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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
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|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For The Quarterly Period Ended November 30, 2002
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)
Registrant's telephone number, including area code: (717) 761-2633
----------------
(Former name, former address and former fiscal year, if changed since last
report) Not Applicable
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, and (2) has been subject to such filing
requirements for the past 90 days. Yes |X| No |_|
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
The registrant had 515,115,664 shares of its $1.00 par value common stock
outstanding as of December 18, 2002.
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RITE AID CORPORATION
TABLE OF CONTENTS
Page
----
Cautionary Statement Regarding Forward Looking Statements .... 1
PART I
FINANCIAL INFORMATION
ITEM 1. Financial Statements:
Condensed Consolidated Balance Sheets as of November 30, 2002
and March 2, 2002 ............................................ 2
Condensed Consolidated Statements of Operations for the
Thirteen Week Periods Ended November 30, 2002 and December 1,
2001 ......................................................... 3
Condensed Consolidated Statements of Operations for the
Thirty-Nine Week Periods Ended November 30, 2002 and
December 1, 2001 ............................................. 4
Condensed Consolidated Statements of Cash Flows for the
Thirty-Nine Week Periods Ended November 30, 2002 and
December 1, 2001 ............................................. 5
Notes to Condensed Consolidated Financial Statements ......... 6
ITEM 2. Management's Discussion and Analysis of Financial Condition
and Results
of Operations ................................................ 18
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk ... 26
ITEM 4. Controls and Procedures ...................................... 27
PART II
OTHER INFORMATION
ITEM 1. Legal Proceedings ............................................ 28
ITEM 2. Changes in Securities and Use of Proceeds .................... 28
ITEM 3. Defaults Upon Senior Securities .............................. 28
ITEM 4. Submission of Matters to a Vote of Security Holders .......... 28
ITEM 5. Other Information ............................................ 28
ITEM 6. Exhibits and Reports on Form 8-K ............................. 28
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 senior credit facility and
other debt agreements;
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 our ability to hire and retain pharmacists and other store personnel;
o the outcomes of pending lawsuits and governmental investigations, both
civil and criminal, involving our financial reporting and other matters;
o competitive pricing pressures and continued consolidation of the
drugstore industry; and
o the efforts of third party payers to reduce prescription drug costs,
changes in state or federal legislation or regulations, the success of
planned advertising and merchandising strategies, general economic
conditions and inflation, interest rate movements, access to capital, and
our relationship with our suppliers.
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 the section
entitled "Management's Discussion and Analysis of Financial Condition and
Results of Operations--Overview and Factors Affecting Our Future Prospects"
included in our Annual Report on Form 10-K for the fiscal year ended March 2,
2002 ("the Fiscal 2002 10-K"), which we filed with the Securities and Exchange
Commission ("SEC") on May 7, 2002 and is available on the SEC's website at
"www.sec.gov".
1
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
RITE AID CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except per share amounts)
(unaudited)
November 30, 2002 March 2, 2002
----------------- -------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents ................ $ 236,962 $ 344,055
Accounts receivable, net ................. 577,322 594,249
Inventories, net ......................... 2,383,879 2,262,111
Prepaid expenses and other current assets 95,680 101,681
----------- -----------
Total current assets.................... 3,293,843 3,302,096
PROPERTY, PLANT AND EQUIPMENT, NET ........ 1,960,876 2,096,030
GOODWILL .................................. 684,535 684,535
OTHER INTANGIBLES, NET .................... 212,342 240,725
OTHER ASSETS .............................. 136,273 168,373
----------- -----------
Total assets............................ $ 6,287,869 $ 6,491,759
=========== ===========
LIABILITIES AND STOCKHOLDERS' (DEFICIT)
EQUITY
CURRENT LIABILITIES:
Short-term debt and current maturities of
convertible notes,
long-term debt and lease financing
obligations............................. $ 96,510 $ 209,457
Accounts payable ......................... 897,120 830,535
Sales and other taxes payable ............ 44,111 49,407
Accrued salaries, wages and other current
liabilities............................. 771,264 688,435
----------- -----------
Total current liabilities............... 1,809,005 1,777,834
CONVERTIBLE NOTES ......................... 244,125 243,000
LONG-TERM DEBT, LESS CURRENT MATURITIES ... 3,343,307 3,427,930
LEASE FINANCING OBLIGATIONS, LESS CURRENT
MATURITIES............................... 171,218 176,081
OTHER NONCURRENT LIABILITIES .............. 805,972 837,737
----------- -----------
Total liabilities....................... 6,373,627 6,462,582
COMMITMENTS AND CONTINGENCIES ............. -- --
REDEEMABLE PREFERRED STOCK ................ 19,638 19,561
STOCKHOLDERS' (DEFICIT) EQUITY:
Preferred stock, par value $1 per share,
liquidation value $100 per share........ 378,417 361,504
Common stock, par value $1 per share ..... 515,115 515,136
Additional paid-in capital ............... 3,134,907 3,151,811
Accumulated deficit ...................... (4,125,117) (4,006,043)
Stock-based and deferred compensation .... 4,537 463
Accumulated other comprehensive loss ..... (13,255) (13,255)
----------- -----------
Total stockholders' (deficit) equity.... (105,396) 9,616
----------- -----------
Total liabilities and stockholders'
(deficit) equity ...................... $ 6,287,869 $ 6,491,759
=========== ===========
See accompanying notes to condensed consolidated financial statements.
2
RITE AID CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
(unaudited)
Thirteen Week Period Ended
------------------------------------
November 30, 2002 December 1, 2001
----------------- ----------------
REVENUES ............................... $3,879,523 $3,732,079
COSTS AND EXPENSES:
Costs of goods sold, including
occupancy costs...................... 2,977,050 2,916,062
Selling, general and administrative
expenses............................. 832,614 848,597
Stock-based compensation expense
(benefit)............................ 2,625 (39,447)
Goodwill amortization ................. -- 5,200
Store closing and impairment charges .. 2,945 18,652
Interest expense ...................... 80,941 82,515
Interest rate swap contracts .......... -- 10,382
Gain on debt and lease conversions and
modifications........................ -- (56)
Share of loss from equity investment .. -- 1,697
(Gain) loss on sale of assets and
investments, net..................... (775) 694
---------- ----------
3,895,400 3,844,296
---------- ----------
Loss before income taxes .............. (15,877) (112,217)
INCOME TAX EXPENSE ..................... 490 546
---------- ----------
NET LOSS .............................. $ (16,367) $ (112,763)
========== ==========
COMPUTATION OF LOSS APPLICABLE TO
COMMON STOCKHOLDERS:
Net loss .............................. $ (16,367) $ (112,763)
Accretion of redeemable preferred
stock................................ (26) --
Cumulative preferred stock dividends .. (7,420) (6,879)
---------- ----------
Net loss attributable to common
stockholders......................... $ (23,813) $ (119,642)
========== ==========
BASIC AND DILUTED LOSS PER SHARE ....... $ (0.05) $ (0.23)
========== ==========
See accompanying notes to condensed consolidated financial statements.
3
RITE AID CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
(unaudited)
Thirty-Nine Week Period Ended
------------------------------------
November 30, 2002 December 1, 2001
----------------- ----------------
REVENUES ............................... $11,660,959 $11,133,286
COSTS AND EXPENSES:
Costs of goods sold, including
occupancy costs...................... 8,960,968 8,608,274
Selling, general and administrative
expenses............................. 2,567,433 2,495,267
Stock-based compensation expense ...... 3,973 2,800
Goodwill amortization ................. -- 15,823
Store closing and impairment charges .. 57,051 40,393
Interest expense ...................... 250,527 313,581
Interest rate swap contracts .......... 278 41,429
Loss on debt and lease conversions and
modifications........................ -- 154,539
Share of loss from equity investment .. -- 12,092
Gain on sale of assets and
investments, net..................... (16,163) (50,761)
----------- -----------
11,824,067 11,633,437
----------- -----------
Loss before income taxes and
extraordinary item................... (163,108) (500,151)
INCOME TAX (BENEFIT) EXPENSE ........... (42,372) 3,046
----------- -----------
Loss before extraordinary item ........ (120,736) (503,197)
EXTRAORDINARY ITEM, gain (loss) on
early extinguishment
of debt, net of income taxes of $0.... 1,662 (66,589)
----------- -----------
NET LOSS .............................. $ (119,074) $ (569,786)
=========== ===========
COMPUTATION OF LOSS APPLICABLE TO
COMMON STOCKHOLDERS:
Net loss .............................. $ (119,074) $ (569,786)
Accretion of redeemable preferred
stock................................ (77) --
Preferred stock beneficial conversion . -- (5,181)
Cumulative preferred stock dividends .. (16,913) (20,247)
----------- -----------
Net loss attributable to common
stockholders......................... $ (136,064) $ (595,214)
=========== ===========
BASIC AND DILUTED LOSS PER SHARE:
Loss before extraordinary item ........ $ (0.26) $ (1.15)
Loss from extraordinary item .......... -- (0.14)
----------- -----------
Net loss per share................... $ (0.26) $ (1.29)
=========== ===========
See accompanying notes to condensed consolidated financial statements.
4
RITE AID CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(unaudited)
Thirty-Nine Week Period Ended
------------------------------------
November 30, 2002 December 1, 2001
----------------- ----------------
OPERATING ACTIVITIES:
Net loss .............................. $(119,074) $ (569,786)
Extraordinary (gain) loss ............. (1,662) 66,589
--------- -----------
Loss from operations .................. (120,736) (503,197)
Adjustments to reconcile to net cash
used in operating activities:
Depreciation and amortization........ 217,057 266,913
Stock-based compensation expense..... 3,973 2,800
Store closing and impairment charges. 57,051 40,393
Loss on debt and lease conversions
and modifications .................. -- 154,539
Interest rate swap contracts......... 278 41,429
Gain on sale of assets and
investments, net ................... (16,163) (50,761)
Changes in income tax receivables and
payables ........................... 24,781 7,101
Changes in operating assets and
liabilities ........................ (5,862) (269,039)
--------- -----------
NET CASH PROVIDED BY (USED IN)
OPERATING ACTIVITIES.................. 160,379 (309,822)
--------- -----------
INVESTING ACTIVITIES:
Expenditures for property, plant and
equipment............................ (73,019) (146,476)
Proceeds from the repayment/sale of
AdvancePCS securities................ -- 484,214
Intangible assets acquired ............ (7,850) (9,103)
Proceeds from dispositions ............ 30,782 19,400
--------- -----------
NET CASH (USED IN) PROVIDED BY
INVESTING ACTIVITIES.................. (50,087) 348,035
--------- -----------
FINANCING ACTIVITIES:
Principal payments on long-term debt .. (203,595) (2,115,461)
Proceeds from the issuance of the
senior credit facility............... -- 1,378,462
Proceeds from the issuance of
convertible notes.................... -- 242,500
Net change in bank credit facilities .. 1,538 --
Change in zero balance cash accounts .. (14,359) 2,224
Proceeds from issuance of stock ....... 280 530,566
Deferred financing costs paid ......... (1,249) (74,522)
--------- -----------
NET CASH USED IN FINANCING ACTIVITIES .. (217,385) (36,231)
--------- -----------
(DECREASE) INCREASE IN CASH AND CASH
EQUIVALENTS........................... (107,093) 1,982
CASH AND CASH EQUIVALENTS AT BEGINNING
OF PERIOD............................. 344,055 92,290
--------- -----------
CASH AND CASH EQUIVALENTS AT END OF
PERIOD................................ $ 236,962 $ 94,272
========= ===========
SUPPLEMENTARY CASH FLOW DATA:
Cash paid for interest (net of
capitalized amounts of $249 and $612,
respectively)........................ $ 226,170 $ 314,490
========= ===========
Cash refunds/(payments) of income
taxes................................ $ 68,668 $ (1,108)
========= ===========
Non-cash investing and financing
activities:
Conversion of debt to common stock... $ -- $ 588,711
========= ===========
Conversion of debt to debt........... $ -- $ 152,025
========= ===========
Components of conversion of leases
from capital to operating:
Reduction in leased assets, net...... $ -- $ 704,191
========= ===========
Reduction in lease financing
obligations ........................ $ -- $ 850,792
========= ===========
Increase in deferred gain............ $ -- $ 168,483
========= ===========
See accompanying notes to condensed consolidated financial statements.
5
RITE AID CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
For the Thirteen and Thirty-Nine Week Periods Ended November 30, 2002 and
December 1, 2001
(Dollars and share information in thousands, except per share amounts)
(unaudited)
1. Basis of Presentation
The accompanying unaudited condensed consolidated financial statements have
been prepared in accordance with generally accepted accounting principles for
interim financial information and with the instructions to Form 10-Q and
Article 10 of Regulation S-X and therefore do not include all of the
information and footnotes required by generally accepted accounting principles
for complete annual financial statements. The accompanying financial
information reflects all adjustments (consisting primarily of normal recurring
adjustments except as described in these notes) which are, in the opinion of
management, necessary for a fair presentation of the results for the interim
periods. The results of operations for the thirteen and thirty-nine week
periods ended November 30, 2002 are not necessarily indicative of the results
to be expected for the full year. These condensed consolidated financial
statements should be read in conjunction with the consolidated financial
statements and notes thereto included in the Company's fiscal 2002 Annual
Report on Form 10-K filed with the SEC.
Certain reclassifications have been made to prior years' amounts to conform
to current year classifications.
2. Recent Accounting Pronouncements
The Company adopted Statement of Financial Accounting Standards ("SFAS")
No. 142, "Goodwill and Other Intangible Assets" effective March 3, 2002. SFAS
No. 142 specifies that all goodwill and indefinite life intangibles shall no
longer be amortized. Goodwill must be allocated to reporting units and
evaluated for impairment on an annual basis with an initial impairment
assessment to be performed upon adoption of SFAS No. 142. The Company has
completed the transitional goodwill impairment test as of March 3, 2002 and
determined that there was no impairment loss to be recognized upon adoption of
SFAS No. 142. At November 30, 2002, the Company had unamortized goodwill of
$684,535 and no indefinite life intangibles.
The impact of the adoption of SFAS No. 142 on the thirteen and thirty-nine
weeks ended December 1, 2001 is as follows:
Thirteen Week Thirty-Nine Week
Period Ended Period Ended
December 1, 2001 December 1, 2001
---------------- ----------------
Reported net loss ....................... $(112,763) $(569,786)
Add back goodwill amortization .......... 5,200 15,823
--------- ---------
Adjusted net loss ....................... $(107,563) $(553,963)
========= =========
Loss before extraordinary item, as
adjusted ............................... $(107,563) $(487,374)
========= =========
Basic and diluted loss per share:
Reported net loss ...................... $ (0.23) $ (1.29)
Goodwill amortization .................. 0.01 0.03
--------- ---------
Adjusted net loss ...................... $ (0.22) $ (1.26)
========= =========
6
RITE AID CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
For the Thirteen and Thirty-Nine Week Periods Ended November 30, 2002 and
December 1, 2001
(Dollars and share information in thousands, except per share amounts)
(unaudited)
2. Recent Accounting Pronouncements -- (Continued)
The Company's intangible assets other than goodwill are finite-lived and
amortized over their useful lives. Following is a summary of the Company's
intangible assets as November 30, 2002 and March 2, 2002.
November 30, 2002 March 2, 2002
------------------------ -----------------------
Gross Gross
Carrying Accumulated Carrying Accumulated
Amount Amortization Amount Amortization
-------- ------------ -------- ------------
Favorable leases and other .................................................. $314,082 $(169,286) $312,677 $(158,290)
Prescription files .......................................................... 345,005 (277,459) 341,422 (255,084)
-------- --------- -------- ---------
Total ...................................................................... $659,087 $(446,745) $654,099 $(413,374)
======== ========= ======== =========
Amortization expense for these intangible assets was $9,889 and $34,515 for
the thirteen and thirty-nine weeks ended November 30, 2002, respectively. The
anticipated annual amortization expense for these intangible assets is
$43,690, $30,559, $15,088, $11,170, and $10,213 in fiscal 2003, 2004, 2005,
2006 and 2007, respectively.
The Company adopted SFAS No. 144, "Accounting for the Impairment or Disposal
of Long-Lived Assets" effective March 3, 2002. SFAS No. 144 addressed the
financial accounting and reporting for the impairment or disposal of long-
lived assets. The Company has determined that there was no impact on the
consolidated financial position or results of operations as a result of the
adoption of SFAS No. 144.
In April 2002, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 145, "Rescission of FASB Statements No. 4, "Reporting Gains and Losses
from Extinguishment of Debt," SFAS No. 44, "Accounting for Intangible Assets
of Motor Carriers" and SFAS No. 64, "Extinguishments of Debt Made to Satisfy
Sinking-Fund Requirements," Amendment of SFAS No. 13, "Accounting for Leases,"
and Technical Corrections." The provisions of SFAS No. 145 that relate to the
rescission of SFAS No. 4 are required to be applied in fiscal years beginning
after May 15, 2002. Any gain or loss on extinguishment of debt that was
classified as an extraordinary item in prior periods presented that does not
meet the criteria in APB Opinion No. 30, "Reporting the Results of Operations
- -- Reporting the Effects of Disposal of a Segment of a Business, and
Extraordinary, Unusual and Infrequently Occurring Events and Transactions" for
classification as an extraordinary item shall be reclassified. Beginning with
fiscal 2004, the Company's financial statements for prior years with
extraordinary items for the early extinguishment of debt will show such items
as reclassified to operations. The provisions related to SFAS No. 13 are
effective for transactions occurring after May 15, 2002 and have been adopted
without material impact. All other provisions of SFAS No. 145, which are
effective for financial statements issued on or after May 15, 2002, have been
adopted without material impact.
In June of 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities". This Statement addresses
financial accounting and reporting for costs associated with exit or disposal
activities and nullifies EITF 94-3, "Liability Recognition for Certain
Employee Termination Benefits and Other Costs to Exit an Activity (including
Certain Costs Incurred in a Restructuring)". SFAS No. 146 requires that a
liability for a cost associated with an exit or disposal activity be
recognized when the liability is incurred. This differs from the guidance in
EITF 94-3, which requires that a liability for costs associated with an exit
plan or disposal activity be recognized at the date of an entity's commitment
to an exit plan. SFAS No. 146 also requires all charges related to an exit
activity, including accretion of interest related to the discounting of the
future liability related to that activity, to be classified in the same line
item on the statement of operations. The provisions of the Statement are
effective for exit or disposal activities that are initiated after December 31,
2002, with early application encouraged. The Company has elected to adopt SFAS
No. 146 effective January 1, 2003. The adoption of SFAS No. 146 will impact
the timing of
7
RITE AID CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
For the Thirteen and Thirty-Nine Week Periods Ended November 30, 2002 and
December 1, 2001
(Dollars and share information in thousands, except per share amounts)
(unaudited)
2. Recent Accounting Pronouncements -- (Continued)
recognition of liabilities on stores closed or severance arrangements entered
into after the adoption date, but will have no impact on the liabilities
recorded by the Company for stores already closed and severance arrangements
already entered into. The adoption will also impact the classification of the
accretion of interest on closed stores in the statement of operations, whereby
the accretion will no longer be classified as part of interest expense but
rather classified as part of store closing and impairment charges.
In November of 2002, the FASB issued FASB Interpretation ("FIN") No. 45,
"Guarantor's Accounting and Disclosure Requirements for Guarantees Including
Indirect Guarantees of Indebtedness of Others". FIN No. 45 requires entities
to establish liabilities for certain types of guarantees, and expands
financial statement disclosures for others. The accounting requirements of FIN
No. 45 are effective for guarantees issued or modified after December 31,
2002, and the disclosure requirements are effective for financial statements
of interim or annual periods ending after December 15, 2002. The Company does
not expect the adoption of FIN No. 45 to have any impact on its consolidated
financial position or results of operations. The adoption of FIN No. 45 will
require the Company to include disclosures in its fiscal 2003 Form 10-K
related to guarantees of lease liabilities assigned to third parties.
3. Loss Per Share
Following is a summary of the components of the numerator and denominator of
the basic and diluted loss per share computation:
Thirteen Week Thirty-Nine Week
Period Ended Period Ended
--------------------------- --------------------------
November 30, December 1, November 30, December 1,
2002 2001 2002 2001
------------ ----------- ------------ -----------
Numerator for earnings per share:
Loss before extraordinary item ....................................... $(16,367) $(112,763) $(120,736) $(503,197)
Accretion of redeemable preferred stock .............................. (26) -- (77) --
Preferred stock beneficial conversion and reset provision ............ -- -- -- (5,181)
Cumulative preferred stock dividends ................................. (7,420) (6,879) (16,913) (20,247)
-------- --------- --------- ---------
Net loss before extraordinary item attributable to common stockholders (23,813) (119,642) (137,726) (528,625)
Extraordinary item, gain (loss) on early extinguishment of debt ....... -- -- 1,662 (66,589)
-------- --------- --------- ---------
Net loss attributable to common stockholders ......................... $(23,813) $(119,642) $(136,064) $(595,214)
======== ========= ========= =========
Denominator:
Basic weighted average shares ........................................ 515,124 516,086 515,134 460,289
Diluted weighted average shares ...................................... 515,124 516,086 515,134 460,289
Basic and diluted loss per share:
Loss from operations ................................................. $ (0.05) $ (0.23) $ (0.26) $ (1.15)
Loss from extraordinary item ......................................... -- -- -- (0.14)
-------- --------- --------- ---------
Net loss per share ................................................... $ (0.05) $ (0.23) $ (0.26) $ (1.29)
======== ========= ========= =========
No potential shares of common stock have been included in the computation of
diluted earnings per share as the Company incurred losses attributable to
common shareholders for the thirteen and thirty-nine week periods ended
November 30, 2002 and December 1, 2001, and the amount would be antidilutive.
At
8
RITE AID CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
For the Thirteen and Thirty-Nine Week Periods Ended November 30, 2002 and
December 1, 2001
(Dollars and share information in thousands, except per share amounts)
(unaudited)
3. Loss Per Share -- (Continued)
November 30, 2002, an aggregate of 169,544 potential common shares related to
stock options, convertible notes and preferred stock and warrants, have been
excluded from the computation of diluted earnings per share.
4. Store Closing and Impairment Charges
Store closing and impairment charges consist of:
Thirteen Week Thirty-Nine Week
Period Ended Period Ended
--------------------------- --------------------------
November 30, December 1, November 30, December 1,
2002 2001 2002 2001
------------ ----------- ------------ -----------
Impairment charges .................................................... $2,531 $ 8,060 $ 8,939 $24,613
Store and equipment lease exit charges ................................ 414 10,590 48,112 15,437
Impairment of other assets ............................................ -- 2 -- 343
------ ------- ------- -------
$2,945 $18,652 $57,051 $40,393
====== ======= ======= =======
Impairment charges
Impairment charges include non-cash charges of $2,531 and $8,060 for the
thirteen week periods ended November 30, 2002 and December 1, 2001,
respectively, for the impairment of long-lived assets (including allocable
goodwill for the thirteen week period ended December 1, 2001) at 7 and 23
stores, respectively. Impairment charges include non-cash charges of $8,939
and $20,413 for the thirty-nine week periods ended November 30, 2002 and
December 1, 2001, respectively, for the impairment of long-lived assets
(including allocable goodwill for the thirty-nine week period ended December 1,
2001) at 61 and 53 stores, respectively. These amounts include the write-down
of long-lived assets at stores that were assessed for impairment because of
management's intention to relocate or close the store or because of changes in
circumstances that indicated the carrying value of the asset may not be
recoverable. Also included in impairment charges for the thirty-nine week
period ended December 1, 2001 are approximately $4,200 of costs related to
software.
Store and equipment lease exit charges
During the thirteen week periods ended November 30, 2002 and December 1,
2001, the Company recorded charges for 4 and 9 stores, respectively, to be
closed or relocated under long-term leases. During the thirty-nine week
periods ended November 30, 2002 and December 1, 2001, the Company recorded
charges for 36 and 42 stores, respectively, to be closed or relocated under
long-term leases. Costs incurred to close a store, which principally include
lease termination costs, are recorded at the time management commits to
closing the store, which is 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. The Company calculates its 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. This liability is discounted using a risk-free rate of interest.
The Company evaluates these assumptions each quarter and adjusts the liability
accordingly. Also included in this line are charges of approximately $1,300
incurred in the thirty-nine weeks ended December 1, 2001, related to the early
termination of an equipment lease.
9
RITE AID CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
For the Thirteen and Thirty-Nine Week Periods Ended November 30, 2002 and
December 1, 2001
(Dollars and share information in thousands, except per share amounts)
(unaudited)
4. Store Closing and Impairment Charges -- (Continued)
The reserve for store and equipment lease exit costs includes the following
activity:
Thirteen Week Thirty-Nine Week
Period Ended Period Ended
--------------------------- --------------------------
November 30, December 1, November 30, December 1,
2002 2001 2002 2001
------------ ----------- ------------ -----------
Balance -- beginning of period ........................................ $313,516 $219,825 $287,464 $233,008
Provision for present value of noncancellable lease payments of
stores designated to be closed...................................... 1,022 7,690 38,313 27,927
Changes in assumptions about future sublease income, terminations and
changes in interest rates........................................... 92 2,953 11,234 (7,140)
Reversals of reserves for stores that management has determined will
remain open......................................................... (700) (53) (1,435) (6,678)
Interest accretion ................................................... 2,092 2,042 7,194 6,725
Cash payments, net of sublease income ................................ (13,245) (12,639) (39,993) (34,024)
-------- -------- -------- --------
Balance -- end of period .............................................. $302,777 $219,818 $302,777 $219,818
======== ======== ======== ========
The Company's revenues and loss from operations for the thirteen and thirty-
nine week periods ended November 30, 2002 and December 1, 2001 include results
from stores that have been closed or that a decision has been made to close as
of November 30, 2002. The revenue and operating losses of these stores for the
periods are presented as follows:
Thirteen Week Thirty-Nine Week
Period Ended Period Ended
--------------------------- --------------------------
November 30, December 1, November 30, December 1,
2002 2001 2002 2001
------------ ----------- ------------ -----------
Revenues .............................................................. $ 29,936 $132,734 $137,525 $435,227
Loss from operations .................................................. (10,711) (18,542) (36,349) (54,807)
Included in loss from operations for the thirteen and thirty-nine weeks
ended November 30, 2002, are depreciation charges of $825 and $5,350,
respectively, and closed store inventory liquidation charges of $7,450 and
$15,671, respectively. Included in loss from operations for the thirteen and
thirty-nine weeks ended December 1, 2001, are depreciation charges of $5,109
and $14,313, respectively, and closed store inventory liquidation charges of
$5,984 and $15,471, respectively. Loss from operations does not include any
allocation of corporate level overhead costs. The above results are not
necessarily indicative of the impact that these closures will have on revenues
and operating results of the Company in the future, as the Company often
transfers the business of a closed store to another Company store, thereby
retaining a portion of these revenues.
5. Sale of Investments
On April 29, 2002 and May 6, 2002, the Company sold shares of drugstore.com.
As a result of these transactions, the Company no longer has an equity
investment in drugstore.com or any other entity. These sales resulted in a
gain of $15,777, which is included in gain on sale of assets and investments,
net, for the thirty-nine week period ended November 30, 2002. These sales do
not affect the business arrangement
10
RITE AID CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
For the Thirteen and Thirty-Nine Week Periods Ended November 30, 2002 and
December 1, 2001
(Dollars and share information in thousands, except per share amounts)
(unaudited)
5. Sale of Investments -- (Continued)
entered into in July 1999 between the Company and drugstore.com. Following
these sales, the Company does not have any equity method investments.
On October 2, 2000, the Company sold its wholly owned subsidiary, PCS, to
AdvancePCS. The proceeds from the sale of PCS consisted of $710,557 in cash,
$200,000 in principal amount of AdvancePCS's unsecured 11% senior subordinated
notes and equity securities of AdvancePCS. During March 2001, the Company sold
the AdvancePCS equity securities for $284,214 resulting in a gain of $53,214,
which was recognized during the thirty-nine week period ended December 1,
2001. Additionally, AdvancePCS repurchased the unsecured 11% senior
subordinated notes for $200,000 plus accrued interest.
6. Income Taxes
The tax benefit of $42,372 for the thirty-nine week period ended November 30,
2002 is comprised of two components. The first reflects a one time income tax
benefit of $44,011 based on the tax law change, enacted on March 9, 2002,
which increased the carryback period of net operating losses incurred in
fiscal 2001 and 2002 from two years to five. The second component is the
provision from operations for state income taxes of $1,639.
The income tax benefit of the NOL's generated in the thirty-nine week
periods ended November 30, 2002 and December 1, 2001 have been fully offset by
a valuation allowance as a result of the Company's determination that, based
on available evidence, it is more likely than not that the deferred tax assets
will not be realized.
The Company had an ownership change for statutory purposes in fiscal 2002,
which resulted in a limitation on the future use of net operating loss
carryforwards. This limitation does not further impair the net operating loss
carryforwards because they are fully reserved.
The Company received federal income tax refunds in the amount of $68,668
during the thirteen week period ended November 30, 2002, based on the
favorable outcome of federal income tax litigation and tax law changes enacted
March 9, 2002.
11
RITE AID CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
For the Thirteen and Thirty-Nine Week Periods Ended November 30, 2002 and
December 1, 2001
(Dollars and share information in thousands, except per share amounts)
(unaudited)
7. Indebtedness and Credit Agreements
General
Following is a summary of indebtedness and lease financing obligations at
November 30, 2002 and March 2, 2002:
November 30, March 2,
2002 2002
------------ ----------
Secured Debt:
Senior secured credit facility ................... $1,380,000 $1,378,462
10.5% senior secured notes due 2002 .............. -- 20,879
12.5% senior secured notes due 2006 ($152,025
face value less unamortized discount of $6,571
and $7,857)..................................... 145,454 144,168
Senior secured (shareholder) notes due 2006 ...... 149,500 149,500
Other ............................................ 7,431 11,284
---------- ----------
1,682,385 1,704,293
Lease Financing Obligations ....................... 178,025 182,625
Unsecured Debt:
5.25% convertible subordinated notes due 2002 .... -- 150,500
6.0% dealer remarketable securities due 2003 ..... 58,125 83,550
6.0% fixed-rate senior notes due 2005 ............ 194,500 194,500
7.625% senior notes due 2005 ..................... 198,000 198,000
4.75% convertible notes due 2006 ($250,000 face
value less unamortized discount of $5,875 and
$7,000)......................................... 244,125 243,000
7.125% notes due 2007 ............................ 350,000 350,000
6.125% fixed-rate senior notes due 2008 .......... 150,000 150,000
11.25% senior notes due 2008 ..................... 150,000 150,000
6.875% senior debentures due 2013 ................ 200,000 200,000
7.7% notes due 2027 .............................. 300,000 300,000
6.875% fixed-rate senior notes due 2028 .......... 150,000 150,000
---------- ----------
1,994,750 2,169,550
---------- ----------
Total debt ........................................ 3,855,160 4,056,468
Short-term debt and current maturities of
convertible notes, long-term debt and lease
financing obligations............................ (96,510) (209,457)
---------- ----------
Long-term debt and lease financing obligations,
less current maturities.......................... $3,758,650 $3,847,011
========== ==========
Substantially all of Rite Aid Corporation's wholly-owned subsidiaries
guarantee the obligations under the senior secured credit facility. These
subsidiary guarantees are secured primarily by a first priority lien on the
inventory, accounts receivable, prescription files, intellectual property and
some real estate assets of the subsidiary guarantors. The Company's
obligations under its 12.5% senior secured notes due 2006 and senior secured
(shareholder) notes due 2006 are guaranteed by substantially all of Rite Aid
Corporation's wholly owned subsidiaries. These guarantees are secured by
second priority liens on the same collateral that secures the senior credit
facility. Rite Aid Corporation is a holding company with no direct operations
and is dependent upon dividends and other payments from its subsidiaries to
service payments due under the senior secured credit facility, the 12.5%
senior secured notes due 2006 and senior secured (shareholder) notes due 2006.
The subsidiary guarantees related to the Company's debt are full and
unconditional and joint and several, and there are no restrictions on the
ability of the parent to obtain funds from its subsidiaries. Also, the parent
company's assets and operations are not material, and subsidiaries not
guaranteeing the credit
12
RITE AID CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
For the Thirteen and Thirty-Nine Week Periods Ended November 30, 2002 and
December 1, 2001
(Dollars and share information in thousands, except per share amounts)
(unaudited)
7. Indebtedness and Credit Agreements -- (Continued)
facilities are minor. Accordingly, condensed consolidating financial
information for the parent and subsidiaries is not presented.
Debt Redemptions
During the thirty-nine week period ended November 30, 2002, the Company
redeemed $25,425 of its 6.0% dealer remarketable securities due 2003 for
$23,763. The early redemption resulted in an extraordinary gain of $1,662, net
of tax of $0, for the thirty-nine week period ended November 30, 2002.
On September 16, 2002, the Company redeemed $150,500 of its 5.25%
convertible subordinated notes due 2002 using its available cash and cash
equivalents. The redemption was made in accordance with the scheduled maturity
of the 5.25% convertible subordinated notes due 2002 and did not result in any
gain or loss.
On September 16, 2002, the Company redeemed $20,879 of its 10.5% senior
secured notes due 2002 using the remaining availability under the term loan
from the senior secured credit facility. The redemption was made in accordance
with the scheduled maturity of the 10.5% senior secured notes due 2002 and did
not result in any gain or loss.
Debt for Equity Exchanges
The Company completed the following debt for equity exchanges during the
thirty-nine weeks ended December 1, 2001.
Carrying Additional
Debt Exchanged Amount Common Paid-In
- -------------- Exchanged Stock Capital
--------- ------- ----------
PCS facility.................................................................................. $ 14,478 $ 1,769 $ 13,867
RCF facility.................................................................................. 169,906 26,370 158,388
5.25% convertible subordinated notes due 2002................................................. 205,308 29,750 307,686
6.00% dealer remarketable securities due 2002................................................. 79,885 12,382 55,633
10.50% senior secured notes due 2002.......................................................... 119,134 16,115 114,223
-------- ------- --------
Total......................................................................................... $588,711 $86,386 $649,797
======== ======= ========
The PCS and RCF facilities were repaid as part of the June 2001 refinancing.
Refinancing
On June 27, 2001, the Company completed a major financial restructuring that
extended the maturity dates of the majority of its debt to 2005 or beyond,
provided additional equity, and converted a portion of its debt to equity. In
connection with the June 27, 2001 refinancing, the company recorded in the
thirty-nine week period ended December 1, 2001 an extraordinary loss on early
extinguishment of debt of $66,589.
Interest Rate Swap Contracts
In June 2000, the Company entered into an interest rate swap contract that
fixed the LIBOR component of $500,000 of the Company's variable rate debt at
7.083% for a two-year period, ended on June 26, 2002. In July 2000, the
Company entered into an additional interest rate swap that fixed the LIBOR
component of an additional $500,000 of variable rate debt at 6.946% for a two-
year period, ended July 10, 2002.
As a result of the June 27, 2001 refinancing, the Company's interest rate
swaps no longer qualified for hedge accounting treatment and therefore, the
changes in fair value of these interest rate swap contracts was recorded as a
component of net loss. Accordingly, the Company recognized a charge of $31,047
representing the amount that the Company would have to pay the counter party
to terminate these contracts as of that date. Subsequent changes in the market
value of the interest rate swaps of $10,382, inclusive of cash payments, were
recorded for the thirteen weeks ended December 1, 2001 and changes in the
market value of the interest rate swaps of $278, inclusive of cash payments,
have been recorded on the income statement for the thirty-
13
RITE AID CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
For the Thirteen and Thirty-Nine Week Periods Ended November 30, 2002 and
December 1, 2001
(Dollars and share information in thousands, except per share amounts)
(unaudited)
7. Indebtedness and Credit Agreements -- (Continued)
nine week period ended November 30, 2002. These amounts represent adjustments
to the aggregate expense recognized by the Company relating to these swaps.
These contracts expired and were fully funded during the thirteen week period
ended August 31, 2002 and have not been renewed. Correspondingly, there is no
termination liability as of November 30, 2002.
Amendment to Senior Credit Facility
On December 23, 2002, the Company entered into an amendment of its senior
secured credit facility to allow optional repurchases of the Company's
publicly traded debt and its senior secured (shareholder) notes due 2006. For
the period from December 23, 2002 to the end of the 2004 fiscal year, the
Company will have up to $300,000 available for optional debt repurchases,
provided that the Company is in compliance with the capital expenditures
covenant of the senior secured credit facility. For fiscal years after 2004,
the Company will have an amount available for optional debt repurchases equal
to the lesser of the availability under the capital expenditures covenant and
a formula based upon the Company's performance in the prior fiscal year. In
addition, during the period from December 23, 2002 to the end of the 2004
fiscal year, the Company may purchase an additional $150,500 of its publicly
traded debt with the net proceeds of additional debt issuances which are
unsecured or are secured by the collateral that secures the senior credit
facility on a second priority basis.
8. Stockholders' Equity
The Company previously issued 3,000 shares of Series B cumulative pay-in-
kind preferred stock at $100 per share, which is the liquidation preference.
The Series B Preferred Stock was convertible into shares of the Company's
common stock at a conversion price of $5.50 per share. On October 5, 2001, the
Company exchanged all outstanding shares of Series B cumulative pay-in-kind
preferred stock for an equal number of shares of 8% Series D cumulative pay-
in-kind preferred stock ("Series D preferred stock"). The Series D preferred
stock differs from the Series B preferred stock only in that the consent of
holders of the Series D preferred stock is not required in order for the
Company to issue shares of the Company's capital stock that are on parity with
the Series D preferred stock with respect to dividends and distributions upon
the liquidation, distribution or winding up of the Company.
In November 2000, the Company reduced the exercise price of approximately
16,684 stock options issued after December 4, 1999 to $2.75 per share, which
represented fair market value of a share of common stock on the date of the
repricing. In connection with the repricing, the Company recognizes
compensation expense for these options using variable plan accounting. Under
variable plan accounting, the Company recognizes compensation expense over the
option vesting period. In addition, subsequent changes in the market value of
the Company's common stock during the option period, or until exercised, will
generate changes in the compensation expense recognized on the repriced
options. The Company recognized expense (reduction of expense) of $0 and
$(40,344) for the thirteen week periods ended November 30, 2002 and December 1,
2001, and $(3,990) and $(6,685) for the thirty-nine week periods ended
November 30, 2002 and December 1, 2001, respectively, related to the repriced
options. The Company recognized net expense of $2,625 and $897 for the
thirteen weeks ended November 30, 2002 and December 1, 2001, respectively,
related to restricted stock and other equity awards. The Company recognized
net expense of $7,963 and $9,485 for the thirty-nine weeks ended November 30,
2002 and December 1, 2001, respectively, related to restricted stock and other
equity awards.
The stock-based and deferred compensation component of stockholders' equity
is comprised of $5,957 and $8,453 related to the repriced options offset by
$1,420 and $7,990 of deferred compensation, as of November 30, 2002 and
March 2, 2002, respectively.
14
RITE AID CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
For the Thirteen and Thirty-Nine Week Periods Ended November 30, 2002 and
December 1, 2001
(Dollars and share information in thousands, except per share amounts)
(unaudited)
9. Commitments and Contingencies
The Company is party to numerous legal proceedings, as discussed below.
Federal investigations
In June of 2002, the SEC issued a cease-and-desist order that completes
their investigation into the Company relating to certain financial reporting
and accounting practices under former management. The cease-and-desist order,
in which Rite Aid neither admits or denies the findings, was pursuant to Rite
Aid's offer of settlement. The Company will pay no fine under the SEC
settlement.
There are currently pending federal governmental investigations, both civil
and criminal, by the United States Attorney, involving the Company's financial
reporting and other matters. Management is cooperating fully with the United
States Attorney. Settlement discussions have begun with the United States
Attorney for the Middle District of Pennsylvania, who has proposed that the
government would not institute any criminal proceeding against the Company if
the Company enters into a consent judgment providing for a civil penalty
payable over a period of years. The amount of the civil penalty has not been
agreed to and there can be no assurance that a settlement will be reached or
that the amount of such penalty will not have a material adverse effect on the
Company's financial condition and results of operations. The Company has an
accrual of $20,000 as of November 30, 2002, which was recorded during the
thirteen week period ended June 1, 2002, in connection with the resolution of
these matters; however, the Company may incur charges in excess of that amount
and the Company is unable to estimate the possible range of loss. The Company
will continue to evaluate its estimate and to the extent that additional
information arises or its strategy changes, the Company will adjust its
accrual accordingly.
The U.S. Department of Labor has commenced an investigation of matters
relating to the Company's associate benefit plans, including the principal
401(k) plan, which permitted associates to purchase the Company's common
stock. Purchases of the Company's common stock under the plan were suspended
in October 1999. In January 2001, the Company appointed an independent trustee
to represent the interests of these plans in relation to the Company and to
investigate possible claims the plans may have against the Company. Both the
independent trustee and the Department of Labor have asserted that the plans
may have claims against the Company. In addition, a putative 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. On October 31, 2002, the Company reached an
agreement with the independent trustee and the attorneys for the putative
class action plaintiff to settle all claims arising out of our associate
benefit plans. Under the agreement, the Company agreed to maintain the current
level of benefits though December 31, 2006 and to pay $4,010 and its insurance
companies agreed to pay $5,500 into a settlement fund. The Company has paid
its portion of the cash settlement into the settlement fund. On November 12,
2002, the District Court entered an order preliminarily approving the
settlement, certifying the class and scheduling a settlement fairness hearing.
The Department of Labor has agreed to close its investigation upon entry of
the final order approving the settlement based upon the agreement. There can
be no assurance that the settlement will be finally approved by the District
Court.
These investigations and settlement discussions are ongoing and the Company
cannot predict their outcomes. If the Company were convicted of any crime,
certain licenses and government contracts such as Medicaid plan reimbursement
agreements that are material to operations may be revoked, which would have a
material adverse effect on the Company's results of operations and financial
condition. In addition, substantial penalties, damages or other monetary
remedies assessed against the Company, including a settlement, could also have
a material adverse effect on the Company's results of operations, financial
condition or cash flows.
15
RITE AID CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
For the Thirteen and Thirty-Nine Week Periods Ended November 30, 2002 and
December 1, 2001
(Dollars and share information in thousands, except per share amounts)
(unaudited)
9. Commitments and Contingencies -- (Continued)
Stockholder litigation
The Company, certain directors, its former chief executive officer Martin
Grass, its former president Timothy Noonan, its former chief financial officer
Frank Bergonzi, and its former auditor KPMG LLP, have been sued in a number of
actions, most of which purport to be class actions, brought on behalf of
stockholders who purchased the Company's securities on the open market between
May 2, 1997 and November 10, 1999. Most of the complaints asserted claims
under Sections 10 and 20 of the Securities Exchange Act of 1934, based upon
the allegation that the Company's financial statements for fiscal 1997, fiscal
1998 and fiscal 1999 fraudulently misrepresented the Company's financial
position and results of operations for those periods. All of these cases have
been consolidated in the U.S. District Court for the Eastern District of
Pennsylvania. On November 9, 2000, the Company announced that it had reached
an agreement to settle the consolidated securities class action lawsuits
pending there and in the Delaware Court of Chancery. Under the agreement, the
Company issued $149,500 of senior secured notes due March 2006 and paid
$45,000 in cash, which was fully funded by the Company's officers' and
directors' liability insurance. As additional consideration for the
settlement, the Company has assigned to the plaintiffs all of the Company's
claims against the above named executives and KPMG LLP. On August 16, 2001,
the district court approved the settlement. Certain of the nonsettling
defendants appealed the order. On September 19, 2002, counsel for the
plaintiffs advised the Company that an agreement in principle had been reached
to settle the stockholder's claims against KPMG, Martin Grass, Frank Bergonzi
and Timothy Noonan. Such settlement remains subject to documentation and
approval by the U.S. District Court. If and when the U.S. District Court
approves such settlement, the pending appeal by such defendants will be
dismissed, whereupon the Company's settlement of the consolidated securities
class action lawsuits will become final. If the settlement does not become
final, this litigation could result in a material adverse effect on the
Company's results of operations, financial condition or cash flows. Several
members of the class have elected to "opt-out" of the class and, as a result,
they will be free to individually pursue their claims. Management believes
that their claims, individually and in the aggregate, are not material.
A purported class action has been instituted by a stockholder against the
Company in Delaware state court on behalf of stockholders who purchased shares
of the Company's common stock prior to May 2, 1997, and who continued to hold
them after November 10, 1999, alleging claims similar to the claims alleged in
the consolidated securities class action lawsuits described above. The amount
of damages sought was not specified and may be material. The Company has filed
a motion to dismiss this complaint for failure to state a claim for which
relief could be granted. On December 19, 2002, the court dismissed the class
action and breach of fiduciary duty claims with prejudice and the individual
claims without prejudice.
Drug reimbursement matters
The Company is being investigated by multiple state attorneys general for
its reimbursement practices relating to partially-filled prescriptions and
fully-filled prescriptions that are not picked up by ordering customers. The
Company is supplying similar information with respect to these matters to the
United States Department of Justice. The Company believes that these
investigations are similar to investigations, which were, and are being,
undertaken with respect to the practices of others in the retail drug
industry. The Company also believes that its existing policies and procedures
fully comply with the requirements of applicable law and intends to fully
cooperate with these investigations. The Company 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 the Company defrauded federal healthcare plans by failing to
appropriately issue refunds for partially filled prescriptions and
prescriptions which were not picked up by customers. The United
16
RITE AID CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
For the Thirteen and Thirty-Nine Week Periods Ended November 30, 2002 and
December 1, 2001
(Dollars and share information in thousands, except per share amounts)
(unaudited)
9. Commitments and Contingencies -- (Continued)
States Department of Justice has intervened in this lawsuit, as is its right
under the law. The Company has reached an agreement to settle these
investigations and the lawsuit filed by the private individual for $7,225,
which is subject to court approval. The Company has accrued $7,225 related to
this potential liability in fiscal year 2002.
These claims are ongoing and the Company cannot predict their outcome. If
any of these cases result in a substantial monetary judgment against the
Company or is settled on unfavorable terms, the Company's results of
operations, financial position and cash flows could be materially adversely
affected.
Other
In June of 2002, the United States Attorney indicted several former
executive officers on several charges, including securities fraud, and one
former executive officer plead guilty to charges of obstruction of an internal
investigation. The Company currently has separation and other arrangements
with certain of these executives. As a result of these indictments, the
Company has ceased payments under these obligations. The Company maintains
liabilities of approximately $27,000 as of November 30, 2002, related to
future obligations under these arrangements. On December 11, 2002, the Company
concluded its investigation of the separation and other arrangements relating
to these employees, and has determined, effective as of December 11, 2002 that
there is no binding obligation under these arrangements. Therefore, the
Company will record an adjustment of approximately $27,000 as a reduction in
selling, general and administrative expenses during the thirteen week period
ending March 1, 2003.
The Company, together with a significant number of major U.S. retailers, has
been sued by the Lemelson Foundation in a complaint, which alleges that
portions of the technology included in the Company's point-of-sale system
infringe upon a patent held by the plaintiffs. The amount of damages sought is
unspecified and may be material. The Company cannot predict the outcome of
this litigation or whether it could result in a material adverse effect on the
Company's results of operations, financial position or cash flows.
The Company is subject from time to time to lawsuits arising in the ordinary
course of business. In the opinion of the Company's 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 the Company's results of operations, financial position and
cash flows if decided adversely.
17
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Overview
Loss before extraordinary item for the thirteen and thirty-nine week periods
ended November 30, 2002 was $16.4 million and $120.7 million, respectively.
Loss before extraordinary item for the thirteen and thirty-nine week periods
ended December 1, 2001 was $112.8 million and $503.2 million, respectively.
The substantial improvement is the net result of several factors, the most
important we believe to be increased pharmacy sales, improved gross margin and
selling, general and administrative expense as a percent of sales, and reduced
interest expense. These elements are described in further detail in the
Results of Operations and Liquidity and Capital Resources sections below.
However, there are other items that must be noted in order to understand the
results of operations. Those items are:
Substantial Investigation Expenses. We continue to incur substantial
expenses in connection with the process of defending ourselves and former
management against various legal actions related to prior business practices
and cooperating with the U.S. Attorney's Office in their investigations of
former management. We incurred $3.3 million and $4.6 million in the thirteen
week periods ended November 30, 2002 and December 1, 2001, respectively, and
$13.2 million and $13.6 million in the thirty-nine week periods ended
November 30, 2002 and December 1, 2001, respectively. We expect to incur an
additional $2.0 million to $5.0 million over the remainder of fiscal 2003, and
expect to continue to incur significant legal and other expenses until the
resolution of the U.S. Attorney's case against certain of our former executive
officers and their investigation of certain of our financial reporting and
other matters.
Stock-Based Compensation Expense. We recorded stock-based compensation
expense (benefit) of $2.6 million and $(39.4) million in the thirteen week
periods ended November 30, 2002 and December 1, 2001, respectively, and
$4.0 million and $2.8 million in the thirty-nine week periods ended
November 30, 2002 and December 1, 2001, respectively resulting primarily from
the impact of applying variable plan accounting to our stock-based
compensation plans and expense on restricted shares.
Gain on Sale of Assets and Investments. In the thirty-nine week period
ended November 30, 2002, we recorded a gain of $15.8 million resulting from
the sale of our investment in drugstore.com. In the thirty-nine week period
ended December 1, 2001, we recorded a gain of $53.2 million resulting from the
sale of AdvancePCS securities.
Loss on Debt and Lease Conversions and Modifications. In the thirty-nine
week period ended December 1, 2001, we recorded a pre-tax loss of
$154.6 million on debt conversions and lease modifications that were performed
in connection with our June 27, 2001 refinancing.
Income Tax Benefit. In the thirty-nine week period ended November 30, 2002,
we recorded a one time $44.0 million income tax benefit related to carryback
of net operating losses made possible by a tax law change.
Other. In the thirty-nine week period ended December 1, 2001, we recorded a
$12.1 million charge related to our share of loss in our investment in
drugstore.com. The investment had no carrying value as of March 3, 2002, and
therefore we recorded no losses in equity investments in subsidiaries in the
thirty-nine week period ended November 30, 2002. In the thirty-nine week
period ended December 1, 2001, we recorded a $15.8 million charge for goodwill
amortization. We recorded no charges for goodwill amortization in the thirty-
nine week period ended November 30, 2002, pursuant to the adoption of
Statement of Financial Accounting Standards ("SFAS") No. 142.
Recent Actions Affecting Operating Results
During fiscal 2002 and the first three quarters of fiscal 2003 we took a
number of actions which had the effect of significantly reducing our operating
results but which management believes were nevertheless necessary. These
actions include, but are not limited to, the sale of assets, the exchange of
our debt for shares of our common stock, the closure, relocation or impairment
of stores and the refinancing of the company. As part of our ongoing business
activities, we will continue to assess stores for potential closure. There can
be no assurance that other such actions may not be required in the future, or
that such actions would not have a
18
material adverse effect upon our operating results for the period in which we
take those actions or subsequent periods.
Results of Operations
Revenues and Other Operating Data
Thirteen Week Thirty-Nine Week
Period Ended Period Ended
--------------------------- --------------------------
November 30, December 1, November 30, December 1,
2002 2001 2002 2001
------------ ----------- ------------ -----------
(Dollars in thousands)
Revenues .............................................................. $3,879,523 $3,732,079 $11,660,959 $11,133,286
Revenue growth ........................................................ 4.0% 5.7% 4.7% 6.9%
Same store sales growth ............................................... 6.7% 6.9% 7.4% 8.3%
Pharmacy sales growth ................................................. 6.9% 8.5% 8.1% 9.6%
Same store pharmacy sales growth ...................................... 9.6% 10.6% 10.7% 11.4%
Pharmacy as a % of total sales ........................................ 64.3% 62.5% 63.6% 61.7%
Third party sales as a % of total pharmacy sales ...................... 92.9% 92.2% 92.7% 92.0%
Front-end sales (decline) growth ...................................... (0.7)% (0.8)% (0.5)% 1.9%
Same store front end sales growth ..................................... 1.9% 1.2% 2.0% 3.6%
Front end sales as a % of total sales ................................. 35.7% 37.5% 36.4% 38.2%
Store data:
Total stores (beginning of period) ................................... 3,444 3,594 3,497 3,648
New stores ........................................................... 1 4 2 7
Closed stores ........................................................ (34) (15) (89) (72)
Store acquisitions, net .............................................. -- -- 1 --
Total stores (end of period) ......................................... 3,411 3,583 3,411 3,583
Relocated stores ..................................................... 4 3 11 11
Revenues
The 4.0% and 4.7% growth in revenues for the thirteen and thirty-nine week
periods ended November 30, 2002 were driven by pharmacy sales growth of 6.9%
and 8.1%, respectively, offset slightly by front end sales declines of 0.7%
and 0.5%, respectively. The decline in front end sales was a direct result of
closing 34 and 89 stores in the thirteen and thirty-nine weeks ended
November 30, 2002, partially offset by positive same store sales increases.
Same store sales growth for the thirteen and thirty-nine week periods ended
November 30, 2002 was 6.7% and 7.4%, respectively. The 5.7% and 6.9% growth in
revenues for the thirteen and thirty-nine week periods ended December 1, 2001
were driven by pharmacy sales growth of 8.5% and 9.6%, respectively, and front
end sales (decline) growth of (0.8)% and 1.9%, respectively.
For the thirteen and thirty-nine week periods ended November 30, 2002,
pharmacy sales led revenue growth with same store sales increases of 9.6% and
10.7%, respectively. Factors contributing to pharmacy same store sales
increases include inflation, improved attraction and retention of managed care
customers, our reduced cash pricing, our increased focus on pharmacy
initiatives such as predictive refill, and favorable industry trends. These
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. These favorable factors were partially
offset by the increase in generic sales mix.
For the thirteen week periods ended November 30, 2002 and December 1, 2001,
front end same stores sales increased 1.9% and 1.2%, respectively. For the
thirty-nine week periods ended November 30, 2002 and December 1, 2001, front
end same store sales increased 2.0% and 3.6%, respectively. The same store
sales increases were primarily a result of improved assortments, lower prices
on key items, and distributing a nationwide weekly advertising circular.
19
Costs and Expenses
Thirteen Week Thirty-Nine Week
Period Ended Period Ended
--------------------------- --------------------------
November 30, December 1, November 30, December 1,
2002 2001 2002 2001
------------ ----------- ------------ -----------
(Dollars in thousands)
Cost of goods sold .................................................... $2,977,050 $2,916,062 $8,960,968 $8,608,274
Gross profit .......................................................... 902,473 816,017 2,699,991 2,525,012
Gross margin .......................................................... 23.3% 21.9% 23.2% 22.7%
Selling, general and administrative expenses .......................... 832,614 848,597 2,567,433 2,495,267
Selling, general and administrative expenses as a percentage of
revenues............................................................. 21.5% 22.7% 22.0% 22.4%
Stock-based compensation expense (benefit) ............................ 2,625 (39,447) 3,973 2,800
Goodwill amortization ................................................. -- 5,200 -- 15,823
Store closing and impairment charges .................................. 2,945 18,652 57,051 40,393
Interest expense ...................................................... 80,941 82,515 250,527 313,581
Interest rate swap contracts .......................................... -- 10,382 278 41,429
Loss on debt and lease conversions and modifications .................. -- (56) -- 154,539
Share of loss from equity investment .................................. -- 1,697 -- 12,092
(Gain) loss on sale of assets and investments, net .................... (775) 694 (16,163) (50,761)
Cost of Goods Sold
Gross margin was 23.3% for the thirteen week period ended November 30, 2002
compared to 21.9% for the thirteen week period ended December 1, 2001. Gross
margin was positively impacted by improvements in pharmacy margin, driven by
increased generic mix and improved third party reimbursements. Gross margin
rate was also positively impacted by flat occupancy expense on a higher sales
base. Although front end margin rate has improved, the lower mix of front end
sales caused a slight decline in front end margin contribution, which
partially offset the positive pharmacy margin trends.
Gross margin was 23.2% for the thirty-nine week period ended November 30,
2002 compared to 22.7% for the thirty-nine week period ended December 1, 2001.
Gross margin was positively impacted by improvements in pharmacy margin,
driven by increased generic mix and improved third party reimbursements. Gross
margin rate was also positively impacted by flat occupancy expense on a higher
sales base. Although front end margin rate has improved, the lower mix of
front end sales caused a decline in front end margin contribution, which
partially offset the positive pharmacy margin trends.
We use the last-in, first-out (LIFO) method of inventory valuation, which is
determined annually when inflation rates and inventory levels are finalized.
Therefore, LIFO costs for interim period financial statements are estimated.
Cost of sales includes a LIFO provision of $17.3 million and $51.8 million for
the thirteen and thirty-nine week period ended November 30, 2002, versus
$15.0 million and $45.0 million for the thirteen and thirty-nine week period
ended December 1, 2001.
Selling, General and Administrative Expenses
The selling, general and administrative expenses ("SG&A") for the thirteen
week period ended November 30, 2002 includes $3.3 million incurred primarily
in connection with our defense of shareholder litigation and cooperating with
various governmental investigations, offset by net receipts of $6.6 million
for non-recurring litigation settlements. Excluding these items, SG&A as a
percentage of revenues was 21.6% for the thirteen week period ended
November 30, 2002. SG&A expense for the thirteen week period ended
20
December 1, 2001, includes $0.9 million to accrue for non-recurring litigation
and $4.6 million incurred primarily in connection with our defense of
shareholder litigation and cooperating with various governmental
investigations. Excluding these items, SG&A as a percentage of revenues was
22.6% for the thirteen week period ended December 1, 2001. SG&A on an adjusted
basis of 21.6% for the thirteen week period ended November 30, 2002 compares
favorably with SG&A on an adjusted basis of 22.6% for the thirteen week period
ended December 1, 2001 due to decreased depreciation and amortization charges
resulting from a reduced store count, reductions in professional fees, reduced
advertising costs, and better leveraging of our fixed costs resulting from
higher sales volume.
The selling, general and administrative expenses for the thirty-nine week
period ended November 30, 2002, includes net charges of $13.7 million of non-
recurring litigation settlements and $13.2 million incurred primarily in
connection with our defense of shareholder litigation and cooperating with
various governmental investigations. Excluding these items, SG&A as a
percentage of revenues was 21.8% for the thirty-nine week period ended
November 30, 2002. SG&A expense for the thirty-nine week period ended
December 1, 2001, includes $3.8 million to accrue for non-recurring litigation
and $13.6 million incurred primarily in connection with our defense of
shareholder litigation and cooperating with various governmental
investigations, offset by receipts of $39.1 million for the settlement of
litigation with certain drug manufacturers. Excluding these items, SG&A as a
percentage of revenues was 22.6% for the thirty-nine week period ended
December 1, 2001. SG&A on an adjusted basis of 21.8% for the thirty-nine week
period ended November 30, 2002 compares favorably with SG&A on an adjusted
basis of 22.6% for the thirty-nine week period ended December 1, 2001 due to
decreased depreciation and amortization charges resulting from a reduced store
count, reductions in professional fees, reduced advertising costs, and better
leveraging of our fixed costs resulting from higher sales volume, partially
offset by higher associate benefit costs.
Store Closing and Impairment Charges
Store closing and impairment charges consist of:
Thirteen Week Thirty-Nine Week
Period Ended Period Ended
--------------------------- --------------------------
November 30, December 1, November 30, December 1,
2002 2001 2002 2001
------------ ----------- ------------ -----------
(Dollars in thousands)
Impairment charges .................................................... $2,531 $ 8,060 $ 8,939 $24,613
Store and equipment lease exit charges ................................ 414 10,590 48,112 15,437
Impairment of other assets ............................................ -- 2 -- 343
------ ------- ------- -------
$2,945 $18,652 $57,051 $40,393
====== ======= ======= =======
Impairment Charges. Impairment charges include non-cash charges of
$2.5 million and $8.1 million for the thirteen week periods ended November 30,
2002 and December 1, 2001, respectively, for the impairment of long-lived
assets (including allocable goodwill for the thirteen week period ended
December 1, 2001) at 7 and 23 stores, respectively. Impairment charges include
non-cash charges of $8.9 million and $20.4 million for the thirty-nine week
periods ended November 30, 2002 and December 1, 2001, respectively, for the
impairment of long-lived assets (including allocable goodwill for the thirty-
nine week period ended December 1, 2001) at 61 and 53 stores, respectively.
These amounts include the write-down of long-lived assets at stores that were
assessed for impairment because of management's intention to relocate or close
the store or because of changes in circumstances that indicated the carrying
value of the asset may not be recoverable. Also included in impairment charges
for the thirty-nine weeks ended December 1, 2001 are approximately $4.2 million
of costs related to software.
Store and Equipment Lease Exit Costs. During the thirteen week periods
ended November 30, 2002 and December 1, 2001, we recorded charges for 4 and 9
stores, respectively, to be closed or relocated under long-term leases. During
the thirty-nine week periods ended November 30, 2002 and December 1, 2001, we
recorded charges for 36 and 42 stores, respectively, to be closed or relocated
under long-term leases. Costs incurred to close a store, which principally
include lease termination costs, are recorded at the time management commits
to closing the store, which is the date that closure is formally approved by
senior
21
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 leases
terminations. This liability is discounted using a risk-free rate of interest.
We evaluate these assumptions each quarter and adjust the liability
accordingly.
As part of our ongoing business activities, we assess stores for potential
closure. Decisions to close stores in future periods would result in charges
for store lease exit costs upon the completion of the liquidation of
inventory, as well as impairment of assets at these stores.
Interest Expense
Interest expense was $80.9 and $250.5 million for the thirteen and thirty-
nine week periods ended November 30, 2002, compared to $82.5 million and
$313.6 million for the thirteen and thirty-nine week periods ended December 1,
2001. The decrease from the thirty-nine week period ended December 1, 2001, to
the thirty-nine week period ended November 30, 2002 was primarily due to the
reduction of debt resulting from the sale of PCS and the June 2001
refinancing. The weighted average interest rates, excluding capital leases, on
our indebtedness for the thirty-nine week periods ended November 30, 2002 and
December 1, 2001 were 7.4% and 8.1%, respectively.
Interest Rate Swap Contracts
We entered into two year interest rate swap contracts in June and July of
2000 to hedge the exposure to increasing rates with respect to our variable
rate debt. As a result of the June 2001 refinancing, the interest rate swap
contracts no longer qualified for hedge accounting treatment, and therefore
the changes in fair value of these interest rate swap contracts was required
to be recorded as a component of net loss. Accordingly, we recognized a charge
of $31.0 million during the thirteen week period ended September 1, 2001,
representing the amount that we would have to pay the counter party to
terminate these contracts. Additionally, changes in the market value of the
interest rate swaps of $10.4 million, inclusive of cash payments, have been
recorded on the operating statement for the thirteen week period ended
December 1, 2001. Changes in market value of the interest rate swaps were not
significant for the thirteen and thirty-nine week periods ended November 30,
2002. These contracts expired and were fully funded during the thirteen week
period ended August 31, 2002 and have not been renewed. Correspondingly, there
is no termination liability as of November 30, 2002.
Income Taxes
The tax benefit of $42.4 million for the thirty-nine week period ended
November 30, 2002 is comprised of two components. The first reflects a one
time income tax benefit of $44.0 million based on a tax law change, enacted on
March 9, 2002, which increased the carryback period of net operating losses
incurred in fiscal 2001 and 2002 from two years to five. The second component
is the provision for state income taxes of $1.6 million.
The income tax benefits of the NOL's generated in the thirty-nine week
periods ended November 30, 2002 and December 1, 2001 have been fully offset by
a valuation allowance as a result of management's determination that, based on
available evidence, it is more likely than not that the deferred tax assets
will not be realized.
We had an ownership change for statutory purposes in fiscal 2002, which
resulted in a limitation on the future use of net operating loss
carryforwards. This limitation does not further impair the net operating loss
carryforwards because they are fully reserved.
We received federal income tax refunds in the amount of $68.7 million during
the thirteen week period ended November 30, 2002, based on the favorable
outcome of federal income tax litigation and tax law changes enacted March 9,
2002.
22
Liquidity and Capital Resources
General
We have two primary sources of liquidity: (i) cash provided by operations
and (ii) the revolving credit facility under our senior secured credit
facility. Our principal uses of cash are to provide working capital for
operations, service our obligations to pay interest and principal on debt, to
provide funds for capital expenditures, and, as of December 23, 2002, to
provide funds available for repurchases of our publicly traded debt and the
senior secured (shareholder) notes due 2006.
Our ability to borrow under the senior secured credit facility is based on a
specified borrowing base consisting of eligible accounts receivable and
inventory. On November 30, 2002, we had $409.6 million in additional available
borrowing capacity under the revolving credit facility net of outstanding
letters of credit of $90.4 million. As of November 30, 2002, the term loan was
fully drawn.
On December 23, 2002, we entered into an amendment of our senior secured
credit facility to allow us to make optional repurchases of our publicly
traded debt and our senior secured (shareholder) notes due 2006. For the
period from December 23, 2002 to the end of our 2004 fiscal year, we will have
up to $300.0 million available for optional debt repurchases, provided that we
are in compliance with the capital expenditures covenant of our senior secured
credit facility. For fiscal years after 2004, we will have an amount available
for optional debt repurchases equal to the lesser of our availability under
the capital expenditures covenant and a formula based upon our performance for
the prior fiscal year. In addition, during the period from December 23, 2002
to the end of our 2004 fiscal year, we may purchase an additional
$150.5 million of our publicly traded debt with the net proceeds of additional
debt issuances which are unsecured or are secured by the collateral that
secures our senior credit facility on a second priority basis.
The senior secured credit facility, as amended, also allows us, at our
option, to issue up to $893.0 million of unsecured debt that is not guaranteed
by any of our subsidiaries, reduced by the following debt to the extent
incurred: (i) $150.0 million of financing transactions of existing owned real
estate; (ii) $643.0 million of additional debt secured by the facility's
collateral on a second priority basis; and (iii) $100.0 million of financing
transactions for property or assets acquired after June 27, 2001. The
$893.0 million of permitted debt, whether secured or unsecured, is reduced by
the aggregate outstanding, undefeased balances of the 6.0% dealer remarketable
securities, the 4.75% convertible notes and the senior secured (shareholder)
notes. As of November 30, 2002, we had outstanding principal balances of
$58.1 million, $250.0 million and $149.5 million of the 6.0% dealer
remarketable securities, 4.75% convertible notes and the senior secured
(shareholder) notes, respectively. As of November 30, 2002, our remaining
permitted debt under the senior secured credit facility is $435.4 million. Our
11.25% senior notes due July 2008 also permit $150.0 million of real estate
financing, $400.0 million of additional other debt and $600.0 million of
additional permitted debt, which includes allowing us to increase our senior
secured credit facility. As of November 30, 2002 our remaining permitted debt
under the 11.25% senior notes due 2008, excluding real estate financing, is
$600.5 million.
The senior secured credit facility, as amended, requires us to meet various
financial ratios and limits capital expenditures. Beginning with the 12 months
ended March 2, 2002, the covenants require us to maintain a maximum leverage
ratio of 8.40:1, increasing to 9.50:1 for the twelve months ended June 1,
2002, and increasing again to 10.00:1 for the twelve months ended August 31,
2002, before gradually decreasing to 6.00:1 for the twelve months ended May 31,
2005. We must also maintain a minimum interest coverage ratio of 1.20:1 for
the twelve months ended March 2, 2002, decreasing to 1.15:1 for the twelve
months ended June 1, 2002 and decreasing again to 1.10:1 for the twelve months
ended August 31, 2002 before gradually increasing to 2.00:1 for the twelve
months ended November 30, 2004. In addition, we must maintain a minimum fixed
charge ratio of 0.9:1 for the twelve months ended March 2, 2002, gradually
increasing to 1.10:1 for the twelve months ended August 31, 2004. Capital
expenditures are limited to $150.0 million annually beginning with the twelve
months ended March 2, 2002. These capital expenditure limits are subject to
upward adjustment based upon availability of excess liquidity as defined in
our senior secured credit facility and unused amounts from the prior fiscal
year. As of December 23, 2002, we may use amounts permitted for capital
expenditures to make optional purchases of our publicly traded debt and
shareholder notes.
23
We were in compliance with the covenants of the senior secured credit
facility, as amended, and our other credit facilities and debt instruments as
of November 30, 2002. With continuing improvements in our 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.
The senior secured credit 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 holders of our
debt to accelerate the maturity of debt having a principal amount of
$25.0 million or more.
Net Cash Provided by/Used in Operating, Investing and Financing Activities
We generated $160.4 million in operating cash flows during the thirty-nine
week period ended November 30, 2002, and used $309.8 million to fund
operations in the thirty-nine week period ended December 1, 2001. Operating
cash flow for the thirty-nine week period ended November 30, 2002 was
positively impacted by improved operating results, income tax refunds of
$68.7 million, a decrease in accounts receivable, and an increase in accounts
payable, which more than offset $226.2 million in interest payments and an
increase in inventory due to seasonal inventory build. Operating cash flow for
the thirty-nine week period ended December 1, 2001 was negatively impacted by
$314.5 million in interest payments and increases in accounts receivable and
inventory.
Cash used in investing activities was $50.1 million for the thirty-nine week
period ended November 30, 2002, due primarily to expenditures for property,
plant and equipment as well as prescription files, offset by proceeds from
asset dispositions. Cash provided by investing activities was $348.0 million
for the thirty-nine week period ended December 1, 2001, due primarily to the
sale of the securities we received in our sale of AdvancePCS.
Cash used in financing activities was $217.4 million and $36.2 million for
the thirty-nine week periods ended November 30, 2002 and December 1, 2001,
respectively. We repaid our 5.25% convertible subordinated notes due 2002 and
our 10.5% senior secured notes due 2002 in the thirty-nine week period ended
November 30, 2002.
Working capital was $1,484.8 million at November 30, 2002, compared to
$1,524.3 million at March 2, 2002.
Capital Expenditures
We plan capital expenditures of approximately $130.0 million during fiscal
2003, consisting of approximately $51.0 million related to new store
construction, store relocation and other store construction projects, and
$79.0 million which will be dedicated to other store improvement activities
and the purchase of prescription files from independent pharmacists. We expect
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. During the thirty-nine week period ended
November 30, 2002, we spent $80.9 million on capital expenditures, consisting
of $38.2 million related to new store construction, store relocation and other
store construction projects and $42.7 million for other store improvement
activities and the purchase of prescription files from independent
pharmacists.
Future Liquidity
We are highly leveraged. Our high level of indebtedness: (a) limits our
ability to obtain additional financing; (b) limits our flexibility in planning
for, or reacting to, changes in our business and the industry; (c) places us
at a competitive disadvantage relative to our competitors with less debt; (d)
renders us more vulnerable to general adverse economic and industry
conditions; and (e) requires us to dedicate a substantial portion of our cash
flow to service our debt. Based upon current levels of operations and planned
improvements in our operating performance, management believes that cash flow
from operations together with available borrowings under the senior secured
credit facility and other sources of liquidity will be
24
adequate to meet our anticipated annual requirements for working capital, debt
service and capital expenditures through the end of fiscal 2004. We will
continue to assess our liquidity position and potential sources of
supplemental liquidity in light of our operating performance and other
relevant circumstances. Should we determine, at any time, that it is necessary
to seek additional short-term liquidity, we will evaluate our alternatives and
take appropriate steps to attempt to obtain sufficient additional funds.
Obtaining any such supplemental liquidity through the increase of indebtedness
or asset sales would require the consent of the lenders under one or more of
our debt agreements. There can be no assurance that any such supplemental
funding, if sought, could be obtained or that our lenders would provide the
necessary consents.
Recent Accounting Pronouncements
We adopted SFAS No. 142, "Goodwill and Other Intangible Assets" effective
March 3, 2002. SFAS No. 142 specifies that all goodwill and indefinite life
intangibles shall no longer be amortized. Goodwill must be allocated to
reporting units and evaluated for impairment on an annual basis with an
initial impairment assessment to be performed upon adoption of SFAS No. 142.
We have completed the transitional goodwill impairment test as of March 3,
2002 and determined that there was no impairment loss to be recognized upon
adoption of SFAS No. 142. At November 30, 2002, we have unamortized goodwill
of $684.5 million and no indefinite life intangibles.
The impact of the adoption of SFAS No. 142 on the thirteen and thirty-nine
week periods ended December 1, 2001 is as follows (in millions except per
share amounts):
Thirteen week Thirty-Nine week
period ended period ended
December 1, 2001 December 1, 2001
---------------- ----------------
Reported net loss ....................... $(112.8) $(569.8)
Add back goodwill amortization .......... 5.2 15.8
------- -------
Adjusted net loss ....................... $(107.6) $(554.0)
======= =======
Loss before extraordinary item, as
adjusted ............................... $(107.6) $(487.4)
======= =======
Basic and diluted loss per share:
Reported net loss ...................... $ (0.23) $ (1.29)
Goodwill amortization .................. 0.01 0.03
------- -------
Adjusted net loss ...................... $ (0.22) $ (1.26)
======= =======
We adopted SFAS No. 144, "Accounting for the Impairment or Disposal of Long-
Lived Assets" effective March 3, 2002. SFAS No. 144 addressed the financial
accounting and reporting for the impairment or disposal of long-lived assets.
We have determined that there was no impact on the consolidated financial
position or results of operations as a result of the adoption of SFAS No. 144.
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements
No. 4, "Reporting Gains and Losses from Extinguishment of Debt," SFAS No. 44,
"Accounting for Intangible Assets of Motor Carriers" and SFAS No. 64,
"Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements," Amendment
of SFAS No. 13, "Accounting for Leases," and Technical Corrections." The
provisions of SFAS No. 145 that relate to the rescission of SFAS No. 4 are
required to be applied in fiscal years beginning after May 15, 2002. Any gain
or loss on extinguishment of debt that was classified as an extraordinary item
in prior periods presented that does not meet the criteria in APB Opinion
No. 30, "Reporting the Results of Operations -- Reporting the Effects of
Disposal of a Segment of a Business, and Extraordinary, Unusual and
Infrequently Occurring Events and Transactions" for classification as an
extraordinary item shall be reclassified. Beginning with fiscal 2004, our
financial statements for prior years with extraordinary items for the early
extinguishment of debt will show such items as reclassified to operations. The
provisions related to SFAS No. 13 are effective for transactions occurring
after May 15, 2002 and have been adopted without material impact. All other
provisions of SFAS No. 145, which are effective for financial statements
issued on or after May 15, 2002, have been adopted without material impact.
25
In June of 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities". This Statement addresses
financial accounting and reporting for costs associated with exit or disposal
activities and nullifies EITF 94-3, "Liability Recognition for Certain
Employee Termination Benefits and Other Costs to Exit an Activity (including
Certain Costs Incurred in a Restructuring)". SFAS No. 146 requires that a
liability for a cost associated with an exit or disposal activity be
recognized when the liability is incurred. This differs from the guidance in
EITF 94-3, which requires that a liability for costs associated with an exit
plan or disposal activity be recognized at the date of an entity's commitment
to an exit plan. SFAS No. 146 also requires all charges related to an exit
activity, including accretion of interest related to the discounting of the
future liability related to that activity, to be classified in the same line
item on the statement of operations. The provisions of the Statement are