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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
[X]ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For The Fiscal Year Ended February 26, 2000
OR
[_]TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For The Transition Period From To
Commission File Number 1-5742
RITE AID CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 23-1614034
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) 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
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which registered
------------------- -----------------------------------------
Common Stock, $1.00 par value New York Stock Exchange
Pacific Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. [X] Yes [_] No
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
The aggregate market value of the voting stock of the registrant held by
non-affiliates of the registrant based on the closing price at which such
stock was sold on the New York Stock Exchange on June 30, 2000 was
approximately $846,587,542. For purposes of this calculation, executive
officers, directors and 5% shareholders are deemed to be affiliates of the
company.
As of June 30, 2000, the registrant had outstanding 329,491,633 shares of
Common Stock, par value $1.00 per share.
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TABLE OF CONTENTS
Page
----
Cautionary Statement Regarding Forward-Looking Statements............... 1
PART I
Item 1. Business................................................... 2
Item 2. Properties................................................. 13
Item 3. Legal Proceedings.......................................... 14
Item 4. Submission of Matters to a Vote of Security Holders........ 16
PART II
Item 5. Market for Registrant's Common Equity and Related
Shareholder Matters........................................ 16
Item 6. Selected Financial Data.................................... 18
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations.................................. 20
Item 7A. Quantitative and Qualitative Disclosures About Market
Risk....................................................... 33
Item 8. Financial Statements and Supplementary Data................ 34
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure................................... 34
PART III
Item 10. Directors and Executive Officers of the Registrant......... 35
Item 11. Executive Compensation..................................... 38
Item 12. Security Ownership of Certain Beneficial Owners and
Management................................................. 46
Item 13. Certain Relationships and Related Transactions............. 47
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form
8-K........................................................ 49
Signatures........................................................... S-1
Financial Statements................................................. F-1
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
This 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;
. The sale of PCS Health Systems, Inc. and other assets which we are
currently negotiating but which may not be consummated;
. 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 this 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 "Factors Affecting Our Future Results"
below.
1
PART I
ITEM 1. Business
We are the second largest retail drugstore chain in the United States based
on store count, serving customers in 30 states across the country and in the
District of Columbia. As of June 30, 2000, we operated 3,776 stores and had a
first or second place market position in 34 of the 65 major U.S. metropolitan
markets in which we operated. We operate in two business segments: the retail
drug segment and the pharmacy benefit management ("PBM") segment.
Retail Drug Segment. Through our retail drug segment, we sell prescription
drugs and a wide assortment of general merchandise. Prescription drug sales
represented approximately 58.4% of our total sales during our fiscal year
ended February 26, 2000 ("fiscal 2000"). Our drugstores filled over 190
million prescriptions during fiscal 2000. Our drugstores also offer non-
prescription health and personal care items, cosmetics, household items,
beverages, convenience foods, greeting cards, one-hour photo development,
seasonal merchandise and numerous other everyday and convenience products,
which we refer to as our "front-end products."
PBM Segment. Rite Aid owns PCS Health Systems, Inc. ("PCS"), one of the
country's largest pharmacy benefits managers, or PBMs. Through PCS, we provide
pharmacy benefit management services to employers, insurance carriers and
managed care companies. During fiscal 2000, PCS processed approximately 300
million prescriptions, served more than 1,200 health plan sponsors and
assisted, through its customers, approximately 50 million people with their
pharmaceutical needs. We are currently involved in negotiations concerning the
possible sale of PCS and an agreement could be announced at any time. However,
there can be no assurance that an agreement will be signed or, if it is, that
any sale will be consummated. If no sale transaction is available on terms we
consider acceptable, we intend to continue to own and operate PCS.
Our headquarters is located at 30 Hunter Lane, Camp Hill, Pennsylvania
17011, and our telephone number is (717) 761-2633. Our common stock is listed
on the New York Stock Exchange and the Pacific Stock Exchange under the
trading symbol "RAD."
Recent Events
On October 18, 1999, Rite Aid announced that Martin L. Grass had resigned
his positions as chairman of the board and chief executive officer of the
company. On October 27, 1999, Rite Aid completed the sale of $300 million of
convertible preferred stock to an affiliate of Leonard Green & Partners, L.P.
Following the investment, Leonard I. Green joined Rite Aid's board of
directors and became a member of its executive committee. On November 15,
1999, Mr. Green became the chairman of the board.
On December 5, 1999, a new executive management team, led by Robert G.
Miller, was hired to address and resolve the business, operational and
financial challenges confronting the company. Mr. Miller also succeeded Mr.
Green as the chairman of the board of directors. The new management team,
which has 94 years of collective experience in retail businesses, consists of:
. Robert G. Miller, Chairman of the Board and Chief Executive Officer;
. Mary Sammons, President, Chief Operating Officer and Board Member;
. David Jessick, Chief Administrative Officer and Senior Executive Vice
President; and
. John Standley, Chief Financial Officer and Executive Vice President.
Upon arrival, the new management team began to address the immediate
operational and liquidity problems that confronted Rite Aid. We believe that
these short term challenges have now been substantially resolved. New
management has also developed a long term operational plan that seeks to
capitalize on the substantial investment that Rite Aid has made in its store
base and distribution facilities. By significantly scaling back our new store
development program and focusing our resources on the successful operation of
existing stores, new
2
management intends to increase prescription drug and front-end sales and
restore the profitability of our operations. New management is also developing
a comprehensive plan to strengthen the company's internal accounting systems
and controls. We believe that the successful implementation of these plans
will allow Rite Aid to meet the continuing challenges that it faces.
The Initial Problems
At the time of their arrival, the new management team faced a series of
immediate challenges. These included:
. Deteriorating Store Operations. Rite Aid experienced substantial
operational difficulties during fiscal 2000. The principal problem was a
decline in customer traffic and revenues due to inventory shortages,
reduced advertising and uncompetitive prices on front-end products. By
November 1999, our out-of-stock level had reached 29% and many popular
products were not available in our stores. This situation resulted from
liquidity constraints and concerns, tighter vendor credit terms
resulting from disputes over payments for outdated or damaged
merchandise and a delay in the opening of Rite Aid's new distribution
center in Perryman, MD which caused delays in the shipment of seasonal
merchandise. During fiscal 2000, Rite Aid also suspended its practice of
circulating regular newspaper advertising supplements. This disrupted
customer traffic and adversely affected revenues. In order to offset the
effects of these actions, former management raised the prices of front-
end products above competitive levels. Customers rejected the higher
prices and revenues continued to decline.
. Restatements of Financial Statements. On June 1, 1999, Rite Aid filed
its Annual Report on Form 10-K for the fiscal year ended February 27,
1999 ("fiscal 1999"). In that filing, Rite Aid restated its consolidated
financial statements for the fiscal years ended February 28, 1998
("fiscal 1998") and March 1, 1997, as well as the interim periods in
fiscal 1999 and 1998. The restatement followed discussions between Rite
Aid and the Staff of the Securities and Exchange Commission (the "SEC")
concerning the Staff's review of Rite Aid's filed registration
statement. On October 11, 1999, following further discussions with the
Staff, Rite Aid announced that it would again restate previously
reported interim and annual financial statements. In its quarterly
report for the second quarter of fiscal 2000, filed on November 2, 1999,
Rite Aid restated its interim financial statements for the thirteen
weeks ended May 29, 1999, the thirteen and twenty-six weeks ended August
29, 1998 and its balance sheet as of February 27, 1999. At that time,
Rite Aid indicated that additional adjustments to its financial
statements might be necessary. On November 11, 1999, KPMG LLP resigned
as Rite Aid's auditor and withdrew its report on the company's
consolidated financial statements for the three-year period ended
February 27, 1999.
. Deteriorating Financial Position. From February 1995 through February
2000, Rite Aid spent $1.9 billion to build, renovate or relocate its
stores and $1.5 billion to acquire PCS. These expenditures, together
with the substantial amounts paid to acquire 1,639 stores during the
same period substantially increased Rite Aid's level of debt and placed
a significant strain on its short term liquidity position. The problems
were exacerbated by the inability to complete a public offering of
equity securities to repay the $1.3 billion short-term credit facility,
which had been established to support the commercial paper issuances
used to acquire PCS and which was due in October 1999. In June 1999,
Rite Aid borrowed $300.0 million from one of its banks under a demand
note because it had issued the maximum amount of commercial paper that
was permitted under its credit facilities. In September 1999, Rite Aid
informed its banks that it anticipated being in default on various
covenants under certain of its credit facilities and in October 1999,
Standard & Poor's and Moody's downgraded Rite Aid's credit rating.
Following these events, Rite Aid lost access to the commercial paper
market. On October 27, 1999, in connection with the preferred stock
investment by an affiliate of Leonard Green & Partners, L.P., Rite Aid's
banks agreed to restructure its $2.3 billion of credit facilities and
the $300.0 million demand note. This resulted in an extension of the
$1.3 billion PCS acquisition credit facility (the "PCS credit
facility"), the $1.0 billion credit facility (the "RCF credit
facility"), the $300.0 million demand note and certain other
indebtedness, but only until November 1, 2000.
3
New Management's Response
Since arriving, Rite Aid's new management team has taken a series of steps to
address the serious problems that confronted the company in December 1999.
These have included:
. Stabilizing our Store Operations. Since their arrival, new management
has:
-- reduced the out-of-stock level in its distribution facilities from
29% in November 1999 to 11% for the week ended July 6, 2000;
-- significantly curtailed new store growth by reducing the number of
new and relocated stores planned for fiscal 2001 and 2002 from
approximately 150 each year to approximately 85 and 100 for the
respective years;
-- strengthened vendor relationships by substantially resolving the
major vendor disputes that had arisen during fiscal 1999 and 2000;
-- reduced the prices of key front-end products, including many popular
health and beauty aid products, by approximately 15%;
-- sold $300 million in retail value of discontinued product at a
substantial discount;
-- established a 52-week national advertising program highlighting key
product categories as well as vendor cooperative events;
-- established and executed effective product promotional programs; and
-- reorganized management structure to focus specifically on critical
functions, such as store operations, pharmacy operations, managed
care and customer service.
These actions have begun to improve our operating results. For the four
weeks ended April 22, 2000, the five weeks ended May 27, 2000, and the
four weeks ended June 24, 2000, we reported increases in same store
sales of 7.1%, 6.6% and 9.7%, respectively, over the same periods in the
prior year. These increases compare favorably to February and March
2000, when our same store sales increases were 3.4% and 4.8%,
respectively.
. Re-Auditing our Financial Statements and Restoring Credibility in our
Financial Reporting. Following the resignation of KPMG LLP and the
withdrawal of their report, new management acted to identify, assess and
resolve Rite Aid's financial reporting issues. This process included a
re-evaluation of the accounting issues identified before December 1999
as well as an investigation and restatement of financial statements for
fiscal 1999 and 1998 and the first two quarters of fiscal 2000.
Following the arrival of our new management team we:
-- engaged Deloitte & Touche LLP, through our audit committee, as our
independent public accounting firm to audit our financial statements
for fiscal 2000 and our restated financial statements for fiscal 1999
and 1998;
-- engaged the law firm of Swidler Berlin Shereff Friedman LLP ("Swidler
Berlin"), through our audit committee, to conduct an investigation of
the company's reporting and accounting practices and Swidler Berlin
retained Deloitte & Touche LLP to assist them with forensic
accounting;
-- determined, based on new management's assessment of the situation,
not to make any further periodic filings with the SEC until the
review of the company's books and records was finished and a new
audit had been completed;
-- retained Arthur Andersen LLP to assist us in a reconciliation of Rite
Aid's books and records which was completed in July 2000; and
-- began to develop a plan to strengthen the company's internal
accounting systems and controls.
This process concluded with the preparation of the financial statements
contained in this annual report. In addition, the Swidler Berlin firm
conveyed the results of its investigation to the audit committee and to
management and were considered in connection with the preparation and
restatement of financial statements. There is a summary of the principal
accounting issues addressed in the restatement of the financial
statements for fiscal 1999 and 1998 under the caption "--Restatement of
Historical Financial Statements." See also notes 22 and 24 of the notes
to consolidated financial statements.
4
. Stabilizing our Financial Condition and Liquidity. New management has
addressed Rite Aid's immediate liquidity needs and stabilized its
financial condition through a series of refinancing transactions
completed in June 2000. Since December 1999, Rite Aid has:
-- obtained consents from its various lenders and bondholders to
postpone the required filing dates under its debt agreements for the
third quarter and full year fiscal 2000 SEC reports until July 11,
2000;
-- entered into a new $1.0 billion senior secured credit facility that
matures in August 2002, including a $500.0 million term loan that
was used to refinance our $300.0 million receivables securitization
facility, pay transaction fees and provide funds for general
corporate purposes and a $500.0 million revolving credit facility;
-- obtained an extension of the maturity dates on the outstanding debt
under our PCS credit facility and our RCF credit facility until
August 2002;
-- exchanged $374.3 million of our outstanding notes due in December
2000 and 2001 for $374.3 million of our notes due in September 2002;
-- exchanged $284.8 million of our outstanding loans for 51.8 million
shares of Rite Aid common stock and $274.8 million of our
outstanding loans for an equivalent amount of secured exchange debt
due August 2002;
-- obtained the agreement of two financial institutions to purchase
$93.2 million of our notes due September 2002 when our 5.5% notes
mature in December 2000; and
-- exchanged $177.8 million in principal amount of our 5.25%
convertible subordinated notes due 2002 for 17.8 million shares of
common stock.
Rite Aid continues to be highly leveraged and the covenants of our new
senior secured credit facility and our existing facilities place
constraints on our operations. However, as a result of the actions
described above, we believe that Rite Aid now has the financial flexibility
and liquidity necessary to execute its long term business strategy.
Our Long Term Strategy
New management's long term strategic plan will scale back our new store
development program and focus on enhancing the performance of our existing
store base. We intend to improve the performance of our existing stores by (1)
capitalizing on our substantial investments in our stores and distribution
facilities; (2) enhancing our customer and employee relationships; and (3)
improving our product offerings in the stores. We will also build a
comprehensive plan to establish and maintain an adequate and reliable system
of controls.
Capitalize on Investments in Store Base and Distribution Facilities. Over
the last five years, we have opened 537 new stores, relocated 967 stores,
generally to larger or free-standing sites, remodeled 253 stores and closed
1,039 stores. We also acquired 1,639 stores during the same period. All of our
stores are now integrated into a common information system. Our investments
have given us one of the most modern store bases in the industry, with 36% of
our stores at June 30, 2000 having been constructed or relocated since the
beginning of fiscal 1998. We have also made significant improvements to our
distribution network to support these new stores, including the opening of two
new high capacity distribution centers and the closure of two older centers.
It generally takes two to four years for our new and relocated stores to
develop the critical mass of customers necessary to achieve profitability.
Because of the large percentage of our stores which have been built or
remodeled in the last three years, attracting more customers is a key
component of our long term strategy.
Enhance Customer and Employee Relationships. We have initiated various
promotional programs that are designed to improve our image with customers.
These include the weekly distribution of a nationwide advertising circular to
announce vendor promotions, weekly sales items and, in our expanded test
market, Rite Aid's customer reward program, "Rite Rewards." Through the use of
technology and attention to customers' needs and preferences, we are
increasing efforts to identify inventory and product categories to enable us
to offer more personalized products and services to customers. We are
developing employee-training programs to improve
5
customer service and educate our employees about the products we offer. We are
also developing new employee programs that create compensatory and other
incentives for employees to provide customers with quality service and to
promote Rite Aid's private label brands.
Improve Product Offerings. In recent years Rite Aid has added popular and
profitable product departments, such as our General Nutrition Companies, Inc.
("GNC") stores-within-Rite Aid-stores and one-hour photo development
departments. We are continuing to develop ideas for new product departments
and have begun to implement plans to expand the categories of front-end
products that we sell in our larger west coast stores. Another important focus
of our new management team is to increase our offerings and sales of private
label Rite Aid brand products by identifying leading product categories that
we can bring to market under our private label brands. We also want to
increase our sales of generic prescription drugs, which provide the same
desired medical benefits as brand name prescription drugs but provide cost
savings to us and our customers. As private label and generic prescription
drugs generate higher margins than branded label, we expect that increases in
the sales of these products would enhance our profitability. We believe that
the addition of new departments and increases in offerings of products and
services are integral components of our strategy to distinguish Rite Aid from
other national drugstore chains.
Build an Adequate and Reliable Financial Reporting System. Following our
comprehensive review of Rite Aid's books and records, new management concluded
it was first necessary to stabilize our accounting systems and procedures and
then to develop, implement and maintain appropriate improvements to assure
that we have adequate and reliable accounting systems and controls. The
company retained Arthur Andersen LLP to provide accounting support to assist
Rite Aid's financial personnel with the resources required to support the
audit of the company's financial statements. New management's long term
strategy includes the development of a comprehensive plan to address the
integrity and reliability of Rite Aid's reporting of financial information.
Accordingly, new management will undertake the first step of this long term
plan by developing policies and procedures that establish a foundation for its
financial and accounting functions, support ongoing improvements and provide
mechanisms for directing, controlling and monitoring our accounting and
financial organization. New management expects that Arthur Andersen LLP will
continue to provide assistance as needed until we are able to operate an
adequate and reliable system of internal accounting controls without outside
support.
Current Challenges and Risks
. Financial Challenges. We have a high level of debt. In June 2000, new
management completed a restructuring of our indebtedness, which extended
the maturities of a significant amount of our indebtedness until at
least August 2002 and provides us with additional borrowing capacity. We
will continue to have significant debt service obligations going forward
and we will be constrained by:
-- interest payment obligations with respect to a total of $5.6 billion
of borrowings and $1.1 billion of capital leases outstanding at June
24, 2000;
-- the financial covenants in our debt agreements, which must be
satisfied in order for us to continue borrowing funds under our
revolving credit facility and may limit our operating flexibility;
and
-- interest rate fluctuations in respect of our floating-rate
indebtedness.
Our ability to refinance our substantial indebtedness before August
2002 will depend, in part, on our ability to execute our long term
strategy and attract more customers to our new and relocated stores.
. Operational Challenges. Our modern, fully-integrated store base allows
us to focus on the challenges of improving our store operations and
increasing store productivity. In responding to the operational issues
that confronted us during fiscal 2000, new management instituted a
number of initiatives to improve store performance. To further improve
our operating performance, we will need to:
-- attract customers through new product offerings and better services;
-- price our products competitively;
-- resolve any issues that may arise with our suppliers; and
-- improve the image of our pharmacies.
. Other Risks. In addition to the foregoing, our business is subject to
other risks including:
-- pending lawsuits against us as well as civil and criminal
investigations by various governmental agencies, including the SEC
and the United States Attorney;
6
-- our ability to develop, implement and maintain reliable and adequate
accounting systems and controls;
-- our reliance on third-party suppliers;
-- changes in third-party reimbursement levels for prescription drugs;
-- our dependence upon key personnel;
-- competition in our markets; and
-- our ability to adhere to governmental regulations with respect to
our pharmacy business.
We describe these risks in greater detail under "Management's Discussion
and Analysis of Financial Condition and Results of Operations--Factors
Affecting Our Future Prospects."
Restatement of Historical Financial Statements
The financial statements for fiscal 1998 and fiscal 1999 and the summarized
information for the first two quarters of fiscal 2000 included in this report
have been restated to reflect various adjustments. The aggregate effect of
these adjustments on the historical financial statements was to reduce net
income by $493.8 million and $535.9 million for fiscal 1998 and fiscal 1999.
On an aggregate basis, the adjustments for fiscal 1998 and 1999 reduced Rite
Aid's retained earnings at February 27, 1999 by $1.6 billion.
The principal adjustments to Rite Aid's fiscal 1998 and fiscal 1999
financial statements are summarized as follows:
Inventory/Cost of Goods Sold
The restated financial statements reflect adjustments to inventory and cost
of goods sold related primarily to reversals of unearned vendor allowances
previously recorded as a reduction to cost of goods sold, to correctly
applying the retail method of accounting, recording writedowns for slow moving
and obsolete inventory, recognizing certain selling costs including
promotional markdowns and shrink in the period in which they were incurred,
accruing for inventory cut-off, and to reflect vendor allowances in the
inventory balances.
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 expenditures. The adjustments also include
increases to depreciation expense to reverse the effects of retroactive
changes made to the useful lives of certain assets and to depreciate assets
misclassified as construction in-progress.
Lease Obligations
The restated financial statements reflect the sale-leaseback of certain
stores as financing transactions. Such transactions had previously been
accounted for as sales with corresponding operating leases. The adjustment to
correct these items resulted in the reversal of the asset sales and the
establishment of lease obligations. In addition, certain leases previously
accounted for as operating leases were determined to be capital leases.
Purchase Accounting
The company acquired Thrifty PayLess, Inc. in fiscal 1997 and Harco Inc. and
K&B Inc. in fiscal 1998. Certain liabilities associated with these
acquisitions that had previously been established with a corresponding
increase to goodwill have been either reduced or eliminated to correctly
reflect the fair value of the assets and liabilities acquired at the date of
acquisition.
7
Accruals for Operating Expense
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.
Exit Costs and Impairment of Operating and Other Assets
The restated financial statements include adjustments to appropriately
reflect charges related to store closures in the period in which the decision,
and ability, to close a store had been made. Other charges not related to
exiting stores and gains from the sale of certain assets previously recorded
against 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. The company also determined that its previous
method of evaluating assets for impairment at a market level was not
appropriate, and that the evaluation should occur at the store level because
this is the lowest level of independent cash flows ascertainable.
For additional information, see note 24 of the notes to consolidated
financial statements.
Description of Business
Retail Drug Segment
Rite Aid's stores sell prescription drugs and a wide assortment of general
merchandise, including over-the-counter drugs, health and personal care items,
cosmetics, greeting cards, household items, convenience foods, photo
development services and seasonal merchandise. We distinguish our stores from
other national chain drugstores in part through the Rite Aid private label
brands, our "stores-within-Rite Aid stores" program with GNC and by our
Internet presence through our website and the drugstore.com website.
Products and Services. During fiscal 2000, sales of prescription drugs
represented approximately 58.4% of our total sales. Rite Aid has derived
revenues of $7.8 billion, $6.7 billion and $5.7 billion, respectively, from
prescription drug sales for each of its last three fiscal years. Rite Aid
sells approximately 20,000 different types of non-prescription, or front-end,
products. No single front-end product category contributed significantly to
Rite Aid's sales during fiscal 2000 although certain front-end product classes
contributed notably to Rite Aid's sales. Our principal classes of products are
the following:
FY 2000
Percentage of
Product Class Sales/Revenues
------------- --------------
Prescription drugs............................................ 58.4%
Vitamins and mineral supplements.............................. 2.0
Cosmetics..................................................... 3.0
Seasonal...................................................... 2.0
Photo Development............................................. 2.0
Beer, wine and liquor......................................... 3.0
Greetings cards............................................... 2.0
Rite Aid offers over 1,500 products under the Rite Aid private label brand,
which contributed approximately 9.2% of our front-end sales in fiscal 2000.
During fiscal 2000, Rite Aid added 80 products under its private label. One of
new management's goals is to increase sales and the number of private label
brand products we offer.
In June 1999, Rite Aid acquired a 22% stake in drugstore.com, an online
source for health, beauty and pharmacy products, for cash of $8.1 million and
the company's agreement to provide access to the company's pharmacy networks
and insurance coverages, advertising contracts and exclusivity agreements. In
connection with this investment, Rite Aid and drugstore.com entered into a 10-
year exclusive strategic alliance pursuant to which drugstore.com became the
exclusive customer online link for prescriptions and other products and
services offered at all Rite Aid retail drugstores. The agreement gave Rite
Aid an immediate presence in the Internet drugstore business and resulted in
one of the first online pharmacies. We are focusing on leveraging our
8
relationship with drugstore.com to increase online sales and to generate
higher in-store sales to online customers who select in-store order pick-up.
At June 30, 2000, we owned approximately 18% of drugstore.com.
On January 7, 1999, Rite Aid announced a strategic alliance with GNC under
which Rite Aid agreed to open, own and operate a minimum of 1,500 GNC "stores-
within-Rite Aid-stores" across the country over a period of approximately four
years. GNC is a leading nationwide retailer of vitamin and mineral supplements
and personal care, fitness and other health-related products. As of June 30,
2000, we built 400 GNC stores-within-Rite Aid-stores. We plan to open 500 GNC
departments in our stores during fiscal 2001.
Rite Aid Stores
In February 1995, Rite Aid initiated a campaign to expand and modernize its
store base. During fiscal 1995, Rite Aid acquired 312 stores located in the
midwest and northeast regions in three acquisition transactions for a total
cost of approximately $175.7 million. In fiscal 1997, Rite Aid acquired
Thrifty PayLess, a drugstore chain with 1,006 stores located on the west
coast, for approximately $1.5 billion. In the same year, Rite Aid acquired
Taylor Drug Stores and Concord Drugs, Inc. for an aggregate cost of $33.6
million. In fiscal 1998, Rite Aid acquired the K&B, Incorporated and Harco,
Inc. chains, with 186 and 146 stores, respectively, for a total cost of
$335.0 million, net of cash acquired. These stores were located in the
southern region of the United States. In February 1999, Rite Aid acquired
Edgehill Drugs, Inc., which had 25 stores in Maryland and Delaware, for $25.0
million in cash. As of June 30, 2000, we had fully integrated these acquired
stores into our operations.
Rite Aid also has been modernizing its storebase. Rite Aid began opening
prototype stores in 1995 that include features that we believe increase
customer satisfaction, including drive-through pharmacies, one-hour film
developing departments, 24-hour stores and a layout that is designed to be
attractive to our customers.
During fiscal 2000, Rite Aid opened 77 new stores, relocated 178 stores,
remodeled 14 stores and closed 181 stores. On a regular basis throughout the
year, we evaluate the performance of our stores. Stores that are redundant,
underperforming or otherwise unsuitable are closed or relocated. Our current
plan for fiscal 2001 is to open approximately 12 new stores, relocate 73
stores and close 53 stores.
As of June 30, 2000, Rite Aid operated 3,776 retail drugstores in the
eastern, southern and western regions of the United States and the District of
Columbia. Rite Aid's strategy is to locate its stores at convenient locations
in fast-growing metropolitan areas. As of June 30, 2000, Rite Aid has a first
or second place market position in 34 of the 65 major U.S. metropolitan
markets in which it operates.
The table below identifies the number of stores by state as of June 30,
2000(/1/):
Store
State Count
- ----- -----
Alabama................. 118
Arizona................. 3
California.............. 624
Colorado................ 46
Connecticut............. 50
Delaware................ 26
District of Columbia.... 7
Georgia................. 36
Idaho................... 23
Indiana................. 36
Kentucky................ 129
Louisiana............... 103
Maine................... 85
Maryland................ 166
Michigan................ 353
Mississippi............. 35
Store
State Count
- ----- -----
Nevada................... 37
New Hampshire............ 40
New Jersey............... 186
New York................. 397
Ohio..................... 292
Oregon................... 75
Pennsylvania............. 378
Tennessee................ 54
Texas.................... 5
Utah..................... 30
Vermont.................. 13
Virginia................. 166
Washington............... 146
West Virginia............ 116
Wyoming.................. 1
-----
Total................... 3,776
9
- --------
(1) As of February 26, 2000, we operated 3,802 stores throughout 31 states,
including the District of Columbia.
Technology. All of our stores are connected to a common information system
and network which can be expanded to accommodate new stores. Additionally,
each Rite Aid store employs point-of-sale technology that facilitates
inventory replenishment, sales analysis and recognition of customer trends.
Our pharmacies employ technology that enables us to fill prescriptions with
increased accuracy and efficiency. In 1998, we began purchasing ScriptPro
units, which can be linked to the pharmacist's computer to fill and label
prescription drug orders. As of June 30, 2000 we had installed ScriptPro units
in 845 of our stores and plan to install approximately 150 additional units in
fiscal 2001. Our customers may also order prescription refills over the
Internet through drugstore.com or through our telephonic rapid automated
refill systems.
Suppliers. During fiscal 2000, we purchased approximately 87% of the dollar
volume of our prescription drugs from a single supplier, McKesson HBOC, Inc.
("McKesson"), pursuant to a long term supply contract which expires in April
2000, subject to a three year renewal at Rite Aid's option. Pursuant to the
contract, McKesson has agreed to sell to Rite Aid all of its branded
pharmaceutical products on an exclusive basis and generic pharmaceutical
products on a non-exclusive basis. If Rite Aid's relationship with McKesson
were disrupted, we could have difficulty filling prescriptions, which would
negatively affect our business. Rite Aid purchases its non-pharmaceutical
merchandise from numerous manufacturers and wholesalers. Rite Aid believes
that competitive sources are readily available for substantially all of the
non-prescription merchandise we carry and that the loss of any one supplier
would not have a material effect on Rite Aid's business.
Rite Aid sells private label and co-branded products that generally are
supplied by numerous competitive sources. The Rite Aid and GNC co-branded
PharmAssure(R) vitamin and mineral supplement products and the GNC branded
vitamin and mineral supplement products that we sell in our stores are
manufactured and developed by GNC as are the Rite Aid brand vitamin and
mineral and supplements.
Customers. During fiscal 2000, Rite Aid served an average of 1.8 million
customers per day. The loss of any one customer would not have a material
adverse impact on the results of the operations of our retail drugstore
segment. No single customer accounts for more than 10% of the total sales of
our retail drug segment.
Competition. Based on the number of stores as of the end of fiscal 2000,
Rite Aid is the second largest retail drugstore chain in the United States. We
compete directly with national chain drugstores, including CVS and Walgreen.
The retail drugstore industry is highly competitive, with retail drugstore
chains not only facing competition within the industry, but also from mail
order pharmacies and other retail outlets offering pharmacy services,
including Internet-based outlets. Rite Aid competes on the basis of store
location and convenient access, customer service and product selection and
price.
Employees. As of February 26, 2000, Rite Aid employed 77,258 employees in
the retail drug segment. Approximately 13% of these employees are pharmacists.
Rite Aid believes that its relationships with the employees in the retail drug
segment are good.
Working Capital. Rite Aid generally finances its inventory and capital
expenditure requirements with internally generated funds and borrowings. We
expect to use borrowings to finance inventories and to support our continued
growth. The majority of our front-end sales are in cash. Third-party insurance
programs, which typically settle in fewer than 30 days, accounted for 87.8% of
our pharmacy sales and 47.8% of our revenues in fiscal 2000. Our customer
returns are not significant.
Seasonality. Rite Aid's retail drug segment does not experience significant
fluctuations in results of operations as the result of seasonality.
Research and Development Rite Aid's retail drug segment does not make
significant expenditures for research and development. In fiscal 2000,
however, Rite Aid spent approximately $10.8 million in connection with the
development of the PharmAssure co-brand and other private label products. In
addition, we expended $500,000 to develop store floor plan prototypes and to
formulate marketing plans for our operating regions and on a nationwide basis.
10
Licenses, Trademarks and Patents. The Rite Aid name is our most significant
trademark and the most important factor in marketing our stores and private
label products. We hold licenses to sell beer, wine and liquor; cigarettes and
lottery tickets. Additionally, we hold licenses granted to us by the Nevada
Gaming Commission. We also hold licenses to operate our pharmacies and our
distribution facilities. Together, these licenses are material to our
operations.
PBM Segment
Our pharmacy benefit management segment, or PBM segment, offers pharmacy
benefit management services to employers, managed care companies (HMOs) and
insurance carriers for management of the wide variety of pharmacy benefit
programs that our customers may offer to their employees or members. PCS also
provides mail order pharmacy services. Rite Aid entered into the pharmacy
benefit management business with the acquisition of PCS from Eli Lilly and
Company in January 1999. PCS is the nation's second largest pharmacy benefits
manager, providing pharmacy related services to approximately 50 million
people in the United States during fiscal 2000.
The Company is currently in negotiations concerning the possible sale of
PCS. The negotiations are on-going and an agreement could be announced at any
time. No agreement has been reached at the time of this filing. No assurance
can be given that an agreement will be reached or that, if an agreement is
entered into, that a sale of PCS will be completed. If no sale transaction is
available on terms we consider acceptable, we intend to continue to own and
operate PCS. Based on the current negotiations, we expect to incur a
substantial loss upon the commitment to sell PCS compared to the acquisition
cost of $1.5 billion. See "Management's Discussion of Results of Operations
and Financial Condition -- General."
PCS Services. PCS does business nationwide and offers its customers a
variety of pharmacy network choices, depending on a customer's needs in
serving its own employees or members. The networks can be broad, where
participating pharmacies may number more than 55,000, or narrow, where
participating pharmacies may be limited to a particular group or even a single
pharmacy. PCS manages its customer pharmacy benefits programs by providing
participants with access to electronic claims adjudication when purchasing
drugs from network pharmacies. The network pharmacy communicates with PCS to
verify plan coverage, plan benefits and participant cost share amounts. PCS
manages the information technologies and data used in these transactions and
also manages the billing and payment aspects of the claim by the pharmacy for
payment by PCS's customer. PCS managed approximately 300 million prescription
claims during fiscal 2000.
PCS also develops formularies that promote the reduction of prescription
drug costs for its pharmacy benefits plan customers. Formularies are lists of
preferred drugs that PCS designs with its customers for the administration of
the client's prescription drug benefit plan. The use of a formulary can reduce
drug costs by promoting generic or less costly drugs that provide and maintain
the desired medical effect of more costly drugs.
In addition, PCS operates a mail order pharmacy for the participants in its
customers' prescription drug benefit plans. PCS fills mail order prescriptions
with drugs from its own inventory. During fiscal 2000, PCS processed an
aggregate of approximately 30,000 prescriptions a day from its two mail order
facilities in Birmingham, Alabama and Fort Worth, Texas. PCS intends to expand
its Internet operations in order to facilitate prescription ordering online.
PCS derives its revenues through contractual arrangements with its
customers, pharmacies and drug manufacturers. These contracts provide PCS with
revenues for pharmacy benefit management services, including claims processing
services and services related to the negotiation and implementation of drug
pricing arrangements with drug manufacturers.
Technology. PCS is focusing on the development of its Internet capabilities,
including its website, PCSRx.com. PCSRx is linked to the drugstore.com website
and to the intranets of many of its customers. PCS also is seeking to increase
its efficiency and reduce the costs of its operations through increased use of
the Internet.
11
Customers. PCS has several large customers. No single customer is
responsible for 10% or more of PCS's consolidated revenues. The loss of any
single large customer, however, could have a material adverse effect on the
PBM segment.
Competition. Competition in the PBM industry is intense. PCS competes with
numerous PBMs, including Merck-Medco Managed Care, a subsidiary of Merck &
Co., Inc., and Express Scripts, Inc., an affiliate of NYLIFE HealthCare
Management, Inc. PCS also competes with smaller companies, including Caremark
International, Inc. and Advance Paradigm, Inc. PCS competes on the basis of
its ability to provide high quality, cost-effective and reliable PBM services
that can meet the wide-ranging needs of its customer base.
Employees. At February 26, 2000, PCS employed 3,560 people. PCS is dependent
on its information technology employees and its technology and information
systems. Rite Aid believes its relationship with the PBM segment's employees
is good.
Working Capital. PCS generally finances its inventory and capital
expenditure requirements with cash generated from operations. The majority of
PCS's prescription drug sales are collected through third parties with
payments received by PCS, in most cases, within 30 days of the sale. PCS
maintains approximately two weeks of inventory to fill its mail order
prescription sales.
Licenses, Trademarks and Patents. PCS's name and its website address,
www.PCSRx.com are its most valuable license and trademark. PCS otherwise does
not rely on any licenses, trademarks or patents.
Regulation
Rite Aid's pharmacies and pharmacists must be licensed by the appropriate
state boards of pharmacy. Our pharmacies and distribution centers are also
registered with the Federal Drug Enforcement Administration. Applicable
licensing and registration requirements require our compliance with various
state statutes, rules and/or regulations. If Rite Aid were to violate any
applicable statute, rule or regulation, our licenses and registrations could
be suspended or revoked.
In recent years, an increasing number of legislative proposals have been
introduced or proposed in Congress and in some state legislatures that would
effect major changes in the healthcare system, either nationally or at the
state level. Such legislative initiatives include prescription drug benefit
proposals for Medicare participants. Also, in recent years both the federal
and state authorities have proposed and have passed new legislation that
imposes on healthcare providers, including pharmacies, significant additional
obligations concerning the protection of confidential patient medical records
and information. Although Rite Aid is well positioned to respond to these
developments, Rite Aid cannot predict the outcome or effect of legislation
resulting from these reform efforts.
PCS is required to comply with various regulations including the Robinson-
Patman Act and various anti-remuneration laws under Medicare and Medicaid. PCS
also is subject to mail pharmacy regulation with respect to its mail service
pharmacies in Fort Worth, Texas and Birmingham, Alabama that may require PCS
to be registered or licensed in states where PCS delivers pharmaceuticals. In
addition, PCS is subject to consumer practice laws and network access
legislation, which may require PCS to admit retail pharmacies to, or maintain
pharmacies within, its pharmacy networks under certain circumstances, and to
comply with licensure and registration laws as applicable under state law.
PCS's business is also subject to the Employee Retirement Income Security Act
of 1974 ("ERISA"). Certain legislation at both the state and federal level is
developing or pending that may relate to PCS's business, such as legislation
that allows plan members to use non-network providers, and that concerns the
confidentiality of patient medical records. Rite Aid cannot predict how PCS
would be affected if any pending legislation concerning its business were
enacted in the future. PCS may be required to comply with other regulations or
legislation as enacted or made applicable to it from time to time.
12
ITEM 2. Properties
We own our corporate headquarters, which is located in a 205,000 square foot
building at 30 Hunter Lane, Camp Hill, Pennsylvania 17011. We lease a 99,000
square foot building near Harrisburg, Pennsylvania for use by additional
administrative personnel. We lease most of our drugstore facilities under non-
cancellable leases, many of which have original terms of 15 to 20 years. In
addition to minimum rental payments, which are set at competitive market
rates, certain leases require additional payments based on sales volume, as
well as reimbursement for taxes, maintenance and insurance. Most of Rite Aid's
leases contain renewal options, some of which involve rent increases.
As of June 30, 2000, Rite Aid had 3,776 retail drugstores, of which 3,476
were leased. The overall average size of each store in the Rite Aid chain is
12,600 square feet. The stores on the east coast average 9,500 square feet per
store. The west coast stores average 21,300 square feet per store. The
southern stores average 12,100 square feet per store.
Rite Aid operates the following distribution centers and overflow storage
locations, which it owns or leases as noted:
Approximate
Owned or Square
Location Leased Footage
-------- -------- -----------
Rome, New York........................................ Owned 291,000
Utica, New York(1).................................... Leased 106,800
Poca, West Virginia................................... Owned 280,000
South Nitro, West Virginia(1)......................... Leased 50,000
Perryman, Maryland.................................... Leased 875,000
Tuscaloosa, Alabama................................... Owned 285,000
Cottondale, Alabama(1)................................ Leased 104,832
Pontiac, Michigan..................................... Owned 370,000
Ogden, Utah(2)........................................ Owned 638,000
Woodland, California(1)............................... Owned 500,000
Woodland, California.................................. Leased 200,000
Wilsonville, Oregon................................... Leased 500,000
Lancaster, California................................. Leased 930,000
--------
(1) Overflow storage locations.
(2) The Ogden, Utah distribution center was sold on March 23, 2000.
Stores serviced by the Ogden distribution center are now being
served by a new distribution center in Lancaster, California.
The terms of the leases for distribution centers range from five to 22
years. In addition to minimum rental payments, certain distribution centers
require tax reimbursement, maintenance and insurance. Most leases contain
renewal options, some of which involve rent increases.
On a regular basis and as part of our normal business, we evaluate store
performance and may close or relocate a store if the store is redundant,
underperforming or otherwise deemed unsuitable. When we close or relocate a
leased store, we often continue to have leasing obligations, in which case
Rite Aid usually attempts to sublease the former store. As of February 26,
2000, Rite Aid subleased approximately 5,811,993 square feet of space as a
result of closing or relocating stores and an additional 7,611,674 square feet
of space in closed stores was not subleased.
Rite Aid owns a 52,200 square foot ice cream manufacturing facility located
in El Monte, California.
Through PCS, Rite Aid also owns a 363,000 square foot building and leases an
additional 140,000 square feet of office space for the general offices and
headquarters of PCS. Also through PCS, Rite Aid leases a 93,800
13
square foot mail order facility in Fort Worth, Texas and owns a 112,000 square
foot mail order facility in Birmingham, Alabama.
ITEM 3. Legal Proceedings
Federal investigations
There are currently pending federal governmental investigations, both civil
and criminal, by the SEC and the United States Attorney, involving our
financial reporting and other matters. Rite Aid is cooperating fully with the
SEC and the United States Attorney. Also, as previously discussed, Rite Aid's
audit committee engaged the law firm of Swidler Berlin Shereff Friedman LLP to
conduct an independent investigation of those matters. The results of Swidler
Berlin's investigation have been conveyed to the audit committee and to
management and were considered in connection with the preparation and
restatement of the financial statements.
The U.S. Department of Labor has commenced an investigation of matters
relating to Rite Aid's employee benefit plans, including its principal 401(k)
plan which permitted employees to purchase Rite Aid common stock. Purchases of
Rite Aid common stock under the plan were suspended in October 1999. Rite Aid
is cooperating fully with the Department of Labor.
These federal investigations are ongoing and we cannot predict their
outcomes. If Rite Aid were convicted of any crime, certain contracts and
licenses that are material to our operations may be revoked, which would have
a material adverse effect on our results of operations and financial
condition. In addition, substantial penalties, damages or other monetary
remedies assessed against Rite Aid could also have a material adverse effect
on our results of operation and financial condition.
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 shareholders 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 complaint 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 Rite Aid's financial statements for its 1997, 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.
If any of these cases were to result in a substantial monetary judgment
against Rite Aid, or is settled on unfavorable terms, Rite Aid'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. Stern and
Nancy A. Lieberman), its former auditor, KPMG LLP, and Rite Aid as nominal
defendant, have been sued by Rite Aid shareholders 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
has made no determination yet as to how it will respond to the derivative
complaints and is unable to predict the ultimate outcome of this litigation.
14
Drug pricing and reimbursement matters
Civil proceedings are continuing involving Rite Aid's pricing-related
practices for prescription drugs. On September 22, 1999, the Florida Attorney
General filed a complaint against Rite Aid in the Second District, Leon
County, alleging violations of the Florida Deceptive and Unfair Trade
Practices Act and the state RICO statute. Rite Aid no longer operates any
retail drugstores in Florida. In essence, Florida asserted that Rite Aid'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. Rite Aid 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. On July 5, 2000, Rite Aid filed a
motion to dismiss the amended complaint.
The filing of the complaint by the Florida Attorney General, and Rite Aid'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. Rite Aid 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. Rite Aid filed motions to dismiss each of the uncertified class
action complaints for failure to state a claim for which relief could be
granted. Rite Aid'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 Rite Aid 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 Rite Aid'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.
Rite Aid 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, Rite Aid 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 Rite Aid could have a material adverse effect on the
financial position and operations of the company as well as necessitate
substantial additional expenditures to cover legal costs as it pursues all
available defenses.
Rite Aid 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. We are supplying similar information with
respect to these matters to the Department of Justice. Rite Aid believes that
these investigations are similar to investigations which were, and are being,
undertaken with respect to the practices of others in the retail drug
industry. Rite Aid also believes that its existing policies and procedures
fully comply with the requirement of applicable law and intends to fully
cooperate with these investigations. We cannot, however, predict their
outcomes at this time.
If any of these cases result in a substantial monetary judgment against Rite
Aid or is settled on unfavorable terms, Rite Aid's results of operations and
financial position could be materially adversely affected.
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
15
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. Rite
Aid 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.
Rite Aid cannot predict the outcome of this action.
Other
In addition, Rite Aid 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 Rite Aid's financial condition, cash flow or results of operations if
decided adversely. Rite Aid, regardless of insurance coverage, does not believe
that it has a material, estimable, and probable liability in regard to these
claims and lawsuits as of February 26, 2000 or July 11, 2000.
ITEM 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of security holders during the fourth
quarter of the fiscal year covered by this report.
PART II
ITEM 5. Market for Registrant's Common Equity and Related Stockholder Matters
Rite Aid's common stock is listed on the New York and Pacific Stock Exchanges
under the symbol RAD. On June 30, 2000, Rite Aid had approximately 11,660
record shareholders. Quarterly high and low stock prices, based on the 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 21 1/16 4 1/2 $.1150
Fourth 13 1/4 6 3/8 $ -- (1)
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 $.1150
- --------
(1) No dividend was declared in the fourth quarter of fiscal 2000. Our current
credit facilities do not allow us to pay dividends.
Sales of unregistered securities On October 27, 1999, Rite Aid issued and
sold to Green Equity Investors III, L.P. 3,000,000 shares of Rite Aid's series
A cumulative convertible pay-in-kind preferred stock ("series A preferred
stock"), at a purchase price of $100.00 per share, for an aggregate purchase
price of $300.0 million. The series A preferred stock had an 8% cumulative pay-
in-kind dividend paid quarterly. On December 10, 1999, Green Equity Investors
III, L.P. exchanged all of its series A preferred stock for 3,000,000 shares of
Rite Aid's series B cumulative convertible pay-in-kind preferred stock ("series
B preferred stock"). The series B preferred stock has the same terms as the
series A preferred stock, except that the series B preferred stock will vote
with the holders of Rite Aid common stock and each holder of series B preferred
stock will have one vote for each share of the common stock issuable upon
conversion of the holder's series B preferred stock. When issued, the series B
preferred stock was convertible into shares of Rite Aid common stock at a
conversion price of $11.00 per share subject to adjustment: (1) to any price
that is lower than the then current conversion price at
16
which Rite Aid issues common stock prior to October 27, 2000; or (2) on March
1, 2002, to the lowest average price, but not less than $7.50, of Rite Aid's
common stock during any consecutive three-month period from October 27, 1999
through February 28, 2001, if such average price is lower than the then current
conversion price or, if not lower, to $11.50. As a result of the exchange of
Rite Aid's bank debt for shares of Rite Aid common stock at an exchange rate of
$5.50 per share, as discussed below, the conversion price for the series B
preferred stock was adjusted to $5.50 per share.
On October 27, 1999, Rite Aid issued a warrant to J.P. Morgan Ventures
Corporation, an affiliate of J. P. Morgan, to purchase 2,500,000 shares of Rite
Aid common stock. The exercise price for the common stock is $11.00 per share,
subject to certain adjustments. The warrant expires on September 23, 2002. The
warrant was issued in connection with the extension and restructuring of Rite
Aid's banking facilities. J. P. Morgan is one of Rite Aid's principal lenders.
On June 14, 2000, certain lenders, including J.P. Morgan Ventures
Corporation, exchanged $284.8 million of their loans under the PCS credit
facility and the $300.0 million demand note into 51,785,434 shares of Rite Aid
common stock at an exchange rate of $5.50 per share.
On June 14, 2000, Rite Aid issued $374.3 million of 10.5% senior secured
notes due 2002 in exchange for $52.5 million of Rite Aid's outstanding 5.5%
notes due 2000 and $321.8 million of Rite Aid's outstanding 6.7% notes due
2001. Also, Rite Aid entered into an agreement with J.P. Morgan and a financial
institution under which they agreed to purchase $93.2 million of the 10.5%
senior secured notes due 2002 when the 5.5% notes that remain outstanding
mature in December 2000.
The series A preferred stock, the series B preferred stock, the warrant, the
10.5% senior secured notes due 2002, and the Rite Aid common stock issued in
exchange for certain Rite Aid private bank debt were issued in transactions
exempt from registration in reliance on Section 4(2) of the Securities Act of
1933, as amended (the "Securities Act").
On June 26, 2000, the holders of $177.8 million principal amount of Rite
Aid's outstanding 5.25% convertible subordinated notes due 2002 exchanged these
notes for 17,779,000 shares of Rite Aid's common stock. The common stock was
issued in a privately negotiated transaction exempt from registration in
reliance on Section 3(a)(9) of the Securities Act.
17
ITEM 6. 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 on pages F-1 through F-39. Selected financial data is
presented for three fiscal years. The company's financial statements for
fiscal years ending February 27, 1999 and February 28, 1998 have been
restated. These restatements supercede the prior restatements of such periods
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 years 1997 and 1996 have not been restated and should not be
relied upon. For a further discussion of the restatement see "Business--
Restatement of Historical Financial Statements" and note 24 of the notes to
consolidated financial statements.
February 27, February 28,
February 26, 1999 1998
2000 (52 weeks)(1) (52 weeks)(2)
(52 weeks) (as restated)(3) (as restated)(3)
------------ ---------------- ----------------
(In thousands, except per share amounts)
Summary of Operations:
REVENUES........................ $14,681,442 $12,782,890 $11,533,423
COSTS AND EXPENSES:
Cost of goods sold, including
occupancy costs.............. 11,412,774 9,743,835 8,603,318
Selling, general and
administrative expenses...... 3,712,279 3,144,134 2,835,395
Gain on sale of stores........ (80,109) -- (52,261)
Goodwill amortization......... 56,832 29,227 26,480
Store closing, impairment and
other charges................ 163,185 192,551 148,560
Interest expense.............. 520,336 277,226 209,152
Share of loss from equity
investment................... 11,893 448 1,886
----------- ----------- -----------
15,797,190 13,387,421 11,772,530
----------- ----------- -----------
Loss before income taxes...... (1,115,748) (604,531) (239,107)
INCOME TAX EXPENSE (BENEFIT) ... 8 (182,049) (52,916)
----------- ----------- -----------
Loss before cumulative effect
of accounting change......... (1,115,756) (422,482) (186,191)
Cumulative effect of
accounting change, net of
income tax benefit of $22,760
............................. (27,300) -- --
----------- ----------- -----------
Net loss.................... $(1,143,056) $ (422,482) $ (186,191)
----------- ----------- -----------
BASIC AND DILUTED LOSS PER SHARE
...............................
Loss before cumulative effect
of accounting change......... $ (4.34) $ (1.64) $ (0.74)
Cumulative effect of
accounting change, net....... $ (0.11) $ -- $ --
----------- ----------- -----------
Net loss.................... $ (4.45) $ (1.64) $ (0.74)
=========== =========== ===========
- --------
(1) PCS was acquired on January 22, 1999.
(2) K&B and Harco Stores were acquired in August 1998.
(3) See note 24 of the notes to consolidated financial statements for a
description of the adjustments resulting from the restatements.
18
February 27, February 28,
February 26, 1999 1998
2000 (52 weeks)(1) (52 weeks)(2)
(52 weeks) (as restated)(3) (as restated)(3)
------------ ---------------- ----------------
(Dollars in thousands except dividends)
Year-End Financial Position:
Working capital (deficit)..... $ 893,053 $ (787,926) $1,247,622
Property, plant and equipment
(net)........................ 3,629,919 3,645,099 2,453,754
Total debt (4)................ 6,608,901 5,914,771 3,125,161
Total assets.................. 10,807,854 10,512,540 7,398,250
Redeemable preferred stock.... 19,457 23,559 --
Stockholders' equity.......... 431,508 1,350,585 1,870,759
Other Data:
Cash dividends declared per
common share................. $ .4375 $ .4375 $ .4075
Basic weighted average
shares....................... 259,139 258,516 250,659
Diluted weighted average
shares....................... 259,139 258,516 250,659
Number of retail drugstores... 3,804 3,821 3,975
Number of employees........... 77,258 89,900 83,000
- --------
(4) Includes capital lease obligations of $1.1 billion, $1.1 billion and $612
million as of February 26, 2000, February 27, 1999 and February 28, 1998,
respectively.
19
ITEM 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
The Management's Discussion and Analysis of Results of Operations for the
years ended 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 "Business--Restatement of Historical Financial
Statements" and note 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
376 new stores, relocated 727 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 to 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 $987.0 million and $1,072.3 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 first fiscal 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.
Possible Sale of PCS. We have had discussions with several parties and are
currently negotiating seriously with one interested party concerning a sale of
PCS. At the date of this filing no agreement has been reached. No assurance
can be given that an agreement will be reached or that, if it is, that any
sale will be consummated. If no sale transaction is available on terms we
consider acceptable, we intend to continue to own and operate PCS. Based on
current negotiations, it is likely that Rite Aid would recognize a significant
loss upon the commitment to sell. In addition, the sale of PCS will result in
a loss of significant tax benefits.
20
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. 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. Giving pro forma effect to these issuances and adjustments, the
basic and fully diluted average shares outstanding at February 26, 2000 would
have increased from 259,139,000 to 347,999,000. 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.
Results of Operations
Consolidated Revenues
- -------------------------------------------------------------------------------
FY 2000 FY 1999 FY 1998
----------- ----------- -----------
(dollars in thousands)
Sales.................................... $14,681,442 $12,782,890 $11,533,423
Sales growth............................. 14.9% 10.8% *
Retail drug segment...................... $13,416,747 $12,692,689 $11,533,423
PBM segment.............................. $ 1,264,695 $ 90,201 $ **
Store data:
Total stores (beginning of period)...... 3,865 3,970 3,745
New stores.............................. 77 163 132
Closed stores........................... (181) (330) (280)
Store acquisitions, net................. 35 62 373
Relocated stores ....................... 178 323 202
Remodeled stores........................ 14 155 84
Total stores (end of period)............ 3,802 3,865 3,970
- -------------------------------------------------------------------------------
* See "Selected Financial Data" for a discussion of Rite Aid's inability to
present comparisons to fiscal 1997.
** PCS was acquired on January 28, 1999
The acquisition of PCS on January 22, 1999 was the primary contributor to
the growth in our consolidated revenues in fiscal 2000 compared to fiscal
1999. The growth in consolidated sales in fiscal 1999 benefitted from full-
year sales of $779.0 million from the Harco, Inc. ("Harco") and K&B, Inc.
("K&B") stores which contributed only $458.2 million of sales in fiscal 1998
following their acquisition on August 27, 1997.
Because PCS was acquired late in fiscal 1999, there is insufficient
operating data for prior periods to present a meaningful comparison to its
operations in fiscal 2000. PCS derived 59.6% of its total revenues in fiscal
2000 from mail order programs. Revenues from manufacturer programs and claims
processing contributed 18.6% and 15.8%, respectively, of total PCS revenues in
fiscal 2000.
21
Retail Drug Segment
- -------------------------------------------------------------------------------
FY 2000 FY 1999 FY 1998
----------- ----------- -----------
Sales (thousands)..................... $13,416,747 $12,692,689 $11,533,423
Sales growth.......................... 5.8 % 9.9% *
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 segment
sales................................ 58.1 % 53.1% 49.2%
Third-party sales as a % of total
pharmacy sales....................... 87.6 % 85.4% 83.4%
Front-end sales growth................ (2.5)% 0.1% *
Same store front-end sales growth..... (2.2)% 6.6% *
Front-end as a % of total segment
sales................................ 41.3 % 44.8% 48.9%
- ------------------------------------------------------------------------------
* See "Selected Financial Data" for a discussion of Rite Aid's inability to
present comparisons to fiscal 1997.
The 5.8% growth in retail drug segment 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 retail drug revenues in fiscal
1999 grew 9.9% over the level in fiscal 1998 as a result of strong growth in
pharmacy revenues and a slight increase in front-end sales.
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 0.13% 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
- ------------------------------------------------------------------------------
FY 2000 FY 1999 FY 1998
----------- ---------- ----------
Costs of goods sold...................... $11,412,774 $9,743,835 $8,603,318
Gross margin............................. 22.3% 23.8% 25.4%
Selling, general and administrative...... $ 3,712,279 $3,144,134 $2,835,395
Selling, general and administrative as a
% of revenues........................... 25.3% 24.6% 24.6%
Gain on sale of stores................... $ (80,109) $ -- $ (52,261)
Goodwill amortization.................... $ 56,832 $ 29,227 $ 26,480
Interest expense......................... $ 520,336 $ 277,226 $ 209,152
Closed store, impairment and other
charges................................. $ 163,185 $ 192,551 $ 148,560
- ------------------------------------------------------------------------------
22
Cost of Goods Sold
Gross margin was 21.9% for fiscal 2000 compared to 23.8% in fiscal 1999.
Gross margins in fiscal 2000 declined from the prior year as a result of the
acquisition of PCS, which operates with lower margins than the retail drug
segment, and the continuing increase in third-party pharmacy sales as a
percentage of total retail drug segment sales. Gross margin declined to 23.8%
in fiscal 1999 from 25.4% in fiscal 1998.
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 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 1999 were improved store level
margins for front-end and pharmacy sales.
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 segment sales were 58.1%, 53.1% and 49.2% in fiscal 2000,
1999 and 1998, respectively. The ratios of third-party sales to total pharmacy
sales were 87.6%, 85.4% and 83.4% for fiscal 2000, 1999 and 1998,
respectively, as the percentage of third-party sales continued to grow in each
period.
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 25.3% of sales in
fiscal 2000, 24.6% 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. These more than offset the effects of the acquisition of
PCS, which operates with a substantially lower SG&A margin than the retail
drug segment.
Goodwill Amortization
Goodwill amortization increased during fiscal 2000 over the level recorded
in fiscal 1999 due to the additional goodwill recorded in connection with the
company's acquisition of PCS in January 1999. The increased fiscal 2000
amortization expense attributable to PCS more than offset a slight reduction
in amortization expense for the company's prior acquisitions. Goodwill
amortization expense increased during fiscal 1999
23
compared to fiscal 1998 due to the amortization of goodwill recorded in
connection with the company's acquisitions of PCS in January 1999, and Harco
and K&B in fiscal 1998. Goodwill amortization expense in fiscal 1999 included
one month of expense associated with PCS and a full year's amortization of the
goodwill recorded in connection with the Harco and K&B acquisitions. Only 26
weeks of goodwill amortization for Harco and K&B was recorded in fiscal 1998.
Interest Expense
Interest expense was $520.3 million in fiscal 2000 compared to $277.2
million in fiscal 1999 and $209.1 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 the company's indebtedness
increased in fiscal 2000 primarily as a result of a full year's interest
expense on 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.
Closed Store, Impairment and Other Charges
During fiscal 2000, fiscal 1999 and fiscal 1998, the company recorded pre-
tax charges of $163.2 million, $192.5 million and $148.6 million, for the
closing of 181, 330 and 280 stores, respectively.
Store closings, impairments and other charges consist of:
For the For the For the
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...... 130,461 87,666 76,442
-------- -------- --------
$163,185 $192,551 $148,650
======== ======== ========
These charges are related entirely to operations in the retail drug business
segment.
Income Taxes
The company had a net loss in fiscal 2000. In addition, as a result of the
restatements of fiscal 1999 and 1998, Rite Aid had net losses in fiscal 1998
and fiscal 1999. Tax benefits of $52.9 million, $182.0 million and $18.2
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. The
company expects 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.
See note 11 of the notes to consolidated financial statements.
Liquidity and Capital Resources
The company 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,
24
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 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.
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 2.0% plus Citibank's base rate. 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 and 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, increasing to
$265.0 million ($243.0 million if PCS is sold) for the four quarter period
ending June 1, 2002.
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.
25
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%. The interest rate on our borrowings under
these facilities will increase by 0.50% per annum if we have not received, and
applied to reduce principal, at least $500.0 million of net proceeds from
asset sales prior to November 1, 2000. 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,
increasing 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 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 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 2000 and $321.8 million of our 6.7% notes due 2001 for an
aggregate of $374.3 million of our new 10.5% senior secured notes due 2002.
After the exchange, $147.5 million of the 5.5% notes due 2000 and
$28.2 million of the 6.7% notes due 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 2002 to certain banks. 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. An additional $274.8 million of borrowings under
the facilities were exchanged for the exchange debt, including the entire
remaining principal amount of the J.P. Morgan 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 credit facilities or demand note, as applicable, and
also received a first lien on our prescription files.
In addition, 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.
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 existing
syndicated 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.
26
Commercial Paper. Until September 24, 1999, the company 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 lines
of credit. All remaining commercial paper obligations were repaid in March
2000.
The increase in commercial paper in 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 1998 were achieved through the issuance of $650.0
million of our 5.25% convertible subordinated notes in the third quarter of
fiscal 1998.
Debt Capitalization. The following table sets forth our debt capitalization
(in millions) at June 24, 2000, following the completion of the restructuring
transactions described above:
As of
June 24,
2000
--------
Secured Debt:
Senior facility(1)................................................. $ 500
PCS facility....................................................... 1,142
RCF facility....................................................... 730
10.5% senior secured notes due 2002(2)............................. 374
Exchange debt...................................................... 275
Prudential note.................................................... 31
Other.............................................................. 16
Lease Financing Obligations......................................... 1,074
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...................................................... $6,717
======
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(1) Proceeds from the term loan portion of the senior 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 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.
27
Net Cash Provided by Operations
The company used $349.3 million of cash to fund operations in fiscal 2000.
Operating cash flow was negatively impacted by $501.8 million of interest
payments. Operating cashflow benefited from an increase in other liabilities
partially offset by an increase