, and
certain insurance claims.
59
RITE AID CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Property, Plant, and Equipment
The restated financial statements reflect adjustments to charge certain
items previously capitalized to expense in the period in which they were
incurred. Such items include certain costs for repairs and maintenance,
interest, and internal software development. The adjustments also include
increases in depreciation expense to reverse the effects of retroactive
changes made to the useful lives of certain assets, to depreciate assets
misclassified as construction in-progress, and to recognize depreciation
expense in the appropriate periods.
Inventory and Cost of Goods Sold
The restated financial statements reflect adjustments to inventory and cost
of goods sold primarily to reverse unearned vendor allowances previously
recorded as a reduction to cost of goods sold, to correctly apply the retail
method of accounting, establish obsolescence reserves, recognize certain
selling costs including promotional markdowns and shrink in the period in
which they were incurred, recognize liabilities for inventory purchases in the
appropriate periods, and reflect vendor allowances in the inventory balances.
Lease Obligations
The restated financial statements reflect adjustments to recognize sale-
leaseback transactions for certain stores as financing transactions. Such
transactions had previously been accounted for as sales and the leasebacks
were accounted for as operating leases. The adjustment to correct these items
resulted in the reversal of the asset sales and the establishment of lease
obligations as capital leases. In addition, adjustments were made to record
certain leases that had previously been accounted for as operating leases.
A summary of the effects of the restatement adjustments on the accompanying
consolidated balance sheets and statements of operations is as follows:
February 26, 2000
---------------------------------------------------------------------
As Previously
Reported in Restatement As Restated
2000 Form 10-K Adjustments (1) Reclassifications (2) and Reclassified
-------------- --------------- --------------------- ----------------
CURRENT ASSETS:
Cash.................. $ 184,600 $ -- $ (4,843) $ 179,757
Accounts receivable,
net.................. 756,182 10,285 (614,432) 152,035
Inventories, net...... 2,643,959 260 (171,782) 2,472,437
Refundable income
taxes................ 147,599 -- -- 147,599
Prepaid expenses and
other current
assets............... 73,130 (4,717) (4,754) 63,659
----------- -------- ---------- ----------
Total current
assets............. 3,805,470 5,828 (795,811) 3,015,487
----------- -------- ---------- ----------
PROPERTY, PLANT AND
EQUIPMENT, NET......... 3,629,919 (32,592) (147,733) 3,449,594
GOODWILL AND OTHER
INTANGIBLES............ 3,131,070 (3,726) (1,816,221) 1,311,123
OTHER ASSETS............ 241,395 4,237 (2,733) 242,899
DEFERRED TAX ASSET...... -- -- 146,916 146,916
NET NON-CURRENT ASSETS
OF DISCONTINUED
OPERATIONS............. -- -- 1,743,828 1,743,828
----------- -------- ---------- ----------
Total assets......... $10,807,854 $(26,253) $ (871,754) $9,909,847
=========== ======== ========== ==========
- --------
(1) Adjustments identified subsequent to the filing of the Company's 2000
Form 10-K.
(2) To reclassify the PBM segment as a discontinued operation and to reflect
certain other reclassifications. See note 26.
60
RITE AID CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
February 26, 2000
-------------------------------------------------------------------------
As Previously
Reported in Restatement As Restated
2000 Form 10-K Adjustments (1) Reclassifications (2) and Reclassified
-------------- --------------- --------------------- ----------------
CURRENT LIABILITIES:
Short-term debt and
current maturities of
long-term debt....... $ 102,050 $ -- $ -- $ 102,050
Accounts payable...... 1,771,198 2,645 (919,781) 854,062
Sales and other taxes
payable.............. 35,053 -- (1,391) 33,662
Income taxes payable.. 127,691 -- (15,887) 111,804
Accrued salaries,
wages and other
current liabilities.. 876,425 (26,317) (46,213) 803,895
Net current
liabilities of
discontinued
operations........... -- -- 390,053 390,053
----------- -------- --------- ----------
Total current
liabilities........ 2,912,417 (23,672) (593,219) 2,295,526
----------- -------- --------- ----------
CONVERTIBLE SUBORDINATED
NOTES.................. 649,986 -- -- 649,986
LONG-TERM DEBT LESS
CURRENT MATURITIES..... 4,738,661 -- -- 4,738,661
CAPITAL LEASE
OBLIGATIONS............ 1,118,204 -- 7,733 1,125,937
DEFERRED INCOME TAXES... 79,220 -- (79,220) --
OTHER NON-CURRENT
LIABILITIES............ 858,401 (3,582) (207,048) 647,771
----------- -------- --------- ----------
Total liabilities.... 10,356,889 (27,254) (871,754) 9,457,881
----------- -------- --------- ----------
REDEEMABLE PREFERRED
STOCK.................. 19,457 -- -- 19,457
STOCKHOLDERS' EQUITY:
Preferred stock....... 308,250 -- -- 308,250
Common stock.......... 259,926 -- 1 259,927
Additional paid-in
capital.............. 1,289,755 2,583 (1) 1,292,337
Accumulated deficit... (1,420,235) (1,582) -- (1,421,817)
Deferred
compensation......... (6,188) -- -- (6,188)
----------- -------- --------- ----------
Total stockholders'
equity............. 431,508 1,001 -- 432,509
----------- -------- --------- ----------
Total liabilities
and stockholders'
equity............. $10,807,854 $(26,253) $(871,754) $9,909,847
=========== ======== ========= ==========
- --------
(1) Adjustments identified subsequent to the filing of the Company's 2000 Form
10-K.
(2) To reclassify the PBM segment as a discontinued operation and to reflect
certain other reclassifications. See note 26.
61
RITE AID CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
25. Restatements of Financial Statements
On June 1, 1999 the Company filed its annual report on Form 10-K which
included its consolidated financial statements covering fiscal years 1997 and
1998 that had been restated to correct certain accounting errors. Subsequent
to this restatement, the Company determined that the errors were greater than
originally discovered and, in its Quarterly Report on Form 10-Q for the second
quarter of fiscal 2000 filed on November 2, 1999, the Company restated its
previously reported interim financial statements and the fiscal year-end
balance sheet as of February 27, 1999.
Subsequent to the restatements described in the preceeding paragraph, the
Company determined that additional adjustments are required to correct errors
in the previously issued financial statements. The adjustments consist of
numerous items; however, the principal reasons and significant effects of the
restatement on the accompanying financial statements from amounts previously
reported in the 1999 Annual Report on Form 10-K are summarized as follows:
As of and for the fiscal For the fiscal As of
year ended year ended March 1,
February 27, 1999 February 28, 1998 1997
--------------------------- ----------------- ----------
Increase
Increase Increase Increase (decrease)
(decrease) (decrease) in (decrease) in in
in retained results of results of retained
earnings operations(1) operations(1) earnings
------------ ------------- ----------------- ----------
Purchase accounting..... $ (300,767) $ (133,866) $ (152,060) $ (14,841)
Exit costs and
impairment of operating
and other assets....... (210,319) 44,694 (141,237) (113,776)
Accruals for operating
expenses............... (466,309) (123,143) (81,006) (262,160)
Property, plant, and
equipment.............. (506,210) (110,435) (246,223) (149,552)
Inventory and cost of
goods sold............. (635,995) (438,799) (63,385) (133,811)
Capital leases and sale-
leaseback accounting... (55,428) (13,683) (40,667) (1,078)
Other................... (163,965) (28,869) (31,097) (103,999)
Income taxes............ 727,163 237,933 263,614 225,616
------------ ---------- ---------- ----------
Total................... $ (1,611,830) $ (566,168) $ (492,061) $ (553,601)
============ ========== ========== ==========
- --------
(1) Represents the effects of the restatement on previously reported amounts
prior to the reclassification of the PBM segment as a discontinued
operation.
Subsequent to the filing of the Company's 2000 Annual Report on Form 10-K
("2000 Form 10-K"), the Company identified errors that had been made when
processing the restatement adjustments described above. These errors affected
the restated results for all annual and interim periods in the Company's 2000
Form 10-K, and resulted in a $1,582 net decrease in retained earnings as of
February 26, 2000. Although the Company believes that the overall impact of
these errors on its financial position as of February 26, 2000 is immaterial,
because of the effect on certain previously reported annual and interim
periods the Company has restated its financial statements from the amounts
reported in its 2000 Form 10-K to reflect the following changes:
58
RITE AID CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
As of and for the fiscal As of and for the fiscal For the fiscal
year ended year ended year ended As of March
February 26, 2000 February 27, 1999 February 28, 1998 1, 1997
--------------------------- ------------------------- ----------------- -----------
Increase Increase Increase Increase Increase Increase
(decrease) in (decrease) in (decrease) (decrease) in (decrease) in (decrease)
retained results of in retained results of results of in retained
earnings operations(1) earnings operations(1) operations(1) earnings
------------- ------------- ----------- ------------- ----------------- -----------
Purchase accounting..... $ 11,032 $ -- $ 11,032 $ -- $ 11,032 $ --
Exit costs and
impairment of operating
and other assets....... (4,513) (19,596) 15,083 9,186 (8,800) 14,697
Accruals for operating
expenses............... 13,356 17,525 (4,169) (5,753) (725) 2,309
Property, plant, &
equipment.............. (22,165) 41,037 (63,202) (90,431) 33,411 (6,182)
Inventory and cost of
goods sold............. 260 260 -- -- -- --
Capital leases and sale
leaseback accounting... 3,884 (3,884) 7,768 7,768 -- --
Other................... (3,436) (2,809) (627) (627) -- --
Income taxes............ -- (22,520) 22,520 40,817 (13,967) (4,330)
-------- -------- --------- --------- -------- -------
Total .................. $ (1,582) $ 10,013 $ (11,595) $ (39,040) $ 20,951 $ 6,494
======== ======== ========= ========= ======== =======
- --------
(1) Represents the effects of the restatement on previously reported amounts
prior to the reclassification of the PBM segment as a discontinued
operation.
A description of the principal adjustments follows:
Purchase Accounting
The Company acquired Thrifty PayLess, Inc. in fiscal 1997 and Harco Inc. and
K&B Incorporated in fiscal 1998. Certain liabilities associated with these
acquisitions that had previously been established have been either reduced or
eliminated with a corresponding decrease in goodwill, to correctly reflect the
fair value of the assets acquired and liabilities assumed at the dates of
acquisition.
Exit Costs and Impairment of Operating and Other Assets
The restated financial statements reflect adjustments to appropriately
recognize charges related to store closures in the period in which the
decision, and ability, to close a store had been made. In addition, other
charges not related to exiting stores and gains from the sale of certain
assets that had previously been recorded as adjustments to the store exit
liability have been reflected as income or expense in the period in which they
were incurred or realized.
Adjustments have also been made to record impairment charges for stores and
other assets in the period in which the impairment occurred; and to change the
method used to evaluate assets for impairment from a market level to an
individual store level because this is the lowest level of independent cash
flows ascertainable for purposes of measuring impairment.
Accruals for Operating Expenses
The restated financial statements reflect adjustments to expense certain
operating costs in the period in which they were incurred and to record a
corresponding liability for those items not paid at the end of the period.
Such costs primarily consisted of payroll, vacation pay, incentive
compensation, executive retirement plans, scheduled rent increases, and
certain insurance claims.
59
RITE AID CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Property, Plant, and Equipment
The restated financial statements reflect adjustments to charge certain
items previously capitalized to expense in the period in which they were
incurred. Such items include certain costs for repairs and maintenance,
interest, and internal software development. The adjustments also include
increases in depreciation expense to reverse the effects of retroactive
changes made to the useful lives of certain assets, to depreciate assets
misclassified as construction in-progress, and to recognize depreciation
expense in the appropriate periods.
Inventory and Cost of Goods Sold
The restated financial statements reflect adjustments to inventory and cost
of goods sold primarily to reverse unearned vendor allowances previously
recorded as a reduction to cost of goods sold, to correctly apply the retail
method of accounting, establish obsolescence reserves, recognize certain
selling costs including promotional markdowns and shrink in the period in
which they were incurred, recognize liabilities for inventory purchases in the
appropriate periods, and reflect vendor allowances in the inventory balances.
Lease Obligations
The restated financial statements reflect adjustments to recognize sale-
leaseback transactions for certain stores as financing transactions. Such
transactions had previously been accounted for as sales and the leasebacks
were accounted for as operating leases. The adjustment to correct these items
resulted in the reversal of the asset sales and the establishment of lease
obligations as capital leases. In addition, adjustments were made to record
certain leases that had previously been accounted for as operating leases.
A summary of the effects of the restatement adjustments on the accompanying
consolidated balance sheets and statements of operations is as follows:
February 26, 2000
---------------------------------------------------------------------
As Previously
Reported in Restatement As Restated
2000 Form 10-K Adjustments (1) Reclassifications (2) and Reclassified
-------------- --------------- --------------------- ----------------
CURRENT ASSETS:
Cash.................. $ 184,600 $ -- $ (4,843) $ 179,757
Accounts receivable,
net.................. 756,182 10,285 (614,432) 152,035
Inventories, net...... 2,643,959 260 (171,782) 2,472,437
Refundable income
taxes................ 147,599 -- -- 147,599
Prepaid expenses and
other current
assets............... 73,130 (4,717) (4,754) 63,659
----------- -------- ---------- ----------
Total current
assets............. 3,805,470 5,828 (795,811) 3,015,487
----------- -------- ---------- ----------
PROPERTY, PLANT AND
EQUIPMENT, NET......... 3,629,919 (32,592) (147,733) 3,449,594
GOODWILL AND OTHER
INTANGIBLES............ 3,131,070 (3,726) (1,816,221) 1,311,123
OTHER ASSETS............ 241,395 4,237 (2,733) 242,899
DEFERRED TAX ASSET...... -- -- 146,916 146,916
NET NON-CURRENT ASSETS
OF DISCONTINUED
OPERATIONS............. -- -- 1,743,828 1,743,828
----------- -------- ---------- ----------
Total assets......... $10,807,854 $(26,253) $ (871,754) $9,909,847
=========== ======== ========== ==========
- --------
(1) Adjustments identified subsequent to the filing of the Company's 2000
Form 10-K.
(2) To reclassify the PBM segment as a discontinued operation and to reflect
certain other reclassifications. See note 26.
60
RITE AID CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
February 26, 2000
-------------------------------------------------------------------------
As Previously
Reported in Restatement As Restated
2000 Form 10-K Adjustments (1) Reclassifications (2) and Reclassified
-------------- --------------- --------------------- ----------------
CURRENT LIABILITIES:
Short-term debt and
current maturities of
long-term debt....... $ 102,050 $ -- $ -- $ 102,050
Accounts payable...... 1,771,198 2,645 (919,781) 854,062
Sales and other taxes
payable.............. 35,053 -- (1,391) 33,662
Income taxes payable.. 127,691 -- (15,887) 111,804
Accrued salaries,
wages and other
current liabilities.. 876,425 (26,317) (46,213) 803,895
Net current
liabilities of
discontinued
operations........... -- -- 390,053 390,053
----------- -------- --------- ----------
Total current
liabilities........ 2,912,417 (23,672) (593,219) 2,295,526
----------- -------- --------- ----------
CONVERTIBLE SUBORDINATED
NOTES.................. 649,986 -- -- 649,986
LONG-TERM DEBT LESS
CURRENT MATURITIES..... 4,738,661 -- -- 4,738,661
CAPITAL LEASE
OBLIGATIONS............ 1,118,204 -- 7,733 1,125,937
DEFERRED INCOME TAXES... 79,220 -- (79,220) --
OTHER NON-CURRENT
LIABILITIES............ 858,401 (3,582) (207,048) 647,771
----------- -------- --------- ----------
Total liabilities.... 10,356,889 (27,254) (871,754) 9,457,881
----------- -------- --------- ----------
REDEEMABLE PREFERRED
STOCK.................. 19,457 -- -- 19,457
STOCKHOLDERS' EQUITY:
Preferred stock....... 308,250 -- -- 308,250
Common stock.......... 259,926 -- 1 259,927
Additional paid-in
capital.............. 1,289,755 2,583 (1) 1,292,337
Accumulated deficit... (1,420,235) (1,582) -- (1,421,817)
Deferred
compensation......... (6,188) -- -- (6,188)
----------- -------- --------- ----------
Total stockholders'
equity............. 431,508 1,001 -- 432,509
----------- -------- --------- ----------
Total liabilities
and stockholders'
equity............. $10,807,854 $(26,253) $(871,754) $9,909,847
=========== ======== ========= ==========
- --------
(1) Adjustments identified subsequent to the filing of the Company's 2000 Form
10-K.
(2) To reclassify the PBM segment as a discontinued operation and to reflect
certain other reclassifications. See note 26.
61
RITE AID CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Year Ended February 28, 1998
-------------------------------------------------------------------------------------------
Restatement
Adjustments Restated as
As Previously as Previously Previously
Reported in Reported Reported in Further As Restated
1999 in 2000 Form 2000 Form Restatement and
Form 10-K 10-K 10-K Adjustments (1) Reclassifications (2) Reclassified
------------- ------------- ----------- --------------- --------------------- ------------
REVENUES................ $11,375,105 $ 158,318 $11,533,423 $ -- $(180,786) $11,352,637
COSTS AND EXPENSES:
Costs of goods sold,
including occupancy
costs................ 8,290,888 312,430 8,603,318 -- (207,079) 8,396,239
Selling, general and
administrative
expenses............. 2,375,636 459,759 2,835,395 (34,918) (4,135) 2,796,342
Gain on sales of
stores............... -- (52,261) (52,261) -- (360) (52,621)
Goodwill
amortization......... 36,452 (9,972) 26,480 -- (311) 26,169
Store closing and
impairment charges... -- 148,560 148,560 -- -- 148,560
Interest expense...... 159,752 49,400 209,152 -- -- 209,152
Share of loss from
equity investments... -- 1,886 1,886 -- -- 1,886
----------- ---------- ----------- ------- --------- -----------
10,862,728 909,802 11,772,530 (34,918) (211,885) 11,525,727
----------- ---------- ----------- ------- --------- -----------
Income (loss) before
income taxes......... 512,377 (751,484) (239,107) 34,918 31,099 (173,090)
INCOME TAX EXPENSE
(BENEFIT).............. 206,507 (259,423) (52,916) 13,967 10,885 (28,064)
----------- ---------- ----------- ------- --------- -----------
Income (loss) from
continuing
operations........... 305,870 (492,061) (186,191) 20,951 20,214 (145,026)
Loss from discontinued
operations, including
income tax benefit of
$10,885.............. -- -- -- -- (20,214) (20,214)
----------- ---------- ----------- ------- --------- -----------
Net income (loss)..... $ 305,870 $ (492,061) $ (186,191) $20,951 $ -- $ (165,240)
=========== ========== =========== ======= ========= ===========
BASIC AND DILUTED INCOME
(LOSS) PER SHARE
Income (loss) from
continuing
operations........... $ 1.22 $ (1.96) $ (0.74) $ 0.08 $ 0.08 $ (0.58)
Loss from discontinued
operations........... -- -- -- -- (0.08) (0.08)
----------- ---------- ----------- ------- --------- -----------
Net income (loss) per
share................ $ 1.22 $ (1.96) $ (0.74) $ 0.08 $ -- $ (0.66)
=========== ========== =========== ======= ========= ===========
- --------
(1) Adjustments identified subsequent to the filing of the Company's 2000 Form
10-K.
(2) To reclassify the PBM Segment as a discontinued operation and to reflect
certain other reclassifications. See note 26.
26. Discontinued Operations
On July 12, 2000, the Company announced that it had entered into an
agreement to sell PCS, its PBM segment, to Advance Paradigm, Inc. for $1.0
billion. The sale was consummated on October 2, 2000. The selling price of PCS
consisted of $675,000 in cash; $200,000 in principal amount of Advance
Paradigm's unsecured 10 year senior subordinated notes (with warrants
attached) and $125,000 in liquidation preference of Advance Paradigm's 11%
Series A Preferred Stock. The senior subordinated notes bear interest at the
rate of 11% per annum for the first 18 months after their date of issuance
(October 2, 2000), 12% for the next six months and 13% thereafter until
maturity. The warrants attached to the senior subordinated notes are not
exercisable for the first 24 months after the date the senior subordinated
notes are issued. Once exercisable, they will be transferable separately from
the senior subordinated notes and entitle the holders collectively to
purchase, for $20 per share, 780,000 shares of Advance Paradigm's Class A
Common Stock (subject to adjustment for certain dilutive events). The senior
subordinated notes may be prepaid by Advance Paradigm in whole at any time;
however, if
66
RITE AID CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
less than the entire outstanding principal amount is prepaid not more than an
aggregate of $75,000 principal amount may be prepaid from the date of
issuance. Upon any prepayment prior October 2, 2002, a ratable portion of the
warrants attached to the senior subordinated notes will expire. The fair value
of the senior subordinated notes is estimated at 75% of their principal
amount. The fair value of the Series A Preferred Stock is estimated at its
stated value. The Company is in the process of obtaining an appraisal to
determine the fair value of the Series A Preferred Stock and warrants at the
consummation date.
Commencing on January 30, 2001 and until Advance Paradigm's stockholders
approve the issuance of Class B Common Stock upon conversion of the Series A
Preferred Stock, the Series A Preferred Stock will pay quarterly dividends,
solely in additional shares of Series A Preferred Stock, at the rate of 11%
per annum for the first six months, 13% for the next six months and 16%
thereafter. Upon approval by
Advance Paradigm's stockholders, the Series A Preferred Stock will be
convertible, at Rite Aid's option, at $20 per share (subject to adjustment for
certain dilutive events), into shares of Class B Common Stock of Advance
Paradigm, Inc. (which are convertible into shares of Class A Common Stock
which is publicly traded). Once converted, Class B Common Stock will be
entitled to share ratably with the Class A Common Stock in dividends declared.
Holders of the Class A Preferred Stock (and of the Class B Common Stock
issuable upon its conversion) have the right to elect two members of Advance
Paradigm's board of directors.
The Company has the right to cause Advance Paradigm to register the senior
subordinated notes (and the attached warrants and the shares issuable upon
exercise of the warrants) and the Series A Preferred Stock (and if converted,
the shares issued upon conversion) for sale under the Securities Act of 1933.
The Company has agreed not to sell more than 50% of the shares of Series A
Preferred Stock (and the shares into which it may be converted) for a period
of 24 months from their date of issuance unless the stockholders of Advance
Paradigm, Inc. do not approve its conversion into Class B Common Stock by
January 30, 2001 or unless the market price of Advance Paradigm's Class A
Common Stock averages $40 per share for 20 consecutive trading days after
April 2, 2001.
The Company applied $575,000 of the proceeds to the outstanding balance of
the PCS facility and the PCS facility released exchange debt and pledged the
Series A Preferred Stock (and all securities issuable upon its conversion) and
the senior subordinated notes to the lenders under the PCS credit facility and
RCF credit facility to secure the Company's obligations thereunder. The
Company is required to use any net proceeds received from any sale of those
securities to further repay the then outstanding balance of the PCS credit
facility and, if repaid in full, to repay the then outstanding balance of the
RCF credit facility.
The PBM segment is reported as a discontinued operation for all periods
presented in the accompanying financial statements and the operating results
of the PBM segment are reflected separately from the results of continuing
operations. The estimated loss on the disposal of the PBM segment, subject to
closing adjustments and final determination of fair value of the Series A
Preferred Stock and warrants, after income tax expense is $334,763
(unaudited), which consists of an estimated loss on disposal, estimated
transaction expenses and net operating income through the date the sale is
consummated. In the first quarter of fiscal 2001 ended May 27, 2000, the
Company recorded a loss of $303,330 (unaudited) and in the second quarter of
fiscal 2001 ended August 26, 2000, an additional loss of $31,433 (unaudited)
will be recorded due to changes in estimates. Additionally, as a result of the
decision to discontinue the operations of the Company's PBM segment, the
Company recorded an increase to the tax valuation allowance and income tax
expense of $146,916 (unaudited) in the first quarter of fiscal 2001.
67
RITE AID CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
February 27, 1999
--------------------------------------------------------------------------------------------
Restatement
Adjustments Restated as
as Previously Previously
As Previously Reported Reported Further As Restated
Reported in in 2000 in 2000 Restatement and
1999 Form 10-K Form 10-K Form 10-K Adjustments (1) Reclassifications (2) Reclassified
-------------- ------------- ----------- --------------- --------------------- ------------
CURRENT LIABILITIES:
Short-term debt and
current maturities of
long-term debt........ $ 1,550,211 $ 52,100 $ 1,602,311 $ -- $ (31,522) $1,570,789
Accounts payable....... 1,455,516 332,700 1,788,216 (2,075) (650,921) 1,135,220
Sales and other taxes
payable............... 34,464 (520) 33,944 -- (981) 32,963
Income taxes payable... 246,833 (136,049) 110,784 -- (2,888) 107,896
Deferred income
taxes................. -- 28,045 28,045 -- 1,630 29,675
Accrued salaries,
wages and other
current liabilities... 403,454 253,786 657,240 (14,031) 57,503 700,712
Net current
liabilities of
discontinued
operations............ -- -- -- -- 115,872 115,872
----------- ----------- ----------- -------- --------- ----------
Total current
liabilities......... 3,690,478 530,062 4,220,540 (16,106) (511,307) 3,693,127
----------- ----------- ----------- -------- --------- ----------
CONVERTIBLE SUBORDINATED
NOTES.................. 649,991 -- 649,991 -- -- 649,991
LONG-TERM DEBT LESS CUR-
RENT MATURITIES........ 2,584,255 (31,964) 2,552,291 -- 31,522 2,583,813
CAPITAL LEASE
OBLIGATIONS............ 69,994 1,040,184 1,110,178 -- 7,733 1,117,911
DEFERRED INCOME TAXES... 138,327 (57,013) 81,314 -- (81,314) --
OTHER NONCURRENT
LIABILITIES............ 311,405 212,677 524,082 -- (153,649) 370,433
----------- ----------- ----------- -------- --------- ----------
Total liabilities.... 7,444,450 1,693,946 9,138,396 (16,106) (707,015) 8,415,275
----------- ----------- ----------- -------- --------- ----------
REDEEMABLE PREFERRED
STOCK.................. 23,559 -- 23,559 -- -- 23,559
STOCKHOLDERS' EQUITY:
Common stock........... 258,862 (1) 258,861 -- -- 258,861
Additional paid-in
capital............... 1,360,219 9,159 1,369,378 627 -- 1,370,005
Retained earnings
(deficit)............. 1,334,651 (1,611,830) (277,179) (11,595) -- (288,774)
Accumulated other
comprehensive
income................ -- (475) (475) -- -- (475)
----------- ----------- ----------- -------- --------- ----------
Total stockholders'
equity.............. 2,953,732 (1,603,147) 1,350,585 (10,968) -- 1,339,617
----------- ----------- ----------- -------- --------- ----------
Total liabilities and
stockholders'
equity.............. $10,421,741 $ 90,799 $10,512,540 $(27,074) $(707,015) $9,778,451
=========== =========== =========== ======== ========= ==========
- --------
(1) Adjustments identified subsequent to the filing of the Company's 2000 Form
10-K.
(2) To reclassify the PBM Segment as a discontinued operation and to reflect
certain other reclassifications. See note 26.
64
RITE AID CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Year Ended February 27, 1999
-------------------------------------------------------------------------------------------
Restatement
Adjustments Restated as
As Previously as Previously Previously
Reported Reported Reported in Further As Restated
in 1999 in 2000 Form 2000 Form Restatement and
Form 10-K 10-K 10-K Adjustments (1) Reclassifications (2) Reclassified
------------- ------------- ----------- --------------- --------------------- ------------
REVENUES................ $12,731,900 $ 50,990 $12,782,890 $ -- $(344,448) $12,438,442
COSTS AND EXPENSES:
Costs of goods sold,
including occupancy
costs................ 9,396,432 347,403 9,743,835 -- (332,235) 9,411,600
Selling, general and
administrative
expenses............. 2,639,739 504,395 3,144,134 79,230 (27,570) 3,195,794
Goodwill
amortization......... 44,090 (14,863) 29,227 -- (3,172) 26,055
Store closing and
impairment charges... 257,336 (64,785) 192,551 -- -- 192,551
Interest expense...... 194,733 82,493 277,226 627 (219) 277,634
Share of loss from
equity investments... -- 448 448 -- -- 448
----------- ---------- ----------- -------- --------- -----------
12,532,330 855,091 13,387,421 79,857 (363,196) 13,104,082
----------- ---------- ----------- -------- --------- -----------
Income (loss) before
income taxes......... 199,570 (804,101) (604,531) (79,857) 18,748 (665,640)
INCOME TAX EXPENSE
(BENEFIT).............. 55,884 (237,933) (182,049) (40,817) 5,925 (216,941)
----------- ---------- ----------- -------- --------- -----------
Income (loss) from
continuing
operations........... 143,686 (566,168) (422,482) (39,040) 12,823 (448,699)
Loss from discontinued
operations, including
income tax benefit of
$5,925............... -- -- -- -- (12,823) (12,823)
----------- ---------- ----------- -------- --------- -----------
Net income (loss)..... $ 143,686 $ (566,168) $ (422,482) $(39,040) $ -- $ (461,522)
=========== ========== =========== ======== ========= ===========
BASIC AND DILUTED INCOME
(LOSS) PER SHARE
Income (loss) from
continuing
operations........... $ 0.55 $ (2.19) $ (1.64) $ (0.15) $ 0.05 $ (1.74)
Loss from discontinued
operations........... -- -- -- -- (0.05) (0.05)
----------- ---------- ----------- -------- --------- -----------
Net income (loss) per
share................ $ 0.55 $ (2.19) $ (1.64) $ (0.15) $ -- $ (1.79)
=========== ========== =========== ======== ========= ===========
- --------
(1) Adjustments identified subsequent to the filing of the Company's 2000 Form
10-K.
(2) To reclassify the PBM Segment as a discontinued operation and to reflect
certain other reclassifications. See note 26.
65
RITE AID CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Year Ended February 28, 1998
-------------------------------------------------------------------------------------------
Restatement
Adjustments Restated as
As Previously as Previously Previously
Reported in Reported Reported in Further As Restated
1999 in 2000 Form 2000 Form Restatement and
Form 10-K 10-K 10-K Adjustments (1) Reclassifications (2) Reclassified
------------- ------------- ----------- --------------- --------------------- ------------
REVENUES................ $11,375,105 $ 158,318 $11,533,423 $ -- $(180,786) $11,352,637
COSTS AND EXPENSES:
Costs of goods sold,
including occupancy
costs................ 8,290,888 312,430 8,603,318 -- (207,079) 8,396,239
Selling, general and
administrative
expenses............. 2,375,636 459,759 2,835,395 (34,918) (4,135) 2,796,342
Gain on sales of
stores............... -- (52,261) (52,261) -- (360) (52,621)
Goodwill
amortization......... 36,452 (9,972) 26,480 -- (311) 26,169
Store closing and
impairment charges... -- 148,560 148,560 -- -- 148,560
Interest expense...... 159,752 49,400 209,152 -- -- 209,152
Share of loss from
equity investments... -- 1,886 1,886 -- -- 1,886
----------- ---------- ----------- ------- --------- -----------
10,862,728 909,802 11,772,530 (34,918) (211,885) 11,525,727
----------- ---------- ----------- ------- --------- -----------
Income (loss) before
income taxes......... 512,377 (751,484) (239,107) 34,918 31,099 (173,090)
INCOME TAX EXPENSE
(BENEFIT).............. 206,507 (259,423) (52,916) 13,967 10,885 (28,064)
----------- ---------- ----------- ------- --------- -----------
Income (loss) from
continuing
operations........... 305,870 (492,061) (186,191) 20,951 20,214 (145,026)
Loss from discontinued
operations, including
income tax benefit of
$10,885.............. -- -- -- -- (20,214) (20,214)
----------- ---------- ----------- ------- --------- -----------
Net income (loss)..... $ 305,870 $ (492,061) $ (186,191) $20,951 $ -- $ (165,240)
=========== ========== =========== ======= ========= ===========
BASIC AND DILUTED INCOME
(LOSS) PER SHARE
Income (loss) from
continuing
operations........... $ 1.22 $ (1.96) $ (0.74) $ 0.08 $ 0.08 $ (0.58)
Loss from discontinued
operations........... -- -- -- -- (0.08) (0.08)
----------- ---------- ----------- ------- --------- -----------
Net income (loss) per
share................ $ 1.22 $ (1.96) $ (0.74) $ 0.08 $ -- $ (0.66)
=========== ========== =========== ======= ========= ===========
- --------
(1) Adjustments identified subsequent to the filing of the Company's 2000 Form
10-K.
(2) To reclassify the PBM Segment as a discontinued operation and to reflect
certain other reclassifications. See note 26.
26. Discontinued Operations
On July 12, 2000, the Company announced that it had entered into an
agreement to sell PCS, its PBM segment, to Advance Paradigm, Inc. for $1.0
billion. The sale was consummated on October 2, 2000. The selling price of PCS
consisted of $675,000 in cash; $200,000 in principal amount of Advance
Paradigm's unsecured 10 year senior subordinated notes (with warrants
attached) and $125,000 in liquidation preference of Advance Paradigm's 11%
Series A Preferred Stock. The senior subordinated notes bear interest at the
rate of 11% per annum for the first 18 months after their date of issuance
(October 2, 2000), 12% for the next six months and 13% thereafter until
maturity. The warrants attached to the senior subordinated notes are not
exercisable for the first 24 months after the date the senior subordinated
notes are issued. Once exercisable, they will be transferable separately from
the senior subordinated notes and entitle the holders collectively to
purchase, for $20 per share, 780,000 shares of Advance Paradigm's Class A
Common Stock (subject to adjustment for certain dilutive events). The senior
subordinated notes may be prepaid by Advance Paradigm in whole at any time;
however, if
66
RITE AID CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
less than the entire outstanding principal amount is prepaid not more than an
aggregate of $75,000 principal amount may be prepaid from the date of
issuance. Upon any prepayment prior October 2, 2002, a ratable portion of the
warrants attached to the senior subordinated notes will expire. The fair value
of the senior subordinated notes is estimated at 75% of their principal
amount. The fair value of the Series A Preferred Stock is estimated at its
stated value. The Company is in the process of obtaining an appraisal to
determine the fair value of the Series A Preferred Stock and warrants at the
consummation date.
Commencing on January 30, 2001 and until Advance Paradigm's stockholders
approve the issuance of Class B Common Stock upon conversion of the Series A
Preferred Stock, the Series A Preferred Stock will pay quarterly dividends,
solely in additional shares of Series A Preferred Stock, at the rate of 11%
per annum for the first six months, 13% for the next six months and 16%
thereafter. Upon approval by
Advance Paradigm's stockholders, the Series A Preferred Stock will be
convertible, at Rite Aid's option, at $20 per share (subject to adjustment for
certain dilutive events), into shares of Class B Common Stock of Advance
Paradigm, Inc. (which are convertible into shares of Class A Common Stock
which is publicly traded). Once converted, Class B Common Stock will be
entitled to share ratably with the Class A Common Stock in dividends declared.
Holders of the Class A Preferred Stock (and of the Class B Common Stock
issuable upon its conversion) have the right to elect two members of Advance
Paradigm's board of directors.
The Company has the right to cause Advance Paradigm to register the senior
subordinated notes (and the attached warrants and the shares issuable upon
exercise of the warrants) and the Series A Preferred Stock (and if converted,
the shares issued upon conversion) for sale under the Securities Act of 1933.
The Company has agreed not to sell more than 50% of the shares of Series A
Preferred Stock (and the shares into which it may be converted) for a period
of 24 months from their date of issuance unless the stockholders of Advance
Paradigm, Inc. do not approve its conversion into Class B Common Stock by
January 30, 2001 or unless the market price of Advance Paradigm's Class A
Common Stock averages $40 per share for 20 consecutive trading days after
April 2, 2001.
The Company applied $575,000 of the proceeds to the outstanding balance of
the PCS facility and the PCS facility released exchange debt and pledged the
Series A Preferred Stock (and all securities issuable upon its conversion) and
the senior subordinated notes to the lenders under the PCS credit facility and
RCF credit facility to secure the Company's obligations thereunder. The
Company is required to use any net proceeds received from any sale of those
securities to further repay the then outstanding balance of the PCS credit
facility and, if repaid in full, to repay the then outstanding balance of the
RCF credit facility.
The PBM segment is reported as a discontinued operation for all periods
presented in the accompanying financial statements and the operating results
of the PBM segment are reflected separately from the results of continuing
operations. The estimated loss on the disposal of the PBM segment, subject to
closing adjustments and final determination of fair value of the Series A
Preferred Stock and warrants, after income tax expense is $334,763
(unaudited), which consists of an estimated loss on disposal, estimated
transaction expenses and net operating income through the date the sale is
consummated. In the first quarter of fiscal 2001 ended May 27, 2000, the
Company recorded a loss of $303,330 (unaudited) and in the second quarter of
fiscal 2001 ended August 26, 2000, an additional loss of $31,433 (unaudited)
will be recorded due to changes in estimates. Additionally, as a result of the
decision to discontinue the operations of the Company's PBM segment, the
Company recorded an increase to the tax valuation allowance and income tax
expense of $146,916 (unaudited) in the first quarter of fiscal 2001.
67
RITE AID CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Summarized operating results of the PBM segment for the years ended February
26, 2000, February 27, 1999 and February 28, 1998 are as follows:
Year Ended
--------------------------------------
February 26, February 27, February 28,
2000 1999 1998
------------ ------------ ------------
Net sales........................... $1,342,495 $344,448 $180,786
Income (loss) from operations before
income tax expense................. 40,081 (18,748) (31,099)
Income tax expense (benefit)........ 30,903 (5,925) (10,885)
---------- -------- --------
Income (loss) from discontinued
operations......................... $ 9,178 $(12,823) $(20,214)
========== ======== ========
Summarized balance sheet data of discontinued operations is as follows:
February February
26, 2000 27, 1999
---------- ----------
Net current liabilities:
Cash and cash equivalents............................ $ 4,843 $ 2,789
Accounts and other receivables, net.................. 614,432 581,060
Other currents assets................................ 42,707 35,217
Claims and rebates payable........................... (924,951) (654,634)
Other current liabilities............................ (127,084) (80,304)
---------- ----------
$ (390,053) $ (115,872)
========== ==========
Net non-current assets:
Property and equipment, net.......................... $ 147,733 $ 117,115
Goodwill and intangibles, net........................ 1,816,221 1,874,499
Noncurrent liabilities............................... (220,126) (238,139)
---------- ----------
$1,743,828 $1,753,475
========== ==========
Acquisition of Discontinued Operations
On January 22, 1999, the Company purchased PCS, a pharmacy benefits
management subsidiary of Eli Lilly and Company. Total consideration was $1.5
billion, with $1.3 billion financed via commercial paper and $200 million paid
in cash. The PCS acquisition was accounted for using the purchase method. In
accordance with APB Opinion No. 16, the Company has recorded the assets and
liabilities of PCS at the date of acquisition at their fair values. The excess
of the cost of PCS over the fair value of the acquired assets and liabilities
of $1,286,089 has been recorded as goodwill.
Intangible Assets of Discontinued Operations
February February 27,
26, 2000 1999
---------- ------------
Goodwill............................................ $1,298,520 $1,298,520
Prescription files and customer lists............... 434,100 434,100
Trade name.......................................... 113,100 113,100
Internally developed software....................... 21,900 21,900
Assembled workforce................................. 13,400 13,400
---------- ----------
1,881,020 1,881,020
Accumulated amortization............................ (64,799) (6,521)
---------- ----------
$1,816,221 $1,874,499
========== ==========
68
RITE AID CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
At acquisition, the Company determined that the estimated useful life of the
goodwill recorded with the PCS acquisition is primarily indeterminate and
likely exceeded 40 years. This estimate was based upon a review of the
anticipated future cash flows and other factors the Company considered in
determining the amount that it was willing to incur for the purchase of PCS.
Additionally, management found no persuasive evidence that any material
portion of these intangible assets would be depleted in less than 40 years.
Accordingly, the Company amortizes goodwill over the maximum allowable period
of 40 years on a straight-line basis.
The value of the PCS trade name is being amortized over its estimated useful
life of 40 years. The value of the customer base and pharmacy network acquired
in the purchase of PCS are being amortized over their estimated lives of 30
years. The value of assembled workforce and internally developed software
acquired are being amortized over their useful lives of six and five years,
respectively.
Impairment of Long-Lived Assets
Long-lived assets of the PBM segment consist principally of intangibles. The
Company compares the estimates of future undiscounted cash flows of its
service lines to which the intangibles relate to the carrying amount of those
intangibles to determine if an impairment has occurred. Long-lived assets and
certain identifiable intangibles to be disposed of, whether by sale or
abandonment, are reported at the lower of carrying amount or fair value less
cost to sell.
Revenue Recognition of Discontinued Operations
Revenues are recognized from claims processing fees when the related claims
are adjudicated and approved for payment. Certain of the agreements require
the customers to pay a fee per covered member rather than a fee per claim.
These fees are recognized monthly based upon member counts provided by the
customers. Revenue from manufacturer programs is recognized when claims
eligible for rebate are adjudicated by the Company. The customer portion of
rebates collected is not included in revenue, and correspondingly payments of
rebates to customers are not included in expenses. Mail order program revenue
is recognized when prescriptions are shipped.
Commitments and Contingencies of Discontinued Operations
PCS Legal Proceedings
In November 1999, PCS received a subpoena from the Office of Inspector
General of the Department of Health and Human Services ("OIG"). The subpoena
requests general information about PCS's formulary programs and rebate
practices and makes no allegation of any wrongdoing by PCS. PCS is fully
cooperating with the inquiry and believes that no regulatory action will be
taken by OIG against PCS that will have a material adverse effect on PCS's
business. The Company cannot predict the outcome of this matter.
In January 1998, a purported class action was brought against PCS by a
participant in a plan managed by PCS in the federal district court in New
Jersey. The plaintiff alleged that PCS is an ERISA fiduciary and that, as
such, breached its fiduciary obligations under ERISA and that PCS received
improper kickbacks and rebates from certain drug manufacturers. PCS believes
that the plaintiff's action is without merit and is vigorously defending this
action. The Company cannot predict the outcome of this action.
69
RITE AID CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
PCS Customer Contracts
The PBM Segment enters into risk contracts with certain customers. These
contracts provide that the Company assume varying percentages of the risk
associated with claims experience differing from fixed fee arrangements under
managed care programs. In addition, the Company, in certain limited
circumstances, guarantees a specific amount of savings for certain customers.
Included in other current liabilities of discontinued operations in the
accompanying consolidated balance sheets are management's estimates of the
amounts required to cover losses incurred under such contracts.
Employment Agreements
Certain officers of PCS were provided with a financial incentive to remain
at the Company. Under this retention incentive program, the participating
officers vest annually in the financial benefits through January 22, 2002. The
value of the benefits is determined based upon the Rite Aid stock price during
the vesting period, but is not to be less than an established floor value. The
Company recognized compensation expense under this program of $7,137 in fiscal
2000 and $706 in fiscal 1999. In the event of a change in control of PCS, the
participating officers immediately become fully vested in the program's
benefits.
See note 14 for retirement plan information related to the PBM segment.
70
SELECTED FINANCIAL DATA
The following selected financial data of Rite Aid should be read in
conjunction with the "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and the audited consolidated financial
statements appearing in this Annual Report. Selected financial data is
presented for three fiscal years. The company's financial statements have been
restated. These restatements supercede the prior restatements announced in
June and November 1999. Substantial time, effort and expense was required over
a six month period to review, assess, reconcile, prepare, and audit financial
statements for fiscal 2000, fiscal 1999 and fiscal 1998. Rite Aid believes it
would require an unreasonable effort and expense to conduct a similar process
to restate fiscal years 1997 and 1996 and that it is unlikely that periods
prior to March 1, 1997 could be restated. Therefore, financial data for fiscal
1997 and 1996 have not been restated and should not be relied upon. For a
further discussion of the restatements, including information relating to the
further restatement of the consolidated financial statements reflected in this
amended Form 10-K, see note 25 of the notes to consolidated financial
statements.
Year ended
-----------------------------------------------------------
February 26, 2000 February 27, 1999 February 28, 1998
(52 weeks) (52 weeks) (52 weeks)(3)
(as restated)(1)(2) (as restated)(1)(2) (as restated)(1)(2)
------------------- ------------------- -------------------
(In thousands, except per share amounts)
Summary of Operations:
REVENUES................ $13,338,947 $12,438,442 $11,352,637
COSTS AND EXPENSES:
Cost of goods sold,
including occupancy
costs................ 10,242,377 9,411,600 8,396,239
Selling, general and
administrative
expenses............. 3,578,861 3,195,794 2,796,342
Gain on sale of
stores............... (80,109) -- (52,621)
Goodwill
amortization......... 24,457 26,055 26,169
Store closing and
impairment charges... 153,317 192,551 148,560
Interest expense...... 528,159 277,634 209,152
Share of loss from
equity investments... 15,181 448 1,886
----------- ----------- -----------
14,462,243 13,104,082 11,525,727
----------- ----------- -----------
Loss from continuing
operations before
income taxes and
cumulative effect of
accounting change ... (1,123,296) (665,640) (173,090)
INCOME TAX BENEFIT...... (8,375) (216,941) (28,064)
----------- ----------- -----------
Loss from continuing
operations before
cumulative effect of
accounting change.... (1,114,921) (448,699) (145,026)
INCOME (LOSS) FROM
DISCONTINUED
OPERATIONS, including
income tax expense
(benefit) of $30,903,
$(5,925) and
$(10,885).............. 9,178 (12,823) (20,214)
CUMULATIVE EFFECT OF
ACCOUNTING CHANGE, net
of income tax benefit
of $18,200............. (27,300) -- --
----------- ----------- -----------
Net loss............ $(1,133,043) $ (461,522) $ (165,240)
=========== =========== ===========
BASIC AND DILUTED (LOSS)
INCOME PER SHARE:
Loss from continuing
operations........... $ (4.34) $ (1.74) $ (0.58)
Income (loss) from
discontinued
operations........... 0.04 (0.05) (0.08)
Cumulative effect of
accounting change,
net.................. (0.11) -- --
----------- ----------- -----------
Net loss per share.. $ (4.41) $ (1.79) $ (0.66)
=========== =========== ===========
71
February 26, 2000 February 27, 1999 February 28, 1998
(52 weeks) (52 weeks) (52 weeks)
(as restated)(1)(2) (as restated)(1)(2) (as restated)(1)(2)
------------------- ------------------- -------------------
(Dollars in thousands except dividends)
Year-End Financial
Position:
Working capital
(deficit)............ $ 719,961 $ (892,115) $ 1,258,580
Property, plant and
equipment (net)...... 3,449,594 3,328,499 2,460,513
Total assets.......... 9,909,847 9,778,451 7,392,147
Total debt (4)........ 6,616,634 5,922,504 3,132,894
Redeemable preferred
stock................ 19,457 23,559 --
Stockholders' equity.. 432,509 1,339,617 1,898,203
Other Data:
Cash dividends
declared per common
share................ $ .3450 $ .4375 $ .4075
Basic weighted average
shares............... 259,139,000 258,516,000 250,659,000
Diluted weighted
average shares....... 259,139,000 258,516,000 250,659,000
Number of retail
drugstores........... 3,802 3,870 3,975
Number of employees... 77,258 89,900 83,000
- --------
(1) See note 25 of the notes to consolidated financial statements for a
description of the adjustments resulting from the restatements.
(2) PCS was acquired on January 22, 1999. On October 2, 2000, Rite Aid
completed the sale of PBM segment. Accordingly, our PBM segment is reported
as a discontinued operation for all periods presented. See note 26 of the
notes to consolidated financial statements.
(3) K&B, Incorporated and Harco, Inc. were acquired in August 1997.
(4) Includes capital lease obligations of $1.2 billion, $1.1 billion and $622
million as of February 26, 2000, February 27, 1999 and February 28, 1998,
respectively.
72
DIRECTORS AND CORPORATE OFFICERS
Directors_______________________________________________________________________
William J.
Bratton/2/ Robert G. Miller/1/ Leonard N. Stern/1/,/2/*,/4/
The Bratton Chairman of the Board Chairman of the Board and
Group, LLC and Chief Executive Officer Chief Executive Officer
(Criminal The Hartz Group
Investigation (Pet Supplies, Hotels, Real Estate
Consulting) Development and Investing)
Alfred M.
Gleason/2/ Philip Neivert/3/ Preston Robert Tisch/1/,/2/,/4/*
Self Employed Private Investor Co-chairman Loews Corporation
Consultant (Hotels, Insurance, Cigarettes,
Oil and Gas, Watches and Clocks)
Alex Grass Mary F. Sammons Gerald Tsai, Jr./1/,/3/
Chief Executive President and Chief Chairman Satmark Media Group
Officer Fleer Operating Officer (ATM Advertising)
Skybox
International
(Trading Cards)
Leonard I.
Green/1/,/4/ Stuart M. Sloan
Senior Partner, Principal, Sloan Capital
Leonard Green & Companies (Investments)
Partners L.P.
(Merchant
Banking)
Nancy A.
Lieberman/1/ Jonathan D. Sokoloff
Partner, Partner, Leonard Green &
Skadden, Arps, Partners L.P.
Slate Meagher (Merchant Banking)
and Flom LLP
(Lawyers)
Executive Officers_______________________________________________________________
Chairman Senior Executive Vice Presidents
- -------- --------------------------------
Robert G.
Miller Elliot S. Gerson David R. Jessick
Chief Executive General Counsel Chief Administrative Officer
Officer
President
- ---------
Mary F. Sammons James P. Mastrian John T. Standley
Chief Operating Marketing and Logistics Chief Financial Officer
Officer
- --------
1 Member of the Executive Committee
2 Member of the Audit Committee
3 Member of the Compensation Committee
4 Member of the Nominating Committee
* Denotes Chair of the Committee
73
Senior Vice Presidents
- ----------------------
Gerald P. Cardinale Charles R. Kibler Eric S. Sorkin
Category Management East Coast Store Operation Pharmacy
Don P. Davis Roger D. Lekberg Joseph S. Speaker
Information Services Distribution/Logistics Administration
Christopher Hall Keith Lovett Gary M. Stein
Chief Accounting Officer Labor Relations Real Estate
Jim C. Hamilton Karen A. Rugen Martin Tassoni
West Coast Store Operations Corporate Communications Category Management
Stanley J. Kahn Robert B. Sari Murray Todd
Vitamin Initiatives Deputy General Counsel Store Operations
and Secretary
Richard J. Varmecky
Finance
CHANGE IN INDEPENDENT AUDITORS
During fiscal year 2000, the firm of KPMG LLP ("KPMG") resigned as
independent auditors of the Company because they were unable to continue to
rely on management's representations. The Company then engaged Deloitte &
Touche LLP to replace KPMG as its independent auditors. Attached hereto as
Exhibit A is a copy of the Form 8-K and the Form 8-K/A filed by the Company
with the Securities and Exchange Commission on November 11, 1999 and December
6, 1999, respectively, in connection with the change in the Company's
independent auditor. The Form 8-K and Form 8-K/A include letters delivered by
KPMG regarding its disagreements with the Company. The complete text of each
of the Form 8-K and Form 8-K/A and their respective exhibits is incorporated
herein by reference. Since the filing of the Form 8-K/A on December 6, 1999,
the Company has reviewed its accounting practices and is developing and
implementing new internal accounting systems and controls as it seeks to
develop reliable and adequate systems.
INVESTOR INFORMATION
Rite Aid Corporation's common stock is listed on the New York and Pacific
Stock Exchanges with the stock symbol RAD. On October 11, 2000, there were
approximately 11,586 stockholders. Quarterly high and low stock prices, based
on New York Stock Exchange composite transactions, together with dividend
information are shown below.
- -------------------------------------------------------------------------------
Fiscal Quarter High Low Dividend
- --------------------------------------------------------------------------------------------------------
2000 First 41 3/4 21 $.1150
Second 26 15/16 17 1/2 $.1150
Third 20 1/8 4 1/2 $.1150
Fourth 13 1/4 6 3/8 --
- --------------------------------------------------------------------------------------------------------
1999 First 36 9/16 29 3/4 $.1075
Second 45 1/8 34 5/8 $.1075
Third 41 9/16 33 9/16 $.1075
Fourth 51 1/8 39 9/16 $.1075
- -------------------------------------------------------------------------------
74
Form 10-K Registrar and Dividend Reinvestment
Transfer Agent
The annual report to the The company offers an
Securities and Exchange Computershare Investor automatic dividend
Commission on Form 10-K Services LLC reinvestment plan for
is available upon P.O. Box A3504 the convenience of
written request to Chicago, IL 60690-3504 stockholders and
Robert B. Sari, the 312-360-5349 employees. For further
secretary of the information, contact:
company, or through the Computershare Investor
EDGAR database on World Services LLC
Wide Web at: P.O. Box A3504
http://www.sec.gov Chicago, IL 60690-3504
312-360-5349
Corporate Information Drugstore Locations as of June 30, 2000
- --------------------- ---------------------------------------
Rite Aid Corporation is the second Alabama............................ 118
largest retail drugstore chain in Arizona............................ 3
the United States based on store California......................... 624
count, serving customers in Colorado........................... 46
30 states across the country and in Connecticut........................ 50
the District of Columbia. During the Delaware........................... 26
fiscal year ended February 26, 2000 District of Columbia............... 7
we operated in two business Georgia............................ 36
segments: the retail drug segment Idaho.............................. 23
and the pharmacy benefit management Indiana............................ 36
segment. Through our retail drug Kentucky........................... 129
segment, we sell prescription drugs Louisiana.......................... 103
and a wide assortment of general Maine.............................. 85
merchandise. Prescription drugs Maryland........................... 166
represented approximately 58.4% of Michigan........................... 351
our total sales during fiscal year Mississippi........................ 35
2000. Our pharmacy benefit Nevada............................. 37
management ("PBM") segment provides New Hampshire...................... 40
services to employers, insurance New Jersey......................... 186
carriers and managed care companies. New York........................... 39
We operated the PBM segment through Ohio............................... 292
a subsidiary, PCS Health System, Oregon............................. 75
Inc., which we sold on October 2, Pennsylvania....................... 378
2000. General Information about the Texas.............................. 5
background and current Utah............................... 30
announcements, is available through Vermont............................ 13
the company's News-On-Demand fax Virginia........................... 166
service at 800-329-5055, and our Washington......................... 146
World Wide Web site at: West Virginia...................... 116
http://www.RiteAid.com Wyoming............................ 1
-----------------------------------------
Rite Aid Corporation Total.............................. 3,776
General Offices:
30 Hunter Lane
Camp Hill, PA 17011-2404
Mailing Address:
P. O. Box 3165
Harrisburg, PA 17105-3165
717-761-2633
At February 26, 2000, Rite Aid
employed 77,258 people,
approximately 10,000 of who
were pharmacists.
75
EXHIBIT A TO ANNUAL REPORT
FORM 8-K AND FORM 8-K/A
A-1
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 8-K
CURRENT REPORT
Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
Date of Report (Date of earliest event reported): November 11, 1999
----------------
RITE AID CORPORATION
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 1-5742 23-1614034
- --------------------------------------------------------------------------------------
(State or other jurisdiction (Commission (IRS Employer
of incorporation) File Number) Identification No.)
30 Hunter Lane, Camp Hill, Pennsylvania 17011
- --------------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (717) 761-2633
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
A-2
ITEM 4. Changes in Registrant's Certifying Accountant.
On November 11, 1999, the firm of KPMG LLP ("KPMG") orally notified a member
of the Audit Committee and the Registrant of their resignation as auditors of
the Registrant because they were unable to continue to rely on management's
representations.
By letter dated November 11, 1999, KPMG advised the Registrant that, in
light of the Registrant's announcement on October 18, 1999 that the Registrant
is planning to restate its consolidated balance sheets as of February 27, 1999
and February 28, 1998 and the related consolidated statements of income,
stockholders' equity and cash flows for each of the years in the three-year
period ended February 27, 1999, KPMG's auditors' report thereon dated May 28,
1999 "should no longer be relied upon." In addition, KPMG requested that the
Registrant advise those persons who have received a copy of KPMG's report and
those persons that the Registrant believes are relying or are likely to rely
on the financial statements to be restated and the related report "of [KPMG's]
notification to [the Registrant] that the Financial Statements and the Report
should no longer be relied upon." (A copy of this letter is attached as
Exhibit 99.1 hereto.) The withdrawn report and KPMG's report on the
Registrant's consolidated financial statements for the fiscal year ended
February 28, 1998 did not contain an adverse opinion or a disclaimer of
opinion and were not qualified or modified as to uncertainty, audit scope, or
accounting principles.
On November 2, 1999, the Registrant filed its Quarterly Report on Form 10-Q
for the thirteen and twenty-six weeks ended August 28, 1999, which included
certain restated financial information. KPMG did not audit, review, or
otherwise report on the financial statements included in the Form 10-Q. In
view of KPMG's resignation on November 11, 1999, the Registrant was not able
to resolve to KPMG's satisfaction, prior to their resignation, the amounts and
causes of the restatement adjustments identified in the Registrant's most
recently filed Form 10-Q and the additional restatement adjustments which may
be required with respect to prior periods not included in that Form 10-Q. KPMG
discussed certain of these matters with members of the Audit Committee. The
Registrant is continuing to review its accounting practices for the past
several years.
In connection with the audits of the Registrant's consolidated financial
statements for the fiscal years ended February 27, 1999 and February 28, 1998,
and during the subsequent unaudited interim periods since the most recently
ended fiscal year, there were no disagreements with KPMG on matters of
accounting principles or practices, financial statement disclosure, or
auditing scope or procedure, which, if not resolved to the satisfaction of
KPMG, would have caused KPMG to make reference to the matter in their report
other than as follows:
In connection with the audit of the Registrant's consolidated financial
statements for the fiscal year ended February 27, 1999, KPMG reported to the
Registrant's Audit Committee the following three disagreements between KPMG
and the Registrant:
(1) KPMG disagreed with the Registrant's view that certain amounts could be
reflected as income based upon estimates of recoveries from vendors.
(2) KPMG disagreed with the Registrant's accounting for certain deferred
costs.
(3) KPMG disagreed with the Registrant's accounting for certain expenses
charged against its acquisition accruals.
With respect to these matters, the Registrant adjusted its financial
statements to record its estimates of the appropriate amounts.
The Registrant has authorized KPMG to respond fully to any successor
independent accounting firm regarding KPMG's audit of the Registrant's
financial statements, the disagreements with the Registrant in connection
therewith, the Reportable Events and KPMG's resignation as auditors of the
Registrant.
At an Audit Committee meeting on June 30, 1999, KPMG delivered a letter to
the Audit Committee dated June 24, 1999 describing the following material
weakness in the Registrant's internal controls. The letter stated
A-3
that the Registrant's internal controls were insufficient to allow the
Registrant's management "to accumulate and reconcile information necessary to
properly record and analyze transactions on a timely basis." The letter
suggested the following actions to "significantly enhance the quality of [the
Registrant's] financial accounting and reporting function": "(a) adding
sufficient qualified accounting personnel, (b) improving the financial
accounting systems, which produce the necessary data, (c) analyzing the data
on a timely basis, and (d) significantly improving documentation supporting
transactions, journal entries, and business decisions on a timely basis." KPMG
has asserted that it informed the Registrant on June 23, 1999 and the Audit
Committee at the June 30, 1999 meeting that, as a result of the issuance of
the material weakness letter, KPMG would not be in a position to issue
quarterly review reports until the matters referred to above were addressed
and resolved. In addition, KPMG has asserted that they informed the Registrant
on June 23, 1999 and the Audit Committee at the June 30, 1999 meeting that
KPMG was no longer willing to rely on representations made by the then serving
Chief Financial Officer. Each member of the Audit Committee and another member
of the Registrant's Board of Directors who attended the June 30, 1999 Audit
Committee meeting deny that any such statements were made at that meeting or
at any other time. The Chief Financial Officer was replaced on July 14, 1999.
Subsequent to June 24, 1999, the Registrant has created new positions in the
financial accounting and reporting department and has filled and is seeking to
fill those positions with qualified personnel. The Registrant is evaluating
system needs in order to improve its financial accounting systems. The
Registrant has restructured its accounting and financial reporting function to
strengthen communication and accountability and is revising its processes and
procedures with respect to transactions, journal entries and approvals to
improve the timeliness with which it is able to document and analyze financial
data.
Simultaneously with their resignation on November 11, 1999, KPMG also
advised the member of the Audit Committee and the Registrant that KPMG had
concerns about the amounts the Registrant charged certain vendors relating to
damaged or outdated products. In June 1999, the Registrant engaged a third
party to handle all damaged or outdated products, including obtaining
appropriate refunds, and accordingly, the Registrant is no longer involved in
processing damaged or outdated products. In view of KPMG's resignation on
November 11, 1999, there was no opportunity for the Registrant to resolve this
matter to KPMG's satisfaction prior to their resignation.
The Registrant is in the process of engaging new independent accountants to
audit and report on the Registrant's restated consolidated balance sheets as
of February 27, 1999 and February 28, 1998 and the related restated
consolidated statements of income, stockholders' equity and cash flows for
each of the years in the three-year period ended February 27, 1999. The new
independent accountants will also audit the Registrant's consolidated
financial statements for the fiscal year ending February 26, 2000.
ITEM 5. Other Events
The Registrant has been advised that the Securities and Exchange Commission
has commenced a formal investigation of the Registrant.
ITEM 7. Financial Statements and Exhibits
(c) The following exhibits are filed with this report:
Exhibit Number Description
-------------- -----------
16.1 Letter of KPMG LLP dated November , 1999*
99.1 Letter of KPMG LLP dated November 11, 1999
- --------
* To be filed by amendment.
A-4
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
RITE AID CORPORATION
Date: November 18, 1999 By: /s/ Elliot T. Gerson
----------------------------------
Name: Elliot T. Gerson
Title:Senior Executive Vice
President, Secretary and
General Counsel
EXHIBIT INDEX
Exhibit Number Description
-------------- -----------
99.1 Letter of KPMG LLP dated November 11, 1999
A-5
Exhibit 99.1
[LETTERHEAD OF KPMG]
BY HAND DELIVERY
- -----------------
November 11, 1999
Board of Directors
Rite Aid Corporation
30 Hunter Lane
Camp Hill, Pennsylvania 17011
Board of Directors:
We have examined the consolidated balance sheets of Rite Aid Corporation and
subsidiaries (the "Company") as of February 27, 1999 and February 28, 1998 and
the related consolidated statements of income, stockholders' equity and cash
flows for each of the years in the three-year period ended February 27, 1999
(the "Financial Statements") and issued our auditors' report thereon dated May
28, 1999 (the "Report").
In light of the Company's announcement in its press release dated October
18, 1999, to the effect that the Company is "planning to restate its quarterly
and annual financial statements for each of its 1999, 1998, and 1997 fiscal
years and for prior years," we cannot continue to be associated with the
Financial Statements. Accordingly, KPMG LLP hereby advises you that our Report
on the Company's Financial Statements should no longer be relied upon.
We request that to the extent you have not already done so, you promptly
advise those persons who have received a copy of the Report, and whom you
believe are relying on the Financial Statements and the related Report, or who
are likely to rely upon the Financial Statements and the related Report, of
our notification to you that the Financial Statements and the Report should no
longer be relied upon. Further, we ask you to determine, together with your
legal counsel, the disclosure(s) which the Company should make to the United
States Securities and Exchange Commission and any other regulatory body having
jurisdiction over the Company. We request that you promptly supply us with
copies of any notifications you make pursuant to the request set forth in this
paragraph.
Very truly yours,
/s/ KPMG LLP
A-6
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 8-K/A
CURRENT REPORT
Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
Date of Report (Date of earliest event reported): November 11, 1999
----------------
RITE AID CORPORATION
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 1-5742 23-1614034
- --------------------------------------------------------------------------------------
(State or other jurisdiction (Commission (IRS Employer
of incorporation) File Number) Identification No.)
30 Hunter Lane, Camp Hill, Pennsylvania 17011
- --------------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (717) 761-2633
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
A-7
ITEM 7. Financial Statements and Exhibits
(c) The following exhibits are filed with this report:
Exhibit Number Description
-------------- -----------
16.1 Letter of KPMG LLP dated December 2, 1999
99.1 Letter of KPMG LLP dated November 11, 1999*
- --------
* Previously filed.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
RITE AID CORPORATION
Date: December 2, 1999 By: /s/ Elliot T. Gerson
----------------------------------
Name: Elliot T. Gerson
Title:Senior Executive Vice
President, Secretary and
General Counsel
A-8
EXHIBIT 16.1
[LETTERHEAD KPMG]
December 2, 1999
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549
Ladies and Gentlemen:
KPMG LLP ("KPMG") was previously the principal accountants for Rite Aid
Corporation ("Rite Aid" or the "Company") and, under the date of May 28, 1999,
we reported on the consolidated balance sheets of the Company and its
subsidiaries as of February 27,1999 and February 28, 1998 and the related
consolidated statements of income, stockholders' equity and cash flows for
each of the years in the three-year period ended February 27, 1999. On
November 11, 1999, we resigned as the Company's principal accountants. We have
read the Company's statements included in Item 4 of its Form 8-K dated
November 18, 1999 ("Item 4"), and we agree with such statements, except as
follows:
KPMG is not in a position to agree or disagree with the Company's statement in
the last sentence of the third paragraph of Item 4.
KPMG disagrees with the Company's statements in the fourth and fifth sentences
of the seventh paragraph of Item 4 to the extent they imply that KPMG did not
communicate the information described in those sentences to the Company's
management. Based on the recollections of the KPMG personnel who attended the
meeting with members of the Company's management on June 23, 1999, KPMG
believes it communicated the information described in the fourth and fifth
sentences to the Company on June 23, 1999.
KPMG is not in a position to agree or disagree with the statements made by the
Company in the sixth sentence of the seventh paragraph of Item 4, because KPMG
is not in a position to know the recollections of the members of the Company's
Audit Committee and the other member of the Company's Board of Directors who
attended the June 30, 1999 Audit Committee meeting. However, the statements
made by the Company in the sixth sentence are inconsistent with the
recollections of KPMG personnel who attended that Audit Committee meeting.
KPMG is not in a position to agree or disagree with the Company's statements
in the eighth, ninth, and tenth sentences of the seventh paragraph of Item 4,
to the effect that the Company is seeking to fill new positions in its
financial accounting and reporting department with qualified personnel, that
the Company is evaluating system needs in order to improve its financial
accounting systems, and that the Company has restructured its accounting and
financial reporting function to strengthen communication and accountability
and is revising its processes and
A-9
[LOGO KPMG]
Page 2
December 2, 1999
procedures with respect to transactions, journal entries and approvals to
improve the timeliness with which it is able to document and analyze financial
data.
KPMG is aware that the Company has entered into an agreement with a third
party concerning the third party's handling of damaged and outdated products,
but KPMG is not in a position to agree or disagree with the Company's
statements in the second sentence of the eighth paragraph of Item 4, to the
effect that the third party engaged by the Company will handle all damaged or
outdated products, including obtaining appropriate refunds, and therefore, the
Company will no longer be involved in processing damaged or outdated products.
KPMG is not in a position to agree or disagree with the Company's statements
in the ninth paragraph of Item 4.
Very truly yours,
/s/ KPMG LLP
Date: December 6, 1999
A-10