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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
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|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For The Fiscal Year Ended March 3, 2001
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
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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)
Delaware
(State or other jurisdiction of
incorporation or organization)
30 Hunter Lane,
Camp Hill, Pennsylvania
(Address of principal executive offices)
Registrant's telephone number, including area code: (717) 761-2633
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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
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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 common 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 May 14, 2001 was
approximately $2,888,464,506. For purposes of this calculation, executive
officers, directors and 5% shareholders are deemed to be affiliates of the
registrant.
As of May 14, 2001 the registrant had outstanding 394,341,787 shares of
common stock, par value $1.00 per share.
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TABLE OF CONTENTS
Page
----
PART I................................................................... 2
ITEM 1. Business............................................... 2
ITEM 2. Properties............................................. 8
ITEM 3. Legal Proceedings...................................... 9
ITEM 4. Submission of Matters to a Vote of Security Holders.... 11
PART II.................................................................. 12
ITEM 5. Market for Registrant's Common Equity and Related
Stockholder Matters.................................... 12
ITEM 6. Selected Financial Data................................ 14
ITEM 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations.................... 16
ITEM 7A. Quantitative and Qualitative Disclosures About Market
Risks.................................................. 31
ITEM 8. Financial Statements and Supplementary Data............ 32
ITEM 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure.................... 32
PART III................................................................. 33
PART IV.................................................................. 34
ITEM 14. Exhibits, Financial Statement Schedules and Reports on
Form 8-K............................................... 34
i
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 our future prospects,
developments and business strategies.
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:
o our high level of indebtedness;
o 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;
o our ability to complete the financial restructuring contemplated by our
May 15, 2001 bank commitment letter;
o our ability to improve the operating performance of our existing stores,
and, in particular, our new and relocated stores in accordance with our
management's long term strategy;
o the outcomes of pending lawsuits and governmental investigations, both
civil and criminal, involving our financial reporting and other matters;
o 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
o our ability to further develop, implement and maintain reliable and
adequate internal accounting systems and controls.
We undertake no obligation to revise the forward-looking statements included
in this report to reflect any future events or circumstances. Our 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 this report
under the section entitled "Management's Discussion and Analysis of Financial
Condition and Results of Operation--Factors Affecting our Future Prospects"
herein.
1
PART I
Item 1. Business
Overview
We are the second largest retail drugstore chain in the United States based
on store count and the third largest based on sales. We operate our drugstores
in 30 states across the country and in the District of Columbia. As of March
3, 2001, we operated 3,648 stores and had a first or second place market
position in 34 of the 65 major U.S. metropolitan markets in which we operated.
Our stores are an average of 12,663 square feet.
Our headquarters are 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".
During all of the fiscal year ended March 3, 2001 ("fiscal 2001"), we
operated in the retail drug segment and for a portion of fiscal 2001, we also
operated in the pharmacy benefit management ("PBM") segment.
Through our retail drug segment, we sell prescription drugs, sales of which
represented approximately 59.5% of our total sales during fiscal 2001. Our
drugstores filled over 204 million prescriptions during fiscal 2001. Our
drugstores also offer non-prescription medications, health and beauty aids and
personal care items, cosmetics, household items, beverages, convenience foods,
greeting cards, photo processing, seasonal merchandise and numerous other
everyday and convenience products which we refer to as our "front-end
products."
Until October 2, 2000, when we sold it to Advance Paradigm, Inc. (now
AdvancePCS), we owned PCS Health Systems, Inc. ("PCS"), one of the nation's
largest providers of pharmacy benefit management services to employers,
insurance carriers and managed care companies. As a result of the sale, the
PBM segment is reported as a discontinued operation for all relevant periods
in the financial statements included in this Annual Report.
From the beginning of fiscal 1997 until December 1999, we were engaged in an
aggressive expansion program. During that period, we purchased 1,554 stores,
relocated 866 stores, opened 445 new stores, remodeled 308 stores and acquired
PCS. These activities had a significant negative impact on our operating
results, severely strained our liquidity and increased our indebtedness to
$6.6 billion as of February 26, 2000. In October 1999, we announced that we
had identified accounting irregularities and our former chairman and chief
executive officer resigned. In November 1999, our former auditors resigned and
withdrew their previously issued opinions on our financial statements for the
fiscal years 1998 and 1999. Thereafter, investigations were begun by the
Securities and Exchange Commission and the United States Attorney for the
Middle District of Pennsylvania into our affairs. In addition, the complaint
in a securities class action lawsuit, which had been filed in March 1999, was
amended to include allegations based upon the accounting irregularities we
disclosed. In December 1999, new senior management was hired. In response to
the situation we faced, we completed the following:
o Restated our financial statements for fiscal years 1998 and 1999, engaged
new auditors to audit our financial statements for fiscal years 1998,
1999 and 2000, and resumed normal financial reporting;
o Refinanced our near term indebtedness to defer virtually all principal
amortization to no earlier than August 2002;
o Improved our front end same store sales growth from a minus 2.2% in
fiscal 2000 to a positive 6.5% in fiscal 2001 by improving store
conditions and launching a competitive marketing program;
o Reduced our indebtedness by $1.4 billion from $6.6 billion on February
26, 2000 to $5.2 billion on April 28, 2001 with the proceeds from the
sale of PCS and as a result of debt for equity exchanges;
o Curtailed our expansion plans resulting in an approximately $441 million
reduction in capital expenditures from fiscal 2000 to fiscal 2001;
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o Pending court approval, settled the securities class action and related
lawsuits for $45 million to be funded with insurance proceeds and $155
million of common stock, cash and/or notes to be issued and paid in
January 2002; and
o Began development and implementation of a comprehensive plan to address
accounting systems and controls.
o Entered into a bank committment letter to refinance a significant
portion of our indebtedness, see "Recent Event".
Our long term operating strategy is to focus on improving the productivity
of our existing store base. We believe that improving the sales of our
existing stores is important to improving our future profitability and cash
flow. We also believe that the substantial investment made in our store base
over the last five years has given us one of the most modern store bases in
the industry. However, our store base has not yet achieved the level of sales
productivity that our major competitors achieve. We intend to improve the
performance of our existing stores by continuing to (i) capitalize on the
substantial investment in our stores and distribution facilities; (ii) enhance
our customer and employee relationships; and (iii) improve the product
offerings in our stores. Moreover, it is estimated that pharmacy sales in the
United States will increase more than 75% over the next five years. This
anticipated growth is expected to be fueled by the "baby boom" generation
entering their 50's, the increasing life expectancy of the American population
and the introduction of several new successful drugs and inflation. We believe
that this growth will help increase the sales productivity of our existing store
base.
Since the beginning of fiscal 1997, we have opened 466 new stores, relocated
945 stores, generally to larger or free-standing sites, remodeled 406 stores
and closed 1,139 stores. We also acquired 1,554 stores during the same period.
All of our stores are integrated into a common information system. At March 3,
2001, 49.8% of our stores had been constructed, relocated or remodeled since
the beginning of fiscal 1997. Our new and relocated stores are generally
larger and need to develop a critical mass of customers to achieve
profitability, which generally takes two to four years. Therefore, attracting
more customers is a key component of our long term operating strategy. We have
also improved our distribution network to support these new stores by, among
other things, opening two high capacity distribution centers.
We have initiated various programs that are designed to improve our image
with customers. These include our weekly distribution of a nationwide
advertising circular to announce vendor promotions, weekly sales items and, in
our expanded test market, our customer reward program, "Rite Rewards." We have
also initiated programs that are specifically directed to our pharmacy
business. These include reduced cash prices and an increased focus on
attracting and retaining managed care customers. Through the use of technology
and attention to customers' needs and preferences, we are increasing our
efforts to identify inventory and product categories that will enable us to
offer more personalized products and services to our customers. We continue to
develop and implement employee training programs to improve customer service
and educate our employees about the products we offer. We are also developing
employee programs that create compensatory and other incentives for employees
to provide customers with quality service, to promote our private label brands
and to improve our corporate culture.
We continue to add 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 continue to develop ideas for new
product departments and have begun to implement plans to expand the categories
of our front-end products. During fiscal 2001, we undertook several
initiatives to increase sales of our Rite Aid brand products and generic
prescription drugs. 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 us from other national
drugstore chains.
Recent Event
On May 16, 2001, we issued a press release announcing the details of a
comprehensive $3.0 billion refinancing package that includes a commitment for
a new $1.9 billion senior secured credit facility fully underwritten by
Citibank NA, J.P. Morgan Chase & Co., Credit Suisse First Boston and Fleet
Retail Finance, Inc. We announced that upon completion of the planned
transactions scheduled to close during our second
3
fiscal quarter, we will have significantly reduced our debt and the amount of
our debt maturing prior to March 2005.
The closing of the new credit facility is subject to the satisfaction of
customary closing conditions and our issuance of approximately $1.05 billion
in new debt or equity securities, of which $527 million, as of May 16, 2001,
has been committed or arranged, as described herein. We plan to raise, at a
minimum, the additional $523 million by issuing equity and fixed income
securities and through real estate mortgage financings in transactions which
are intended to close simultaneously with, and which will be conditioned upon,
the closing of the new credit facility. The new credit facility will be
secured by inventory, accounts receivable and certain other assets owned by
our subsidiaries. The facility will be used to repay our first and second lien
debt, pay expenses associated with the planned refinancing and for general
working capital purposes.
In the $527 million in new debt and equity securities that has already been
committed is a $149 million private placement comprised of 22.7 million shares
of common stock committed on March 22, 2001 at $5.50 per share and 3.8 million
shares of common stock committed on May 2, 2001 at $6.50 per share. The closing
of this equity investment will take place simultaneously with, and is contingent
upon, the completion of the new credit facility.
One of the holders has committed to exchange $152 million of our 10.5% senior
secured notes due 2002 for $152 million of new 12.5% senior secured notes
maturing in 2006. The new notes will be secured by a second lien on the
collateral securing the new credit facility. In connection with the exchange,
the holder will receive five-year warrants to purchase approximately 3.0 million
shares of our common stock at $6.00 per share. The exchange will take place
simultaneously with, and is contingent upon, the closing of the new credit
facility.
We also announced that included in the $527 million that has already been
committed are recently completed or contracted private exchanges of common
stock for $226.2 million of our bank debt and 10.5% senior secured notes due
2002, as described herein.
Once the refinancing transactions are completed, our remaining debt due
before March 2005 will be $152.0 million of our 5.25% convertible subordinated
notes due 2002, $107.8 million of our 6.0% dealer remarketable securities due
2003, $259.2 million of our 10.5% senior secured notes due 2002 and
amortization of the new credit facility. We expect to use internally generated
funds to retire both the 5.25% notes and the dealer remarketable securities at
maturity and to meet the amortization payments under the new credit facility.
We also announced that funds to repay the 10.5% notes at maturity are included
in the new credit facility.
We are being advised on the refinancing by Salomon Smith Barney Inc., J.P.
Morgan Chase & Co. and Credit Suisse First Boston.
The debt and equity securities that we will offer will not be registered
under the Securities Act of 1933, as amended, and may not be offered or sold
in the United States absent registration or an applicable exemption from such
registration requirements.
As described in our May 16, 2001 press release, the completion of the
proposed refinancing of our credit facility is subject to customary closing
conditions, some of which are beyond our control, and also to our ability to
successfully complete the additional financings required by the commitment
letter for the refinancing. While we believe we will successfully complete the
refinancing, there can be no assurance that the refinancing transactions will
be consummated.
Except as set forth herein, this Annual Report does not give effect to the
consummation of the refinancing.
Description of Business
Retail Drug Segment
Our stores sell prescription drugs and a wide assortment of general
merchandise that we call "front-end products," including over-the-counter
medications, health and beauty aids and personal care items, cosmetics,
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greeting cards, household items, convenience foods, photo processing services
and seasonal merchandise. We distinguish our stores from other national chain
drugstores, in part, through our private label brands, our "stores-within-Rite
Aid stores" program with GNC and by our Internet presence through our website,
www.riteaid.com, and the drugstore.com website. Our stores range in size from
approximately 5,000 to 40,000 square feet. The larger stores are concentrated
in the western United States. Substantially all of the stores we have opened
since 1995 are based on our prototype 12,500 square foot freestanding building
and such stores typically include a drive-thru pharmacy.
Products and Services. During fiscal 2001, sales of prescription drugs
represented approximately 59.5% of our total sales. In fiscal years 2001, 2000
and 1999, prescription drug sales were $8.6 billion, $7.8 billion and $6.7
billion, respectively, of our revenues. We sell approximately 24,600 different
types of non-prescription, or front-end, products. No single front-end product
category contributed significantly to our sales during fiscal 2001 although
certain front-end product classes contributed notably to our sales. Our
principal classes of products are the following:
Fiscal Year 2001
Percentage of
Product Class Sales/Revenues
------------- --------------
Prescription drugs ....................... 59.5%
Over-the-counter and personal care ....... 10.9
Health and beauty aids ................... 5.8
General merchandise and other ............ 23.8
We offer over 1,500 products under the Rite Aid private label brand, which
contributed approximately 10.0% of our front-end sales in fiscal 2001. During
fiscal 2001, we added 159 products under our private label. We intend to
increase the number and the sales of our private label brand products.
We have a strategic alliance with GNC under which we plan to open, own and
operate a minimum of 1,000 GNC "stores-within-Rite Aid-stores" across the
country by July 2003. GNC is a leading nationwide retailer of vitamin and
mineral supplements and personal care, fitness and other health-related
products. As of March 3, 2001, we operated 605 GNC stores-within-Rite Aid-
stores. We plan to open 220 GNC stores-within-our-stores during fiscal 2002.
Our strategy is to locate our stores at convenient locations in fast-growing
metropolitan areas. As of March 3, 2001, we have a first or second place
market position in 34 of the 65 major U.S. metropolitan markets in which we
operate. We have significantly reduced our store development program in order
to focus our efforts and resources on improving the operations of our existing
store base. Consistent with our operating strategy, during fiscal 2001, we
opened 9 new stores, relocated 63 stores, remodeled 98 stores and closed 163
stores. Our current plan for fiscal 2002 is to open approximately 6 new
stores, relocate 25 stores and remodel 76 stores. Our fiscal 2002 planned
store openings and relocations are not concentrated in any specific geographic
region.
5
The table below identifies the number of stores by state as of March 3,
2001:
State
----- Store Count
-----------
Alabama................................................... 129
Arizona................................................... 3
California................................................ 598
Colorado.................................................. 31
Connecticut............................................... 45
Delaware.................................................. 26
District of Columbia...................................... 8
Georgia................................................... 52
Idaho..................................................... 22
Indiana................................................... 8
Kentucky.................................................. 124
Louisiana................................................. 96
Maine..................................................... 82
Maryland.................................................. 154
Michigan.................................................. 345
Mississippi............................................... 32
Nevada.................................................... 37
New Hampshire............................................. 40
New Jersey................................................ 177
New York.................................................. 406
Ohio...................................................... 281
Oregon.................................................... 72
Pennsylvania.............................................. 369
Tennessee................................................. 51
Texas..................................................... 5
Utah...................................................... 30
Vermont................................................... 13
Virginia.................................................. 162
Washington................................................ 139
West Virginia............................................. 110
Wyoming................................................... 1
-----
Total.................................................. 3,648
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Technology. All of our stores are integrated into a common information
system, which enables us to fill prescriptions with increased accuracy and
efficiency and that can be expanded to accommodate new stores. Additionally,
each of our stores employs point-of-sale technology that facilitates inventory
replenishment, sales analysis and recognition of customer trends. As of March
3, 2001, we had installed ScriptPro automated pharmacy dispensing units which
are linked to our pharmacists' computers and fill and label prescription drug
orders, in 871 stores. In fiscal 2001, we developed and implemented several
new technologies and applications, including productivity improvements related
to our piece picking and inventory movement management. We also made
modifications to our proprietary pharmacy information system in order to
improve its user interface and information output. We also simplified our cash
register or point of sale processes. Our customers may also order prescription
refills over the Internet through drugstore.com or over the phone through our
telephonic rapid automated refill systems.
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Suppliers. During fiscal 2001, we purchased approximately 93% of the dollar
volume of our prescription drugs from a single supplier, McKesson HBOC, Inc.
under a contract which runs until April 2004. Under the contract, McKesson
HBOC has agreed to sell to us all of our requirements of branded
pharmaceutical products. With limited exceptions, we are required to purchase
all of our branded pharmaceutical products from McKesson HBOC. We purchase
generic (non-brand name) pharmaceuticals from a variety of sources on an
exclusive basis and generic pharmaceutical products on a non-exclusive basis.
If our relationship with McKesson HBOC was disrupted, we could have difficulty
filling prescriptions, which would negatively affect our business. We purchase
our non-pharmaceutical merchandise from numerous manufacturers and
wholesalers. We believe that competitive sources are readily available for
substantially all of the non-pharmaceutical merchandise we carry and that the
loss of any one supplier would not have a material effect on our business.
During fiscal 2001, we made significant efforts to resolve prior issues and
disputes and to improve our relationships with our suppliers and vendors and
we believe these efforts have been successful.
We sell 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 developed by GNC,
and along with our Rite Aid brand vitamin and mineral supplements, are
manufactured by GNC.
Customers. During fiscal 2001, our stores served an average of 1.9 million
customers per day as compared to an average of 1.8 million customers per day
in fiscal 2000. The loss of any one customer would not have a material adverse
impact on our results of operations. No single customer accounted for more
than 10% of our total sales.
Competition. The retail drugstore industry is highly competitive. In the
sale of prescription drugs, we compete with, among others, retail drugstore
chains, independently owned drugstores, mass merchandisers, supermarkets,
discount stores and mail order pharmacies. We compete on the basis of store
location and convenient access, customer service, product selection and price.
Employees. As of March 3, 2001, we had 75,500 employees. Approximately 12%
of these employees are pharmacists. There is a national shortage of
pharmacists. Our management is implementing various employee incentive plans
in order to attract and retain qualified pharmacists. We believe that our
relationships with our employees are good.
Research and Development. We do not make significant expenditures for
research and development.
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.
Regulation
Our 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 we 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. The legislative initiatives include prescription drug benefit
proposals for Medicare participants. Although we believe we are well
positioned to respond to these developments, we cannot predict the outcome or
effect of legislation resulting from these reform efforts. Also, in recent
years, both 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.
7
PBM Segment
On October 2, 2000, we consummated the sale of PCS to Advance Paradigm (now
known as AdvancePCS) for $710.5 million in cash, equity securities of
AdvancePCS and AdvancePCS's $200.0 million 11% promissory notes. In March
2001, we sold the AdvancePCS equity securities in an underwritten public
offering for a total of $284.1 million (net of selling commissions) and
AdvancePCS paid the promissory note in full plus accrued and unpaid interest.
We applied $1,093.5 million of the proceeds from the sale of PCS to reduce our
debt. We recorded a loss on disposal of $168.8 million in fiscal 2001 as a
result of the sale.
Item 2. Properties
We own our corporate headquarters, which are 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 3,358 of our drugstore
facilities under non-cancelable leases, many of which have original terms of
10 to 22 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 our leases contain renewal options, some of which involve rent
increases.
As of March 3, 2001, we operated 3,648 retail drugstores. The overall
average size of each store in our chain is 12,663 square feet. The stores on
the east coast average 9,502 square feet per store. The west coast stores
average 20,802 square feet per store. The central stores average 10,323 square
feet per store.
We operate the following distribution centers and overflow storage
locations, which we own or lease as indicated:
Approximate
Owned or Square
Location Leased Footage
-------- ------ -------
Rome, New York ........................... Owned 291,000
Rome, New York(1) ........................ Leased 71,400
Utica, New York(1) ....................... Leased 115,000
Poca, West Virginia ...................... Owned 264,000
Dunbar, West Virginia(1) ................. Leased 61,000
South Nitro, West Virginia(1) ............ Leased 50,000
Perryman, Maryland ....................... Leased 885,000
Tuscaloosa, Alabama ...................... Owned 238,000
Tuscaloosa, Alabama(1) ................... Leased 27,000
Cottondale, Alabama(1) ................... Leased 125,000
Pontiac, Michigan ........................ Owned 362,000
Woodland, California ..................... Owned 521,300
Woodland, California(1) .................. Leased 200,000
Wilsonville, Oregon ...................... Leased 518,000
Lancaster, California .................... Leased 917,000
- ---------------
(1) Overflow storage locations.
The original terms of the leases for our 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.
We also own a 52,200 square foot ice cream manufacturing facility located in
El Monte, California.
On a regular basis and as part of our normal business, we evaluate store
performance and may reduce its size, close or relocate a store if the store is
redundant, under performing or otherwise deemed unsuitable. When we reduce in
size, close or relocate a store, we often continue to have leasing obligations
or own the property, but we attempt to sublease the space. As of March 3,
2001, we subleased 5,558,000 square feet of space and an additional 4,019,000
square feet of space in closed or relocated stores was not subleased.
8
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. We are cooperating fully with the SEC
and the United States Attorney.
The U.S. Department of Labor has commenced an investigation of matters
relating to our employee benefit plans, including our principal 401(k) plan,
which permitted employees to purchase our common stock. Purchases of our
common stock under the plan were suspended in October 1999. In January 2001,
we appointed an independent trustee to represent the interests of these plans
in relation to us and to investigate possible claims the plans may have
against us. Both the independent trustee and the Department of Labor have
asserted that the plans may have claims against us. The investigations, with
which we are cooperating fully, are ongoing and we cannot predict their
outcomes. In addition, a purported class action lawsuit on behalf of the plans
and their participants has been filed by a participant in the plans in the
United States District Court for the Eastern District of Pennsylvania.
These investigations are ongoing and we cannot predict their outcomes. If we
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 us could also
have a material adverse effect on our results of operations, financial
condition and cash flows.
Stockholder Litigation
We, certain of our directors, our former chief executive officer Martin
Grass, our former president Timothy Noonan, our former chief financial officer
Frank Bergonzi, and our former auditor KPMG LLP, have been sued in a number of
actions, most of which purport to be class actions, brought on behalf of
stockholders who purchased our securities on the open market between May 2,
1997 and November 10, 1999. All of these cases have been consolidated in the
U.S. District Court for the Eastern District of Pennsylvania. On November 9,
2000, we announced that we had reached an agreement to settle the consolidated
securities class action lawsuits pending against us in the U.S. District Court
for the Eastern District of Pennsylvania and the derivative lawsuits pending
there and in the Delaware Court of Chancery. Under the agreement, which has
been submitted to the U.S. District Court for the Eastern District of
Pennsylvania for approval, we will pay $45 million in cash, which will be
fully funded by our officers' and directors' liability insurance, and issue
shares of common stock in 2002. The shares will be valued over a 10 day
trading period in January 2002. If the value determined is at least $7.75 per
share, we will issue 20 million shares. If the value determined is less than
$7.75 per share, we have the option to deliver any combination of common
stock, cash and short-term notes, with a total value of $155 million. As
additional consideration for the settlement, we have assigned to the
plaintiffs all of our claims against the above named executives and KPMG LLP.
Several members of the class have elected to "opt-out" of the class and, as a
result, if the settlement is approved by the court, they will be free to
individually pursue their claims. Management believes that their claims,
individually and in the aggregate, are not material.
9
Drug Pricing and Reimbursement Matters
On October 5, 2000, we settled, for an immaterial amount, and without
admitting any violation of the law, the lawsuit filed by the Florida Attorney
General alleging that our non-uniform pricing policy for cash prescription
purchases was unlawful under Florida law.
The filing of the complaint by the Florida Attorney General, and our press
release issued in conjunction therewith, precipitated the filing of a
purported federal class action in California and several purported state class
actions, all of which (other than those pending in New York that were filed on
October 5, 1999 and those pending in California that were filed on January 3,
2000) have been dismissed. A motion to dismiss the action in New York is
currently pending. We believe that the remaining lawsuits are without merit
under applicable state consumer protection laws. As a result, we intend to
continue to vigorously defend against them and we do not anticipate that if
fully adjudicated, they will result in an award of damages. However, such
outcomes cannot be assured and a ruling against us could have a material
adverse effect on the financial position and results of operations of the
company as well as necessitate substantial additional expenditures to cover
legal costs as we pursue all available defenses.
We are being investigated by multiple state attorneys general for our
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. We believe 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. We also believe that our existing policies and
procedures fully comply with the requirements of applicable law and intend to
fully cooperate with these investigations. We cannot, however, predict their
outcomes at this time.
An individual acting on behalf of the United States of America, has filed a
lawsuit in the United States District Court for the Eastern District of
Pennsylvania under the Federal False Claims Act alleging that we defrauded
federal health care plans by failing to appropriately issue refunds for
partially filled prescriptions and prescriptions which were not picked up by
customers. The Department of Justice has not decided whether to join this
lawsuit, as is its right under the law, and its investigation is continuing.
We have filed a motion to dismiss the complaint for failure to state a claim.
If any of these cases result in a substantial monetary judgment against us
or is settled on unfavorable terms, our results of operations, financial
position and cash flows could be materially adversely affected.
Store Management Overtime Litigation
We are a defendant in a class action pending in the California Superior
Court in San Diego with three subclasses, comprised of our California store
managers, assistant managers and managers-in-training. The plaintiffs seek
back pay for overtime not paid to them and injunctive relief to require us to
treat our store management as non-exempt. They allege that we decided to
minimize labor costs by causing managers, assistant managers and managers-in-
training to perform the duties and functions of associates for in excess of
forty hours per week without paying them overtime. We believe that in-store
management were and are properly classified as exempt from the overtime
provisions of California law. We have filed a motion to decertify the class
which is currently pending. Our results of operations and financial position
could be materially adversely affected by an adverse judgment in this matter.
Other
We are subject from time to time to lawsuits arising in the ordinary course
of business. In the opinion of our management, these matters are adequately
covered by insurance or, if not so covered, are without merit or are of such
nature or involve amounts that would not have a material adverse effect on our
financial condition, results of operations or cash flows if decided adversely.
10
Item 4. Submission of Matters to a Vote of Security Holders
On December 6, 2000, we held our 2000 Annual Meeting of Stockholders. At the
2000 Annual Meeting, our stockholders:
1. Elected three directors to hold office until the Annual Meeting of
Stockholders in 2003 by the following votes:
(a) William J. Bratton ................... For: 313,733,384* Against: 70,375 Abstain: 7,560,123
(b) Stuart M. Sloan ...................... For: 314,415,440* Against: 65,175 Abstain: 6,883,267
(c) Jonathan D. Sokoloff ................. For: 314,366,614* Against: 70,375 Abstain: 6,926,893
Following the 2000 Annual Meeting of Stockholders, the following persons
continued to serve as our Directors: Robert G. Miller, Alfred M. Gleason, Alex
Grass (resigned January 4, 2001), Leonard I. Green, Nancy A. Lieberman, Mary
F. Sammons, Leonard N. Stern and Gerald Tsai, Jr.
2. Approved, adopted and ratified our 2000 Omnibus Equity Plan by the
following vote:
For: 156,023,933* Against: 22,955,892 Abstain: 2,323,130
3. Declined to adopt a stockholder proposal to sell our company to the
highest bidder by the following vote:
For: 17,029,174 Against: 160,168,193* Abstain: 4,126,718
4. Declined to adopt a stockholder proposal requesting that our management
prepare and make public an employment diversity report by the following vote:
For: 12,121,942 Against: 163,783,162* Abstain: 5,397,853
5. Declined to adopt a stockholder proposal to declassify our Board of
Directors by the following vote:
For: 23,303,172 Against: 153,228,708* Abstain: 4,768,656
An asterisk "*" indicates that the results include 58,722,800 votes cast in
respect of all of the outstanding shares at the time of the 2000 Annual
Meeting of Stockholders of our 8% series B cumulative convertible pay-in-kind
preferred stock.
There were 140,060,927; 140,039,797; 140,060,925; and 140,063,346 broker
non-votes for each of Item 2, Item 3, Item 4 and Item 5, respectively.
11
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
Our common stock is listed on the New York and Pacific Stock Exchanges under
the symbol "RAD". On May 4, 2001, we had approximately 11,719 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 Year Quarter High Low Dividend
----------- ------- ---- --- --------
2002 (through May 18, 2001).............. First 9 5 1/4 --
2001..................................... First 8 1/2 4 3/4 --
Second 8 1/2 4 --
Third 4 3/8 2 7/16 --
Fourth 6 3/32 1 3/4 --
2000..................................... First 41 3/4 21 $.1150
Second 26 15/16 17 1/2 $.1150
Third 20 1/8 4 1/2 $.1150
Fourth 13 1/4 6 3/8 --
We have not declared or paid any cash dividends on our common stock since
the third quarter of fiscal 2000 and we do not anticipate paying cash
dividends in the foreseeable future. Our credit facilities do not allow us to
pay cash dividends and we anticipate that any credit facility we enter into in
connection with a refinancing of our indebtedness will not allow us to pay
cash dividends. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Credit Facilities and Debt
Restructuring."
Recent sales of unregistered securities. On October 27, 1999, we sold to
Green Equity Investors III, L.P. 3,000,000 shares of our series A cumulative
convertible pay-in-kind 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 our 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 votes with the holders of our common
stock and each holder of series B preferred stock has one vote for each share
of the common stock issuable upon conversion of the holder's series B
preferred stock. The holders of our series B preferred stock are also entitled
to vote separately as a class to elect two directors to our Board of
Directors. Leonard I. Green and Jonathan D. Sokoloff are the series B
directors. When issued, the series B preferred stock was convertible into
shares of our common stock at a conversion price of $11.00 per share subject
to adjustment. As a result of the exchange of our bank debt for shares of our
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, we issued a warrant to J.P. Morgan Ventures
Corporation, an affiliate of J.P. Morgan, to purchase 2,500,000 shares of our
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 our
PCS and RCF facilities in October 1999.
On June 14, 2000, certain lenders, including J.P. Morgan Ventures
Corporation, exchanged an aggregate of $284.8 million of their loans
outstanding under the PCS credit facility, the RCF credit facility and the
$300.0 million demand note into an aggregate of 51,785,434 shares of our
common stock at an exchange rate of $5.50 per share.
On June 14, 2000, we issued $374.3 million of our 10.5% senior secured notes
due 2002 in exchange for $52.5 million of our outstanding 5.5% notes due
December 2000 and $321.8 million of our outstanding 6.7% notes due December
2001. We also entered into an agreement with J.P. Morgan and another 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.
12
The series A preferred stock, the series B preferred stock, the warrant, the
10.5% senior secured notes due 2002 and our common stock issued in exchange
for certain of our bank debt were issued in transactions exempt from
registration in reliance on Section 4(2) of the Securities Act.
On June 26, 2000, the holders of approximately $177.8 million principal
amount of our 5.25% convertible subordinated notes due 2002 exchanged these
notes for an aggregate of 17,779,000 shares of our 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.
On November 10, 2000, the holders of approximately $79.9 million principal
amount of our 5.25% convertible subordinated notes due 2002 and $12.3 million
principal amount of our 6.0% dealer remarketable securities due 2003 exchanged
these notes for an aggregate of 9,222,200 shares of our 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.
On January 23, 2001, the holders of approximately $5.5 million principal
amount of our 6.0% senior notes due 2005 and $2.0 million principal amount of
our 7.625% senior notes due 2005 exchanged these notes for an aggregate of
862,500 shares of our 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.
On January 26, 2001, the holders of approximately $15.0 million principal
amount of our 5.25% convertible subordinated notes due 2002 exchanged these
notes for an aggregate of 1,875,000 shares of our 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.
On January 30, 2001, the holders of approximately $20.0 million principal
amount of our 5.25% convertible subordinated notes due 2002 exchanged these
notes for an aggregate of 2,600,000 shares of our 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.
On March 14, 2001, the holders of approximately $201.4 million principal
amount of our 5.25% convertible subordinated notes due 2002 exchanged these
notes for an aggregate of 29,204,160 shares of our common stock. The common
stock was issued in an exchange offer exempt from registration in reliance on
section 3(a)(9) of the Securities Act.
On March 14, 2001, the holders of approximately $77.9 principal amount of
our 6.0% dealer remarketable securities due 2003 exchanged these notes for an
aggregate of 12,072,175 shares of our common stock. The common stock was
issued in an exchange offer exempt from registration in reliance on Section
3(a)(9) of the Securities Act.
On April 6, 2001, the holders of approximately $3.9 million principal amount
of our 5.25% convertible subordinated notes due 2002 and $2.0 million
principal amount of our 6.0% dealer remarketable securities due 2003 exchanged
these notes for an aggregate of 856,000 shares of our 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.
The following described transactions make up the $527 million in new equity
and debt securities we have committed to issue or have issued as of May 16,
2001 in connection with the refinancing plan we announced on May 16, 2001 and
which is described under the caption "Recent Event" in Item 1 of this Annual
Report.
o On March 22 and May 2, 2001, respectively, we agreed to issue 22.7
million and 3.8 million shares of common stock at $5.50 and $6.50 per
share, respectively (an aggregate of $149.6 million). The shares of
common stock will be issued in a transaction exempt from registration in
reliance on Section 4(2) of the Securities Act.
o On April 25, 2001, the holders of approximately $11.0 million principal
amount of our 10.5% senior secured notes due 2002 exchanged these notes
for an aggregate of 1,925,000 shares of our common
13
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.
o On April 25, 2001, the holders of approximately $5.0 million principal
amount of our 10.5% senior secured notes due 2002 exchanged these notes
for an aggregate of 785,000 shares of our 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.
o On April 27, 2001, we agreed with (i) holders of our RCF credit facility
to exchange $10.0 million principal amount of indebtedness under the RCF
credit facility, and (ii) holders of our PCS credit facility to exchange
$5.0 million principal amount of indebtedness under the PCS credit
facility, for an aggregate of 2,144,936 shares of our common stock. The
common stock will be issued in a transaction exempt from registration in
reliance on Section 4(2) of the Securities Act.
o As amended on April 30, 2001, pursuant to an agreement entered into on
April 12, 2001, we agreed to exchange approximately $132.7 million
principal amount of indebtedness under our RCF credit facility for
21,216,772 shares of our common stock. The shares of common stock will be
issued in a transaction exempt from registration in reliance on Section
4(2) of the Securities Act.
o On May 2, 2001, holders of our RCF credit facility agreed to exchange
$10.0 million principal amount of indebtedness for an aggregate of
1,443,814 shares of our common stock. The shares of common stock will be
issued in a transaction exempt from registration in reliance on Section
4(2) of the Securities Act.
o On May 15, 2001, a holder of our RCF credit facility exchanged $10.0
million principal amount of indebtedness under the credit facility for an
aggregate of 1,473,405 shares of our common stock. The common stock was
issued in a transaction exempt from registration in reliance on Section
4(2) of the Securities Act.
o On May 16, 2001, we agreed to issue five year warrants to purchase
approximately 3.0 million shares of common stock at $6.00 per share.
These warrants will be issued in connection with the exchange by a
holder of $152.0 million of our 10.5% senior secured notes due 2002 for
a like principal amount of new 12.5% senior secured notes due 2006. The
warrants will be issued in a privately negotiated transaction exempt
from registration in reliance on Sections 3(a)(9) of the Securities
Act.
o We have also committed in three additional transactions to issue shares
of our common stock in exchange for an aggregate of $40.3 million of our
10.5% senior secured notes due 2002 and $2.2 million of our RCF credit
facility. The number of shares to be issued in each transaction will
depend on the average price of our common stock in the pricing period
contained in the agreement relating to the transaction. The shares of
common stock will be issued in privately negotiated transactions exempt
from registration in reliance on Section 3(a)(9) and Section 4(2),
respectively, of the Securities Act.
Item 6. Selected Financial Data
The following selected financial data should be read in conjunction with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and the audited consolidated financial statements and related
notes appearing on pages F-1 through F-40. Selected financial data is
presented for four fiscal years. As previously discussed in our 10-K/A dated
October 11, 2000, substantial time, effort and expense was required over a six
month period to review, assess, reconcile, prepare and audit our financial
statements for fiscal 2000, fiscal 1999 and fiscal 1998. We believe it would
require an unreasonable effort and expense to conduct a similar process
related to fiscal year 1997. Certain reclassifications have been made to prior
years' amounts to conform to current year classifications.
14
Fiscal Year Ended
--------------------------------------------------------------------------
March 3, 2001 February 26, 2000 February 27, 1999 February 28, 1998
(53 weeks) (52 weeks) (52 weeks) (52 weeks)
------------- ----------------- ----------------- -----------------
(In thousands, except per share amounts and other data)
Summary of Operations:
REVENUES ............................................ $ 14,516,865 $ 13,338,947 $ 12,438,442 $ 11,352,637
COSTS AND EXPENSES:
Cost of goods sold, including occupancy costs ...... 11,151,490 10,213,428 9,406,831 8,419,021
Selling, general and administrative expenses ....... 3,458,307 3,607,810 3,200,563 2,773,560
Goodwill amortization .............................. 20,670 24,457 26,055 26,169
Store closing and impairment charges ............... 388,078 139,448 195,359 155,024
Interest expense ................................... 649,926 542,028 274,826 202,688
Loss on debt conversions and modifications ......... 100,556 -- -- --
Share of loss from equity investments .............. 36,675 15,181 448 1,886
Gain on sale of fixed assets ....................... (6,030) (80,109) -- (52,621)
------------ ------------ ------------ ------------
15,799,672 14,462,243 13,104,082 11,525,727
------------ ------------ ------------ ------------
Loss from continuing operations before income taxes
and cumulative effect of accounting change........ (1,282,807) (1,123,296) (665,640) (173,090)
INCOME TAX EXPENSE (BENEFIT) ........................ 148,957 (8,375) (216,941) (28,064)
Loss from continuing operations before cumulative
effect of accounting change....................... (1,431,764) (1,114,921) (448,699) (145,026)
INCOME (LOSS) FROM DISCONTINUED OPERATIONS,
including income tax expense (benefit) of $13,846,
$30,903, $(5,925) and $(10,885).................... 11,335 9,178 (12,823) (20,214)
Loss on disposal of discontinued operations, net of
tax benefit of $734............................... (168,795) -- -- --
CUMULATIVE EFFECT OF ACCOUNTING CHANGE, net of
income tax benefit of $18,200...................... -- (27,300) -- --
------------ ------------ ------------ ------------
Net loss.......................................... $ (1,589,224) $ (1,133,043) $ (461,522) $ (165,240)
============ ============ ============ ============
BASIC AND DILUTED (LOSS) INCOME PER SHARE:
Loss from continuing operations................... $ (5.15) $ (4.34) $ (1.74) $ (0.58)
Income (loss) from discontinued operations ......... (0.50) 0.04 (0.05) (0.08)
Cumulative effect of accounting change, net ........ -- (0.11) -- --
------------ ------------ ------------ ------------
Net loss per share................................. $ (5.65) $ (4.41) $ (1.79) $ (0.66)
============ ============ ============ ============
Year-End Financial Position:
Working capital (deficit)......................... $ 1,955,877 $ 752,657 $ (892,115) $ 1,258,580
Property, plant and equipment (net)............... 3,041,008 3,445,828 3,328,499 2,460,513
Total assets...................................... 7,913,911 9,845,566 9,778,451 7,392,147
Total debt ....................................... 5,894,548 6,612,868 5,922,504 3,132,894
Redeemable preferred stock........................ 19,457 19,457 23,559 --
Stockholders' equity.............................. (354,435) 432,509 1,339,617 1,898,203
Other Data:
Cash dividends declared per common share.......... $ 0 $ .3450 $ .4375 $ .4075
Basic weighted average shares..................... 314,189,000 259,139,000 258,516,000 250,659,000
Diluted weighted average shares................... 314,189,000 259,139,000 258,516,000 250,659,000
Number of retail drugstores....................... 3,648 3,802 3,870 3,975
Number of employees............................... 75,500 77,300 89,900 83,000
(Footnotes on next page)
15
- ---------------
(1) PCS was acquired on January 22, 1999. On October 2, 2000, we sold PCS. See
"Business--PBM Segment." Accordingly, our PBM segment is reported as a
discontinued operation for all periods presented. See note 24 of the notes
to the consolidated financial statements.
(2) K&B, Incorporated and Harco, Inc. were acquired in August 1997.
(3) Total debt includes capital lease obligations of $1.1 billion, $1.1
billion, $1.1 billion and $622 million as of March 3, 2001, February 26,
2000, February 27, 1999 and February 28, 1998, respectively.
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Overview
Management believes that the following matters should be considered in
connection with the discussion of results of operations and financial
condition:
Recent Actions Affecting Operating Results. During fiscal 2001, we took a
number of actions which had the short term effect of significantly reducing
our operating results but which management believes were nevertheless
necessary. Among the actions taken were: (i) the sale of PCS which resulted in
our recognizing a loss of $168.8 million and an increase in income tax expense
of $146.9 million; (ii) the exchange of approximately $597.3 million of our
debt for shares of our common stock which resulted in a net loss of $100.6
million; (iii) our decision to close or relocate certain stores that resulted
in an approximate $149.2 million charge included in the $388.1 million
recorded charges for store closures and impairment; and (iv) the restatement
and audit of our fiscal 1999 and 1998 financial statements and the related
investigation conducted by our audit committee of prior accounting
irregularities resulted in our incurring and recording of $82.1 million of
accounting and legal expense. We anticipate taking similar actions in the
future that may have a material negative impact upon our operating results for
the period in which we take those actions or subsequent periods. We also
expect to incur significant costs and fees in connection with the refinancing
described under "Recent Event".
Maturing Store Base. Since the beginning of fiscal 1997, we built 466 new
stores, relocated 945 stores, remodeled 406 and closed 1,139 stores. These
new, relocated and remodeled stores represented approximately 49.8% of our
total stores at March 3, 2001 and are generally larger, free standing stores
and have higher operating expenses than our older stores. New stores generally
do not become profitable until a critical mass of customers is developed.
Relocated stores also must attract additional customers to achieve comparable
profitability to the store that was replaced. We believe that the period of
time required for a new store to achieve profitable operations is generally
between two and four years. This period can vary significantly based on the
location of a particular store and on other factors, including the investments
made in purchasing prescription files for the location and advertising. Our
recent liquidity constraints have limited our ability to purchase prescription
files and make other investments to promote the development of our new and
relocated stores. We believe that our relatively high percentage of new and
relocated stores is a significant factor in our recent operating results.
Management believes that as these newer stores mature they should gain the
critical mass of customers needed for profitable operations. We believe this
continuing maturation should positively affect our operating performance in
future periods. If we are not able to improve the performance of these new and
relocated stores, it will have a material adverse effect on our ability to
restore the profitability of our operations.
Substantial Investigation Expenses. We have incurred substantial expenses
in connection with the process of reviewing and reconciling our books and
records, restating our 1998 and 1999 financial statements, investigating our
prior accounting practices and preparing our financial statements. Included in
these expenses are the costs of the Deloitte & Touche LLP audits, the
investigation by the law firm of Swidler, Berlin, Shereff, Friedman, assisted
by Deloitte & Touche LLP, conducted for our audit committee concerning the
accounting irregularities which led to the restatement of our financial
statements for our 1999 and 1998 fiscal years and the costs of retaining
Arthur Andersen LLP to assist management in reviewing and reconciling our
books and records. We incurred $82.1 million in fiscal 2001 and we expect to
incur $10.0 million to $15.0 million in fiscal 2002. We anticipate that we
will continue to incur significant legal and other expenses in connection with
the ongoing litigation and investigations to which we are subject.
16
Dilutive Equity Issuances. In June 2000, we 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 our common stock were issued in exchange for $462.6
million principal amount of our outstanding indebtedness. In addition, in
November 2000, January 2001 and April 2001, we completed numerous privately
negotiated transactions, and in connection with these transactions, an
aggregate total of 18,125,700 shares of our common stock were issued in
exchange for approximately $156.6 million principal amount of our outstanding
indebtedness. In March 2001, we also exchanged approximately $279.3 million
principal amount of outstanding indebtedness for an aggregate of 41,276,335
shares of our common stock upon completion of a public tender offer. As a
result of these exchanges, we recorded an aggregate loss on conversion of
approximately $100.6 million in fiscal 2001 and will record additional losses
in fiscal 2002. In addition, pursuant to the conversion price adjustment and
pay-in-kind dividend provisions of the series B convertible preferred stock
issued to Green Equity Investors III, L.P. in October 1999, 61,095,219 shares
of our common stock were issuable upon the conversion of such preferred stock
at March 31, 2001. Assuming the transactions which occurred subsequent to
March 3, 2001 and prior to May 4, 2001 had occurred on March 3, 2001, the
common shares outstanding would have increased from 348,055,000 to
392,868,382. In light of our substantial leverage and liquidity constraints,
we will continue to consider opportunities to use our equity securities to
discharge debt or other obligations that may arise. Such issuances will have a
dilutive effect on the outstanding shares of our common stock.
Accounting Systems. Following its review of our books and records,
management concluded that further steps were needed to establish and maintain
the adequacy of our internal accounting systems and controls. In connection
with the audit of our financial statements, Deloitte & Touche LLP advised us
that it believed there were numerous "reportable conditions" under the
standards established by the American Institute of Certified Public
Accountants which relate to our accounting systems and controls and could
adversely affect our ability to record, process, summarize and report
financial data consistent with the assertions of management in the financial
statements. We are developing and implementing comprehensive, adequate and
reliable accounting systems and controls which address the reportable
conditions identified by Deloitte & Touche LLP.
Sale of PCS. On October 2, 2000, we sold PCS, our PBM segment, to Advance
Paradigm (now AdvancePCS). The selling price of PCS consisted of $710.5
million in cash, $200.0 million in principal amount of AdvancePCS's 11%
promissory notes and AdvancePCS equity securities. Accordingly, the PBM
segment is reported as a discontinued operation for all periods presented in
the accompanying financial statements, and the operating income of the PBM
segment through October 2, 2000, the date of sale, is reflected separately
from the income from continuing operations. The loss on disposal of the PBM
segment was $168.8 million. Additionally, we recorded an increase to the tax
valuation allowance and income tax expense of $146.9 million in the first
quarter of fiscal 2001 in continuing operations.
Working Capital. We generally finance our 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. Over
75% of our front-end sales are in cash. Third-party insurance programs, which
typically settle in fewer than 30 days, accounted for 90.3% of our pharmacy
sales and 53.7% of our revenues in fiscal 2001.
Seasonality. We experience seasonal fluctuations in our results of operations
in the fourth quarter as the result of the seasonal nature of Christmas and the
flu season. We tailor certain front-end merchandise to capitalize on holidays
and seasons.
17
Results of Operations
Year Ended
------------------------------------------
March 3, February 26, February 27,
2001 2000 1999
----------- ------------ ------------
(dollars in thousands)
Sales..................................................... $14,516,865 $13,338,947 $12,438,442
Sales growth.............................................. 8.8% 7.2% 9.6%
Same store sales growth................................... 9.1% 7.9% 15.5%
Pharmacy sales growth..................................... 8.7% 15.6% 18.2%
Same store pharmacy sales growth.......................... 10.9% 16.2% 21.9%
Pharmacy as a % of total sales............................ 59.5% 58.4% 54.2%
Third-party sales as a % of total pharmacy sales.......... 90.3% 87.8% 85.4%
Front-end sales growth.................................... 3.8% (2.6)% 0.8%
Same store front-end sales growth......................... 6.5% (2.2)% 6.6%
Front-end as a % of total sales........................... 40.5% 41.6% 45.8%
Store data:
Total stores (beginning of period) ...................... 3,802 3,870 3,975
New stores .............................................. 9 77 163
Closed stores ........................................... (163) (181) (330)
Store acquisitions, net ................................. -- 36 62
Total stores (end of period) ............................ 3,648 3,802 3,870
Remodeled stores ........................................ 98 14 155
Relocated stores ....................................... 63 180 331
Sales
The 8.8% growth in revenues in fiscal 2001 is driven by an increase of 3.8%
in front-end sales, an increase of 8.7% in pharmacy sales and the additional
week in fiscal 2001. Our total revenues growth in fiscal 2000 of 7.2 % was
fueled by strong growth in pharmacy sales, offset by a slight decline in front
end sales. Same store sales growth for fiscal 2001 was 9.1%. As fiscal 2001
was a 53 week year, same store sales are calculated by comparing the 53 week
period ending March 3, 2001 with the 53 week period ending March 4, 2000.
For fiscal 2001 and 2000, pharmacy revenues led sales growth with same store
sales increases of 10.9% and 16.2%, respectively. Fiscal 2001 increases were
generated by our ability to attract and retain managed care customers, our
successful pilot markets for reduced cash pricing, our increased focus on
pharmacy initiatives such as will call and predictive refill, and favorable
industry trends. These favorable trends include an aging population, the use
of pharmaceuticals to treat a growing number of healthcare problems, and the
introduction of a number of successful new prescription drugs. Fiscal 2000
pharmacy increases were driven by favorable industry trends, as well as the
purchase of prescription files from independent pharmacies.
The lower growth in same store pharmacy sales in fiscal 2001 was due
primarily to a significant reduction in the number of prescription files we
purchased and store relocations we effected. The lower growth in fiscal 2000
was due primarily to a reduction as compared to fiscal 1999 in the number of
relocations effected.
Same store front-end sales, which includes all non-prescription sales, such
as seasonal merchandise, convenience items, and food and other non-
prescription sales, increased 6.5% from fiscal 2000. This increase was fueled
by the reinstatement of our weekly circular advertising program, and was also
driven by strong performance in seasonal businesses, consumables, vitamins,
general merchandise and private brands. Same store front-end sales in fiscal
2000 decreased 2.2% from fiscal 1999 levels. This decrease was due to elevated
levels of out-of-stock merchandise in the 3rd and 4th quarters of fiscal 2000,
and the decision of former management to suspend the weekly advertising
program in fiscal 2000 and to raise front-end prices to levels that were not
competitive.
18
Year Ended
------------------------------------------
March 3, February 26, February 27,
2001 2000 1999
----------- ------------ ------------
(dollars in thousands)
Costs of goods sold ............................................................ $11,151,490 $10,213,428 $9,406,831
Gross margin ................................................................... 23.2% 23.4% 24.4%
Selling, general and administrative expenses ................................... $ 3,458,307 $ 3,607,810 $3,200,563
Selling, general and administrative expenses as a percentage of revenues ....... 23.8% 27.0% 25.7%
Goodwill amortization .......................................................... $ 20,670 $ 24,457 $ 26,055
Store closing and impairment charges ........................................... 388,078 139,448 195,359
Interest expense ............................................................... 649,926 542,028 274,826
Loss on debt conversions and modifications ..................................... 100,556 -- --
Share of loss from equity investments .......................................... 36,675 15,181 448
Gain on sale of fixed assets ................................................... (6,030) (80,109) --
Cost of Goods Sold
Gross margin was 23.2% for fiscal 2001 compared to 23.4% in fiscal 2000. The
slight decline in margin is attributable to a shifting in sales mix to
pharmacy from front-end. In fiscal 2001, the percentage of front-end sales to
total sales decreased to 40.5% from 41.6% in 2000. Also contributing to the
lower margin in 2001 was an increase in sales of cigarettes and liquor as a
percentage of front-end sales. Additionally, we incurred $17.5 million in
inventory liquidation losses related to our closed stores. Partially
offsetting the items above was an improvement in the margin of front-end goods
(exclusive of cigarettes and liquor). These increases resulted from a more
profitable product mix, and from increases in the levels of one-hour photo and
phone card sales.
Gross margin declined to 23.4% in fiscal 2000 from 24.4% in fiscal 1999. The
decline in gross margin in fiscal 2000 from fiscal 1999 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. We incurred significant costs in fiscal 2000 in connection with
the 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 2000 were improved
store level margins for front-end and pharmacy sales.
Also negatively impacting gross margins in the periods presented was the
continuing industry trend of rising third-party sales coupled with decreasing
margins on third-party reimbursed prescription sales. Third-party prescription
sales typically have lower gross margins than other prescription sales because
they are paid by a person or entity other than the recipient of the prescribed
pharmaceutical and are generally subject to lower negotiated reimbursement
rates in conjunction with a pharmacy benefit plan. Pharmacy sales as a
percentage of total sales were 59.5%, 58.4% and 54.2% in fiscal 2001, 2000 and
1999, respectively and third-party sales as a percentage of pharmacy sales
were 90.3%, 87.8%, and 85.4% in fiscal 2001, 2000 and 1999, respectively.
We use the last-in, first-out (LIFO) method of inventory valuation. The LIFO
charge was $40.7 million in fiscal 2001, $34.6 million in fiscal 2000 and
$36.5 million in fiscal 1999. We have changed our 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 23.8% of sales in
fiscal 2001, 27.0% in fiscal 2000 and 25.7% in fiscal 1999. SG&A expenses for
2001 were favorably impacted by a $20.0 million increase in estimated
insurance recovery related to the settlement of the shareholder's class action
lawsuit, and by $20.0 million received related to the partial settlement of
litigation with certain drug manufacturers. Offsetting these items was $82.1
million incurred in connection with the restatement of our
19
historical financial statements, and the incurrence of $45.9 million in non-
cash expense related to variable plan accounting on certain management stock
options, and restricted stock grants. If these non-operating and non cash
items are excluded, our SG&A as a percentage of revenues would have been
23.2%. SG&A expense for 2000 was unfavorably impacted by a charge of $232.8
million related to litigation issues, offset by a reversal of stock
appreciation rights accruals of $45.5 million. Excluding these non-operating
and non cash items results in an adjusted SG&A as a percentage of sales of
25.6% in fiscal 2000. SG&A on an adjusted basis of 23.2% for fiscal 2001
compares favorably with SG&A on an adjusted basis of 25.6% for fiscal 2000 due
to lower depreciation expense resulting from a net reduction in our store
count, decreased repair and maintenance and terminated project costs, and the
better leveraging of fixed SG&A costs resulting from our higher sales volume.
The increase in SG&A expense as a percent of sales in fiscal 2000 over
fiscal 1999 is predominately attributable to increased accruals for litigation
and other contingencies, as described above.
Store Closing and Impairment Charges
Store closing and impairment charges consist of:
Year Ended
---------------------------------------
March 3, February 26, February 27,
2001 2000 1999
-------- ------------ ------------
(dollars in thousands)
Impairment charges ....................... $214,224 $120,593 $ 87,666
Store lease exit costs ................... 57,668 18,855 107,693
Impairment of investments ................ 116,186 -- --
-------- -------- --------
$388,078 $139,448 $195,359
======== ======== ========
Impairment Charges
In fiscal 2001, 2000 and 1999, store closing and impairment charges include
non-cash charges of $214.2 million, $120.6 million and $87.7 million,
respectively, for the impairment of long-lived assets (including allocable
goodwill) of 495, 249 and 270 stores, respectively. These amounts include the
write-down of long-lived assets to estimated fair value at stores that were
assessed for impairment as part of our on-going review of the performance of
our stores or management's intention to relocate or close the store.
Store Lease Exit Cost
Costs incurred to close a store, which principally consist of lease
termination costs, are recorded at the time management commits to closing the
store, which is the date that the closure is formally approved by senior
management, or in the case of a store to be relocated, the date the new
property is leased or purchased. We calculate our liability for closed stores
on a store-by-store basis. The calculation includes the future minimum lease
payments and related ancillary costs, from the date of closure to the end of
the remaining lease term, net of estimated cost recoveries that may be
achieved through subletting properties or through favorable lease
terminations. As a result of focused efforts on cost recoveries for closed
stores during fiscal 2001, we experienced improved results, which has been
reflected in the assumptions about future sublease income. This liability is
discounted using a risk-free rate of interest. We evaluate these assumptions
each quarter and adjust the liability accordingly.
Impairment of Investments
We have an investment in the common stock of drugstore.com, which is
accounted for under the equity method. The initial investment was valued based
upon the initial public offering price for drugstore.com. During fiscal 2001,
we recorded an impairment of our investment in drugstore.com of $112.1
million. This write-down was based upon a decline in the market value of
drugstore.com's stock that we believe to be other than temporary.
Additionally, we recorded impairment charges of $4.1 million for other
investments.
20
Interest Expense
Interest expense was $649.9 million in fiscal 2001 compared to $542.0
million in fiscal 2000 and $274.8 million in fiscal 1999. The substantial
increase in fiscal 2001 and fiscal 2000 is due to higher average levels of
indebtedness and higher interest rates on debt. In fiscal 2001, we increased
our average outstanding debt with the addition of the $1.1 billion senior
secured credit facility, which includes a $600.0 million term loan and a
$500.0 million revolving credit facility. We used the term loan to terminate
our accounts receivable securitization facility and repurchased $300.0 million
of unpaid receivables thereunder and funded $66.4 million of transaction costs
related to our debt restructuring. The remainder of the term loan together
with the revolving credit facility were used for general corporate purposes,
including reviewing, reconciling and restating our 1998 and 1999 financial
statements, the cost of the audit of our restated financial statements and
investigation costs. These items were partially offset by reductions of
indebtedness in the second half of the fiscal year resulting from the sale of
PCS and debt for equity exchanges. In fiscal 2000, our debt increased as a
result of the $1.3 billion borrowed in January 1999 under the PCS credit
facility and the $300.0 million of demand note borrowings to supplement cash
flows from operating activities. The annual weighted average interest rates on
our indebtedness in fiscal 2001, fiscal 2000 and fiscal 1999 were 8.2%, 7.4%
and 6.8% respectively.
Income Taxes
We had net losses in fiscal 2001, fiscal 2000 and fiscal 1999. Tax expense
of $149.0 and tax benefits of $26.6 million (including the benefit related to
cumulative effect of accounting change) and $216.9 million have been reflected
for fiscal 2001, fiscal 2000 and fiscal 1999, respectively. The full benefit
of the net operating loss carryforwards ("NOLs") generated in each period has
been fully offset by a valuation allowance based on management's determination
that, based on available evidence, it is more likely than not that some of the
deferred tax assets will not be realized. We expect to file amended tax
returns and utilize the NOL's against taxable income in prior years to the
maximum extent possible. It is likely that an "ownership change" for statutory
purposes may occur as a result of our refinancing efforts, including issuances
of equity and exchanges of debt for equity. If an ownership change occurs, the
use of our existing NOLs and possibly our net unrealized built-in losses would
be subject to limitations. Of the $147.6 million recoverable taxes recorded as
of February 26, 2000, we have collected or have offsets of $122.7 million. The
remaining $24.9 million has been reclassified to other non current assets since
we anticipate collection beyond fiscal 2002.
Other Significant Charges
In addition to the operational matters discussed above, our results in the
current fiscal year have been adversely affected by other significant charges.
We recorded a net loss of $168.8 million on the disposal of the PBM segment.
As a result of the decision to dispose of the PBM segment, we recognized an
increase in the income tax valuation allowance of $146.9 million for fiscal
2001. We also recorded a pre-tax loss of $100.6 million on debt conversions
and modifications, and recorded a loss of $36.7 million representing our share
of the drugstore.com losses.
Discontinued Operations
On July 12, 2000, we announced the sale of the PBM segment, at which time
the PBM segment was subjected to discontinued operations accounting. Prior to
becoming a discontinued operation on July 12, 2000, the PBM segment generated
net income of $11.3 million from February 27, 2000 through July 11, 2000,
compared to net income of $9.2 million in fiscal 2000 and a net loss of $12.8
million in fiscal 1999.
Liquidity and Capital Resources
We have two primary sources of liquidity: (i) cash provided by operations
and (ii) the revolving credit facility under our senior secured credit
facility. We may also generate liquidity from the sale of assets, including
sale-leaseback transactions. During fiscal 2001 and fiscal 2000, cash provided
by operations was not sufficient to fund our working capital requirements. 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. On May 15, 2001, we
entered into a commitment letter to refinance a significant portion of our
indebtedness. See "Recent Event".
21
Credit Facilities and June 2000 Debt Restructuring
In June 2000, we completed a major financial restructuring that provided us
with additional liquidity, extended the maturity dates of a substantial amount
of our debt until at least August 2002 and converted a portion of our debt to
equity.
Senior Secured Credit Facility. In June 2000, we entered into a $1.0
billion (which was increased to $1.1 billion in November 2000) senior secured
credit facility with a syndicate of banks led by Citibank N.A., as agent. The
facility matures on August 1, 2002, and consists of a $600.0 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 available for general corporate purposes. The
revolving facility provides us with borrowings for working capital
requirements, capital expenditures and general corporate purposes. Borrowings
under the facilities generally bear interest either at LIBOR plus 3.0%, if we
choose to make LIBOR borrowings, or at Citibank's base rate plus 2%. For
additional information about the interest rates applicable to our credit
facilities, see "Quantitative and Qualitative Disclosures about Market Risks"
below.
We are required to pay fees of 0.50% per annum on the daily unused amount of
the commitment. Substantially all of our wholly-owned subsidiaries guarantee
our obligations under the senior secured credit facility. These subsidiary
guarantees are secured by a first priority lien on the inventory, accounts
receivable, intellectual property and some of the real estate assets of the
subsidiary guarantors. Our direct obligations under the senior credit facility
are unsecured.
The senior secured credit facility contains customary covenants, which place
restrictions on the assumption of debt, the payment of dividends, mergers,
liens and sale-leaseback transactions. The facility requires us to meet
various financial ratios and limits our capital expenditures. In connection
with the additional term loan borrowings in November 2000, we also amended
certain of the financial covenants in this facility to conform to the less
restrictive covenants in our other debt agreements for a limited period of
time. For the three quarters ended March 3, 2001, our covenants required us to
maintain a minimum interest coverage ratio and a minimum fixed charge coverage
ratio of .95:1, increasing to a minimum interest coverage ratio of 1.40:1 and
a minimum fixed charge ratio of 1.19:1 for the four quarters ending June 1,
2002. For the three fiscal quarters ended March 3, 2001, our consolidated
EBITDA (as defined in the senior secured credit facility) was required to be
no less than $364.0 million, increasing to $720.0 million for the four
quarters ending June 1, 2002. In addition, our capital expenditures were
limited to $186.0 million for the three fiscal quarters ended March 3, 2001,
increasing to $243.0 million for the four quarters ending June 1, 2002.
For the three quarters ended March 3, 2001, our EBITDA (as so defined) was
$410.1 million, our interest coverage ratio was 1.07:1, our fixed charge
coverage ratio was 1.03:1 and our capital expenditures were $113.6 million.
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 our 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 March 3, 2001, the $600.0 million term loan was fully drawn and
we had $394.6 million in additional available borrowing capacity under the
revolving facility.
Other Credit Facilities. In June 2000, we extended to August 2002 the
maturity date of our RCF credit facility and our PCS credit facility.
Borrowings under the PCS credit facility bear interest at LIBOR plus 3.25% and
borrowings under the RCF credit facility bear interest at LIBOR plus 3.75%.
These credit facilities contain restrictive covenants which place restrictions
on the assumption of debt, the payment of dividends, mergers, liens and sale-
leaseback transactions. They also require us to satisfy financial covenants
which are generally slightly less restrictive than the covenants in our senior
secured credit facility. The
22
facilities also limit the amount of our capital expenditures to $186.0 million
for the three quarters ended March 3, 2001, increasing to $243.0 million for the
four quarters ending June 1, 2002. We applied $1.1 billion (all of the net
proceeds from the sale of PCS minus certain expenses) to reduce the outstanding
balances of the PCS credit facility and the PCS exchange debt described below.
Under the terms of these facilities, after giving effect to the $100.0 million
increase in the term loan, we are permitted to incur up to an additional $35.0
million of indebtedness under the senior secured credit facility without the
further consent of the lenders. At April 28, 2001, we had $1.1 billion of
borrowings outstanding under these credit facilities and exchange debt. These
facilities are also guaranteed and secured as described below. The RCF credit
facility is secured by a first lien on the stock of drugstore.com.
As part of the restructuring of our debt in June 2000, 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 shares
of our common stock. This resulted in a total of $284.8 million of debt under
these facilities, including $200.0 million of the outstanding principal of the
demand note, being exchanged for an aggregate of 51,785,434 shares of our
common stock at an exchange rate of $5.50 per share. We recorded a gain on
this exchange of debt of $5.2 million in the second quarter of fiscal 2001. An
additional $274.8 million of borrowings under the facilities were exchanged
for the exchange debt, including the entire remaining principal amount of the
demand note. The terms of the exchange debt are substantially the same as the
terms of our RCF and PCS credit facilities and the interest rate is currently
LIBOR plus 3.25%. The lenders of the exchange debt have the same collateral as
they did with respect to their loans under the PCS and RCF credit facilities.
Also, as part of the restructuring of our debt in June 2000, 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.
In connection with modifications to the PCS and RCF credit facilities, the
exchange of debt for exchange debt and the amendment of 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. The holders of exchange debt also
received a first lien on our prescription files. Except to the extent
previously secured, our direct obligations under those facilities and
guarantees remain unsecured.
Debt Covenants. We were in compliance with the covenants of the senior
secured credit facility and our other credit facilities and debt instruments
as of March 3, 2001. With continuing improvements in operating performance, we
anticipate that we will remain in compliance with our debt covenants. However,
variations in our operating performance and unanticipated developments may
adversely affect our ability to remain in compliance with the applicable debt
covenants.
Commercial Paper. Until September 24, 1999, we issued commercial paper
supported by unused credit commitments to supplement cash generated by
operations. Since the loss of our investment grade rating in fiscal 2000, we
are no longer able to issue commercial paper. Our outstanding commercial paper
amounted to $192.0 million at February 26, 2000 and $1,783.1 million at
February 27, 1999. All remaining commercial paper obligations were repaid in
March 2000.
Exchange Offers. In June 2000, we completed the exchange of $52.5 million
of our 5.5% notes due December 2000 and $321.8 million of our 6.7% notes due
December 2001 for an aggregate of $374.3 million of our 10.5% senior secured
notes due September 2002. After the exchange, $147.5 million of the 5.5% notes
due December 2000 and $28.2 million of the 6.7% notes due December 2001
remained outstanding. In connection with the exchange, we entered into a
forward purchase agreement with J.P. Morgan and another financial institution
under which they agreed to purchase $93.2 million of the 10.5% senior secured
notes due 2002. These financial institutions purchased $16.7 million of the
5.5% notes and $20.4 million of the 6.7% notes on July 27, 2000; $53.8 million
of the 5.5% notes on September 13, 2000; and $.5 million of the 6.7% notes on
December 14, 2000; and exchanged the purchased notes with us for the 10.5%
senior secured notes due 2002. The remaining $76.9 million of 5.5% notes due
in December 2000 were retired at maturity with general corporate funds and the
$1.8 million that remained under the forward purchase agreement.
23
On June 26, 2000, we issued 17,779,000 shares of our common stock in
exchange for approximately $177.8 million principal amount of our 5.25%
convertible subordinated notes due 2002. As a result of this exchange, we
recorded a loss of approximately $89.0 million in the second quarter of fiscal
2001.
On November 10, 2000, we issued 9,222,200 shares of our common stock in
exchange for approximately $79.9 million principal amount of our 5.25%
convertible notes due 2002 and $12.3 million principal amount of our 6.0%
dealer remarketable securities due 2003. As a result of this exchange, we
recorded a loss of approximately $8.3 million in the third quarter of fiscal
2001.
On January 23, 2001, we issued 862,500 shares of our common stock in
exchange for approximately $5.5 million principal amount of our 6.0% senior
notes due 2005 and $2.0 million principal amount of our 7.625% senior notes
due 2005. As a result of this exchange, we recorded a gain of approximately
$4.3 million in the fourth quarter of fiscal 2001.
On January 26 and January 30, 2001, we issued an aggregate of 4,475,000
shares of our common stock in exchange for approximately $35.0 million
principal amount of our 5.25% convertible subordinated notes due 2002. As a
result of this exchange, we recorded a loss of approximately $12.8 million in
the fourth quarter of fiscal 2001.
Debt Capitalization. Subsequent to March 3, 2001, the following debt for
equity exchanges were completed:
o On March 14, 2001, the holders of approximately $201.4 million principal
amount of our 5.25% convertible subordinated notes due 2002 exchanged
these notes for an aggregate of 29,204,160 shares of our common stock and
the holders of approximately $77.9 million principal amount of our 6.0%
dealer remarketable securities due 2003 exchanged these notes for an
aggregate of 12,072,175 shares of our common stock. As a result of these
exchanges, we recorded a loss of approximately $119.2 million in the
first quarter of fiscal 2002.
o On April 6, 2001, the holders of approximately $3.9 million principal
amount of our 5.25% convertible subordinated notes due 2002 and
$2.0 million principal amount of our 6.0% dealer remarketable securities
due 2003 exchanged these notes for an aggregate of 856,000 shares of our
common stock. As a result of these exchanges, we recorded a loss of
approximately $2.5 million in the first quarter of fiscal 2002.
o On April 25, 2001, the holders of approximately $11.0 million principal
amount of our 10.5% senior secured notes due 2002 exchanged these notes
for an aggregate of 1,925,000 shares of our common stock. As a result of
this exchange, we recorded a loss of approximately $1.2 million in the
first quarter of fiscal 2002.
o On April 25, 2001, the holders of approximately $5.0 million principal
amount of our 10.5% senior secured notes due 2002 exchanged these notes
for an aggregate of 785,000 shares of our common stock. As a result of
this exchange, we recorded a loss of approximately $0.6 million in the
first quarter of fiscal 2002.
24
The following table sets forth our debt capitalization at April 28, 2001,
following the completion of the refinancing transactions described above and
the repayment of the PCS credit facility by $437.5 million and the exchange
debt facility by $46.6 millon utilizing proceeds from AdvancePCS's retirement
of its $200.0 million obligation to us and the sale of AdvancePCS shares.
As of
April 28, 2001 (1)
-----------------
($ in millions)
Secured Debt:
Senior secured credit facility ........................... $ 800
PCS credit facility ...................................... 154
RCF credit facility ...................................... 730
10.5% senior secured notes due 2002 ...................... 452
Exchange debt ............................................ 170
Capital lease obligations ................................ 20
Other .................................................... 12
Lease Financing Obligations ............................... 1,076
Other Senior Debt:
6.7% notes due 2001 ...................................... 7
6.0% dealer remarketable securities due 2003 ............. 108
6.0% notes due 2005 ...................................... 195
7.625% notes due 2005 .................................... 198
7.125% notes due 2007 .................................... 350
6.125% notes due 2008 .................................... 150
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 ............ 152
------
Total Debt ............................................... $5,224
======
- ---------------
(1) We have entered into commitments for additional debt for equity exchanges
that have not yet been consumated and are not reflected in the table set
forth above, and on May 15, 2001, we entered into a commitment letter to
refinance a significant portion of our indebtedness--see "Recent Event".
Net Cash Provided By (Used In) Operating, Investing and Financing Activities
We used $704.6 million of cash to fund continuing operations in fiscal 2001.
Operating cash flow was negatively impacted by $543.3 million of interest
payments. Operating cash flow was also negatively impacted from an increase in
current assets, primarily resulting from repurchasing $300.0 million of
accounts receivable when we refinanced the accounts receivable securitization
facility, and a decrease in accounts payable and other liabilities.
In fiscal 2000, we used $623.1 million of cash to fund continuing
operations. Operating cash flow was negatively impacted by $501.8 million of
interest payments. Operating cash flow was also negatively impacted from an
increase in current assets and a decrease in accounts payable partially offset
by an increase in other liabilities.
Cash provided by investing activities was $677.7 million for fiscal 2001.
Cash was provided from the sale of our discontinued operations, various other
assets, less expenditures for fixed and intangible assets.
25
Cash used for investing activities was $552.1 million and $2.7 billion for
fiscal years 2000 and 1999, respectively. Cash used for store construction and
relocations amounted to $573.3 million for fiscal 2000 and $1.2 billion for
fiscal 1999. In addition, cash of $1.4 billion was used to acquire PCS in
fiscal 1999.
Cash used in financing activities was $64.3 million for fiscal 2001. The
cash used consisted of payments of $78.1 million of deferred financing costs
partially offset by net debt borrowings of $6.8 million and proceeds from
sale-leaseback transactions of $7.0 million. During fiscal 2001, we used the
proceeds from the sale of our PBM segment to reduce our borrowings.
Cash provided by financing activities was $905.1 million for fiscal 2000 and
$2,660.3 million for fiscal 1999. Increased borrowings under our RCF and PCS
credit facilities which replaced our commercial paper program and the sale of
$300.0 million of preferred stock were the main financing activities during
fiscal 2000. In fiscal 1999, we issued commercial paper to finance the
acquisition of PCS. Also during fiscal 1999, net proceeds were received from
the issuance of $700.0 million in long-term debt and $200.0 million of dealer
remarketable securities. Cash provided by financing activities included
proceeds received from store sale-leaseback transactions of $74.9 million and
$505.0 million for fiscal 2000 and 1999, respectively.
Capital Expenditures
We plan to make total capital expenditures of approximately $140.0 million
during fiscal 2002, consisting of approximately $34.7 million related to new
store construction, store relocation and other store construction projects. An
additional $89.2 million will be dedicated to other store improvement
activities and the purchase of prescription files from independent
pharmacists. Management expects that these capital expenditures will be
financed primarily with cash flow from operations and borrowings under the
revolving credit facility available under our senior secured facility.
Future Liquidity
We are highly leveraged. Based upon our current levels of operations and
expected improvements in our operating performance, management believes that
cash flow from operations, together with available borrowings under our senior
secured credit facility and our other sources of liquidity (including asset
sales) will be adequate to meet anticipated requirements for working capital,
debt service and capital expenditures until August and September 2002, when
$2.5 billion of our indebtedness (as of April 28, 2001), including the
revolving credit facility under the senior secured credit facility, matures.
For a discussion of factors that could affect our current assessment, see "--
Factors Affecting Our Future Prospects" below. Our ability to replace,
refinance or otherwise extend these obligations will depend in part on our
ability to successfully execute our long-term strategy and improve the
operating performance of our stores. On May 15, 2001, we entered into a
commitment letter to refinance a significant portion of our indebtedness, see
"Recent Event".
Accounting Change
In fiscal 2000, we changed our application of the LIFO method of accounting
by restructuring our LIFO pool structure through a combination of certain
geographic pools. The reduction in the number of LIFO pools was made to more
closely align the LIFO pool structure to store merchandise categories. The
effect of this change in fiscal 2000 was to decrease our earnings by $6.8
million (net of income tax benefit of $4.6 million) or $.03 per diluted common
share. The cumulative effect of the accounting change was a charge of $27.3
million (net of income tax benefit of $18.2 million) or $.11 per diluted
common share. The pro forma effect of this accounting change would have been a
reduction in net income of $6.4 million, (net of income tax benefit of $4.2
million) or $.02 per diluted common share for fiscal 1999.
Recent Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for
Derivative Instruments and Hedging Activities". SFAS 133 is effective for all
fiscal years beginning after June 15, 2000. SFAS 133, as amended by SFAS 138,
establishes accounting and reporting standards for derivative instruments,
including certain derivative instruments embedded in other contracts, and for
hedging activities. All derivatives, whether designated in hedging
relationships or not, will be required to be recorded on the balance sheet at
fair value. If the derivative is designated and effective as a fair value
hedge, the changes in the fair value of the derivative and
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the changes in the hedged item attributable to the hedged risk will be
recognized in earnings. If the derivative is designated and effective as a
cash-flow hedge, changes in the fair value of the effective portion of the
derivative will be recorded in other comprehensive income ("OCI") and will be
recognized in the income statement when the hedged item affects earnings. SFAS
133 defines new requirements for designation and documentation of hedging
relationships as well as ongoing effectiveness assessments in order to use
hedge accounting. For a derivative that does not qualify as a hedge, changes
in fair value will be recognized in earnings. On March 4, 2001, in connection
with the adoption of the new Statement, we will record a reduction of
approximately $29.0 million in OCI as a cumulative transition adjustment for
derivatives designated as cash flow-type hedges prior to adopting SFAS 133.
Certain issues currently under consideration by the Derivatives
Implementation Group ("DIG") may make it more difficult to qualify for cash
flow hedge accounting in the future. Pending the results of the DIG
delibera