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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For The Quarterly Period Ended August 31, 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
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, 17011
Camp Hill, Pennsylvania (Zip Code)
(Address of principal executive offices)
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. X Yes 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 515,126,181 shares of its $1.00 par value common
stock outstanding as of September 27, 2002.
RITE AID CORPORATION
TABLE OF CONTENTS
Page
Cautionary Statement Regarding Forward Looking Statements 3
PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements:
Condensed Consolidated Balance Sheets as of August 31, 2002 and
March 2, 2002 4
Condensed Consolidated Statements of Operations for the Thirteen Week
Periods Ended August 31, 2002 and September 1, 2001 5
Condensed Consolidated Statements of Operations for the Twenty-Six
Week Periods Ended August 31, 2002 and September 1, 2001 6
Condensed Consolidated Statements of Cash Flows for the Twenty-Six
Week Periods Ended August 31, 2002 and September 1, 2001 7
Notes to Condensed Consolidated Financial Statements 8
ITEM 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 17
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk 24
ITEM 4, Controls and Procedures 25
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings 26
ITEM 2. Changes in Securities and Use of Proceeds 26
ITEM 3. Defaults Upon Senior Securities 26
ITEM 4. Submission of Matters to a Vote of Security Holders 26
ITEM 5. Other Information 27
ITEM 6. Exhibits and Reports on Form 8-K 27
2
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
This report includes forward-looking statements within the meaning of
the Private Securities Litigation Reform Act of 1995. These forward-looking
statements are identified by terms and phrases such as "anticipate," "believe,"
"intend," "estimate," "expect," "continue," "should," "could," "may," "plan,"
"project," "predict," "will" and similar expressions and include references to
assumptions and relate to our future prospects, developments and business
strategies.
Factors that could cause actual results to differ materially from
those expressed or implied in such forward-looking statements include, but are
not limited to:
o our high level of indebtedness;
o our ability to make interest and principal payments on our debt and
satisfy the other covenants contained in our credit 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".
3
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
RITE AID CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except per share amounts)
(unaudited)
August 31, 2002 March 2, 2002
--------------- -------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $270,880 $344,055
Accounts receivable, net 616,371 594,249
Inventories, net 2,253,343 2,262,111
Prepaid expenses and other current assets 101,332 101,681
--------- ---------
Total current assets 3,241,926 3,302,096
PROPERTY, PLANT AND EQUIPMENT, NET 2,004,298 2,096,030
GOODWILL 684,535 684,535
OTHER INTANGIBLES, NET 219,900 240,725
OTHER ASSETS 185,570 168,373
--------- ---------
Total assets $6,336,229 $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 $213,026 $209,457
Accounts payable 812,163 830,535
Sales and other taxes payable 45,486 49,407
Accrued salaries, wages and other current liabilities 733,328 688,435
--------- ---------
Total current liabilities 1,804,003 1,777,834
CONVERTIBLE NOTES 243,750 243,000
LONG-TERM DEBT, LESS CURRENT MATURITIES 3,387,062 3,427,930
LEASE FINANCING OBLIGATIONS, LESS CURRENT MATURITIES 172,689 176,081
OTHER NONCURRENT LIABILITIES 800,749 837,737
--------- ---------
Total liabilities 6,408,253 6,462,582
COMMITMENTS AND CONTINGENCIES --- ---
REDEEMABLE PREFERRED STOCK 19,612 19,561
STOCKHOLDERS' (DEFICIT) EQUITY:
Preferred stock, par value $1 per share, liquidation value $100 per share 370,997 361,504
Common stock, par value $1 per share 515,125 515,136
Additional paid-in capital 3,142,337 3,151,811
Accumulated deficit (4,108,750) (4,006,043)
Stock-based and deferred compensation 1,910 463
Accumulated other comprehensive loss (13,255) (13,255)
--------- ---------
Total stockholders' (deficit) equity (91,636) 9,616
--------- ---------
Total liabilities and stockholders' (deficit) equity $6,336,229 $6,491,759
========= =========
See accompanying notes to condensed consolidated financial statements.
4
RITE AID CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
(unaudited)
Thirteen Week Period Ended
--------------------------
August 31, 2002 September 1, 2001
--------------- -----------------
REVENUES $3,856,320 $3,691,074
COSTS AND EXPENSES:
Costs of goods sold, including occupancy costs 2,973,199 2,856,756
Selling, general and administrative expenses 851,232 826,428
Stock-based compensation benefit (6,746) (845)
Goodwill amortization --- 5,280
Store closing and impairment charges 58,223 22,105
Interest expense 84,955 102,377
Interest rate swap contracts 14 31,047
Loss on debt and lease conversions and modifications --- 21,882
Share of loss from equity investment --- 4,512
Loss (gain) on sale of assets and investments, net 1,477 (1,636)
--------- ---------
3,962,354 3,867,906
--------- ---------
Loss before income taxes and extraordinary item (106,034) (176,832)
INCOME TAX EXPENSE 649 2,500
--------- ---------
Loss before extraordinary item (106,683) (179,332)
EXTRAORDINARY ITEM, gain (loss) on early extinguishment of debt, net of
income taxes of $0 1,392 (66,589)
--------- ---------
Net loss $ (105,291) $(245,921)
========= =========
COMPUTATION OF LOSS APPLICABLE TO COMMON
STOCKHOLDERS:
Net loss $ (105,291) $(245,921)
Accretion of redeemable preferred stock (26) ---
Preferred stock beneficial conversion --- (5,181)
Cumulative preferred stock dividends (2,263) (6,688)
--------- ---------
Net loss attributable to common stockholders $ (107,580) $(257,790)
========= =========
BASIC AND DILUTED LOSS PER SHARE:
Loss before extraordinary item $ (0.21) $(0.40)
Loss from extraordinary item --- (0.14)
--------- ---------
Net loss per share $ (0.21) $(0.54)
========= =========
See accompanying notes to condensed consolidated financial statements.
5
RITE AID CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
(unaudited)
Twenty-Six Week Period Ended
----------------------------
August 31, 2002 September 1, 2001
--------------- -----------------
REVENUES $7,781,436 $7,401,207
COSTS AND EXPENSES:
Costs of goods sold, including occupancy costs 5,983,918 5,692,211
Selling, general and administrative expenses 1,734,819 1,646,671
Stock-based compensation expense 1,348 42,247
Goodwill amortization --- 10,623
Store closing and impairment charges 54,106 21,741
Interest expense 169,586 231,066
Interest rate swap contracts 278 31,047
Loss on debt and lease conversions and modifications --- 154,595
Share of loss from equity investment --- 10,395
Gain on sale of assets and investments, net (15,388) (51,455)
---------- ----------
7,928,667 7,789,141
---------- ----------
Loss before income taxes and extraordinary item (147,231) (387,934)
INCOME TAX (BENEFIT) EXPENSE (42,862) 2,500
---------- ----------
Loss before extraordinary item (104,369) (390,434)
EXTRAORDINARY ITEM, gain (loss) on early extinguishment of debt, net of
income taxes of $0 1,662 (66,589)
---------- ----------
Net loss $ (102,707) $(457,023)
========== ==========
COMPUTATION OF LOSS APPLICABLE TO COMMON
STOCKHOLDERS:
Net loss $ (102,707) $(457,023)
Accretion of redeemable preferred stock (51) ---
Preferred stock beneficial conversion --- (5,181)
Cumulative preferred stock dividends (9,493) (13,368)
---------- ----------
Net loss attributable to common stockholders $ (112,251) $(475,572)
========== ==========
BASIC AND DILUTED LOSS PER SHARE:
Loss before extraordinary item $ (0.22) $(0.95)
Loss from extraordinary item --- (0.15)
---------- ----------
Net loss per share $ (0.22) $(1.10)
========== ==========
See accompanying notes to condensed consolidated financial statements.
6
RITE AID CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(unaudited)
Twenty-Six Week Period Ended
----------------------------
August 31, 2002 September 1, 2001
--------------- ----------------
OPERATING ACTIVITIES:
Net loss $(102,707) $(457,023)
Extraordinary (gain) loss (1,662) 66,589
--------- ---------
Loss from operations (104,369) (390,434)
Adjustments to reconcile to net cash used in operating activities:
Depreciation and amortization 147,326 180,176
Stock-based compensation expense 1,348 42,247
Store closing and impairment charges 54,106 21,741
Loss on debt and lease conversions and modifications --- 154,595
Interest rate swap contracts market value adjustment 278 31,047
Gain on sale of assets and investments, net (15,388) (51,455)
Changes in income tax receivables and payables (44,002) (9,702)
Changes in operating assets and liabilities (44,432) (26,536)
--------- ---------
NET CASH USED IN OPERATING ACTIVITIES (5,133) (48,321)
--------- ---------
INVESTING ACTIVITIES:
Expenditures for property, plant and equipment (48,063) (127,300)
Proceeds from the repayment/sale of AdvancePCS securities --- 484,214
Intangible assets acquired (5,556) (4,900)
Proceeds from dispositions 25,582 12,684
--------- ---------
NET CASH (USED IN) PROVIDED BY INVESTING ACTIVITIES (28,037) 364,698
--------- ---------
FINANCING ACTIVITIES:
Principal payments on long-term debt (26,528) (2,114,360)
Proceeds from the issuance of the senior credit facility --- 1,378,462
Net change in bank credit facilities (12,500) ---
Change in zero balance cash accounts (766) (20,075)
Proceeds from issuance of stock 280 530,418
Deferred financing costs paid (491) (73,972)
--------- ---------
NET CASH USED IN FINANCING ACTIVITIES (40,005) (299,527)
--------- ---------
(DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (73,175) 16,850
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 344,055 92,290
--------- ---------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $270,880 $109,140
========= =========
SUPPLEMENTARY CASH FLOW DATA:
Cash paid for interest (net of capitalized amounts of $176 and $0, respectively) $170,864 $250,070
=====================================
Cash payments (refunds)of income taxes $1,392 $ (7,675)
=====================================
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
7
RITE AID CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
For the Thirteen and Twenty-Six Week Periods Ended
August 31, 2002 and September 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 twenty-six week periods ended August 31, 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 August 31, 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
twenty-six weeks ended September 1, 2001 is as follows:
Thirteen week Twenty-Six week
period ended period ended
September 1, 2001 September 1, 2001
----------------- -----------------
Reported net loss $ (245,921) $ (457,023)
Add back goodwill amortization 5,280 10,623
--------------------- ---------------------
Adjusted net loss $ (240,641) $ (446,400)
===================== =====================
Basic and diluted loss per share:
Reported net loss $ (0.54) $ (1.10)
Goodwill amortization 0.01 0.02
--------------------- ---------------------
Adjusted net loss $ (0.53) $ (1.08)
===================== =====================
8
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 of August 31, 2002 and March 2, 2002.
August 31, 2002 March 2, 2002
--------------- -------------
Gross Gross
Carrying Accumulated Carrying Accumulated
Amount Amortization Amount Amortization
------ ------------ ------ ------------
Favorable leases and other $313,429 $(165,932) $312,677 $(158,290)
Prescription files 343,664 (271,261) 341,422 (255,084)
--------------- ---------------- ------------ ---------------
Total $657,093 $(437,193) $654,099 $(413,374)
=============== ================ ============ ===============
Amortization expense for these intangible assets was $11,876 and
$24,626 for the thirteen and twenty-six weeks ended August 31, 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 Statement of Financial Accounting
Standards (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 not adopted SFAS No.
146, and has not determined whether it will elect to adopt SFAS No. 146 before
the required date. The adoption of SFAS No. 146 will impact the timing of
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.
9
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 Period Ended Twenty-Six Week Period Ended
-------------------------- ----------------------------
August 31, September 1, August 31, September1,
2002 2001 2002 2001
---------- ------------ ---------- -----------
Numerator for earnings per share:
Loss before extraordinary item $(106,683) $(179,332) $(104,369) $(390,434)
Accretion of redeemable preferred stock (26) --- (51) ---
Preferred stock beneficial conversion and reset
provision --- (5,181) --- (5,181)
Cumulative preferred stock dividends (2,263) (6,688) (9,493) (13,368)
--------- --------- --------- ---------
Net loss before extraordinary item attributable to
common stockholders (108,972) (191,201) (113,913) (408,983)
Extraordinary item, gain (loss) on early
extinguishment of debt 1,392 (66,589) 1,662 (66,589)
--------- --------- --------- ---------
Net loss attributable to common stockholders $(107,580) $(257,790) $(112,251) $(475,572)
========= ========= ========= =========
Denominator:
Basic weighted average shares 515,158 477,464 515,139 432,390
Diluted weighted average share 515,158 477,464 515,139 432,390
Basic and diluted loss per share:
Loss from operations $(0.21) $(0.40) $(0.22) $(0.95)
Loss from extraordinary item --- (0.14) --- (0.15)
--------- --------- --------- ---------
Net loss per share $(0.21) $(0.54) $(0.22) $(1.10)
========= ========= ========= =========
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 twenty-six week periods
ended August 31, 2002 and September 1, 2001, and the amount would be
antidilutive. At August 31, 2002, an aggregate of 172,058 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 Period Ended Twenty-Six Week Period Ended
-------------------------- ----------------------------
August 31, September 1, August 31, September 1,
2002 2001 2002 2001
---------- ------------ ---------- ------------
Impairment charges $5,548 $8,690 $6,408 $16,583
Store and equipment lease exit charges 52,675 13,415 47,698 4,847
Impairment of other assets --- --- --- 311
--------- --------- --------- ---------
$58,223 $22,105 $54,106 $21,741
========= ========= ========= =========
Impairment charges
Impairment charges include non-cash charges of $5,548 and $4,490 for
the thirteen week periods ended August 31, 2002 and September 1, 2001,
respectively, for the impairment of long-lived assets (including allocable
goodwill for the thirteen week period ended September 1, 2001) at 41 and 13
stores, respectively. Impairment charges include non-cash charges of $6,408 and
$12,383 for the twenty-six week periods ended August 31, 2002 and September 1,
2001, respectively, for the impairment of long-lived assets (including allocable
goodwill for the twenty-six week period ended September 1, 2001) at 54 and 30
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 thirteen and twenty-six week periods ended
September 1, 2001 are approximately $4,200 of costs related to software.
10
Store and equipment lease exit charges
During the thirteen week periods ended August 31, 2002 and September
1, 2001, the Company recorded charges for 32 and 26 stores, respectively, to be
closed or relocated under long-term leases. During the twenty-six week periods
ended August 31, 2002 and September 1, 2001, the Company recorded charges for
32 and 33 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.
The reserve for store and equipment lease exit costs includes the
following activity:
Thirteen Week Period Ended Twenty-Six Week Period Ended
-------------------------- ----------------------------
August 31, September 1, August 31, September 1,
2002 2001 2002 2001
---------- ------------ ---------- ------------
Balance --- beginning of period $272,195 $216,961 $287,464 $233,008
Provision for present value of noncancellable lease
payments of stores designated to
be closed 36,198 18,474 37,291 21,565
Changes in assumptions about future sublease
income, terminations and changes in
interest rates 16,572 (1,949) 11,142 (10,093)
Reversals of reserves for stores that management has
determined will remain open (95) (3,110) (735) (6,625)
Interest accretion 2,645 2,350 5,102 4,683
Cash payments, net of sublease income (13,999) (12,901) (26,748) (22,713)
-------- --------- --------- ---------
Balance --- end of period $313,516 $219,825 $313,516 $219,825
========= ========= ========= =========
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. These sales resulted in a gain of $15,777,
which is included in gain on sale of assets and investments, net, for the
twenty-six week period ended August 31, 2002. These sales do not affect the
business arrangement 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 twenty-six week period ended September 1, 2001.
Additionally, AdvancePCS repurchased the unsecured 11% senior subordinated notes
for $200,000 plus accrued interest.
6. Income Taxes
The tax benefit of $42,862 for the twenty-six week period ended August
31, 2002 is comprised of two components. The first reflects an 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 $1,149.
11
The income tax benefit of the NOL's generated in the twenty-six week
periods ended August 31, 2002 and September 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 has undergone an ownership change for statutory purposes
during fiscal 2002, which resulted in a limitation on the future use of net
operating loss carryforwards. The Company believes that this limitation does not
further impair the net operating loss carryforwards because they are fully
reserved.
7. Indebtedness and Credit Agreements
General:
Following is a summary of indebtedness and lease financing obligations
at August 31, 2002 and March 2, 2002:
August 31, 2002 March 2, 2002
---------------------------------------------------
Secured Debt:
Senior secured credit facility $ 1,365,962 $ 1,378,462
10.5% senior secured notes due 2002 20,879 20,879
12.5% senior secured notes due 2006 ($152,025 face value
less unamortized discount of $7,000 and $7,857) 145,025 144,168
Senior secured (shareholder) notes due 2006 149,500 149,500
Other 10,568 11,284
--------------------- ------------------------
1,691,934 1,704,293
Lease Financing Obligations 179,718 182,625
Unsecured Debt:
5.25% convertible subordinated notes due 2002 150,500 150,500
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 $6,250 and $7,000) 243,750 243,000
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
--------------------- ------------------------
2,144,875 2,169,550
--------------------- ------------------------
Total debt 4,016,527 4,056,468
Short-term debt and current maturities of convertible notes,
long-term debt and lease financing obligations (213,026) (209,457)
--------------------- ------------------------
Long-term debt and lease financing obligations, less current
maturities $ 3,803,501 $ 3,847,011
===================== ========================
Debt Redemptions:
During the thirteen and twenty-six week periods ended August 31, 2002,
the Company redeemed $20,925 and $25,425 of its 6.0% dealer remarketable
securities due 2003 for $19,533 and $23,763, respectively. The early redemption
resulted in an extraordinary gain of $1,392 and $1,662, net of tax of $0, for
the thirteen and twenty-six week periods ended August 31, 2002, respectively.
12
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 proceeds 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 twenty-six weeks ended September 1, 2001.
Carrying Additional
Amount Common Paid-In
Debt Exchanged 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
============== ============== =============
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
thirteen week period ended September 1, 2001 an extraordinary loss on early
extinguishment of debt of $66,589 (including $40,735 of deferred debt issue
costs written off), loss on debt and lease conversions and modifications of
$21,882, a charge of $31,047 related to interest rate swap contracts and
deferred debt issue costs of $73,972.
In connection with the June 27, 2001 refinancing, the Company exchanged
$152,025 of its existing 10.5% senior secured notes due 2002 for an equal amount
of 12.5% notes due September 2006 (the "12.5% senior secured notes"). In
addition, the holders of these notes received warrants to purchase 3,000 shares
of Company common stock at $6.00 per share. On June 29, 2001, the warrant
holders exercised these warrants, on a cashless basis, and as a result
approximately 982 shares of common stock were issued. The fair value of the
warrants issued in connection with the 12.5% senior secured notes were recorded
as a component of additional paid-in capital of $9,000. This resulted in a
discount on the 12.5% senior secured notes of $9,000 which is being amortized
over the life of the 12.5% senior secured notes as a component of interest
expense.
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
during the thirteen week period ended September 1, 2001, representing the amount
that the Company would have to pay the counter party at September 1, 2001 to
terminate these contracts. Changes in the market value of the interest rate
swaps of $14 and $278, inclusive of cash payments, have been recorded on the
income statement for the thirteen and twenty-six week periods ended August 31,
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 August 31,
2002.
13
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 $(8,923)and $(2,750)
for the thirteen week periods ended August 31, 2002 and September 1, 2001, and
$(2,992) and $37,129 for the twenty-six week periods ended August 31, 2002 and
September 1, 2001, respectively, related to the repriced options.
The stock-based and deferred compensation component of stockholders'
equity is comprised of $5,459 and $8,453 related to the repriced options offset
by $3,549 and $7,990 of deferred compensation, as of August 31, 2002 and March
2, 2002, respectively.
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 judgement 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 accrued
$20,000 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. The investigations, with which the Company is cooperating
fully, are ongoing and the Company cannot predict their outcomes. 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. As a result of discussions with the
independent trustee and the attorneys for the putative class action plaintiff,
the Company has arrived at a preliminary understanding which would resolve all
claims arising out of our associate benefit plans by an agreement to maintain
the current level of benefits and requires the Company to pay $4,010 and its
insurance companies to pay $5,500 into a settlement fund. The Company has
accrued its portion of the cash settlement. Various non-monetary terms and
conditions remain to be negotiated and agreed upon and any agreement reached
will be subject to the approval of the Department of Labor and the District
Court. There can be no assurance that a settlement of the matter will be agreed
upon or, if agreed upon, approved by the Department of Labor and the District
Court.
14
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.
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 operation 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 such settlement is approved by the U.S. District Court, 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 claim which is pending before the court. These claims are
ongoing and the Company cannot predict their outcome. An unfavorable outcome
could result in a material adverse effect on the Company's results of
operations, financial condition or cash flows.
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 intend 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 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 reserved $7,225
related to this potential liability in fiscal 2002.
These claims are ongoing and the Company cannot predict their outcome.
If any of these cases result in a substantial monetary judgement 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.
15
Other
In June of 2002, several former executive officers were indicted by the
United States Attorney on various criminal 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 $26,400 as of August 31, 2002, related to future obligations
under these arrangements. The Company is conducting an investigation of these
arrangements and based upon the outcome, the Company may adjust these
liabilities and record this adjustment as a reduction to selling, general and
administrative expenses.
The Company, together with a significant number of major U.S.
retailers, have 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 conditions 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 condition and
cash flows if decided adversely.
10. Subsequent Event
In September and October of 2002, the Company received cash receipts of
$12,300 for settlement of litigation with certain drug manufacturers. This
receipt will be recorded as a reduction to selling, general and administrative
expenses in the third quarter of fiscal 2003.
16
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Overview
Loss before extraordinary item for the thirteen and twenty-six week
periods ended August 31, 2002 was $106.7 million and $104.4 million,
respectively. Loss before extraordinary item for the thirteen and twenty-six
week periods ended September 1, 2001 was $179.3 million and $390.4 million,
respectively. The substantial improvement is the net result of several factors,
the most important we believe to be increased 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:
Litigation Related Charges and Credits. In the thirteen and twenty-six
week period ended August 31, 2002, we recorded charges of $0.3 million and $20.3
million, respectively, related to governmental investigations. In the thirteen
and twenty-six week periods ended September 1, 2001, we recorded $24.1 million
and $39.1 million, respectively, related to proceeds received from litigation
settlements with certain drug manufacturers and increased litigation related
accruals by $7.1 million and $2.9 million, respectively.
Substantial Investigation Expenses. We continue to incur substantial
expenses in connection with the process of defending ourselves and former
management against various shareholder actions and cooperation with the U.S.
Attorney's Office in their investigations of former management. We incurred $3.2
million and $5.6 million in the thirteen week periods ended August 31, 2002 and
September 1, 2001, respectively, and $9.9 million and $9.0 million in the
twenty-six week periods ended August 31, 2002 and September 1, 2001,
respectively. We expect to incur an additional $5.0 million to $10.0 million
over the remainder of fiscal 2003, and expect to continue to incur significant
legal and other expenses in connection with the ongoing litigation and
investigations to which we are subject.
Stock-Based Compensation Expense. We recorded stock-based compensation
(benefit) expense of $(6.7) million and $(0.8) million in the thirteen week
periods ended August 31, 2002 and September 1, 2001, respectively and $1.3
million and $42.2 million in the twenty-six week periods ended August 31, 2002
and September 1, 2001, respectively resulting primarily from the impact of
applying variable plan accounting to our stock-based compensation plans.
Gain on Sale of Assets and Investments. In the twenty-six week period
ended August 31, 2002, we recorded a gain of $15.8 million resulting from the
sale of our investment in drugstore.com. In the twenty-six week period ended
September 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 twenty-six
week period ended September 1, 2001, we recorded a pre-tax loss of $154.6
million on debt conversions and lease modifications that were performed in
connection with the June 27, 2001 refinancing.
Income Tax Benefit. In the twenty-six week period ended August 31,
2002, we recorded a $44.0 million income tax benefit related to carryback of net
operating losses made possible by a tax law change.
Other. In the twenty-six week period ended September 1, 2001, we
recorded a $10.4 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
twenty-six week period ended August 31, 2002. In the twenty-six week period
ended September 1, 2001, we recorded a $10.6 million charge for goodwill
amortization. We recorded no charges for goodwill amortization in the twenty-six
week period ended August 31, 2002, pursuant to the adoption of SFAS No. 142.
Recent Actions Affecting Operating Results
During fiscal 2002 and the first two quarters of fiscal 2003 we took a
number of actions which had the short-term effect of significantly reducing our
operating results but which management believes were nevertheless necessary.
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. We anticipate taking
actions in the future similar to some of those described above that may have a
material negative impact upon our operating results for the period in which we
take those actions or subsequent periods.
17
Results of Operations
Revenues and Other Operating Data
Thirteen Week Period Ended Twenty-Six Week Period Ended
-------------------------- ----------------------------
August 31, September 1, August 31, September 1,
2002 2001 2002 2001
---------- ------------ ---------- ------------
Revenues $3,856,320 $3,691,074 $7,781,436 $7,401,207
Revenue growth 4.5% 7.3% 5.1% 7.5%
Same store sales growth 7.1% 8.9% 7.7% 9.1%
Pharmacy sales growth 8.2% 9.8% 8.7% 10.2%
Same store pharmacy sales growth 10.8% 11.7% 11.3% 11.8%
Pharmacy as a % of total sales 63.1% 61.0% 63.3% 61.3%
Third party sales as a % of total pharmacy sales 92.6% 92.0% 92.6% 91.9%
Front-end sales (decline) growth (1.1)% 3.0% (0.4)% 3.2%
Same store front end sales growth 1.3% 4.8% 2.0% 5.0%
Front end sales as a % of total sales 36.9% 39.0% 36.7% 38.7%
Store data:
Total stores (beginning of period) 3,454 3,631 3,497 3,648
New stores --- --- 1 3
Closed stores (10) (37) (55) (57)
Store acquisitions, net --- --- 1 ---
Total stores (end of period) 3,444 3,594 3,444 3,594
Relocated stores 3 4 7 8
Revenues
The 4.5% and 5.1% growth in revenues for the thirteen and twenty-six
week periods ended August 31, 2002 were driven by pharmacy sales growth of 8.2%
and 8.7%, respectively, offset slightly by front end sales declines of 1.1% and
0.4%, respectively. The 7.3% and 7.5% growth in revenues for the thirteen and
twenty-six week periods ended September 1, 2001 were driven by pharmacy sales
growth of 9.8% and 10.2%, respectively, and front end sales growth of 3.0% and
3.2%, respectively. Same store sales growth for the thirteen and twenty-six week
periods ended August 31, 2002 was 7.1% and 7.7%, respectively.
For the thirteen and twenty-six week periods ended August 31, 2002,
pharmacy sales led revenue growth with same store sales increases of 10.8% and
11.3%, 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 August 31, 2002 and September 1,
2001, front end same stores sales increased 1.3% and 4.8%, respectively. For the
twenty-six week periods ended August 31, 2002 and September 1, 2001, front end
same store sales increased 2.0% and 5.0%, 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.
18
Costs and Expenses
Thirteen Week Period Ended Twenty-Six Week Period Ended
-------------------------- ----------------------------
August 31, September 1, August 31, September 1,
2002 2001 2002 2001
---------- ------------ ---------- ------------
Cost of goods sold $2,973,199 $2,856,756 $5,983,918 $5,692,211
Gross profit 883,121 834,318 1,797,518 1,708,996
Gross margin 22.9% 22.6% 23.1% 23.1%
Selling, general and administrative expenses 851,232 826,428 1,734,819 1,646,671
Selling, general and administrative expenses as a
percentage of revenues 22.1% 22.4% 22.3% 22.2%
Stock-based compensation (benefit) expense (6,746) (845) 1,348 42,247
Goodwill amortization --- 5,280 --- 10,623
Store closing and impairment charges 58,223 22,105 54,106 21,741
Interest expense 84,955 102,377 169,586 231,066
Interest rate swap contracts 14 31,047 278 31,047
Loss on debt and lease conversions and modifications --- 21,882 --- 154,595
Share of loss from equity investment --- 4,512 --- 10,395
Loss (gain) on sale of assets and investments, net 1,477 (1,636) (15,388) (51,455)
Cost of Goods Sold
Gross margin was 22.9% for the thirteen week period ended August 31,
2002 compared to 22.6% for the thirteen week period ended September 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 positively impacted by flat occupancy expense on a higher sales base
and by lower inventory liquidation costs related to closed stores. Offsetting
the positive pharmacy margin trends was a decline in front end margin
contribution caused by a lower mix of front end sales and lower vendor promotion
allowances and rebates.
Gross margin was 23.1% for the twenty-six week period ended August 31,
2002 compared to 23.1% for the twenty-six week period ended September 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 positively impacted by flat occupancy expense on a higher sales base
and by lower inventory liquidation costs related to closed stores. Offsetting
the positive pharmacy margin trends was a decline in front end margin
contribution caused by a lower mix of front end sales.
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 $34.5
million for the thirteen and twenty-six week period ended August 31, 2002,
versus $15.0 million and $30.0 million for the thirteen and twenty-six week
period ended September 1, 2001.
Selling, General and Administrative Expenses
The selling, general and administrative expenses ("SG&A") for the
thirteen week period ended August 31, 2002 includes $3.5 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 22.0% for the thirteen week period ended
August 31, 2002. SG&A expense for the thirteen week period ended September 1,
2001, includes $7.1 million to accrue for non-recurring litigation and $5.6
million incurred primarily in connection with our defense of shareholder
litigation and cooperating with various governmental investigations, offset by
receipts of $24.1 million for the settlement of litigation with certain drug
manufacturers. Excluding these items, SG&A as a percentage of revenues was 22.7%
for the thirteen week period ended September 1, 2001. SG&A on an adjusted basis
of 22.0% for the thirteen week period ended August 31, 2002 compares favorably
with SG&A on an adjusted basis of 22.7% for the thirteen week period ended
September 1, 2001 due to decreased depreciation and amortization charges
resulting from a reduced store count, reductions in professional fees, and
better leveraging of our fixed costs resulting from higher sales volume,
partially offset by higher associate benefit costs.
19
The selling, general and administrative expenses ("SG&A") for the
twenty-six week period ended August 31, 2002, includes charges of $20.3 million
to accrue for non-recurring litigation and $9.9 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 21.9% for the twenty-six week period ended August 31, 2002. SG&A
expense for the twenty-six week period ended September 1, 2001, includes $2.9
million to accrue for non-recurring litigation and $9.0 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
twenty-six week period ended September 1, 2001. SG&A on an adjusted basis of
21.9% for the twenty-six week period ended August 31, 2002 compares favorably
with SG&A on an adjusted basis of 22.6% for the twenty-six week period ended
September 1, 2001 due to decreased depreciation and amortization charges
resulting from a reduced store count, reductions in professional fees, 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 Period Twenty-Six Week Period
Ended Ended
------- -------
August 31, September 1, August 31, September 1,
2002 2001 2002 2001
------- ------- ------- -------
Impairment charges $ 5,548 $ 8,690 $ 6,408 $16,583
Store and equipment lease exit charges 52,675 13,415 47,698 4,847
Impairment of other assets -- -- -- 311
------- ------- ------- -------
$58,223 $22,105 $54,106 $21,741
======= ======= ======= =======
Impairment Charges. Impairment charges include non-cash charges of $5.5
million and $4.5 million for the thirteen week periods ended August 31, 2002 and
September 1, 2001, respectively, for the impairment of long-lived assets
(including allocable goodwill for the thirteen week period ended September 1,
2001) at 41 and 13 stores, respectively. Impairment charges include non-cash
charges of $6.4 million and $12.4 million for the twenty-six week periods ended
August 31, 2002 and September 1, 2001, respectively, for the impairment of
long-lived assets (including allocable goodwill for the twenty-six week period
ended September 1, 2001) at 54 and 30 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
thirteen and twenty-six weeks ended September 1, 2001 are approximately $4.2
million of costs related to software.
Store and Equipment Lease Exit Costs. During the thirteen week periods
ended August 31, 2002 and September 1, 2001, the Company recorded charges for
32 and 26 stores, respectively, to be closed or relocated under long-term
leases. During the twenty-six week periods ended August 31, 2002 and September
1, 2001, the Company recorded charges for 32 and 33 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 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 and liquidation of inventory, as well as
impairment of assets at these stores.
Interest Expense
Interest expense was $85.0 and $169.6 million for the thirteen and
twenty-six week periods ended August 31, 2002, compared to $102.4 million and
$231.1 million for the thirteen and twenty-six week periods ended September 1,
2001. The decrease 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 twenty-six week period
ended August 31, 2002 and September 1, 2001 were 7.4% and 8.1%, respectively.
20
Interest Rate Swap Contracts
We entered into interest rate swap contracts 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 is 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 $0.1and $0.3 million, inclusive of
cash payments, have been recorded on the income statement for the thirteen and
twenty-six week periods ended August 31, 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 August
31, 2002.
Income Taxes
The tax benefit of $42.9 million for the twenty-six week period ended
August 31, 2002 is comprised of two components. The first reflects an 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 $1.1 million.
The income tax benefits of the NOL's generated in the twenty-six week
periods ended August 31, 2002 and September 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 have undergone an ownership change for statutory purposes during
fiscal 2002, which resulted in a limitation on the future use of net operating
loss carryforwards. We believe that this limitation does not further impair the
net operating loss carryforwards because they are fully reserved.
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 and to
provide funds for capital expenditures.
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 August 31, 2002, we had $378.5 million in additional available
borrowing capacity under the revolving credit facility net of outstanding
letters of credit of $113.2 million. In addition, the term loan was fully drawn
except for $21.5 million, which is available and was used to pay for the
remaining outstanding 10.5% senior secured notes when they matured on September
15, 2002.
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 5.25% convertible subordinated
notes, the 6.0% dealer remarketable securities and the 4.75% convertible notes
and the 12.5% senior secured notes. As of August 31, 2002, we had outstanding
principal balances of $150.5 million, $58.1 million, $250.0 million and $149.5
million of the 5.25% convertible subordinated notes, 6.0% dealer remarketable
securities, 4.75% convertible notes and the senior secured notes, respectively.
As of August 31, 2002, our remaining permitted debt under the senior secured
credit facility is $284.9 million. The permitted debt amount increased to $435.4
million following the redemption of the 5.25% convertible subordinated notes on
September 16, 2002. 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 August 31, 2002 our remaining
permitted debt under the 11.25% senior notes due 2008, excluding real estate
financing, is $600.5 million.
21
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.
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
August 31, 2002. With continuing improvements in operating performance, we
anticipate that we will remain in compliance with our debt covenants. However,
variations in our operating performance and unanticipated developments may
adversely affect our ability to remain in compliance with the applicable debt
covenants.
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.
On September 16, 2002, we redeemed $150,500 of our 5.25% convertible
subordinated notes due 2002 using 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, we redeemed $20,879 of our 10.5% senior secured
notes due 2002 using proceeds 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.
Net Cash Provided by/Used in Operating, Investing and Financing Activities
We used $5.1 million and $48.3 million to fund continuing operations in
the twenty-six week periods ended August 31, 2002 and September 1, 2001,
respectively. Operating cash flow for the twenty-six week period ended August
31, 2002 was negatively impacted by $170.9 million of interest payments,
increases in accounts receivable, inventory and decreases in accounts payable.
Operating cash flow for the twenty-six week period ended September 1, 2001 was
negatively impacted by $250.1 million in interest payments and increases in
accounts receivable and inventory.
Cash used in investing activities was $28.0 million for the twenty-six
week period ended August 31, 2002, due primarily to expenditures for property,
plant and equipment as well as intangible assets, offset by proceeds from asset
dispositions.
Cash provided by investing activities was $364.7 million for the
twenty-six week period ended September 1, 2001, due primarily to the sale of the
securities we received in our sale of AdvancePCS. Cash used in financing
activities was $40.0 million and $299.5 million for the twenty-six week periods
ended August 31, 2002 and September 1, 2001, respectively. Proceeds from the
issuance of the new senior secured credit facility, issuance of common stock,
and the sale of our AdvancePCS securities were all used to pay down a
significant portion of our debt, which significantly impacted cash used in
financing activities in the twenty six week period ended September 1, 2001.
Working capital was $1,437.9 million at August 31, 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 $61.0 million related to new store
construction, store relocation and store remodel projects. An additional $69.0
million will be dedicated to the purchase of prescription files from independent
pharmacists, improvements to distribution centers, technology enhancements and
other corporate requirements. Management expects that these capital expenditures
will be financed primarily with cash flow from operations and borrowings under
the revolving credit facility available under our senior secured facility.
During the twenty-six week period ended August 31, 2002, we spent $53.6 million
on capital expenditures, consisting of $26.0 million related to new store
construction, store relocation and other store construction projects. An
additional $27.6 million was related to other store improvement activities and
the purchase of prescription files from independent pharmacists.
22
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 its other sources of liquidity will be adequate to meet our
anticipated annual requirements for working capital, debt service and capital
expenditures through the end of fiscal 2003. 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 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 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. 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 August 31,
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
twenty-six week periods ended September 1, 2001 is as follows (in millions
except per share amounts):
Thirteen week Twenty-Six week
period ended period ended
September 1, 2001 September 1, 2001
----------------- -----------------
Reported net loss $ (245.9) $ (457.0)
Add back goodwill amortization 5.3 10.6
--------- ---------
Adjusted net loss $ (240.6) $ (446.4)
========= =========
Basic and diluted loss per share:
Reported net loss $ (0.54) $ (1.10)
Goodwill amortization 0.01 0.02
--------- ---------
Adjusted net loss $ (0.53) $ (1.08)
========= =========
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 are effective for financial statements issued on or after May
15, 2002.
23
In June of 2002, the FASB issued Statement of Financial Accounting
Standards (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 not adopted SFAS
No.146, and has not determined whether it will elect to adopt SFAS No. 146
before the required date. The adoption of this Statement will impact the timing
of recognition of liabilities on stores closed or severance arrangements entered
into after the adoption date, but will have not impact on the current
liabilities recorded by the client for store 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.
Factors Affecting Our Future Prospects
For a discussion of risks related to our financial condition,
operations and industry, refer to "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, which we filed with the SEC on May 7, 2002.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Our future earnings, cash flow and fair values relevant to financial
instruments are dependent upon prevalent market rates. Market risk is the risk
of loss from adverse changes in market prices and interest rates. The major
market risk exposure is changing interest rates. Increases in interest rates
would increase our interest expense. Since the end of fiscal 2002, our primary
risk exposure has not changed. We enter into debt obligations to support capital
expenditures, acquisitions, working capital needs and general corporate
purposes. Our policy is to manage interest rates through the use of a
combination of variable-rate credit facilities, fixed-rate long-term obligations
and derivative transactions.
The table below provides information about the company's financial
instruments that are sensitive to changes in interest rates. The table presents
principal payments and the related weighted average interest rates by expected
maturity dates as of August 31, 2002.
Fair Value
at August
31,
2003 2004 2005 2006 2007 Thereafter Total 2002
--------- -------- --------- ----------- --------- --------- ----------- ----------
(dollars in millions)
Long-term debt,
Including
current portion
Fixed rate $175.4 $59.1 $2.5 $392.9 $739.3 $952.1 $2,321.3 $1,610.2
Average
Interest Rate 6.00% 6.06% 11.66% 6.82% 7.56% 7.71% 7.34%
Variable Rate $15.0 $37.5 $60.0 $1,253.5 $149.5 $1,515.5 $1,515.5
Average
Interest Rate 5.56% 5.56% 5.56% 5.56% 9.31% 5.93%
24
As of August 31, 2002, 39.5% of our total debt is exposed to
fluctuations in variable interest rates. During the thirteen week period ended
August 31, 2002, the two interest rate swap contracts that fixed an aggregate of
$1.0 billion of our LIBOR based variable rate debt terminated and were not
renewed. This increases our exposure to fluctuations in market interest rates.
Our ability to satisfy interest payment obligations on our outstanding
debt will depend largely on our future performance, which, in turn, is subject
to prevailing economic conditions and to financial, business and other factors
beyond our control. If we do not have sufficient cash flow to service our
interest payment obligations on our outstanding indebtedness and if we cannot
borrow or obtain equity financing to satisfy those obligations, our business and
results of operations will be materially adversely affected. We cannot assure
you that any such borrowing or equity financing could be successfully completed.
As of August 31, 2002, we had one credit facility: the $1.9 billion
syndicated senior secured credit facility. The ratings on this facility were BB-
by Standard & Poor's and B2 by Moody's. The interest rate on the variable rate
borrowings on this facility are LIBOR plus 3.75%.
ITEM 4. CONTROLS AND PROCEDURES
(a) Evaluation of disclosure controls and procedures. Our principal
executive officer and principal financial officer, after evaluating the
effectiveness of our disclosure controls and procedures (as defined in Exchange
Act Rules 13a-14(c) and 15d-14(c)) as of a date within ninety days before the
filing date of this report, have concluded that, as of such date our disclosure
controls and procedures were adequate and effective to ensure that material
information relating to Rite Aid would be made known to them by others within
the company.
(b) Changes in internal controls. There were no significant changes in
our internal controls or in other factors that could significantly affect Rite
Aid's disclosure controls and procedures subsequent to the date of their
evaluation, nor were there any significant deficiencies or material weaknesses
in Rite Aid's internal controls. As a result, no corrective actions were
required or undertaken.
25
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
The U.S. Federal Trade Commission commenced an investigation of us on
September 11, 2002 of matters relating to consumer privacy and advertising
practices. We have not been accused of any wrongdoing and we are fully
cooperating with the Federal Trade Commission. The investigation is in its
preliminary stages and we cannot predict its outcome at this time.
On September 19, 2002 counsel for the plaintiffs in the stockholder
litigation advised us 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 such settlement is approved by the U.S.
District Court, the pending appeal by such defendants will be dismissed,
whereupon our settlement of the consolidated securities class action lawsuits
will become final.
Item 2. Changes in Securities and Use of Proceeds
Not applicable.
Item 3. Defaults Upon Senior Securities
Not applicable.
Item 4. Submission of Matters to a Vote of Security Holders
On June 26, 2002, we held our 2002 Annual Meeting of Stockholders. At the 2002
Annual Meeting, our stockholders:
1. Elected two directors to hold office until the 2005 Annual Meeting of
Stockholders and until their respective successors are duly elected and
qualified, by the following votes:
Common and Series D Preferred stockholders:
Robert G. Miller For: 428,794,242 Against: 0 Withheld: 8,473,659
Alfred M. Gleason For: 428,517,277 Against: 0 Withheld: 8,750,625
Series D Preferred
stockholders:
For: 66,124,816 Against: 0 Withheld: 0
Following the 2002 Annual Meeting of Stockholders, the following persons
continued to serve as our Directors: William J. Bratton, Alfred M. Gleason,
George G. Golleher, Leonard I. Green, Mary F. Sammons, Robert G. Miller, Stuart
M. Sloan and Jonathan D. Sokoloff.
2. Defeated a stockholder proposal that requested our Board of Directors
to establish a policy that it will make its best efforts to appoint
only independent directors to serve on the Board's Audit, Compensation
and Nominating Committees:
Common stockholders:
For: 60,425,336 Against: 115,002,173 Abstain: 5,187,466
Series D Preferred
stockholders:
For: 0 Against: 66,124,816 Abstain: 0
26
Item 5. Other Information
Not applicable.
Item 6. Exhibits and Reports on Form 8-K
(a) The following exhibits are filed as part of this report.
Exhibit Incorporation
Numbers Description by Reference to
- ------- ----------- ---------------
3.1 Restated Certificate of Incorporation dated December 12, Exhibit 3 (i) to Form 8-K,
1996 filed on November 2, 1999
3.2 Certificate of Amendment to the Restated Certificate of Exhibit 3 (ii) to Form 8-K,
Incorporation dated October 25, 1999 filed on November 2, 1999
3.3 Certificate of Amendment to Restated Certificate of Exhibit 3.4 to Form S-1, File
Incorporation dated June 27, 2001 No. 333-64960, filed on July
12, 2001
3.4 8% Series D Cumulative Convertible Pay-in-Kind Preferred Exhibit 3.5 to Form 10-Q,
Stock Certificate of Designation, dated October 3, 2001 filed on October 12, 2001
3.5 By-laws, as amended on November 8, 2000 Exhibit 3.1 to Form 8-K, filed
on November 13, 2000
3.6 Amendment to By-laws, adopted January 30, 2002 Exhibit T3B2 to Form T-3,
filed on March 4, 2002
4.1 Indenture dated as of September 10, 1997 by and between Exhibit 4.1 to Registration
Rite Aid Corporation, as issuer, and Harris Trust and Statement on Form S-3, File No.
Savings Bank, as trustee, related to the Company's 5.25% 333-39699, filed on November 6,
Convertible Subordinated Notes 1997
4.2 Indenture dated as of September 22, 1998 by and between Exhibit 4.1 to Registration
Rite Aid Corporation, as issuer, and Harris Trust and Statement on Form S-4, File No.
Savings Bank, as trustee, related to the Company's 6% 333-66901, filed on November 6,
Dealer Remarketable Securities 1998
4.3 Indenture dated as of December 21, 1998, between Rite Exhibit 4.1 to Registration
Aid Corporation, as issuer, and Harris Trust and Savings Statement on Form S-4, File No.
Bank, as trustee, related to the Company's 51/2% Notes 333-74751, filed on March 19,
due 2000, 6% Notes due 2005, 6 1/8% Notes due 2008 and 6 1999
7/8 Notes due 2028
4.4 Supplemental Indenture dated as of February 3, 2000, Exhibit 4.1 to Form 8-K, filed
between Rite Aid Corporation, as issuer, and U.S. Bank on February 7, 2002
Trust National Association, to the Indenture dated as of
August, 1993 and Morgan Guaranty Trust Company of New
York, relating to the Company's 6.70% Notes due 2001,
7.125% Notes due 2007, 7.70% Notes due 2027, 7.625%
Notes due 2005 and 6.875% Notes due 2013
4.5 Supplemental Indenture, dated as of February 3, 2000, Exhibit 4.2 to Form 8-K, filed
between Rite Aid Corporation and Harris Trust and on February 7, 2000
Savings Bank, to the Indenture dated September 10, 1997,
between Rite Aid Corporation and Harris Trust and
Savings Bank, related to the Company's 5.25% Convertible
Subordinated Notes
4.6 Supplemental Indenture, dated as of February 3, 2000, Exhibit 4.3 to Form 8-K, filed
between Rite Aid Corporation and Harris Trust and on February 7, 2000
Savings Bank, to the Indenture dated September 22, 1998,
between Rite Aid Corporation and Harris Trust and
Savings Bank, related to the Company's 6% Dealer
Remarketable Securities
27
4.7 Supplemental Indenture, dated as of February 3, 2000, Exhibit 4.4 to Form 8-K, filed
between Rite Aid Corporation and Harris Trust and on February 7, 2000
Savings Bank, to the Indenture dated December 21, 1998,
between Rite Aid Corporation and Harris Trust and
Savings Bank, related to the Company's 10.5% Senior
Secured Notes due 2002
4.8 Indenture, dated as of June 14, 2000, among Rite Aid Exhibit 4.1 to Form 8-K, filed
Corporation, as issuer, each of the Subsidiary on June 21, 2000
Guarantors named therein and State Street Bank and Trust
Company, as Trustee, related to the Company's 10.5%
Senior Secured Notes due 2002
4.9 Indenture, dated as of June 27, 2001, between Rite Aid Exhibit 4.7 to Registration
Corporation, as issuer, and State Street Bank and Trust Statement on Form S-1, File No.
Company, as trustee, related to the Company's 12.5% 333-64950, filed on July 12,
Senior Secured Notes due 2006 2001
4.10 Indenture, dated as of June 27, 2001, between Rite Aid Exhibit 4.8 to Registration
Corporation, as issuer, and BNY Midwest Trust Company, Statement on Form S-1, File No.
as trustee, related to the Company's 113/4Notes due 333-64950, filed on July 12,
December 2008 2001
4.11 Indenture, dated as of November 19, 2001, between Rite Exhibit 4.3 to Form 10-Q, filed
Aid Corporation, as issuer, and BNY Midwest Trust on January 15, 2002
Company, as trustee, related to the Company's 4.75%
Convertible Notes due December 1, 2006
4.12 Indenture, dated as of April 4, 2002, between Rite Aid Exhibit T3C to Form T-3, filed
Corporation, as issuer, and BNY Midwest Trust Company, on March 4, 2000
as trustee, related to the Company's Senior Secured
Notes due March 15, 2006
10.1 Amended and Restated Employment Agreement, dated as of Filed herewith
June 27, 2002, between Rite Aid Corporation and David R.
Jessick
11 Statement regarding computation of earnings per share
(See note 3 to the condensed consolidated financial
statements)
99.1 Certification of CEO and CFO Pursuant to 18 United Filed herewith
States Code, Section 1350, as enacted by Section 906 of
the Sarbanes-Oxley Act of 2002
Rite Aid Corporation filed a Current Report on Form 8-K on June 24, 2002
disclosing under Item 5 a press release dated June 21, 2002 announcing that the
Securities and Exchange Commission has issued a cease-and-desist order that
completes an investigation of the Company relating to certain financial
reporting and accounting practices under prior management. The cease-and-desist
order, in which Rite Aid neither admits or denies the findings, was issued
pursuant to Rite Aid's offer of Settlement.
28
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: October 15, 2002
RITE AID CORPORATION
By: /s/ ROBERT B. SARI
----------------------------
Robert B. Sari
Senior Vice President and
General Counsel
Date: October 15, 2002
By: /s/ CHRISTOPHER HALL
----------------------------
Christopher Hall
Executive Vice President and
Chief Financial Officer
29
CERTIFICATIONS
I, Robert G. Miller, Chairman and Chief Executive Officer, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Rite Aid
Corporation;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:
a. designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
b. evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date
of this quarterly report (the "Evaluation Date"); and
c. presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of the registrant's board of directors:
a. all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b. any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
Date: October 15, 2002
By: /s/ ROBERT G. MILLER
----------------------------
Robert G. Miller
Chairman and
Chief Executive Officer
30
CERTIFICATIONS
I, Christopher Hall, Executive Vice President and Chief Financial Officer,
certify that:
1. I have reviewed this quarterly report on Form 10-Q of Rite Aid
Corporation;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:
a. designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
b. evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date
of this quarterly report (the "Evaluation Date"); and
c. presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of the registrant's board of directors:
a. all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b. any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
Date: October 15, 2002
By: /s/ CHRISTOPHER HALL
----------------------------
Christopher Hall
Executive Vice President and
Chief Financial Officer
31